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PENN SQUARE BANK FAILURE

HEARINGS
BEFORE THE

COMMITTEE ON
BANKING, FINANCE AND UEBAN AFFAIES
HOUSE OF EEPEESENTATIVES
NINETY-SEVENTH CONGRESS
SECOND SESSION

PART 2
SEPTEMBER 29 AND 30, 1982

Serial No. 97-93
Printed for the use of the
Committee on Banking, Finance and Urban Affairs

U.S. GOVERNMENT PRINTING OFFICE
12-745 0




WASHINGTON : 1983

HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
FERNAND J. ST
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




^ , Rhode Island, Chairman
J
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

CONTENTS
(Witnesses listed in order of appearance)
Hearings held on:
September 29, 1982...

Page
1

September 30, 1982

267
SEPTEMBER 29,

1982

WITNESSES

John R. Boyd, former senior vice president and manager, energy division,
Seattle-First National Bank
H. Perry Driggs, Jr., president, Michigan National Bank
Richard G. Jaehning, president, Seattle-First National Bank; accompanied by
Arland D. Hatfield, senior vice president and manager, energy division
John R. Lytle, former vice president, Continental Bank's Mid-Continent Oil &
Gas Division
John H. Perkins, president, Continental Illinois National Bank; accompanied
by George R. Baker, executive vice president, general banking services;
Edward M. Cummings, executive vice president; James C. Cordell, vice
president, Texas division, oil and gas group worldwide; Richard S. Brennan,
executive vice president and general counsel; and Robert E. L. Walker,
associate general counsel....

138
110
125
3

62

ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN THE RECORD

Driggs, H. Perry, Jr., response to request of Chairman St Germain regarding
investors of Michigan National Bank in Longhorn Limited partnerships
Lytle, John R.:
Financial statement
Prepared statement..
Perkins, John H., response to request of Chairman St Germain relating to the
signature and amount on loan document of First Penn Corp., dated February 24, 1982
St Germain, Chairman Fernand J.:
Copy of FBI affidavit for a search warrant of a residence in Clearwater,
Fla., dated September 9, 1982
"How an Oil Firm Grew With Aid of Big Banks Despite Its Cash Bind",
article from The Wall Street Journal, September 21, 1982
Letters submitted from:
John R. Lytle to William Patterson, dated January 28, 1981, describing certain participations involving Penn Square, Continental and
Michigan National
Frank L. Murphy, vice president, First Penn Corp., Penn Square
Bank, dated February 24, 1982, to Continental Illinois, 231 South
LaSalle St., Chicago, to verify for Peat, Marwick, Mitchell & Co.,
an audit request in the amount of $10 million

123
29
8
69
20
86

51

65

APPENDIXES

A.—1981 Annual Report and Form 10-K Continental Illinois Corp., Continental Illinois National Bank and Trust Co., of Chicago
B.—"Assignment of Overriding Royalty Interests"




(in)

157
219

IV
SEPTEMBER 30,

1982

WITNESSES

William J. Sayers, general manager, IBM Poughkeepsie Employees Federal Page
Credit Union, Poughkeepsie, N.Y
273
Philip Loiacona, treasurer and manager, Boiling Air Force Base Federal
Credit Union, Washington, D.C
372
John Arnold, manager, Southwest Corporate Federal Credit Union, Dallas,
Tex
372
John Mangan, executive vice president, Killeen Savings & Loan Association,
Killeen, Tex
373
Mario Renda, president and executive director, First United Fund, Ltd.,
Garden City, Long Island, N.Y
404
William Goldsmith, executive vice president, Professional Asset Management,
Del Mar, Calif
404
ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN THE RECORD

Arnold, John:
Additional information submitted at the request of—
Congressman Frank Annunzio
Congressman Bruce F. Vento
Table showing the investments in Penn Square by the Southwest Corporate Federal Credit Union
Audited statements of Penn Square Bank, N.A., prepared by Peat, Marwick,
Mitchell & Co., and obtained by the committee from Peat, Marwick, Mitchell & Co. subsequent to the hearing
Loiacona, Philip, supplemental statement furnished as a result of a colloquy
with Congressman Annunzio
St Germain, Hon. Fernand J.:
Capital Adequacy Report of the Professional Asset Management, dated
March 10, 1982
"Deposits of Financial Institutions in Penn Square Bank," chart referred
to by Congressman Barnard in colloquy
Letter, dated September 29, 1982, from Chairman E. F. Callahan of the
National Credit Union Administration responding to Chairman St Germain's request for further information concerning credit union losses
in the Penn Square failure
Map showing location of federally insured credit unions with uninsured
deposits in Penn Square
Material described by Mr. Goldsmith's attorney as "the questionnaire
form completed by Penn Squre Bank and submitted to Professional
Asset Management," requested by Chairman St Germain
Sayres, William J.:
Dunn & Bradstreet report
"Growing With Energy," Penn Square Bank annual report of 1981 and
financial statements
Prepared statement on behalf of the IBM Poughkeepsie Employees Federal Credit Union, with referred-to addenda and other pertinent
material




384
387
373
428
382
412
271

269
270
419
298
275
301

FAILURE OF PENN SQUARE BANK
WEDNESDAY, SEPTEMBER 29, 1982
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,

Washington, B.C.
The committee met, pursuant to call, at 9:30 a.m., in room 2128,
Rayburn House Office Building, Hon. Fernand J. St Germain
(chairman) presiding.
Present: Representatives St Germain, Minish, Annunzio,
LaFalce, Oakar, Vento, Barnard, Lowry, Schumer, Patman, William J. Coyne, Wylie, McKinney, Leach, Paul, Weber, McCollum,
Carman, Wortley, Roukema, Lowery, and James K. Coyne.
The CHAIRMAN. The committee will come to order.
This morning we will resume hearings into the failure of the
Penn Square Bank of Oklahoma City.
The shock waves from what was once a relatively obscure shopping center bank have rolled across financial institutions in at
least 35 States and have stirred new doubts about the effectiveness
of the Federal financial supervisory system.
Today's testimony will center on Penn Square's amazing ability
to churn out and market energy loans to other commercial banks
from coast to coast—loans that once held the glitter of fast-buck
profits from the oil and gas fields of the Southwest.
With energy loans flowing out of Penn Square faster than Oklahoma was pumping oil, one can only speculate why no one in the
Comptroller's Office had the curiosity to start tracing the streams
across the financial community.
In fact, that parking lot at the little Penn Square shopping
center became a veritable traffic jam of money brokers and bankers grabbing onto the financial merry-go-round, trying to get the
brass ring, while the OCC continued to search its manual for the
chapter on "go-go" banking.
The questions about why so many knew so little intensified after
this committee discovered during the August 16 hearings in Oklahoma that Penn Square had secretly made millions of dollars of interest and principal payments to upstream banks on nonperforming loans—a fact that examiners should have uncovered quickly
and sounded the alarm to the banks holding the delinquent paper,
or at a minimum, raised yellow caution flags for their fellow regulators in the various regions.
I have expressed my disappointment in the Comptroller's Office,
but it is all too easy to lay the total blame on the doorstep of the
regulators. Banking judgments are made by bankers, not by the
Comptroller.




(1)

2

For an industry that has made eloquent and frequent pleas for
less regulation and less government interference, it is not particularly convincing to hear the argument that "Uncle Sam should
have protected us."
Throughout this 2y2-month investigation, we have constantly returned to the question of how sophisticated banking institutions,
equipped with big staffs and big budgets, could slip so deeply into
the Penn Square morass. What super sales pitch rolled off the
tongues of the Bill Jennings and the Bill Pattersons?
I know that recounting mistakes and listening to Monday morning quarterbacking of banking judgments is not a happy task for
any banker. We know that most, if not all, our witnesses today
wish they had never heard of Penn Square. We have received excellent cooperation from the banks appearing here today and the
committee is appreciative of this fact.
Two of the witnesses, John R. Lytle and John Boyd, have lost
their positions at their respective banks—Continental Illinois and
Seattle First National—in the wake of the Penn Square failure.
Clearly Penn Square is exacting a heavy toll on these two gentlemen. Despite this, both have been forthright and very cooperative
as the committee has prepared for this hearing. We appreciate
their willingness to help the committee unravel the story.
This testimony is essential to the legislative and oversight responsibilities assigned this committee by the House of Representatives. To understand what happened at Penn Square, it is very important that we have full knowledge of how these correspondent relationships began, how they grew, and how all the relationships developed between the various banking institutions and when and
how much the regulators knew and what they did with the knowledge.
At this time the Chair would note that in compliance with House
and committee rules, copies of these rules are available to the witnesses at the witness table.
In addition, each witness has been furnished in advance with a
copy of the rules by mail.
Since some of the witnesses today will be accompanied by counsel, I should clarify now what the role of counsel will be.
Under the House and committee rules, witnesses at investigatory
hearings may be accompanied by counsel to advise them of their
rights. 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 the committee should be addressed to the Chair by the witness, not by
counsel. The Chair will do all within its 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
along with the Chair, a quorum for the taking of testimony.
Our first witness this morning will be Mr. John R. Lytle. Mr.
Lytle, would you be good enough to approach the witness table
with your counsel?
[Witness sworn.]
The CHAIRMAN. I understand you have a prepared statement,
Mr. Lytle.
Mr. LYTLE. Yes, I do. Thank you.




3
The CHAIRMAN. We would be happy to hear from you at this
time.
TESTIMONY OF JOHN R. LYTLE, FORMER VICE PRESIDENT,
CONTINENTAL BANK'S MID-CONTINENT OIL & GAS DIVISION
Mr. LYTLE. Mr. Chairman, members of the committee, my name
is John Lytle. Until July of this year, I was manager of the Continental Bank's Mid-Continent Oil & Gas Division.
My division was responsible for the oil and gas participation
loans with the Penn Square Bank. At the time the Comptroller of
the Currency closed the Penn Square Bank on July 5, 1982, the
Mid-Continent Division had approximately $2.2 billion of oil and
gas loans. $1,056 billion were with the Penn Square Bank.
I graduated from the University of Illinois in 1957, with a bachelor of science degree in economics and finance. After serving 2
years as an officer in the U.S. Navy, 1957-59, I joined Continental
Illinois National Bank in 1959, 23 years ago.
In 1977, I was made section manager, oil and gas division, with
account responsibility for independent oil companies.
In August 1980, the oil and gas group was restructured. I was
named manager of the newly formed Mid-Continent Division which
had responsibility for independent oil companies in the geographic
area east of Denver, except for Texas. The Oklahoma section was
part of the Mid-Continent Division.
I have been published, on occasion, on articles relating to independent gas.
Continental Bank first started doing business with Penn Square
Bank in 1978. I was introduced to Bill Patterson of Penn Square by
Dennis Winget, head of the Continental's Oklahoma section.
A majority of the loans with Penn Square were overline participations. These were loans where Penn Square would make the loan
and then sell a portion to the participating bank.
For example, if the total loan or credit were for $10 million,
Penn Square would take $1 million and the participating bank $9
million.
Even in the case of smaller loans, Penn Square often would sell
90 percent or more to the participating bank rather than take its
legal limit share.
Significantly, in the case of participation loans, the loan documentation was initiated and held by Penn Square Bank.
The dollar amount of Continental participations and other loans
with Penn Square customers increased each year in 1979 and 1980,
increased dramatically in 1981 and continued to grow in the first
quarter of 1982.
The following are approximate numbers:
As of December 31, 1980, Continental's loans with Penn Square
customers were $250 million; as of September 31, 1981, $550 million; as of December 31, 1981, $800 million; and as of June 30, 1982,
$1,056 billion.
This growth, in part, reflected the boom in the Oklahoma oil and
gas economy and drilling activity which continued to expand at a
rapid rate until approximately May of this year. The growth also




4

reflected the Continental Bank's aggressive pursuit of this business.
What is significant is that three-quarters of a billion dollars of
new loans were booked subsequent to the Comptroller of the Currency's findings in April 1980, of banking violations by Penn
Square Bank.
We at the Continental Bank were not privy to these findings.
Nor were we told that Penn Square Bank was on the Comptroller's
"watch list" of problem banks or that it was operating under an
August 1980 letter agreement with the Comptroller's Office.
Almost $500 million of Penn Square loans were added after July
1981, when, as we now know, the Comptroller's Office warned the
Penn Square board of directors that the bank was flirting with disaster and considered issuing a cease and desist order.
Again, we at Continental were not informed of the Comptroller's
assessment and the contemplated action regarding Penn Square.
Had we been timely informed of the Comptroller's adverse findings, we would not have increased our loan participations with
Penn Square and would have taken protective steps in regard to
existing loans.
Parenthetically, we were not told that Mr. Eldon Beller was just
a figurehead president with no loan authority for oil and gas loans,
or 80 percent of Penn Square's total loan portfolio, as I understand,
he testified in substance before this committee.
Bill Patterson told me on a number of occasions that loan approvals were held up because they were on Mr. Beller's desk awaiting approval.
As a result of the explosive growth in oil and gas loans in 1981,
documentation and reporting problems developed. These, which I
will call operating problems, were perceived as early as the fall of
1981 by Continental and corrective action was instigated.
For example, review of Continental's loan files disclosed certain
of the loan documents were missing. These were participation loans
where the loan documentation had been initiated by Penn Square
and they had failed to supply Continental with copies of all the
loan documents.
A list of missing documents was prepared and sent to Penn
Square and they began furnishing copies from their loan files.
The CHAIRMAN. Are you saying the documents had never been
provided prior to this event where you found out some were missing or they had been provided and disappeared?
Mr. LYTLE. I can't say with any certainty that there was never a
case where documents were provided and disappeared. I might
point out that these are not loan documents per se; they are photostatic copies of the documentation which was kept on record in
Penn Square Bank. I can say with certainty that the vast majority
of the exceptions we discovered at that time were documents that
had not yet been provided to Continental Bank.
There was also a problem reconciling the principal and interest
balances reported by Penn Square and Continental. As a consequence, certain loans were shown as past due when in fact principal and interest were current.
A Continental team was sent to Penn Square to reconcile the
numbers. This was an ongoing project and not completed until




5
April 1982. The result of the investigation was to confirm that the
past due problem was primarily a reporting and documentary problem and not a credit problem because the borrowers could not pay
on time.
We were never told Penn Square had advanced interest payments on behalf of certain of its borrowers until late in the days of
Penn Square's existence.
It was not until June 1982 that we had any reason to believe the
Penn Square Bank was in trouble financially.
Before recounting the June events, I would like to refer to some
statistics which reflect the dramatic and sudden turn down in the
Oklahoma oil and gas economy.
Probably the best indicator of oil and gas activity is the Hughes
count of active drilling rigs. As can be seen from the chart I have
provided; the rig count in Oklahoma continued to increase during
all of 1981 and in the first quarter of 1982.
As late as May 1982, the rig count in Oklahoma stood at 800
active drilling rigs, the highest in history, up 150 rigs, or 23 percent, from May 1981.
At the same time, drilling activity in Texas and nationally was
down 18 and 13 percent respectively.
However, by June 1982—and the date I used was the day after
Penn Square was closed, July 6—the Oklahoma rig count is down
by 155 rigs from May and 45 rigs, 7 percent, from the preceding
year.
By September of this year, the Oklahoma rig count was 479,
down 321 rigs from May and 276 rigs, or 36 percent from the preceding year.
Thus the Oklahoma turn down had caught up with the statistics
that were prevalent throughout the country by September.
The rapid deterioration in gas prices was equally dramatic. As
late as May 1982, purchasers of gas in the Oklahoma deep, unregulated Anadarko Deep Basin were still aggressively seeking contracts.
El Paso Gas, a large buyer of natural gas supplying California,
dropped its offering price in May from 110 percent of oil to 100 percent of oil, or to approximately $6.60 per thousand cubic feet, but
was still looking for customers.
At about the same time, Michigan-Wisconsin Pipeline reduced its
price to $6 per thousand cubic feet. The relatively low acceptance
rate of the $6 price indicated continuing optimism by sellers of gas.
However, by July and August 1982, no one was offering contracts
for deep gas in the Anadarko basin at any price.
Currently, Arkla Pipeline is offering $3.50 per thousand cubic
feet for deep gas on a 1- to 3-year contract.
As can be seen from the rapid decline in drilling activity and collapse in gas prices, the bottom fell out of the Oklahoma oil and gas
economy in June of this year.
It was the week of June 14, 1982, that Bill Patterson told me that
the Federal examiners were going to require Penn Square Bank to
charge off approximately $10 million to loss loans.
The CHAIRMAN. Excuse me. Was that when he visited you in Chicago?
Mr. LYTLE. I don't recollect.




6
The CHAIRMAN. Did he tell you this in person or telephone?
Mr. LYTLE. I don't recollect.
The CHAIRMAN. Was he alone when he told you this or was he
accompanied by anyone?
Mr. LYTLE. I was about to say I guess he told me by telephone
since about 80 percent of our communication was by telephone, but
I cannot specifically recollect the date except the general week and
the means by which he conveyed the $10 million figure to me.
I immediately asked him if any losses were Continental participations; he said none. He further added he had arranged investors
that would cover the $10 million writeoff by additional purchases
of Penn Square stock.
By the week of June 21, the estimated loan loss amount had
grown to $20 million. By the weekend of June 26 and 27, Patterson
reported the Comptroller's Office was insisting that Penn Square
raise $30 million of new equity by June 30, or they were going to
shut the bank down.
On June 29, the Comptroller's Office notified Continental's
chairman, Mr. Roger Anderson, of the Penn Square crisis and the
fact that an examiner from his office would meet the next day to
review Penn Square problem loans in which the Continental Bank
had participations.
On June 30 and July 1, we met with the examiners reviewing a
list of problem loans compiled by them. It was in connection with
this review that we learned for the first time of apparent missing
collateral and collateral substitutions.
For example, according to our records and earlier representations by Patterson, a certain loan was secured by the unlimited
guarantee of a wealthy individual affiliated with the drilling venture.
When the examiner suggested that the loan be charged off as a
loss loan, I pointed out it was secured or supported by the unlimited guarantee of the individual.
The examiner said, "No, all you have is smaller—than the
amount of the loan—limited guarantees."
Similarly, we were told by the examiner that another loan, instead of being secured by oil leases as shown on our copy of the
note, was collateralized by a Florida marina.
This also came from the bank examiner on the 30th or 1st of
July.
At some point during this review of loans, I called Patterson who
had been suspended and was at home. Patterson's office files had
been locked by either the Comptroller's Office or perhaps the
FDIC. I told Patterson to go to his office, or have someone go to the
office and have the examiners unseal his files and get the unlimited guarantee.
Patterson replied, "I'm sorry, John, I never got it."
On July 5, 1982, the Federal banking authorities pronounced
Penn Square Bank insolvent and closed the bank. That same day, I
was placed on special assignment.
On August 30, 1982,1 was terminated.
In a press release, I charged that I was being made a scapegoat
and I still feel that way. I wasn't responsible for the Penn Square
collapse. And I wasn't responsible for Continental Bank's being in




7
the oil and gas business, and for their stated strategy of growing
with the oil and gas business.
In a 1981 article entitled "In the Highflying Field of Energy Finance, Continental Illinois Bank Is Striking It Rich,,, the Wall
Street Journal reported, and I quote in part:
Twenty-five years ago it wasn't easy for an independent oil man with a big dream
to get the funding he needed. Most banks considered making loans like that too
speculative.
But Continental Illinois National Bank & Trust Co., was willing to finance some
of the projects that others refused.
Now, in an industry where memories are long, the bank is being rewarded for its
years of attention. It has become a leader in the highflying field of energy finance.
And it's still building business by making deals other banks won't.

The article continues:
Continental's strategy could turn out to have an Achilles heel. If the price of oil
continues to drop, energy companies will find it harder to repay bank loans.
If the price of oil [continues to] go up, everybody will be heroes again. If not, some
banks may be hurt.
But Continental says energy financing is dangerous only for newcomers. Bank officials are also confident that the current drop in oil prices will be brief. "This is
just a little blip," says John A. Redding, [my boss] senior vice president in charge of
the bank's oil and gas group. He believes that Saudi Arabia's ability to manipulate
oil prices will prevail over the softening effects of a decline in demand. "When the
Saudis get the price where they want it," he says, "they will adjust supply to equal
demand."

The article concludes:
While it has many admirers, Continental's aggressive lending style has also been
criticized as unnecessarily risky. In response, Continental officials cite the bank's
record. Cushioned in part by rising oil prices, chargeoffs and net loan losses in the
energy area have averaged less than half of those in regular lending over the past
five years, says Gerald Bergman [Redding's boss], executive vice president in charge
of lending to special industries.

What happened to John Lytle is not important to this committee
in its investigation. What is important is that corrective legislation
be enacted which will prevent a recurrence of a Penn Square debacle to the extent possible.
Had the Comptroller's Office notified the participating banks of
its knowledge of Penn Square's deteriorating financial and operating conditions, we would have taken steps to minimize or altogether avoid loan losses.
The CHAIRMAN. Thank you, Mr. Lytle.
[Mr. Lytle's prepared statement follows:]




8
STATEMENT OF JOHN R. LYTLE
Mr. Chairman and Members of the Committee:
My name is John Lytle.

Until July of this year, I

was manager of the Continental Bank's Mid Continent Oil &
Gas Division.

My division was responsible for the oil & gas

participation loans with the Penn Square Bank.

At the time

the Comptroller of the Currency closed the Penn Square Bank
on July 5, 1982, the Mid Continent Division had
approximately $2.2 billion of oil & gas loans.

$1,056

billion were with the Penn Square Bank.
I graduated from the University of Illinois in
1957, with a Bachelor of Science degree in economics and
finance.

After serving two years as an officer in the

United States Navy (1957-59), I joined Continental Illinois
National Bank in 1959.
In 1977, I was made Section Manager, Oil & Gas
Division, with account responsibility for independent oil
companies.

In August, 1980, the Oil & Gas Group was

restructured.

I was named manager of the newly-formed Mid

Continent Division which had responsibilty for independent
oil companies in the geographic area east of Denver, except
for Texas.

The Oklahoma section was part of the Mid

Continent Division.




9
Continental Bank first started doing business with
Penn Square Bank in 1978.

I was introduced to Bill

Patterson of Penn Square by Dennis Winget, head of the
Continental's Oklahoma section,
A majority of the loans with Penn Square were
overline participations.

These were loans where Penn Square

would make the loan and then sell a portion to the
participating bank.

For example, if the total loan or

credit were for $10 million, Penn Square would take $1
million and the participating bank $9 million.

However,

even in the case of smaller loans, Penn Square often would
sell 90% or more to the participating bank, rather than take
its legal limit share.

Significantly, in the case of

participation loans, the loan documentation was initiated by
Penn Square Bank.
The dollar amount of Continental participation and
other loans with Penn Square customers increased each year
in 1979 and 1980, increased dramatically in 1981 and
continued to grow in the first quarter of 1982.
approximate numbers.

These are

As of 12/31/80, Continental's loans

with Penn Square customers were $250 million; as of 9/31/81,
$550 million; as of 12/31/81, $800 million; and as of
6/30/82, $1,056 billion.

This growth, in part, reflected

the boom in the Oklahoma oil and gas economy and drilling
activity which continued to expand at a rapid rate until




-

2

-

10
approximately May of this year.

The growth also reflected

the Continental Bank's aggressive pursuit of this business.
What is significant is that three-quarters of a
billion dollars of new loans were booked subsequent to the
Comptroller of the Currency's findings in April, 1980, of
banking violations by Penn Square Bank.

We at the

Continental Bank were not privy to these findings.

Nor were

we told that Penn Square Bank was on the Comptroller's
"watch list" of problem banks or that it was operating under
an August, 1980 letter agreement with the Comptroller's
office.
Almost $500 million of Penn Square loans were
added after July, 1981, when, as we now know, the
Comptroller's office warned the Penn Square Board of
Directors that the bank was "flirting with disaster" and
considered issuing a cease and desist order.

Again, we at

Continental were not informed of the Comptroller's
assessment and contemplated action regarding Penn Square.
Had we been timely informed of the Comptroller's
adverse findings, we would not have increased our loan
participations with Penn Square and would have taken
protective steps in regard to existing loans.
Parenthetically, we were not told that Mr. Eldon
Beller was just a figurehead President with no loan
authority for oil & gas loans, or 80% of Penn Square's total




- 3 -

11
loan portfolio, as I understand he testified in substance
before this Committee.

Bill Patterson told me on a number

of occasions that loan approvals were held up because they
were on Beller's desk awaiting approval.
As a result of the explosive growth in oil & gas
loans in 1981, documentation and reporting problems
developed.

These - what I will call operating problems -

were perceived as early as the fall of 1981 and corrective
action was instigated.

For example, review of Continental's

loan files disclosed certain of the loan documents were
missing.

These were participation loans where the loan

documentation had been initiated by Penn Square and they had
failed to supply Continental with copies of all the loan
documents.

A list of missing documents was prepared and

sent to Penn Square and they began furnishing copies from
their loan files.

There was also a problem reconciling the

principal and interest balances reported by Penn Square and
Continental.

As a consequence, certain loans were shown as

"past due" when in fact principal and interest were
current.

A Continental team was sent to Penn Square to

reconcile the numbers.

This was an ongoing project and not

completed until April of 1982.

The result of the

investigation was to confirm that the "past due" problem was
primarily a reporting problem and not a credit problem




- 4 -

12
because the borrowers could not pay on time.

We were never

told Penn Square had advanced interest payments on behalf of
certain of its borrowers.
It was not until June of 1982, that we had any
reason to believe the Penn Square Bank was in trouble
financially.
Before recounting the June events, I would like to
refer to some statistics which reflect the dramatic and
sudden turn down in the Oklahoma Oil & Gas economy.
[

RIG COUNT
May 3, 1982

Oklahoma
Texas
US

800
1,030
3,312
July 6, 1982

Oklahoma
Texas
US

645
817
2,816
Sept 7, 1982

Oklahoma
Texas
Total US

479
785
2,526

May 4, 1981

Chg. fr.
yr prev

0/0

650
1,264
3,801

+150
-234
-500

+23
-18
-13

-45
-533
-1,168

-7
-39
-29

-276
-630
-1,658

-36
-44
-39 ]

July 6, 1981
690
1 ,350
3,984
Sept 8, 1981
755
1,415
4,184

Probably the best indicator of oil and gas
activity is the count of active drilling rigs.

As can be

seen from the chart, the rig count in Oklahoma continued to
increase during all of 1981 and the first quarter of 1982.
As late as May, 1982, the rig count in Oklahoma stood at 800
active drilling rigs, up 150 rigs or 23% from May, 1981.

At

the same time, drilling activity in Texas and nationally was
down 18% and -13% respectively.




- 5 -

13
In July, 1982, the Oklahoma rig count is down by
155 rigs from May and 45 rigs and 7% from the preceding
year.
By September of this year, the Oklahoma rig count
was 479, down 321 rigs from May and 276 rigs or 36% from the
preceding year.
The rapid deterioration in gas prices was equally
dramatic.

As late as May, 1982, purchasers of gas in the

Oklahoma deep, unregulated Anadarko Basin were still
aggressively seeking contracts.

El Paso Gas, a large buyer

of natural gas supplying California, dropped its offering
price in May from 110% of oil to 100% of oil, or to
approximately $6.60 per thousand cubic feet (MCF), but
continued to actively buy.

At about the same time,

Michigan-Wisconsin Pipeline reduced its price to $6.00 MCF.
The relatively low acceptance rate of the $6.00 price
indicated continuing optimism by sellers of gas.

However,

by July and August of 1982, no one was offering contracts
for deep gas in the Anadarko Basin at any price!

Currently,

Arkla Pipeline is offering $3.50 MCF for deep gas on*a one
to three year contract.
As can be seen from the rapid decline in drilling
activity and collapse in gas prices, the bottom fell out of
the Oklahoma oil and gas economy in June of this year.
- 6 -

12-745 0—83

2




14
It was the week of June 14, 1982, that Bill
Patterson told me that the Federal examiners were going to
require Penn Square Bank to charge off approximately $10
million of "loss loans."

He said Penn Square had investors

who would cover the $10 million write-off by purchase of
Penn Square Bank stock.

I asked if any of the losses were

Continental participations.

He said none were.

By the week of June 21, the loan loss amount had
grown to $20 million.

And by the weekend of June 26-27,

Patterson reported the Comptroller's office was insisting
that Penn Square raise $30 million of new equity by June 30,
or they were going to shut the bank down.
On June 29, the Comptroller's office notified
Continental's Chairman, Mr. Roger Anderson, of the Penn
Square crisis and the fact that an examiner, from his office
would meet the next day to review Penn Square problem loans
in which the Continental Bank had participations.
On June 30 and June 31, we met with the examiners
reviewing a list of problem loans compiled by them.

It was

in connection with this review that we learned for the first
time of apparent missing collateral and collateral
substitutions.
For example, according to our records and earlier
representations by Bill Patterson, a certain loan was
secured by the unlimited guarantee of a wealthy individual




- 7 -

15
affiliated with the drilling venture.

When the examiner

suggested that this loan should be charged off as a loss
loan, I pointed out it was secured by the unlimited
guarantee of the individual.

The examiner said, "no, all

you have is smaller (than the amount of the loan) limited
guarantees."

Similarly, we were told by the examiner that

another loan, instead of being secured by oil reserves as
shown on our copy of the note, was collateralized by a
Florida marina.
At some point during this review of loans, I
called Patterson who had been suspended by Penn Square and
was at home.

Patterson's office files had been locked by

either the Comptroller's office or the FDIC.

I told

Patterson to go to his office and have the examiners unseal
his files and get the unlimited guarantee.

Patterson

replied, "I'm sorry, John, I never got it."
On July 5, 1982, the Federal banking authorities
pronounced Penn Square Bank insolvent and closed the bank.
That same day, I was placed on "special assignment."
August 30, 1982, I was terminated.

On

In a press release, I

charged that I was being made a scapegoat.

I still feel

that way.

I wasn't responsible for the Penn Square

collapse.

And I wasn't responsible for the Continental Bank

being in the oil and gas lending business.

In a 1981

article entitled "In the Highflying Field of Energy Finance,




- 8 -

16
Continental Illinois Bank Is Striking It Rich," the Wall
Street Journal reported:
Twenty-five years ago, it wasn't easy
for an independent oil man with a big
dream to get the funding he needed. Most
banks considered making loans like that
too speculative.
But Continental Illinois National Bank
& Trust Co. was willing to finance some
of the projects that others refused.
Now, in an industry where memories are
long, the bank is being rewarded for its
years of attention. It has become a
leader in the highflying field of energy
finance.
And it's still building business by
making deals other banks won't.
* * *
The article continues:
Continental's strategy could turn out
to have an Achilles heel. If the price
of-oil continues to drop, energy companies will find it harder to repay bank
loans.
* * *
If the price of oil (continues to) go up,
everybody will be heroes again. If not,
some banks may be hurt.
But Continental says energy financing
is dangerous only for newcomers. Bank
officials are also confident that the
current drop in oil prices will be
brief. "This is just a little blip, says
John A. Redding, [my boss] senior vice
president in charge of the bank's oil and
gas group. He believes that Saudi
Arabia's ability to manipulate oil prices
will prevail over the softening effects
of a decline in demand. When the Saudis
get the price where they want it, he
says, they will adjust supply to equal
demand.
* * *




- 9 -

17
The article concludes:
While it has many admirers,
Continental's aggressive lending style
has also been criticized as unnecessarily
risky. In response, Continental
officials cite the bank's record.
Cushioned in part by rising oil prices,
charge-offs and net loan losses in the
energy area have averaged less than half
of those in regular lending over the past
five years, says Gerald Bergman
[Redding's boss], executive vice president in charge of lending to special
industries.
What happened to John Lytle is really unimportant
to this Committee in its investigation.

What is important

is that corrective legislation be enacted which will, to the
extent possible, prevent a recurrence of a Penn Square
debacle.

Had the Comptroller's office notified the

participating banks of its knowledge of Penn Square's
deteriorating financial and operating conditions, we would
have taken steps to minimize or altogether avoid loan

DATED:

September 29, 1982




- 10 -

18
The CHAIRMAN. AS far as the legislation you suggested is concerned, don't you think it is just as important—on the one hand you
want someone to notify the participating banks—that is important,
but how about all the individuals that didn't have the sophistication
of Continental and some of the other participating banks and yet
invested in Penn Square, put deposits in over and beyond the
$100,000 limit hours before it shut down, members of the board of
directors of Penn Square who 2 days before the demise of Penn
Square put enormous sums of money over and beyond the $100,000?
Don't you think we should look a little bit at their situation as
well?
Mr. LYTLE. I agree, Mr. Chairman. We do not live in a perfect
world. I don't think legislation is possible that can cure all problems.
The CHAIRMAN. I think what you are referring to, at least what
the Chair is interested in, is that we come to our senses and realize
that this requirement over the years, or this religious fervor over
the years for secrecy be done away with and that we treat banks
like we treat any other corporation in this country that is publicly
held and that they have to issue reports to their stockholders that
are accurate about nonperforming loans, and so forth.
Mr. LYTLE. Speaking as a public citizen, I believe I agree with
you. My specific feelings about improvements in the legislation
relate only to a very careful look at a specific problem.
If the bank examiner knows that there is no guarantee or that
there is a discrepancy in the documentation of a note which has
been sold to an upstream bank, it is my opinion that that upstream
bank has the privilege of that secrecy and should not be excluded
from the information.
That is the point I am trying to make.
The CHAIRMAN. By the same token, it appears as though the
Comptroller's Office in one region didn't talk to the Comptroller's
Office in another.
Otherwise the Comptroller's Office in the Chicago region would
have looked more closely at these loans on your books, the participations.
Mr. LYTLE. Very definitely. We had the bank examiners in Continental in May. They were still there in June doing a routine examination of my division as well as the other oil and gas divisions.
We had problems developing we were discussing. We had one
loan that was in serious condition. On the other hand, 12 months
earlier the bank examiners had cited no loans for special consideration, any kind of rating, that were Penn Square overlines from
Continental Bank, zero.
I have forgotten the statistic about our outstandings, but I would
guess it was $250 to $500 million at that time.
Certainly some of the problems that existed when the FDIC and
our special team went down in July 1982 had to have existed in
May 1981.
The CHAIRMAN. I would say to the members of the committee, we
are talking about computerized examinations in the future. You
may have read some of the releases from the regulatory agencies. I
think we want to look at that very carefully in view of what we are
hearing from Mr. Lytle at this moment.




19
Mr. Lytle, in your testimony you mentioned a BGP Marina in
Florida. Do you know any more other than what you just told us
about that, that it is being used as a guarantee?
Mr. LYTLE. I heard the words BGP from Fortune Magazine or
some other publication.
The CHAIRMAN. YOU didn't hear them from Mr. Patterson?
Mr. LYTLE. NO; that is one of the cases I referred to.
The photostat of the note document we received said in the
typed-in space that refers to the collateral, oil and gas leases and
made no reference to real estate or a marina or whatever it was.
The CHAIRMAN. YOU are not aware of the fact this is a rather
cause celebre down in the Clearwater-Tampa area of Florida?
Mr. LYTLE. I am not aware of the marina.
The CHAIRMAN. FBI raids, tapes on Patterson conversations, et
cetera?
Mr. LYTLE. The first I learned of it was that information given to
me by the Federal bank examiner who had examined Penn Square
and who came up to visit us on the 30th and 1st.
He told me we did not have oil and gas leases, but rather, had
some Florida real estate. After that
The CHAIRMAN. A lot of it was under water?
Mr. LYTLE. That is right. Remember, I left the bank for practical
purposes in terms of information gathering 3 days later.
After that all of my knowledge of the BGP and the switch of collateral I have learned in the newspapers and other publications.
The CHAIRMAN. I would like to insert in the record at this point
a copy of an FBI affidavit for a search warrant of a residence in
Clearwater, Fla., dated September 9, 1982.
[The material follows:]




20
Affidavit for
Search Warrant

linitrb flairs Statrirt (Eourt

82-

FOR THE
MIDDLE DISTRICT OF FLORIDA

1 & 4H-NN
Docket No._

UNITED STATES OF AMERICA

Case No._

A three-story residence at 700 Spottis Woode
Lane, Clearwater, Fla., described as a red
brick structure with attached garage (carpor'
consisting of approximately 40 rooms and located within a walled/fenced compound and
bordering on an inter-coastal waterway.

AFFIDAVIT FOR
SEARCH WARRANT

BEFORE U. S. Magistrate Thomas G. Wilson, Tampa, Fla.
Address of Judge1 or Federal Magiaratc

Name of Judge' or Federal Magistrate

The undersigned being duly sworn deposes and says:
That he has reason to believe that ( o n t h e p r e m i s e s k n o w n M )
700 S p o t t i s Woode L a n e ,
C l e a r w a t e r , F l a . , a t h r e e - s t o r y r e s i d e n c e d e s c r i b e d as a red b r i c k s t r u c t u r e
w i t h a t t a c h e d g a r a g e / c a r p o r t . c o n s i s t i n g o f a - p r o x i m a t e l y 40 rooms a n d l o c a t e
w i t h i n a w a l l e d / f e n c e d compound a n d b o r d e r i n g o n a n i n t e r - c o a s t a l w a t e r w a y .

in the

Middle

District of

Florida

there i now being concealed certain property, namely telephonic voice recordings and/or
s
tapes of conversations or transcripts of such recordings'"!^tween Allen M. Se
and Bill G. Patterson, which constitute evidence of the commission of a
criminal offense in violation of Title 18, U. S. Code, Sections 1014, 656
and 371, or which are contraband, fruits of a crime, or things otherwise
criminally possessed, or property designed or intended for use or which is
or have been, used as the means of committing a criminal offense
which are
here give alleged grounds for search and seizure1

And that the facts tending to establish the foregoing grounds for issuance of a Search Warrant
are as follows:'
(See A f f i d a v i t

for-Search

Warrant)

ALFRED W. SCUDIERI
* " — « «> *»*•"•
__?P_ecia_l _ Agen_t L_ Fjedera 1_ JBureau__of_.
Investigation
°»^ ruu.tT~y.~~
Sworn to before me, and subscribed in my presence, S e p t e m b e r 9 ,
, 19 82




THOMAS G .

WILSON

United S t a t e s

Ww 1 «• w « i M.ii«r.

Magistrate

21

^™ S2 - 16 4M-V\/
I.

SUMMARY OF ALLEGATIONS

The following affidavit alleges that there is probable cause to
believe violations of Title 18 USC Sections 1014, 371 and 656 have occurred
relative to the purchase of real estate property belonging to Allen M.

Senall

and that these violations were carried out by certain officers of the Penn
Square Bank of Oklahoma City, Oklahoma, and by other individuals, some of
whom are known and others who are unknown, and that evidence of this crime
is presently being concealed at the residence of A. M. Senall, 700 Spottis
Woode Lane, Clearwater, Florida, in the form of voice recordings.
Affiant, Special Agent Alfred W. Scudieri, being duly sworn, depose
and say:
II.

BUSINESS ASSOCIATES OF A . . N SENALL
TTK

On April 15, 1982, August 26, 1982, and September 7, 1982, Allen
M. Senall, President, A. M. Senall Company, 714 Grand Central Avenue, Clearwater, Florida, was interviewed by Special Agents of the FBI and identified
the following business entities and individuals with whom he has conducted
business between the period 1980 to the present time:
The Metropolitan Bank and Trust Company (MBTC) of Tampa - a
banking institution that was declared insolvent by the Federal Deposit Insurance
Corporation (FDIC) on February 12, 1982; Donald Regar - the former president
of MBTC; Paul Mansfield - a former MBTC loan officer; Allen Z. Wolf son - a
Tampa based real estate developer currently incarcerated for bank fraud
violations; John Eloian, a Tampa based osteopath and business associate of
Allen Z. Wolfson; Arlis Roberts - a Tampa based businessman and associate of
Allen Z. Wolfson; The Port Tarpon Marina - a condominium conversion project
located at. Tarpon.Springs, Flor ida.,
Thomas D^_ Chilcott, former operator of a fraudulent commodities
investment pool in Colorado;
Samantha Petroleum Corporation, a Utah corporation, whose board
of directors as of December 15, 1981, were: Allen M. Senall, Roger A. Larson,
Clark Long, Brook Grant, and John Gaskill;
Brook Grant, former president of Samantha and former brother-inlaw of Dick Penny, a vice president, Correspondent Banking Division, of Chase
Manhattan Bank (CMB), New York, which participated in numerous loans to




1

22
loans to Senall's enterprises through Penn Square Bank (PSB), of Oklahoma
City, Oklahoma;
Margaret C. (Meg) Sipperly, a loan officer of CMB;
Chase Manhattan Bank, a New York bank which was an "upstream"
bank for PSB loan participations involving Allen Senall and others;
Maximo Moorings, Inc., (MMI), a Florida corporation, formerly
owned by Allen M. Senall; Mitchell Joseph; Melvin Wank; Doug Robertson, and
Clark Long;
Penn Square Bank, N. A., (PSB), a bank located in Oklahoma City,
which was closed by the Controller of the Currency on July 5, 1982, currently
known as Deposit Insurance National Bank of Oklahoma City, whose board
chairman was Bill P. Jennings; whose president was Eldon L. Beller; and whose
former president was Fr-ank L.' Murphy; whose senior executive vice president
(Oil and Gas Division) was Bill G. Patterson; loan officers Tom Orr and Pat
McCoy; senior vice president of Oil and Gas Division who was Tom Swineford;
and whose director and executive vice president of Loan Administration was
Rick Dunn;
BGP Marina, Inc., (BGP), a Florida corporation formed by Bill G.
Patterson for the purpose of purchasing MMI from Allen Senall;
Clark Long, a former loan officer of PSB who subsequently was
employed by Allen Senall of Samantha Petroleum;
Glen Terry, President of Samantha Petroleum;
Alan R. Miller, Attorney for Saket Petroleum;
Ken Tureaud, President of Saket Petroleum;
Walter Heller, a mortgage brokerage firm;
Herb Gruber, the Miami agent for Walter Heller.
III.

FACTS OF^NSTAOTLCASE

On April" 15, 1982", Allen M. SenaHLtold ^Special" Agents^AXf rj>d jf.
Scudieri and Ronald H. Jordan of the FBI that he is in the business of
purchasing boating marinas in Florida and-elsewhere, and converting rental
boat slips for sale under a condominium concept. He entered into a business
arrangement with the Metropolitan Bank and Trust of Tampa to finance such a
conversion at The Port Tarpon Marina, Tarpon Springs, Florida. According to
Senall, a proposed financing package at MBTC was arranged by Allen Wolf son
with Donald Regar and Paul Mansfield. This conversion was ultimately




2

23
financed with funds collected from individual investors including Wolfson and
Arlis Roberts.
On August 26, 1982, Allen Senall advised Special Agents Alfred W.
Scudieri and Gary Pilawski that he regularly dealt with Bill G. Patterson and
Thomas Orr, officers of the Penn Square Bank of Oklahoma City, Oklahoma, as
an individual and as a principal of Samantha Petroleum. He also acknowledged
he knew PSB officers William Jennings, Frank Murphy and Eldon Beller. He
identified Kenneth Tureaud, Alan Miller, Saket Petroleum, Thomas Chilcott
and Melvin Wank as business associates of his who also borrowed at PSB.
Senall described his purchase of Maximo Moorings, Inc. for 6.5
million dollars. He borrowed 4.1 million of this amount from PSB. The Chase
Manhattan Bank of New York participated in this loan. Meg Sipperly of Chase
was his contact at that bank.
Senall said that in January, 1982, he was about to lose Maximo for
non-payment of debts. He had conversations with Herb Gruber of the Walter
Heller Corporation regarding his sale of the marina, but the transaction oould
not be finalized.

In January, 1982, he was telephonically contacted by Bill G.

Patterson who told Senall he wanted to "front" for the purchase of Maximo
under the corporate name of BGP Marina, Inc. The sale of the marina to BGP
occurred in March, 1982, and was financed at the PSB.
Senall advised he tape records all telephonic business conversations
that are made to or from his residence. He advised he is in possession of
several recordings with Patterson including the one described above which he
maintains at his residence; however, he declined to furnish these tapes to the
FBI.
On September 7, 1982, Special Agent James A. Montee, a C.P.A.,
examined records of" the PSB relating to three PSB loans totaling 7.5 million
dated M*arch 10, 1982. The "stated purpose of each loan was for use in acquisition of oil and gas leases. These loans were authorized by Bill G.

Patterson

and presented to PSB's loan committee by Patterson as being loans related to
oil and gas investment ventures. Special Agent Montee's analysis of these
loans determined that the proceeds of these loans, in fact, were used to
purchase Maximo Marina, Inc., by BGP Marina, Inc., and not for use in the
acquisition of oil and gas leases.




3

24
On September 7, 1982, Allen Senall was interviewed by Special
Agents Scudieri and Montee, and at that time he advised that Thomas Swineford,
Pat McCoy, Rick Dunn and Clark Long are employees of PSB with whom he
has dealt regarding loans at PSB. He further identified Dick Penny as an officer of CM3 with whom he dealt regarding loans. He identified Brook Grant,
Mitchell Joseph, Doug Robertson and Glen Terry as individuals who, by virtue
of their business association with Senall, had knowledge of Senall's loans with
PSB.
Senall reiterated that he tape recorded business conversations at
his residence and, as of September 7, 1982, maintained at least a portion of
these recordings at his residence at 700 Spottis Woode Lane, Clearwater. He
stated that in his opinion at least one such recording of a conversation between
him and Bill G. Patterson contained evidence of a criminal act, specifically
the misapplication of $335,000 of bank funds by Bill G. Patterson. This is one
of five recordings with Patterson he maintains at his residence.

Senall again

declined to furnish such recordings to the FBI and stated that he would not
feel obligated to comply with a subpoena requiring their production.
Senall further stated that in his extensive experience in dealing
with bank officers, it was not unusual for conflicts of interest to arise. In his
opinion, "that's the way all bankers do business."
From my experience as a Special Agent of the FBI, I have learned
that voice recordings are fragile in nature and are easily altered or erased.
All information contained herein received by Agents of the FBI
other than the affiant, was directly conveyed to the affiant by these individuals.

ALFREDr^^-SGUDIERI ^--Special Agent
Federal Bureau of Investigation
Sworn to before me, and subscribed in my presence, September 9, 1982.




THOMAS G. WILSON, U. S. Magistrate

25
The CHAIRMAN. I would say this to you: You are no longer with
Continental. If you wrote that statement yourself, you are a pretty
good writer. You probably could write a tremendous novel based on
Penn Square and probably make more money than you were making
at Continental.
Mr. LYTLE. I have thought of that.
The CHAIRMAN. Mr. Lytle, in public accounts as you have stated,
you have taken a great deal of blame and abuse for the problems
that Continental has had as a result of their relationship with
Penn Square. You were a vice president in the Mid Continent Oil
& Gas Division of the bank. You had $1 billion involved in these
loans. Do you do this all by your onesy, solely, or were there any
communications with anybody above you in this financial institution?
Mr. LYTLE. Yes, sir, daily.
The CHAIRMAN. Daily? So there were others who were reviewing
the relationship between Penn Square or the purchase of participations from Penn Square you described to us earlier in the testimony?
Mr. LYTLE. Yes,

sir.

The CHAIRMAN. Could you tell us who was your superior, monitor, adviser at Continental in this area?
Mr. LYTLE. From a chain of command point of view, I reported to
John Redding, the senior vice president in charge of the oil and gas
group. He had four divisions reporting to him. These divisions comprised all of the oil and gas lending done by Continental worldwide.
Mr. Redding reported to Gerald Bergman, head of special industries, and had a dozen divisions headed by three group managers,
Jack Redding being one of them, reporting to him.
From a direct credit approval point of view with certain exceptions, that was the chain of command for credit approval.
The CHAIRMAN. Let me ask you this: You referred to the article
that seems to be complimentary to Continental about how they
were expanding and flying high and doing tremendously well in
energy loans and that they were the experts and there was a
payoff, their involvement over many years.
As a result of that article, certainly someone at the bank had to
pay tribute to you for your work in this area.
Did you ever get a pat on the back from up in the ivory tower
saying, gee, you are doing a great job. You are getting these wonderful participations?
Mr. LYTLE. It was sufficient for me to get a pat on my back from
my boss. I got that frequently. His boss would occasionally compliment me. The bank was very fair to me in terms of compensation
as well as the two promotions I recounted.
I might add I excluded from the quote in the Journal specific
mention to three or four different customers that were mentioned
as new customers and indicative of the type of new business, good
work we had done.
I had been involved in bringing in two of them and indirectly involved with the other two, so I was getting credit and recognition
for it and certainly feel that I was fairly treated in terms of my
contribution.




26
The CHAIRMAN. Mr. Lytle, as you are aware, while we were down
in Oklahoma City, the news hit the wires about some of your personal loans; and very frankly there was a little confusion as to the
exact amount of your personal loans. Did you indeed borrow
money?
Mr. Eldon Beller told us you had borrowed money for a home
mortgage, but he was very, very vague at the time. Are you prepared at this point in time to tell us about this—these personal
loans?
Mr. LYTLE. I would be happy to.
In June or July 1980, I mentioned to Bill Patterson that my then
extensive home addition was going to require some additional
funds. Bill said to me, why don't you borrow it from Penn Square?
At that time I had a $170,000 loan with Continental Bank in
their real estate department, and I said, well, Bill, that would be
fine. You are a close correspondent bank and a good friend and I
would be happy to do it; what would be the terms and conditions?
He said you would borrow on a mortgage type loan at prices
charged similar borrowers.
I began a relationship by borrowing $20,000, but from the
moment that I started it, I had a tacit agreement with Patterson
that if he wanted to take out Continental's $170,000—well, it was
an assignment of beneficial interest, but the effect of it was it is a
first mortgage loan—he could take that out and would have a secured mortgage loan.
I continued to borrow from July 1980 through January 1982. The
peak of the loan occurred in December 1981, was there for 30 days,
and was fully paid
The CHAIRMAN. What was the amount of the peak?
Mr. LYTLE. $565,000. The loan was fully paid on January 25
The CHAIRMAN. Was that secured, by the way?
Mr. LYTLE. NO, sir.
The CHAIRMAN. That
Mr. LYTLE. Yes, sir.
The CHAIRMAN. HOW

was unsecured?

does the amount of that loan relate to your
net worth? What is the ratio of the loan amount to your net worth?
Mr. LYTLE. Let me make that point.
From a credit point of view, whether to take collateral certainly
is influenced by an individual's net worth, but it is equally influenced by his other debts because in the event of a crisis, or an inability to pay, the real competition is the other creditors, not the
individual who is borrowing the money.
As my statement will show—and that is available to the committee if they are willing to look at it, I had virtually no other debts
other than the $170,000 that I earlier mentioned. Specifically, I
had
The CHAIRMAN. By the way, that you say was for an addition to
your home?
Mr. LYTLE. Yes.
The CHAIRMAN. YOU

know poor Mr. Beller down there in Oklahoma City thought that that was to buy a home. He didn't realize
what the prices of homes are up there in the Chicago Continental
area.




27
Mr. LYTLE. I paid considerably less for my home than I did for
the addition.
I will say the addition was about 50 or 60 percent. I bought the
house with a wife and put the addition on with four kids and two
dogs.
Mr. ANNUNZIO. Mr. Chairman, would you yield on that point?
The CHAIRMAN. Sure, Mr. Annunzio.
Mr. ANNUNZIO. Mr. Lytle, did you ever report these loans to your
superiors at the bank?
Mr. LYTLE. NO, I did not.
Mr. ANNUNZIO. Why not?
Mr. LYTLE. I didn't feel and

still don't, that there was any reporting responsibility. I borrowed from First of Winnetka 15 years ago to
buy some real estate; I had a loan in the Continental Bank real
estate department.
Mr. ANNUNZIO. But the Winnetka is next door to Continental. You
are at Penn Square 1,000 miles away.
The CHAIRMAN. If I might reclaim my time, we can get to that
point later, but I think Mr. Lytle is right. He wasn't borrowing
from Continental, and I don't know of any responsibility.
Would you please continue?
Mr. ANNUNZIO. Mr. Chairman, did he have any deposits at Penn
Square? Why was Penn Square so nice to him?
The CHAIRMAN. That is what I am trying to find out.
Mr. ANNUNZIO. He is a nice looking man, I know that.
Mr. LYTLE. I think we are talking about the quality of my loan.
The CHAIRMAN. I asked you what your collateral was.
Mr. LYTLE. There was no collateral.
The CHAIRMAN. Therefore, we would have to look at your net
worth.
Mr. LYTLE. Net worth, and overall assets. I have done a careful
computation of my personal financial statement as of the day
before each of the notes that I took down at Penn Square, as I
gradually built this facility up.
At no time in the course of my borrowing at Penn Square did I
ever have less than 2 to 1 available collateral to cover the dollar
amount of the loan, using as values, (a) appraised real estate, and
(b) the subsequent price of oil and gas properties that I sold them
for, so that I think both numbers prove to be at least conservative.
So the balance sheets showed no other debt, 2 to 1 asset coverage
on the takedowns, and the handshake agreement with Bill Patterson—and I must point out at this time all during this time Bill Patterson and I had a relationship of extreme trust.
When I told Bill Patterson I would do something, he believed me.
I told him that he could have collateral any time he wanted it.
The CHAIRMAN. By the same token, when he told you something,
you believed him?
Mr. LYTLE. I did,
The CHAIRMAN.

sir.

The beliefs were well founded on both sides, or
do you think maybe you got taken a little bit?
Mr. LYTLE. I wish I had never heard of Penn Square Bank, to
quote the chairman.
The CHAIRMAN. HOW about Bill Patterson?
Mr. LYTLE. Same thing.




28
The CHAIRMAN. If you think he was a hero, tell us.
Mr. LYTLE. However, that condition did not prevail until June or
July 1982. In carefully examining my relationship, in talking to my
conferees in the bank, we had no reason to believe Bill Patterson
was dishonest prior to that point.
Eclectic, colorful, certainly one of the best go-getters the oil
patch has ever seen, but not dishonest.
The CHAIRMAN. YOU told us what the peak of your loans were.
You told us you have a financial statement that is available to the
committee?
That being the case, I will ask unanimous consent to have it inserted in the record at this point.
[The financial statement of Mr. Lytle follows:]




JOHN R. LYTLE PERSONAL NET WORTH STATEMENT
7/14/80
Cash

9/30/80

12/15/80

1/13/81

4/20/81

7/V81

1

2

1

3

1

18

8/24,
13

9/27/81

12/10/81

• 3/11/82

3/30/82

43

4

31

36

1

1

1

1

1

1

1

1

50

40

40

60

60

70

75

79

79

104

104

125

125

125

Trust

150

150

150

150

150

150

150

150

150

150

150

House and Lot

500

525

550

575

575

600

600

625

650

675

675

2

2

2

2

3

3

3

3

3

5

5

Profit Sharing Net

35

35

35

35

35

30

30

30

30

30

30

Oil Properties Cost

0

0

0

0

0

63

63

68

68

182

5

Total Assets

250

775

809

841

844

947

964

1,024

1,080

1,238

1,030

Bank Debt-Continental
Penn Square
State Nat'l
1st Winnetka
Community Bk
Healdton
Total Bank Debt

170
0
17
20
0
0
207

170
20
17
20
0
0
227

170
50
17
20
0
0
257

170
75
17
20
0
0
282

170
100
17
20
0
0
307

170
180
18
20
0
0
388

0
370
18
20
0
0
408

0
420
18
15
0
0
453

0
490
18
15
0
0
523

5

5

5

5

5

5

5

5

5

5

5

Total Liabilities

212

232

262

287

312

393

413

458

528

749

301

Net Worth

538

548

547

554

532

554

551

566

552

489

729

52

52

112

112

+295

-4

606

603

678

664

784

725

Securities
Personal Property

Cash Value Life Ins.

tO

Other Payables

Adjust Net Worth for market value of oil properties




0
0
18
15
565 .
146
744

0
0
17
15
264
0
296

*£>

30
The CHAIRMAN. Mr. Wylie.
Mr. WYLIE. Mr. Lytle, in your opinion, who is the ultimate villain in the Penn Square episode?
Mr. LYTLE. I haven't had time to sit back and come to a conclusion that definite, Mr. Wylie.
I just don't know. Certainly there has been a lot of problems that
have come up. I also might point out that I left Continental Bank
effective as of July 5 and have not had the benefit of discovery
since then as to the problems that occur in Continental.
Mr. WYLIE. Chairman St Germain made the observation that
maybe it is a cast of thousands. I don't know. Would that be a
proper characterization?
Mr. LYTLE. I think it would be closer than trying to identify one
person, yes, sir.
Mr. WYLIE. Did Continental buy loans from Penn Square which
were, in fact, made to Penn Square's own directors or to companies
which those directors owned or represented?
Mr. LYTLE. Yes, sir.
Mr. WYLIE. Can you

tell us how much money was involved in
those loan participations?
Mr. LYTLE. NO, not with any definite figure, but it would be safe
to say where there was a direct or indirect involvement by a director, well over $100 million of our portfolio.
Mr. WYLIE. Would it be fair to say that this amount is abnormally high relative to Continental's participation with other banks?
Mr. LYTLE. Which amount, sir?
Mr. WYLIE. The $100 million you just mentioned.
Mr. LYTLE. I don't know that. It was relatively high compared to
my division's participation with other banks, but I am not privy to
the other dozens of divisions that Continental and their involvement with the correspondent banks.
Mr. WYLIE. HOW are the loans collateralized?
Mr. LYTLE. Our primary source of collateral was—and I presume
continues to be—oil and gas reserves. Oil and gas reserves are unproduced oil properties where an appraisal has been made by an
outside engineering firm and a loan value attributed to it.
Probably the second largest category would be refining assets
and inventory. I answer this question with regard to my overall
portfolio, not the specific guaranteed loans that you referred to.
Mr. WYLIE. Can you describe your relationship with Bill Jennings while you were at Continental?
Mr. LYTLE. My contacts with Jennings were cordial, infrequent,
and I was respectful of him.
Mr. WYLIE. Did you personally extend personal loans to him at
any time?
Mr. LYTLE. Did John Lytle or his Mid-Continent Division do so?
Mr. WYLIE. Yes, sir.
Mr. LYTLE. NO.
Mr. WYLIE. Can you

describe your relationship with Bill Patterson when you were with Continental?
Mr. LYTLE. Much more intimate, a close personal friend, a business relationship of deep trust, and one of constant contact; telephone primarily.
Mr. WYLIE. The chairman asked me to yield. I would be glad to.




31
The CHAIRMAN. Mr. Lytle, you got very close to Bill Patterson,
handshakes, he lent you money, right?
In retrospect, would you not agree that he was lending you
money so that he was taking you and Chicago—rather Continental
Illinois—for a sleigh ride and that indeed he wasn't being your
friend, but he was buying you?
Mr. LYTLE. I thought about that before I borrowed; probably not
much during the borrowing, and then constantly since the collapse;
so my answer is very sincere.
I think it takes a moment to recount the environment in which I
was operating. Continental Bank wanted to build loans. We discovered in 1978 and later developed in 1980, and early in 1981, a very
prolific producer of what we thought were excellent loans.
We were discovered by the Northern, SeaFirst, Chase, Michigan
National, and others, as having had a tremendously close relationship with Penn Square.
As manager—and you remember I am not a lender, I am managing a group of lenders and approving their credits; I took it upon
myself to build a very strong relationship on behalf of Continental
Bank with Bill Patterson and with Bill Jennings, but primarily
with Patterson.
Patterson is a loan obtainer; Lytle is a loan obtainer.
We go out on the street and find new customers. If I bring in a
loan of $30 million to Continental Bank, it is a proper loan, unsecured or secured, a good individual; I get a pat on the back.
When I gave what became a $565,000 loan to Penn Square Bank,
I was doing my best correspondent bank a favor in hopes of building a relationship.
The reason I used $30 million at Continental is because that is
roughly as important to us as the $565,000 was to Penn Square.
This was a significant income earning asset for Penn Square, and
I felt that I was doing Penn Square a favor and would obtain the
opposite of the implication, Mr. Wylie, that you suggested.
Certainly the newspapers didn't report it that way, but that was
the thinking that went through my going to that bank instead of
the bank where I presently borrow in Oklahoma City or where I
could have borrowed in Chicago.
It felt to me that it was something that was beneficial both to me
and to the Continental Bank.
Mr. WYLIE. The answer to this question may require some
thought on your part. I do think your opinion is important.
To what extent would you say Bill Jennings is responsible for
Penn Square's failure?
Mr. LYTLE. That is a very difficult question, because it involves
the responsibility of a chief executive for his people. If you said to
me are my loan officers responsible for the bad loans that were
made at Penn Square, I would say in part, but so am I.
I was their manager. I could have stopped them.
I could have discouraged this loan or that and did, of course, in
many situations.
Certainly to an important extent as chief executive, further, as a
very oldtime and experienced "oilie" in the Oklahoma oil patch,
Bill Jennings had access to information about financial conditions




32

of companies that could have been and perhaps was very helpful to
the lenders.
The degree of his day-to-day involvement in the oil lending, Mr.
Wylie, is a mystery to me.
As I said in my prepared statement, I was flabbergasted by
Beller's position. I thought that the bank had hired an excellent
technician with many years of operating and credit experience to
come in and relieve Jennings of some of this responsibility for overseeing Patterson.
I had conversations with Jennings on several occasions this year
where he indicated there was a need to control Patterson, the implication being that Beller should do it or that he was doing it.
Certainly Mr. Jennings must bear a portion of the blame for the
failure of Penn Square Bank.
Mr. WYLIE. SO, should Bill Patterson bear a portion of the blame?
Mr. LYTLE. Well, to the extent that the discrepancies I have
hinted at and certainly will come out eventually by the investigating authorities, yes.
To a lesser extent, in that his lending authority was perhaps limited, yes.
I agree he should bear a portion of the blame.
Mr. WYLIE. Thank you, Mr. Chairman.
I believe that is all I have right now.
Thank you, Mr. Lytle.
The CHAIRMAN. Mr. Annunzio.
Mr. ANNUNZIO. Thank you, Mr. Chairman.
Mr. Lytle, your statement is indeed interesting. I would have
been more receptive to your statement if it had been more complete.
I think that in your statement you are being too modest. I also
want to point out to you that I am not here to defend Continental
or any other bank. They are big boys. You soon learn that on this
committee, and they should be willing to take their lumps, but
what bothers me is that in your statement there is not a single
mention of the personal relationship you had with Penn Square
and its officials.
Why have you not mentioned the rather large and strange loan
of $560,000 that was made to you by Penn Square?
I also would like to ask—answer me if you think there was not a
conflict of interest. I am of the opinion there was a conflict of interest.
I don't think you could have received $560,000 from Penn Square
if you were not doing business with Penn Square. I don't think as
an individual you could go to Oklahoma City and Penn Square, out
of the goodness of their heart, give you a loan of $560,000 on a
piece of property outside of the city of Chicago.
I would like for you to answer that question.
Mr. LYTLE. I will try to remember all of the questions.
If I exclude one, please remind me.
The first question—I forgot. I didn't mention it.
In the letter Mr. St Germain sent to me inquiring into the subject that we are talking about today, there was no reference to my
personal involvement.




33
However, I am aware that it has gotten tremendous publicity
and it has also been carefully looked into by Federal authorities.
I left it up to your level of interest to mention it.
Second, I have mentioned that in my opinion, as a credit man,
the loan that I had at Penn Square was a good solid loan; one of
the best evidences of a good solid loan is when you decide to pay it,
you can pay it.
I further volunteer that Continental Bank criticized my participation with Penn Square in December 1981 and within 25 or 30
days I moved the full $565,000 to another bank in Oklahoma City
with whom I had no affiliation.
I got a commitment from that bank within 5 days.
Mr. ANNUNZIO. Tell us why you moved the loan.
Mi;. LYTLE. Because Continental Bank criticized my participation,
my borrowing from Continental—pardon'me, my borrowing from
Penn Square Bank, and while they didn't say move it, I said, you
want me to move it, they said that would be fine.
I said I will move it.
Mr. ANNUNZIO. I yield to Mr. Barnard.
Mr. BARNARD. Did you get any help from Penn Square to move
that loan?
Mr. LYTLE. Yes, sir.
Mr. JAMES COYNE. Could

you have paid off the loan if you had
not been able to roll it over?
Mr. ANNUNZIO. DO you want me to yield to you? I will yield. Go
ahead.
Mr. JAMES COYNE. Could you have repaid that loan were you
unable to find another bank to refinance it?
Mr. LYTLE. The answer to that question is, probably not in 5
days, but I have a house which the record will show has had an
appraised value a year, lVfe years ago, of $600,000, or a package of
real estate, two contiguous lots.
Second, I had oil properties at the time which would be—and I
am afraid I can't estimate it, but which had $200,000 to $300,000 in
value.
I sold those oil properties at those values in March of this year,
60 days after I paid off the loan. So, frankly, Mr. Coyne, it would
have taken longer than 5 days, but there was enough liquidity in
the available assets to have paid it off, yes, sir.
Mr. ANNUNZIO. Mr. Lytle, if you thought there was no conflict of
interest on these loans, why did you move the loans? I just cannot
understand it.
Mr. LYTLE. I worked for the Continental Bank. I have been there
23 years. When I get a suggestion, I consider it a request or order.
That is what I did.
Mr. ANNUNZIO. But in earlier testimony you thought that it
wasn't necessary to report this loan that you made to your superiors at Continental Bank?
Mr. LYTLE. I did not report that loan. I did not report the
$170,000 loan which I made in our real estate department.
That may seem strange to you, but they weren't aware of that.
We were a big enough organization so that that would be logical. I
didn't report the Winnetka loan.




34
Mr. ANNUNZIO. After 23 years of working for an institution like
Continental, you didn't feel that you had an obligation to report
these types of loans being made with a bank that Continental was
doing business with through you?
That sounds inconceivable to me because you are dealing—you
know, you people that work in banks have an idea that this is your
money. You are dealing with the people's money. It was the people's money that you were pushing back and forth.
Mr. LYTLE. Well, your opinion is consistent with that of some of
the senior people at Continental. I differ with it.
Mr. BARNARD. Will the gentleman yield?
Mr. ANNUNZIO. I yield.
Mr. BARNARD. Just the reverse though, isn't that against the
law?
I mean, from the standpoint of insider loans as covered by the
Financial Institutions Regulatory Act of 1978?
Mr. LYTLE. I am not a laywer, but it is my opinion that I am not
an insider.
Mr. BARNARD. What about in the reverse? Didn't Mr. Patterson
have some loans with you?
Mr. LYTLE. Let me continue on the first point. Of course, subsequent to this I have inquired of counsel and we have talked with
Federal authorities about it and nobody has suggested that the
loan was illegal or improper.
In answer to your question regarding Patterson, the answer is
not to my knowledge. We never made a loan to Bill Patterson at
Continental Bank.
Mr. ANNUNZIO. Mr. Lytle, one more question.
My time has expired. You say that there was no conflict of interest. Can you name for me the names of any other individuals at
Continental Bank who received loans from Penn Square, and I
assure you that if you name those individuals, I will ask the chairman of this committee to subpena those individuals to this hearing?
You say you are the scapegoat. Tell us what other individuals at
Continental got loans?
Mr. LYTLE. I am aware of only in name, not detail, that Mr.
Brednick, Gary T. Brednick, and Mr. Ralph Kramer—K-r-a-m-e-r—
both had credit relationships at Penn Square. I might also add, Mr.
Annunzio, I am aware in an equally superficial way that Mr. Jennings had a very significant personal loan at Continental Bank, $7
to $10 million would be my guess.
Mr. ANNUNZIO. Are you the scapegoat for these people? Do you
consider yourself the scapegoat for these people?
Mr. LYTLE. NO.
Mr. ANNUNZIO.

Mr. Chairman, my time is up. I would like to
know who you are the scapegoat for.
The CHAIRMAN. For the record, Mr. Lytle, could you give us the
titles of the two gentlemen whose names you mentioned?
Mr. LYTLE. Vice presidents in the Mid-Continent Division.
The CHAIRMAN. In other words, the same division you were in?
Mr. LYTLE. They reported to me.
The CHAIRMAN. They were under you?




35
Mr. ANNUNZIO. Did they have the same sweetheart deals that
you had?
Mr. LYTLE. I said I had no knowledge of the details. I might add
that I had no knowledge of the loans. I was not informed by either
one of them of their credit relationship and have learned of it in
the last 30 to 60 days.
The CHAIRMAN. TO clear up the record again, as far as the loan
to Jennings is concerned from Continental, was that a personal
loan or a stock loan?
Mr. LYTLE. Well, a stock loan might be a personal loan.
The CHAIRMAN. Was it a loan to the holding company?
Mr. LYTLE. NO, sir.

The CHAIRMAN. It was to Jennings as an individual?
Mr. LYTLE. That is my information.
I might explain that that kind of a loan, a loan to an individual
secured by real estate or whatever interest Mr. Jennings has
wouldn't be handled by my division in the normal course of business, which explains my lack of knowledge of the credit facility.
I believe it has been subsequently paid, I might add.
The CHAIRMAN. Mr. Paul.
Mr. PAUL. Thank you, Mr. Chairman.
Mr. Lytle, I have a question that is not nearly as specific as those
you have been receiving.
It is more generalized and more philosophic. My understanding
of the inflationary process is that when governments create money
and credit there is bound to be malinvestment and misdirection of
investment.
I am of the firm conviction that we as a government have been
creating a lot of new money and credit out of thin air. For this
reason it is inevitable that we will have misdirection and malinvestment of many, many funds.
If we have a sound monetary system, one can make good decisions in banking, but loans can go sour. I would like you to respond
as to what you think is the most important here: Did we come
upon this problem because of bad decisions, in a major sense, or
has it come about because there has been an inflationary climate, a
massive creation of new money and credit out of thin air, which
causes an inevitable misdirection and malinvestment of money?
Do you think both are involved? Which one is the most important?
Mr. LYTLE. That is a question for an economist. My initial or superficial reaction is that we certainly benefited in building our
portfolio by the tremendous increases in oil values in the late seventies and early eighties; but you must look back at why those oil
values occurred and then you get into the general U.S. economy
and you get into questions about controlled prices in the Middle
East.
I am not sure that it really is an oil answer, but very clearly a
lot of the growth and outstanding things that we saw was a result
of increased asset values.
I might say further a lot of the losses that apparently are contemplated by the overline banks are the result of decreased asset
values in the portfolios they held as collateral.




36

One of the reasons those asset values has decreased is that credit
in the Oklahoma environment is now frozen. There is a panic down
there. There is no credit available. When you don't have a buyer
who can borrow, you don't have a price. That is one of the reasons
why these losses are being incurred.
So it is a two-edged sword. The lack of credit certainly hurts the
economy. Perhaps as you are suggesting, an excess of credit could
hurt the economy.
Mr. PAUL. It seems to me that if there is a massive increase in
asset value and a reaction where the asset value drops at least on
paper, it is the result of a bad monetary system.
I happen to believe that our problems are a result of the monetary policy that exists here, for it entices people to participate in
exactly what happened down there, and that is a lot of bad decisionmaking because people are getting the wrong information from
the marketplace.
That is all I have, Mr. Chairman.
Mr. LYTLE. I might make just one further comment, Mr. Paul.
An additional problem, which I certainly wouldn't suggest is a
problem with this committee, was the irregular effects as the result
of the Natural Gas Policy Act passing and the tremendous emphasis that it placed on deep unregulated gas.
A huge portion of the money spent in Oklahoma in the last 3
years went into the sub 15,000 drilling area and a huge portion of
the losses that are going to be incurred went into that.
One of the effects of this concentration was a deemphasis and a
deeconomization of the value of the shallow gas. We also were
plugged at much earlier times in their history because so much
deep gas was available.
As that stopped, the economy slowed down.
If full deregulation had been enacted at the time of the NGPA, I
think this problem would have been severely mitigated.
Mr. PAUL. I think that is an important point too. Not only do we
put out a lot of misinformation by messing up the monetary
system, but we send out a lot of misinformation regularly with our
policies of regulation, deregulation, and whatever.
Thank you.
The CHAIRMAN. MS. Oakar.
Ms. OAKAR. Thank you, Mr. Chairman.
Mr. Lytle, to what extent in your position as vice president in
charge of this division were you part of the decisionmaking process
dealing with Penn Square?
Mr. LYTLE. Would you like to know what my loan limit was and
the administrative process of approval?
Ms. OAKAR. I just want to know if you had any part of the decisionmaking process. Did you make the recommendation, for example?
Mr. LYTLE. Certainly, I understand.
All accounts or prospective accounts are assigned to loan officers.
A loan officer in my division in large part working with a professional engineer who is on our staff in payroll prepares a loan proposal, a formal written proposal, suggesting that a credit be enacted. That proposal is approved by himself and by the engineer




37
where it is required and then circulated up the chain of management to a predetermined altitude.
That altitude is determined by the size of the loan.
If the loan were $5 million and my limit—and it was for a
while—was $5 million, then the loan officers, the engineers, and
my approval would be sufficient to commit and disburse the credit.
At that point a review process is automatically enacted which is
completely out of the control of the lending division.
First, the loan division, the operating area, follows for documentation and makes sure that the document package is complete,
with backup from our inside or outside counsel.
Ms. OAKAR. SO you were the number one individual to make the
recommendation and it was up to a committee afterward to either
disprove or approve your recommendation, is that right?
Mr. LYTLE. That is not correct. The No. 1 person making the recommendation in all cases is the loan officer responsible for the account. I only used myself as an example.
If the loan were a legal limit loan, or $150 million or something
like that, the same process would occur. The loan officer would prepare a recommendation. He would give it to his section head or in
the absence of his section head, which was the case in Oklahoma,
his division manager.
I would give it to my group manager. The group manager would
give it to the department head and all of those requirements would
be necessary for approval.
Ms. OAKAR. When you give it to your department head, would
you have any recommendation attached?
Mr. LYTLE. Yes.
Ms. OAKAR. And you recommended that this be granted?
Mr. LYTLE. That is correct.
Ms. OAKAR. NOW you worked for this institution for 23 years?
Mr. LYTLE. Yes, ma'am.
Ms. OAKAR. IS there anything in the bylaws of your bank

Mr.
Chairman, this is a little faintly reminiscent of the Bert Lance case
where this committee, which I was a member of at the time, looked
at bylaws of his bank.
Is there anything in the bylaws or were you ever told during the
course of your 23 years of experience that it would be perceived as
a conflict of interest if you indeed engaged in using your position
for any perception of personal gain?
The CHAIRMAN. With a correspondent bank?
Ms. OAKAR. Right.
Mr. LYTLE. I am not comparable to Bert Lance in that I am not a
comptroller or executive officer in the bank, I might say parenthetically.
The CHAIRMAN. Mr. Lytle, we looked—what we looked at with
Bert Lance had nothing to do with his being the Comptroller or at
OMB.
Mr. LYTLE. NO; I said a control person at the Continental Bank. I
am not an executive officer by any definition and there is a very
clear definition of that.
The bank has rules, a policy. I have never seen the bylaws of the
bank. It has rules of personal conduct and policy.
Ms. OAKAR. What do they say?




38
Mr. LYTLE. They are 15 or 20 pages.
Ms. OAKAR. Anything that relates to your requesting of a client a
half million dollar loan. This is flabbergasting to me. So many
people, you know, are probably trying to get mortgages from your
bank, just average kinds of loans. You get a half a million dollar
loan.
Mr. LYTLE. The bank doesn't discuss size at all with regard to
this area.
It specifically says you should not borrow from a correspondent
bank unless it is for certain personal needs including homes and
then gives two or three other examples, personal investments I believe is another one.
Ms. OAKAR. They do caution you about dealing with
Mr. LYTLE. They describe very carefully the parameters under
which you should deal with a correspondent bank.
Ms. OAKAR. YOU were within those parameters?
Mr. LYTLE. It was my opinion I was within those parameters.
That is correct.
Ms. OAKAR. When you mention that you had a hand shake agreement—and I am referring to your response to a question—for this
loan, what do you mean by that?
You were talking about your relationship with Mr. Patterson,
how much you trusted each other, all that.
Mr. LYTLE. A handshake agreement in my opinion means that I
have said to Bill Patterson I will supply collateral to him whenever
he asks for it.
Ms. OAKAR. Didn't you have to fill out forms like most normal
people who deal with a bank do? How did you get this loan?
Mr. LYTLE. When he asked for it, if he ever had, I would have
plenty of forms to fill out.
Ms. OAKAR. YOU mean you never filled out the normal—you were
not treated under the normal conditions that an individual who
tries to get any loan, whether it is $20,000, $5,000?
Mr. LYTLE. That is not correct at all.
Ms. OAKAR. Let alone one-half a million.
Mr. LYTLE. That is not correct at all. I completely complied with
all of the documentary requirements of an unsecured loan from
Penn Square Bank.
Ms. OAKAR. What do you mean by a hand shake
Mr. LYTLE. The hand shake relates to my commitment to Patterson to provide collateral which would convert the existing unsecured loan to a secured loan.
When you pledge real estate, as you well know, that is a lot of
documents.
Ms. OAKAR. My time has expired, but I have to say that it occurs,
at least to this member, that this was extraordinary conditions and
it certainly appears to be a conflict.
Thank you.
The CHAIRMAN. Mr. Lytle, at any point did Continental, with its
vast resources and outstanding energy team, did they at any point
have engineers and energy experts in Oklahoma City or in Oklahoma who went to the sites of these loans, energy loans, to determine
if the information and documentation from Penn Square was accurate?




39
Mr. LYTLE. Mr. Chairman, routinely in every case that I am
aware of Continental Bank's engineers made independent—that is,
independent of Penn Square—verification of the engineering information on which we made the basis of our loan values.
The CHAIRMAN. Excuse me. Let's be a little more specific. Because the board of directors down at Penn Square thought you had
engineers living there 365 days a year. Were these engineers—did
they go to Oklahoma? Did they actually look at the sites, or did
they just look at data and analyze data?
Mr. LYTLE. Site viewing doesn't really provide very much in the
way of loan value. Historical performance and engineering interpolation is what provides loan value.
Our engineers went either to the offices of the borrowing customer of Penn Square and looked at their internal records, or they
went to a third party, independent consulting petroleum engineering firm, much like an auditing or CPA firm, and looked at the records which that firm had prepared on behalf of the borrower.
Most frequently, at one time or another, they visited both offices.
Always in the case of a new customer, we would visit both the borrower and the outside engineering firm. There were some cases
where large independent oil companies did not feel the need for an
outside engineering firm.
A private firm with no SEC reporting responsibilities might hire
a purely professional staff of reservoir engineers who did all of
their inside work. In that case, Continental Bank's engineers would
go directly to that firm and obtain decline curve production information, estimates of comparable reservoirs, and form their opinion
directly as a result of their own observations.
The CHAIRMAN. Which would lead this Member to wonder about
the qualifications of that high class group that you had at Continental to evaluate.
Mr. LYTLE. Well, I can only qualify my answer by saying that I
am not privy to the details of the reported lost reserves. I have not
seen that. I also must say, in all fairness, that there has been a
very severe decline in reserve values. It was common practice a
year ago, and I say common
The CHAIRMAN. Excuse me, Mr. Lytle. I have to call on other
members.
You know, don't keep harping on the fact that the price of oil
went down. The problem at Penn Square began long before the
price of oil ever started to go down.
Mr. Weber.
Mr. WEBER. Mr. Lytle, we are here today to determine whether
there is a need for new legislation to obtain the information needed
to find out what went wrong, whether the laws and regulations on
the books today were properly executed or not properly executed,
or do we need new laws, or do our laws need to be strengthened, or
new instruments of public protection need to be provided.
You are telling us that what went wrong is a lack of notification
and disclosure. That may be the case. We may need a notification
and disclosure system rather than the longstanding policy of nondisclosure we have had under existing law.
But, before we go into that kind of a system, I think that we
need to know more about your conduct with this bank, and I am




40
not here to say whether or not the personnel policies of your bank
were violated, much less whether any violation of law occurred, but
in my judgment I will say that I cannot think of a situation in
which there was a more clear case of a conflict of interest than the
unsecured loan of $560,000 that was granted to you, whether or not
it was at market rates of interest, whether or not it was adequately
secured by your own personal net worth in that situation.
You were in a situation where apparently you were granting
loans to this bank which had given you that unsecured loan, extended that loan to you without adequate loan documentation.
Were you on the team of investigators that went to Penn Square
to determine this problem with the past due accounts?
Mr. LYTLE. NO, I was not. That was done by a group of operating,
experienced people from the loan division and from other areas of
the bank.
Mr. WEBER. Apparently they didn't turn up anything they should
have turned up if the investigation had received to the truth of the
matter. Apparently also you were extending loans on representations, oral representations that there was an unlimited guarantee
from some individual.
What I want to know is, you mentioned in response to Congresswoman Oakar's line of questioning that before extending a loan
you and your department would review the loan package, the document package. If the document package was being reviewed, why
did you in fact make advances to Penn Square on the basis of
where a documentation was missing? Especially not only the routine documentation, but especially relying on what was apparently
a guarantee which had never been shown to you?
Mr. LYTLE. I can only answer that in the second person. I did not
have the responsibility for reviewing documentation packages. I
have explained our procedure for making these loans. I very
seldom saw a document as it passed from customer to Penn Square
to us to our loan division, but I can envision a number of circumstances that I would regard as normal where a loan officer might
make a commitment based on a sufficient amount of documentation, but not full or complete documentation in the interests of
completing the transaction for some outside reason, and, as you
know, customers are always in a hurry.
We might make the commitment without full documentation.
Then follow forward later. That was the case in the failure to receive the fully—the unlimited guarantee that I referred to in my
opening statement. We also had cases where documentation was
given to us in photostat and then released by Penn Square without
our knowledge.
Ms. OAKAR. Will the gentleman yield?
Mr. WEBER. I will be happy to yield.
Ms. OAKAR. Did you approach Mr. Patterson concerning your
personal loan prior to your reviewing the Penn Square deal?
Mr. LYTLE. What do you mean by deal, Ms. Oakar?
Ms. OAKAR. The transaction between your bank and Penn
Square.
Mr. LYTLE. Well, our relationship with Penn Square was ongoing.
It began in 1978 and continued until July 5 when the bank failed.




41
Ms. OAKAR. Then let me rephrase it. I am sorry to take the gentleman's time on this.
Precisely when did you approach Mr. Patterson concerning your
own personal loan?
Mr. LYTLE. July 1980.
Ms. OAKAR. Precisely when did you have anything to do with the
Penn Square review?
Mr. LYTLE. I was a section manager in the oil and gas division
beginning in 1977. It is my recollection t h a t our first contacts with
Penn Square began in 1978.
Ms. OAKAR. When did they finally get approval of the transaction?
Mr. LYTLE. A S I said just a moment ago, we had continuing transactions.
The first transaction, if it was in 1978, would have been consummated in 1978.
Ms. OAKAR. When was the final approval? What date?
Mr. LYTLE. Of the first transaction at Continental with Penn
Square?
Ms. OAKAR. Of the final transaction.
Mr. LYTLE. July 5, 1982, I presume. We had daily contact and did
daily transactions until the bank closed. I am afraid I am not quite
following the gist of your questioning.
Ms. OAKAR. I guess my questioning relates to whether or not
part of the deal was t h a t you would get this loan and possibly be
influenced in terms of your sanctioning of the continuing relationship between your bank and Penn Square.
Mr. LYTLE. Well, I can only say t h a t we were buying loans actively before my first borrowing. When I terminated it on J a n u a r y 25,
there was no down t u r n in our activity. We, in fact, put another
quarter of a billion dollars worth of loans on after t h a t date.
Mr. WEBER. May I reclaim my time? I know my time is expiring
or has expired.
May I ask one further question? How much blame would you attribute to the poor loan documentation and the review for the
money t h a t Continental Bank lost?
Mr. LYTLE. Mr. Weber, an answer to t h a t would be a guess and
t h a t I believe would be irresponsible. I have not been in Penn
Square or reviewed the documentations t h a t led to the poor loan
documentation except on J u n e 30 and July 1.
We have had 30 people down there working 6-day weeks since
then. That is where the discoveries come from. It has not been reported to me.
If you want me to guess, I would say substantial. That is almost
an irresponsible guess because I don't know.
The CHAIRMAN. Mr. Lytle, you and Mr. Patterson, as you say,
became close personal friends. It has been brought to our attention
Penn Square did some rather lavish entertaining of customers as
well as correspondents and people in institutions like yourself t h a t
were doing business. Were you the recipient of any of this lavish
entertainment? Lavish could be—depends on the eyes of the beholder.




42
Some might say taking you to McDonald's for a hamburger was
lavish. Others might say well, it was Burger King. I don't know if
you like them stir fried, pan fried, or charcoal fried.
Did you have dinner with Mr. Patterson when he was in Chicago?
Mr. LYTLE. Quite frequently.
The CHAIRMAN. I don't know if you saw the article in Fortune
magazine, where it shows a picture of Mr. Patterson standing
there, heaving drumsticks around. In other words, he was throwing
food around the restaurant; in the Cowboy's Club in Oklahoma
City, drinking beer out of his boot. Were you ever with him when
he was a little cantankerous?
Mr. LYTLE. Yes. Apparently, if the press can be accurate—is accurate, I missed most of it, but on occasion I saw Patterson acting
cantankerous.
The CHAIRMAN. Did that give you reason to question—the people
from Manufacturers-Hanover in the Cowboy's Club saw him drinking beer out of a boot and said, "We don't want any part of that
guy."
Sometimes one looks at the activities of an individual who is supposedly a good businessman and how responsible they are after
hours as well. That didn't give you cause to pause?
Mr. LYTLE. Bill was a new business producer. He wasn't a loan
officer at Continental and he wasn't responsible for any of the decisionmaking that was made at Continental. There weren't any loans
put on at Continental by Bill Patterson. If that was his style and if
it was offensive to some—and on occasion it was to me
The CHAIRMAN. YOU found it amusing?
Mr. LYTLE. I said on occasion it was offensive to me. On occasion
I found it amusing. If that was his style, that was what made Bill
the best oil and gas new business producer in the Southwest, and
we accepted it with a grain of salt and continued to process our
loan applications in the same rigorous detail that we did in other
loans that didn't come from Penn Square.
The CHAIRMAN. Mr. Vento.

Mr. VENTO. Thank you, Mr. Chairman.
Mr. Lytle, what percentage of the oil and gas division business in
your years of experience were extended to Penn Square activities
as one of the corresponding banks that had business with you?
What percentage of the business went to that particular institution compared to the total that you had responsibility for?
Mr. LYTLE. I had, on June 30, $1,056 of overlines and direct
shared credits from Penn Square originated customers.
Of that approximately one-third was direct business and twothirds was participations.
At that date or near that date, I had $2.2 billion of outstanding
loans so that $1.2 billion was generated from other correspondent
banks and in direct credit relationships.
Mr. VENTO. Sounds like about two-thirds. Two-thirds, three-fifths
of your business in this area was solely with Penn Square?
Mr. LYTLE. Not quite. If you mean participations from Penn
Square and if we use for the record $600 million, that would be less
than one-third.




43
I should add further, when you mention oil and gas business,
that I was manager of, but one of four divisions and they all had
substantial outstandings, so that Penn Square's involvement at
Continental might have been a substantially lower percentage, 10
or 15 percent.
Mr. VENTO. Ten or fifteen percent, but a major portion of the
business that you were engaged in was with Penn Square and your
responsibility
Mr. LYTLE. Certainly in my area of responsibility.
Mr. VENTO. Were any other customers approaching that particular level?
Mr. LYTLE. NO, sir.
Mr. VENTO. Could you

give us an order of magnitude for the committee and perhaps give us more precise information for the
record?
Mr. LYTLE. I don't have it. We did not keep records of total outstandings per correspondent bank, but instead looked through the
bank in keeping with our credit analysis procedure to the borrower
himself and kept records of total outstandings per borrower or per
group of affiliated borrowers.
Mr. VENTO. I understand the dynamics, Mr. Lytle, but there is
nothing that approached that where any of them make up 5 percent of the total portfolio you had at any given time?
Mr. LYTLE. Not in my opinion and specifically not in my division.
Mr. VENTO. I understand it is a general answer. This was an extraordinary relationship that you had with this correspondent
bank in your division, is that correct?
Mr. LYTLE. Yes.
Mr. VENTO. It had

unusual characteristics in other respects, but
in any case it was very unique?
Mr. LYTLE. Yes; we had been very successful in obtaining overline business from Penn Square in spite of the perceived competition by the four or five other major banks who were trying hard to
get it all.
You will hear that later today.
Mr. VENTO. On page 3 of your statement you point out some
shortcomings of the Comptroller of the Currency, I guess, in terms
of their regulation and the fact that they did not notify you of
some of the activities. Did you ever ask for any information from
the Comptroller of the Currency?
Did you ever ask for information from them as to the status of
Penn Square Bank, its financial solvency? Its loan portfolio? Any
other information?
And were you refused or given that information?
Mr. LYTLE. The answer is no. I had no access to the Comptroller
of the Currency and never personally tried to obtain it. If the bank
did, I am not aware of it and did not have it reported to me.
Mr. VENTO. You are not aware of the bank having done that.
You did not seek—did you encourage your other officers at the
bank to make some inquiries of any regulator in terms of their
oversight responsibilities that utilized that information and
brought that to bear on the decision that you were responsible for?
Mr. LYTLE. We had no reason to be suspicious and continued to
encourage our officers to look to the ultimate borrower for full doc-




44

umentation and credit support and communication rather than
Penn Square.
Mr. VENTO. And you are satisfied within your division, the oil
and gas division at Continental, that that verification was forthcoming? You personally did not see it, but did you ever receive any
communication or any information from the employees that were
responsible to you as to any questionable verification process or
any problems with verification?
Mr. LYTLE. From time to time I was helpful to the employees in
putting a little pressure on Patterson to get this document or that.
We constantly, over the time of my responsibility, had a pipeline of
incoming documentation. What is significant is that the overall
performance by Penn Square appeared to be satisfactory.
There may have been at any given time a list of 24 things that
were needed; but 2 months later there was a list of 24 things that
were needed and only 2 of them were still on it, so that the pipeline appeared to not be sluggish and that Penn Square appeared to
be performing as had been requested.
Mr. VENTO. Mr. Lytle, one of the things that strikes me as a
little unusual is the loan program, the personal loan program you
are involved in. I understand that that is a sensitive subject.
Did you have any loans of this magnitude or seek any loans from
other correspondent banks over the history of your working as an
officer at either this institution or others, other than for a home
mortgage?
Did you seek any other types of loans of this magnitude with correspondent banks that you had a direct responsibility over or to in
your past work as an officer at any financial institution?
Mr. LYTLE. NO; I had no need to. I had no apparent desire or
need to borrow any significant amounts until I began this addition.
Penn Square was, as I have pointed out, what I thought was my
logical choice for this one, and subsequently I have reduced my indebtedness by over half, by sale of oil properties.
Mr. VENTO. YOU sought no other loans with any other correspondents that you had responsibility from or over, just from Penn
Square?
Mr. LYTLE. That's correct. They were the first ones I went to.
They said fine. That is all I went to.
The CHAIRMAN. Mr. Coyne.
Mr. JAMES COYNE. Mr. Lytle, you state in your statement that
you feel you have been made a scapegoat for the failure of Penn
Square. I am concerned about your statement that the Comptroller
of the Currency did not tell you about the bank's problems.
Following up on the question of Mr. Vento, did you ask Mr. Patterson or anybody at Penn Square whether they were being examined by the Comptroller of the Currency? Did you ask to delve into
the bank's own records as we would expect somebody who had 1
billion dollars' worth of liabilities?
Mr. LYTLE. With one exception, I did not. I asked him about the
results of the 1981 audit report which showed a writeoff of $4 million of bad loans. Bill reported to me that I believe the number was
$3 million of the $4 million were non-oil and gas loans, which I
thought was exceptional.




45
Mr. JAMES COYNE. YOU said you were surprised not to have been
told they were on the so-called watch list. Did you ever ask if they
were on the watch list?
Mr. LYTLE. NO; I did not ask him that.
Mr. JAMES COYNE. Wouldn't you think it would be prudent of
you to ask a major customer like that what their status was in the
eyes of the Comptroller?
Mr. LYTLE. NO; I have never asked any bank that.
Mr. JAMES COYNE. YOU also blamed your mistakes on the energy
marketplace, the dramatic drop in energy prices in the Oklahoma
area. Is it not true that the economists at Continental Bank early
in 1982 were saying energy prices were going to be coming down
and, of course, after early 1982, you were still making big loans
into the Anadarko Basin. Did you discuss the energy marketplace
with your bank's economist; and what kind of expert advice did
you get from him?
Mr. LYTLE. We don't have a professional petroleum economist.
We do have occasional discussions with our economists, and we
have an informal pricing committee in the oil and gas group that
had periodic discussions about prices.
In the spring of 1982 we made severe cutbacks in our estimates
of escalation of prices to the point where we stopped escalating
deep gas prices at existing contract levels.
We did not anticipate—nor did our economists—that deep gas
prices would drop the $2 to $4 that they have dropped since May.
Oil prices had already dropped the year before and we had already implemented adjustments on those.
Mr. JAMES COYNE. But you did not discuss with your economist
at the bank what his predictions were for oil prices?
Mr. LYTLE. On occasion—and I have no specific recollection of
it—we did talk to our economists about it. They sat in on our discussions of pricing.
Mr. JAMES COYNE. Did they ever give you any reason to be cautious or more cautious?
Mr. LYTLE. I don't recollect any.
Mr. JAMES COYNE. Of course, you also blame others for not fully
documenting the credit or maintaining accurate fulfillment of the
documentation.
I am interested in your 10-K of last year; there is a quote on
page 21 that brags about the emphasis of your bank on credit quality.
On page 5 you say "Our longstanding emphasis on credit quality
has become increasingly important."
On page 21, you say "The basic policy governing the management of a lending portfolio is the diversification of risk over a variety of customers, industries, and countries."
Did you not read this report, or did you not think it applied to
your division at the bank?
[The "1981 Annual Report and Form 10-K" of the Continental
Illinois Corp., parent of the Continental Illinois National Bank and
Trust Co., of Chicago may be found at the end of the hearing as
Appendix A.]
Mr. LYTLE. I can't remember reading it. If I had read it, I would
have agreed with it and felt that the $1 billion or $2 billion loan

12-745 0—83

4




46

portfolio that I managed didn't represent an intense concentration
because I felt that it was a good quality portfolio and continued to
do so up until May or July of this year.
Mr. JAMES COYNE. The reliance you placed on that was based on
the engineering studies that said you were fully collateralized?
Mr. LYTLE. That is correct.
Mr. JAMES COYNE. Did you observe engineers like DeGallier &
McNaughton make analyses of these secured collaterals?
Mr. LYTLE. Yes, sir, with the exception I mentioned earlier. We
received engineering reports either from a DeGallier & McNaughton, a Keeling or a Lawson, and then independently analyzed them
with our in-house staffs.
Mr. JAMES COYNE. SO you accepted their quantification of the reserves, but then you applied your own dollar value to the MCF?
Mr. LYTLE. Not at all. Very frequently the reason for the physical visit of my engineers to DeGallier—not to specify them in particular, but to anybody, was to make changes in the physical volumetric predictions made by DeGallier to fit our feelings about a
specific group of wells or field.
Mr. JAMES COYNE. Have any wells proven to be poorly analyzed
by them or do you feel their reserve analyses are accurate? Is it
just because the price changed so dramatically you find yourself
undercollateralized?
Mr. LYTLE. I haven't been around to see the chapter and verse of
the decline. I can tell you from personal knowledge that one of the
problems that developed has been the lack of gas takes in the Deep
Anadarko. Nobody is buying gas. I don't think the engineers are
responsible for predicting that. I don't know who should have been.
I wish we had known it.
That has been one of the problems, but I can't say with any specificity to what degree the engineers were inaccurate as to volumetric predictions as compared to dollar predictions.
Mr. JAMES COYNE. Did Ernst & Whinney ever come into your division and audit your assets?
Mr. LYTLE. I have never had any contact with any of the auditors
from Ernst & Whinney.
Mr. JAMES COYNE. SO there has never been any audit by any of
your bank's auditors?
Mr. LYTLE. I cannot agree with that, Mr. Coyne. Information
about my division is readily available to any authorized people in
the bank and our comptrollers or audit division could very easily
have supervised an outside audit.
I had no contact and no discussions on a subjective basis which
would be the only way I could help.
Mr. JAMES COYNE. Did your auditors contact Penn Square, Mr.
Patterson, or any of the people with Penn Square?
Mr. LYTLE. Yes.
Mr. JAMES COYNE.

Finally, if I may, one last question, Mr. Chairman.
Mr. LYTLE. Excuse me, Mr. Coyne. Our internal auditors contacted them. I am not aware whether Ernst & Whinney did.
Mr. JAMES COYNE. When you began with Continental 15 years
ago, did you take a credit class?




47
Mr. LYTLE. I began 23 years ago and spent the first 3 years
trying to learn credit.
Mr. JAMES COYNE. Did they ever warn you in credit class about
developing close personal relationships with major credits?
Mr. LYTLE. I can't remember.
Mr. JAMES COYNE. Did they ever warn you about the vagaries of
the commodity market and the ease with which prices can come
down in volatile commodities just as easily as they go up?
Mr. LYTLE. Probably not, but I certainly learned that over the
course of my career as a lender. I learned it again in spades this
summer.
Mr. JAMES COYNE. Finally, did the credit class teach you not to
accept the documentation provided by a lender but to demand that
you go beyond that documentation for your own independent verification?
Mr. LYTLE. It sure did. That was our practice. If you remember,
Penn Square wasn't a lender—wasn't a borrower. It was an independent oil man. We went directly to them for verification of all
our engineering.
Mr. JAMES COYNE. Could you give me the interest rates you paid
on these various loans you had during 1981 that were rolled over?
For example, the interest rate that you were paying on your
Penn Square loan, the Continental mortgage that you rolled over
to it, and the loan interest rate paid on the Community Bank loan
that basically refunded your own personal loan. Not just the rate,
but any other terms that might be relevant to the loan.
Mr. LYTLE. The rate I paid at Continental was prime, I believe.
Mr. JAMES COYNE. Your home mortgage was a prime rate floating loan?
Mr. LYTLE. This was an interim mortgage, construction facility.
It was prime rate, fixed, I believe.
Mr. JAMES COYNE. SO this was a new house then, that $170,000?
Mr. LYTLE. It is a new house in my back yard. It is part of the
house we live in.
Mr. JAMES COYNE. YOU had no mortgage then? No other mortgage?
Mr. LYTLE. I had a $17,000 mortgage that still exists.
Mr. JAMES COYNE. The prime rate was on the Continental loan.
What was the rate on the Penn Square loan?
Mr. LYTLE. First off, when I began the relationship, I asked what
the rate would be. Independently both Patterson and President
Jennings said it would be a similar rate charged by us for other
borrowers on a mortgage basis.
The facts of the rates were that they ranged from 10.5 to prime,
Oklahoma prime, which is 1 or IV2 percent over national prime.
They were different rates on each of the seven or eight notes that I
took down.
Mr. JAMES COYNE. Let's say you had seven notes then on December 1981, $490,000 with Penn Square. At the time I believe the
prime rate in the country was about 19.5 percent. What was your
rate that you were paying on that $490,000?
Mr. LYTLE. It ranged on each note. Some of it was 10.5 or 21;
others of it was as low as 11. I did a study after the fact, looking
into this, because basically I accepted Jennings and Patterson's




48
representations as true and found that on occasion I could have
borrowed on a normal mortgage rate at a lower rate from other institutions.
In most cases I found that the rate that I was borrowing at was 1
or 1V2 percent under what I perceived to be another mortgage rate
that was comparable.
Mr. JAMES COYNE. SO you felt you were getting a lower price
than you would otherwise?
Mr. LYTLE. In some cases—the dollar amount, and if you look at
the takedowns in the loans, you realize most of this borrowing occurred in the last part of 1981.
Mr. JAMES COYNE. SO you had roughly 50,000 dollars* worth of
interest liability for 1981, is that right?
Mr. LYTLE. I think it was closer to about $42,000 or $43,000.
Mr. JAMES COYNE. What was your salary from the bank during
this period that you had a $50,000 interest liability?
Mr. LYTLE. My total compensation from Continental for 1981
was—including bonuses, profit sharing, and exercise of some options—in the $125,000 range.
Mr. JAMES COYNE. HOW much was salary?
Mr. LYTLE. $69,000.
Mr. JAMES COYNE. SO you had 42,000 dollars' worth of interest on
a $69,000 salary, is that right?
Mr. LYTLE. Yes,

sir.

Mr. JAMES COYNE. Thank you, Mr. Chairman.
Mr. LYTLE. I might add, I also had drilling income in 1981.
The CHAIRMAN. Mr. Lytle, we have provided your attorney, and
he should have for you, a letter dated January 28, 1981, from you
to Bill Patterson describing certain participations involving Penn
Square, Continental, and Michigan National.
The letter reads that there was a meeting with Michigan National that determined the people were "pleased with the package of
credits you put together last November. I feel they are grateful to
you and to us for the help. As we did previously"—and now I read
slowly—"I reassured them that we would take the credits out at
maturity or whenever they felt unconfident."
That is a tacit buy-back agreement that was in effect, is that not
correct?
Mr. LYTLE. I would disagree. There was never any agreement by
Continental to buy back Michigan National loan participations.
The CHAIRMAN. What does that mean? "I reassured them that
we would take the credits out at maturity or whenever they felt
unconfident?"
Mr. LYTLE. I must point out the letter was addressed to Bill, not
Michigan National. It was a chatty update on what—we had been
responsible for introducing Michigan National to Penn Square as a
result of Michigan coming to us and asking for some overline participations from Continental. We said try Penn Square.
When this letter was called to our attention in connection with a
routine audit of Continental Bank by the Federal examiners in
May 1981, I assured the examiners at the time that there was no
such understanding, that Michigan National was purchasing directly from Penn Square, and there was no recourse against Continental.




49
The CHAIRMAN. But indeed, weren't these repurchased prior to
maturity?
Mr. LYTLE. I misunderstood the first two words.
The CHAIRMAN. Were these not repurchased prior to maturity?
Mr. LYTLE. We have never purchased any loan participations
from Michigan National.
The CHAIRMAN. Did Penn Square purchase them prior to maturity?
Mr. LYTLE. I have no knowledge of that.
The CHAIRMAN. Well, as a matter of fact, they did; they did, sir;
they did. "Thanks again for your help. I think that this is a service,
t h a t working together we can provide to others/'
Were you working for Continental Bank or were you working for
Penn Square?
Mr. LYTLE. I was very clearly working for Continental Bank and
trying to maintain our position as the lead overline correspondent
with Penn Square.
The CHAIRMAN. That means t h a t in so doing, I guess Michigan
will tell us you snared Michigan into the net. That is the way they
feel, by the way.
My point is, is it—was it your ordinary function to go out and
seek out other banks to purchase these wonderful participations for
Penn Square as an officer at Continental?
Mr. LYTLE. N O .

The CHAIRMAN. Isn't t h a t an unusual thing to do?
Mr. LYTLE. The only occasion where I got involved with introducing a third-party bank was Michigan National.
The CHAIRMAN. What did this sentence mean? "Thanks again for
your help." Which help was that? What kind of help?
Mr. LYTLE. A S I said at the beginning, this was kind of a chatty
letter to Bill I wrote just before I took a month's vacation and it
was just
The CHAIRMAN. Had he arranged for you to go fishing someplace
or something?
Mr. LYTLE. N O , sir.

The CHAIRMAN. What kind of help are you talking about?
Mr. LYTLE. I don't remember any specific reference to this help.
The CHAIRMAN. It is not a wordy letter.
Mr. LYTLE. It is pretty wordy.
The CHAIRMAN. When you see a cryptic letter, you know it has
been dictated and lined and looked at with care. For example, reading again from the letter, "I think t h a t this is a service t h a t working together we can provide to others."
What do those words mean? Is that chatty or does it have meaning? It has meaning to me.
Mr. LYTLE. I am not sure I know what it means. I might add I
have had on numerous occasions conversations both after I talked
to the examiners about this letter and prior on several occasions
with various personnel at Michigan National and all of which I reassured them if they bought participations directly from Penn
Square t h a t they were on the hook themselves and t h a t Continental had no involvement.
The CHAIRMAN. Who were the others you were going to provide
service to?




50
Mr. LYTLE. Possibly other correspondent banks.
The CHAIRMAN. I ask you again, was it part of your duties at
Continental Bank to seek out other correspondent banks on behalf
of Penn Square?
Mr. LYTLE. It was part of my duty at Continental Bank to maintain a continuing good relationship with Penn Square.
The CHAIRMAN. Would you answer my question? Was it part of
your duty to seek out other correspondents for Penn Square?
Mr. LYTLE. My answer is directly responsive. We were unable to
handle the workload of loan requests that came to us from Penn
Square in 1981 in spite of the very obvious rapid growth we had in
1981.
I didn't have the staff or numbers of experienced personnel to do
so. Therefore, introducing Patterson to other banks, turning them
loose on their own as I have stated I did with Michigan was a help
to Continental, even though the direct help was to Penn Square in
that it took the pressure off Continental to try to process more
loans than they had the personnel for.
The CHAIRMAN. What obligation did Continental have to process
loans for Penn Square?
Mr. LYTLE. We had no obligation
The CHAIRMAN. Did you receive any remuneration from Penn
Square for these added duties you took on to yourself as a service
to Penn Square and Mr. Patterson?
Mr. LYTLE. NO; specifically not. I felt the duties I took on were to
relieve the pressure on Continental because of our weak manpower
position.
The CHAIRMAN. Therefore, are you telling us Continental was
buying more loans than they could really process and that is perhaps why they had these participations frdm Penn Square that
proved to be not as valuable as they should have been?
Mr. LYTLE. I would not say so. I would say we were buying as
many loans as we had the ability to process and couldn't increase
the rate until we got more time, people, and experience.
The CHAIRMAN. At this point, I would like to put in the record,
the January 28, 1981, letter we are referring to.
[The letter referred to follows:]




51
CONTINENTAL BANK
CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY OF CHICAGO • 231 SOUTH LA SALLE STREET. CHICAGO. ILLINOIS 606S i
J0MN

January 28, 1981
J

Mr. William Patterson
Executive Vice President
Penn Square Bank
1919 Penn Square
Oklahoma City, Oklahoma 73126
Dear Bill:
Just want you t o know that Caroline Janda and her crew had
a meeting w i t h Arnold Middeldorf and h i s people a t Michigan
National and determined t h a t they are p l e a s e d with the
package of c r e d i t s that we put t o g e t h e r l a s t November. I
f e e l they are g r a t e f u l both t c you and t o U3 for the h e l p .
I t looks l i k e they are growing both i n confidence and
understanding of o i l r e l a t e d l e n d i n g , but as we did p r e v i o u s l y , I reassured then that wejwould take_the c r e d i t s out
at maturity or whenever they f e l t unconfident.
Thanks again f o r your h e l p . I think that t h i s i s a s e r v i c e ,
that working t o g e t h e r , we can provide t o o t h e r s .
Sincerely^,

liprefoici/.




i*S<s/?/

*•

L m

VICE PRES1DEH j

08173

SUBSIDIARY OF CONTINENTAL ILLINOIS CORPORATION

fi£

52
The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. Mr. Lytle, to follow up the chairman's inquiry to
you about this letter from you to Bill Patterson, and I repeat, in
that letter it says "I reassured them."
How did you reassure them? by letter? by commitment?
How did this informal agreement take place?
Mr. LYTLE. There was never any agreement by Continental to
buy back Michigan National loans. I cannot explain the meaning of
the sentence that I wrote in January 1981.
Mr. BARNARD. YOU don't feel that created an obligation?
Mr. LYTLE. Absolutely not.
Mr. BARNARD. It didn't? You said it did. "I reassured them that
we would take the credits out at maturity or whenever they felt
unconfident."
Unless all of my little knowledge is gone, I think that a formal
takeout, or even an agreement—how did you reassure these
people?
Did you do it with a letter?
Mr. LYTLE. I think you have put your finger on the exact point.
This was a letter to Bill Patterson. This was not a takeout agreement with Michigan National.
Mr. BARNARD. YOU are on record in this letter stating that you
made a commitment to Michigan National or to Mr. Arnold Middeldorf. That is not a participation.
Mr. JAMES COYNE. Would the gentleman yield to me?
I would like to know why you felt you had to tell Bill Patterson
that you had reassured these people that you would take them out.
Mr. LYTLE. I don't remember.
Mr. JAMES COYNE. Can you think about it a little bit? As a
banker, why is there any reason you would tell him that you have
reassured a third party bank that you are taking them out? Is
there any reason you can think of to do that at all?
Mr. LYTLE. This letter was brought up to me by the examiners.
They apparently dismissed it in May 1981. It was brought up again
in June 1982 by the Comptroller, and I have had plenty of time to
think about it. I do not know of any reason why I would have said
that, and to get back to Mr. Barnard's comment, it is very clearly
the opposite of an agreement. There was no agreement, and there
is nothing in writing between Continental and Michigan National
which would constitute an agreement.
Mr. BARNARD. Mr. Lytle, why were you fired?
Mr. LYTLE. I was fired because—and I am quoting—the bank lost
confidence in my managerial and credit ability. Period.
Mr. BARNARD. Were you designated as a marketing man or
market business development officer or were you a combination of
marketing and technician?
Mr. LYTLE. I am not a qualified engineer. I think the word "technician" would mean that in the oil and gas area.
Mr. BARNARD. I don't necessarily mean that. I mean anybody
that has been in the banking business 23 years has accumulated
naturally—in the position that you had—a very important responsibility. You had acquired a general knowledge of the operations of
banking, right?




53
Mr. LYTLE. Well, I was the lowest level of management in the
lending scheme at Continental. That certainly was important to
me, but it is a valid point.
Mr. BARNARD. YOU managed a portfolio of over $2 billion in
loans?
Mr. LYTLE. Correct, but it must be put in perspective at a very
large bank that it was the lowest level of management because
there was no section head in the Oklahoma side.
Second, I have and had almost no operating knowledge. I don't
understand how a loan division works or any of the operating portions of a bank.
My entire experience at Continental has been on the lending
platform as an officer and then junior manager.
Mr. BARNARD. HOW did the Penn Square Bank come to be a customer of Continental? Did you develop that relationship?
Mr. LYTLE. In 1978 I was introduced to Bill Patterson by Dennis
Wingat [phonetic] who was then the only loan officer responsible
for the State of Oklahoma and reporting to me. Mr. Winget
brought in and introduced to the bank and initiated the credit requests that constituted the beginning of our relationship.
Mr. BARNARD. Then from that point on, it developed to be your
responsibility? Were you not at some point in time suspicious or
concerned that this little small neighborhood bank in Oklahoma
City was effecting or creating a loan portfolio of over $2.5 billion?
Mr. LYTLE. Well, I wasn't suspicious of it. I was aware of it. I was
not suspicious about Penn Square's activities until
Mr. BARNARD. Isn't it unusual for a bank to have an 80 percent
concentration of loans in just one particular area? Isn't that blatantly poor bank management?
Mr. LYTLE. We brought in, Penn Square introduced a major customer to us in January of this year. I asked Bill how he did it and
how did he get it out of one of the downtown banks. Bill said, Mr.
Jennings loaned money to his daddy and the relationship goes back
three generations. That is only one impact Mr. Jennings has on the
Oklahoma oil and gas economy. He was primarily the oil and gas
lender in town and was receiving very little in the way of compensation from the downtown banks.
On numerous occasions we had borrowing requests from Penn
Square to do overline credits for directors of other banks in town,
for example
Mr. BARNARD. The point I am making is that you in your testimony have indicated that you think legislation is necessary to protect banks like the Continental. It looks to me though that the conditions were so obvious to most experienced bankers that they
themselves would have been concerned about the status of Penn
Square.
Mr. LYTLE. Penn Square had a lock on the oil and gas business in
Oklahoma. Why, I don't know. You would have to ask the
banks
Mr. BARNARD. They were not the biggest bank in Oklahoma,
were they?
Mr. LYTLE. NO, they weren't.
Mr. BARNARD. Why didn't the other banks want to lock it up?




54
Mr. LYTLE. Nor were they the only bank with competence to loan
in the oil and gas business. The fact is, and we have relationships
with a half dozen other banks in Oklahoma, is that we saw no or
little business being produced in the last IV2 years from banks
other than Penn Square. It was our only access to major portions of
new credit.
Mr. BARNARD. For the record you indicated that the Penn Square
account was brought to you by Mr. Dennis Winget.
Mr. LYTLE. Winget.
Mr. BARNARD. What happened to him?
Mr. LYTLE. He resigned from Continental in August 1981 and
went to Penn Square.
Mr. BARNARD. That is a good deal.
In your personal financial statement, evidently you must have
had a tremendous markup of all properties in 1982, because if I
read it correctly, according to the March 30 statement you decreased indebtedness by $437,000, yet your assets were not decreased but $175,000.
How did you get the money to pay off these loans?
Mr. LYTLE. I sold a substantial portion of my oil properties in
March
Mr. BARNARD. SO you had that undervalued. You showed a value
of
Mr. LYTLE. I showed values at cost I believe on my personal
Mr. BARNARD. $182,000. Then you liquidated that and that is how
you paid off the loans?
Mr. LYTLE. Yes,

sir.

The CHAIRMAN. Mr. Leach.
Mr. LEACH. Mr. Chairman, I have no questions for Mr. Lytle.
The CHAIRMAN. Mr. Lowry.
Mr. LOWRY. Thank you, Mr. Chairman.
Mr. Lytle, thank you for your testimony. I was just wondering
before I get to my question, did the other energy loan officers in
the Oklahoma banks drink beer out of their boots?
Mr. LYTLE. Not to my knowledge.
Mr. LOWRY. That may be the reason that they had the market. I
don't know.
I am concerned about the lack of time and communication between the situation that the bankers had determined in Oklahoma
and the amount of time by which that information was available in
Illinois. Your testimony says that over $500 million in loans, new
participation, were made after July 1981 when the Comptroller's
reports on Penn Square were flirting with disaster.
During that period of time, there must have been bank examinations going on with Continental on essentially the same participation loans. If examiners in Penn Square thought there was a real
problem with these loans, I wonder about examiners in the participation loans of Continental, did they state problems with these
Continental participation loans?
Mr. LYTLE. In May 1981 we completed an examination conducted
by the FDIC—by the Comptroller of the Currency's office, and
there were no Penn Square overlines cited for special mention of
any sort.




55
The next examination was in process in May and June 1982. We
had no examination in the interim. At that time there was discussion of a growing number of loans. We had had two bankruptcies
occur, one in May, one in June. And there were going to be some
names that were cited in the May 1982, or June 1982 report.
Back to your original comment, the examiners at Continental
had recourse to Continental Bank's records. They were essentially
in agreement with both my divisions opinion about the credit, and
second, Continental Bank's rating committee, quality control effort
that also looked at all of these credits.
Apparently, there was no dissatisfaction or suspicion. The flirting with disaster may not have referred to overline credits at Continental or it may have referred to the discrepancies and documentation where we thought we had something and the Penn Square
Bank had something else.
I cannot speculate any farther than that, Mr. Lowry.
Mr. LOWRY. Do you believe the performance by Continental's
participation would have been different had this information been
available to the bank examiners?
Mr. LYTLE. In all probability it would have been dramatically different. In fact, I cannot quote the individual who said it from the
Comptroller's office but he said if we let this information out, it
will be a disaster, or some words to that effect. What he meant was
probably, the overline banks would pull the strings shut and stop
and have a full examination and look at the record.
We might have a healthy Penn Square now if that had happened.
Mr. LOWRY. There are of course reasons for confidentiality requirements on the examination. As a banker, would there be a way
that with participating loans this information could have been
available to the participating bank, Continental, and still not have
been creating a big problem with the lack of confidentiality?
Do you see a way that that could be done?
Mr. LYTLE. There already is a mechanism. For example, in the
International Harvester loan, it is examined at only one bank. The
mechanism apparently is not fully implemented by the Comptroller, or maybe there are restrictions which prevent him from fully
implementing it. It may not include participation purchases rather
than joint bank credits. The latter being separate notes by each
bank rather than the purchase of a note.
My only hope is that that can be examined, strengthened if necessary and certainly implemented to a greater degree than it has
been in the past.
Mr. LOWRY. Would you suggest this committee look at oversight
responsibilities with the Comptroller as far as the exercising of
that information between the different offices?
Mr. LYTLE. Yes, sir.
Mr. LOWRY. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. McCollum of Florida.
Mr. MCCOLLUM. I will pass, Mr. Chairman.
The CHAIRMAN. Mr. Wortley.
Mr. WORTLEY. Mr. Lytle, do you think that

the loan participation
instrument is well suited for energy-related loans in an environ-




56
ment like Penn Square, where there were so many noncollateralized loans, and high charge-off rates?
Mr. LYTLE. NO.

Mr. WORTLEY. Do you have any further comment on that? Why
was your bank accepting so many, then, if you didn't think it was a
good idea yourself?
Mr. LYTLE. Well, you put it in the concept of now, not then. We
then preferred to have direct facilities as compared to overline participation facilities for a number of smaller and apparently less important reasons. But the main reason I answer emphatically is it
eliminates the possibility of the upstream bank not having authentic collateral and loan obligation documents, because they will be
party to the executions.
Mr. BARNARD. Would the gentleman yield?
Mr. WORTLEY. Ye#s, I will.
Mr. BARNARD. Isn't that up to the policy of the bank? Couldn't
the bank require that they have the proper documentation?
Mr. LYTLE. Yes,

sir.

Mr. BARNARD. And you didn't do that?
Mr. LYTLE. We were desirous of improving as many direct as we
could. But it is not clearly a legislative matter. It is a bank policy
matter.
Mr. BARNARD. That is true. And would you say that is a good
policy?
Mr. LYTLE. It certainly is.
Mr. BARNARD. TO not have the documentation, to rely completely
upon the corresponding bank.
Mr. LYTLE. I beg your pardon, sir. I misunderstood you. It is a
good policy to insist on direct original documentation.
Mr. BARNARD. But you didn't do that, did you.
Mr. LYTLE. NO, sir.

Mr. BARNARD. Was that because of your friendship with Bill Patterson?
Mr. LYTLE. NO, sir.
Mr. BARNARD. Was

that because of your confidence in Bill Patterson?
Mr. LYTLE. It was until Penn Square, fairly standard banking
practice in buying credits from smaller banks to buy on a participation basis rather than to put together
Mr. BARNARD. But you are dealing with a small bank in Oklahoma City. You are not dealing with the Michigan National Bank or
Seattle First National Bank. You are dealing with a bank that is
probably not nearly as sophisticated as Continental in lending
practices.
Aren't you letting them guide your policies?
Mr. LYTLE. Not at all. Our policy was to try to implement as
many direct credits as possible, but we bought participation loans
from banks throughout the country, both in the oil patch and outside of it. And Penn Square was no exception.
Mr. BARNARD. But there couldn't be any legislation that would
mandate that you get good documentation, could there?
Mr. LYTLE. NO, sir, I don't believe so.
Mr. BARNARD. Thank you.




57
Mr. WORTLEY. Mr. Lytle, do you think that the Penn Square
affair has affected the national corresponding banking system?
Mr. LYTLE. Yes, sir.
Mr. WORTLEY. It has been badly damaged would you
Mr. LYTLE. Yes, sir.
Mr. WORTLEY. DO you think the secondary loan

say?

market has
become inhibited as a result of this fiasco?
Mr. LYTLE. By secondary loan, you mean participation purchases?
Mr. WORTLEY. Yes.
Mr. LYTLE. Yes, sir.
Mr. WORTLEY. I yield

back the balance of my time, Mr. Chairman.
The CHAIRMAN. Mr. Schumer.
Mr. SCHUMER. Thank you, Mr. Chairman.
I think that so far these hearings have been extremely helpful in
two ways. One way which has been discussed repeatedly is alleged
conflicts of interest. I just have one question on that, Mr. Lytle. Do
you think it should be made illegal for you as a major loan officer
at Continental to take out a $500,000 loan or any loan from a bank
you are dealing with like Penn Square? Do you think that is
wrong?
Mr. LYTLE. I don't think it is wrong. Bankers have to borrow
somewhere just like everybody.
Mr. SCHUMER. I would say there are lots of banks that you were
not dealing with personally, wouldn't you say?
Mr. LYTLE. I would further recommend perhaps that reporting
responsibilities might be implementing, not in a legislative level
but at a bank policy level.
Mr. SCHUMER. YOU don't think it should be made illegal?
Mr. LYTLE. I have stated earlier the bank criticized me for this
facility fairly severely. I would have liked very much to have
known I made a wrong judgment in their opinion when I owed
$30,000 rather than when I owed $565,000, and regret not having
reported it.
Mr. SCHUMER. Thank you.
The other area which I think deserves a lot of focus is the area of
bank operations. This is a unique look for all of us into how a
major bank functions and I, quite frankly, am appalled. I don't
think a small businessman would, without some better controls, do
the kind of things that you allege Continental Illinois has done.
You say that the inspection agencies were lax—and they certainly were—but what about the bank? You mentioned that when you
found out long after buying a participation that some of the collateral for some of the loans Penn Square sold you was nonxistent or
made up. Don't you check those out? Isn't it bank policy that you
should have some written document certifying that the collateral
exists?
How does it happen? Your friend Mr. Patterson says, "Well, we
are collateralizing this with the Statue of Liberty" and you write
down "collateral"? I don't understand.
Mr. LYTLE. We check them out. We take photostatic copies of all
the documentation.




58
Mr. SCHUMER. You don't run an independent check on what a
correspondent bank says is collateral? You don't send out anybody
to check?
Mr. LYTLE. We have had audit reviews
Mr. SCHUMER. Routinely. Do you or don't you? Is that standard
policy at Continental?
Mr. LYTLE. It is standard policy to get examples of documentation, photostatic copies
Mr. SCHUMER. That is not my question.
Mr. LYTLE. Then please repeat it.
Mr. SCHUMER. IS there an independent verification of collateral?
Mr. LYTLE. By an outside
Mr. SCHUMER. By Continental in a loan Penn Square has made.
Mr. LYTLE. Our audit division is empowered to do that and does
it with correspondent banks.
Mr. SCHUMER. SO what happened here? Let's talk about Continental Illinois' audit division. Why didn't it discover that this
marina didn't exist?
Mr. LYTLE. I am not prepared to discuss that matter, not being
responsible for or involved in the audit division's activities and not
being here as a representative of Continental. I do know
Mr. SCHUMER. SO, as the loan officer, all your job entails is getting a Xeroxed copy of a loan agreement and putting it in the file
somewhere, something which by your own testimony wasn't done
too well. Is that your only responsibility?
Mr. LYTLE. Our responsibility was to forward it to the loan division who reviewed it for completeness with the help of their counsel.
Mr. SCHUMER. Did the loan division on any of these loans ever
send you information stating that the collateral didn't exist or was
exaggerated?
Mr. LYTLE. NO.
Mr. SCHUMER. NO. Why?
Mr. LYTLE. They had no

way of knowing. All they could say was
that the collateral wasn't in yet, in which case we would attempt
to obtain it as I mentioned in my earlier comments, opening comments.
Mr. SCHUMER. I am not a banker so I don't understand that.
They say the collateral wasn't in yet. What does that mean, the
marina wasn't built?
Mr. LYTLE. That means that the documentation supporting the
credit wasn't complete according to our files, and that we should
provide more information to them.
Mr. SCHUMER. In other words, but that gets to the heart of my
question. There is no independent verification? What you are just
saying is that Penn Square, because of all these loans you are
buying, hasn't sent you the actual paper. That is not what I am
asking.
I am asking if there are independent verifications; whether an
auditor just looks to see that the paper is there or whether he goes
and checks the collateral randomly, regularly, or ever?
Mr. LYTLE. I have referred to our independent internal auditing
division. Although I am not competent to comment on the degree
of their investigation. I also should mention that I have no idea of




59
the degree of investigation performed by our outside auditors,
Ernst & Whinney. There may be verification there.
All I can tell you with specificity is what my divisions and my
loan officers
Mr. SCHUMER. So you, who are in charge of roughly $2 billion of
loans, had no idea, after 23 years in the bank, of what kind of verification procedures existed? I find that appalling. I am not a businessman, but I would hope that that is not typical of the way
banks conduct business in America. I will ask the president of your
bank, I would like to ask every banker in this room, because if it is,
we are in a lot of trouble.
Mr. LYTLE. I think that characterizing it as "no idea" is entirely
inaccurate. We prepared, assembled and provided for the loan division and these subsequent outside reviewing authorities the package of loan documentation. In the case of an overline, they were
given to us by a bank instead of by a borrower.
But the question applies just as directly to a borrower
Mr. SCHUMER. SO if I am in the oil and gas business, and I say I
have, I don't know, 5 million barrels in my little oil well, and I
send in a piece of paper that says, I sign 5 million, Charles
Schumer, no one goes out and checks?
Mr. LYTLE. I may have testified to this earlier, Mr. Schumer. But
we check in every case on an example exactly like that. A qualified
Continental staff reservoir engineer physically visits the place of
records of the production that shows or made the estimate that
your 5 million barrels was in the ground
Mr. SCHUMER. Did they visit the marina? That is what I don't
understand.
I am really confused by all of that.
Mr. LYTLE. Are you satisfied with my answer about the physical
visit on the reserves?
Mr. SCHUMER. IS it done randomly?
Mr. LYTLE. It is done in every case.
Mr. SCHUMER. Every case.
Mr. LYTLE. Yes.
Mr. SCHUMER. With a
Mr. LYTLE. We don't

correspondent bank or only a direct loan?
visit a corresponding bank to determine
loan values. We visit an outside competent engineering firm or
visit the company directly. In the case of the marina as my prepared statement indicates, we didn't know we had a marina for collateral. We were told we had oil and gas leases for collateral.
Mr. SCHUMER. But my point is, you were told.
Mr. LYTLE. We were shown
Mr. SCHUMER. YOU seem in your statement to absolve youself
and everybody else because somebody lied to you. The whole idea of
an independent check is to find out whether someone is lying to
you.
Mr. LYTLE. We were told that there was oil and gas leases supporting that loan. We had no incidence or occasions where there
had been misrepresentations
Mr. SCHUMER. HOW did you know
Mr. LYTLE. Penn Square. We had no discovery of any incidents
over the 5-year relationship or 4-year



60
Mr. SCHUMER. But you never sent an outside person to investigate it because it was a corresponding bank.
Mr. LYTLE. That is not correct. We sent our audit division, outside of my division.
Mr. SCHUMER. The audit division sent independent investigators
or did it just check and see that the paper was signed right and
said something correctly?
Mr. LYTLE. The paper that I am referring to that made me think
I had oil and gas leases was in Continental Bank.
Mr. SCHUMER. Right; who said there were oil and gas leases
there?
Mr. LYTLE. The photostatic copy of the note.
Mr. SCHUMER. Signed by Penn Square?
Mr. LYTLE. NO, sir; signed by the borrower of the funds from
Penn Square. It was a Penn Square note.
Mr. SCHUMER. Then there was independent verification of that?
Mr. LYTLE. Then there was a photostatic copy of that note mailed
up to us.
Mr. SCHUMER. And no independent verification?
Mr. LYTLE. Except to the extent that our audit division visited
Penn Square and other correspondent banks and could physically
have gone to that note and said look, this note doesn't say oil and
gas leases, it says a marina, if that is the case.
That is what I was told by the examiners. There was no independent verification. That was our routine
Mr. SCHUMER. That is my point, that there was no independent
verification. I find
Mr. LYTLE. Except for that, which was fairly extensive.
The CHAIRMAN. Would the gentleman yield on that point?
Mr. SCHUMER. Yes, I yield to the chairman.
The CHAIRMAN. NOW, Mr. Lytle, who signed the note?
Mr. LYTLE. The borrower of Penn Square.
The CHAIRMAN. Who was the borrower? A fellow you knew,
wasn't it, a good friend of yours, went out drinking with him?
Mr. LYTLE. Never went out drinking with him.
The CHAIRMAN. Never went out drinking with Patterson?
Mr. LYTLE. Patterson wasn't the borrower.
The CHAIRMAN. Patterson is the one who borrowed the money
for the marina.
Mr. LYTLE. NO.
The CHAIRMAN.
Mr. LYTLE. We

Who borrowed it?
were only involved in a small portion of it. The
borrower was an independent oil and gas man who was one of his
partners. I don't know if that name has been made public, Mr. St
Germain. If it hasn't, I probably
The CHAIRMAN. Everybody's name has been made public here.
Mr. LYTLE. Then you tell me and I will confirm—
The CHAIRMAN. Well, I mean
Mr. LYTLE. We had one-third of the three, and I am quoting Fortune magazine, one-third of the three upstream facilities.
The CHAIRMAN. Pardon? I am sorry.
Mr. LYTLE. Quoting Fortune magazine, there was a $7 or $8 million investment in a marina. We funded a small portion of that,



61
either $2V2 or $3V2 million of it, on a note signed by an independent oil and gas man out of Penn Square.
The CHAIRMAN. Patterson's name was not on it?
Mr. LYTLE. N O , sir.

The CHAIRMAN. It seems I recall the board of directors of Penn
Square approving—Mr. Barnard, you were there in Oklahoma City.
Didn't the board approve loans to Patterson for the marina as
well? That seems to be my recollection.
Mr. LYTLE. Continental Bank was not involved in funding t h a t
portion of the credit. This was an unrelated funding from an independent oil man who had
The CHAIRMAN. With the marina as collateral?
Mr. LYTLE. Apparently. We were told that it was oil and gas
leases and we had other credits
The CHAIRMAN. Mr. Schumer is trying to find out how come
those wonderful engineers that were checking, verifying the oil and
gas leases couldn't tell the difference between an oil and gas lease
and a marina. Is t h a t correct, Chuck?
Mr. SCHUMER. That is what I am trying to find out, Mr. Chairman.
Mr. LYTLE. Well, I think we have got a little misunderstanding in
terms. This was a loan against oil and gas leases, not against oil
and gas reserves.
Mr. SCHUMER. But you still have to check out some collateral
Mr. LYTLE. That is correct.
Mr. SCHUMER. I mean, you seem to be—well, we didn't have the
Xerox copy. So if somebody, man on the Moon, would have sent
you a copy and just signed it, I, man on the Moon, say that this is
collateral, you would have put it in the file and everyone would
have been happy?
Mr. LYTLE. Depending on the nature of the collateral.
Mr. SCHUMER. Then the audit division would make sure it is in
the file. I wouldn't run a candy store like that.
The CHAIRMAN. Mr. Schumer, you see, if you fly in in a Lear jet,
drive up in a Mercedes convertible, you have got diamond rings on
both hands and gold chains around your neck, you are a fantastic
oil man and the loans come easy. You weren't aware of that?
Mr. SCHUMER. I am not a
The CHAIRMAN. Mr. Schumer,

I might mention to you that we
were down in Carrizo Springs, Tex., a few years ago. There was a
bank there that was so small, I could understand their making mistakes. They loaned money on half a Mercedes, on the air-conditioner in the president's wife's beauty parlor, third-hand air-conditioner.
Ms. Oakar.
Ms. OAKAR. Mr. Chairman, the gentleman, Mr. Lytle, has indicated that he feels there is corrective legislation t h a t should be enacted. I just wondered, a lot of bankers are going to say, not another layer of bureaucracy.
I wonder, do you personally hold yourself responsible in anyway,
shape or form for what you term the Penn Square debacle?
Mr. LYTLE. It is very apparent that I made some credit misjudgments in looking at some of the credits. I can't speak with any
specificity because I haven't seen the turndown.

 0—83
12-745
5


62
We had some problem credits in June, when I left the bank, and
we had them a year ago. That was part of the portfolio and part of
the job. If I could look back at any time over my past year's experience, today or a year ago today, I would have pointed out things I
would have done differently. Yes, I was involved.
The CHAIRMAN. Mr. Lytle, we want to thank you for your stimulating appearance and for your cooperation and assistance to the
committee. We may have some further written questions to send
you once we have heard from the ivory tower and others. Behind
you we have got the ivory tower about to approach the witness
table.
Mr. LYTLE. I will be happy to answer any questions, and personally speaking as an independent I have thoroughly enjoyed discussing this with you. I think some of my opinions have been changed
as a result of your questions.
Thank you.
The CHAIRMAN. Thank you, Mr. Lytle.
Now we would ask Mr. John Perkins, president; Mr. George
Baker, executive vice president; Mr. Edward Cummings, executive
vice president; Mr. James Cordell, vice president—I have got to
mention this—Texas division, oil and gas group worldwide, to approach the table.
Mr. Perkins, Mr. Baker, are we ready to stand and raise our
right hands?
[Witnesses sworn.]
The CHAIRMAN. Thank you, gentlemen.
Mr. Perkins, you have a prepared statement.
Mr. PERKINS. Yes, I do.

The CHAIRMAN. Since you have been here before, you know how
it goes and you may proceed.
TESTIMONY OF JOHN H. PERKINS, PRESIDENT, CONTINENTAL
ILLINOIS NATIONAL BANK; ACCOMPANIED BY GEORGE R.
BAKER, EXECUTIVE VICE PRESIDENT, GENERAL BANKING
SERVICES; EDWARD M. CUMMINGS EXECUTIVE VICE PRESIDENT; JAMES C. CORDELL, VICE PRESIDENT, TEXAS DIVISION,
OIL AND GAS GROUP WORLDWIDE; RICHARD S. BRENNAN, EXECUTIVE VICE PRESIDENT AND GENERAL COUNSEL; AND ROB
ERT E. L. WALKER, ASSOCIATE GENERAL COUNSEL

Mr. PERKINS. Thank you, Mr. Chairman.
Mr. Chairman and members of the committee, I am John H. Perkins, president of Continental Illinois National Bank and Trust Co.,
of Chicago. With me today are George R. Baker and Edward M.
Cummings, executive vice presidents, and James C. Cordell, senior
vice president, of Continental Bank.
Mr. Baker, as head of our general banking services group, has
principal responsibility for the corporate lending areas of the bank.
Mr. Cummings, an experienced and highly regarded senior lending officer, is a member of the committee of present and former
Continental officers, which has been charged with responsibility for
investigating the events surrounding Continental's dealings with
Penn Square Bank.




63

In his investigative role Mr. Cummings has developed considerable familiarity with the facts and history of Continental's relationship and transactions with Penn Square and its parent, First Penn
Corp.
Mr. Cordell is the widely respected head of our oil and gas
group's Texas division and the bank's senior oil and gas lending officer. He is also a petroleum engineer, has 40 years' experience in
the oil and gas industry, and is an active member of various associations of specialists in oil and gas finance and petroleum engineering.
Also here with me today are Richard S. Brennan, executive vice
president and general counsel, and Robert E. L. Walker, associate
general counsel, of Continental Illinois.
Since 1954 Continental has been a leader among banks in financing the development of this country's oil and gas resources and
lending to established and emerging businesses directly engaged in
or providing services to the oil and gas industry.
Continental has played a major role in financing the independent sector of the oil and gas producing industry and has maintained important lending relationships worldwide with most of the
oil and gas industry majors.
Virtually all lending carries risk, and lending to the oil and gas
segment of our economy is certainly no exception. However, the
record of Continental's oil and gas lending from 1954 through 1981
was exceptional. Throughout that entire period the incident of loss
was negligible.
Many emerging companies which have since become significant
factors in the oil and gas industry could not have achieved their
success if major U.S. financial institutions, such as Continental,
had not been willing to go on the line with substantial financial
support.
This has not been a one-way street. For Continental and others,
oil and gas lending has been a profitable business. From 1954
through 1981, Continental consistently enjoyed attractive returns
from its oil and gas activities.
One of our strategies over the years has been to grow with major
and vital industries which offer the bank a better than average
return on investment. The energy sector is one such industry.
Moreover, financial support of the oil and gas industry accords
with a broadly perceived public interest. Indeed, in recent years
adequate financing for domestic energy has been an essential ingredient in this country's program to reduce U.S. dependency on
foreign suppliers.
In 1978 Continental began to participate in what ultimately
became a large volume of oil and gas financings originated by Penn
Square Bank in Oklahoma. By summer of 1982, Continental held
interests in such financings aggregating approximately $1,050 million.
These were not direct loans to Penn Square Bank, although Continental did from time to time make available to Penn Square
Bank a Federal funds facility of as much as $3 to $4 million and
made available to its parent, First Penn Corp., a credit which, at
its maximum, was $7 million.



64
The CHAIRMAN. Mr. Perkins, at that point I would ask you to
hold for a moment. Staff is going to hand you some documents.
Now, you have just stated that Continental's maximum loan to
First Penn Corp., was $7 million. The first three-pajge item that I
have asked staff to give you consists of a letter dated February 24,
1982, from Frank Murphy, vice president, First Penn Corp., addressed to Continental Illinois, 231 South LaSalle Street, Chicago.
Mr. Murphy is asking that Continental verify for Peat, Marwick,
and Mitchell First Penn Corp.'s indebtedness to Continental Illinois.
As you can see, the letter indicates that the loan was for $10 million. As you will also note, that information was verified as correct
by an official of Continental Illinois National and returned to the
bank. Penn Square, that is.
The second part of the package is a copy of the loan note from
Continental Illinois, again for $10 million. The third sheet indicates
that stock backing this loan was transferred from Fidelity Bank in
Oklahoma City to Continental.
The second matter is a page from the consolidated financial
statements of First Penn Corp. for year end 1981. This page was
included in the Peat, Marwick, and Mitchell audit. It reflects that
the holding company had a note payable for $10 million at an interest rate floating with Chicago prime.
Now, Mr. Perkins, would you or one of your colleagues address
the signature on the verification? We can't seem to determine who
signed the verification. More importantly, would you clear up the
discrepancy between the amount you have just stated, maximum
amount of $7 million, and the $10 million on the note and verification?
Mr. PERKINS. I am trying to find the signature.
The CHAIRMAN. The signature is on the first page. Pardon? On
the verification, that first item that you have.
Mr. PERKINS. Mr. Chairman
The CHAIRMAN. It looks like "Surl Scholar/'
Mr. PERKINS. I really can't offer you any light on that. I don't
recognize the signature. These kinds of verifications normally
would come directly to the audit division
The CHAIRMAN. Could you see if you could identify that signature for the record?
Mr. PERKINS. Oh, yes, be glad to.
[The document referred to by Chairman St Germain requesting
Mr. Perkins verification of the signature on the first page follows:]




65
A-/

./>>:

\

1/
/!/>'/$>

Lll^i

Rt

Xfcfc
4-2>.

7^7^
T3F

Pei\i\ Square Bni\l<«
February 24, 1982

CONTINENTAL ILLINOIS
231 South LaSalle Street
Chicago, IL 60693
Dear Sir:
Peat, Marvick, Mitchell & Co., Suite 1200E, First National Center,
Oklahoma City, OK 73012, are making their usual examination of our
financial statements, and we shall be obliged, therefore, if you will
kindly confirm to them the amount of our indebtedness to you as of
the close of business on December 31, 1981. According to our records,
our indebtedness to you on that date was as follows:

Date of note:
Due date:
Original amount:
Unpaid balance:
Interest
Rate:
Date paid to:
Brief description of

September 21, 1981 S
March 31, 1982 y
$10,000,000.00 ^
$10,000,000.00
ji-l
Continental Prime .
A-l
11-23-81 ,
/ -/
collateral:
PSB Stock
Yours truly,

Frank L. Murphy/
/
Vice President
First Penn Corporation
The information stated above is (V) correct
( ) not correct
(Please give details of differences, if any.)
Signature

Title

.. f. . . . - ,
.
. . .

ar.d TriisH^^ygf Ct'.-go

Date




I s/f8A

66
Chle.,0. Ilimo... Septeriber 2 2 . 1 *
Date
ON DEMAND, the undersigned, for value received, promises to pay to the order of

-Continental Illinois National Bank and Trust Company of Chicago, at iu office m Chicago, m
m
Ten m i l l i o n and 00/100
.

.

.

.

Doll

with Interest thereon from date until paid at a rate per annum equal to the prime rata from time to time in effect ;
-0Z\
;
per annum. The term "prime rate", as used herein, shall m
at any time the rate per annum then charged by said Bank (hereinafter, together with any holder hereof, called the Bank
Chicago, Illinois, for 90-day unsecured commercial loans to large corporate customers of the highest credit standing; and
rate at which interest accrues hereon shall change from time to time concurrently with each change in the prime rata. All inte
shall be-payable 3ba>MC3y and be computed for the actual number of days elapsed on the basis of a year consisting of 360 d;
The undersigned shall have the right to prepay this Note in full or in part at any time.
The term "Collateral", as used herein, snail mean: (i) the following described property, if any:

98,354 shares of the cocmon shares of
*
*quarterly/^

Eirx* Penn £RXP&XK£XPJI

Square Bank, N.A.

/
/r/^f
~pr

(ii) any and all other property of every kind or description (a) of or in the n a m e of the undersigned now or hereafter, for any reason or purp
whatsoever, in the possession or control of, or in transit to, the Bank or any agent or bailee tor the B a n k , or (b) in w h i c h the Bank now
hereafter has a security interest securing any of the Liabilities (as hereinafter defined) pursuant to the provisions of any written agreemen
instrument other than this Note; and (iii) any a n d all dividends, distributions and other rights on or with respect to, and substitutions for i
proceeds of, any of the foregoing. T h e t e r m " L i a b i l i t i e s " , as used herein, shall m e a n all obligations of t h e undersigned under this Note i
all other obligations of the undersigned to the Bank, howsoever created, arising or e v i d e n c e d , whether direct or indirect, absolute or contingi
or now or hereafter existing, or due or to b e c o m e d u e . T h e undersigned agrees that, to secure the payment of this Note a n d all other Liabilit
the Bank shall have a lien upon a n d security interest in the Collateral and any and all b a l a n c e s , credits, deposits, accounts or mon
of or in the name of the undersigned now or hereafter w i t h the Bank; and the undersigned further agrees to deliver to t h e B a n k , upon
request, in due form for transfer, any of the Collateral which may at any time be in or come into the possession or e o n t r o t o f the undersign
T h e cancellation or surrender of this N o t e , upon payment or otherwise, shall not affect the right of the Bank to retain t h e Collateral for .
other Liabilities. The Bank shall be d e e m e d to have exercised reasonable care in the custody a n d preservation of the Collateral if H ta
such action for that purpose as the undersigned shall request in writing, but failure of the Bank to comply with any such request shall
of itself be deemed a failure to exercise reasonable care, and no failure of the Bank to preserve or protect any rights with respect to
Collateral against prior parlies, or to do any act with respect to preservation of the Collateral not so requested by the u n d e r s i g n e d , s>
be deemed a failure to exercise reasonable c a r e in the custody or preservation of the Collateral.
All obligations of the u n d e r s i g n e d , and all rights, powers and remedies of the Bank, expressed herein shall be in addition to, and
in limitation of. those provided by law or in any written agreement or instrument (other than this Note) relating 10 any of the Liabilities or i
security therefor. In addition to all ofher rights possessed by it, the Bank may from time to time, whether before or after Default (as hereina
defined), at its sole discretion and without notice to the undersigned, take any or all of the following actions: (a) transfer all or any part of
Collateral into the name of the Bank or its nominee, with or without disclosing that such Collateral is subject to the lien and security inter
hereunder; (b) notify any obligors on any of the Collateral to make payment to the Bank of any amounts d u e or to b e c o m e due with resp
thereto; (c) enforce collection of any of the Collateral by sort or otherwise, or surrender, release or e x c h a n g e all or any pari thereof; (d) t;
control of any proceeds of any of the C o l l a t e r a l ; and (e) extend or renew for one or more periods (whether or not longer t h a n the ongi
period) this Note or any obligation of any nature of any obligor with respect to this Note or any of the C o l l a t e r a l , and grant any releas
compromises or indulgences with respect to this Note or any extension or renewal thereof or any security therefor or to any obligor hereuni
or thereunder.
If the undersigned shall tail to pay, w h e n due, any amount payable with respect to any of the Liabilities or to perform any otl
obligation to the Bank, or if the undersigned or any Collateral or any balances, credits, deposits, accounts or moneys of or in the name ot
undersigned now or hereafter with the Bank shall become subject to order of any court or to any other legal process or restraint or to <
adverse cla;m, or if the Bank shall feel insecure for any reason whatsoever, such event shall constitute a Default hereunder. Upon Defa
(1) this Note and all other Liabilities may (notwithstanding any provisions thereof), at the option of the B a n k , and without d e m a n d or not
of any kind, be declared, and t h e r e u p o n immediately shall become, due and payable. (2) the Bank may. from time to t i m e , without demand
notice of any kind, appropriate and apply toward the payment of such of the Liabilities, and in such order of application, as the Bank n
from time to time elect, any and all b a l a n c e s , credits, deposits, accounts or moneys of or in the n a m e of the undersigned then or thereat
with the Bank. (3) the undersigned agrees to pay all expenses, including reasonable attorneys' tees and legal e x p e n s e s , incurred by the Br
in endeavoring to collect any of the Liabilities or to enforce its rights with respect to any ot the Collateral, a n d (4) the Bank may exercise fr
time to time any rights and remedies available to it under the Uniform Commercial C o d e as in effect from time to time in Illinois or otherw
available to fL Without limiting the f o r e g o i n g , upon Default the Bank may. to the fullest extent permitted by applicable law, without noli
advertisemenU hearing or process of taw of any kind, (a) enter upon any premises where any of the Collateral may be located and U
possession of and remove such C o l l a t e r a l , (b) sell any or all of the Collateral, free of all rights and claims of the undersigned therein e
thereto, at any public or private sale or brokers' b o a r d , and (c) bid for and purchase any or aJI of t h e Collateral at any such sale or broke
board. The undersigned hereby expressly waives presentmenL d e m a n d , notice of dishonor, protest a n d . to the fullest extent permitted
applicable law. any and all other notices, advertisements, hearings or process ot law in connection with the exercise by the Bank of any of
rights and remedies upon D e f a u l t If any notification of Intended disposition of any of the Collateral is required by law, such notification
mailed, shall be deemed reasonably and properly given If mailed at least five days belore such disposition, postage p r e p a i d , addressed to •
undersigned either at the address s h o w n below or at any other address ot the undersigned appearing on the records of the Bank. A
proceeds of any of the Collateral r e c e i v e d by the Bank may be applied by the Bank to the payment of expenses In connection with t
Collateral, including reasonable attorneys' fees and legal expend - and any balance of such proceeds m a y be applied by the Bank towi
the payment of such of the Liabilities, and in such order of application, as the Bank may from time to time elect. No delay on the part of '
Bank in the exercise of any right or r e m e d y shall operate as a waiver thereof, and no single or partial exercise by the Bank of any right
remedy shall preclude other or further exercise thereof or the exercise of any other right or remedy. If more than one party shall exec:
this Note, the term "undersigned" as used herein shall mean all parties signing this Note and each of t h e m , and alt such parties shall
Jointly and severally obligated hereunder.
The loan evidenced hereby has been made, and this Note has been delivered, at C h i c a g o . Illinois, and shall be governed by o
construed in accordance with the laws of the State of Illinois. If this Note is not dated when executed by the u n d e r s i g n e d , the Bank is here
authorized, without notice to the u n d e r s i g n e d , to date this Note as of the date w h e n the loan evidenced h e r e b y is m a d e . Wherever possll
each provision of this Nofe shall be interpreted in such manner as to be effective and valid under applicable law, but If any provision of t:
Note shall be prohibited by or invalid under such law, such provision shall be ineffective to the extent of such prohibition or Invalidity, withe
invalidating the remainder of such provision or the remaining provisions of this Note.

FIRST PENN CORPORATION
Adrift

P.O. Box 26208
Oklahoma City, Oklahoma 73126




Bill P^J^nings, President

67
CONTINENTAL BANK
CONTINENTAL ILLINOIS NATIONAL BANK AND TRUTT COMPANY OF CHICAGO
231 SOUTH LA SALLE STREET. CHICAGO. ILLINOIS 60693

(FEDERAL RESERVE FORM U-I)
FALSE OR DISHONEST STATEMENT ON THIS FORM MAY BE PUNISHABLE BY FINE OR IMPRISONMENT (US. CO
•jTTLE 15, SECTION 78ff AND TITLE 18, SECTIONS 1001, 1005 AND 1014). A BORROWER WHO FALSELY CERTIF
^ E PURPOSE OF A CREDIT ON THIS FORM OR OTHERWISE WILLFULLY OR INTENTIONALLY EVADES T
PROVISIONS OF REGULATION U WILL ALSO VIOLATE FEDERAL RESERVE REGULATION X, "RULES GOVERNI
BORROWERS WHO OBTAIN SECURITIES CREDIT".
A

j^rtrudioos:
(1) Section 221.3(a) of Regulation U requires that a statement of purpose must be obtained in connection with any extenrior
credit by a bank secured directly or indirectly by any stock. The term "slock" b defined in section 2213{f) and includes
security commonly known as a stock; any voting trust certificate;any security convertible, with or without consideration, i
such security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right.
(2) Part 1 (3) and (4) need be filled in only if the purpose of the credit described in Part I (1) is other than to purchue or c
margin stock. The term "margin slock" is defined in section 2213(v) and generally means (1) stocks that are registered c
national securities exchange and stocks that are on the Federal Reserve Board's List of OTC Margin Stocks, (2) debt securi
(bonds) that are convertible into such stocks and (3) shares of most mutual funds.
(3) Part II "Date and source of valuation" need be filled in only if such source fa other than regularly published information
journal of general circulation.
(4) Part II, except for the certification by the officer of the bank, need not be completed in the case of a credit of $5,000 or
which is not for the purpose of purchasing or carrying margin stock. However, in such cases, Part I must be completed.
(5) Please print or type (if space is inadequate attach separate sheet).

PARTI To be completed by borrower(s)
(1)

(2)

Is this credit in the amount of S
!
purchasing or carrying margin stock?'
ir •«„«« A - * * ^ * *K- e«*/-;r;^ «..™«r«
II no , describe tne specitic purpose

!

.*.
, or any part thereof, for the purpose of
„
Purchase bank stock

O

_

In addition to this credit, do you have any other outstanding credit that has been extended by
this bank, or has this bank agreed to extend additional credit to you? *

O

Is any of the collateral listed in tables (1) and (2) of Part II to be delivered, or has any such
collateral been delivered, from a bank, broker, dealer or person other than you?
i

i

(3) If "yes", from whom? .... J.. .i^. iL.*?.?L!?;.i*.

Against payment to deliverer?

0
D

(4) Has any of the collateral listed in Part II been owned less than. 30 days?
Q|
The undersigned has (have) read this form and any attachments thereto and hereby certifies and affirms that
[ the best of my (our) knowledge and belief the information contained therein is true, accurate and comple
Furthermore, to the best of my (our) knowledge, the securities listed as collateral in Part II are authentic, g?
uine, unaltered, and not stolen, forged or counterfeit
ecution of t h i s form s h a l l not c o n s t i t u t e a Bank conmltment to renew or extend a d d i t i o n a l
FIBST PENK, CORPORATION

SIGNED

_

_

(Bocrowo'i njoiturt)

-•
(Print of trp« name)

(I>rt*)

-

SIGNED

Jz£^../L^..t.r...?...r..r.
(Bocrcrwrry^satur*)

—

^y«..-BLiLL.P....JLeimiug&^P.residenL.
(Print or type r»jj»)

THIS FORM SHOULD NOT BE SIGNED IN BLANK




:....z
(Ditt)'

68
5
FIRST PENN CORPORATION
Notes to Financial Statements, Continued

During 1981, the Company sold certain of its unimproved land at a gain of
$401,000.
Also during 1981, the Company acquired the Bank's land used
principally for its drive-in facility at its recorded cost of $469,426.
(6) Deposits
Included in time deposits of the Bank at December 31, 1981 and 1980 are approximately $162,400,000 and $116,473,000 (including $32,000,000 and $8,300,000
held by First Perm Corporation), respectively, of certificates of deposit in
denominations of $100,000 or more.
Interest expense on such deposits
approximated $20,761,000 and $8,765,000 (including $1,824,000 and 270,000 on
deposits held by First Penn Corporation), for the years ended December 31,
1981 and 1980, respectively.
(7) Commercial Paper
The Company obtains funds to support its investment activities through the
issuance and sale of commercial paper.
Commercial paper aggregated
$38,674,788 (with weighted average interest rates approximating 10.942) and
$14,640,252 (with weighted average interest rates approximating 17.572) at
December 31, 1981 and 1980, respectively.
(8) Notes Payable
The following summarizes notes payable for which the Company is obligated:
1981
Interest rate floating with Dallas prime, due
February 27, 1981, secured by land with a
recorded cost of approximately $1,240,000

1980

-

1,106,800

10,000,000

7,500,000

$ 10,000,000

Interest rate floating with Chicago prime, due
on demand, secured by 98,354 shares of
Bank common stock

$

•

8,606,800

The interest at Chicago floating prime will increase by 1/22 in February 1982
with subsequent bi-annual increases of 1/42. Interest is payable quarterly.
Quarterly principal payments of $250,000 begin March 1982 with final payment
in March 1992.
(9) Income Taxes
The consolidated income tax provisions for 1981 and 1980 differ from the
normally expected income tax rate of 462 principally because of income from
tax-exempt municipal securities and investment tax credits. The income tax
benefit for the parent company represents the excess of amounts payable by
its subsidiaries in lieu of paying income taxes on a separate return basis
over the taxes payable on the consolidated return.




(Continued)

69
The CHAIRMAN. Then would you address the second part of my
question, the difference between the $7 million and the $10 million?
Mr. PERKINS. Yes; as I understand it, based particularly on what
Mr. Baker has just told me, this loan was a $10 million loan which
we were the agent for the loan, and it is on our form. We participated $3 million of this loan to the Seattle First Bank in Washington. That is my understanding. I would like to verify t h a t independently but I believe t h a t is correct.
The CHAIRMAN. Good. We will ask the Seafirst people as well and
get double verification.
I am sorry for the interruption, but you can see why we had this
little dilemma.
[Subsequent to the hearing, the following information was received from the Continental Bank for inclusion in the record:]
Pursuant to your request we have reviewed the confirmation signature appended
to the First Penn Corporation's letter to us asking for confirmation of a Peat, Marwick, Mitchell and Co. audit request, dated February 24, 1982, concerning the loan
Continental Bank had made to the First Penn. This is a standard auditing request
and our investigation shows that it was handled in a normal manner by our Operations Control Division which had the loan records of the Bank reviewed by Dyanne
Scholvin, who signed the request, confirming the original loan and current balance
outstanding of $10,000,000.00. As we explained during our testimony, we were acting
as an agent bank in the transaction with Seattle First National Bank which had
purchased $3,000,000.00 of the original loan. With an audit inquiry of this nature it
is usually not material to the auditing firm what banks may be holding portions of
the original loan since the purpose of their inquiry is to confirm an outstanding liability owed by the audited company.
Mr. PERKINS. Yes; I

can.

We were talking about what we were in effect liable for. With
these exceptions, the loans we are talking about were financial accommodations to customers developed by Penn Square Bank largely in the Oklahoma market or to borrowers who had previously
been customers of both Continental and Penn Square. I would like
to emphasize t h a t point. These were some almost 300 different
loans at the time, J u n e 30 date, to a whole series of customers, not
to the Penn Square Bank.
As one medium for establishing a lending presence in various
markets, Continental has for many years worked with, and in
many cases purchased loan participations from, local correspondent
banks operating in such markets, including a number of Oklahoma
banks.
In the late 1970's Penn Square Bank appeared to be in a favorable position to provide Continental with loan participations which
would accord Continental additional access to the Oklahoma
market for oil and gas credits. This market was comprised predominantly of independent producers; t h a t is, producers other than the
major oil and gas companies.
These Oklahoma independents tended to deal primarily with
Oklahoma-based financial institutions. Continental had over the
years enjoyed considerable success in financing oil and gas independents in various locales, including Oklahoma, and further expansion in the rapidly growing Oklahoma market seemed attractive.




70
In the period preceding the second half of 1981, primarily -because of high oil and gas prices, oil and gas exploration activity
was at a high level. Moreover, U.S. energy policy exempting deep
well gas from price control triggered a flurry of deep well drilling
which, because of the large outlays required for specialized rigs and
other added costs, resulted, even when successful, in recovery of
high cost gas.
The activity level was especially high in Oklahoma, where new
deep gas and other discoveries in the Anadarko Basin encouraged
heavy investment, the major part of which was financed.
Early in 1982 oil and gas prices dropped significantly from prior
levels, and the volume of gas purchased declined. This drastically
affected the oil and gas industry and the financing of its activities.
Drilling for high cost deep well gas has become less attractive.
Activity slackened as investment incentives were reduced and as
discoveries provided less valuable than originally thought. The
result has been a severe decline in industry activity, putting many
medium sized and smaller businesses under severe cash flow and
debt service strain.
Penn Square was a primary lender in the Oklahoma oil and gas
production industry and marketplace, and many of its loans were
adversely affected by the unexpected downturn in Oklahoma's economic fortunes.
This turn of events was obviously not favorable for Penn Square
Bank. However, Penn Square's situation did not by any means
appear to be all negative. Between 1978 and 1981 Penn Square's
parent holding company, unlike the vast majority of U.S. banking
institutions during the same period, had been successful on a
number of occasions in selling additional stock for the purpose of
increasing Penn Square's capital base.
This was especially reassuring because Penn Square Bank's
needs for additional capital were unusually large by reason of its
fast rate of asset growth over these years. In addition, Penn
Square's earnings history and rates of return on assets and capital
had been very healthy.
Penn Square had become the fifth or sixth largest bank in the
State of Oklahoma, and it appeared to be making further inroads
on its competitors there. It is true that Penn Square had had prior
auditing problems and bank examination criticisms, which were
known. However, the qualified auditors' letter regarding Penn
Square's 1980 audit, which was received in the spring of 1981, appeared to relate primarily to housekeeping matters. The same was
true of criticisms made during early 1981 by the national bank examiners.
Subsequently, moreover, Penn Square had hired a highly regarded new president and several executives with experience in back
office problems. It seemed to be making significant progress. This
progress was recognized in a satisfactory special supervisory examination completed by the national bank examiners in November
1981.
In March 1982 Penn Square received an unqualified audit for its
1981 fiscal year from Peat, Marwick, Mitchell & Co. In short, the
fact that Penn Square had a severe problem did not become appar-




71
ent until well into the national banking examiners* review, which
began in April 1982.
On June 29, 1982, Continental was notified by the Comptroller of
the Currency that the examination of Penn Square Bank had revealed very serious loan problems. On July 5, 1982, the Comptroller
closed Penn Square Bank and the FDIC took over as receiver in liquidation.
Continental's involvement in the Penn Square loans has had
severe consequences for Continental. As has been announced in the
press, at the end of the second quarter of 1982, an extraordinary
$220 million provision was made to Continental's reserve for possible loan losses, to accommodate anticipated possible losses from
Penn Square loans.
What caused all of these problems? There are several obvious
causes. The extent to which each contributed, however, is a question we are still seeking to sort out. The adverse economic events—
and the particular severity with which they impacted on the Oklahoma market—were a significant factor, as I have indicated.
Production loans to oil and gas independents which are excellent
or good credits in a period of satisfactory energy prices become
more marginal credits in a period of sustained price weakness, and
loans collateralized by rigs or other production equipment, which
are secure credits at a time when rigs are in short supply, become
much less secure when large numbers of rigs suddenly become idle
and unmarketable.
However, economic adversity was not the sole cause. The energy
credits originated by Penn Square appear to present more problems than could have been caused solely by the economic downturn, drastic as it was.
Penn Square as an originator and servicer of a large amount of
loans in which our bank participated was, to say the least, a disappointment. Not only did Penn Square fail properly to complete essential analytical and followup work necessary to underwrite, document, collateralize, and report on a number of the loans which it
originated, but Penn Square appears to have misled Continental regarding material aspects of some of the transactions, including,
among other things, the existence of collateral and secondary obligations which had been held out as the basis for some of the transactions.
In the complicated and somewhat frenzied workout which commenced hard on the heels of the closing of Penn Square, the FDIC
and the participating banks are learning more each day about the
loans which Penn Square originated.
Until this process is complete, a comprehensive assessment of the
underwriting and loan documentation deficiencies, and a detailed
chronicle of instances in which participants may have been misled
by Penn Square, cannot be made.
With regard to some of the Penn Square participations, there appears the possibility of departures by Continental personnel from
our bank's own procedures. We are in the process of reviewing and
evaluating the 300 loans in which Continental participated to determine the extent to which our personnel may have failed to adequately check and review underlying loan and collateral documentation.



72

We are also seeking to determine whether and to what extent
there are situations in which our personnel may have made hasty
credit decisions contrary to Continental's credit evaluation procedures and to what extent there have been other departures from
standard Continental procedures in specific transactions or from
other directives.
We are fully cognizant of the magnitude of the Penn Square
matter and its considerable impact on our institution. We have designated a committee of respected present and former officers of
Continental, none of whom has been otherwise involved in any way
with Penn Square, to investigate the history and circumstances of
our relationship with Penn Square, to review the performance of
Continental personnel in connection with the Penn Square transactions and to reevaluate our systems and procedures.
Our board of directors has established a special committee of unaffiliated directors to review the investigation conducted by the officers' committee. The special committee of the board has its own
outside counsel and independent auditors to advise it and has
broad powers to determine the scope of the investigation. In short,
the Penn Square matter is receiving unstinting, careful attention.
Continental, like other major banking institutions, has rigorous
and exacting procedures for credit approval and loan documentation and for periodic annual loan review of all credits. These procedures apply whether a loan is originated directly by Continental or
is a participation in a loan originated in a bank.
Although our investigation of the Penn Square transactions is
not completed, it has progressed sufficiently that I can tell you that
we believe that our problem in Penn Square was with human
error, not with the bank's procedures.
We have taken action to assure that henceforth our procedures
are systematically followed. As an additional precaution, our officers' committee, in conjunction with the special committee of nonaffiliated directors, is midway through an intensive study to determine whether additional controls are needed.
Since the closing of Penn Square Bank on July 5, 1982, Continental's management and its advisers have devoted a great deal of
time and attention to the Penn Square situation as it affects our
institution.
We believe that we are addressing our problems in an orderly
and careful manner. We believe in our basic business principles,
and we are confident that these principles, supported by the fundamental strengths of our institution and reinforced by what we have
learned from this experience, provide the basis for a successful
future.
We would be very pleased now to respond to your questions.
With your leave, I will call upon Mr. Baker, Mr. Cummings, or Mr.
Cordell to answer those questions which they are better able to address than I because of greater familiarity with Penn Square
events or other matters or more extensive knowledge of the energy
industry.
The CHAIRMAN. We are in hopefully what might prove to be, if
the Senate can get its act together on the continuing resolution,
the last week of this session prior to the eventful day known as November 2. That is a very meaningful date for many of us who sit




73
here who do have contested races. We have tried to convince our
constituents t h a t we have civil service status, but that hasn't
worked.
Under the circumstances, a lot of things are happening, and
there was no way to predict what today's schedule might be. It
turns out t h a t it is absolutely imperative t h a t there will be a conference on legislation coming within the purview of this committee
dealing with thrifts and commercials and credit unions.
Mr. PERKINS. We have heard of that.
The CHAIRMAN. I hope and trust t h a t the other witnesses who
are going to be appearing later on today after this panel are aware
of it as well.
Under the circumstances, we have to beg your indulgence and
t h a t of the members of the committee. We are now going to recess,
go into conference without benefit of sustenance, and return here
at no later t h a n 3 p.m. We would ask you if you would be good
enough to let staff know where you are going to be. If we hit a snag
and can get here before 3 p.m., I would like to resume prior to t h a t
time for the convenience of the witnesses.
So, why don't we say that in any event we will be in recess and
start at about 2 o'clock and no later t h a n 3 o'clock, but at least
about 3 o'clock we would like to have you back here, as well as the
people from Michigan National, Mr. Driggs and Mr. Peterson.
All of the witnesses t h a t are scheduled to testify today, please be
available here along about 2 o'clock—actually, it will take an hour
for this panel, so 3 o'clock. If we don't get back until 3 o'clock, we
don't start up until 3 o'clock. We have no control over that because
we will be arguing with Senators, and you never know how long
that takes.
Mr. PERKINS. Mr. Chairman, your ability in t h a t field is quite
legendary.
The CHAIRMAN. Mr. Barnard said the last one took 14 V2 minutes.
The committee will be in recess to the call of the Chair.
[Whereupon, at 12:18 p.m. the committee recessed, to reconvene
the same day at the call of the Chair.]
AFTERNOON SESSION

The CHAIRMAN. The Banking, Finance and Urban Affairs Committee will resume its sitting.
We trust you gentlemen enjoyed your respite. We worked.
Mr. PERKINS. I trust you got everything solved.
The CHAIRMAN. The conference is all over with, the papers have
been signed, the Senate is going to the floor momentarily.
Mr. Perkins, Mr. Lytle was dismissed from your institution; and
this morning, in answer to questions from the various members of
the committee as to why the dismissal, he restricted himself to repeating the statement that was issued by the bank. He was with
the bank for, what, 22, 23 years?
Mr. PERKINS. Twenty-two or twenty-three years, I believe.
The CHAIRMAN. Good employee all t h a t time?
Mr. PERKINS. That was
The CHAIRMAN. Obviously, he was promoted as time went along.
Mr. PERKINS. Yes, I would say a good employee, yes.




74
The CHAIRMAN. It seems peculiar that he restricted himself to
that statement.
Upon his departure did he take with him any pension benefits,
and so forth, or had they accrued? He was what, 53 years old?
Mr. PERKINS. Forty-seven, I think. In his late forties, I believe.
The CHAIRMAN. Does anyone at the table, among this distinguished group of individuals with you have knowledge of what the
terms of his departure were?
Mr. PERKINS. I had knowledge of that, Mr. Chairman, but I
really don't have it on the tip of my tongue.
The CHAIRMAN. HOW about Mr. Baker, Mr. Cummings?
Mr. PERKINS. The technical questions on pension plans and
things of that type get pretty complicated, and I would hesitate to
try to just call it off the top of my tongue because I really don't
remember.
The CHAIRMAN. YOU have no technicians with you that would be
familiar with that.
Mr. PERKINS. NO, that is one area we didn't think to bring along.
We have all the
The CHAIRMAN. TO be honest with you, Mr. Perkins, as I reflect
upon this morning's hearings, I asked myself, well, now I wonder
what the terms of the departure were or dismissal or severance.
Was there severance pay? Does he still get a certain amount? Is he
on pension? Is he getting an early pension?
Suppose we submit a set of questions to you on that and have
them answered in writing?
Mr. PERKINS. If you would like to submit them, I would be delighted.
[The information referred to is retained in the committee files.]
The CHAIRMAN. I can understand, you have how many employees
at your institution?
Mr. PERKINS. It is about 13,000.
The CHAIRMAN. SO you might have a bit of a problem. We don't
quarrel with that.
Now, did any of you—Mr. Perkins, did you, yourself, ever meet
any of the individuals at Penn Square Bank and sit down with
them, such as Mr. Jennings, Mr. Patterson, and any of the others,
during this period of time that the loan participations that were
being purchased from Penn Square sort of went up rather dramatically on the charts?
Mr. PERKINS. NO, I know none of them. I have never been in the
Penn Square Bank.
The CHAIRMAN. Mr. Baker.
Mr. BAKER. Yes; I met some of the people. I met Mr. Patterson
on two occasions, and Mr. Jennings on two occasions, and have
been introduced to a number of the customers.
The CHAIRMAN. Did you meet them in Chicago or in Oklahoma
City?
Mr. BAKER. Once in Chicago and once in Oklahoma City.
The CHAIRMAN. YOU did go to Oklahoma City?
Mr. BAKER. In April of this year.
The CHAIRMAN. April of this year, you were not yet aware of the
problems that existed?




75
Mr. BAKER. NO; it was a routine trip to Oklahoma City in connection with an economic briefing t h a t we were having there. Our
economists were speaking.
The CHAIRMAN. YOU went to Oklahoma City for a convention?
With all due deference to Oklahoma City, and I was there and I
didn't think they had many conventions there. You had a convention there?
Mr. BAKER. NO;, our economists go and make a presentation on
their current view of the economy in a number of cities.
The CHAIRMAN. For the benefit of the local financial institutions?
Or investors?
Mr. BAKER. Customers, banks in the area. We invite there—there
were probably 75 or 100 there that night.
Mr. PERKINS. It is part of our marketing effort.
The CHAIRMAN. A S far as the participations t h a t Continental had
that they purchased from Penn Square, what was the amount at
its high point?
Mr. PERKINS. Approximately $1,050 million.
The CHAIRMAN. $1,050 million?
Mr. PERKINS. Yes.

The CHAIRMAN. When you and I were young, Mr. Perkins, there
used to be the "Lucky Strike Hit P a r a d e / ' most people wouldn't remember that. They used to rate the songs, you know, from 1 to 10
on the list. Now they rate other things 1 to 10. But take a Lucky
Strike rating. How would you rate the amount of participation
loans purchased from Penn Square by Continental? Would they
be—these were all energy loans, correct?
Mr. PERKINS. Yes.
The CHAIRMAN. Energy-related

loans. Where would they rank on
your chart, your popularity charts at Continental?
Mr. PERKINS. In terms of total volume?
The CHAIRMAN. Yes; compared to other financial institutions
from which you were purchasing participations.
Mr. PERKINS. A S I said in my statement we have had participations with correspondents; we have been active in correspondent
banking for many, many years.
The CHAIRMAN. I am well aware of that.
Mr. PERKINS. But this situation was a statement which we made
in our July 21 press release on our financial results for the quarter, we said t h a t this was a unique situation and I believe that
same wording applies to the Penn Square situation. This is—the
amount of these participations are just—not comparable to anything else. The others tend to be figures of $20 or $25 million at the
most.
The CHAIRMAN. All right. Now, the gentleman who was here this
morning, he was given a pink slip. He seems to have been penalized. However, you know I have quite a few employees and I remember old Harry Truman said "the buck stops here." Right?
Now here is a chap down the line, as a matter of fact he obviously didn't have to report his loans he made or he sought from Penn
Square, or anything of the sort, because he wasn't considered, obviously, t h a t important at Continental. Yet he was—he seems to be
the gentleman who has taken the, you know, he has taken the
brunt of the blame. Didn't anyone, Mr. Baker—Mr. Cummings, I




76
understand you were in Europe so we couldn't ask you about it.
But Mr. Cordell, the Texan, you are the Texas expert, Mr. Baker,
and you, Mr. Perkins—don't you think t h a t you share a little of
that? Didn't that $1 billion figure come to your attention?
Mr. PERKINS. Not to my attention until last spring when it appeared in some publications. On the other hand, it had come at
various places at various times, and as I recall, Mr. Chairman,
there were several people t h a t have left the bank since t h a t time.
The CHAIRMAN. Mr. Baker.
Mr. PERKINS. Let me say, I think from the chairman on down we
all share responsibility. Obviously.
The CHAIRMAN. Mr. Baker.
Mr. BAKER. Yes,

sir.

The CHAIRMAN. Since you had met Mr. Jennings and Mr. Patterson you probably knew about the extent of the participations here.
Mr. BAKER. I knew about the magnitude of our involvement, although we were of the impression t h a t many of those were direct
loans as opposed to participations.
The CHAIRMAN. YOU were under the impression?
Mr. BAKER.

Yes.

The CHAIRMAN. Oh, t h a t is good.
Mr. Baker, did you ever meet Mr. Hefner?
Mr. BAKER. Not prior to J u n e 29. I have met him since then.
The CHAIRMAN. Mr. Swan.
Mr. BAKER. I may have met him—well, I am sure that I met him
in Oklahoma City that day we were there.
The CHAIRMAN. HOW about J. D. Allen? He was a partner of Mr.
Swan.
Mr. BAKER. I presume so, although I
The CHAIRMAN. Nothing t h a t really would have impressed you.
Mr. BAKER. NO.

The CHAIRMAN. Mr. Patterson obviously on occasion would go
into Chicago and entertain some of the people at Continental. Were
you ever the beneficiary of his lavishness, his entertainment?
Mr. BAKER. NO, I was not.
CHAIRMAN. YOU mean

The

he never took you for for a drink?

Mr. BAKER. Never.

The CHAIRMAN. Mr. Cordell, how about you and Mr. Patterson,
did you ever meet him along the way?
Mr. CORDELL. I met him probably twice, once in Chicago when I
just happened to be there, and I met him, shook his hand in the
hallway probably twice at an industry convention, and that is all I
ever recall.
The CHAIRMAN. HOW about other individuals I have asked about?
Mr. Jennings.
Mr. CORDELL. NO, sir.
The CHAIRMAN. Mr. Hefner.
Mr. CORDELL. N O , sir.
The CHAIRMAN. Mr. Swan.
Mr. CORDELL. N O , sir.
The CHAIRMAN. Mr. J. D. Allen.
Mr. CORDELL. N O , sir.
The CHAIRMAN. Mr. Cummings,

you were brought in to conduct
an inquiry, brought in from the European branch I imagine be-




77
cause you have ties, your ties were not that close with the people
working at the Chicago main office and you were brought in to conduct an inquiry and look into the overall situation. Is that correct?
Mr. CUMMINGS. To conduct it together with two other officers of
the bank and some outside people. I was the senior officer.
The CHAIRMAN. YOU were brought in to bring an unbiased view
probably because you were not as close as some individuals involved?
Mr. CUMMINGS. Well, that is right. I was not close to the Penn
Square situation or the customers at all. Of course I knew the
people in the bank.
The CHAIRMAN. Can we be sure that the microphones are on?
You have a soft typical voice, were you stationed in France or
England?
Mr. CUMMINGS. I was stationed in London, but I was responsible
for covering the Continent.
The CHAIRMAN. OK. Now, during this period of time that you
have been looking at the situation in Chicago have you made any
recommendations for change to the parent institution?
Mr. CUMMINGS. The review process we are going through really
has had two phases. We, first of all, in the phase that I was most
closely involved with was discussing the personnel side of the problem to see whether there had been failures in the management of
the various divisions and departments concerned. That phase really
has been completed and recommendations or evaluations were
made by the group that I was working with.
Now what is going on in the bank is what we call phase II of this
same review process, which is to look into the policies and procedures of the—primarily of the lending activities of the bank and
see whether there were any recommendations that should be made
for changes there.
I was really principally and only involved with the first phase
which was completed and evaluations made of the people in the
way responsibilities were carried out.
The CHAIRMAN. Mr. Annunzio.
Mr. ANNUNZIO. Thank you, Mr. Chairman.
Mr. Perkins, I have read your statement once and I have listened
to the testimony this morning, and I have listened to the testimony
in Oklahoma City. I can't help but compare, you know, when I read
some of the swindles of Yellow Kid Wild. I think that this fellow
Jennings and the other principal involved at the bank bamboozled
a lot of people, including people in Oklahoma City. It is shocking
that they got away with it for so long.
In the examination of the bank at Penn Square by the Comptroller's Office, when they examine a bank, here you are a large depositor, if you please, at Penn Square. Was there any way that you
could know what was happening? In other words, when the Comptroller of the Currency comes in and examines the books at the
Continental Illinois Bank and then at Penn Square, is there ever
any coordination?
Mr. PERKINS. Congressman, I would be hard-pressed to answer
that not knowing the inner workings of the Comptroller's Office.
We have had during these recent—these recent months we have
seen quite a bit of coordination as we are all trying to get at these

12-745 0—83

6




78
problems and work our way through it. But what they do internally or how their reports are circulated from one office to the other I
just don't know.
Mr. ANNUNZIO. The thing I am getting at is, if the Regional Director's Office of the Comptroller of the Currency in Oklahoma
City is making an examination of the books, and if they come in
with a problem, they find a severe problem—after all they did
issue a cease and desist order—don't they come back to let an institution like yours that has a couple of billion dollars invested, know
what is going on?
Mr. PERKINS. Well, as I said, I really don't know what their procedures are. As I recall, the cease and desist order that was issued
was after June 29 and at that time, from June 29 on we were in
constant communication with the Comptroller and his people as
well as with other regulatory authorities.
Mr. ANNUNZIO. Would you tell the committee just where you
stand now? In other words, the Federal Deposit Insurance Corporation has ordered this bank closed.
Mr. PERKINS. Right.
Mr. ANNUNZIO. They are in the process of liquidating assets.
How will Continental share in this liquidation?
Mr. PERKINS. I would ask Mr. Baker to answer that. He has been
working with the people there as we said earlier. We now have an
office in Oklahoma City. There are 33 or 34 people in that office.
They are working their way through this loan by loan and item by
item in cooperation with the FDIC and the other banks.
George, would you like to comment?
Mr. ANNUNZIO. Give us some idea of what the amount is that
you probably can recoup or recover?
Mr. BAKER. Well, as to the amount, Congressman, you will recall
we started out with $1,054,000,000 in loans involved in Penn Square
and in July made a provision for loss of $220 million against those
loans which would suggest that our best judgment at that point in
time was that our realization net, net would go in the magnitude of
$835 million. Obviously that is a difficult judgment to make and
can be affected by further changes in the economy, declines in gas
prices or what have you. But it will be a matter of working out a
whole series of loans.
We are involved in some 250 loans. Some of them Penn Square
has a participation in, some of which they don't. We will have a
crew of people in Oklahoma City for several years because many of
these are long-term loans that will theoretically be paid from the
production of gas.
So we are interdependent to some extent in that in some cases
the Penn Square and ourselves and the SeaFirst or the Chase might
be involved in the same situation with sometimes looking at the
same collateral, sometimes looking at different pieces of collateral,
but obviously it will require a very close coordination and cooperation. But our best judgment as to the realization has not changed.
We continue to think that it will be in the neighborhood of $835
million.
Mr. ANNUNZIO. What is the total amount of the deposits in Continental?




79
Mr. PERKINS. Well, deposits are a little difficult to measure because they adjust quite a bit when you get into Eurodollars, but
the
Mr. ANNUNZIO. Assets?
Mr. PERKINS. Assets of the bank, it runs in the $45 or $46 billion
area. The total, the loan portfolio, is commonly thought of as the
loan portfolio, is in the area of $34 billion or so.
Mr. ANNUNZIO. HOW severely can you tell, in view of the fact you
have assets between $40-some billion, and Mr. Baker estimates a
loan writeoff of $220 million?
Mr. PERKINS. Yes.

Mr. ANNUNZIO. I have read the papers, I know what their stock
reports are. But how severely have you been hurt, and is there an
opportunity to recoup if the economy changes?
Mr. PERKINS. Well, certainly if the economy were to improve and
the demand for oil and gas improve, it would help this liquidation
process. No question about that. But it is a very severe problem obviously when we have to provide $220 million as a special provision
for losses on top of the normal provision that we make quarterly.
That varies with the state of the economy.
Mr. ANNUNZIO. My time has expired, but I want to ask one question. To your knowledge, did Continental Illinois have personal
loans to any officers of Penn Square?
Mr. PERKINS. Perhaps I could ask Mr. Cummings to cover that?
Mr. CUMMINGS. NO, we did not. The loan referred to this morning to Mr. Jennings was a loan that was made and repaid, I think,
in 1978. At any rate it was before we had had any participations
from the bank. In fact, before we had the loan to the bank holding
company.
Since that loan to Mr. Jennings has been paid we have had no
other loans to officers of the Penn Square Bank.
Mr. ANNUNZIO. My time is up, Mr. Chairman.
The CHAIRMAN. Why don't you ask him what the purpose of that
loan was and the amount of it in 1978?
Mr. CUMMINGS. AS I recall that loan was—the amount was $1
million, whether it had built up to that or not, I don't know. But it
was secured by stock in, as I remember, a utility company in the
Southwest. We had no problem with that loan. It was repaid on
schedule.
The CHAIRMAN. DO you recall what the purpose of the loan was?
Mr. CUMMINGS. I believe it was to make investments in another
company.
The CHAIRMAN. Wasn't it 1978 that Jennings retook control of
Penn Square?
Mr. CUMMINGS. TO my knowledge
Mr. BAKER. Yes.
Mr. PERKINS. TO

my recollection, Congressman, it is that it was
several years before when he took control of it. The figure 1975
sticks in the back of my mind.
The CHAIRMAN. Thank you.
Mr. Weber.
Mr. WEBER. Thank you, Mr. Chairman.




80

Mr. Perkins, I notice on page 10 of your testimony the statement
that our problem in Penn Square was with human error, not with
the bank's procedures.
My question is, whose human error are you talking about? Internal error within the bank, or are you talking external error on the
part of Government supervisors? Or can you clarify that?
Mr. PERKINS. Well, what we mean by that statement is the question really, I was trying to address there is, are our basic policies
and ways of doing business and our procedures and practices as
spelled out in the way we are supposed to be doing things, are they
basically at fault or is it because some of our practices and procedures were not followed as they should have been through human
failure of one kind or another.
What I was trying to say here is that we think that basically this
was a unique situation and that as we look at the total picture we
still have a very strong situation. But in this situation there was
human failure to completely follow the practices and procedures
that are in place.
Mr. WEBER. SO basically I guess what you are saying is that the
bank had certain procedures that were good, but that you are satisfied with apparently, pending any corrections that may come
through your study; but your people apparently failed to execute
those procedures properly?
Mr. PERKINS. Yes; and of course, as I said here, our investigation
is still in place but it has been going on for some time now. That is
our conclusion at this time.
Mr. WEBER. DO you feel, based on your conclusion at this time,
that if your bank procedures had been followed, to what extent do
you feel that that would have reduced your losses?
Mr. PERKINS. I would think it would be extremely difficult to
quantify and I hesitate to do it, but I would think it would have
been sizable.
Mr. WEBER. DO you have any complaint with or recommendation
regarding changes or corrections in the Federal law or Federal regulations of any kind?
Mr. PERKINS. NO, I don't believe I would at this point. This is obviously a very, very large subject that you are all addressing in this
area. But as you well know, there are good reasons for some of the
problems, both good reasons legally and financially and otherwise,
of the confidentiality of certain types of institutions like banks and
relationships and there are other problems that you have been
raising this morning. I think I would hesitate to just try to get at
that in just a few lines.
Mr. WEBER. YOU have no particular recommendations at this
time as to legislation, then, that Congress ought to adopt?
Mr. PERKINS. NO, I don't believe so. I would be glad to address
specific things, issues, but I don't believe so.
Mr. WEBER. DO you have any fault with auditors, either at
Arthur Young Co. or Peat, Marwick, Mitchell & Co. people? I noticed
earlier in your testimony you reviewed their qualifications to their
audit report and concluded that that was basically what you called
housekeeping matters.




81
Have you made any demand upon Arthur Young or Peat Marwick with respect to recouping your losses or liabilities in this
matter?
Mr. PERKINS. NO; we have not. But I would like to ask Mr. Cummings to comment on a phase of that.
Mr. CUMMINGS. We were particularly interested in those opinions more in connection with our loan to the First Penn Corp.,
which is the holding company that owns the bank. In that area we
were—we saw, of course, and were aware of the qualified opinion
from Arthur Young which we got in the spring of 1981 and then
we followed that situation during that year to see whether the
Penn Square Bank was taking corrective measures.
As far as we could tell at the time because of the new president,
for instance, new petroleum engineers and improvements in the
backroom and other things, then the fact that there was a clean
opinion given on the audit which we received in the spring of 1982,
we were, as far as we could tell the condition within the bank was
satisfactory.
Mr. WEBER. OK.
Mr. CUMMINGS. I

would say we had no reason to be critical of the
Arthur Young or Peat Marwick audits.
Mr. WEBER. Are you saying that based on the information that
was available to you, if you had executed your own banking procedures properly you would have been well satisfied to have received
any losses in this situation? Perhaps that question isn't clear.
You have no criticisms of the way in which our laws relate to
financial disclosures in this situation. Your main criticism is the
self-criticism of the way in which your own procedures were executed?
Mr. PERKINS. Yes; in a broad way. Obviously to the extent that
we were given incorrect information or to the extent that things
were said to us on which we relied that were just plain not true or
maybe perhaps even more than that, obviously that is a different
matter.
Mr. WEBER. In connection with fraud or—were there any forgeries of instruments that you are aware of?
Mr. PERKINS. I don't believe so, but I don't believe we can answer
that question. I don't believe at this stage that that is an answerable question.
Mr. WEBER. My time has expired.
The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. Thank you, Mr. Chairman.
Mr. Perkins, just a moment ago you said that everyone in the
bank from the top echelon down shared in the responsibility. How
did you mean that?
Mr. PERKINS. Well, perhaps that was too broad a statement when
I said everyone in the bank. I think what we call the corporate
office or senior management level, different people had different
responsibilities but overall you can't be chairman or president of a
large organization without sharing some broad responsibility in
those areas at least.
Going down from that, down the chain of people that were involved, both in the lending side and in the processing auditing and




82

other sides, certainly there are degrees of responsibility in these
specific lines and channels.
Mr. BARNARD. Not meaning to put words in your mouth, what
you
Mr. PERKINS. I didn't mean that Mr. Cummings had any responsibility for it.
Mr. BARNARD. What you say is that you had in place policies and
practices of performance which normally would not have allowed a
situation like this to develop?
Mr. PERKINS. We believe that is correct.
Mr. BARNARD. And possibly somewhere along the line the checks
and balances that you had in place fell apart and
Mr. PERKINS. That was what I meant in the sense of it was a
human problem.
Mr. BARNARD. Did you have a loan review committee or a loan
administration committee that checked behind the lending officer
to be sure that all the documents were in place, somebody who was
unbiased in their dealings with the customer?
Mr. CUMMINGS. Maybe I should answer that since I have been involved in trying to review this.
Mr. BARNARD. I was thinking of Mr. Cordell because he was
working in the department. Aren't you in this department?
Mr. CUMMINGS. He is in a different division of the oil and gas
department.
Mr. BARNARD. Excuse me. I came from a country bank. I don't
know all about this.
Mr. CORDELL. I am in the oil and gas group, but I run a separate
division, and I was not involved in the midcontinent division, nor
did John Lytle work for me nor did I work directly with him. I was
in the oil and gas group in a similar position running the Texas
division.
Mr. BARNARD. What is the practice in your division? Do you have
checks and balances to examine this?
Is this a normal volume of activity, whether it be oil and gas or
any other particular lending operation? Is this a normal volume of
activity for a bank this size, a $400 million bank, generating 2.5 billion dollars worth of loans, of which your bank participated over $1
billion? Is that a normal volume for a bank this size?
Mr. CORDELL. That is a large volume from one source, but we do
not look at that bank as the entity to whom we are loaning. Each
loan and each separate note is a separate deal, and we should look
at it, we should evaluate it, and we did as a separate deal. Every
loan is looked at separately no matter whether it is a participation
or not.
Mr. BARNARD. When do you look at it, Mr. Cordell, before the
loan is made or after the loan is made? Did you know that there
were supposed to be records where the collateral value was doctored after the loan was made?
Mr. CORDELL. If those kinds of things happen, that obviously is
fraud, but you would look at the documentation and determine
whether or not it was all there before you put money out the door.
Mr. BARNARD. Well, I think I have pursued that long enough.
Did the audit and the statement of either of the auditors influence the bank at all?




83
Mr. PERKINS. The audit of the Penn Square Bank?
Mr. BARNARD. Yes; you had two audits. You had one with one
paragraph qualifying a matter and you had a second audit which
really didn't in essence offer any qualification at all. Did either one
of these letters or audits influence the bank?
Mr. PERKINS. They were obviously part of our analysis and thinking. How much it influenced the people t h a t were directly involved
one way or the other, I don't know, but it is clear from the records
t h a t these were looked at and analyzed and appraised.
Mr. BARNARD. Of course you come from one direction as far as a
participating bank, a lot of other institutions involved in this
matter, such as credit unions, who had money invested there, and
they were relying on advisers and other people.
Do you think possibly legislation should develop t h a t would put
some legal emphasis to statements of auditing firms?
Mr. PERKINS. Again, I don't feel qualified enough on that. I am
sure there has been a lot of debate on t h a t in many ways. On the
other hand, it does seem to me t h a t the responsibilities on them
are very heavy and, as you know, there is a body of court rulings
and opinions built up which do place pretty heavy responsibility.
So, I am not so sure there is—my offhand view would be t h a t
there is no need for a legal prescription on that. Nor do I think it
would be very easy to write the law.
Mr. BARNARD. Mr. Cummings, when we were in Oklahoma City
and we were talking with directors of the Penn Square Bank, to
the person, if I am correct, not one of them felt t h a t the Comptroller of the Currency should have closed this bank. Every one of
them felt t h a t the bank was sound. Every one of them said t h a t
they felt that the bank could have been salvaged.
Being bankers and knowing something of what makes a sound
bank and an unsound bank, do you think this bank should have
closed?
Mr. PERKINS. Not having been a part of all the details on the
bank or with the history of it or the data available, I would be very
hard pressed to have a firm opinion on that.
On the other hand, I did spend several days in Washington at
various meetings at the Comptroller's and the FDIC. I know an
enormous amount of analysis was made on this, and it seemed very
clear to everyone t h a t the bank was not viable.
Mr. BARNARD. Did you have any question as to why it took them
so long to make a decision if the history of this situation goes back
several years? On two occasions they asked the board of directors
to come to Dallas and discuss the very involved situation of the
bank. Maybe they threatened cease and desist, maybe they didn't.
Nobody is very clear on that.
Wouldn't you think t h a t over a period of 2V2 years it took the
Comptroller's Office a long time to make a decision?
Well, I know you are in a ticklish situation of having to criticize
the Comptroller of the Currency, but in your position you have a
better evaluation of it t h a n those of us on the committee.
Mr. PERKINS. Of course, the Comptroller has been at this many,
many years in the office, and on the whole I think the record has
been quite good. The facts of any individual situation it seems to
me are very, very difficult to appraise, and there is also an enor-




84
mous legal responsibility on the Comptroller in taking an action of
this type.
Mr. BARNARD. But in this situation, though, this delay has cost
some innocent institutions, many credit unions, one right here in
the building, hundreds of thousands, millions of dollars.
Mr. PERKINS. Well, I agree with that, and I really hesitate to
comment whether something should have been done sooner or not,
but in any case I think it is fair to say that when we are in an
economy such as we are in, it is not a risk-free economy, and I
think it is very hard to make by law or anything else a completely
risk-free situation.
Mr. BARNARD. May I have just one other question, Mr. Chairman?
The CHAIRMAN. True, but you know by the same token, Mr. Barnard, as one who has been in the hierarchy of high finance
Mr. BARNARD. Who?
The CHAIRMAN. Thee, thou. Isn't it true there is a prudent man
rule? There is prudent man rule, isn't there?
Mr. BARNARD. I understand there is one in the law.
The CHAIRMAN. I didn't want you to forget about it. You keep
telling me about it. You exercise it. I am proud of you.
Mr. BARNARD. I try to. I wish everybody on this committee did.
Mr. Perkins, do you think the bankers in this country generally
believe that the Office of the Comptroller of the Currency, those
who come within his jurisdiction, has the power to remove management if they don't correct practices that they feel are unsound?
Mr. PERKINS. Oh, I believe that the general view is they have
that ultimate power one way or another. That seems to be an issue
that is not quite all that clear from some of the things I have read
recently.
Mr. BARNARD. I told the Comptroller when he was before us, that
if he didn't think he had that power, I hoped we were in executive
session because he was turning loose every national bank in the
country if they decided that he didn't have that power.
How many other members of your bank, personnel of the bank,
officers, or otherwise, were dismissed because of Penn Square
Bank?
Mr. PERKINS. Let me see if I can call it off. In the chain above
Mr. Lytle there were three officers that resigned or retired. In the
other side, in the loan review area, the head of that group retired
and the auditor—the internal auditor that is—was reassigned and
was replaced as an auditor.
Mr. BARNARD. One final question. Do you have a policy in Continental about officers of your bank borrowing from customers, borrowing from a participating bank?
Mr. PERKINS. I need to get some recollection here. We have a
code of conduct, or whatever we want to call it, and this covers a
fairly extensive code. It covers all these kinds of issues as to how
this should or should not be done, terms and conditions, reporting
of things, things of that type, and it also requires each officer to
review it annually and sign a statement on that.
Mr. BARNARD. Thank you very much.
The CHAIRMAN. HOW frequently do you revise your code?




85
Mr. PERKINS. Could I ask one of the people that worked on it? I
think it is reviewed fairly regularly. I don't remember when the
last basic revision took place.
Mr. WALKER. We reviewed the code about 2 years ago, and I
don't believe anything was changed because it was found to be covering the problems and circumstances that we saw. The code is
probably 7 or 8 years old now. As said earlier, it was reviewed
about 2 years ago for sufficiency and was found to be adequate.
The CHAIRMAN. Has it been reviewed and changed since July of
this year?
Mr. WALKER. We have looked at it again and see no changes that
are necessary.
The CHAIRMAN. Would it be possible to supply the committee a
copy of the code of conduct?
Mr. PERKINS. Normally, we consider that a proprietary internal
matter. On the other hand, given the significance of this and given
the fact that certainly we want to be cooperative, we can probably
make that available. I would like to consult with my associates.
The CHAIRMAN. We are looking at not the entire code. We are
not concerned with that, but rather
Mr. PERKINS. I understand.
The CHAIRMAN [continuing]. Rather at the loans, loan officers
and high ranking personnel, what they would be borrowing from
correspondent banks and participating banks, whatever.
Mr. PERKINS. Let me discuss that with my associates and Mr.
Walker will get in touch with Mr. Lewis or somebody from your
staff.
The CHAIRMAN. Thank you. That would be helpful.
Mr. Baker, we on the committee have become very familiar with
the GHR. We read now about GHR in Good Hope, La. I am going
to ask unanimous consent to insert in the record a copy of an article from the Wall Street Journal of September 21, 1982, describing
the current problems of this company, which is another oil and
natural gas company—this company, by the way, is run by an
amazing gentleman named Jack Stanley, who took the company
into bankruptcy in 1975, expanded while in bankruptcy and somehow got Continental to lend him $115 million late in 1979 to get
out of bankruptcy.
This same article indicates that the creditors questioned Stanley's expansion while they were not getting paid, and introduced
the company to John Lytle. At the same time Banque de Paris,
known as PariBas, began extending letters of credit and eventually
involved none other than Chase, Seattle First National, and other
American banks along with Continental Illinois. This amazing company has about $70 million in past due bills, still owes about $20
million from its chapter 11 period, most of it to the Department of
Energy.
One company, Grinell Fire Protection Systems from Providence,
R.I., filed in court a log showing some 70 phone calls over 5 months
to GHR, trying to collect a $298,000 claim. The log says in December 1981 Grinell was being told "the till was empty". Apparently in
February of this year the cash shortage got so severe that the bottled water and coffee were taken out for nonpayment.




86
[The article from the Wall Street Journal referred to by Chairman St Germain follows:]
[From The Wall Street Journal, Sept. 21, 1982]
How

AN O I L FIRM G R E W W I T H A I D OF B I G BANKS DESPITE ITS CASH B I N D

GHR CONVINCED THE LENDERS EXPANDING ITS REFINERY WAS BEST WAY TO PROSPER
JACK STANLEY'S RAPID CLIMB

GOOD HOPE, LA.—A quarter century ago, Jack Stanley was an 18-year-old highschool dropout pumping gasoline. Today, he is the unquestioned boss and sole owner
of GHR Cos., a $3.3 billion-a-year oil and natural-gas empire t h a t ranks as the nation's third largest private industrial company.
The building of GHR often has been tumultuous. In 1975, with dozens of creditors
clamoring for money, Mr. Stanley took his company into Chapter 11 of the bankruptcy code, where it stayed for five years, expanding enormously all the while, the
GHR refinery here, one of the country's biggest, has regularly been accused of
breaking environmental laws and has suffered fires, chemical spills and worker
unrest; and even swallowed the town of Good Hope when it needed room to expand.
But such turbulence didn't stop some of the world's biggest banks from putting up
hundreds of millions of dollars to fuel Mr. Stanley's dreams. Within the last two
years, a consortium of 14 banks, headed by Continental Illinois National Bank &
Trust Co., Chase Manhattan Bank and Banque de Paris et des Pays-Bas, has lent
GHR $750 million. Now, however, the bankers are having reason to regret their
stake in this little-known empire.
UNPAID BILLS

The company's rapid expansion coincided with a decline in oil prices and demand,
and GHR is suffering a cash shortage. Dozens of suppliers that sell the company
products ranging from drilling equipment to stationery have sued GHR for millions
of dollars in unpaid bills. Fifteen percent of GHR's white-collar work force has been
laid off in the past few weeks for ''economic reasons." The company has been unable
to make its interest payments. The banks and GHR have agreed to delay repaying
part of the debt.
In an interview, Mr. Stanley acknowledges his company's cash crunch but expresses confidence t h a t the company will work out its problems. Besides obtaining
the restructured bank agreement, the company is in the process of selling $100 million of gas reserves to raise money. "I can't see any real problems," he says. "We
just need to figure out how to get a few more dollars."
But some of his bankers are less confident. Says a top executive of one lead lender
of GHR: "I wish to hell we weren't in it."
Many of the country's most aggressive banks, including Citibank, Bank of America and Security Pacific National Bank, declined to lend money to GHR last year.
Several of the banks that did lend to the company—notably Continental Illinois,
Chase and Seattle First National—have been h u r t badly by other energy-loan losses,
especially in the demise of Oklahoma City's Penn Square bank.
In GHR's case, these banks say their loans are sufficiently covered by the company's natural-gas reserves, valued at more t h a n $1 billion. But they acknowledge t h a t
trying to recover money by taking over assets is an expensive and time-consuming
process they strive mightly to avoid. Says one banker: "It's one thing to have oil and
gas in the ground and another thing to get it out."
Thus, the GHR story is in part an account of how banks have eagerly pursued
risky energy loans carrying the promise of big returns: GHR has been paying 2V2
percentage points over the prime rate. It is also a testament to the persuasive
powers of John R. Stanley.
He is an enigma, an intensely private man who regularly refuses to have his picture taken for fear it might aid would be kidnappers and endanger his wife and four
children. In nonbusiness relations, the 43-year-old Mr. Stanley is a reticent man, associates say, who shows little interest in the trappings of wealth. One exception:
three vintage J a g u a r sports cars.
A PIONEER

Some outsiders who have dealt with him speak of Mr. Stanley almost reverently.
Edwin Edwards, who while governor of Louisiana helped lure Mr. Stanley and his




87
corporate headquarters from Massachusetts says, "If you were writing an epic about
America 150 years ago he'd be the pioneer, the one who climbed the mountain, the
one who beat the odds." And a Houston banker observes, "He can make you a believer in what he wants to do."
To some employees, he is a hard-driving mean-talking boss. One former GHR geologist recalls that when he went to work at the company Mr. Stanley told him:
"I'm a greedy son of a bitch. If I ever catch you giving anything away, I'll have your
ass."
Even some bankers seem to fear him. One lending officer begs a reporter not to
quote him by name, after discussing Mr. Stanley.
Mr. Stanley is a tall man with thinning light-brown hair and boyish mannerisms;
he sometimes answers questions by shrugging his shoulders, rolling his eyes skyward, or grinning sheepishly. He is a jogger who generally avoids alcohol, seeming
to reserve indulgence for his business. He has been seen working at his refinery
until 2 a.m. At home, a computer terminal allows him to monitor the business.
Details of his early years in Springfield, Mass., are sketchy. After dropping out of
high school (he eventually received a diploma), Mr. Stanley tried a local engineering
school for two years while pumping gasoline to earn money. He quit school again
and turned his full attention to the oil business.
Mr. Stanley leased the station he worked at and called it "Jack's Gas." Later,
using the name of Gasland Inc., he acquired more stations; by 1970, he controlled
about 230 in New England and New York.
He wanted more. Soon he went into oil-and-gas exploration in Texas and bought a
small, 7,000-barrel-a-day refinery in the Louisiana town of Good Hope.
When Mr. Stanley found large natural-gas deposits in Texas, he used reserves
valued at about $200 million as collateral for bank loans to finance an ambitious
new venture: building an ammonia plant that would use his natural gas as a feedstock. Not one to start small, Mr. Stanley embarked on building what would have
been the largest ammonia plant in the country. He changed his company's name to
Good Hope Industries.
The project was never completed. The price of ammonia fell sharply. Reevaluation
of the gas reserves halved their value. As a result, a $100 million financing package
to be headed by Citibank fell through.
Banks, led by the First City National Bank of Houston, which had extended shortterm credit, began pressing for immediate repayment and urged him to sell his gas
properties for $65 million. Instead, Good Hope on Oct. 31, 1975, filed in a Massachusetts bankruptcy court for protection under Chapter 11 of the bankruptcy law,
which allows a company to continue to operate while it figures out a plan to pay its
creditors.
The move didn't appear to stunt Mr. Stanley's ambition. "Most people slim down
during bankruptcy. He had the vision to expand," says Sumner Darman, a lawyer
who represented one of the creditor committees for the proceeding. For five years
Mr. Stanley kept 2,000 creditors at bay while he poured millions of dollars into expanding his refinery. By the middle of 1980, when the company came out of bankruptcy proceedings, its assets stood at $530 million, at least double the level of five
years earlier.
COMMUNICATIONS PROBLEM

Mr. Stanley accomplished this growth by convincing his creditors that the company's survival—and their repayment—depended on his spending huge amounts on
upgrading and expanding his refinery. His banks, as secured creditors, by early 1977
were paid off the nearly $35 million they were owed; hundreds of unsecured creditors didn't receive a penny of their $35 million during the bankruptcy. (Most now
have been paid, with interest.)
On more than one occasion, creditors complained that Mr. Stanley was abusing
their forbearance. In a September 1977 letter to the court, William Neary, a creditors' lawyer, complained that the company was expanding far beyond what had
been agreed upon, raising "serious questions . . . as to the real motives of the debtor
and its objectives in this proceeding."
Says Mr. Stanley: "A lot of that was a communications problem. In a bankruptcy,
everything isn't absolutely peaches and cream."
During the Chapter 11 period, Mr. Stanley's growth continued to strain his capacity to pay for it. In a July 1978 status report, Mr. Neary wrote that he had been told
by Mr. Stanley of "a severe cash-flow problem" that was causing the company to
run "extremely late" in paying refinery bills.




The creditors, seeking a way to get off the hook, introduced the company to John
Lytle of Continental Illinois (whom the bank recently dismissed as head of its
energy lending group for his role in the Penn Square fiasco). Banque de Paris,
known as Paribas, also had struck a relationship with Good Hope Industries, issuing
letters of credit to finance oil deals.
Continental was then building a reputation that would for a time make it the
envy of the banking world. Rising oil prices had spurred the domestic oil industry,
and Continental moved aggressively to finance t h a t growth. Since the bank could
often demand rates well above prime from these untried companies, the business
was lucrative.
Continental Illinois memos show that the bank was well aware of GHR's cash
problems—and perhaps even welcomed them. One memo from Mr. Lytle noted the
company anticipated that prospective cutbacks by GHR customers "will cause a
cash problem in J a n u a r y which will force the creditors to allow some form of outside financing.''
In late 1979, Continental Illinois agreed to lend Mr. Stanley $115 million, paving
the way for Good Hope's May 1980 emergence from bankruptcy proceedings with a
plan to pay off all creditors 100 cents on the dollar over a period of years.
Continental's interest soon drew other investors, who say they were impressed by
Mr. Stanley's plans to transform his refinery into a state-of-the-art operation that
could t u r n inexpensive heavy crude into such high-value products as gasoline. They
were comforted by his sizable natural-gas reserves and his successful exploration
ventures.
In addition, "we thought Stanley was a survivor," says Donald Christie, who handles the GHR account for Paribas.
Mr. Stanley's cash requirements soon exceeded the banks' initial commitments.
Within months after lending $50 million a year ago, Chase raised its ante to $125
million. Paribas increased its loans and letters of credit to GHR to $245 million, and
Continental's exposure grew to $165 million. In December, 11 other banks were
brought in, increasing Mr. Stanley's loans to the current $750 million.
Banks that declined to lend the company money cite the generally poor condition
of the refining business. More t h a n one also indicate doubts about Mr. Stanley. One
banker, asked to elaborate, says, "I don't want to get into personalities."
Here is a list of GHR Cos. banks and the amounts they've lent the company:
List of GHR Co. Banks
Millions

Banque de Paris et des Pays-Bas
Continental Illinois National Bank & Trust Co
Chase Manhattan Bank
National Bank of Detroit
Seattle-First National Bank
North Carolina National Bank
European American Bank & Trust Co
Banque Arabe et internationale D'Investissement
Mercantile National Bank of Dallas
Industrial National Bank of Rhode Island
Canadian Commercial Bank
First National Bank & Trust Co. of Oklahoma City
American Security Bank, Washington, D.C
Capital National Bank of Houston
Total

$245
165
125
50
30
25
25
25
13
10
10
10
10
7
$750

Mr. Stanley's personality and idiosyncracies pervade GHR. The company often operates without formal budgets, former executives say. "Forget about getting a
budget," one former department head recalls being told by the accounting department. "I was just supposed to spend money until I was told to stop."
William D. Crays, GHR's executive vice president for finance, says that with the
company's rapid growth, GHR wasn't able to develop "highly sophisticated budgets." But now, he says, GHR is "trying to develop more formalized types of approach."
Former executives say Mr. Stanley inspects nearly every bill paid. He acknowleges scrutinizing bills down to $1,000. One former GHR executive recounts how,
during an 8 a.m. business meeting, he received a phone call from Mr. Stanley questioning a $20 lunch tab.




89
GHR has a stormy history of employee relations. The company has a running
battle with the Oil, Chemical and Atomic Workers union over contract and organizing issues. GHR claims individual employees have sabotaged the plant, and last
year it fired 24 workers for refusing to take lie-detector tests.
A string of executives, lured by the fat salaries Mr. Stanley offers, have come and
gone. Some quit, others were fired, many of those interviewed said working for Jack
Stanley was an experience they would rather not repeat. "Going into his office was
like walking into a cave where there's a bear with a bad migraine," one former official says.
"I don't think I have a temper," says Mr. Stanley. "But if I find something isn't
being done, I've got to do something about it."
One three-year GHR veteran who was dismissed as part of this month's cost-cutting effort says he learned of his dismissal from a curt note left on this desk telling
him he had been "terminated for economic reasons."
GHR's boardroom setup is unusual, too. Xavier J. Grilletta Sr., chairman of B &
G Crane Service Inc. of Jefferson, La., was listed as a GHR director in a company
mailing to suppliers. But Mr. Grilletta, whose company is a supplier of GHR, says,
"I've never agreed to be on the board of directors and don't consider myself a
member. Jack once told me he owed me so much money he was going to name me to
his board. I thought he was joking."
Mr. Crays says GHR sent out a "proposed list" of directors, but hasn't yet put
together a board. "Mr. Stanley is the board of directors," he says.
Supplier lawsuits against the company this year have included a $480 claim—
which was settled—for an unpaid airplane flight and many claims for hundreds of
thousands of dollars of unpaid-for drilling or refinery equipment. One supplier,
Grinnell Fire Protection Systems Co. of Providence, R.I., filed in court a log showing
some 70 phone calls it said it made to GHR over five months trying to collect a
$298,000 claim.
The log shows t h a t in December, Grinnell was being told by GHR that "the till
was empty." Last February, according to the log, a GHR employee said the cash
shortage was so severe the company's "bottled water and coffee" were taken out for
nonpayment.
In many supplier cases settled so far, the court eventually ordered (or GHR
agreed to) full payment of the claim, but the process took months and the payments
often would be stretched out.
Mr. Crays estimates GHR has about $70 million in past-due bills. Mr. Stanley says
the company is in the midst of settling them and hopes to do so in 30 days—though
payment may take longer.
Mr. Stanley's payment record has led many suppliers to demand cash on delivery
or certified checks, says a former GHR accountant. Cashing GHR checks is complicated because many are drawn on the Third National Bank of Hampden County,
located in Mr. Stanley's hometown of Springfield, Mass. Sources say W. R. Grace &
Co. several months ago delivered chemicals to the refinery and immediately flew
GHR's check to Massachusetts to cash it quickly. The check bounced anyway. A
Grace spokesman declined comment on the matter but says GHR currently doesn't
owe it any money.
GHR still owes about $20 million from its Chapter 11 period, most of it to the
federal Energy Department as a settlement of alleged oil-pricing violations in the
1970s. The Energy Department has filed a complaint with the bankruptcy court
claiming GHR violated its agreement when it failed to post a $13 million letter of
credit with the government. The department has asked that GHR either post the
letter of credit or be put in liquidation under the bankruptcy law.
Mr. Crays notes that meeting the government's demands would further strain
GHR's cash problems. Mr. Stanley says the dispute is near a compromise and dismisses the bankruptcy threat.
"Lawsuits always sound ominous, but it doesn't ever work out that way," he says.
Mr. Stanley says he wants to focus on working out the operating problems at his
refinery, which has added $500 million in new equipment over the past two years.
He talks like a man who has lost his yen to grow. "I'm 43, and enough's enough,"
he says. "I've got a good-sized company and I want to consolidate my gains and
reduce the debt."
While such words are undoubtedly welcome to his banks, some question whether
the man who built the GHR empire can slow down. "Cash-flow problems have
caused him to pull his neck in," says Tom Crooks, an official of C-E Lummus, a
Combustion Engineering Inc. unit that has worked on the GHR refinery. "But he is
always sticking it out again."




90
Mr. Grilletta, the unwilling director, echoes that idea. "Jack Stanley," he says, "is
either going to be the richest or the brokest man in the world."

The CHAIRMAN. Mr. Baker, could you tell us how Continental Illinois got involved with this intriguing situation?
Mr. BAKER. Well, I can't give you all the details of it. It occurred
in late 1979, as you indicated, and it was in Mr. Lytle's area of responsibility, although obviously a loan of that magnitude would
have other people participating in it.
Companies do in fact come out of bankruptcy, you know, as they
go into bankruptcy, and we have not been averse to financing a
company coming out of bankruptcy if it can make a logical reorganization plan.
In this case we obviously felt that there was a logical plan. Mr.
Stanley is an unusual man, as you probably also saw from that article. He started with one gas station and now has a gigantic refinery in Good Hope and very valuable gas resources in Texas.
He has been very adversely affected by the economy and the
drop in demand for crude and the throughput in his refineries, so
he has a severe cash flow problem, evidenced by the trade credit
and the bank situation and so forth.
More than that, as to the origination of the loan, I can't tell you
a great deal. I wasn't involved in it. I am now probably more involved in it than I was before.
The CHAIRMAN. NOW, do we have Mr. Brennan here?
Mr. BRENNAN. Yes.

Mr. PERKINS. Yes, he is here.
The CHAIRMAN. Mr. Brennan, I am going to ask staff to hand you
a document titled "Assignment of Overriding Royalty Interests."
Both on the first and third pages of that material you note the
GHK Exploration Co. making the royalty assignment.
Is not GHK Exploration Co., one of the interests of Mr. Robert
Hefner III? Do you recall working on this one?
Mr. BRENNAN. Yes. I am aware that—yes. GHK Exploration
Co.
The CHAIRMAN. IS it one of the interests of Robert Hefner III?
Mr. BRENNAN. GHK Exploration Co. is a partnership, an Oklahoma partnership, and Mr. Hefner I believe is the general partner.
The CHAIRMAN. On the first page, royalty interest is assigned to
a "Continental Leasing Company," a general partnership in care of
Bill Patterson, Penn Square Bank. On page 3 of the material, a
royalty interest is assigned to Continental Illinois Energy Development Corp., a Delaware corporation with a Houston address.
Are either of these Continental-named entities which received
these royalties a part of the Continental Bank of Illinois?
Mr. BRENNAN. Certainly Continental Illinois Energy Development Corp. is related to Continental Bank. Continental Illinois
Energy Development Corp. is a subsidiary of Continental Illinois
Corp., the parent company of the bank.
The CHAIRMAN. Were these royalty assignments collateral for a
loan, do you know?
Mr. BRENNAN. I believe not.
The CHAIRMAN. Or were they part of
Mr. BRENNAN. I am not familiar with this specific transaction.




91
The CHAIRMAN. DO you know if this was part of Continental's efforts at Oklahoma to go to direct rather t h a n participation loans
through another bank?
Mr. BRENNAN. May I consult with Mr. Baker?
The CHAIRMAN. Certainly.
Mr. BRENNAN. I am sorry; I ought to be familiar with this document, but I am not, and if you give me just a second to look
through it.
The CHAIRMAN. Mr. Cummings, did you at any point happen to
come upon these assignments and royalties, et cetera, et cetera?
Mr. CUMMINGS. N O , we did not. In our review we really didn't
review specific transactions loan by loan.
Mr. PERKINS. I think it fair to say, though, Mr. Chairman, that
t h a t kind of a thing wouldn't be for some purpose about direct
versus indirect or anything. That was probably a particular transaction t h a t had particular interests to our Houston subsidiary in
this field and was a direct deal entered into on a businesslike basis.
The CHAIRMAN. In view of the fact t h a t Mr. Brennan is not that
thoroughly familiar at this point, what we will do is have staff address some questions to him.
Mr. BRENNAN. We will be delighted to answer them for the
record.
[A legal document, "Assignment of Overriding Royalty Interests,"
dated April 7, 1982, was submitted for the record and may be found
at the end of the hearing as Appendix B.]
The CHAIRMAN. Mr. Perkins, did you come to Washington sometime about July 1 at the behest of the Federal supervisory agencies
to have discussions of Penn Square and its problems?
Mr. PERKINS. A S a matter of fact, I happened to be in the Maryland area on J u n e 28 or J u n e 29, and we were having a dinner
here in Washington with some customers, and when I got back to
the hotel I had a telephone call from Roger Anderson, chairman of
the bank.
He had received a call earlier in the day from the Comptroller
indicating t h a t there was a meeting of three of the banks involved
in this credit with the Comptroller of the Currency. We talked on
the phone, and we agreed t h a t I would stay overnight and go over
to the Comptroller's Office the next morning and meet with him
and his staff with the Chase and Seafirst people.
The CHAIRMAN. NOW, that was July
Mr. PERKINS. That would have been July 1. It was J u n e 29 in the
evening when I got t h a t call, or I had gotten it earlier in the day,
but I answered it then.
The CHAIRMAN. And was there any discussion as to the feasibility of salvaging Penn Square at that time during that meeting
amongst the parties involved?
Mr. PERKINS. I am trying to recall. It seemed to me t h a t the discussions, as I recall them, were not on the feasibility of salvaging
so much but rather on the form in which the closing of the bank
would take place.
The CHAIRMAN. Had they decided at t h a t point t h a t they were
closing it?
Mr. PERKINS. I really can't answer that, Mr. Chairman. There
were several days then and there were a lot of discussions, and it is




92
a little hard to separate those first couple of days from t h a t July
fourth weekend, when there were a lot of back and forth discussions.
The CHAIRMAN. NOW, we were told that Mr. Hefner, as well as
Bill Jennings, were in the office of Continental J u n e 30 seeking assistance, I think, with respect to the capital requirements.
Did you meet with them, Mr. Baker?
Mr. BAKER. N O , I did

not.

The CHAIRMAN. Mr. Perkins, you were in this area?
Mr. PERKINS. N O , I was here in Washington.
The CHAIRMAN. YOU were here. Therefore, you didn't meet with
them at t h a t time?
Mr. PERKINS. We heard they were in the bank.
The CHAIRMAN. Mr. Cummings probably had not arrived yet
from his sojourn in the British Isles.
Mr. CUMMINGS. Right.
The CHAIRMAN. Mr. Cordell, you were in Texas?
Mr. CORDELL. Yes.

The CHAIRMAN. DO you know who they met with on this occasion, Mr. Perkins?
Mr. PERKINS. It is my recollection—and again I would want to
check the facts carefully—but it is my recollection t h a t he was in
the bank and t h a t he did meet with certain people in the energy
division, including Mr. Redding, who was then head of the oil and
gas area.
Is t h a t your recollection, George, of what we heard?
Mr. BAKER. Yes, I think those people were in Chicago for a day
or two and I believe met with Mr. Lytle, Mr. Redding, and possibly
Mr. Bergman.
The CHAIRMAN. This was Jennings and Hefner t h a t went there?
Mr. BAKER. Yes.
The CHAIRMAN. NOW,

Mr. Perkins, if you had been aware of Mr.
Lytle's loan relationships with Penn Square, you know the handshake loans from Bill Patterson, what would your reaction have
been at the time that they occurred? Would you have consented to
them? What would you have said about them? Obviously you were
not aware of them at the time they occurred or transacted.
Mr. PERKINS. I was not involved in that, but I think Mr. Cummings has reviewed a good deal of that.
The CHAIRMAN. Before we get to Mr. Cummings, Mr. Perkins,
you are the chief honcho. What I am asking you is without seeing
your code of conduct, what would your feeling have been? What
would your reaction have been to it?
Mr. PERKINS. Well, very questioning and very dubious and wondering why and what? Are there conflicts? Those kinds of questions.
The CHAIRMAN. This morning you were present when we were
questioning Mr. Lytle about that.
Mr. PERKINS.

Yes.

The CHAIRMAN. He said well, you got to go to some bank. Of
course, there were 14,000 banks around the country you can go to.
So you agreed t h a t there should have been a little more discretion
exercised
Mr. PERKINS. Oh,




yes.

•

*

93
The CHAIRMAN. Rather than play buddy-buddy with Patterson.
That clouds your judgment. In other words, when somebody is
doing what appears to be a favor for you.
Mr. PERKINS. Well, I would put it on the basis that arranging the
loan situations with a bank for whom you are handling a great
deal of the business raises real questions.
The CHAIRMAN. OK.

Ms. Oakar.
Ms. OAKAR. Thank you, Mr. Chairman.
Following up on your question, in Mr. Lytle's testimony, he says
on page 8, August 30, 1982, "He was terminated. In a press release
I charged I was being made a scapegoat", and on page 8 in your
testimony, Mr. Perkins, you say the Penn Square transaction was,
to say the least, a disappointment.
"They failed to properly complete essential analytical and followup work necessary," and so forth.
They deliberately failed to provide you with information and deliberately misled Continental.
Now, what was your responsibility? What was the bank's responsibility? What was the bank's responsibility in procuring the
proper documents and analyses and indeed, is Mr. Lytle the scapegoat in this operation?
Do you assume, does your bank, beyond Mr. Lytle, assume any
responsibility for the travesty that took place?
Mr. PERKINS. Well, I believe we talked about that, I think, before
you were able to be here and clearly, there is a lot of responsibility
for this and for the fact that procedures were not carried out properly and that the
Ms. OAKAR. I am sorry I was not here, but do you blame it on
Mr. Lytle essentially, or do you assume that some other people are
responsible?
Mr. PERKINS. Mr. Cummings is the gentleman who has been involved in this investigatory process internally. I would like to ask
him to comment on that.
Mr. CUMMINGS. The point of this phase of our management
review when we were looking into the actions of our various officers was trying to see exactly where the responsibility lay and
where it might have broken down.
The way lending is handled in our bank or in any large commercial bank is, I think, basically, the responsibilities start with the account officers and the managers of a particular division where a
loan is to be examined, recommended, approved and booked.
That is, the basic responsibility lies for both making the original
credit decision and getting it approved at the proper levels and
seeing that the documentation is in good order and that the collateral has been received and is either received in-house or else it has
been proved that it is in proper condition.
Ms. OAKAR. In such a large transaction, however, wouldn't the
upper echelon of the
Mr. CUMMINGS. What I was going on to say was that beyond the
account officers and the section managers, then would be the division manager and the department managers.

12-745 0—83

7




94
Their responsibility would be principally in analyzing and approving larger loans referred to them and then, of course, they also
do have a responsibility for seeing that the
Ms. OAKAR. That the division is well managed.
Would your board of trustees get involved in a decision of approval or disapproval?
Mr. CUMMINGS. No.
Mr. PERKINS. Could

I just make a comment. There may be some
confusion. I have tried to make it clear.
This was a series of 200 and almost 300 different loan transactions ranging in amounts from several hundred thousand dollars
up to many millions and it was not a big transaction with Penn
Square so much as a series of loans, many of which came through
Penn Square.
But they were a series of individual transactions and were handled in that fashion and took place over a period of time.
Ms. OAKAR. Just one last quick question. Mr. Lytle indicated at
the end of his testimony that he felt that there was some corrective
legislation that ought to be enacted to prevent a recurrence of this
situation.
Do you agree with that?
Mr. PERKINS. NO, I don't believe I do. I think as you get into your
examination, you may or may not decide that there are certain aspects that would require something, but overall, this was a breakdown which we have been discussing and it seems to me that you
cannot legislate complete perfect performance at all times.
Ms. OAKAR. Was he the only one fired? Mr. Lytle, was he the
only one fired?
Mr. PERKINS. Depends on—well, there were a series of six or
seven people involved, Mr. Lytle was dismissed, as you say; there
were several other people, several senior officers that were either
retired or resigned.
The CHAIRMAN. MS. Oakar, it was the modern-day version—you
realize it is Chicago—of the Valentine's Day massacre.
Mr. Leach.
Mr. LEACH. Mr. Perkins, I had the privilege of joining the chairman of the committee for the session in Oklahoma City. I came to
the conclusion that perhaps Penn Square was an aberration, and I
certainly can believe that problems in the midlevel of your bank,
both with regard to judgment and perhaps conflict of interest, are
also an aberration.
The question remains, however, whether the overextension of
large banks is an aberration or whether it is a problem endemic in
American banking. It is a question as to whether Penn Square was,
in fact, the queen of spades in a house of cards that extends the
length and breadth of American banking.
You have concluded in your testimony and I quote, "that we believe our problem in Penn Square was one of human error, not
with the bank's procedures/'
Mr. PERKINS. Yes.
Mr. LEACH. I would

like to ask several questions in this regard.
Your bank has a long and distinguished history as the leading
agricultural lending bank in America. I have talked with a number
of rural bankers about Continental, and you are held in the highest




95
regard. But they also expressed to me their exasperation at the incredible loan documentation that you require with agricultural
lending. Do you think you had comparably rigid standards in the
case of your petroleum lending, particularly with regard to Penn
Square?
Mr. PERKINS. Leave out the last phrase, "particularly with
regard to Penn Square," I believe we do have the same kind of
very specific requirements.
Mr. Cordell could detail in great detail, both from an engineering
standpoint and credit standpoint, the kind of requirements we have
and I think we have probably made some banks in other areas in
the energy industry as distraught as some of our Iowa friends in
documentation and the rest.
We believe that this was a unique situation and that the failure
was in this area.
Mr. LEACH. One is left with the impression, frankly
The CHAIRMAN. He qualified his answer deleting the words
"Penn Square." Is he saying that they did not require this of Penn
Square?
Mr. PERKINS. I am saying, Mr. Chairman, that we believe we
have these same rigid standards and apply them throughout the organization, not just with Mr. Leach's Iowa friends in the agricultural area, but the breakdown in the failure was with this Penn
Square situation.
The CHAIRMAN. In other words, you did not use the same criteria
or requirements?
Mr. PERKINS. We had the same requirements and criteria but
they were not carried out.
The CHAIRMAN. OK.
Mr. LEACH. Let me pursue

this a little bit because from the perspective of an Iowan, a resident of a small-bank State, there is the
sense that small loans are subject to very rigid standards and that
the larger the loan, the less rigid the standards.
We have in the State of Iowa very strict standards regarding the
condition of our banks. In 1980, I believe, Penn Square received a
scope qualification in an audit conducted by one of the largest
American auditing firms, by an auditor who holds a very prestigious position, or did, as head of the banking audit body of the
CPA's of the country.
I would like to ask you whether that scope qualification caused
your bank any alarm and whether you took any action because of
it. A scope qualification, as I understand it, does not mean that the
bank failed to meet capital requirements, but indicates that the
auditors did not know what the loan liabilities were. What did your
bank do when you looked at this audit statement, or did you not
look at the audit statement?
Mr. PERKINS. We did—we obviously were concerned as everyone
else was. I think I should distinguish, Mr. Leach, we had two relationships in a sense, one of them was the participations in the oil
and energy and oil and gas and energy loans with the Penn Square
through the division, Mr. Lytle's division, as discussed this morning.
The other relationship, which was much smaller, was handled in
our U.S. banking division, which was loans to the Penn Square




96
Corp., the holding company, which ran as high as $7 million at the
most and then overnight, Federal funds loans, which ran $3 or $4
million.
There were considerable concerns about that audit and Mr. Cummings is very familiar with that, having reviewed that whole situation here and I would like him to comment on it, because we did
take a number of actions because of it.
Mr. CUMMINGS. A similar question was asked before you were
here, Mr. Leach, and I said that we had in mind the loan to the
First Penn Holding Co.
We discussed it with bank management, we felt satisfied they
were doing the things which had been required or recommended,
which were, first of all, they hired a new president who at the time
we understood was going to be the managing force in the bank;
they hired new people in their petroleum and engineering department and the operations end of it; we followed the review—reviewed with the management of the bank the quality of their loan
portfolio and were satisfied that things were apparently improving
and, of course, the following spring of 1982, they had a clean audit
from Peat, Marwick, Mitchell & Co.
So, in general, we thought that things were being corrected at
the bank.
Mr. LEACH. Let me pursue this.
Mr. PERKINS. We also sent some teams of our own people down to
help in and work with them to try to satisfy ourselves that things
were getting improved.
The CHAIRMAN. When?
Mr. LEACH. The chairman asked when this occurred.
The CHAIRMAN. When did you send those teams down?
Mr. Cummings, would you be good enough to get the mike a
little closer. Don't be afraid of it now, it does not bite. We are
having trouble hearing you, sir.
Mr. CUMMINGS. We sent one group of, a team from our auditing
department down in October 1981, another team in December 1981
and March or April 1981, there was a group of people from our
loan operations division that went down to work and assist with
the operating end of the bank.
Mr. LEACH. Coming back to the question of bank procedures, I
would like to go beyond that to ask whether bank policies are at
stake.
As you know, a number of banks in the country, and you are
considered a leader in this area, have placed a great deal of emphasis on growth. There is some question, however, whether growth
has occurred at the expense of prudence.
Now, hindsight is always an easy thing in this area, particularly
hindsight when the American economy turns down a bit. But in
this regard, there is one kind of dollar sign that was very interesting that Mr. Lytle presented to us.
It has been argued that some banks are not only growth oriented, but are rewarding growth-oriented employees. Mr. Lytle, for example, indicated he had a $69,000 salary, but his total remuneration from the bank amounted to about $125,000 a year.
The questions I would raise to you are: Are you reexamining
your policy of promoting growth and do you think that you and




97
other banks in your general category are rewarding growth over
prudence in terms of employee remuneration?
Mr. PERKINS. This is a very interesting question and it is certainly on the top of many bankers' discussions as to whether or not
these things relate.
I would say that in terms of the bank's total growth, our aim was
to grow soundly, to compete but to compete soundly, and in general
have a high, strong position in the industry and indeed to increase
our market share, but on the right basis.
We had always from a management policy standpoint taken the
position that we wanted to grow but we wanted to grow with quality and we didn't want growth just for growth's sake but rather
growth for the proper reason.
The second question relates to incentive compensation in the
banking industry or you can say in most any industry, but particularly the financial industry. The banking industry was probably
one of the ones for incentive compensation to come in later in the
game than anywhere else.
But as the banks and particularly the major banks began to compete more and more with all kinds of other businesses, as indeed
financial services business spread throughout all kinds of both depository and nondepository institutions and as managing the large
worldwide corporations tended to compete for the same types of
people, it was clear that we had to have certain types of incentive
plans in our business if we were going to remain competitive and
attract the first rate staff that we believe we have.
Now the question comes, how do you manage those incentive systems?
Our general incentive system is not one related to growth or production or things of that type. It is a system based on the performance of our bank in relationship and in competition with what we
call our peer banks, the top 10 banks in the country as measured
by total size.
This is for a total staff, it is not a quota type of thing, a sales
type thing at all, not at all. It is the total performance of the bank.
Indeed many of the criteria involved in appraising our record vis-avis the others have to do with the adequacy of our loan reserves,
with the quality of our credit and many of those features just
trying to avoid that situation.
I would conclude and say that we do have a few special situations where we are competing in very specialized markets where
the incentive system is tied more to appraisal of individual performance. For example, in the Federal Government, municipal, and
agency trading departments where we have a large and old and established department there, we are competing for people there not
with the general banking market, but we are competing with the
investment bankers and other trading houses, and we have had to
gear a special incentive program more in line with what we have
had because those people are very, very mobile.
Mr. LEACH. I appreciate that. Let me say coming from a small
business oriented as well as a small bank State that the rural areas
have been swept of funds by money market mutual funds and all
sorts of other means including interbank lending. We have seen
high-priced money chase higher priced money at the largest bank




98
extreme of less than perfect judgment while small banks have
made tougher, harder, more prudential decisions.
Let me come back again to your bank as any other business.
When you deal with a commercial client you deal on the basis of
dollars and cents, but you also deal on the basis of judgment. That
is, a bank deals with another company because of the people that
head that company.
Mr. PERKINS. Right.
Mr. LEACH. HOW did you as a banker and as an individual assess
Mr. Jennings and Mr. Patterson?
Mr. PERKINS. Well, as I said, I think before you came in, I do not
know either of those gentlemen and have not met them. Certainly
I think I would share what I assume is your assessment on the
basis of what I have learned since the June 29 period.
Mr. LEACH. I think it is relevant, not only because of this unique
situation, a bank operating differently from any other bank, as a
merchant bank in essence, but because of the idea that a bank's
very differentness would incline other banks to follow it carefully.
The fact that your bank has $1 billion in participation loans based
on the judgment of a young lending officer is a reflection on bank
management, which I think ought to be reassessed.
Let me go to another question. As I understand it, the day after
the regulatory authorities informed the major banks that there
was a problem with Penn Square, Seattle First made a public announcement of their potential bank lending losses. Your bank did
not immediately make a comparable announcement. Do you think
you were correct in not making an early announcement?
Mr. PERKINS. We believe we were correct, Congressman. We believe that the situation was so sudden in terms of what we were
faced with, was so large and that we had so many legal responsibilities under the Securities Acts and others that prudent judgment
would say we better know what we are, where we are before we
make some statement.
We felt that it was absolutely necessary to go through that portfolio item by item and come to conclusions as to what our loss
might be before we set such a loss. We felt it would be obviously
imprudent to have a special provision of so many hundreds and
hundreds and hundreds of millions that you just couldn't do that.
We thought it would be equally bad to make a provision that we
thought might be all right the first day and discover a couple days
later when we learned more that it should have been twice as big
and have to come back which is to destroy whatever credibility we
might have.
Mr. LEACH. I understand that. Let me ask a different question
Mr. PERKINS. Like I say, though, we felt also that we have very
serious legal responsibilities when we published our second quarter
financial statements that we had to say that in our judgment the
provision for loan losses was adequate and that is not an easy
statement to make when you are faced with that kind of situation.
Mr. LEACH. Understood.
One of the questions that a lot of us have stems from the regulatory authorities' assertion that they had problems with Penn
Square over a long period of time. Do you feel that your bank was




99
adequately informed by regulatory authorities of the difficulties at
this bank? Do you think upstream banks should have been given
far more information since Penn Square was performing a merchant banking function, or should there have been a confidential
relationship between the regulatory authorities and the bank in
question?
Mr. PERKINS. This is a very difficult and interesting question. As
you know, the whole concept of confidentiality and confidence in
financial institutions, of legal responsibilities of the regulator for
what action he takes, all of these things—and not the least of
which is if they circulate bad information or information that
doesn't turn out right and we act the other way, we might hurt
somebody badly that would or should not have been hurt and
would have a legal claim there.
So there are a lot of good reasons for confidentiality, not the
least of which is the National Bank Act says so, for the comptroller.
But having said that, you get an interesting question when you
get to this special nature of upstream participations and frankly, it
is our feeling that we have to be responsible for what we do. We
cannot go blaming this person or that person. But that was a very
interesting thought and concept; I am sure that will need and get a
lot of review.
Mr. LEACH. It has been alleged that Continental had loan officers
on a permanent basis at Penn Square. Did your bank operate that
way? Did you have what in essence were desks at Penn Square?
Mr. PERKINS. That statement has been made and we do not believe we did. Perhaps Mr. Cummings might comment on that. He
was involved in looking at all those issues very carefully.
Mr. CUMMINGS. We talked about that because there have been
comments about that in the press and it is not—it is not correct.
We never had any people stationed permanently there. We had
that one operating working force that spent a few days there and
then of course from time to time our officers were naturally down
in Oklahoma City seeing the bank and seeing other customers.
But they never had desks or were permanent fixtures at Penn
Square.
Mr. PERKINS. It would be quite customary for officers who travel
to a different territory to work with the customers there including
the correspondent banks, generally the bankers get to be friends
and they might borrow a phone once in a while or something like
that, but this is just that kind of a thing.
Mr. LEACH. Finally, let me ask a broader question. Do you think
that the problems brought to light in this situation are of such
nature as to jeopardize the banking system in America today? Do
you think in retrospect that large money center banks really have
been chasing too high-priced money and putting that money out
into lending situations that are less than credible?
Mr. PERKINS. Oh, I don't think so. We go through these cycles
and surely when the business has been good for a long time and
you get strong markets like the energy markets, has a tendency to
push pretty hard sometimes. But I wouldn't label it to chasing
every higher priced money and that kind of thing.




100
In hindsight obviously when the economy turns down and stays
down for the long length of time that it has, you get a lot of problems and you ask yourself, "if," but I would say it is one of those
cycle type of things.
Mr. LEACH. I will say this in defense of Continental, you have
grown basically in the American economy in contrast with your
principal competitors whose growth has been primarily abroad.
Your being the sixth or seventh largest bank and yet first in
American commercial lending is something, frankly, that I tip my
hat to.
Mr. PERKINS. Thank you.
Mr. LEACH. Mr. Chairman, I have no further questions.
The CHAIRMAN. Thank you, Mr. Leach.
Let me ask you this question, Mr. Perkins. As you know, for a
long period of time there has been discussions as to how secret we
should keep the findings of the regulatory agencies in the area of
financial institutions and whether or what the advisability would
be of having a little more sunshine coming in through the cracks.
As I stated earlier today, all major corporations have to file with
the SEC their reports to the stockholders in detail.
Do you think perhaps there should be some review—without setting out of bounds or inner bounds but some review of this passion
for secrecy that has predominated over such a long period of time?
Mr. PERKINS. I would make two comments on that. One, in terms
of filing information and public disclosure and all the rest of that, I
believe that the banking industry or at least the large publicly held
organizations that are subject to SEC rules and the rest do just as
much if not more than other industry does.
I remember well when our annual report
The CHAIRMAN. Excuse me, Mr. Perkins, but do they have to
make public if indeed one of the regulatory agencies asks them to
sign a letter of agreement or if they are found to be too heavily—to
have too many problem loans and put on a problem list? That is
not made public, sir.
Mr. PERKINS. Yes, we have to—we publish quarterly under the
accounting rules the nonperforming loan figures; we publish great
detail and chargeoffs and recoveries. We publish all those things
including all the 10-K's and things like that. We publish twice as
much data as most major corporations.
Now having said that you raise the other very specific question
because it happens to be a regulated industry of the type it is,
whether or not there should be publicity if in fact on a bank examination, say of the results of a bank examination or some portion of
it a statement like that, I think that is a very difficult question and
cannot be answered.
It is not something that I would think should be done. At least, I
would certainly have to be convinced. If you published that the examiners are in, at our last examination we had this criticism or
that criticism and the directors, when the examination was reviewed with the directors as it is under the present procedure by
the Comptroller's Office, that they were told that they must do this
or that or the other thing—that kind of publicity would very quickly lead to potential runs on banks, it would certainly change the
ability of banks, their access to the money markets, the money




101
market funds would very quickly stop depositing money in the
banks.
The CHAIRMAN. Mr. Perkins, you are giving me the argument
t h a t has been cited over the years.
Mr. PERKINS. Yes.
The CHAIRMAN. I

didn't know that, I thought perhaps since you
were no longer president of the ABA you might have, you know,
cut those traces and had second thoughts about this.
Mr. PERKINS. What I am saying, Mr. Chairman, is t h a t this is a
very touchy area when you get into it.
The CHAIRMAN. Definitely. I have been told over the years it is
very touchy. By the same token, let me say this to you; as you
know, Penn Square ignored the Comptroller, really, let's not kid
each other. They ignored the Comptroller.
Mr. PERKINS. Yes.

The CHAIRMAN. Said, you know, who do you think you are? Jennings says, Hey, I will take care of you, and he brought this poor
patsy in and set him up as president and he was president no more
t h a n Santa Claus was.
However, if you, Continental Illinois, Chase, Seattle, Michigan
National, the multitude of credit unions and S&L's t h a t put money
into Penn Square had known that the Comptroller had asked t h a t
certain steps be taken and they had not been taken, don't you
agree that Penn Square and Jennings would have taken the steps
necessary had the public, the sophisticated public in particular like
yourselves, known about the problems at Penn Square? Because
otherwise you would not have bought one single loan from them.
That would be self-policing. Think on it t h a t way. I know I am
not going to convince you at this point, Mr. Perkins, but by cracky,
I think t h a t the time has come where we have got to revisit this.
We have been looking at too many of these situations over the
years where innocent people have been lead down the primrose
path.
You know, on the one hand you want to stop the run on the
bank. How about the run on—how about the people, the institutions, individuals, t h a t took a bath on this and in previous instances going back to Sharpstown, the first one in 1972?
Mr. PERKINS. I am not trying to dismiss this lightly or say it
doesn't need examination, but I do think there are some very serious considerations on both sides and I certainly can't speak for
whether your statement makes sense as to what they might have
done under those circumstances.
But frankly, I am not privy to what Mr. Patterson or Mr. Jennings might have done or what the Comptroller might have done
or did.
Mr. LEACH. Will the gentleman yield?
The CHAIRMAN. Sure.
Mr. LEACH. There is a another question t h a t is more profound
than the question of possible conflicts of interest and petty crookedness. That is, we have a unique case in American banking: a
very small bank t h a t grew very fast and developed an upstream relationship with a series of other banks.
Mr. PERKINS.

Yes.




102
Mr. LEACH. One aspect of policy worthy of review is whether a
large bank should develop such a relationship with a fast growing
small bank. Once it was developed, one would think this relationship would stick out within your bank, if not like a sore thumb, at
least like a unique thumb. One would also think t h a t the documentation would have to be doubly strong, t h a t the review of the banking practices would have to be doubly energetic.
In retrospect, did you examine the relationship in a philosophical
way as well as in a practical way?
Mr. PERKINS. N O , these came up as individual loans as opposed to
the other, and the answer to a lot of your comments of what one
would think are very, very much part of this phase two of our examination asking just all of those questions and rethinking all of
those issues to be sure t h a t we are on the right track, or if we are
not t h a t we correct it.
On the other hand, I do think t h a t while this abberation here is
obviously in a class by itself, over many, many years given our unit
banking system basically in this country, or our lack of interstate
and national banking, given that, the system of correspondent
banking with the upstream participations working with the customers around the country has been very, very significant in terms
of getting business done.
I think of the many, many banks t h a t were—where we work in
Iowa, where we participate all the time and have for a century. Or
more.
Mr. LEACH. But none t h a t grew at t h a t rate. Granted, oil is a
unique case. I am sorry to take the gentleman's time.
Mr. PERKINS. All businesses in Iowa are very well managed. That
has been our experience over the years.
Mr. LEACH. Don't I wish.
The CHAIRMAN. I quote from testimony, Mr. Perkins, we will
hear in a few moments, and this testimony is given by Perry
Driggs, Jr., who is testifying on behalf of Michigan National Bank.
Mr. PERKINS. OK.
The CHAIRMAN. I quote:
One of our correspondent banks, Continental Bank, was contacted to discuss loan
participations with them—meaning Continental—and they discussed with representatives of our Battle Creek office the field of energy lending in which compared
to Continental, we had relatively little experience.
A representative of Continental introduced us to officers of Penn Square Bank
which Continental indicated was a source of high quality, secured floating rate
loans. We were pleased initially as well as later to have been accepted into what we
perceived was a fraternity of reliable energy lenders including Continental, Chase
Manhattan, Seattle-First and Northern Trust.
Relying initially upon assurances of Penn Square's expertise, we proceeded in November of 1980 to participate in approximately $12 million of Penn Square loans.

And we will hear the rest of it.
Now, had you known a little more of the problems of Penn
Square; you, Continental, would you have taken these delightful
people from Michigan National, friends of yours t h a t you have
been doing business with over the years, it is like taking one of
your children, you know, and walking them into quicksand.
You know, that is my point when I asked you about perhaps it
might be wise if the regulators when they find problems in the
bank, had a little more sunshine in, a little more disclosure. Don't




103
you feel badly about the fact that people at Continental lead people
in Michigan into the quicksand of Penn Square?
Mr. PERKINS. Well, Mr. Chairman, I am not familiar with whether our people did that or did not do it or the circumstances at the
time, so I would hesitate to
The CHAIRMAN. DO you doubt the veracity of Mr. Driggs?
Mr. PERKINS. I do not. But I
The CHAIRMAN. I thought you were friends.
Mr. PERKINS. We are. I am not questioning that a bit.
The CHAIRMAN. I am reading to you from his testimony.

In other
words, he is saying that they went on your assurances. You are the
big honcho at Continental. People understand, you are responsible
for your bank. Right?
Mr. PERKINS. Of course.

The CHAIRMAN. DO you know who it was that met with the
people of Michigan National, Mr. Cummings, and took them by the
hand and introduced them to swinging Bill Patterson?
Mr. CUMMINGS. During our interview process we did learn, I believe, that the people from Michigan National were in the Continental Bank and as my understanding is, they were introduced by
Mr. Lytle to I believe Patterson and maybe some other people from
the Penn Square who as I understand it were in the Continental
Bank not by prearrangement to meet Michigan National, but they
happened to be there at that time.
I certainly can't answer anything as to what was said as far as
assurances as to whether Penn Square was
The CHAIRMAN. By the way, was it proper for Mr. Lytle in the

capacity he had to be—to be introducing, as he admitted in the testimony or that famous letter that I read this morning, to Mr. Patterson, where he said, you know, I can introduce you to people in
Michigan National and so forth, and we will introduce you to other
people.
In other words, he was helping Mr. Patterson and Penn Square
sell their loans. Let me read from the letter:
"Thanks again for your help. I think this is a service that we can
provide to others," meaning other banks, of course. Was that part
of his duty, Mr. Perkins, since he was working for Continental?
Should he have been doing that as well?
Mr. PERKINS. Well, if you take it in the context that you take it,
no. But if you take it in the context that Mr. Cummings just said
where the people were all in the bank at the same time and they
were talking about energy loans and they were introduced, that is
another question.
The CHAIRMAN. I just read that testimony, it is more than an introduction, sir. It says:
One of our correspondent banks, Continental, was contacted to discuss loan participation. They discussed with representatives of our Battle Creek office the field of
energy lending, which compared to Continental we had relatively little experience.
A representative of Continental introduced us to officers of Penn Square which
Continental indicated as a source of high quality secured floating rate loans.
We were pleased initially as well as later to have been accepted into what we perceived as a fraternity of reliable energy lenders including Continental, Chase, Seattle-First




104
You know, maybe you can take issue with Mr. Lytle's veracity
but here is Mr. Driggs of Michigan National Bank and he is
saying—do you think that is a description of a casual meeting, Mr.
Cummings?
Mr. CUMMINGS. I can only tell you what we
The CHAIRMAN. Did they happen to meet at the cigarette stand
or the coffee machine?
Mr. CUMMINGS. I am quoting what Mr. Lytle and other people
in
The CHAIRMAN. Are you that naive to buy that?
Mr. CUMMINGS. Well, yes, I believe what they said because Patterson was in our bank fairly often; Michigan National had asked
as I understand it, the officers of our bank who handled the Michigan National Bank correspondent relationship about the possibility
of participating in loans.
They were in our bank and met a banker from whom we had
been purchasing loans. I don't think that indicates being naive. I
think it is an entirely possible scenario.
The CHAIRMAN. YOU just think it was happenstance? They just
happened to meet and they got married? You know, nobody tried
to—it wasn't like that one in "Fiddler on the Roof," the matchmaker.
There was no matchmaker, it just happened?
Excuse me, but I was going to excuse you people and say we will
go to the next witnesses but in view of the answers I am getting
here, I am going to ask you to please stay around a while. I am
going to vote and I shall return and we will pursue a few other
little items here because I can't understand the answers.
We will be in recess subject to the call of the Chair.
[Recess.]
The CHAIRMAN. The committee will come to order.
I would ask the two counsel if they would be gracious enough to
sort of sit behind their clients, because we need a little more room
at the witness table.
At this time, I would ask Mr. Perry Driggs, Jr., president of
Michigan National Bank; Mr. Herbert K. Peterson, executive vice
president, Michigan National Bank, to approach the witness table.
Please approach the witness table. Just bring another chair up.
Mr. Driggs and Mr. Peterson, would you kindly stand and raise
your right hands?
[Witnesses sworn.]
The CHAIRMAN. Thank you, gentlemen. Please be seated.
I want the two of them for a few moments.
Mr. Driggs, pull the microphone over to you a little bit. We are
going to allow you to read your entire statement a little later.
Were you here when I read a quote from page 2 of your statement, the one about the Continental Bank was contacted?
Mr. DRIGGS. Yes, I was here.
The CHAIRMAN. IS that a truthful statement?
Mr. DRIGGS. Yes, it was.
The CHAIRMAN. DO you know

who indeed discussed participations
at Continental from your institution?
Mr. DRIGGS. Initially our vice chairman, Mr. Paul Sauder.
The CHAIRMAN. IS he here this afternoon?
Mr. DRIGGS. NO, he is not.




105
The CHAIRMAN. Did he describe his conversation to you?
Mr. DRIGGS. He was not in the conversation. He sent representatives.
The CHAIRMAN. Whom?
Mr. DRIGGS. Mr. Herb Peterson, Mr. Arnold Middeldorf, and Mr.
Melvin Buser, from our Battle Creek office.
The CHAIRMAN. With whom did he have contact prior to sending
the people from your Battle Creek office to Continental Illinois?
Mr. DRIGGS. I don't know of the individuals who he had contact
with. He met with some after the American Bankers Association
convention in Chicago in 1980.
One of the ones I do know he had contact with was Mr. John
Lytle, but he might have had contact with other people.
The CHAIRMAN. IS it your understanding that the contact that
was made with Penn Square and Mr. Patterson was just a casual
thing that might have happened at the coffee machine, or was
there an appointment arranged for the three people from Battle
Creek to meet with the people from Penn Square by Mr. Lytle?
Mr. DRIGGS. All I know is that they went over to meet with Mr.
Lytle to discuss participation with the Continental Illinois.
The CHAIRMAN. OK, and what type of participations, primarily
energy-oriented?
Mr. DRIGGS. Primarily energy-oriented.
The CHAIRMAN. All right, and, as a result of that meeting, Michigan National began engaging in participations with Penn Square.
Is that correct?
Mr. DRIGGS. After that meeting; yes.
The CHAIRMAN. And which other institutions were recommended
by Continental and Mr. Lytle for energy participation loans?
Mr. DRIGGS. TO the best of my knowledge, no other institution.
The CHAIRMAN. NO other institution?
Mr. DRIGGS. Yes.
The CHAIRMAN. And

so, do you think that the relationship that
developed between Michigan National and Penn Square was just a
casual thing that happened, like I stated earlier, or do you think
there was a matchmaker involved?
Mr. DRIGGS. Well, from my understanding of the conversations
that went on at that first meeting, it was more than just casual.
The CHAIRMAN. It was more than just casual. In other words, Mr.
Lytle put the parties together and said to you people at Michigan
National, these people at Penn Square, Patterson, a tremendous
fellow, a great salesman? You heard Mr. Lytle describe Patterson
this morning, did you not?
Mr. DRIGGS. I met Mr. Patterson; he certainly was a great salesman.
The CHAIRMAN. Oh, you met him, too?
Mr. DRIGGS. Yes, I did.

The CHAIRMAN. OK. Let me get back to my friends at Continental.
Mr. Baker, do you think that that arrangement was a very
casual one that happened at the coffee machine, or do you think
that Mr. Lytle, indeed, as an officer at Continental, arranged an
appointment, encouraged Penn Square and Michigan National—




106
Michigan National, rather—to purchase participations from Penn
Square?
Mr. BAKER. I really don't know, not having been there, and I
don't know the circumstances under which Mr. Patterson either
happened to be there or was there by arrangement, but obviously
we frequently are in the position of putting buyers and sellers together.
Michigan National, like ourselves, and many other banks in the
northern tier of the country, were not experiencing the loan
demand t h a t some other parts were. In 1980, there was a tremendous demand by banks and lending institutions for energy loans,
and I am confident, no matter what the circumstances, we were
not trying to be harmful to Michigan National.
The CHAIRMAN. N O one has contended that you were, sir.
Mr. BAKER. I understand.
The CHAIRMAN. YOU know I am getting a little waltz here that I
think is ridiculous.
Mr. PERKINS. Could I comment, Mr. Chairman? You and I are
like ships passing in the night, because I don't think we have all
this disagreement.
The CHAIRMAN. It was Mr. Cummings, your expert from the British Isles, who said he thought it was very casual.
Mr. PERKINS. Mr. Chairman, I am not trying to give a little waltz
or dance at all. We are trying to answer you forthrightly on what
we know. Mr. Cummings suggested t h a t all he had heard was Mr.
Lytle's version, and it was as described. We brought the two parties
together—a limited thing.
The CHAIRMAN. He said Mr. Patterson happened to be at Continental.
Mr. PERKINS. That is correct.
The CHAIRMAN. Let me interrupt you for a second. I understand
we have Mr. Peterson here.
Were you at t h a t initial meeting, Mr. Peterson?
Mr. PETERSON. Yes, I was.
The CHAIRMAN. All right.

Now, in your opinion, did Mr. Patterson just happen to be there when you went to Continental, or was
there a prearranged meeting?
Mr. PETERSON. We have no knowledge t h a t any meeting with Mr.
Patterson was prearranged.
The CHAIRMAN. YOU went to discuss participations?
Mr. PETERSON. With Mr. Lytle.
The CHAIRMAN. Anyone else?
Mr. PETERSON. Only several members of his staff t h a t were introduced to us during the time we were there.
The CHAIRMAN. They introduced you to whom as a result of t h a t
for the purpose of entering into participation loans?
Mr. PETERSON. I am sorry, Mr. Chairman. From the Continental,
persons from the Continental Bank?
The CHAIRMAN. NO—from which institutions? In other words,
Continental did not have any participations to sell you at the time?
Mr. PETERSON. We had no participations with Continental at t h a t
time.
The CHAIRMAN. Right. You met with Mr. Lytle and members of
his staff or his division.




107
Mr. PETERSON. That is correct.
The CHAIRMAN. YOU discussed what you were seeking to persons
for participations?
Mr. PETERSON. Yes,

sir.

The CHAIRMAN. Did they make any recommendations?
Mr. PETERSON. They indicated t h a t one of their major correspondents was in the bank, and that they would be happy to introduce
them to us.
The CHAIRMAN. Let me ask you this, Mr. Peterson.
The meeting with Mr. Lytle, did you happen to just be driving by
Continental from Battle Creek and decide to drop in and say, "Hi,
Mr. Lytle/' or had that been an arranged meeting?
Mr. PETERSON. That was an arranged meeting.
The CHAIRMAN. YOU had an appointment?
Mr. PETERSON. Yes,

sir.

The CHAIRMAN. Right, and then Mr. Patterson happened to be in
the bank?
Mr. PETERSON. Yes,

sir.

The CHAIRMAN. Was any other individual from any other institution, that had some participations in energy-related loans for sale,
in the bank t h a t day?
Mr. PETERSON. Not to my knowledge.
The CHAIRMAN. SO the only casual individual who happened to
be there casually was Mr. Patterson?
Mr. PETERSON. He had several members of his staff with him, but
that is correct.
The CHAIRMAN. Hanging around the coffee machine?
Mr. PETERSON. NO, sir.
The CHAIRMAN. YOU did

not think that that might have been an
arranged meeting by Mr. Lytle? You don't think he might have
said, hey, Bill, Patterson, t h a t is? Why don't you get some of your
honchos here, because the people from Michigan National are
coming in, and I want to put you people together?
Mr. PETERSON. At the time of the meeting, I certainly didn't, because I was told of the substantial relationship t h a t had been developed over the last few years between the two banks.
The CHAIRMAN. What do you think happened?
Mr. PETERSON. It could have been
The CHAIRMAN. OK.
Mr. PERKINS. I honestly

don't know what happened at that time,
and I certainly have no reason to doubt the statements t h a t are in
the Michigan National's testimony. I believe t h a t what was said
was based on what we had got just from the version t h a t we have
from Mr. Lytle.
As Mr. Baker said, we do bring parties together. That is a
normal thing to do, and I think can be done quite properly.
On the other hand, if your question is to the extent that one of
our people or Mr. Lytle are out and actively touting and pushing
and trying to develop a lot of business or move a lot of loans, or
something on behalf of other banks, clearly t h a t is—clearly, I
would be critical of that.
The CHAIRMAN. It could happen without your knowledge?
Mr. PERKINS. That is right.




108
So I don't think—I really don't think we have a disagreement at
all.
The CHAIRMAN. All right.
I have one more question for this group hopefully, and then Mr.
Barnard does, and then we will excuse you, and we will get to the
genial gentleman from Michigan.
Mr. Cummings.
Mr. CUMMINGS. During this interview process that we conducted
in this management review, we talked to many, many people, and I
should say that there were other officers of our oil and gas department besides Mr. Lytle in separate interviews who had confirmed
the circumstances of the Michigan National people and the Penn
Square people being in the bank at the same time.
The CHAIRMAN. NO one denies they were there at the same time?
Mr. CUMMINGS. Not by prearrangement, and it was not unusual
for Bill Patterson and some of his people to be in our bank presenting loans, discussing loans, or presenting loan documentation. That
was what was going on at that time.
Mr. PERKINS. Again, we are just talking different views.
The CHAIRMAN. Which of you gentlemen was interviewed by
Goldman-Sachs with respect to loan participations?
Mr. BAKER. I was.
The CHAIRMAN. Mr. Baker, tell me if this is correct:
GOLDMAN-SACHS. Did you have any written policies regarding guidelines for purchaser of loan participations?
Continental Officer: No.

That was you, Mr. Baker?
Mr. BAKER. Yes.

The CHAIRMAN [reading].
GOLDMAN-SACHS. Were there specific controls of concentration of loan participations?

The Continental officer answered "No."
Is that accurate?
Mr. BAKER. That is correct.
The CHAIRMAN. HOW do you square that with what Mr. Perkins
told Mr. Leach from Iowa about the guidelines that are in effect
and that were not implemented in the Penn Square situation?
Mr. BAKER. I think the reference that Mr. Perkins was making
was to our procedures and policies relative to collateral, and participation in loans on a basis that is consistent with our direct lending, which is the intention of participations that we look at them
in the same way that we look at a direct loan that we are making;
so I don't think there is any inconsistency between what I was
saying there and what Mr. Perkins said.
The CHAIRMAN. Mr. Perkins, didn't I understand you to say to
Mr. Leach when he asked you about the very thorough questions
that people in the agricultural area have to answer prior to receiving a loan, that you said that is true, and we do the same in all
other areas as well, but unfortunately not in the Penn Square
case? I am a little confused here.
Do you have guidelines for your lending officers, and for people
applying for loans and participations or don't you?



109
Mr. PERKINS. Well, we have certain standards and procedures
and requirements on any loan that we make, and when we take
participations we are, when we take participations the policy, or
the procedures are supposed to be the same procedures to be followed as if we were doing it directly ourselves.
Mr. BAKER. The question in the Goldman-Sachs interview as I interpreted it at the time, Mr. Chairman, had to do specifically with
participations, do you have specific procedures and policies loaningwise relative to participations and my answer was no, they are the
same as they are relative all other loans.
The CHAIRMAN. Or you could have answered yes, we do have.
Mr. BAKER. They are the same ones we have for all loans.
The CHAIRMAN. Thank you, Mr. Baker, Mr. Perkins, Mr. Cummings, Mr. Cordell.
Mr. PERKINS. Thank you, Mr. Chairman.
The CHAIRMAN. I am sorry. Excuse me, Mr. Barnard.
Mr. BARNARD. Thank you, Mr. Chairman.
Actually my question was going to be to Mr. Driggs and Mr. Peterson. If you want to excuse the others.
The CHAIRMAN. I am going to have them give their statements
and we will go with them next.
Mr. BARNARD. Let me ask a question.
The CHAIRMAN. Why not?
Mr. BARNARD. Mr. Driggs, I have a feeling that possibly the
Michigan National had to be sold this arrangement a little bit. The
reason I have that impression is that because of the letter that Mr.
Lytle wrote Mr. Patterson on January 28, 1981, and in your testimony you said that we proceeded in November 1980, just 2 months
before then, to participate in approximately $12 million of Penn
Square's loans.
Then on January 28, 1981, Mr. Lytle writes Mr. Patterson, did
you hear the composition of that letter when it was read?
Mr. DRIGGS. Yes, I heard it when it was read.
Mr. BARNARD. The thing that concerns us is that he says that
they have met with Arnold Middeldorf. Is he with your bank?
Mr. DRIGGS. Yes, he is. He is here today.
Mr. BARNARD. It says: "They are pleased with the package of
credits that you had put together. They are grateful. It looks like
they," meaning you, "are growing both in confidence and understanding." Do I understand from that that very possibly your staff
had some questions about all of this arrangement?
Mr. DRIGGS. I am sure they went into detail with the engineers
of Continental, the information that they had, and they went into
the relationships they had with Penn Square and their expertise in
oil and gas and we respected Continental very highly.
Mr. BARNARD. But you still had some questions about it?
Mr. DRIGGS. That is correct.
Mr. BARNARD. And then the other question is, does your bank
normally require a takeout for participation loans? "I assured
them that we would take the credits out at maturity and whenever
they feel unconfident."
If you got that arrangement from everyone, you would be in very
good shape?
Mr. DRIGGS. Very good shape.

12-745 0—83
8


110
Mr. BARNARD. IS that your understanding all of the time?
Mr. DRIGGS. Not all the time.
We have takeouts when we have construction mortgages and
there would be an in-mortgage at the time with a takeout from a
savings and loan or life insurance company, so there are arrangements when they are at maturity takeouts under many different
situations.
Mr. BARNARD. But not at any time?
Mr. DRIGGS. Not at any time.
Mr. BARNARD. I have no further questions.
The CHAIRMAN. Gentlemen, again we thank you for your participation, your assistance, your cooperation.
There may be some questions in writing subsequently that might
arise once we have heard from other witnesses and we will submit
them to you, Mr. Perkins, as you know, in the usual manner.
Mr. PERKINS. We will be delighted to follow through on that and
we will follow through on the comments this afternoon with your
staff.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you kindly, gentlemen.
I understand we have Mr. Middeldorf here as well.
Mr. Driggs, yourself, Mr. Peterson, and Mr. Middeldorf are going
to testify.
Mr. DRIGGS. Yes.

[Mr. Middeldorf sworn.]
The CHAIRMAN. YOU may proceed, Mr. Driggs.
TESTIMONY OF H. PERRY DRIGGS, JR., PRESIDENT,
MICHIGAN NATIONAL BANK

Mr. DRIGGS. Thank you, Mr. Chairman.
I am Perry Driggs, the president of Michigan National Bank of
Lansing, Mich. I would like to briefly describe our bank before
commenting upon our involvement with the Penn Square Bank.
Michigan National Bank, headquartered in Lansing, Mich., with
assets of $2 billion, is the flagship bank of the Michigan National
Corp., a registered bank holding company with $6.6 billion in assets
and having 27 subsidiaries.
Michigan National Bank is unique in Michigan in operating offices in five cities located beyond the 25-mile branch restrictions
applicable to other Michigan banks.
The Battle Creek office of Michigan National Bank is one such
office which, while technically a branch of Michigan National
Bank, operates as a separate subsidiary of the bank. Thus it maintains a separate advisory board of directors and is headed by a
senior vice president who is the functional equivalent of a bank
president.
Michigan National Bank, in essence, operates a small bank holding company, and is itself a subsidiary of a bank holding company,
Michigan National Corp.
The Battle Creek office, with assets of approximately $480 million, would be the fourth largest subsidiary of the Michigan National Corp. if separately chartered.




Ill
It functioned, in part, as the energy division of Michigan National Bank.
Michigan National's involvement with Penn Square Bank
stemmed from pressures created when the cost of our funds exceeded the Michigan interest rate ceilings on many loans. In an effort
to maintain and improve profitability, it was determined that the
bank should expand further its floating interest rate commercial
loan portfolio.
Such loans were difficult to obtain due to Michigan's depressed
economic environment, so we turned to our correspondent banks
for assistance.
One of our correspondent banks, Continental Bank, was contacted to discuss loan participations with them. They discussed with
representatives of our Battle Creek office the field of energy lending, in which, compared to Continental, we had relatively little experience.
A representative of Continental introduced us to officers of Penn
Square Bank, which Continental indicated was a source of high
quality, secured, floating rate loans. We were pleased initially, as
well as later, to have been accepted into what we perceived was a
fraternity of reliable energy lenders including Continental, Chase
Manhattan, Seattle-First, and Northern Trust.
Relying initially upon assurances of Penn Square's expertise, we
proceeded in November 1980 to participate in approximately $12
million of Penn Square's loans. These participations were purchased based upon our independent analysis of the loans, and Continental's assurances and offers of assistance.
The CHAIRMAN. Mr. Driggs, you say Continental's assurance, and
so forth. Would you be a little more specific?
I mean, Continental is a building.
Mr. DRIGGS. John Lytle and his staff indicated that they would
help us in understanding the credits, in looking at the borrowers
and indicating whether they had good relationships with them, and
so forth.
They introduced these two gentlemen to several engineers and
told them, I understand the quality of the engineers' reports
coming from Penn Square, but you can—I will defer that to these
gentlemen later. They were at the specific meeting.
Relying initially upon assurances of Penn Square's expertise, we
proceeded in November 1980 to participate in approximately $12
million of Penn Square's loans. These participations were purchased based upon our independent analysis of the loans, and Continental's assurances and offers of assistance.
Initially we were interested in smaller secured loans of under $1
million bearing a floating interest rate. This arrangement complemented Continental's position since it did not wish to be involved
in participations of less than $1 million.
Satisfied with the initial participations, we later participated in
larger loans having become familiar with the performance of the
loans and having gained a greater awareness of Penn Square's operation.
This occurred, however, only after we had demonstrated our willingness and ability to process the smaller loans, and become eligible for consideration of larger participation positions.




112
The relationship grew until June 1982 at which time Michigan
National Bank was involved in loan participations totaling in
excess of $190 million. These Penn Square participations continued
to perform in an extremely satisfactory manner until the bank was
closed.
The CHAIRMAN. Excuse me. On that point, you are aware of the
fact that now, I would assume from the reports and so forth and
the hearings that we held in Oklahoma City, that these loans were
performing well, many of them, because Penn Square was paying
the interest to the upstream banks on nonperforming loans?
Have you become aware of that?
Mr. DRIGGS. We have become aware of that since the bank was
closed.
The CHAIRMAN. DO you know if any of your loans were nonperforming loans at the time Penn Square was paying interest?
I mean at this point do you have any loans on which they were
doing that?
Mr. PETERSON. Yes, I believe that we probably do, Mr. Chairman.
The CHAIRMAN. Don't feel bad because, as I said in Oklahoma
City, gentlemen, and you are small compared to the big city slickers that got took, and the Federal Reserve Board, and the comptroller of the regional office got took. These people, they outslicked
the slickers.
Excuse me. Proceed.
Mr. DRIGGS. Certainly.
Michigan National was asked early in 1982 to extend a fully secured line of credit to First Penn Corp., the parent of Penn Square.
Based upon our analysis of the creditworthiness of First Penn, its
apparent healthy financial condition and our experience with the
Penn Square Bank loan participations, the requested line of credit
was approved for $5 million.
This line of credit was used infrequently, only for short periods
of time and all advances made prior to June 25, 1982, were promptly repaid.
In late June 1982, the Michigan National Battle Creek office was
informed that sizeable chargeoffs of the Penn Square loans had
been requested by the Comptroller of the Currency.
It was our understanding that in connection with examination of
Penn Square, the Comptroller was requesting an infusion of $30
million of equity capital into the bank. Representatives of Penn
Square Bank asked Michigan National to extend secured loans to
substantial customers of Penn Square for approximately $16 million.
While Michigan National was aware of the importance of this
capital infusion, insufficient information was provided to Michigan
National by June 30, 1982, to permit us to act upon the request.
Upon learning of this request, and due to its nature, I immediately made efforts to contact officials of the Comptroller of the Currency on June 30 to determine the seriousness of Penn Square's
condition.
I was unable to obtain any specific information.
As the committee is aware, the Comptroller closed Penn Square
Bank shortly thereafter.




113
The tragic consequences of the Penn Square closure are well
known. Our bank, along with numerous other banks, credit unions,
other financial institutions and individuals, now faces substantial
losses.
With 20-20 hindsight, we now recognize that greater reliance
was placed upon our associations with other institutions, our own
analysis of the Penn Square Bank and the overall record of satisfactory performance by the Penn Square Bank than should have
been the case.
However, it must be remembered that there was nothing significant in our bank's relationship with Penn Square which
The CHAIRMAN. Excuse me. Could I interrupt one more time?
You just said with 20-20 hindsight we now recognize that greater
reliance was placed upon our associations with other institutions.
Which other institutions do you refer to?
Mr. DRIGGS. We were involved with many leading banks who
also placed reliance and had a very fine energy division; they too
were caught.
The CHAIRMAN. YOU say here that you now recognize that greater reliance was placed upon our associations with other institutions.
Now, which other institutions other than Continental or more
specifically John Lytle recommended Penn Square, passed on to
you?
Mr. DRIGGS. AS we got into the Penn Square situation, I called
an individual at the Chase Manhattan that I knew.
The CHAIRMAN. Who was that individual?
Mr. DRIGGS. Mr. Richard Piney.
The CHAIRMAN. P-i-n-e-y?
Mr. DRIGGS. Yes.

The CHAIRMAN. What is his capacity with Chase?
Mr. DRIGGS. He is no longer with Chase, but at that time he was
the vice president in charge of the correspondents relationship.
The CHAIRMAN. IS he the one that dealt with Penn Square?
Mr. DRIGGS. That is correct.
The CHAIRMAN. At Chase they didn't purchase through the
energy division, did they? These participations?
Mr. DRIGGS. We learned that later.
The CHAIRMAN. YOU learned later, rather than go through the
energy division to have it analyzed properly by energy, what they
did was go through Mr. Piney?
Mr. DRIGGS. In the correspondents division.
The CHAIRMAN. He generated a lot of business that way?
Mr. DRIGGS. It is my understanding, on occasion they did refer
some of the loans to the energy division. I do not know of Chase's
working
The CHAIRMAN. Which other institutions?
Mr. DRIGGS. Basically Continental and Chase.
The CHAIRMAN. One phone call to Piney, was that it?
Mr. DRIGGS. And a conversation with him later.
The CHAIRMAN. Phone call to Mr. Piney and other than that the
introduction by Mr. Lytle of Mr. Peterson and Mr. Middeldorf to
Mr. Patterson; no, no, to Mr. Patterson and his coterie, who happened to casually be at Continental Bank that particular day?



114
Mr. DRIGGS. That is correct.
The CHAIRMAN. OK., proceed, please.
Mr. DRIGGS. That was on my part. However, there were other individuals who made checks in addition to the ones that I did.
The CHAIRMAN. YOU are at page 5.
Mr. DRIGGS. OK.

However, it must be remembered that there was nothing significant in our bank's relationship with Penn Square which would
have prompted a greater investigation into the creditworthiness of
Penn Square than was performed.
We had confidence in Continental Bank and its experience in the
energy field.
The CHAIRMAN. Continental and its experience in the energy
field were saying John Lytle and his staff?
Mr. DRIGGS. The entire energy division of Continental Illinois.
They were well known to be expert in the field in the United
States.
The CHAIRMAN. All right.
Mr. DRIGGS. Whenever we found the documentation of a loan
participation upon which we had made advances was inadequate
under the loan policies of our bank, the loan was promptly repurchased by Penn Square in accordance with the assurances we had
been given. Even with respect to the line of credit we extended to
the First Penn Corp., advances made on that line of credit were
promptly repaid until the very end.
In short, there was nothing evident from our associations with
other institutions or our transactions with the Penn Square Bank
that raised a warning flag regarding our involvement with that
bank and its portfolio.
It is now apparent that the reliance we placed on these matters
was misplaced and we at Michigan National are currently assessing our internal controls and credit approval procedures and will
modify these controls and procedures in an effort to avoid a similar
experience wherever and to whatever extent is dictated by our assessment.
Michigan National Bank continues to be a strong financial institution and shares the committee's desire to prevent any similar
misfortune from recurring.
Notwithstanding any losses that might be incurred, we are confident that Michigan National can continue its history of prudent,
professional, and successful lending practices that have exemplified
it in the State of Michigan.
I would like to introduce to the committee Mr. Herbert K. Peterson, our executive vice president responsible for overall lending,
and Mr. Arnold J. Middeldorf, our senior vice president responsible
for the operations of our Battle Creek office, which managed the
Penn Square relations.
We will be glad to respond to the best of our ability to any questions the committee may have.
Thank you.
The CHAIRMAN. Thank you, Mr. Driggs.
On page 5 you say, "Even with respect to the line of credit we
extended to the First Penn Corp. advances made on that line of
credit were promptly repaid until the very end."



115
Mr. DRIGGS. That is correct.
The CHAIRMAN. Then what?
Mr. DRIGGS. At the very end two advances were made.
The CHAIRMAN. In what amounts, sir?
Mr. DRIGGS. $2 million and $3 million.
The CHAIRMAN. TO the First Penn Corp. For what purpose, do
you recall?
Mr. DRIGGS. We did not know at the time it was used in and out
to repurchase or when their commercial paper was terminated and
they needed a brief line until the commercial paper was reissued,
we assumed it was for that purpose.
The CHAIRMAN. That is the paper that they were selling down
there to some of their customers? Remember that?
Mr. BARNARD. Yes.

The CHAIRMAN. That had been highly recommended to some of
the customers of the Penn Square Bank?
Mr. DRIGGS That was the purpose that they used it for.
The CHAIRMAN. Right. I may ask competent staff to help me with
some initials here, but I am looking at an "Assets Subject to Criticism."
This is from the Comptroller examiner's reports:
$1 million Lockridge, William; Guarantor, Hefner, Robert A., Ill; Doctor and
horse man residing in Kentucky. A consolidation loan to pay off previous debts and
provide operating capital.
Collateral presented is second to real estate mortgage on 900-acre farm with substantial improvements in Kentucky.
Assessed value, $5,580,000, prior lien $3,250,000.
Financial statement on maker reflects heavy total liabilities, $5,963,000 against
net worth of $1,727,000 vested in the farm $5.5 and thoroughbreds, $1,403 million.
Financial statement on Guarantor Hefner reveals debts of $2,397,000 and net
worth of $25,780,000 centered in oil and gas, $24,665,000.
The servicing officer admits the loan was booked as an accommodation to guarantor Hefner who is also a bank customer. Although the guarantor provides ample
support, above normal supervision of this out-of-territory credit is indicated in view
of maker's financial conditions.

The CHAIRMAN. Examiner was Mr. Hooks, officer was good old
Bill Patterson. Now, reading from a Penn Square document entitled "Interest Advance to Participating Banks on Commercial
Loans as of November 30, 1981: Lockridge, William To Cover Nonpayment."
Mr. DRIGGS. That is where they were paying the interest, loans
that were not performing?
The CHAIRMAN. Correct. It says William Lockridge, he is the
doctor and horse man who resides in Kentucky, and the note
number is 24399, participating bank is Michigan National, prepaid
$16,273.96. Do you remember that one at all?
Mr. DRIGGS. Are you saying that the interest was paid by Penn
Square Bank, and are we familiar with that?
The CHAIRMAN. This is one on which interest was prepaid by
Penn Square Bank. Were you still holding this one when the cards
came tumbling down?
Mr. DRIGGS. We were not aware of any interest being paid by the
bank.
The CHAIRMAN. I didn't imply that you did. Unfortunately you
should have known but you didn't know because you were not informed.




116
This was an internal Penn Square document which was reviewed
by Peat, Marwick & Mitchell, but they kept it a secret. Did you
know Mr. Lockridge at all who was the borrower in this instance
from Kentucky?
Mr. MIDDELDORF. I did not know him personally, no.
The CHAIRMAN. OK.

Mr. Middeldorf, we have not had the pleasure of asking you
about your impression of that first meeting to discuss energy loans,
whether you thought it was just happenstance that Mr. Patterson
was at Continental or whether upon reflection, you think that
maybe it was a little more than a casual situation.
Mr. MIDDELDORF. At the meeting at that time, I didn't think
about it being anything but happenstance.
Now, there is a question in my mind as to whether or not it was.
The CHAIRMAN. Let me ask you this. Mr. Peterson, Mr. Middeldorf, you were assigned by Mr. Driggs to look into purchasing participations in energy loans, is that correct?
Mr. DRIGGS. NO, our vice chairman, Mr. Sauder, asked Mr. Peterson and Mr. Middeldorf to follow the lead that he had started.
The CHAIRMAN. OK.

Did you purchase participations in energy loans from institutions
other than Penn Square?
Mr. PETERSON. We did

not.

The CHAIRMAN. NOW, you have heard about this delightful letter
that has been quoted from within; it says "I reassured them that we
would take the credits out at maturity or whenever they felt unconfident."
That is referring to Arnold Middeldorf and his people at Michigan National, a letter from Mr. Lytle to Mr. Patterson dated January 28, 1981. Was there indeed a reassurance given to you by Mr.
Lytle that if there were any problems they would repurchase the
loans from Mr. Lytle, Mr. Middeldorf?
Mr. MIDDELDORF. Yes, there was, in the original package of loans
that we eventually purchased the $13 or $12 million, I definitely
had the, came away from that meeting that I had the assurance
from Mr. Lytle that if we had any difficulties with those loans,
they would be taken out.
The CHAIRMAN. Continental would repurchase them from you or
Penn Square?
Mr. MIDDELDORF. Right.
The CHAIRMAN. Doug, why don't you proceed for a while.
Mr. BARNARD. One of the things that concerns the committee
considerably is that how much attention and really credit analysis
was given the loans that were sold up from Penn Square to Continental and also to Michigan National.
In one group of loans that they sold up, to Michigan National
there were three loans, and two of these loans we happen to know
were loans that had been criticized by the bank examiners but they
later satisfied the bank examiners because they sold them to you. I
would like to ask you, for the sake of the record, although I don't
want the specifics in the record, Mr. Chairman, because I think
classifications by the Comptroller are somewhat confidential, but I
would like for you to read the comments of the Comptroller about




117
two of these loans and for you to tell me about the credit analysis
when you bought them.
The point I am getting at, Mr. Driggs, is t h a t the bank shouldn't
buy loans carte blanche. Just because they came up in a cash
letter, you were not supposed to just give credit and forget about it.
Mr. DRIGGS. That is true.
Mr. BARNARD. It appears, though, in some instances t h a t might
have been done but Mr. Peterson and Mr. Middeldorf would just, it
is at the bottom of page 1 called Old Dominion Oil Corp.
J u s t read that. That is where you bought $557,672 out of a $1
million transaction.
Mr. PETERSON. Mr. Barnard, I have the Old Dominion Oil Corp.
report.
I have not seen this, nor am I personally familiar with the details of this credit. It is very hard for me to answer your question
based on that.
Mr. BARNARD. If I just walked in off the street and provided you
my financial statement, and it showed a deficit net worth of
$144,000, and I asked you for a loan of $1,930,000, and actually you
didn't advance t h a t much, but here is a negative net worth and yet
Michigan National participated in t h a t loan.
I was incorrect to begin with, to the tune of $383,672. I am sure
after you got into it you sold it back to them but in the meantime,
t h a t had taken place. They had gotten it out of their portfolio up to
you and maybe you got it back.
Before you gave them credit for participations, was there an
analysis of the quality of the loans?
Mr. PETERSON. Yes, sir.
Mr. BARNARD. Look at the

next one, the item on the long sheet. I
rather not call out the name of the account.
Mr. PETERSON. Mr. Barnard, although this name is familiar with,
or familiar to me, I just cannot discuss the credit in any detail. We
could perhaps address that in questions t h a t you may have in writing at a later time.
Mr. BARNARD. Well, we have to get these documents back because of the nature of them.
I just cannot see how, with the information t h a t the Comptroller
has furnished us here about these particular credits, how in the
world anybody could have made a proper credit evaluation of the
situation, just based upon the outstandings and the net worth and
the documentation, and in one instance, it says t h a t the bank was
taking a blank assignment on oil and gas leases, but nothing has
been filed:
The servicing officer states that no filings on the O&G leases, because the borrower turns the leases so quickly that another filing would cloud title and delay the
sale of the leases.

You couldn't possibly know where you stood from the standpoint
of taking a place in the credit.
Mr. DRIGGS. I think the thing we will have to supply the committee with was our analysis of those credits, what the leases were,
and the procedures t h a t we went through to approve them.
Mr. BARNARD. And whether or not you asked them to buy it
back?




118
Mr. DRIGGS. That is correct.
Mr. BARNARD. Could we do that, Mr. Chairman?
The CHAIRMAN. Why, of course.
Mr. DRIGGS. We will supply you with that information.
Mr. BARNARD. HOW does all of this jell with your statement on
page 5 where it says
It must be remembered that there was nothing significant in our bank's relationship with Penn Square which would have prompted a greater investigation into the
creditworthiness into the Penn Square than was performed.

In other words, you do not remember, probably, Mr. Middeldorf,
enough activity of request to repurchase loans that you had any
further questions?
Of course, I believe you did have some questions when the arrangements began in January 1981—right?
Mr. MIDDELDORF. Regarding what?
Mr. BARNARD. Well, as we read in the letter from Mr. Lytle to
Mr. Patterson, he says that there had been a meeting with Arnold
Middeldorf and his people at Michigan National and it determined
that they are pleased with the package of credits that was put together last November—this was written in January.
In other words, they were talking to you in January about loans
that they had sent to you in November, and I am just reading from
the letter.
It says that, "It looks like they are growing both in confidence
and understanding of oil-related lending, but as we did previously,
I assured them that we would take the credits out at maturity/'
I am trying to get an answer, yes or no. Were you concerned
about the quality of the loans?
Mr. MIDDELDORF. NO, I was not.
Mr. BARNARD. Mr. Lytle thought you were.
Mr. MIDDELDORF. I was not familiar with that

letter at that time
and I do not know what prompted him to write that letter.
Mr. BARNARD. On reflection, though, you think you possibly
should have had some caution?
Mr. MIDDELDORF. NO. At the time we were dealing with Penn
Square, no.
Now—yes.
Mr. BARNARD. I hope so.
The CHAIRMAN. I will address the questions to you initially, Mr.
Driggs, and if you feel someone else should answer, that is perfectly acceptable, because I realize that you cannot know everything
about what is going on.
Did you indeed make, or did Michigan National make, personal
loans to Bill Patterson and others at Penn Square, apart from the
participations?
Mr. DRIGGS. Just one moment, Mr. Chairman.
The CHAIRMAN. If you have someone who can answer that, I
would be happy to swear them in for you.
Mr. DRIGGS. Yes, we did.
Mr. BROWN. May I address the Chair?
The CHAIRMAN. Unusual, but in view of
Mr. BROWN. Thank you, Mr. Chairman.

the circumstances, yes.

The problem we have is about accounts and names of people.




119
The CHAIRMAN. I am sorry, but what?
Mr. BROWN. Accounts under the Right to Financial Privacy Act
passed by this committee in 1978.
The CHAIRMAN. We are amending it tomorrow.
Mr. BROWN. We have no reluctance whatsoever to providing the
committee with it.
The CHAIRMAN. Let me try something else.
Mr. BROWN. Provide us the procedure; we will be glad to do what
we can.
The CHAIRMAN. Well, we do know that there was a loan to the
marina in Florida, and that is the one we discussed earlier today
wherein Mr. Patterson is a player.
Would you check with counsel to see if you can discuss that loan?
Mr. DRIGGS. Yes, I will, Mr. Chairman.
Mr. Chairman, we made loans to some officers and directors of
Penn Square. We will be glad to supply you with information in
accordance with the Privacy Act, and in compliance with whatever
law there is, so that you can see what was done.
The CHAIRMAN. All right, I think I can ask this question without
causing a problem.
Were there indeed loans made, and I am not asking to whom the
loans were made, but with the collateral being for the marina in
Florida that has been discussed earlier today, or participations?
Mr. DRIGGS. Participations, yes.
The CHAIRMAN. And are you at liberty to tell us what the status
of that participation in the Florida Marina loan would be today?
Mr. DRIGGS. I think either Mr. Peterson or Mr. Middeldorf would
be in a better position to tell you.
Mr. MIDDELDORF. Right now, the loan is in the process of being
foreclosed on.
We have not proceeded simply because there is, as we understand it, some investigation work going on by the FDIC.
The CHAIRMAN. AS well as others?
Mr. MIDDELDORF. AS well as others.
The CHAIRMAN. There was a loan to Bill Jennings, chairman of
the board of Penn Square, we understand, in the amount of $1.5
million that was secured by a stock of TOS, an oil supply company
that has filed for bankruptcy.
Do you recall how this loan found its way into your portfolio and
what the status of that loan is at this time?
Mr. DRIGGS. I will refer to Mr. Peterson.
Mr. PETERSON. The initial contact for the request for that loan
was made by Mr. Patterson to me.
The CHAIRMAN. On behalf of?
Mr. PETERSON. On behalf of Mr. Jennings.
The CHAIRMAN. And do you know the status of that loan at this
point in time?
Mr. PETERSON. That loan was never fully disbursed.
It is delinquent and, excuse me, Mr. Chairman, I have run into
the same problem, I guess, on the Financial Privacy Act, in being
careful about
The CHAIRMAN. The status of a loan?
We are aware, and we have made public




120
Mr. PETERSON. Mr. Chairman, as I have indicated, it is delinquent.
The CHAIRMAN. Fine.
Mr. Driggs, if you at Michigan National had been cognizant of
the fact t h a t a cease-and-desist agreement with the Office of the
Comptroller of the Currency had been entered into, and t h a t Penn
Square was under constant surveillance by the Office of the Comptroller of Currency, do you feel that you would have participated in
the energy-related loans or the other loans that you participated in
with Penn Square?
Mr. DRIGGS. N O , we would not have. I spoke with a representative of the Comptroller regarding that and said we would have put
more pressure on Penn Square and the other banks involved and
perhaps their office. In t h a t light, perhaps the whole situation
would have been corrected quickly, and the bank would not have
been closed.
The CHAIRMAN. When did you first learn of the problems with
Penn Square?
Mr. DRIGGS. The morning of J u n e 30.
The CHAIRMAN. The morning of J u n e 30?
Mr. DRIGGS. Yes.

The CHAIRMAN. Did you learn t h a t from the Chicago Office of
the Comptroller? Were you called, or did you have to seek information? How did the information come to you, sir?
Mr. DRIGGS. Mr. Patterson had met with people in our bank to
raise loans for the bank. I was not aware of the purpose of the
loans, and we had called a meeting to discuss them on Wednesday,
and Wednesday morning, they came to my office and said: "We do
not have sufficient information. There appears to be some problems
with Penn Square Bank because of the chargeoffs."
At t h a t point, I inquired of the Office of the Comptroller of the
Currency in Chicago and talked to Mr. Bob Burns, asked him if he
could give me any light on what was happening at Penn Square.
He said he had been informed of the situation
The CHAIRMAN. By the Dallas Office of the Comptroller?
Mr. DRIGGS. I don't know where his information came from, but I
got no definitive information as to how serious the problem was
from the perspective of the Comptroller at t h a t time.
I asked if I could call the Dallas office myself and they said they
preferred to have me work through them and we would be getting
back in touch.
Mr. Patterson came down to the office. He was in the bank. We
discussed with him what was going on. He reassured us t h a t they
had need for capital, t h a t there were many wealthy individuals
who were interested in buying the bank or putting up capital, and
we had tried to ascertain through a long discussion just what was
going on.
Eventually, we discovered t h a t there was going to be a special
meeting with his board and the Comptroller in Oklahoma City the
next morning.
The CHAIRMAN. HOW did you discover that?
Mr. DRIGGS. He indicated that to us.
The CHAIRMAN. Mr. Patterson, not the Comptroller's Office?




121
Mr. DRIGGS. I asked if we could send Mr. Middeldorf down there
to find out what was happening. He said, yes. Mr. Middeldorf flew
down with them that evening, and was unable to get into the meeting because the Comptrollers Office, rightfully so, wanted it for
just the inside directors and officers who are managing that bank.
We did learn after that meeting that Mr. Patterson was dismissed and that they did offer a cease-and-desist order.
The CHAIRMAN. YOU learned when after that?
Mr. DRIGGS. The next morning.
The CHAIRMAN. From whom did you learn that?
Mr. DRIGGS. Mr. Middeldorf learned that from either Mr. Jennings or Mr. Patterson.
The CHAIRMAN. Excuse me, but do you recall, Mr. Middeldorf,
from whom you learned that or how you came about that information, the dismissal and the cease-and-desist?
Mr. MIDDELDORF. Yes; I was there Thursday morning, the board
of Penn Square met at 8 o'clock and the meeting with the Comptroller was to be at 9 o'clock.
I talked to Mr. Jennings about attending the meeting with the
Comptroller. He said it was all right with him if it was all right
with the Comptroller.
I came up to his office at 9 o'clock and he informed me that the
board had just suspended Bill Patterson.
I asked him then to attend the meeting he was going to have
with the Comptroller in an effort to determine what was going on
and he went back in and came out and said, "They do not want
you there. However, after the meeting is over, I will tell you what
happened."
I came back up to his office close to noon, and the meeting had
broken up and he had said that the Comptroller had issued a temporary cease-and-desist order and that they were required to set up
a compliance committee and he was very shaken and that was the
end of the conversation.
The CHAIRMAN. Again, that information came to you, not from
the Comptroller's Office?
Mr. MIDDELDORF. NO.

The CHAIRMAN. But not from the Comptroller, but from Mr. Jennings.
Mr. MIDDELDORF. That is right.
The CHAIRMAN. When did you hear from the Comptroller's
Office, you called the office in Chicago, they said, don't call us, we
will call you.
When did they call you?
Mr. DRIGGS. AS I recall, Mr. Jerry Bergman of Continental Illinois called me Thursday afternoon or Thursday during the day and
said there would be a meeting in the old board room of the Continental Illinois with representatives of the major banks that were
participating with Penn Square to discuss the situation.
We flew to Chicago and representatives from all the major banks
that you are going to be hearing from were there. We met most of
the day, eventually a representative
The CHAIRMAN. Which day was that?




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Mr. DRIGGS. Friday. Eventually a representative from the Federal Reserve came to discuss their involvement and what they would
like to try to see done.
And during the day, I called Mr. Burns
The CHAIRMAN. DO you recall what the Federal Reserve representative, who he was, which office he was from?
Mr. DRIGGS. From Washington, D.C.
The CHAIRMAN. Washington, D.C.
Mr. DRIGGS. Yes.

The CHAIRMAN. Did he happen to tell you what they were prepared to do?
Mr. DRIGGS. They wanted to know
The CHAIRMAN. I just wanted your version. We have had them
talking already.
Mr. DRIGGS. They wanted to know what we, as banks, would do,
and discussion of the problem.
During the long day t h a t we were at Continental Illinois, I went
out and called Mr. Burns again and spoke with him about the
Penn Square matter and got the—did not get a definitive answer.
The CHAIRMAN. This is Mr. Burns. What is his first name?
Mr. DRIGGS. Bob.

The CHAIRMAN. IS it B-y-r-n-e-s?
Mr. DRIGGS. Burns. B-u-r-n-s.
The CHAIRMAN. B-u-r-n-s, OK.
Mr. DRIGGS. Rufus O. Burns is his name.
The CHAIRMAN. R-u-f-u-s?
Mr. DRIGGS. I don't know how. He indicated
The CHAIRMAN. He said don't call me, don't call Dallas?
Mr. DRIGGS. Not at t h a t time. He was very—he wanted to be
kept apprised of everything t h a t we learned and also
The CHAIRMAN. He wanted you to tell him?
Mr. DRIGGS. I told him we were in meetings.
The CHAIRMAN. He is in the Comptroller's Office and he is
asking you for information, right?
Mr. DRIGGS. He wanted to be apprised of what we learned and he
indicated to me that he would tell us information t h a t he had gathered.
The CHAIRMAN. SO what did he tell you?
Mr. DRIGGS. At t h a t point, I did not get any further information.
The CHAIRMAN. When did you hear from him again?
Mr. DRIGGS. Frankly, the bank was closed on the day after the
Fourth holiday and I do not recall when I heard from their office
again.
The CHAIRMAN. Rufus and you have been friends for a long time?
Mr. DRIGGS. We had known each other, dealt with each other
and their staffs for some time, yes.
The CHAIRMAN. YOU going to send him a Christmas card again
this year after the way he treated you? Don't answer t h a t one.
Gentleman, our staff have noted in going over the documentation
t h a t in many of the Longhorn-named limited partnerships with the
name Longhorn, I understand there is a plethora of them t h a t are
on file in Oklahoma and in these either Carl Swan or J. D. Allen
are participants, usually as general partners.




123
There were a number of Michigan residents listed as limited
partners. Are any Michigan National directors, officers, or employees limited or general partners in any limited partnerships in
which Carl Swan or J. D. Allen were involved, these Longhorn
partnerships?
Have you been able to determine that?
Mr. DRIGGS. Have we been able to determine that?
The CHAIRMAN. Yes; I understand the staff discussed t h a t with
you a few days ago.
Mr. DRIGGS. Yes.

The CHAIRMAN. At the time, you did not know. I wonder if you
would be able to find anything else in the interim?
Mr. DRIGGS. J u s t within the last 2 days, I have learned t h a t one
of our directors of our—one of our affiliate banks and our chairman was involved in one of the limited partnerships.
The CHAIRMAN. All right.
Mr. DRIGGS. Yes.
The CHAIRMAN. John

Doe lives in Peoria, 111. I like t h a t because
t h a t is Bob Michel's hometown, Peoria. And all of a sudden Carl
Swan and J. D. Allen, and a resident of Peoria who is a little
prominent becomes involved in a limited partnership. So John Doe
in Peoria tells his friends about having gone into the limited partnership in energy and things, particularly toward the end of the
tax year. It is a shelter, people are all looking for shelters.
Would you think perhaps if we were to look at the addresses of
the individuals who were, did participate from Michigan National
you might have some of their friends and neighbors and associates
in the communities also amongst Michigan residents in these limited partnerships in Longhorn? I am not saying there is anything
wrong, but isn't t h a t how it usually happens? I am trying to explain to my staff how it happens. Would you confirm t h a t or not?
Mr. DRIGGS. Sometimes it occurs through a broker who works
the partnership, other times word of mouth.
The CHAIRMAN. That can happen at cocktail parties?
Mr. DRIGGS. Yes; certainly could.
The CHAIRMAN. Or by the coffee machine?
Mr. DRIGGS. It certainly could.
The CHAIRMAN. Really. Would it be any problem for you to identify for us specifically the names of these individuals t h a t you are
aware of now who were a part of Michigan National t h a t participated in these partnerships as well as their home addresses and
work addresses?
Mr. DRIGGS. We will be glad to take the list and we will identify
everyone that we can.
The CHAIRMAN. We could then just look at the pattern.
Mr. DRIGGS. All right, be happy to supply the committee with
that information.
[The information submitted by Mr. Driggs follows:]
In response to the committee's request for the names, home addresses and work
addresses of directors, officers and employees of Michigan National Bank who are
investors in Longhorn Limited partnerships, please be advised that the following
are investors in Longhorn related limited partnerships:




124
Name

S. C. Stoddard
Herbert H. Jacob

Position

Chairman of the board

Home address

Business address

Birmingham, Mich. 48010

1700 Woodward, Bloomfield
Hills, Mich. 48010.
Director, MNB-Oakland, MNB- Bloomfield Hills, Mich. 48013.... 1 Ajax Drive, Madison
W. Metro (affiliates of
Heights, Mich. 48091.
MNB).

The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. Mr. Driggs, at any time on examination of your
bank by the Office of the Comptroller of the Currency, I believe it
is the Battle Creek office that maintained most of these participation loans.
Mr. DRIGGS. Yes.

Mr. BARNARD. Was it examined by the Comptroller of the Currency?
Mr. DRIGGS. Yes; we are examined approximately every year.
Mr. BARNARD. On any occasion were any of these loans that you
purchased from Penn Square criticized by the bank examiners?
Mr. DRIGGS. In examination during May 1981 there were four or
five loans that were criticized by the Office of the Comptroller; yes.
Mr. BARNARD. Following that did the bank continue their participation arrangement with the Penn Square Bank?
Mr. DRIGGS. AS I understand it, our Battle Creek office looked to
each one of those loans and prior to the final wrap-up of the examination of the Comptroller's Office in September, all of the loans
were brought current to or paid in full, and I am not—I don't recollect all the facts but an investigation was made into each one of
those loans by our officers.
When the Comptroller performs an examination of our bank we
ask each area to look at the loans or the criticized assets or any
suggestions and write a detailed report to the Comptroller's Office.
That was done, and evidently every condition was satisfied prior to
the conclusion of the examination.
Mr. BARNARD. And you were not sufficiently concerned at that
point to discontinue your participation arrangement with Penn
Square?
Mr. DRIGGS. We were not.
Mr. BARNARD. YOU still maintained the confidence?
Mr. DRIGGS. That is correct.
Mr. BARNARD. In Mr. Patterson?
Mr. DRIGGS. Yes.

Mr. BARNARD. I have no further questions, Mr. Chairman.
The CHAIRMAN. I know that you will be sorry to hear this, Mr.
Driggs, Mr. Peterson, Mr. Middeldorf, but I don t have any further
questions at this time, either.
So we want to thank you for your assistance, your cooperation
with staff, that of your personnel. You have been very helpful.
There may be further questions in writing, already you have one
that you will fill the blanks in for us on.
Mr. DRIGGS. We will be happy to respond to any questions.
Thank you very much.
The CHAIRMAN. You have very competent advisers, I know, so
that should make it easier.




125

Mr. DRIGGS. We appreciate that.
The CHAIRMAN. Thank you very much.
The CHAIRMAN. At this time I ask Mr. Richard Jaehning and
Arland Hatfield be kind enough to approach the witness table.
Thank you, Mr. Hatfield and Mr. Jaehning have been sworn. I
understand you have a prepared statement.
Mr. JAEHNING. Yes.

The CHAIRMAN. Would you be kind enough to proceed?
TESTIMONY OF RICHARD G. JAEHNING, PRESIDENT, SEATTLEFIRST NATIONAL BANK; ACCOMPANIED BY ARLAND D. HATFIELD, SENIOR VICE PRESIDENT AND MANAGER, ENERGY DIVI
SION

Mr. JAEHNING. Mr. Chairman, distinguished members of the
committee, I am Richard Jaehning, president of the Seattle-First
National Bank, and this is Mr. Arland Hatfield, senior vice president and manager of the Energy Division at Seafirst.
We are here today to cooperate fully with the committee in its
continuing inquiry into the failure of Penn Square Bank. We share
this panel's interest in the complex set of relationships which arose
not only between Penn Square, its customers and participating
banks, but with Federal Government's regulatory agencies as well.
With the chairman's permission, we will spare the committee's
time and not detail here the minute-to-minute chronology of Seafirst's dealings with Penn Square. We will, however, be glad to address any questions the committee may have on that progression.
We would prefer to get right down to the how and why of the
matter, because quite frankly those questions have caused a great
deal of very painful corporate soul-searching at Seafirst during the
past several months.
Seafirst has always prided itself on being a conservative bank
with an earned reputation for sound management. Over the past
couple of decades, we have enjoyed steady growth and a position as
the regional financial leader in the Pacific Northwest.
We became interested in energy lending in the mid-1970's when
our strategic analysis predicted a strong and ongoing demand for
credit services in that field. We had already been doing business in
Alaska in connection with the pipeline; and it seemed a natural
progression to begin looking into oil and gas lending in the Southwest.
Our interest in energy was sparked in the late 1970's when,
along with many other financial institutions across the Nation, we
began to feel mounting pressures from high, volatile interest rates,
partial deregulation, increased competition from unregulated nearbanks, and a general worsening of the economy. Particularly in our
own Pacific Northwest, where economic health is tied to the timber
and aerospace industries, the recession began early, and is as
severe as any place in the Nation today.
By 1979, we were looking at the potential opportunities Penn
Square was beginning to offer.
We were looking at the large, successful banks who were already
dealing with that institution. We were looking at our own short
but successful history in energy lending. We were looking at the


http://fraser.stlouisfed.org/
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clean bill of health the Comptroller of the Currency's examiners
continued to give Penn Square loans. And it all looked good to us.
In retrospect, we wish we had looked a little longer and a little
deeper. We wish the Comptroller or Penn Square officers had
shared with us the serious inadequacies in the lending, credit, and
documentation policies of that institution.
Although we believe that adequate credit review policies did
exist within our bank, it is clear that in some instances, documentation lagged far behind loan volume and collateral was not verified. Credit work was slow, and more importantly, it was based
upon industry assumptions about the future of oil prices. At this
point, Seafirst is a little bruised and more than a little embarrassed, but we hope and expect a vital recovery.
Steps have been taken in that direction. We have opened an
office in Oklahoma City and have staffed it with some of our best
credit people. They have contacted all the customers involved in
the Penn Square participations and are working with the FDIC to
purchase those loans.
We have thoroughly reviewed our credit policies and procedures
and have made certain they will be adhered to. Our Energy Division is headed by a seasoned credit administrator and is staffed by
bank officers with proven abilities to work within our established
credit review framework.
Mr. Chairman, members of the committee, we have had to say
some hard things today. We will not soon forget Penn Square, but
we are not going to let it haunt us either. Seafirst is, and will continue to be a conservative, well-managed institution that has
earned the confidence of its customers, its peers, and its community.
We will be pleased to answer the committee s questions.
The CHAIRMAN. Thank you, Mr. Jaehning.
No. 1, oftentimes a brief statement and a straight out statement
is a very clear statement, and I congratulate you on it.
On page 2, "by 1979 we are looking at the potential opportunities
Penn Square was beginning to offer. We were looking at the large
successful banks who were already dealing with that institution."
Where did you get that information, that Penn Square had potential opportunities, that it was offering and that the large successful banks were already, a lot of successful banks already were
dealing with that institution?
Mr. JAEHNING. I didn't have direct contact at that time so it is a
little difficult for me to give you a specific answer on that.
But reflection would indicate that our energy department which
had been formed by then, had received a contact from Bill Patterson, and we were aware that both Chase and Continental had been
doing business in the Southwest
The CHAIRMAN. In other words, and Mr. Hatfield could help you
on this if you would like.
Was it an ABA meeting, an IBA meeting or did Mr. Patterson
come up to Seattle and say, hey, I am selling, you buying?
Don't get me wrong, that is the way he operated.
Mr. HATFIELD. I was named as energy manager at Seafirst in
July. Mr. Boyd was the manager who met and was in contact with
Mr. Patterson of Penn Square at the initial contact time.




127
The CHAIRMAN. SO are we to assume—we will hear from Mr.
Boyd after we hear from you.
When you made that statement, Mr. Jaehning, at page 2, what
you are saying is that Mr. Patterson who somehow or other met
Mr. Boyd who was at that time heading up the energy department
division?
Mr. JAEHNING. That is right.
The CHAIRMAN. And said here I am, Wild Bill Patterson, I am
selling if you are buying and by-cracky, I have sold to Continental
and to Chase and to Who's Who all over the place? Is that an accurate description?
As I said to others, don't feel bad, that is the way he operated.
Mr. JAEHNING. I cannot tell you if that is an accurate description
or not, but I certainly wouldn't refute it.
The CHAIRMAN. All right.
Then you say, "we were looking at the clean bill of health, the
Comptroller of the Currency's examiners continued to give Penn
Square loans," and then at the end of your statement you say, had
you known what the real facts were things would have gone a little
differently, correct?
Mr. JAEHNING. That is right.
The CHAIRMAN. AS you probably have heard, the one thing that
bothers me here that I think perhaps we have to look at, I am not
one of the members who feels we need a whole lot of legislation, I
think perhaps we need more application of the prudent man rule
and better judgment and of course judgment is one of those things,
that is why we have the erasers on pencils, we all make mistakes.
But in this area I happen to feel that we may be at a point
where the time has come to disclose a little more about the facts in
this situation of the financial institution when there needs to be
some corrective actions taken, and that this idea of keeping it a
grand secret, you know, perhaps we ought to revisit this because
after all, if you are running a good—incidentally, everything we
have heard to date is that your institution up there in the State of
Washington is a first class institution, has been for many years,
you have served the area well, nothing we have heard except complimentary remarks and evaluations.
So what problem would you have with disclosure when the
Comptroller comes in or one of the other regulators comes in and
finds that an institution is not being properly managed and that
unless they clean up their act, they will be facing public scrutiny.
Would you have any trouble with looking at a little more disclosure than we have had to date? Piercing that veil of secrecy slightly?
Mr. JAEHNING. There is a way today to do partially what you are
talking about. It is called the shared national credits. That would
be where a bank would have a credit and we would not be a participant, but a direct lender in a credit to that particular customer.
Thus, if there is an examination that takes place in Minneapolis,
for example, that information would then be passed on to us.
I really can see no reason why this particular rule that the
Comptroller has could also apply in the Penn Square situation. We
are participants, we had a right to know, I think, when they came




128
in and looked at the documentation and found it to be inadequate.
We had a right to know that.
As a shared participant in t h a t particular loan, no matter who it
was, I think we should have had that information.
The CHAIRMAN. YOU feel the Comptroller's office was delinquent
in not providing t h a t information?
Mr. J A E H N I N G . I am not absolutely sure how t h a t rule applies
across the board. I do know t h a t in a national credit such as one
with International Harvester, for example, and with many other
credits, t h a t the examination takes place at the lead bank and the
classification at the lead bank is then distributed to t h e other participating banks.
All I am saying is I cannot understand why something of t h a t
type couldn't work in a case like this.
The CHAIRMAN. That is all right for you. You are a participating
bank in a loan.
Mr. J A E H N I N G . That is right.
The CHAIRMAN. H O W about the S&L next door to you or the
credit union next door to you who deposited funds in excess of
$100,000 in Penn Square? How were they helped by that?
Mr. J A E H N I N G . Well, you are here getting into an extremely sensitive area on how much information you are going to divulge.
The CHAIRMAN. Mr. Jaehning, we have in the past seen very few
instances like Penn Square where the whole thing is shut down
and people take the loss. To date we have been able to—we have
been looking at mergers and what have you and even though some
have had to wait a long period of time, in most instances they have
been made whole after a long period of time.
In this instance, there is very little probability t h a t many of
those people, t h a t anyone who had deposits over $100,000 will be
made whole.
And, just as I say, I think t h a t it is important t h a t we take a
careful look at this secrecy and see whether we have not worshipped at that shrine too long a period of time, and that perhaps
maybe we should look at a few other idols and deities.
Unfortunately we will have to ask your indulgence to r u n over
and cast a vote. We will be back momentarily.
Mr. J A E H N I N G . Yes, sir.

[Recess.]
The CHAIRMAN. The committee will be in order.
Mr. Jaehning, have you taken any trips to Oklahoma, to Oklahom a City, to visit Penn Square and the people there?
Mr. J A E H N I N G . I did.

The CHAIRMAN. Recently?
Mr. JAEHNING. Not recently.

The CHAIRMAN. When was that? When were you last there?
Mr. J A E H N I N G . I have been to Oklahoma City within t h e last 6
weeks to visit our people there.
The CHAIRMAN. Prior to that?
Mr. J A E H N I N G . I visited our people there twice in the last 2
months.
The CHAIRMAN. And prior to that?
Mr. J A E H N I N G . I made a trip to Oklahoma City at the end of January 1982.




129
The CHAIRMAN. And what was the purpose of t h a t trip, Mr.
Jaehning?
Mr. J A E H N I N G . I had taken over the world banking area. It started reporting to me in August 1981, along with some other duties I
had in the bank. I had set out a schedule to travel to certain areas
around the world, including Oklahoma City, to become more familiar with the different areas t h a t reported to me.
This was just a scheduled trip to Oklahoma City to better understand what the situation was there.
The CHAIRMAN. And while there, you met with whom from Penn
Square?
Mr. J A E H N I N G . I met Mr. Patterson and Mr. Jennings from the
Penn Square Bank.
The CHAIRMAN. HOW about Mr. Beller?
Mr. J A E H N I N G . Yes, I met Mr. Beller.
The CHAIRMAN. Did you spend much time with Mr. Beller?
Mr. J A E H N I N G . I spent about 2 hours, one breakfast with him.
The CHAIRMAN. And with Mr. Jennings?
Mr. J A E H N I N G . He was at the same breakfast.
The CHAIRMAN. Did you see Mr. Jennings subsequently?
Mr. J A E H N I N G . Very briefly.
The CHAIRMAN. Mr. Patterson.
Mr. J A E H N I N G . Again
The CHAIRMAN. J u s t a breakfast?
Mr. J A E H N I N G . N O .

The CHAIRMAN. Did he take you to.the Cowboy Club?
Mr. J A E H N I N G . N O , no; I saw Mr. Patterson. I was there for 2
days. Off and on we made some calls, and we would come back and
I had a dinner at Mr. Jennings' house, for example, with about 20some people, and Mr. Patterson
The CHAIRMAN. Was Mr. Beller at t h a t dinner?
Mr. J A E H N I N G . I think he was; yes.
The CHAIRMAN. Our information was poor Mr. Beller—you know,
there was a song, poor Mr. Chisholm—strummed on his mandolin;
our impression was he just about spent a lot of time strumming his
mandolin, not t h a t he is not a wonderful gentlemen, he is, but Mr.
Jennings and Mr. Patterson used him as a—to placate the Comptroller. That was why I am wondering: When you were there, who
did you feel was running the operation?
Mr. J A E H N I N G . Well, I had a long conversation with Mr. Beller
and Mr. Jennings together, because I had some concerns about documentation problems that we had been having and
The CHAIRMAN. Mr. Beller couldn't have been very helpful
there?
Mr. J A E H N I N G . Well, he was.
The CHAIRMAN. That is not
Mr. J A E H N I N G . Whether he was giving me a song and dance, you
know; hindsight would say he probably was.
The CHAIRMAN. YOU know, we had a nice discussion with him in
Oklahoma City. He admitted that he was, you know; he was told
t h a t t h a t area, energy, was out of his—out of bounds for him.
Mr. J A E H N I N G . He did not tell me that, nor did Mr. Jennings tell
me that.




130
The CHAIRMAN. NOW, Mr. Jaehning, how often did you review
the credits of Penn Square, and did you participate in any discussions on the Penn Square loans with your management committee?
Mr. JAEHNING. I was not on the credit committee. There were
two committees that reviewed credit from Penn Square, and I will
ask Arland to go over that briefly with you because he was on
those committees.
One was in the world banking area and the other was the general credit review committee for the bank.
I did not serve in those committees. I am on the management
committee and have been and was, but credits of the size of Penn
Square basically were not management committee credits. In other
words, we reviewed credits at the management committee that
were at our house limit or above.
Our house limit was about $30 million. Most of these credits
were in the area of $3 million to $10 million, and they were reviewed at the world banking committee and at the general credit
committee of the bank.
The CHAIRMAN. Was it just Mr. Boyd who had responsibility for
Penn Square loans, or was it somebody higher up the ladder?
Mr. JAEHNING. He reported to John Nelson, the executive vice
president, and John Nelson was for a period of time the chairman
of the world banking credit committee and also served on the
bank's credit committee.
Late in 1981, or early 1982, probably about January
Mr. HATFIELD. Yes, February.

Mr. JAEHNING. Then Arland Hatfield, at my request, was made
chairman of the World Banking credit committee.
The CHAIRMAN. TO replace?
Mr. JAEHNING. John Nelson.
The CHAIRMAN. When did Mr. Nelson retire?
Mr. JAEHNING. John retired from the bank; he is still on the payroll, but he retired from the bank in July.
The CHAIRMAN. Could we say, was he a Penn Square casualty?
Mr. JAEHNING. Yes, I would say he is a Penn Square casualty.
The CHAIRMAN. NOW, you say that—did you get involved in looking into the Penn Square participations, Mr. Jaehning?
Mr. JAEHNING. I did not.

The CHAIRMAN. Yet you took the trip to Oklahoma City, and
while there, you took the opportunity to discuss documentation on
these loans?
Mr. JAEHNING. Well, we had a

The CHAIRMAN. Did you have somebody with you?
Mr. JAEHNING. John Boyd, from our bank, was with me.
The CHAIRMAN. On that trip to Oklahoma City?
Mr. JAEHNING. Yes; but we had had some concern about inadequate documentation; we felt that we needed some reassurance,
and in my conversations, as I say, with Messrs. Jennings and
Beller, I was given all kinds of assurance to the effect that: "Believe me, that documentation was improving; that documentation
was in good shape; that, yes, they had had some problems with documentation, but that is why Mr. Beller was there because he was a
credit person, and don't worry about these things."




131
I still had some concerns after my visit, and I asked Arland to go
down and just take a look around, look at a few files and see what
he thought about the progress at the bank.
The CHAIRMAN. Arland is Mr. Hatfield?
Mr. J A E H N I N G .

Yes.

The CHAIRMAN. Tell us about your going down and looking
around.
Mr. HATFIELD. I went down in the latter part of February. I
spent 2 days at Penn Square. The purpose of my visit was to look
at the procedures t h a t the bank used in evaluating their credits,
and then the review process t h a t they used in—after the credit had
been made or approved by the various committees t h a t approved it.
I also wanted to meet with
The CHAIRMAN. What did you find?
Mr. HATFIELD. I wanted to meet with the people and get my own
personal evaluation of their quality.
The CHAIRMAN. Tell us about who you met and who was approving these loans?
Mr. HATFIELD. My initial meeting was with Mr. Beller. I visited
with Mr. Beller and went through the people he hired mainly from
First Oklahoma and had brought over as key people to work with
him on the review process and the approval process.
I spent about two hours with him and then left him and went
with Mr. Richard Dunn, who was their loan review officer and
spent about 2 hours with him.
Later on in the day, I asked if I could start looking at some credits. I had some specific credits I wanted to look at; those t h a t we
had significant exposure in—some large loans. I looked through
those credits. The people I visited with said they had just been in
the process of upgrading and cleaning up the credit files.
I wanted to look at some they had not cleaned up. I went
through and checked documentation on four very large credits and
found them to be OK.
I went back to Mr. Beller and asked him if I could look at their
loan policy statement, if they had such a thing. I also would like to
look at the minutes of their meeting of their loan committee to see
what kinds of loans they were reviewing and approving.
I did that.
The CHAIRMAN. What kinds of loans were they looking at and approving?
Mr. HATFIELD. They were approving all the loans made within
the bank.
The CHAIRMAN. Including all energy loans?
Mr. HATFIELD. All energy loans. I asked him who is the chairperson of the loan committee, and he said, "I am."
The CHAIRMAN. Who was t h a t now?
Mr. HATFIELD. Mr. Beller.
He said I would invite you to come in in the morning; we are
going to have a loan committee meeting to go over various loans.
Mr. Joe Semler, deputy manager of the energy division, was with
me. We went to t h a t meeting.
They reviewed two energy credits t h a t morning. I asked him
questions about the collateral, how they determined the collateral,
the basis of the reserves, and we went through the geology and




132
who the geologist reported to. He told me he was totally independent. This was Mr. Beller, and I saw them approve these two loans
and the committee broke up. I spent the rest of the day visiting
with a geologist in the geology department.
The CHAIRMAN. What we are hearing is—Mr. Barnard and I are
hearing—a story we did not hear in Oklahoma City. Mr. Barnard,
why don't you relieve me a few minutes, and I will be back.
Mr. BARNARD. Thank you, Mr. Chairman.
Gentlemen, we certainly do appreciate your coming the long distance that you have to be with us all day long. Maybe we have
gained a little empathy from you about all the challenges we have
on this committee.
Mr. Jaehning, how do you recognize credit, a credit manager or
officer, in any commercial bank? Do you recognize him as a very
skilled individual, someone who is highly experienced, highly
knowledgeable, and so on? What is your general characterization of
a credit officer? What would you expect out of a credit officer?
Mr. JAEHNING. I have a great deal of respect for credit officers in
any bank, and the credit officers in our bank are normally a
person that has been in credit for a long period of time. Credit is
not something that you learn in a year or two. Most of our people
that are senior credit officers today have been with the bank anywhere from 15 to 30 years, and they are very disciplined people.
They are also very patient people and have very good judgment.
They believe that you have to have all the facts. They believe that
you have to have good documentation. They believe that you never
have the chance to ever get any documentation once you advance
funds.
Mr. BARNARD. Wouldn't you expect that same qualification from
an officer of a bank from whom you were buying a substantial
amount of loans?
Mr. JAEHNING. I would, yes.
Mr. BARNARD. Did the Seattle First, as far as Mr. Patterson was
concerned?
Mr. JAEHNING. My association with Mr. Patterson was maybe an
hour or so in a 2-day period. Really, I would have a hard time evaluating that period of time whether Mr. Patterson was a supersalesman or a super credit officer.
Mr. BARNARD. Well, then, you mean that you were relying upon
your own credit department for the creditworthiness of those loans
as opposed to Penn Square?
Mr. JAEHNING. Well, yes, and remember that we were buying
participations, that we were given great assurances that these credits had been checked, that they were good credits, and that the documentation was proper. But yes, we share some of that responsibility.
Mr. BARNARD. Of course, you know Monday-morning quarterbacking is always very, very easy when you are judging the Seattle
Sea Hawks, but
Mr. JAEHNING. Please.
Mr. BARNARD. YOU said in your statement that you were looking
at the clean bill of health the Comptroller of the Currency examiners continued to give Penn Square loans.




133
I would say about the Penn Square Bank, t h a t here is a $400 million bank in a shopping center, in Oklahoma City, that, is generating 80 percent of its loans in one particular field.
I thought t h a t banks were very much concerned about concentration and overconcentration.
That is one aspect.
No. 2 is t h a t it was very active in the field of brokered funds.
That is the big one. We have a schedule of all the credit unions in
this country t h a t were depositing money down there at unusually
high interest rates, another red flag.
It just appears to me t h a t a bank the quality of Seattle First and
the Continental and the Michigan National and others would have
noticed some of these characteristics and really identified it as a
go-go bank—like one of these go-go nightclubs, it is not there for
too long. Did you ever question any of these unusual characteristics
of this institution?
Mr. J A E H N I N G . Yes. We questioned it in the fall of 1981. We had
a concentration policy within our bank at about 150 percent of capital.
We went beyond t h a t in J a n u a r y 1982 and the Energy Department was told very loudly to get back within those limits as soon
as possible. There were many attempts to do this.
We did not purchase any new energy loans after about February
or March 1982. We made advances on commitments we had but we
effectively cut off the Energy Department and t h a t was in February or March 1982.
Mr. BARNARD. In cutting off the Energy Department, were you
also cutting off the Penn Square Bank?
Mr. J A E H N I N G . Yes.
Mr. BARNARD. Was t h a t

because of your own evaluations of those
credits and the operations of Penn Square?
Mr. J A E H N I N G . It was more in the area of concentration and the
fact that we were exceeding our rules as far as concentration was
concerned.
The CHAIRMAN. What was the date now, February 1982?
Mr. J A E H N I N G . February or March 1982.
The CHAIRMAN. YOU decided that it was energy loans or Penn
Square energy and Penn Square loans?
Mr. J A E H N I N G . The Energy Department had exceeded its concentration limits at t h a t point.
The CHAIRMAN. Did the Energy Department lend money to some
of the big swingers at Penn Square?
Mr. J A E H N I N G . Well, we had some 120 customers that were participating in at Penn Square Bank and, you know, we have
now
The CHAIRMAN. Excuse me, I am not talking about participation.
I will get specific.
A chap named Ron Burks. I don't know if he had a $2 million
line of credit or $2 million plus $205,000 but as of February 1982
your institution approved a $2 million line of credit to him, on
which he drew down about $1,689,000.
Then there was Mr. Patterson, December 1981, $1.4 million. They
were signed by John Boyd. It doesn't say what it was for.




134
Then we have $2.5 million, at least, to Jennings, and the last,
$1.5 million was drawn down in May.
Were you familiar with those loans, Mr. Jaehning?
Mr. J A E H N I N G . I was not at t h a t time, no. I am familiar with the
Jennings loan today, yes.
The CHAIRMAN. But the February 1982, after you told the Energy
Department to slow down they still proceeded with another $2 million to Mr. Burks, were you aware of that?
Mr. J A E H N I N G . I was not, and I qualify t h a t by saying t h a t we
had commitments out t h a t we did honor after t h a t date.
The CHAIRMAN. I am sorry.
Mr. BARNARD. GO right ahead.
The CHAIRMAN. Want me to go for a while?
Mr. BARNARD. I want to ask him one thing.
I know we will hear the testimony of Mr. John Boyd, former
senior vice president and general manager, but was his dismissal
because he violated bank policies and procedures, and practices in
the administration of these loans?
Mr. J A E H N I N G . Well, basically, yes, John did violate some of our
policies and practices and we felt t h a t in July t h a t he probably
didn't have confidence in us and we didn't have confidence in him
at t h a t point.
Mr. BARNARD. Did he have any other problems with other credits
other than with Penn Square?
Mr. J A E H N I N G . There were credits in the energy area we were
having problems with at t h a t time, yes.
Mr. BARNARD. Was this because of documentation?
Mr. J A E H N I N G . N O .
Mr. HATFIELD. N O , they were just
Mr. BARNARD. J u s t not creditworthiness.
Mr. HATFIELD. Problems with economy or

lack of drilling capacity or need for drilling.
Mr. BARNARD. Had these loans been approved by your credit
committee?
Mr. HATFIELD. Most of them had, yes.
Mr. BARNARD. In other words, they were processed by Mr. Boyd
but, on the other hand, they were approved by the loan committee
then?
Mr. HATFIELD. Mr. Boyd at t h a t time had a $10 million lending
limit so he could approve loans up to t h a t amount. Over a certain
dollar amount, if it were a new credit, the credit committee would
review that. So many of the loans were on review, there were quite
a few t h a t were approved.
Mr. BARNARD. Since the Penn Square have you had to tighten up
your procedures and policies?
Mr. J A E H N I N G . Yes. As I mentioned in my statement, we have
had a full review of our procedures, policies, lending limits, and the
authority of the different committee levels, and so forth.
We have tightened up considerably.
Mr. BARNARD. One final question which I asked the others.
How much importance or significance did you give the statement
by the auditors, the old auditors as well as the new auditors?
Mr. J A E H N I N G . I was not aware of the original statement until
just recently. The statement t h a t came out in March of this year




135
that everything was fine and everything was clean—I was aware of
shortly after it was issued.
Arland, do you want to adddress this?
Mr. HATFIELD. I was aware in 1980 of the qualification. We questioned Penn Square. At the time I was there I questioned them
about it. They said it was mainly the fact that they didn't have the
qualified people to handle the paper work, that they had corrected
those things and that the Comptroller had given them a clean bill
of health as of that date.
Mr. BARNARD. Mr. Jaehning, I know the chairman is going to
follow up on this but I want to ask it also.
On your visit to Oklahoma City and your breakfast with the
management team of Penn Square, you left there with every satisfaction that Mr. Beller
The CHAIRMAN. Eldon Beller.
Mr. BARNARD [continuing]. He was the chief executive officer
with the authority and supervision of the credit function of the
bank?
Mr. JAEHNING. I left there with the idea he was the chief credit
officer. I don't think there was any doubt that Mr. Jennings was
the chief executive officer but I was given every reason to believe
that Eldon was the chief credit officer of that bank.
Mr. BARNARD. And you gained no indication that he was supposed to stay out of Mr. Patterson's bailiwick?
Mr. JAEHNING. I did not.
Mr. BARNARD. Thank you,

Mr. Chairman.
I have no further questions.
The CHAIRMAN. Did you have any indication he was supposed to
stay out of Mr. Patterson's bailiwick, Mr. Hatfield, to wit, energy
loans?
Mr. HATFIELD. NO. Contrarily, I was told he was this senior credit
person and in charge of the credit committee.
The CHAIRMAN. One of these days when we have the transcript
ready I would commend to you as interesting reading the hearing
in Oklahoma City and the testimony of Mr. Beller himself, that he
was there, it was SOP [standard operating procedure] an understanding about his employment that stated it was understood he
would not get involved in those areas because those were sancrosanct and belonged to Mr. Patterson and Mr. Jennings.
Does Seafirst have correspondent relationships with Chase and
Continental and Michigan National?
Mr. JAEHNING. Yes, it would be like any other bank.
The CHAIRMAN. Did you discuss with those institutions, Penn
Square, at any point in time, Mr. Jaehning?
Mr. JAEHNING. I did

not.

The CHAIRMAN. Mr. Hatfield.
Mr. HATFIELD. I did

not.

The CHAIRMAN. TO refresh my memory because of the vote that
intervened, as I recall, to the best of your knowledge, the relationships that developed between Seafirst and Penn Square was primarily as a result of Mr. Patterson calling upon Mr. Boyd in some
way, shape, manner or fashion and going from there?
Mr. JAEHNING. That would be my understanding, yes.




136
The CHAIRMAN. Did either of you ever verify with Chase, Continental or Michigan National the fact that they were purchasing
participations from Penn Square?
Mr. JAEHNING. I did not.
Mr. HATFIELD. I did.
The CHAIRMAN. YOU did?
Mr. HATFIELD. I did.
The CHAIRMAN. At what period of
Mr. HATFIELD. In the fall of 1981,

time, Mr. Hatfield?
I was down in the energy division visiting with some of the officers about particular loans and I
met Mr. Pat Goye, the correspondent from Continental Bank, who
serviced our bank on the west coast. I asked him at that time about
the Penn Square relationship and he said that they had an excellent relationship with them.
The CHAIRMAN. What was his name again?
Mr. HATFIELD. Pat Goye.
The CHAIRMAN. Goye?

Mr. HATFIELD. Goye. G-o-y-e.
The CHAIRMAN. Pat Goye. I am curious. You said that the reason
Mr. Boyd was dismissed, pinkslipped, was that not only Penn
Square but there were other credits that you had problems with
that he had approved?
Mr. JAEHNING. A S I indicated earlier, there were some other
problems in our energy department.
The CHAIRMAN. When did those surface?
Mr. JAEHNING. Most of the problems in energy have surfaced
this last spring, and this last summer.
The CHAIRMAN. And in July? When Penn Square
Mr. JAEHNING. Actually, prior to July.
The CHAIRMAN. But Mr. Boyd was with you prior to July.
Mr. JAEHNING. That is right.
The CHAIRMAN. Had he been given notice prior to July 4 that his
services were no longer required?
Mr. JAEHNING. NO.

The CHAIRMAN. When did he get that notice?
Mr. JAEHNING. Probably around the middle of July.
The CHAIRMAN. Subsequent to the demise of Penn Square?
Mr. JAEHNING. Yes, sir.

The CHAIRMAN. SO, is it fair to assume that in reality his departure was primarily due to the problems with the Penn Square
loans?
Mr. JAEHNING. Primarily, yes.
The CHAIRMAN. Thank you.

Mr. Nelson's retirement was for that same reason? Early retirement?
Mr. JAEHNING. Yes, although there are some other circumstances
involved. John had been moved out of the world banking area back
in the end of March or first part of April, and a new manager had
been put in that area. So there were other situations involved in
that particular retirement.
The CHAIRMAN. Other than those two were there any other casualties?
Mr. JAEHNING. Not at this time; no.
The CHAIRMAN. OK.




137
Did you hear from the Comptroller's Office at any point in time
about the problems of Penn Square?
Mr. J A E H N I N G . Prior to what date?
The CHAIRMAN. Prior to the shutting of it down.
Mr. J A E H N I N G . Our chairman received a call, I believe around
the 29th of June.
The CHAIRMAN. Of June?
Mr. J A E H N I N G . Of June.
The CHAIRMAN. OK. From whom did he receive t h a t call, sir?
Mr. J A E H N I N G . Somebody in the Comptroller's Office.
The CHAIRMAN. YOU don't know who?
Mr. J A E H N I N G . I don't know who it was.
The CHAIRMAN. DO you know what he was told?
Mr. J A E H N I N G . We were asked, along with Continental and
Chase, if we wished to come to Washington, D.C., and to go over
some problems at Penn Square with the Comptroller.
The CHAIRMAN. DO you know who attended t h a t meeting?
Mr. J A E H N I N G . I did, and Arland Hatfield did.
The CHAIRMAN. At that time what were you told?
Mr. J A E H N I N G . We were told t h a t an ongoing exam that started
back in April was showing some very serious problems with the
Penn Square Bank. We were told t h a t there were a number of
chargeoffs t h a t would be listed and t h a t the Penn Square Bank at
that time was trying to raise additional capital. We were asked
whether we felt there was anything t h a t we or other banks might
be able to do to try and support Penn Square Bank.
The CHAIRMAN. TO assist in raising additional capital?
Mr. J A E H N I N G . That was one of the questions presented; yes.
The CHAIRMAN. That was the first you knew t h a t the situation
had been—had become so dire?
Mr. J A E H N I N G . Yes.
CHAIRMAN. D-i-r-e?
Mr. J A E H N I N G . Yes.
The CHAIRMAN. All right.

The

Does Seattle First have its own energy analysis department? In
other words, do you have engineers, geologists in your energy department?
Mr. HATFIELD. We have an engineer.
The CHAIRMAN. An engineer?

Mr.

HATFIELD.

We have an engineer.

The CHAIRMAN. An engineer?

Mr. HATFIELD. And we use outside consultants.
The CHAIRMAN. Did you send the outside consultants or your engineer to Oklahoma City?
Mr. HATFIELD. Our engineer had gone down to Penn Square and
reviewed with their geologists and their engineering department
their system.
The CHAIRMAN. Their system. How much time did your engineer
spend there?
Mr. HATFIELD. I can't answer that.
The CHAIRMAN. Roughly.
Mr. HATFIELD. I would say 2 days, but I cannot say for sure.
The CHAIRMAN. When was that?
Mr. HATFIELD. In the fall.




138
The CHAIRMAN. Of 1981?
Mr. HATFIELD. 1981. Yes.
The CHAIRMAN. And subsequent

to that did any of your technicians go to Oklahoma City to look at any of Penn Square's loans?
Mr. HATFIELD. Mr. Boyd can respond more to that because he
was the manager at that time. I am only aware of the one visit.
The CHAIRMAN. Who else do you have technically qualified at Seattle First on energy loans? You have one engineer, and you use
outside private consultants.
Mr. HATFIELD. Yes.

The CHAIRMAN. IS that the sum total of it?
Mr. HATFIELD. That is the sum total of it.
The CHAIRMAN. AS compared to Continental which seems to
have
Mr. HATFIELD. Yes. That is right.
The CHAIRMAN. Which seems to have a greater number of individuals involved?
Mr. HATFIELD. Yes.

The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. I have no questions, Mr. Chairman.
The CHAIRMAN. Gentlemen, we want to thank you. Were you
with me in Seattle?
Mr. BARNARD. NO.
The CHAIRMAN. YOU didn't come?
Mr. BARNARD. Oklahoma City was my only trip.
The CHAIRMAN. YOU missed a wonderful trip.
Mr. JAEHNING. YOU didn't have to mention

the Seahawks,
though.
The CHAIRMAN. I didn't mention them. OK. Really, as you know,
we were there in the fall; the full committee was there for hearings
on the economy and I understand it has not improved since we
were there. I am sure that you didn't—I hope you didn't mind too
much coming to Washington to visit with us.
Mr. JAEHNING. This time of the year it is beautiful.
The CHAIRMAN. We want to thank you for your cooperation, your
assistance to the staff, and there might be additional questions we
might be submitting in writing and that is it.
Mr. JAEHNING. Thank you very much.
The CHAIRMAN. Thank you, gentlemen.
Now we hear from Mr. John R. Boyd, who has been, until recently, senior vice president of the energy division of Seattle-First National Bank.
[Witness sworn.]
Proceed, sir.
TESTIMONY OF JOHN R. BOYD, FORMER SENIOR VICE PRESIDENT
AND MANAGER, ENERGY DIVISION, SEATTLE-FIRST NATIONAL
BANK
Mr. BOYD. Until July 15, 1982, I was senior vice president and
manager of the energy division of Seattle-First National Bank. I
am pleased to appear before the committee to answer questions related to the Penn Square Bank operations. I hope that the facts
that I am able to give will be helpful in your deliberations.




139
For background, Seafirst has been involved in making energy-related loans since the mid-1970,s. In March 1978, the bank established an energy department which later became a division of Seafirst's World Banking Group.
The division was given a global responsibility. We sought and
made energy loans in the areas of drilling equipment, refining,
service companies, and production payment financing. Our primary
geographic areas of lending were the Southwest, Alaska, Canada,
and South America.
By the end of 1980 our average outstanding energy loans exceeded $200 million.
During the 1980-81 period, the level of oil and gas prices moved
sharply upward, which increased the level of drilling for oil and
gas. Our energy loan portfolio grew accordingly.
By December 31, 1981, the energy division had average outstanding energy loans of $846 million. Seafirst's relationship with Penn
Square began in early 1979. At that time, we were advised that
Penn Square was using Continental Illinois and Chase Manhattan
as its principal upstream correspondents.
Seafirst's relationship with Penn Square began slowly. By the
end of 1979, Penn Square-related loans amounted to $4 million of
the energy division's then outstanding $79 million in loans.
By the end of 1981, Penn Square-related loans accounted for approximately $300 million of the energy division's $1 billion loan
portfolio. All Penn Square energy loans in which Seafirst participated during 1980, 1981, and 1982 were covered by written master
participation agreements executed by both banks in each of the 3
years. These agreements required Penn Square to properly collateralize and to evaluate the creditworthiness of each loan.
During our 3-year involvement with Penn Square, the Office of
the Comptroller of the Currency had regularly examined Seafirst,
and had raised no questions concerning our Penn Square-related
loan participations. Further, we were aware that the Comptroller
had regularly examined Penn Square, and we had no indication
from the Office of the Comptroller or from Penn Square's management of any problem.
In fact, sometime after a visitation of Penn Square Bank by the
Office of the Comptroller, which I believe occurred in September
1981, several members of Penn Square's management advised me
that the Comptroller's Office had commented favorably on additions to the bank's personnel, and improvements made in its systems.
The first time I can recall the Comptroller's Office commenting
to us regarding Penn Square was following the Comptroller's April
1982 examination of Seafirst's energy division. At that time, I was
advised that examiners of the Comptroller's Office might wish to
come back and examine certain Penn Square loans.
So far as I am aware, we, at Seafirst, heard nothing further from
the Comptroller until the last week in June. I understand at that
time our senior management received a call from the Office of the
Comptroller in Washington, D.C. As you know, a few days later,
Penn Square was closed by the Comptroller's Office.
I will be pleased to answer the committee's questions.




140
The CHAIRMAN. Thank you, Mr. Boyd. At page 2, you say, Seafirst's relationship with Penn Square began in early 1979. "At t h a t
time, we were advised Penn Square was using Continental Illinois
and Chase Manhattan and as its principal upstream correspondents.^
You say "we." Who are "we"? "At that time we were advised
He

He

*

>>

Mr. BOYD. I was advised of that.
The CHAIRMAN. IS t h a t the editorial "we"?
Mr. BOYD. I didn't mean it—an associate of mine, Y. C. Chao, we
were together.
The CHAIRMAN. Who is Y. C. Chao?
Mr. BOYD. He is a vice president of Seattle-First National Bank.
The CHAIRMAN. He is still there?
Mr. BOYD. Yes, sir.
The CHAIRMAN. Y. C ?

Mr. BOYD. C-h-a-o.

The CHAIRMAN. Y. C. Chao. And his position at Seafirst?
Mr. BOYD. At that time he worked under me in the energy department.
The CHAIRMAN. And now he does what?
Mr. BOYD. I believe he is still in the energy department.
The CHAIRMAN. About the same level is he? Did Mr. Hatfield replace you in the energy department?
Mr. BOYD. Yes.
CHAIRMAN.

The

The man?

Mr. BOYD. NO; he did not replace me. No.
The CHAIRMAN. Who replaced?

Mr. BOYD. He replaced me, yes, as manager of the energy department, and Mr. Chao is in the same position.
The CHAIRMAN. That he was in relation to Mr. Hatfield as he
was in relation to you?
Mr. BOYD. I believe t h a t is true, yes.
The CHAIRMAN. SO let's start over again. The "we" refers to you
and Mr. Chao?
Mr. BOYD. Yes.
The CHAIRMAN. HOW

did Penn Square come to your attention
and the fact that it had, that it was selling participations to Chase
and Continental?
Mr. BOYD. Bill Patterson called Seattle-First some time in March
or April 1979 inquiring about a letter of credit t h a t t h e bank had
issued in relationship to one of the loans t h a t he was working with
in Oklahoma. That particular technical question was straightened
out and he asked the individual whom he was speaking to if Seafirst had an oil and gas department.
And they said, yes, they did. And I spoke with him on the phone.
He introduced himself, told me what they were doing at Penn
Square, and asked if he could come by and visit with us—which he
did.
The CHAIRMAN. GO ahead.
Mr. BOYD. Which he did probably 30 days later. We visited and
from t h e standpoint of what Penn Square was doing, what they
were hoping to do and so forth, and I made a trip to Oklahoma
probably in May 1979, or thereabouts.




141
The
tion?
Mr.
The
Mr.
The

CHAIRMAN. YOU

made the trip to Oklahoma at his invita-

BOYD. It was mutual. He invited me to come and I accepted.
CHAIRMAN. Who picked up the tab, the air fare?
BOYD. I paid my own, yes, sir.
CHAIRMAN. Seattle-First paid it?
Mr. BOYD. Yes, sir.
The CHAIRMAN. Did Mr. Chao go with you?
Mr. BOYD. N O , sir, I went by myself.
The CHAIRMAN. Did Mr. Patterson give you any references, any

people t h a t you should contact to verify the accuracy and the veracity of his statements to you about participations that Chase and
Continental had with Penn Square?
Mr. BOYD. Yes, sir, he did. He gave us a Continental Illinois
Bank person.
The CHAIRMAN. Anyone in particular at Continental Illinois?
Mr. BOYD. I cannot recall.
The CHAIRMAN. Could it have been John Lytle?
Mr. BOYD. NO; I knew John Lytle.
The CHAIRMAN. YOU knew John Lytle from before?
Mr. BOYD. Yes,

sir.

The CHAIRMAN. Did you at any point check out Penn Square
with John Lytle?
Mr. BOYD. By our working together on a number of large credits
from 19—mid-1981, I would say probably from February 1981 when
we started to look at the larger credits t h a t were offered by Penn
Square, John Lytle and I had an opportunity to work together.
The CHAIRMAN. YOU knew already at this point in time you had
become involved with Penn Square? You were already in the pool?
Mr. BOYD. Yes, sir.
The CHAIRMAN. Swimming

away.
Did you talk to anyone at Chase about their participations?
Mr. BOYD. I don't recall, Mr. Chairman.
The CHAIRMAN. YOU do say in your statement, as did the gentleman who testified earlier, that "at the time we were advised Penn
Square was using Continental and Chase Manhattan as its principal upstream correspondents?"
Mr. BOYD. Yes, sir.
The CHAIRMAN. YOU didn't follow up on that?
Mr. BOYD. I can't tell you for sure.
The CHAIRMAN. TO the best of your recollection?
Mr. BOYD. TO the best of my recollection, I did.
The CHAIRMAN. YOU said on page 3: "Further,

we were aware
that the Comptroller had regularly examined Penn Square, and we
had no indication from the Office of the Comptroller or from Penn
Square management of any problem."
Did you really expect the Comptroller, in view of the secrecy that
prevails in all of these areas, would have informed you of any problems that Penn Square was having?
Mr. BOYD. N O , sir, I made an assumption t h a t if Penn Square
credits were passed by the Comptroller in Seattle, and passed at
Penn Square t h a t those credits must be creditworthy.
The CHAIRMAN. YOU are a young man and I anticipate you would
like to stay in the business in the future.

 - 8 3
12-745 0
10


142
You might be informed of the fact that we have found the Comptroller's Office with one region doesn't talk to the Comptroller's
Office in the other region, and you shouldn't in the future assume
that they do that much conversationalizing. It is too bad, but that
is the case.
Mr. BOYD. Unfortunately.
The CHAIRMAN. Next paragraph, "Several members of Penn
Square's management advised me that the Comptroller's Office had
commented favorably on additions to the bank's personnel, and improvements made in its systems."
That is a self-serving statement by people from Penn Square
itself, correct?
Mr. BOYD. At the time I thought it was a statement of fact.
The CHAIRMAN. NOW you realize it was self-serving?
Do you recall who the members of Penn Square's management
team were that gave you that advice?
Mr. BOYD. Mr. Patterson, Mr. Beller, and Mr. Jennings.
The CHAIRMAN. Was that on a visitation that you made to Penn
Square in Oklahoma City?
Mr. BOYD. Yes, sir, and also on the telephone.
The CHAIRMAN. Did you talk with Mr. Beller very frequently on
the telephone?
Mr. BOYD. Probably five or six times.
The CHAIRMAN. With Mr. Beller?
Mr. BOYD. Yes,

sir.

The CHAIRMAN. And the subject of the conversations, do you
recall?
Mr. BOYD. General things, Mr. Chairman. No, I cannot recall.
The CHAIRMAN. YOU know those of us who were in Oklahoma
City and spoke to Mr. Beller found out he wasn't allowed to be involved in energy loans?
Mr. BOYD. Well, I did not speak with him on energy loans.
The CHAIRMAN. Well, what did you discuss with him?
Mr. BOYD. I

The CHAIRMAN. Did he go on the fishing trip?
Mr. BOYD. NO, sir.
The CHAIRMAN. That was to invite him on the fishing trip?
Mr. BOYD. NO, sir.
The CHAIRMAN. Can you tell us who went on the fishing trip?
Mr. BOYD. Yes, sir, Mr. Jennings, Mr. Patterson, just officers

or
directors.
The CHAIRMAN. Some of the big participants, Hefner, Swan?
Mr. BOYD. Mr. Hefner IV, went on the fishing trip; Mr. Swan.
I believe those were the only ones at Penn Square.
The CHAIRMAN. From your institution, who was along?
Mr. BOYD. Mr. William Jenkins, Mr. Gillis, Mr. Jay Langhurst,
who is the vice president responsible for Oklahoma, Mr. David Jenkins, Mr. Al Eerkes, and Mr. Robert Schultz.
The CHAIRMAN. HOW about Mr. Nelson?
Mr. BOYD. NO, sir, I went, of course.
The CHAIRMAN. Mr. Chao?
Mr. BOYD. He had responsibility for Texas. As a regional manager, Mr. Langhurst had responsibility for Oklahoma.




143
The CHAIRMAN. Mr. Jaehning said that they didn't become too
involved with any of the Penn Square loans. I wonder how come he
went on the fishing trip?
Mr. BOYD. Mr. Jaehning did not go on the fishing trip. Mr. Jenkins.
The CHAIRMAN. Oh, I am sorry.
I asked—who did you say went from Seattle?
Mr. BOYD. William M. Jenkins.
The CHAIRMAN. OK.

Let me ask you this, Mr. Boyd: Did you have total control? Were
you the last word in purchasing participations from Penn Square,
or did you report to anyone above you?
Mr. BOYD. Well, there were two types of participations which we
purchased from Penn Square.
The larger credits which were above my $10 million lending authority had to receive a previous approval before those credits,
before we could book those credits.
The credits which were under $10 million, I had the authority to
commit and to make those commitments.
The CHAIRMAN. YOU went up to $846 million from Penn Square?
Mr. BOYD. NO, sir, we went into the $350 million or in that area.
The CHAIRMAN. OK. In that $350 million would you say the majority of the credits were above or under the $10 million mark?
Mr. BOYD. The majority would be under.
The CHAIRMAN. SO that indeed you indeed were
Mr. BOYD. I had a substantial responsibility in regard to those
credits.
The CHAIRMAN. SO that, is it fair to assume that you had a substantial responsibility and you made the judgments and unfortunately unbeknownst to you Penn Square was not doing as well as
people thought they were?
Mr. BOYD. Yes, sir, that is a fair assessment.
The CHAIRMAN. Were you, or when did you become aware, if you
did, of the fact that on some of these participations that were nonperforming, that Penn Square was paying the interest on them to
the upstream banks like Seattle and Chase and Continental?
Mr. BOYD. I wasn't aware of that until after the June situation.
I don't know whether I read it or was told or whatever the case
may be.
The CHAIRMAN. HOW soon after the shutdown of Penn Square—
you left in mid-July?
Mr. BOYD. Yes, sir, July 15.
The CHAIRMAN. Would you be aware whether or not on any of
those loans that Penn Square, that were nonperforming where
Penn Square was paying the interest, would you be aware of the
fact that any of those were held by Seattle First?
Mr. BOYD. NO, sir.
The CHAIRMAN. YOU

did not have enough time between the shutting down and the time you left?
Mr. BOYD. NO, sir.
The CHAIRMAN. Mr. Barnard?
Mr. BARNARD. Mr. Boyd, how

First?
Mr. BOYD. Fourteen years.




long had you been with the Seattle

144
Mr. BARNARD. What is your background in the bank? What had
been your progress in the bank?
Mr. BOYD. I began as a trainee in September 1968 and in the
trust department.
I was a portfolio manager and a security analyst receiving a designation of charter financial analyst and in 1975 I moved across
from the trust department into corporate banking. I was elected a
vice president, I believe, in 1975.
I worked in the corporate banking section, which was involved in
the world banking area, and the U.S. department for 8 months,
and in 1976 I began working in the South, what we call our Southwest market, and went into, we specialized in energy in 1978, and
worked in t h a t capacity until the present.
Mr. BARNARD. With you as the senior vice president?
Mr. BOYD. Yes.

Mr. BARNARD. When were you promoted to t h a t position?
Mr. BOYD. That would have been about 1981, I believe. The
middle of 1981, in there.
Mr. BARNARD. Were you ever at any time for your own reasons
concerned about the volume of loans being generated by Penn
Square?
Mr. BOYD. That was definitely one of the things t h a t I had my
attention drawn to. I spent a great deal of time with Mr. Jennings
going over the philosophy of the merchant banking concept. One of
the things t h a t he had always talked about in t h a t situation is upstream; the key to success is an upstream correspondent must
learn to respect and must have respect for the work t h a t is done;
and, therefore, the quality of their participations, the quality of
their paperwork was the foundation upon which to move the bank
further on.
Mr. BARNARD. Did you develop a confidence in their expertise to
document loans?
Mr. BOYD. I believe t h a t they were doing an adequate job at the
time; yes. I won't say it too strong.
Mr. BARNARD. YOU had no problems with them then from the
standpoint of insufficient documentation or collateral evaluation?
Mr. BOYD. We did have from time to time, and we would have to
call them and have to spur them to give us information; yes.
Mr. BARNARD. Why would you tolerate a situation like that?
Mr. BOYD. TWO things. One was the—what I thought was the
competence of the people; and the second thing is they were an
emerging organization.
Mr. BARNARD. YOU didn't think they were competent?
Mr. BOYD. The competence of their people.
Mr. BARNARD. But they couldn't document loans.
Mr. BOYD. I think their workload was heavy.
Mr. BARNARD. TOO heavy?
Mr. BOYD. At times, yes, sir.

Mr. BARNARD. That wasn't a red flag, as far as you were concerned?
Mr. BOYD. It depends on when in the relationship. In 1979 and
1980, I don't believe it was a red flag. It was not a red flag. When
they brought on 35 or 40 of the new people that were in the bank, I




145
believe when Mr. Patterson resigned, there was something like 80
people in the energy department.
Mr. BARNARD. He ran the department, though, didn't he?
Mr. BOYD. Yes,

sir.

Mr. BARNARD. And what was your evaluation of his background
as compared to yours in making oil and gas loans?
Mr. BOYD. I looked at Bill Patterson in the context of the people
that worked for him, of the senior management in the bank, of the
directors of the bank. I thought Bill functioned very well as a generator of business, and the people t h a t he had working for them
showed a great deal of independence and many of them were very
skilled. So, from the standpoint of his background, I guess I looked
at him as a business developer and as a manager of t h a t area.
Mr. BARNARD. In appraising just general operations of Penn
Square, did you think it was overconcentrated considering its size
and its capital and the volume of business, as well as some of the
arrangements it was making with its participating banks?
Mr.- BOYD. In hindsight t h a t is obviously true.
Mr. BARNARD. Isn't it a general rule in banking t h a t concentration is something you have to be aware of?
Mr. BOYD. A S a manager, yes, sir.

Mr. BARNARD. It seems like everybody, including Seattle First
and Continental, Chase and others just absolutely were oblivious or
did not consider the overconcentration. I just don't quite understand that.
I realize it was at a go-go period when you needed profits, but on
the other hand didn't it violate every cardinal principle of good
bank management as far as concentration was concerned?
Mr. BOYD. The only expression t h a t I can say is t h a t the merchant bank concept, as Mr. Jennings had proposed, I was—I
thought was—a sound one, and t h a t
Mr. BARNARD. He was primarily nothing but a loan broker,
right?
Mr. BOYD. I looked at it as much more than that.
We in our arrangement worked a number of this master participation agreement which I referenced earlier in my statement,
which essentially I thought had in it the requirements t h a t were
necessary for them to fulfill the commitments t h a t they had made
to us.
The second thing is t h a t we looked at the deep Anadarko Basin,
and the activity t h a t was involved in Oklahoma was not a price
sensitive business, but a much longer economic development, which
would allow the companies involved in it to receive adequate financial returns.
I did not look at it as speculation but rather as an orderly development of a large gas field in a very prolific area.
Mr. BARNARD. Did you find t h a t the overlarge banks in t h a t
area, and also in the Texas area, were as involved in oil and gas
leases as Penn Square was percentagewise?
Mr. BOYD. NO; not percentagewise. They were involved. I can't
comment on the extent of their activity. I don't know.
Mr. BARNARD. They were cautious of their concentration, though,
weren't they?
Mr. BOYD. Yes, sir. One thing is because of their age.




146
Mr. BARNARD. HOW many of those loans were front-end loans
where you actually went in at the very beginning as far as financing the equipment, and so forth, rather than based upon production?
Mr. BOYD. Most of our loans, I believe, in the early part of the
relationship were equipment loans. So, therefore, you had equity by
the borrower to buy a certain piece of equipment and you lent
against that.
Mr. BARNARD. What ratio?
Mr. BOYD. About 70-percent debt, 30-percent equity.
As far as, and as we got into production financing, no, I would
say the majority of the loans had proved producing reserves behind
them.
Mr. BARNARD. Well, the real question is do you think that Seattle-First National was fair in removing you from their employment?
Mr. BOYD. Well, I was the person that initiated this relationship.
I was the person that was primarily responsible for it. I represented to management that I had given due diligence, that I had
known the people, and so forth.
Of course, it was a large concentration within our banking corporation, particularly larger credits when you make a serious commercial mistake, then yes, it is normally expected that you will
resign.
Fair, I don't know about it. But in any event, this is what happened.
Mr. BARNARD. One of the gentlemen that testified here today
said he was a scapegoat for his particular organization. Do you feel
that you were the scapegoat of Seattle-First National?
Do you think that others would be responsible?
Mr. BOYD. I take the primary responsibility for this situation. I
don't think I have the sole responsibility. I don't think you are
saying that, but it is a hard situation to face, no question about it,
because from the amount of work and the diligence that I tried to
put into the situation and to have it arrive at this conclusion is
Mr. BARNARD. I am not familiar with all the relationships with
Penn Square, but did you make any loans to officers or directors of
Penn Square?
Mr. BOYD. Yes,
Mr. BARNARD.

sir.

Did they, in turn, make any loans to officers and
directors of Seattle-First?
Mr. BOYD. Yes, sir, and I was the recipient of that loan. I had a
$10,000 car loan there, which was made in April 1980.
I pay $234 a month, I believe, at 14-percent rate. It was $10,000.1
pay $234.31 a month.
Mr. BARNARD. It must be about a 6- or 7-year loan?
Mr. BOYD. Four-year loan.
Mr. BARNARD. There is nothing in the bylaws or policies or practices of Seattle-First that would not condone loans of this kind with
correspondents?
Mr. BOYD. I can't comment on that. Not so far as I know, Mr.
Barnard.




147
Mr. BARNARD. It has been suggested today that some banks have,
I think they call it a code of ethics, or something of that kind,
which probably would have frowned upon this type of relationship.
Your bank, of course, did not have that, I presume?
Mr. BOYD. We do have a code of conduct, and we, as officers, are
required to sign it on an annual basis.
Mr. BARNARD. What was your rate of interest on this loan?
Mr. BOYD. Fourteen percent.
Mr. BARNARD. That was 7-percent add-on?
Mr. BOYD. HOW do you mean, sir?
Mr. BARNARD. OK; 14-percent APR; was that a preferential rate?
Mr. BOYD. NO, sir.

In my own bank I could have gotten an employee loan that was
equal to or better than what I had at Penn Square.
Mr. BARNARD. Why did you go to Penn Square?
Mr. BOYD. It was totally a convenient thing. I was in Seattle and
was leaving on an airplane, and Bill Patterson was there, and I
said, "Well, I have got to leave because I have to fill out my situation downstairs," and he said, "No, I will be glad to do it for you,"
and did it and set it up on the basis that I explained to you.
Mr. BARNARD. Was this before he had made a loan with you?
Mr. BOYD. Well, yes, this was made in April 1980, April 7.
Mr. BARNARD. Did you subsequently loan him money?
Mr. BOYD. Yes, sir, I did.
Mr. BARNARD. What kind of
Mr. BOYD. I will be pleased

loan was that?
to share it with you. My problem is

that
Mr. BARNARD. Confidentiality.
Mr. BOYD. Yes, sir.
Mr. BARNARD. I have no further questions, Mr. Chairman.
The CHAIRMAN. Mr. Barnard, the loan was to Mr. Bill Patterson.

Mr. Patterson reported to the board of directors of Penn Square
Bank; the date of the report was December 10, 1981. He reported to
the board of directors of Penn Square that he had borrowed
$1,400,000, $1,200,000, now to purchase First Penn Corp. stock, and
he borrowed that from Seattle-First National Bank, and the collateral pledged to secure the credit—another handshake deal—none.
Mr. BARNARD. Did you make that loan to him?
Mr. BOYD. Yes, sir, I did.
The CHAIRMAN. Just a handshake; no
Mr. BOYD. It was an unsecured loan

collateral?
substantiated by a balance

sheet; yes, sir.
The CHAIRMAN. Rather substantial, wasn't it, $1,400,000 on just a
signature?
Mr. BOYD. Mr. Chairman, in a secured or unsecured situation,
the balance sheet and the income-producing characteristics of the
borrower are enough, but it is a rather substantial loan unsecured.
The CHAIRMAN. Of course it is.
Mr. Lowery.
Mr. LOWERY. Thank You, Mr. Chairman.
Mr. Boyd, thank you for staying to this hour.
In addition to the $10,000 consumer loan which I consider well
within the parameters of guidance laws and so on, were there




148
other loans to officers, personal loans to officers of Seattle from
Penn Square?
Mr. BOYD. Not to my knowledge.
Mr. LOWERY. Thank you.
As I understand it most of the loans from banks to their own directors, $10,000 consumer loans, $20,000 education loans, mortgage
loans are not beyond that.
What is the total participation in loans of Seattle First and Penn
Square acquired loans?
Total amount of money?
Mr. BOYD. $400 million is what the bank has reported.
Mr. LOWERY. Of that $400 million, how much was acquired after
July 1981?
Mr. BOYD. Sir?
Mr. LOWERY. I used July 1981 because in previous testimony today
we had people state that at that time the banking examiners of
Penn Square had stated considerable concern about the situation,
the loans at Penn Square.
Mr. BOYD. That date I don't have, Mr Lowery, but I would say
probably half of the loans were funded, more than half, from July
1981 to February or March 1982.
Mr. LOWERY. SO more than half, at least $200 million?
Mr. BOYD. Yes, sir.
Mr. LOWERY. I am interested—and

this question was asked previously—in understanding the existing and necessary confidentiality
requirements, not being exactly sure what the law says on that, I
am endeavoring to find out what the law says on that, if there is a
procedure or if it would be advisable for information that was
available to bank examiners in Oklahoma, available to bank examiners in Seattle or in Chicago. If so, should those examiners have
been using that information when they looked at the loan portfolio
within their examination of Seattle First National Bank?
I think this is one of the main areas this committee really wants
to look at to see if there are some improvements that can be made
either through oversight or legislation.
What would your opinion be, if that would be important, if that
would have been important in this case, and if as a banker that
would be desirable?
Mr. BOYD. My opinion is that if the Dallas office of the Comptroller's Office had notified the Seattle office of the Comptroller's
Office, to just make a visitation and only look at the Penn Square
Bank loans, there would be no need to communicate any information. Their very presence of examining loans and asking questions
on a certain segment of loans would alert, I believe, the management or at the very least, the lending officer's attention to not only
was the documentation probably not as it should be, you would go
back to the source, to that orginating bank.
This does not help the many people that are affected, of course,
on the deposit side of Penn Square Bank.
This would only be speaking to the loan participations, but hindsight is perfect, if we had had that information, or whenever we
got the information, we would not have continued on the pattern of
involvement with Penn Square that we did.




149
Mr. LOWERY. This is not to say that Seattle First or Continental
should have picked this up as their own procedures, but we all
know that they should have done so.
Mr. BOYD. Yes, sir, that is correct. You can never be too diligent.
I know about that.
Mr. LOWERY. I am glad you mentioned the depositors.
This is not directly related to this hearing, but I think it emphasizes the point that it is important that the citizens of this country
understand those depositors were covered by FDIC and they have
received $253 million in deposits, and deposits have been taken
care of by FDIC in Penn Square. I only mention that because of the
importance of the confidence within the banking system that the
consumers and depositors in this nation must have.
Among other things, it proves that the FDIC, the bank protection
of depositors, does work; but we are, of course, very concerned
about the financial viability of institutions. That is also very important to the public, because we know what the results of the lack of
that confidence would be. What I am interested in, and I know the
chairman and other members of the committee share the interest
from their questions, is looking at additional procedures or additional oversight by this committee to calm the fears of the public.
I thank you.
Mr. BOYD. Yes,

sir.

Mr. LOWERY. Thank you, Mr. Chairman.
The CHAIRMAN. A few more questions, Mr. Boyd.
You mentioned in answer to a question by Mr. Barnard that you
looked at the competence of the people at Penn Square.
Tell us about the people that you felt were competent in Penn
Square. Who were they?
Mr. BOYD. I thought their engineering department was particularly skillful, Mr. Gilbert and his associate who were very knowledgeable petroleum reserve engineers.
Mr. Gordon Spears who is the vice president. Our engineer who
has 30 years in evaluating the economic prospects for a large petroleum company came with the bank, and he went and made a personal review and interviewed these people.
I had worked with them but he came away saying that they had
one of the finest engineering departments and systems that he had
seen anywhere.
The general level of people that Mr. Patterson had working for
him directly, and you asked for specific names.
The CHAIRMAN. Yes, and their functions.
Mr. BOYD. May I refer to the annual report of Penn Square
Bank?
The CHAIRMAN. Of course.
Mr. BOYD. In general, Mr. Chairman, most of the people that
were in Penn Square Bank had had previous banking experience, I
would say in some of the finest financial institutions in the country, and they were proven as experienced lenders.
When you start in 1979, it is very small. There were less than 10
or 12 people. You can see the gradual additions of competent and
capable people being added to that staff.
The CHAIRMAN. If they are all so competent and capable, what
happened?




150
Mr. BOYD. I don't have the facts. It is very difficult. I have given
a great deal of thought to this. I don't know the answer, sir.
The CHAIRMAN. If you had an engineer, Gordon Spears?
Mr. BOYD. Gordon Spears.
The CHAIRMAN. That worked at Seattle once and he was brought
on board when?
Mr. BOYD. Brought on board in February 1982.
The CHAIRMAN. February 1982?
Mr. BOYD. Yes, sir.
CHAIRMAN. Prior to that did
Mr. BOYD. NO, we did not.
The CHAIRMAN. But you stopped

The

you have an engineer?

making loans in February 1982
except for commitments that had been made, purchasing participations, I mean?
Mr. BOYD. Yes, but most of our loans were not production loans,
most of our loans were equipment loans.
The CHAIRMAN. My point is this, sir, equipment loans are for
equipment to produce, right?
Mr. BOYD. Yes,

sir.

The CHAIRMAN. And the collateral that you were getting or looking at, was it just equipment or was it also the reserves?
Mr. BOYD. NO, we had some reserve loans in our portfolio. I see
that I was not clear is what I am trying to correct here.
The CHAIRMAN. I tell you what is not clear to me, you gave us a
nice dissertation on Mr. Gordon Spears' evaluating the Energy Department or the technical personnel at Penn Square. That man
didn't come on board until February 1982.
We were told that you were told in January and February 1982,
hey, we have got too much participation with Penn Square. Cease
and desist. Is that not the way it happened?
Mr. BOYD. Yes,

sir.

The CHAIRMAN. SO who evaluated the engineering department at
Penn Square prior to February 1982?
Mr. BOYD. It was not evaluated in a technical sense, sir. In the
judgment—what made us feel so comfortable was when Mr. Spears
completed his examination we assumed
The CHAIRMAN. Your Monday morning quarterbacking, man.
Mr. BOYD. TO the extent of the system.
The CHAIRMAN. Let's go back.
Mr. BOYD. OK.
The CHAIRMAN. YOU

have decided in 1980—when did you start

participations?
Mr. BOYD. In

1979.

The CHAIRMAN. 1979. Who evaluated the engineering department
of Penn Square in 1979?
Mr. BOYD. There was not one at that time.
The CHAIRMAN. When was an evaluation made and when was
the engineering department at Penn Square coming into existence?
Mr. BOYD. In

1980.

The CHAIRMAN. Who evaluated it for you in 1980?
Mr. BOYD. NO one.

The CHAIRMAN. Who evaluated it for you in 1981?
Mr. BOYD. NO one.




151
But my point is, Mr. Chairman, that we had a number of production payment financings that we had taken as participations. Mr.
Spears went down and verified those systems and verified the way
in which they conducted their engineering.
I made the assumption that they had conducted their engineering previous to that review subject to the systems that he was
shown.
The CHAIRMAN. Sir, you purchased the participations prior to
Mr. Gordon Spears coming on the scene?
Mr. BOYD. Yes, sir.

The CHAIRMAN. And making his evaluation. That means that
you had no evaluation prior to that time when you were purchasing the participations.
Mr. BOYD. That is right.
The CHAIRMAN. IS that not correct?
Mr. BOYD. Yes, sir; that is correct.
The CHAIRMAN. All right.

So to say they had a competent engineering department, you
didn't know that while you were buying all the participation, you
didn't find that out until after you stopped purchasing.
Mr. BOYD. That is correct.
The CHAIRMAN. Whom did you have as technical personnel
within your energy department at Seattle First prior to February
1982 at which time Mr. Gordon Spears came on the scene?
Mr. BOYD. We had no one.

The CHAIRMAN. It was you and Mr. Chao?

Mr. BOYD. At that time of February 1982, there were
The CHAIRMAN. Prior to 1982, February 1982, 1979, 1980, 1981.
Mr. BOYD. We had no technical people on our staff at that time.
The CHAIRMAN. I got bedazzled by your former officers here,
excuse me, not you, they did it. They said they had an energy man,
they didn't have an engineer until after they stopped, told you to
stop purchasing participations.
Mr. BOYD. But we had consultants from the outside that reviewed our production but they did not review Penn Square's
energy department.
The CHAIRMAN. Correct. I don't doubt that. We understand that.
Mr. BOYD. Yes, sir.
The CHAIRMAN. That

is clear on the record.
Now, you told me about these competent people. Are these in
people Mr. Eldon Beller brought in?
Mr. BOYD. Many of them were, came into the energy—came directly into the energy division
The CHAIRMAN. When Mr. Eldon Beller was made president?
Mr. BOYD. Yes.
CHAIRMAN. That wasn't until 1981 or August 1981, I believe.
Mr. BOYD. 1981, yes, sir.
The CHAIRMAN. Prior to that, what kind of competent people did

The

Bill Patterson have and who were they?
Mr. BOYD. I am sorry, Mr. Chairman, I cannot—the names
escape me.
The CHAIRMAN. I would imagine so. I think the whole kit and caboodle was Patterson and Jennings.
Now, on the fishing trip.




152
Mr. BOYD. Yes, sir.

The CHAIRMAN. What was the purpose of the fishing trip?
Mr. BOYD. The purpose of the fishing trip was to introduce the
senior management of Penn Square Bank and a number of our customers which we had met through Penn Square to the senior management of our bank.
The CHAIRMAN. Customers of

Mr.
The

BOYD. The Penn Square t h a t we had participations
CHAIRMAN. Were they from the Oklahoma area?
Mr. BOYD. Yes.
The CHAIRMAN. Mr. Hefner.

in.

Mr. BOYD. The Fourth, yes, sir.

The

CHAIRMAN.

Who else?

Mr. BOYD. Mr. Swan.

The CHAIRMAN. Mr. Swan. He is on the board at Penn Square.
Both a board member and a borrower and a customer of yours as a
result of your having met Bill Patterson.
Mr. BOYD. Yes, sir. Mr. Allen.

The
Mr.

CHAIRMAN. Mr. Allen,
BOYD. Mr. Gray, Gary

all right.
Gray.

The CHAIRMAN. IS he a customer?

Mr. BOYD. Customer of Sea-First.
The CHAIRMAN. And Penn Square, and is he from—which area is
he from? Oklahoma?
Mr. BOYD. Oklahoma City, yes. These were all Oklahoma people.
The CHAIRMAN. All right. These were customers?
Mr. BOYD. Yes, sir.

The CHAIRMAN. And you were buying participations from these
customers actually, t h a t is what they were as customers, right?
Mr. BOYD. Buying participations—we were introduced to
The CHAIRMAN. From Penn Square?
Mr. BOYD. Yes, sir.
CHAIRMAN. All right.
Mr. BOYD. OK.
The CHAIRMAN. What was the

The

date of the fishing trip?

Mr. BOYD. In early June.
The CHAIRMAN. 1982.
Mr. BOYD. J u n e 10, 11, or 12.
The CHAIRMAN. At t h a t time

you had already been told by your
managment at Seattle-First to cease and desist further purchases
of participations. In other words, cool it.
Mr. BOYD. Yes, sir.

The CHAIRMAN. Did you disobey those instructions?
Mr. BOYD. I tried not to. The fishing trip was established in February 1982 t h a t we were going to have it in early J u n e so t h e
actual trip took place during this time period. I should say the trip
actually took place in the early part of June, but we had made the
invitation in February or March, in t h a t area.
I still felt because of the size of the participations and the relationship that we had with Penn Square Bank, t h a t it was import a n t t h a t our management have an opportunity to visit with them
on a firsthand basis.




153
The CHAIRMAN. Usually when you are trying to—when you want
to romance a customer you romance the customer because you
want to have more business with t h a t customer.
Mr. BOYD. Yes, sir.
The CHAIRMAN. Once

you have decided you don't want more
business with t h a t customer, isn't it a waste of money, time and
effort to romance the customer?
Mr. BOYD. Well, we wanted to maintain the position t h a t we had
with those individuals and to allow our senior management to visit
with them.
The CHAIRMAN. It was mentioned to us t h a t these chaps would
know because of their involvement with Penn Square, t h a t Penn
Square was having problems. On t h a t fishing trip was there any
discussion of the problems t h a t Penn Square was facing?
Mr. BOYD. N O , sir.
The CHAIRMAN. None whatsoever?
Mr. BOYD. N O , sir.
The CHAIRMAN. All right.

Mr. BOYD. TO my knowledge, no. No, sir.

The CHAIRMAN. SO how long was the fishing trip?
Mr. BOYD. We had a dinner in Seattle, Wash., on Thursday night
and we left Friday morning for British Columbia.
The CHAIRMAN. By plane.
Mr. BOYD. Yes, sir, by seaplane.

The CHAIRMAN. Was it one plane?
Mr. BOYD. NO, it was several planes.
The CHAIRMAN. Several planes.
Mr. BOYD. Yes, sir. And landed at Big Bay and the planes left
approximately 10 o'clock the following Sunday morning.
The CHAIRMAN. SO you were there how many days?
Mr. BOYD. It would have been Friday morning to Sunday morning, 2 days.
The CHAIRMAN. Did you stay in the same facility?
Mr. BOYD. N O , sir. There were cabins t h a t were
The CHAIRMAN. But everybody didn't do their own cooking?
Mr. BOYD. NO, no, the lodge

The CHAIRMAN. YOU had a lodge where you could cook the meals,
and so on?
Mr. BOYD. Yes,

sir.

The CHAIRMAN. A little conversation?
Mr. BOYD. Yes, sir.

The CHAIRMAN. N O TV up there, was there?
Mr. BOYD. N O , sir.
The CHAIRMAN. N O

radio?
Mr. BOYD. NO—well, yes, there was radio.
The CHAIRMAN. SO you did a lot of talking?
Mr. BOYD. Yes.

The CHAIRMAN. And at no time during t h a t conversation did Mr.
Swan, Mr. Patterson, Mr. Jennings, Mr. Hefner, mention the fact
t h a t Penn Square needed some capital, additional capital?
Mr. BOYD. N O , sir. The conversation was general about the
United States, about inflation, about unemployment, what was
going on in Oklahoma.
It was a very general and convivial




154
The CHAIRMAN. What was it that was going on in Oklahoma that
was discussed?
Mr. BOYD. The level of drilling, what the results were from some
Anadarko wells. It was general energy and general economic discussions and held in small groups.
The CHAIRMAN. That was it?
Mr. BOYD. Yes,

sir.

The CHAIRMAN. Did you get to be friendly with any of the officers at Penn Square during your relationship in purchasing participations from Penn Square?
Mr. BOYD. Yes, I knew Mr. Patterson very well, I knew Mr. Jennings fairly well.
The CHAIRMAN. Were your principal contacts with those two?
Mr. BOYD. On a day-to-day basis, probably more with Bill Patterson and then his staff.
The CHAIRMAN. Did you take any trips with Mr. Patterson? Any
vacation trips, sojourns?
Mr. BOYD. NO, sir, well, the fishing trip.
The CHAIRMAN. Other than the fishing trip?
Mr. BOYD. NO, I never traveled with him.
The CHAIRMAN. When in Oklahoma City, did you ever go out and
have dinner with him after a long hard day's work?
Mr. BOYD. I probably had dinner with Mr. Patterson in Oklahoma twice in the 3 years that I knew him.
The CHAIRMAN. Did he ever take you out to the Cowboy Club?
Mr. BOYD. Not that I recall.
The CHAIRMAN. YOU did not see the performance?
Mr. BOYD. NO, sir.

The CHAIRMAN. Did he ever perform for you? You were here earlier when we discussed some of his performances.
Mr. BOYD. Yes, sir, I read
The CHAIRMAN. Chicken legs and all.
Mr. BOYD. I never saw that. I read the Fortune article, yes.
The CHAIRMAN. Did he ever demonstrate to you his capacity,
wooden leg? Hollow leg?
Mr. BOYD. Yes, we have had a drink together, yes, sir.
The CHAIRMAN. And how about in Seattle?
Mr. BOYD. Normally we would eat dinner in the bank dining
room or at a local restaurant.
The CHAIRMAN. Mr. Leach.
Mr. LEACH. Thank you, Mr. Chairman. I have no questions at
this time, thank you.
The CHAIRMAN. Mr. Boyd, we want to express our deep appreciation to you for bearing with us. It has been a long day but I hope
you will understand that some of it was beyond our control, that
we had no alternative on.
Frankly, I will be honest with you, it is 8:15, is that what it is?
Yes. I would like to have allowed you to have left earlier, but by
the same token, we did not want to inconvenience you by having to
wait another day.
We wanted to get the witnesses in today that we scheduled for
today. So we thank you.




155
Incidentally, I want to express my personal appreciation to you
for your assistance, your cooperation with the staff throughout and
your presence here. I would just say I wish you well.
Mr. BOYD. Thank you, sir.
The CHAIRMAN. The committee will now recess until tomorrow
morning at what, 6:30?
We will recess to 9:30, and we will have William Goldsmith, and
Mr. Mario Renda as our leadoff witnesses.
I Thank Mr. Patman, Mr. Lowery, and Mr. Leach, for joining us.
[Whereupon, at 8:17 p.m., the committee was adjourned, to reconvene at 9:30 a.m., Thursday, September 30, 1982.]









12-745 0—83
11

1981
Annual Report
andForm 10-K

(157,

158

About the Cover
From Le Touquet, France, and Fairmont, Minnesota,
senior vice presidents Jean-Louis F. L. Recoussine (left)
and Garry J. Scheuring came by different paths to help
typify the combined diversity of Continental's people
on this year's Report cover.
At work "behind that quiet facade," Recoussine oversees international activities in Europe from London.
Scheuring is responsible for multinational relationships
worldwide from offices in Chicago and Toronto.
Together, they signify a basic strength that daily amplifies the others featured in recent years' cover photos of
ironworkers at work on the new Continental Illinois Center
offices now nearing completion in New York and of longtime stockholder Rell Small, who bought his shares a few
weeks after the crash in 1929.
That was years before Recoussine and Scheuring and
many others began gathering education and experience, to
join Continental and become part of an organization that
unites and integrates an increasingly diverse staff worldwide—to make the coming years outshine the 125 we
celebrate in this one, building on basic strengths.




Table of Contents
Performance in Review
Letter to Stockholders
The Businesses of Continental
Board of Directors
Committees of the Board
Corporate Management
Financial Index
Management's Discussion and
Analysis of Financial Condition and
Results of Operations
Financial Statements
Notes to Financial Statements
Management Report
Report of Independent Accountants
Form 10-K
Worldwide Facilities
Stockholder Information

2
4
8
12
13
14
15
16

32
36
45
45
55
59
Inside back cover

159
Performance in review

Some key measures of Continental's performance in 1981,
as well as a perspective on the Corporation's growth over
the past five years, are presented in the charts and graphs
on this and the following page. This section prefaces the
more detailed financial discussion and statements beginning on page 16 of this combined Annual Report and
Form 10-K.
A Review of 1981
Income before security transactions was $260.3 million in
1981, a gain of $36.2 million or 16.1 per cent from 1980.
Strong advances in both net interest and non-interest
income contributed to the increase. These gains were
partly offset by a moderate 11.7 per cent increase in noninterest expenses, reflecting the continuing, selective
investment for growth in Continental's businesses, and by
a $24 million larger provision for credit losses in line with
general business conditions and a growing loan portfolio.
The year's results were achieved in the face of market
volatility, slowing economic growth, and changing regulation—and reflect more than one year's success. They also
reflect basic market strengths built over decades, and
translate into a five-year compound average annual earnings growth rate of more than 15 per cent, one of the best
among major money-center banks.
Year-to-Year Comparisons
Net interest income continued to be the major source of
revenue in 1981, but declined as a percentage of total revenues due to a 32.3 per cent increase in other operating
income. A 12.4 per cent increase in average earning
assets added $101.9 million to net interest income, while

Sources of Net
Interest' and Other
Operating Income




a nine-basis-point narrower margin reduced the figure
by $29.3 million. Security trading profits reached a record
$27.9 million, despite exceptionally adverse market conditions. Both domestic and foreign fee income increased,
while foreign exchange results were strong, but declined
overall due to translation losses.
Non-interest expense amounted to 61.8 per cent of net
interest and other operating revenues in 1981, compared
with 63.5 per cent in 1980. Staff expense, which includes
salaries, wages, and benefits, and is the largest category of
operating expense, increased as a percentage of total noninterest expense from 51 per cent in 1980 to 54 per cent.
Five-Year Comparisons
Over the past five years, income before security transactions has grown by 76.8 per cent to $6.58 per share,
exceeding the five-year inflation rate of 59.7 per cent, as
measured by the Consumer Price Index (CPI). Cash dividends per share have increased 61 per cent to $1.90,
which also exceeds the CPI rate of inflation. The relationship of dividend pay-outs to income before security transactions has been maintained in the 30 per cent range in e a c h |
of the past five years, and was 28.88 per cent in 1981. In
other words, 29 cents of every dollar of 1981 earnings
were returned to stockholders, while 71 cents were reinvested in the Corporation. Stockholders' equity grew to
more than $1.7 billion in 1981, and has grown by more
than 87 per cent over the last five years. Return on stockholders' equity improved to 16.1 per cent, from the 15 per
cent range achieved in each of the previous five years,
while return on total assets was 0.59 per cent, equaling
the five-year average.

Per-Share Income Before
Security Transactions

Distribution of Net
Interest and Other
Operating Income

$878

r

Income Before
Security

"1

.-Salaries and Wages-*"
r Benefits
70
60
1,'Q

JfNet Occupancy
J Expense
" Equipment
X
Expense

1

_ Income Taxes
>her Expen>e

160
Financial Hi»hli<ihts
1980

1981

Per cent
change

Operating Results ($ in thousands)
$

910,406
260,315
254,623
16.10%
0.59%

$

837,874
224,143
225,941
15.53%
0.56%

8.6%
16.1
12.7

$

6.58
6.44
1.90
43.19
33%
5.0x

$

5.70
5.75
1.70
38.76
31%
5.5x

15 4%
12 0
11.7
11.4
6.0
(9.0)

$46,971,755
29,594,005
33,299,226
289,169
1,710,692

$42,089,408
27,313,667
27,629,701
246,413
1,524,942

11.5%
8.3
20.5
17 3
12.1

39,537,500
17,094
12,713

39,256,231
18,428
12,257

Income before security transactions
Net income
Return on equity
Return on total assets
Per-Share Data

Closing price—December 31
Year-End Totals ($ in thousands)
Assets
Loans and lease receivables
Stockholders' equity
Average common shares outstanding
Number of common stockholders of record at year-end
Number of employees at year-end

Dividends Declared Per Share

Stockholders' Equity
at Year-End

Return on Average
Stockholders' Equity

1.52

4 VH m

KnWpi

15

MM

N

3 I N W\ P3 N

1977

1978 1979 1980 1981




1977

1978 1979 1980 1981

1977

1978 1979 1980 1981

161
To the Stockholders

It is a pleasure to report another record year, although high
and erratic interest rates made 1981 a trying time for the
banking industry and our customers. Results advanced in
line with our planned objectives and long-term strategy.
The 16.1 per cent gain in income before security transactions (to $260.3 million or $6.58 a share) provided
another encouraging mark of consistently strong performance, in a year of uneven and often adverse business conditions. Major factors in the gain were increased interest
income and other operating income, coupled with continued close attention to credit quality and expense control.
Both the 16.1 per cent gain in income before security
transactions and the 12.7 per cent gain in net income (to
$6.44 a share) exceeded the rate of inflation, which
declined by a commonly accepted measure from 12.4 per
cent to 8.9 per cent during the year. Reduced inflation was
198l's best economic news and, with further progress on
that front, can be good news for years to come. Despite the
doubts and difficulties which accompany efforts to curb
inflation and have cut short previous attempts, the Federal
Reserve and the Reagan Administration seem prepared to
stick with the priority they have given this one. In that
case, persistence will prevail, where previous efforts have
fallen short and failed. Present inflationary pressures are
part of the price of previous short-lived efforts, and this
one presents basic correctives.
High Interest Rates No Boon to Banks
Though it may be news to any who still harbor the notion
that high or rising interest rates are a boon to the banks,
bank earnings gains generally took an opposite path from
interest rates throughout the year, rising as rates fell in the
first and fourth quarters but declining when rates rose in
between.
The notion that banks thrive on high rates rarely held
true for the money centers, and was still less so in 1981.
Strong fourth-quarter gains gave earnings a year-end glow,
but came on the heels of nine successive prime rate
decreases, three of them led by Continental.
Some spectacular gains in a few major banks' fourthquarter earnings made headlines, but generally reflected
special conditions. Some were turnaround situations and
several were aided by unusually high bond-trading profits.
Others showed sharp declines. For all eight of the other
major money-center bank holding companies with which
we compare our performance, the combined gain in
income before security transactions was less than 2.7 per
cent for the year as a whole. Including our 16.1 per cent,
the overall gain for the group was a little better, but still
less than 3.8 percent.
Progress in Important Performance Measures
Against this background, continued progress in other
important performance measures was even more encouraging than continuing more than 20 years of steady annual
earnings gains.




The return on average stockholders' equity increased to
16.1 per cent from 15.5 per cent in 1980, the previous
high. The return on average total assets increased to 0.59
per cent, compared with 0.56 per cent in 1980. Both of
these gains brought us closer to new long-term goals we
have set in these important measures.
The dividend was increased by 11.1 per cent, to a new
annual rate of $2.00 a share, extending our record of
annual increases to 13 years. Stockholders' equity also was
increased by an additional 12.1 per cent, with $179 million
of retained earnings increasing the year-end total equity to
more than $1.7 billion, as we continued to build our capital base for further growth and future gains.
Emphasis on Resource Allocation
Continued emphasis on allocating greater resources to
business areas with greater long-term potential, combined
with careful management of expenses in every area
throughout the organization, helped contain other operating expense. This grew by 11.7 per cent, well below the
20.1 per cent growth rate of 1980.
The basic corporate strengths and market developments
behind that outstanding performance are dealt with in the
body of this Annual Report, including our Report on Form
10-K. Two fundamental elements reflected throughout the
additional data and discussion contained in this Report,
however, deserve fuller treatment here. Those two fundamentals are people and planning. The integration and
interaction of these two fundamentals in large part account
for our exceptional record of steady earnings gains in each
of the past 20 years, and particularly in the past decade.
These are also fundamental strengths that can lead to further progress and higher goals in years to come.
Key Strategic Targets Raised
Our basic goal has been and continues to be increasing the
value of the stockholders' investment. In the decade from
1970 to 1980, our annual return to investors averaged 10.5
per cent, the highest among major money-center bank
holding companies.
As a concrete step toward further enhancing the attractiveness of our stock as an investment, long-range targets
for two key performance measures were raised in 1981,
and new higher goals were set, to be achieved over the
strategic planning horizon. The return on equity goal was
raised to 18 per cent, from 15 per cent over the past several years. Our target for return on total assets was raised
to 0.65 per cent, or six basis points above our average
return during the last five years.
Both of these higher goals are long-range strategic
objectives, attainable only through sustained effort over a
period of time. Both goals are now being incorporated into
our planning, budgeting, and resource allocation processes, however, and we are already moving closer to both
as noted earlier in the 1981 results.

162
How soon we will achieve these goals, of course,
depends in part on factors we cannot foresee. Fundamental
problems in the U.S. economy have yet to be worked out
and have indeed been heightened in recent years by rising
political, social, and economic pressures around the world.
At the same time, trends toward deregulation, increased
competition, and consolidation in the financial services
industry continue to mount.
These are subjects of continuing attention and concern.
We recognize that our performance may be influenced in
the short term by broad environmental forces, but we
believe that it will ultimately continue to be determined by
our own strategies and efforts. Success will depend on our
ability to anticipate and assess those forces, and pilot our
own course with skill and insight—in other words, on
first-ciass people and effective planning.
Matching Strengths to Market Demands
The markets of 1981 were highly volatile, as interest rates
reacted to inflation, changing expectations, and the sweeping tax, spending, and social programs introduced by the
Reagan Administration to strengthen national security
and deal wim underlying structural problems in the
U.S. economy.
The Federal Reserve Board attempted to exercise
restraint on growth of the money supply over the course
of the year. Although results from this difficult task were
not constantly evident from week to week, and markets
reacted nervously, and the Fed's role was not always
appreciated, its policies helped produce a significant and
long-sought decline in the rate of inflation.
Unsettled market conditions put a premium on such
basic strengths as balance sheet management. Having long
relied more heavily than most banks on market-priced
funds rather than on fixed-rate consumer deposits, we had
long since developed the broad experience and made the
adjustments that others had to make when consumer
deposits began to dwindle and become more cosdy. Combined with an organization-wide emphasis on pricing all
services productively and appropriately, our funding capabilities helped advance our position in highly competitive
corporate financial markets worldwide. Our interest rate
sensitivity structure was carefully managed, with much of
our loan growth in floating rate credits that could be favorably funded as market rates changed.
Emphasis on Credit Quality
As the economic downturn and prolonged high interest
rates placed even some strong businesses in a weakened
condition, cash-basis and renegotiated credits made up 1.9
per cent of the portfolio at year-end, compared with 1.6
per cent in 1980 and 1.9 per cent in 1979. Our long-standing emphasis on credit quality has become increasingly
important, as high interest expense and low sales volume
present unusual pressures in several industries, and appear




likely to be reflected in continued credit problems until
conditions improve.
The specific mechanisms for monitoring and maintaining the quality of the lending portfolio are discussed on
page 21. Considering the kinds of apprehensions that
sometimes arise in times like these, however, at least two
points deserve mention here.
One is that our position as a leading wholesale lender is
the direct result of a commitment to meeting the legitimate
credit needs of customers throughout the business cycle.
The relationships and specialized industry and customer
knowledge built up in that process are extremely valuable.
Our credit losses during significant cyclical downturns
over the past several years have compared favorably with
those of other major money-center bank holding companies.
Another basic strength is our consistent earnings growth
over many years. Our strong earnings stream creates a
bulwark against the kind of business conditions that
developed in 1981 and seem likely to continue into 1982,
as we continue to serve and build our business base.
Developmental Factors
In addition to maintaining a leading position in traditional
corporate lending markets, we also are well-positioned to
take advantage of the growing business need for more
comprehensive financial strategies.
Through the process of systematic resource allocation,
we have been steadily building organizational and technological capabilities in corporate and commercial finance,
leasing, cash management, investment banking, and
mergers and acquisitions consulting over the past several
years. In all of these areas, our people have earned a reputation for excellence. As these and related businesses continue to grow and develop, they should continue to play an
increasingly important role in advancing our successful
corporate banking effort, further augmenting our other
major strengths in more traditional banking areas.
Regulatory Change Brings New Opportunities
At the same time that uncertain economic conditions are
testing the strengths and resourcefulness of financial institutions, the dynamics of the nation's financial marketplace
are also changing, and opening new opportunities. The
past year brought some notable legislative and regulatory
breakthroughs, and some equally notable disappointments.
Perhaps the most notable progress came in our headquarters state of Illinois, which has long lagged behind
other states in banking law. Passage of landmark multibank holding company legislation allowed bank holding
companies to acquire established banks in their headquarters region and one adjacent region among five regions of
the state.
Two other bills passed by the Illinois legislature eliminated consumer credit usury ceilings and paved the way
for specialized International Banking Facilities now in

163
place in the state, under changes in Federal Reserve
regulations.
Progress on the Federal level was less evident and
somewhat disappointing. While the magnitude and pace of
evolutionary change transforming the financial services
industry continue to mount, with non-regulated institutions
further increasing their market share, generally unproductive debate continued over three key issues. One was interstate banking, which is already here in some respects for
banks such as ours, and in other respects for all sorts of
business concerns except banks. Another was the GlassSteagall Act, which maintains an overdrawn distinction
between commercial and investment banking in certain
key areas of interest to us. The third was Regulation Q,
which attempts to hold down the rates that banks and thrift
institutions may pay on consumer deposits—an increasingly futile restriction that simply diverts deposits to other
takers.
The ultimate broad outcome of all three issues seems
fairly certain, for the financial markets have long since
passed by Congress and the regulators. Corporate banking
for years has been conducted on a national scale. Our business long ago progressed from basic lending to the development of comprehensive financial services and strategies.
The resounding growth of money market funds has made
government rate-setting on consumer savings largely moot.
What remains is for the legislators and regulators—and
perhaps more important at this point, several of the private
sector contenders—to recognize that changes cannot be
prevented by legislation, and that markets, rather than
rules and regulations, will determine the outcome in
the end.
As we have noted before, timely resolution of these
issues is not critical to our own immediate prospects, but
prompt and proper resolution of these questions can have
a direct effect on the country's economic strength and our
long-term future. Short-term temporizing by the Depository Institutions Deregulation Committee on the 1980 law
to unwind Regulation Q rate ceilings, for example, only
drives more deposits into funds outside the regulation,
denies some consumers more attractive returns, and continues to weaken savings incentives.
Building on Basic Strengths
Trends shaping the global economy and changing the
structure of its financial markets have been evident for
years, and the issues that they raise have long been part of
our planning considerations. For the past several years,
groups throughout the organization have been examining

CZ<?^^_
Roger E. Anderson
Chairman of the Board of Directors
and Chief Executive Officer




our long-term direction. These continuing efforts had a
direct effect on our course in 1981, and will help to guide
our future.
Some of the measures are discussed in "The Businesses
of Continental," beginning on page 8, but developing
broad strategies and specific business goals is a continuing, evolutionary process.
For the 1980s and the years immediately ahead, building
on basic strengths is more than a slogan; it reflects an
ongoing business strategy. We intend to capitalize on the
strengths we have built, and continue to build on them
year by year.
We will need to choose our markets to prosper in the
years ahead. We will need to design and price our services
productively, and deliver them wim genuine value added.
We must continue to improve productivity and pay close
attention to our return to investors. We must continue to
anticipate and foster change and progress in our own business and in those we serve.
We feel that we have the basic strategies and proven
strengths in place today to produce outstanding results.
Above all, however, we recognize that successful strategies depend on capable people. Thus when we speak of
our basic strengths, we are speaking above all of talented
people. To all who helped produce these results as Continental enters its 125th year, we wish to express our sincere
appreciation.
In the same vein, we want to express our thanks here for
the long and devoted service of mree of our directors, and
welcome three new directors elected during the year.
In keeping with our Board's retirement policy, Michael
Tenenbaum retired at our 1981 Annual Meeting last April,
having served since 1973, and two of our most senior
directors plan to retire at our forthcoming Annual Meeting.
They are William A. Hewitt, a director since 1955, and
Gordon R. Corey, a director since 1966. Mr. Hewitt's
more than a quarter-century of service has been of outstanding lengdi, and together with Mr. Tenenbaum's eight
years and Mr. Corey's 16 years of dedicated attention to
our affairs, helpful to the Corporation in every way. Their
many contributions are gready appreciated.
Three new directors elected during the year are: Weston
R. Christopherson, chairman of the board and chief executive officer of Jewel Companies, Inc.; Robert A. Hanson,
president and chief operating officer of Deere & Company;
and William L. Weiss, president of Illinois Bell Telephone
Company. We are pleased to have these outstanding business leaders on our Board.

^^_
John H. Perkins
President

^L^c^i^.
Donald C. Miller
Vice Chairman
Chicago, Illinois, February 22, 1982




164

Miller. Anderson,

^^^SSMiiS^

165
The Businesses of Continental

Continental's activities have expanded in many areas amid
the changing opportunities of the past decade and remarkable evolution in the global marketplace.

To provide a clearer view of strengths and strategies and
how the many business units tie together, this discussion
looks at the basic functions that shape performance.

Credit Services
Credit services continue to be the core of our business,
though other, related financial services are important and
have become increasingly so in recent years. In 1981
interest income from lending accounted for 76.2 per cent
of total revenues.
Commercial and Industrial Lending
A primary commitment to wholesale banking, a leading
position in key areas such as energy lending, and an
aggressive push into attractive markets across die U.S.
have made Continental one of the nation's top commercial
and industrial lenders as well as the nation's sixth largest
bank holding company. A similar emphasis worldwide
continues to enhance Continental's market position as a
key financial institution for U.S. and foreign-based multinational corporations, and guides continuing, selective
international expansion keyed to changing opportunity in
the global economy.
1981 Highlights
m Advancing leadership in corporate financial service
markets worldwide, the commercial and industrial loan
portfolio grew to $12.8 billion at year-end.
• New regional offices in Atlanta, Detroit, Minneapolis,
and White Plains, New York, further expanded the Bank's
U.S. network to 13 locations. Construction of Continental
Illinois Center neared completion on New York's Madison
Avenue, for consolidation of Continental's extensive operations mere.
• Under new Illinois law (and still subject to regulatory
approval), agreements were reached to acquire two small
and promising banks chosen for their commercial business
potential in Chicago's north and west suburbs of Buffalo
Grove and Oakbrook Terrace.
• One of the first four U.S. banks authorized to open
banking facilities in Canada, Continental's Toronto-based
subsidiary was converted to Continental Illinois Bank
(Canada), and the Calgary office became a branch of the
new bank.
• Following international expansion into Buenos Aires,
Santiago, Madrid, and Lagos, Nigeria in 1980, Bank
offices in Barcelona and Puerto Rico were formally
opened in 1981. To make the best use of the Corporation's
resources, peripheral Bank facilities in Dusseldorf,
Edinburgh, Munich, and Rotterdam were closed, as was a
Bank subsidiary in Vienna. Services to customers will be
provided from Continental's larger European offices.
Real Estate Lending
One of the nation's leading real estate lenders, Continental
specializes in commercial and residential construction




A
Detroit/
i •'
Chicago»
A B
Newark
Cleveland

N.
- Dallas •

New representative offices in 1981 (A) expand U.S. network.

lending and mortgage banking. Building on a premier
position in the metropolitan Chicago market, plans are
keyed to high-growth domestic markets and to greater participation in mortgage origination, sales, and servicing
programs as economic conditions permit.
1981 Highlights
m The real estate portfolio grew selectively to more than
$3.9 billion, a 12 per cent gain from year-end 1980.
Consumer Lending
The Bank maintains a strong position in selected retail
markets in the metropolitan Chicago area, and nationwide
through its Town & Country Charge MasterCard and
VISA network. Strategies center on markets where highquality service can be delivered effectively and profitably.
1981 Highlights
u Changing competitive and market conditions led to a
move away from indirect or secondary consumer lending,
to concentrate resources on direct lending to customers.
• Legislation in Illinois and many other states lifted or
eliminated interest ceilings, to improve retail credit profitability in a higher-rate environment. The annual percentage
rate on MasterCard and VISA accounts nationwide was
raised to 19.8 per cent from 18 per cent.
Related Services
An expanding network of subsidiaries and new, specialized
divisions within the Bank steadily enhance finance capabilities. The earning power of diese activities both contributes to and combines with strong and growing capital and
asset bases, enabling the Corporation to take advantage of
emerging opportunities while building market position in
established areas.
Lease Financing
Continental Illinois Leasing Corporation
Energy Development Finance
Continental Illinois Energy Development Corporation

166
Commercial Finance
Continental Illinois Commercial Corporation
Merchant Banking
Continental Illinois Limited
Mortgage Banking
Republic Realty Mortgage Corporation
Edge Act Financing
Continental Bank International
1981 Highlights
• Net income from non-bank subsidiaries grew to $41.2
million in 1981, from $13.7 million in 1980.
• Continental Illinois Leasing Corporation's portfolio grew
by almost 84 per cent to $728.1 million, and revenues
increased 44.2 per cent to $54.4 million. Along with participation in the first leveraged financing of a preferred
stock purchase, further expansion opened new opportunities, with the acquisition of a leasing company in Brazil
and continued advances in the U.K. market, and additional
leasing facilities in regional offices in the U.S.

• The energy development corporation, serving smaller
producers who might not qualify for traditional bank
financing, continued to augment Continental's premier
position in the Houston energy market.
• Continental Illinois Commercial Corporation, adding
specialized asset-based lending to customer financing
alternatives, grew rapidly in both portfolio size and
profitability.
• Investment banking activities in the Euromarket
increased substantially in 1981, despite difficult market
conditions; with effective planning and key personnel in
place, Continental Illinois Limited managed or co-managed 27 issues worth $1.6 billion, compared with seven
issues worth $600 million in 1980. The merchant bank
also managed or co-managed 37 syndicated credits totaling
more than $8 billion, also a record for the unit.
• Continental Bank International, an Edge Act subsidiary
specializing in international financial services, expanded
to 11 U.S. locations with openings in Cleveland, Dallas,
Minneapolis, Philadelphia, San Francisco, and Seattle.

Funding Operations
Maintaining and expanding the wide diversity of domestic
and offshore sources developed over many years, funding
operations have become an increasingly vital strength, as
high and volatile market rates and regulatory ceilings
siphoned low-cost consumer deposits.
lYeasury Operations
Long-standing reliance on market-priced sources of funds
positions Continental to respond to rapidly shifting market
conditions. The Corporate Treasury group formally coordinates an established position in funding, interest rate sensitivity, and non-credit risk management.
Strategies vary with market conditions and trends in the
economy, but the guiding aim is to manage interest rate
sensitivity and the capital account so as to control the risk
inherent in sudden interest rate swings, while maximizing
potential funding profits.
1981 Highlights
• In line with the current objective of reducing the Corporation's rate sensitivity, several steps were taken to
lengthen overall liability maturities, including reductions
in bom the taxable and tax-exempt investment portfolios
and two innovative $100-million note issues. These are
discussed in greater detail on pages 26 and 39 of this
Report.
• Taking advantage of new state and federal laws and regulations, an International Banking Facility was opened in
Chicago, to take overseas commercial deposits free from
domestic reserve requirements and interest rate ceilings,
and to extend credit to foreign customers. The new unit
strengthens competitiveness in international markets and




Treasury representatives coordinate risk management.

supplements similar funding capabilities provided by other
Bank units in London, Singapore, Nassau, Bahrain, and a
corporate subsidiary in the Netherlands Antilles.
• Improved systems and reporting mechanisms significantly aided worldwide management of non-credit risks.
Deposit-Gathering Activities
Maintaining consumer deposits in certain markets through
selective approaches has proved a workable strategy,
despite regulatory obstacles and rapidly changing conditions. Automatic banking, for example, has long been a
particular strength. A positive response to Illinois' unit
banking law, automatic banking also avoids the escalating
costs of extensive retail branch systems common among
competitors in other states. Resources continue to focus on
advancing technology in funds garnering.
1981 Highlights
m In its first nine months of operation, the Money Network of shared automatic teller machines grew to 61
financial institutions.

167

• In Chicago, plans were laid to remodel the Rookery
banking facility to serve as an additional Personal Financial Service Center. Along with similar Bank centers at the
30 North LaSalle and Clark/Division facilities, the Center
will offer a range of services geared to selected market
segments.

• Various regulatory and legislative developments, including die lifting of rate ceilings on certain time-deposit
instruments and some provisions of die Economic Recovery Tax Act of 1981, opened significant new opportunities
for the Bank to compete more equitably for consumer
deposits.

Investment and Fiduciary, Trading, and
Non-Credit Services
Strong emphasis on investment and fiduciary, trading,
and non-credit services is geared to broader goals. These
services play an increasingly important role not only
in gaining and maintaining customer relationships, but in
building earnings and the capital base for further growth.
Investment Management/Fiduciary Services
Building on long-standing strengths in corporate and
personal investment management, account management,
and financial advisory services, augmented by national
leadership in merger and acquisition depositary and bond
trusteeship, strategies center on delivering innovative services to selected markets.
Recent initiatives include securities lending of employee
benefit plan assets, self-insurance programs for hospitals
and other institutional markets, and specialized financial
services for high-net-worth individuals.
1981 Highlights
m Trust fee revenues rose 19.6 per cent to $53.6 million.
• The Midwest's first complete securities lending program
to brokerage firms introduced new opportunities for
employee benefit plans to gain additional income from
their securities portfolios.
• Continental Illinois International Investment Corporation
(CHIC) strengthened its worldwide investment management capabilities, serving institutional markets from
London and individual clients from Switzerland.
• Generating an annual return of 35.5 per cent over the
past three years, the commingled high-growth fund for
employee benefit plans more than doubled the return of the
S&P 500 and ranked third among me 34 similar bank-managed funds measured by the Frank Russell consulting firm.
• Providing high-value-added services nationwide for corporate executives and other high-net-worth clients, Financial Advisory Services' activities expanded to include
seminars on the effects of me 1981 Tax Act.
• Trust subsidiaries in Boca Raton and Sarasota received
preliminary regulatory approval to offer full trust and
investment services, further enhancing Continental's presence in this key market.
Bond and Currency Trading
One of the nation's leading bond dealers and underwriters,
the Bank continues to advance in new directions, such as




Trust fee revenues rise 19 6 per cent.

financial futures consulting, to minimize interest rate risk
for corporations and correspondent banks. On anodier
front, foreign exchange trading operations built further
presence in money markets worldwide.
1981 Highlights
m Security trading profits totaled a record $27.9 million,
reflecting comprehensive strengths under some of the most
volatile taxable and tax-exempt market conditions seasoned traders could recall.
• Introducing the nation's first bank Financial Futures
Advisory Service for corporations and correspondent
banks put long experience in portfolio management to
further use.
• Attuned to me ongoing internationalization of capital
markets, the Bank began trading for its own account in
precious metals, opened trading in selected foreign securities, and established direct security sales representation in
London and Hong Kong.
• Foreign exchange trading revenues reached $34.3 million, a gain of 10.6 per cent.
Non-Credit Services
In independent surveys, Continental ranks high among the
leading firms in mergers and acquisitions consulting, private placements, corporate financial advice, and other strategic investment services. These services, combined with
nationally-recognized leadership in cash management,
check processing, and trade finance, are keys to further
gains in major markets by helping customers develop creative, comprehensive capital strategies.
The productivity of these services can be gauged in
profitability for customers and the Corporation.

168
1981 Highlights
u The Mergers and Acquisitions Division continued its
rapid growth, participating in transactions valued at more
than $1 billion in the last two years of operation.
• Despite volatile capital markets, Private Placement continued its growth in volume and reputation, completing
innovative transactions involving tax-exempt bonds and
leveraged leases, taxable discount notes, and variable rate
notes.
• Corporate Financial Advisory Services advanced client
abilities to meet complex financial challenges, participating in several major leveraged buy-out, asset redeployment, and valuation projects.
• A new and more comprehensive cash disbursement service, "Complete Control Plus," advanced cash management services for the corporate market.
• While explicit Federal Reserve pricing of cash letter services had a major impact on the market, the Bank contin-

ued to advance toward the top among the nation's leading
check processors.
• Innovative applications of Trade Finance products continued to produce a growing stream of fee income, while
expanding capabilities in multi-country projects and equipment export finance broadened the range of worldwide
customer service.
Equity Activities
Continental Illinois Venture Corporation and Continental
Illinois Equity Corporation provide important financing
alternatives for small to medium-sized companies, while
generating a growing stream of income for the Corporation.
1981 Highlights
• Gains on the sale of equity investments, principally by
Continental Illinois Venture Corporation, advanced sharply
to $42 million from $8.2 million in 1980 and $7.6 million
in 1979.

Management Services
Recognizing the fundamental importance of first-rate
professional management services in overall corporate performance, the following activities provide central support
for earnings growth and competitive gains.
Planning and Information Services
Resource allocation coupled with close control of expenses
continue to receive top priority. All key business areas
have been analyzed for current realities and future growth
prospects, in studies designed to match investments in
manpower and other scarce resources with long-term profit
potentials. Continued improvements in systems and support capabilities also enhance current productivity.
1981 Highlights
• Technological and reporting capabilities across the Corporation were brought together, with merging of systems
and accounting functions in the Financial Information
Services Division.
• Pioneering moves in electronic mail systems and office
automation drew national attention—as did the development of important new tools that reduce the amount of
time and money spent in performing labor-intensive activities and increase management's decision-making
effectiveness.
Personnel, Legal, and Corporate Affairs
Superior performance depends on a staff attuned to competitive markets and aware of social responsibilities. Continuing training and development programs combine with a
strong commitment to affirmative action to produce a challenging and supportive work environment which prepares
all employees to meet high corporate objectives, expand
their involvement in public affairs, and advance to their
full potential. The Law Department, focusing resources
on legal, regulatory, and public policy issues facing the




Improvements in systems and support capabilities enhance productivity.

Corporation, continues to play a major role in reducing
the regulatory barriers facing banks on both the state and
Federal levels.
1981 Highlights
• Women and minorities continued to advance throughout
the organization. In 1981 minorities accounted for 17.9
per cent of officer, manager, and professional staff, compared with 5.3 per cent in 1971. Women advanced to make
up 41.5 per cent of officers, managers, and professionals
in 1981, compared with 17.7 per cent ten years ago.
• Quality of worklife programs, alternative work sites,
and expanding training and development programs were
introduced to meet changing employee needs and enhance
productivity.
• Continued improvement in salary, benefit, and incentive
compensation positions strengthened the ability to attract
and retain top-caliber people.
• A Public Policy Committee was established to bring
together concerned parties from all Continental units and
address more effectively the issues that directly affect the
Corporation's future, such as interstate banking, international .trade, and urban revitalization.

169
Board of Directors
Continental Illinois Corporation
Continental Illinois National Bank and Trust Company of Chicago

Roger E. Anderson
Chairman of the Board of Directors and
Chief Executive Officer
John H. Perkins
President
Donald C. Miller
Vice Chairman
Raymond C. Baumhart, S.J.
President
Loyola University of Chicago
James F. Bere
Chairman and Chief Executive Officer
Borg-Warner Corporation
(chemical, plastic, air conditioning, building, industrial, and automotive products
and equipment)
Weston R. Christopherson
Chairman of the Board and Chief
Executive Officer
Jewel Companies, Inc.
(diversified retailer of food, drugs, and
consumer products)
Gordon R. Corey
Financial Consultant; Retired Vice
Chairman
Commonwealth Edison Company
(electric power company)
Robert A. Hanson
President and Chief Operating Officer
Deere & Company
(agricultural and industrial equipment)
William A . Hewitt
Chairman and Chief Executive Officer
Deere & Company
(agricultural and industrial equipment)




William B . Johnson
Chairman and Chief Executive Officer
IC Industries, Inc.
(holding company with major interests in
commercial products, consumer products,
and railroad activities)
Jewel S. Lafontant
Senior partner
in the law firm of Lafontant, Wilkins
& Jones
Vernon R. Loucks, Jr.
President and Chief Executive Officer
Baxter Travenol Laboratories, Inc.
(medical care products)
Frank W. Luerssen
President
Inland Steel Company
(steel production)
Robert H. Malott
Chairman and Chief Executive Officer
FMC Corporation
(machinery and chemicals for industry
and agriculture)
Marvin G. Mitchell
Retired; formerly Chairman of the Board
and Chief Executive Officer
CBI Industries, Inc.
(holding company with major interests in
metal plate fabricating and construction
worldwide, oil and gas drilling, marine
construction and repair work, water and
wastewater treatment, real estate, and
investments)

Keith R. Potter
Retired; formerly Vice Chairman
International Harvester Company
(farm equipment, motor trucks,
and construction equipment)
John M. Richman
Chairman and Chief Executive Officer
Dan & Kraft, Inc.
(diversified manufacturer and marketer of
food and consumer products and plastic/
packaging products)
Paul J. Rizzo
Senior Vice President and Member of the
Corporate Office
International Business Machines
Corporation
(information processing systems and
related services)
Thomas H. Roberts, Jr.
Chairman of the Board and Chief
Executive Officer
DEKALB AgResearch, Inc.
(research and production of h y b r i d s corn, sorghum, poultry, and swine)
William L. Weiss
President
Illinois Bell Telephone Company
(telephone utility)
Blaine J. Yarrington
Executive Vice President
Standard Oil Company (Indiana)
(crude oil, chemicals, and petroleum
products)

-. Is

170
Committees of the Board
Audit
R. H. Malott, Chairman
F. W. Luerssen, Vice Chairman
W. R. Christopherson
Compensation and Nominating
J. F. Bere, Chairman
W. B. Johnson, Vice Chairman
V. R. Loucks, Jr.
M. G. Mitchell
J. M. Richman
Loan
R. E. Anderson, Chairman
J. H. Perkins, Vice Chairman
D. C. Miller
R. C. Baumhart, S.J.
G. R. Corey
R. A. Hanson
W. A. Hewitt
B. J. Yarrington
Trust and Investment Services
R. E. Anderson, Chairman
J. H. Perkins, Vice Chairman
D. C. Miller
J. S. Lafontant
K. R. Potter
P. J. Rizzo
T. H. Roberts, Jr.
W. L. Weiss

Nominations
The Compensation and Nominating Committee of the Board of Directors will consider potential candidates for election as
directors who are recommended in writing by stockholders of the Corporation.
Recommendations should be sent to the
Secretary, Mr. Ray F. Myers, 231 South
LaSalle Street, Chicago, Illinois 60693,
and should be received by December 15,
1982, to be considered for inclusion in the .
slate of nominees which will be proposed
by the Board of Directors at the 1983
Annual Meeting. Such recommendations
should include: a description of the candidate's business experience and other relevant background information during at
least the past five years; company directorships and any other organizational
affiliations of the candidate; amount of
Common Stock of the Corporation beneficially owned by the candidate; any
involvement of the candidate during at
least the past five years in legal proceedings or other matters that would be material to an evaluation of ability and
integrity.
February 22, 1982

February 22,1982

Board of Director! (left to right) Bert; Roberts; Weiss; Malott; Corey; Mitchell; Johnson; Yarrington; Potter; Miller, Vice Chairman; Riao; Myers, General Counsel an
Secretary; Anderson, Chairman of the Board of Directors and Chief Executive Officer; Perkins, President; Baumhart; Lafontant; Hanson; Loucks; Hewitt; Christophers*
Luerssen; Richman.




171
Corporate Management

Corporate Office
Roger E. Anderson (60)*
Chairman of the Board of Directors
and Chief Executive Officer
Officer of the Corporation since 1969
John H. Perkins (60)*
President
Officer of the Corporation since 1969

Eugene Holland, Jr. (59)*
Executive Vice President and Chairman, Credit Policy Committee
Officer of the Corporation since 1973
Alfred F. Miossi (59)*
Executive Vice President and
Director of International Affairs
Officer of the Corporation since 1976

Donald C. Miller (61)*
Vice Chairman
Officer of the Corporation since 1972

Financial Services
Caren L. Reed (47)*
Executive Vice President
Officer of the Corporation since 1981

Bond and Treasury Services
David G. Taylor (52)*
Executive Vice President and Treasurer
Officer of the Corporation since 1976

International Banking Services
Leo C. deGrijs (55)*
Executive Vice President
Officer of the Corporation since 1981

Corporate Financial Services
Edwin J. Hlavka(44)
Senior Vice President and Auditor
Officer of the Corporation since 1972

Multinational Banking Services
John E. Porta (50)*
Executive Vice President
Officer of the Corporation since 1977
Special Industries Services

Corporate Personnel Services
Corporate Affairs
Eugene R. Croisant (44)*
Executive Vice President
Officer of the Corporation since 1974
General Banking Services
George R. Baker (52)*
Executive Vice President
Officer of the Corporation since 1974
Edward M. Cummings (60)*
Executive Vice President and Area
Corporate
Officer—Europe
Officer of the Corporation since 1971




Gerald K. Bergman (47)*
Executive Vice President
Officer of the Corporation since 1980
U.S. Banking Services
Hollis W. Rademacher (46)*
Executive Vice President
Officer of the Corporation since 1980
Law Department
Ray F. Myers (61)*
Executive Vice President,
General Counsel and Secretary
Officer of the Corporation since 1974
Operations and
Management Services
Personal Banking Services
Gail M. Melick (53)*
Executive Vice President
Officer of the Corporation since 1974

Financial Information Services
J. Joseph Anderson (43)*
Executive Vice President and Controller
Officer of the Corporation since 1972
Personal Banking Services
William D. Plechaty (45)*
Executive Vice President
Officer of the Corporation or the Bank
since 1970
Real Estate Services
James D. Harper, Jr. (47)*
Executive Vice President
Officer of the Corporation since 1974
Trust and Investment Services
Edward S. Bottum (48)*
Executive Vice President
Officer of the Corporation since 1980
Investment Services
Richard W. Foss (55)
Senior Vice President
Officer of the Bank since 1980
*Executive officer, ages in parentheses. The executive
officers of the Corporation are elected by the Board
of Directors to hold office until the first meeting of
the Board after the Annual Meeting of stockholders
next following election, and until a successor is qualified. The executive officers may be removed and
replaced only by the Board of Directors, and may be
removed, with or without cause, at any time by a
majority vote of the Directors at the time in office.
All the executive officers have served in an executive capacity with the Corporation, the Bank, or an
affiliate of the Corporation for more than five years.
February 22, 1982

172

"Management's Discussion and Analysis of
Financial Condition and Results of Operations
Consolidated Statement of Condition
Consolidated Statement of Income
Consolidated Statement of Changes in
Financial Position
Consolidated Statement of Changes in
^Stockholders' Equity
"Consolidated Statement of Condition
>
(Continental Bank and Subsidiaries)
Notes to Financial Statements
Management Report
Report of Independent Accountants
Comparative Financial Data
Consolidated Average Statement of Condition :
and Net Interest Income
Analysis of Year-to-Year Changes in
Net Interest Income
Average Deposit Analysis
Investment Securities
^
Maturity of Loans
Loans and Lease Financing Receivables
Average Loans and Lease Financing Receivables
Analysis of Net Credit Loss Experience
Allocation of Reserve For Credit Losses
Selected Quarterly Financial Data
Consolidated Statement of Income—Quarterly ••
*
Consolidated Average Statement of Condition ; ;
* and Net Interest Income—Quarterly <




173
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Financial Review
A New Approach
As the complexity of Continental Illinois Corporation in
geographical scope, range of service, and internal structure
has grown, providing a meaningful and understandable
discussion of performance and progress has become more
important.
This year, our Annual Report has been combined with
the Report on Form 10-K filed annually with the Securities
and Exchange Commission. The aim of the new format is
to provide detailed, uniform financial data and discussion
to all who are interested in Continental's performance.
The management discussion portion of this Report is
divided into eight parts. The first section provides a capsule summary of the Corporation and its environment. The
second section discusses the income statement, focusing on
revenues, expenses, and profitability, while the third part
explores the quality of the loan portfolio. The fourth section examines the Corporation's overall financial condition, and sets out the policies and approaches used in
managing funding and capital positions. A fifth part looks
at the performance of non-bank subsidiaries. A sixth section examines the results of operations during the fourth
quarter of 1981, while a seventh part, in keeping with the
Financial Accounting Standards Board Statement 33,
attempts to suggest the impact of inflation on operations.
The final section, the financial statements and their related
footnotes, details the Corporation's financial position and
results of operations.
We hope that this new format will be helpful in your
understanding of Continental and its operations.

About Continental
Continental Illinois Corporation, a bank holding company,
was incorporated under Delaware law in 1968. Originally
founded as Conill Corporation, Continental took its present
name in 1972. Except for qualifying shares held by directors, the Corporation is sole shareholder of Continental
Illinois National Bank and Trust Company of Chicago, the
sixth largest commercial bank chartered in the U.S. based
on assets and the seventh largest in deposits at the end
of 1981.
Providing commercial, personal, trust, and money
market services across the country and around the world,
Continental Bank comprises most of the Corporation's
business, accounting for 95 per cent of total assets and 90
per cent of earnings in 1981.
As the needs of the financial marketplace in the United
States and overseas evolve, however, the scope of activities is expanding continually. Building on a global network
of branches, representative offices, subsidiaries, and affiliates staffed by more than 12,000 people, Continental consistently seeks to capitalize on opportunities for profitable
growth in related financial fields.




To enhance performance in today's dynamic and highly
competitive financial marketplace, business units are
organized around strategic market segments. Staffed and
structured to place the Corporation's full financial, technological, and human resources at the service of customers
who share similar, specialized needs, each unit plays a
specific role designed to deliver superior credit and noncredit services at competitive cost. Strategies in all areas
are attuned to economic and regulatory conditions in the
domestic and international markets served.
Supervision and Regulation
Two key factors in the performance of all bank holding
companies are loan volume and the margin between lending rates and the interest rates paid to obtain lendable
funds in worldwide money markets. Federal government
policies, including those of the Board of Governors of the
Federal Reserve System, can influence financial and credit
market conditions at any given time, and in tum affect
interest rate levels and the ability to lend. Thus changes
in those policies also can influence Continental's performance.
The Federal Reserve Board (FRB) also is one of bank
holding companies' principal regulators. The amended
Bank Holding Company Act of 1956 generally limits holding companies to activities that the FRB determines are
closely related to banking or managing or controlling
banks. A bank holding company cannot acquire substantially all of the assets or control more than 5 per cent of
the voting shares of any commercial bank of which it is
not already the majority shareholder, without the FRB's
approval. The FRB cannot approve any application to
acquire voting shares in an additional commercial bank
outside the state in which the holding company's existing
bank subsidiaries are located unless specifically authorized
by the laws of the additional bank's state.
Subject to FRB regulation, banks and their Edge Act
corporation subsidiaries, which engage in international
banking and finance, may establish foreign branches. Subject to FRB approval, Edge Act corporations also may
establish branches in the United States and invest in the
shares of financial companies whose transactions in the
U.S. are solely and directly related to international business. With FRB consent, bank holding companies and any
of their non-bank subsidiaries may own or control the voting shares of any company in which an Edge Act corporation may invest.
In addition to the FRB, national banks like Continental
Bank are regulated by the Comptroller of the Currency
and the Federal Deposit Insurance Corporation (FDIC),
on matters including loan limits, borrowings, deposit
reserves, interest rates, and dividends. Note 16 to the
financial statements outlines limitations on the amount of
dividends that Continental Bank may declare.

174

Federal law places restrictions on extensions of credit
from banks to their parent bank holding companies and,
with some exceptions, to other affiliates, on investments in
stock or other securities thereof, and on the taking of such
securities as collateral for loans. Banks and their affiliates
Selected Financial Data and Ratios (consolidated)
Year ended December 31
'
(S in millions, except per-share data)
Earnings
Net interest and other operating income . . .
Income before security gains or losses . . . .
Net income
Per-Share Data
Income before security gains or losses
Net income
Cash dividends declared
Average Statement of Condition Items
Earning assets
Total assets
Deposits
Bonds, mortgages, and similar debt
Stockholders' equity
Financial Ratios*
Equity to total assets
Return on earning assets
Return on total assets
Return on equity
Dividend pay-out
'Computed using income before security gains or losses and annua

are subject to other restrictions on the issuance, flotation,
underwriting, public sale, and distribution of securities.
Operations in other countries are subject to various restrictions, and to the supervision of various regulatory authorities, under Federal law and the laws of those countries.

$ 1,008
260
254

$

$ 6.58
6.44
1.90

$ 5.70
5.75
1.70

$ 4.95
4.99
1.52

$ 4.51
4.49
1.38

$ 4.05
4.02
1.26

$37,113
44,004
27,428
722
1,616

$32,979
39,565
24,953
600
1,443

$27,427
33,252
22,370
521
1,294

$22,841
26,965
18,656
419
1,122

$19,885
23,044
16,142
329
965

3.67%
0.70
0.59
16.10
28.88

878
224
226

3.64%
0.68
0.56
15.53
29.78

$

712
194
196

$

3.89%
0.70
0.58
15.00
30.69

611
169
168

4.15%
0.73
0.62
15.04
30.64

Summary
Throughout 1981, the forces of change were at work in
the economy, both in the United States and internationally.
These changes had significant effects on the banking

Income Before Security Transactions

Compound Five-Year
Annual Earnings Growth Rate

224.1 >

225

W.l>

200
ltt.7^
175

144.2^.

150
125
100
1977

1978

1979




1980

4.M
0.72
0.62
14.94
31.06

industry in general, and particularly on worldwide financial institutions like Continental.
Most important, financial markets in the U.S. and
abroad reacted unpredictably to the economic initiatives
of the Reagan Administration and the Federal Reserve
Board's efforts to reduce inflation by controlling the

2MJ

250

526
144
143

'ersgei for statement of condition items.

Income Statement Analysis

275

$

1977

1978

1979

1980

175
growth of the m o n e y supply in a difficult and volatile
world economy.
Operating results in 1981 reflect this challenging envir o n m e n t — a n d the basic strengths w h i c h enabled Continental to c o p e with the m a r c h of e v e n t s . Careful attention
to resource allocation, e x p e n s e c o n t r o l , funding, and
liquidity m a n a g e m e n t all m a d e i m p o r t a n t contributions
to the following key results:
I n c o m e before security transactions of $*260.3 million,
o r $ 6 . 5 8 a s h a r e in 1981 increased 16.1 per cent from the
$ 2 2 4 . 1 million o r $ 5 . 7 0 a share a c h i e v e d in 1980. N e t
i n c o m e rose 12.7 per cent to $ 2 5 4 . 6 million or $ 6 . 4 4 per
s h a r e from $ 2 2 5 . 9 million o r $ 5 . 7 5 a s h a r e a y e a r a g o .
Return on total assets of 0 . 5 9 per cent i m p r o v e d from
last y e a r ' s 0 . 5 6 per cent; the return on a v e r a g e stockholde r s ' equity w a s 16.1 per c e n t , c o m p a r e d with 15.5 per cent
a year a g o .
N e t interest i n c o m e on a taxable equivalent basis
increased by 8.6 p e r cent; 12.4 p e r cent g r o w t h in earning
assets m o r e than offset a nine-basis-point decline in die net
interest m a r g i n .
Credit loss provisions of $120 million e x c e e d e d net
credit losses of $71.1 million, raising the year-end reserve
for credit losses to $ 2 8 9 . 1 million. N e t credit losses
r e m a i n e d level at 0 . 2 4 per cent of a v e r a g e loans and leases
outstanding.
Other operating i n c o m e totaled $ 3 2 2 . 4 million, up 3 2 . 3
per cent from $ 2 4 3 . 6 million in 1980.
Other operating e x p e n s e rose 11.7 per c e n t , a m u c h
slower growth rate than in recent y e a r s , with e x p a n d i n g
services and b u s i n e s s v o l u m e s continuing u n d e r lower
inflation rates and careful m a n a g e m e n t control.

Interest Comparison

1977

interest income • •

1978




1979

1980

1981

Net Interest Income Rises
Net Interest Income ($ in millions)
1981
Interest income
Taxable equivalent (TE)
adjustment

1980

1979

$5,964.2

$4,472.5

$3,168.1

104.6

Net interest income (TE)

$

107.5

103.5

6,068.8
5,158.4

Interest income (TE)
Interest expense

4,580.0
3,742.2

3,271.6
2,594.3

910.4

$

837.8

$

677.3

Net interest i n c o m e ( T E ) w a s u p 8.6 p e r cent in 1981,
c o m p a r e d with gains of 2 3 . 6 p e r cent in 1980 and 13.3 p e r
cent in 1979.
C h a n g e s in net interest i n c o m e result from c h a n g e s in
both v o l u m e and the net interest m a r g i n . Volume refers to
the dollar level of e a r n i n g assets, while the net interest
margin s h o w s the relationship b e t w e e n interest yields on
earning assets a n d the cost of funds required to support
them.
A s the following table s h o w s , higher v o l u m e s h a v e c o n tributed to net interest i n c o m e g r o w t h in each of the past
three y e a r s . T h e effects of c h a n g e s in the net interest margin have varied. T h e increase in net interest i n c o m e in
1981 w a s d u e entirely to v o l u m e gains; and under volatile
credit m a r k e t c o n d i t i o n s , funding costs generally rose
faster than the a v e r a g e yield o n earning assets, p r o d u c i n g
a nine-basis-point n a r r o w e r net interest m a r g i n . Toward
year-end, h o w e v e r , funding costs stabilized a n d m a r g i n s
r o s e , as an e c o n o m i c d o w n t u r n curtailed private investm e n t and l o w e r e d interest rate levels. D u r i n g 1980 the
margin rose seven basis points to 2 . 5 5 per cent amid
u n p r e c e d e n t e d interest rate fluctuations. D u r i n g 1979 the
net interest margin declined 14 basis points to 2 . 4 8 p e r
cent, as funding costs rose faster than asset yields t h r o u g h out the year.

Average Domestic and
Foreign Earning Assets

1977

1978

Foreign
Domeitk

1979

1980

1981

176
Domestic and Foreign Operations
1981
1980
1979
1979 vs
1978 Average earning assets ($ in billions):
Domestic
$22.9
$20.0
$17.0
Change due to increase in
Foreign
14.2
12.9
10.4
earning assets
$101.9
$140.0
$114.6 Net interest income (TE)
Change due to increase
($ in millions):
(34.7)
(decrease) in net margin .. .
(29.3)
20.5
Domestic
$ 708
$ 696
$ 566
Foreign
202
142
111
$ 72.6
$ 79.9
Net increase
$160.5
Net interest margin (TE):
Domestic
3.09%
3.48%
3.33%
Domestic and Foreign Volumes Advance
Foreign
...
1.43
1.10
1.07
During 1981 earning assets increased worldwide, with
Income before security transactions
domestic volumes growing faster than foreign volumes.
($ in millions):
Average domestic earning assets increased 14.3 per cent
Domestic
$ 186
$ 161
$ 162
from 1980 to $22.9 billion, while foreign earning assets
Foreign
74
63
32
averaged $14.2 billion, up 9.7 per cent from 1980.
The division of income and expense into domestic and forTotal loans rose 17.7 per cent to average $28.6 billion
eign components is based in part on internal allocations,
and were the major source of earning asset growth.
which may differ from those used by other bank holding
Domestic loans accounted for $2.9 billion of total loan
companies. Condensed financial statements pertaining to
growth, while foreign loans, which include those made
domestic and foreign operations appear in Note 15 to the
from the head office to customers overseas, as well as
financial statements, where the same allocation consideracredits extended by overseas branches and subsidiaries,
tions apply.
rose by $1.4 billion. The foreign portion of the total loan
Approximately 41 per cent of average total assets was
portfolio remained at about 30 per cent.
attributable to foreign operations in 1980 and 1981, comDomestic earning asset growth was accompanied by a
pared with 40 per cent in 1979.
redistribution of funds among investment alternatives.
Other Operating Income Rises Significantly
Reflecting a continuing emphasis on strengthening market
With continuing efforts to build non-credit services to supposition, average domestic loans rose to 85.1 per cent of
port and supplement lending activities, total other operataverage domestic earning assets, up from 82.7 per cent
ing, or non-interest, income was up 32.3 per cent from
last year.
1980, which in turn rose 17.2 per cent from 1979, bringDue to domestic market conditions, the volume of
ing the five-year average growth rate to 21.0 per cent.
investment and trading securities and other short-term

Increase in Net Interest
Income (TE) ($ in millions)

1981 vs
1980

1980 vs
1979

investments decreased, and these assets declined as a percentage of total domestic earning assets.
Foreign earning assets also were reallocated. Average
loans accounted for 64.0 per cent of average earning
assets, compared with 59.4 per cent in 1980. Average
investment and trading account securities and other shortterm investments increased a combined 8.3 per cent in
reaction to favorable international market conditions, but
declined as a percentage of earning assets as other investments increased at greater rates.
A large share of average foreign earning assets traditionally has been held in the form of short-term money market
investments (placements), which offer higher liquidity but
lower yields than loans. During 1981 these investments
were reduced botii in dollar terms and as a percentage of
average earning assets. Placements accounted for 31.7 per
cent of foreign earning assets during 1981, compared with
36.5 per cent in 1980.
As in previous years, foreign interest margins were
below domestic margins, partly because of the lower
yields on foreign placements and partly because most foreign earning assets are financed by funds on which interest
is paid.




Among the major components of this increase, domestic
and foreign fee income rose $29.8 million or 23.7 per cent
over last year.
A substantial portion of the $16.7 million rise in domestic fee income was generated by charge card membership
fees, instituted in September 1980. These fees totaled $17
million in 1981, up $12 million from last year. In addition,
fees for credit facilities, commissions, and service charges
increased significantly, while merchant discounts related to
charge card business decreased.
Foreign fee income rose 24.5 per cent from 1980, due
primarily to expanded bankers acceptance and letter of
credit business.
Recently, securities trading and foreign exchange have
been less stable income sources than other non-interest
income items, reflecting the volatility of interest and
exchange rates brought about by inflation and efforts to
control it.

177
Securities trading profits and commissions fluctuated
widely during 1981; fourth quarter activity produced $22.4
million of the annual $27.9 million total. Profits from foreign exchange activities declined 3.4 per cent to $31.1
million in 1981.
Other operating income growth was helped significantly
by gains on sales of equity investments in 1981. Such sales
are recurring, normal transactions, although the amounts
may vary from year to year. More than 94 per cent of the
gains on the sales of equity investments during 1981 was
generated by the venture capital subsidiary, compared
with approximately 82 per cent in 1980 and 60 per cent
in 1979.
All other income in 1981 decreased 53.9 per cent to
$12.3 million. In 1981 all other income included only $1
million in foreign withholding taxes paid by borrowers on
Continental's behalf, compared with $14.3 million in 1980
and $4.2 million in 1979.

$ 44.8

27.9

6.1

15.7

34.3

31.0

11.3

(3.2)

1.3

1.3

88.9
66.6

72.2
53.5

57.4
43.2

8.2
26.5
$243.6

7.6
33.8
$207.7

•

42.0
12.3
$322.4

Other Operating Income

Other Operating Expense—
Per Cent Increase
1981

Staff expense
Salaries and wages
Benefits
Total staff expense . . . .
Net occupancy expense
Equipment expense
1979 Other expense
Total
$ 37.4

Other Operating Income ($ in millions)
1981
$ 53.6

Trust income
Security trading profits and
commissions
Foreign exchange profits:
Trading operations
Translation gains (losses)
net
Fee income:
Domestic
Foreign
Gains on sales of equity
investments
All other income
Total

Expense Growth Rate Slows
During 1979 and 1980, non-interest expense (excluding
the provision for credit losses) increased at an annual rate
of more than 20 per cent. Careful monitoring of expense
growth along with easing inflationary pressures reduced
the rate of growth to only 11.7 per cent in 1981.
As shown in the following table, growth in many other
operating expense categories moderated significantly.
Management is committed to managing expense growth
at levels in keeping with high quality service, business
growth, and corporate profitability goals.

All other income
Foreign exchange profits
Security trading profits

1980

1979

16.6%
21.8
17.7
23.3
0.1
1.0
11.7%

14.1%
20.0
15.3
28.7
33.5
23.4
20.1%

19.9%
15.1
18.9
22.3
31.8
22.3
20.9%

Staff expense growth in 1981 resulted from a 3.7 per
cent increase in staff size to 12,713 full-time equivalent
employees at year-end, and from increases in merit, promotional, and incentive pay, and in various benefit
programs.
The stabilization of equipment expense in 1981 was due
primarily to a decline in rental expense. The purchase of
certain equipment which previously had been leased contributed to a substantial decrease in equipment rental
expense. Equipment expense for 1981 reflects an expanded
system of automatic teller machines.
The following table lists some of the key other expense
items and the percentage changes during the last three years.

Other Operating Expense

Other
Equipment
Net occupancy
Staff

expense
expense
expense 2
expense •

800

400
322.4

623.8

54.3

180.8

:>:>»..:

600

300
arm
287.7

31.1
27.9

34.7

464.5
ttt 4

12.3 r - T T i

4

400

1979




1980

1981

1977

36.8
36.8

27 5

90.2

1978

144.9

118.4

321.6

1978

178.9

l"'-'''4

153.3 P P I 340.5

1980

1981

178
Other Expense—
Per Cent Increase (Decrease)

Asset Quality A n a l y s i s
Lending is Continental's principal business, and the extension of credit always carries s o m e risk that a borrower
(3.1)%
(5.2)%
(17.8)%
Advertising and public affairs.
will not be able to repay a loan when it matures. Although
Insurance (primarily FDIC) . .
23.1
2.5
15.1
managing risk and maximizing the profitability of the
Legal, audit, and other
purchased services
(8.5)
18.8
36.0
overall loan portfolio is one key to performance in bankStationery, postage, and
ing, credit losses must be considered a normal cost of
22.7
supplies
5.9
11.3
doing business.
9.7
22.4
Telephone
21.2
The basic policy governing the management of the lendTravel and business
ing portfolio is the diversification of risk over a variety of
promotion
23.5
33.8
20.5
All other
(4.3)
38.3
25.8
customers, industries, and countries. Appropriate diversi23.4%
Total
2 2 . 3 % fication—combined with thorough evaluation, documenta1.0%
tion, and follow-up on every credit by highly trained
Income Taxes Up on Higher
Earnings
lending officers—lessens the effect of any potential loss
Income tax expense was up 2 9 . 7 per cent from 1980, due
that might result from a single event.
primarily to a greater level of pre-tax i n c o m e , as well as
Overall credit losses must be evaluated against m e profto a reduction in the level of tax-exempt interest income.
itability of die loan portfolio as a w h o l e , as well as in light
Federal income taxes increased approximately $ 2 4 . 6 milof Continental's total earning power.
lion, while foreign taxes were up $ 4 . 7 million. State and
Domestic and Foreign Loan Demand Continues
Strong
local taxes declined $ 8 7 3 , 0 0 0 .
The demand for credit which prevailed throughout 1980
During 1980 the same factors accounted for most of the
continued into 1981, as corporate borrowers relied upon
8 0 . 5 per cent increase in income tax expense fr6m 1979; a
banks as an important liquidity source. Except for a modyear ago, Federal income taxes rose $ 2 2 million, foreign
est softening of loan demand in February, average total
taxes increased $16.5 million, and state and local taxes
loans increased each month, with somewhat heavier
were up $ 4 million.
growth occurring in the second half of the year. While
The effective tax rate in 1981 was 3 2 . 2 per cent, c o m increases in foreign and domestic loans contributed varypared with 2 9 . 8 per cent in 1980 and 21.4 per cent in
ing percentages to each month's loan growth, on the aver1979. These rates are lower than the statutory Federal rate
age, domestic loans accounted for about 68 per cent of the
of 4 6 per cent due to the treatment of tax-exempt interest
annual increase.
and dividend income, investment tax credits, and capital
gains on investment sales.
1980

1981

Note 14 to the financial statements provides further
information on the Corporation's income taxes.

Salaries and wages 833
Employee benefits • •

Staff Expense
(Average Per Employee)

24

Average Loans

40
20.*

lM^,

21

17.7

18

35

-

30

K3^0>
1 4 ^ ^

15,

25

9.1
, ,,.,

12
9
6
4.5

3

J./




5.1

""Ti

10,0

^

179
Commercial and industrial loans remained the largest
and fastest-growing domestic loan category, increasing
24.3 per cent to average $10.7 billion. Mortgage and real
estate loans, which increased 12.9 per cent to $3.7 billion,
and loans to financial institutions, up 13.5 per cent to $2.4
billion, also contributed significantly to domestic loan
growth.
The allocation of resources among domestic and foreign
loans is influenced by the trend of the return on capital
employed, as well as by internally established country
lending limits. These limits take into account both political
and economic conditions abroad.
The following tables show estimated distributions of
foreign loans, based on the domicile of the guarantor. To
conform to 1981 presentation, certain 1980 amounts have
been reclassified.
December 31

Foreign Loans ($ in millions)

1981

1980

$ 3,741
1,833
2,133
1,811
528
$10,046

Europe
North America
,
Latin America/Caribbean
Asia/Pacific
Africa/Middle East
Total

$3,330
1,493
1,820
1,243
496
$8,382

The following classifications are based primarily on the
most recent criteria established by the World Bank.
Although the aggregate data displayed in the table have
gained common acceptance, they are not the most appropriate way to measure risk, which must always be evaluated on a case-by-case basis.

Non-Performing Credits
(As Percentage of Total Credits at Year-End)

Foreign Loans by Per-Capita Income Level
($ in millions)
December 31
1981
1980
Developed countries
$5,734 57.1% $5,073 60.5%
Oil-exporting countries
1,499 14.9
627
7.5
Developing countries:
Higher income (over $699). 2,206 22.0
2,272 27.1
Middle income ($300$699)
484
4.8
296
3.5
Lower income (less than
$300)
24
0.2
13 0.2
Centrally planned economies .
99
1.0
101
1.2
Total
$10,046 100.0% $8,382 100.0%
Non-Performing Loans and Credit Losses Reflect
Economic Conditions
Non-performing loans and lease financing receivables
include cash-basis credits, on which interest is recorded
only when received, and renegotiated credits, on which the
terms have been restructured to provide for the reduction
or deferral of interest or principal payments, primarily
to accommodate the weakened financial condition of
borrowers.
Non-performing credits and their effect on earnings in
the aggregate reflect the economic conditions prevailing
during a year, and periodic variations must be expected.
As a result of high interest rate levels and an economic
slowdown in 1981, non-performing credits of $653 million
represented 1.9 per cent of total loans and lease receivables outstanding at year-end, compared with $444 million
or 1.6 per cent at year-end 1980. Before the cyclic rise in
1981, non-performing credits declined steadily from $705
million or 5.7 per cent of the total loan and lease portfolio
reported at year-end 1975, amid a severe economic slump.

Reserve for
Credit Losses

168.1

1977

1978

1979




1980

Net charge offs ~
Provision .
Reserve at year-end I

180
The following table provides a summary of the loan and
lease financing portfolio by category, with related credit
loss and non-performing data ($ in millions):
December 31,1981
Nonperforming
Loans:
Domestic:
Commercial and
industrial loans . . . .
Mortgage and real
estate loans
Loans to financial
institutions (b)
Loans for purchasing or
carrying securities ..
Consumer installment
loans
oans
other loans
Total
Foreign
?n
Total loans
Lease financing receivables . .
nancing receivable
Total loans and lease
financing
receivables
Less: Unearned
income
Total loans and lease
financing receivables
(net)

Nonperforming
credit
percentage

Average
balance

$34

$10,741

7.40

2

3,713

50

1.89

(1)

2,409

9
27
566
71
637
16

0.56
3.07
2.55
0.70
1.97
1.42

Average net
Net credit
credit loss
losses (a) percentage (a)

$12,862

$187

3,957

293

2,633

1.45%

—

(1)

1,447
1,002
19,648
9,078
28,726
842

$33,299

$71

$29,568

423

—

0.36
0.30

304

$71

0.18%

336

23
5
62
8
70
1

0.3195
0.05

$29,264

212
1,588
878
22,130
10,046
32,176
1,123

1.58
0.49
0.31
0.08
0.24
0.11

1.73
0.26
0.34
0.10
0.26
0.03

0.24%

0.26%

(a) As a percentage of average balance.
(b) Includes loans to real estate investment I

The following table shows worldwide non-performing
credits by component. The $209 million increase in
non-performing loans and lease receivables during 1981
Non-Performing Loans and Lease
Financing Receivables ($ in millions)
Cash-basis loans and lease receivables:
Mortgage and real estate
All other loans (a)
Lease receivables
Total cash basis
Renegotiated loans and lease receivables:
Mortgage and real estate
All other loans (a)
Lease receivables
Total rene
Total . . .
(a) Includes loans to real




reflects the generally sluggish economic conditions
which must be expected periodically within the normal
business cycle.
December 31
1979
$252
295
16

$169
232
20

$235
• 160
24

1977
$192
131
16

456

563
$ 49

90
$653

$276

$ 21
2

23
$444

$—
75

27
$446

75
$414

$

1
90

91
$547

181

(S in millions, except per-share data)
Interest income that would have been
recorded at the original rate for the year
ended December 31
Interest income that was recorded for the year
ended December 31
Lost interest income for the year ended
December 31 (pre-tax)

1981
Cash-basis Renegotiated

$ 107

$

1980
Cash-basis Renegotiated

3

$ 110

$ 56

—

24

21

$

3

$ 86

$ 35

24
$ 83

Total

$

Total

5

$ 61

1

22

$

4

$ 39

Lost interest income for the year ended
December 31 (after-tax)

$ 42

$

2

$ 44

$ 18

$

2

$ 20

Per-share impact (after-tax)

$1.08

$0.04

$1.12

$0.45

$0.05

$0.50

As shown in the table above, the computed loss of aftertax income associated with non-performing credits totaled
$44 million in 1981. The increase in the computed loss
was caused by an increase in principal and the higher
interest rates prevailing in 1981, partially offset by an
increase in interest received.
In 1981 net credit losses increased 15.8 per cent to
$71.1 million from 1980, amid a downturn in the American economy. Recoveries on loans previously charged off
totaled $21.1 million in 1981 and significantly reduced
losses. Despite the higher dollar amount charged off, net
credit losses remained 0.24 per cent of average loans and
lease financing receivables, unchanged from last year's
level. While the aggregate percentage relationship was
below the five-year average, data in the table at the top of
page 23 show that there has been no consistent historical
loss pattern for individual loan categories. Net credit card
losses again declined, to $18.7 million on $651 million
average loan volume in this area, compared with $25 million on $663 million average volume in 1980.
Resen'e for Credit Losses Increased
As in the past, the 1981 provision for credit losses exceeded net credit losses for the year, continuing the expansion of the reserve to a level appropriate to the expanded
volume of credit. The net addition to the reserve for credit
losses was $42.7 million in 1981, compared with $34 million in 1980 and almost $21 million in 1979. The reserve
for credit losses of $289.1 million equaled 0.87 per cent of
total credits at year-end, compared with $246.4 million or
0.89 per cent at the close of 1980.
Management considers the reserve for credit losses adequate to absorb potential losses, based on the quality of
credits in the portfolio, past experience, and economic
prospects in the U.S. and abroad. Review of loans and
leases is a thorough and continuous process, with special
attention given to any problem credits.
Although the table on page 52 shows an allocation of
the reserve for credit losses for the past five years, the
entire reserve is available for any loan which might be
charged off.




Reconcilements of the consolidated reserve for credit
losses and of that portion of the reserve allocated to foreign operations for the past three years may be found in
Note 5 to the financial statements.

Statement of Condition Analysis
The consolidated statement of condition as of the end of
the year reflects Continental's financial condition on that
date. A more meaningful analysis of condition can be
obtained by reviewing statements of condition based on
average balances.
Asset. Capital Bases Increase
Average total assets grew by about $4.4 billion or 11.2 per
cent in 1981. As in previous years, interest-earning assets
increased substantially, reflecting higher loan and lease
financing receivable balances. The average loan portfolio
grew 17.7 per cent, to $28.6 billion.
Yields on investment securities were less attractive in
1981 than yields on other alternatives, and average investment securities held did not change significantly from
1980. The portfolio mix did change, however; U.S. Treasury and Federal agency securities increased to 46 per cent
of the total from 40 per cent in 1980, and state, county,
and municipal securities declined to 38 per cent from
45 per cent. This shift in portfolio composition reduced
tax-exempt interest income from 1980.
Customers' liability on acceptances, a fee-generating as
opposed to an interest-earning asset, increased 21.2 per
cent, in line with the corporate goal of expanding noninterest income. This growth also was reflected in the offsetting liability of acceptances outstanding.
As in prior years, the growm in earning assets was
financed largely through interest-bearing liabilities. In
1981 these sources of funds supported 90.6 per cent of
earning assets, compared with 90.2 per cent in 1980. The
major components of interest-bearing liabilities have been
foreign time deposits, short-term borrowings, and commercial certificates of deposit.

182
1981

1981
1980
Average balance as a
percentage of average
earning assets
34.5%
35.7%

($ in millions)
Time deposits in foreign offices

Average
balance
$12,814

Average
interest
rate
15.1%

Short-term borrowings:
Federal funds purchased and securities sold under repurchase
agreements
Commercial paper
Other short-term borrowings
Total short-term borrowings

$ 8,557
958
1,507
$11,022

16.4%
16.8
12.8
15.9%

23.0%
2.6
4.1
29.7%

23.9%
2.3
3.6
29.8%

Commercial certificates of deposit

$ 6,431

16.1%

17.3%

14.9%

In 1981 average foreign time deposits increased $1 billion
Stockholders' equity averaged $1.6 billion in 1981, a
or 8.7 per cent from 1980, while short-term borrowings
12.0 per cent increase from 1980, and was 3.64 per cent of
were up 11.8 per cent from last year's $9.8 billion avertotal assets at year-end. Leverage (average total assets/
age. Commercial certificates of deposit averaged $6.4 bilaverage equity) decreased slightly to 27.2x in 1981 from
lion, an increase of 31.2 per cent over 1980.
27.4x in 1980.
Demand deposits declined slightly in 1981, reflecting
Earnings retention was the primary source of equity
more sophisticated client cash-management techniques and growth in 1981. The internal funding rate—which meathe October adoption of same-day settlement procedures
sures the growth in equity generated by earnings after
for interbank settlements made through the Clearinghouse
dividends to stockholders—was 11.4 per cent in 1981,
Interbank Payment System (CHIPS). Domestic demand
compared with 10.9 per cent last year. Stockholders
deposits averaged $4.2 billion in 1981, down 0.5 per cent
received 28.88 per cent of 1981 income before security
from last year, while demand deposits in foreign offices
transactions in the form of dividends, while in 1980 the
declined 5.0 per cent, averaging $1.3 billion.
dividend pay-out ratio was 29.78 per cent.
Savings deposits also declined slightly in 1981, as
At December 31, 1981, there were no plans for capital
higher rates available elsewhere continued to attract conexpenditures or other commitments that depend on addisumer funds. Savings deposits averaged $1.2 billion, down tional equity for financing. The need for additional equity
0.5 per cent from 1980. Savings deposits funded 3.3 per for any purpose is monitored through a continuous plancent of average earning assets in 1981, down from 3.8 per
ning and review program which takes into account asset
cent in 1980.
growth, dividend policy, and internal funding, as well as
general economic conditions.

Average Total Assets

Return on
Average Assets

55
50

0.62

44.0

45

0.62

PS

39.5^.

40
35

n m fej 14

30
25

EPQ

m

33.2^

02

* ^

m

20

1977

1978

1979




1980

1981

1977

1978

1979

1980

1981

183

The following table shows a two-year comparison of
Continental's quarterly stock quotations and dividends
declared.
Cash
dividends
Low declared

High
1981
First
Second
Third
Fourth

$36%
42¥*
40%
39%

$30%
33%
34%
32%

$0.45
0.45
0.50
0.50
$1.90

$29%
30%
31%
32%

$21%
25%
27%
27%

$0.40
0.40
0.45
0.45
$1.70

Total
1980
First
Second
Third
Fourth
Total

Although Continental defines its capital base as stockholders' equity, other definitions have broadened the concept to
include long-term debt. Long-term obligations include
notes, mortgage notes, and a capitalized lease (see Note 8
to the financial statements).
During 1981 two debt offerings were made: one
domestic, the other foreign. Both offerings included warrants which, if exercised, would result in an additional
$400 million (par amount) of debt outstanding.
At December 31, 1981, long-term debt represented 33.5
per cent of capital as measured in the broader definition—
equity plus debt. This ratio, which has shown little change
over the past few years, was 30.7 per cent at year-end
1980. Between December 31, 1979, and December 31,
1981, net long-term debt increased by $332.7 million,
while stockholders' equity grew by $347.7 million.

Market Value of Stock

High
At December 31
Low I

Liquidity, Interest Rate Sensitivity Policies
to Meet Earnings Goals
Liquidity management policies are designed to provide a
continuing flow of funds to meet the financial commitments of the Corporation and the needs of its customers. In
the ordinary course of business, cash flows are generated
from interest and fee income, as well as from loan repayments and the maturity or sale of other earning assets, providing varying amounts of the liquidity needed.
The most important sources of liquidity are the acquisition of new deposits and borrowings and the rollover of
maturing deposits and borrowings. Domestically, the Corporation has relied on Federal funds purchased, securities
sold under repurchase agreements, commercial paper, and
commercial certificates of deposit as major liquidity
sources. Time deposits in foreign offices have been the
primary source of funds from outside the United States.
Longer-term funds have been provided by a variety of debt
instruments, including two innovative $100 million longterm note issues with warrants in 1981.
Continental employs the funds acquired to finance the
expansion of its earning asset base, which has largely centered in loan growth during the past three years. In 1981
average loans increased $4.3 billion.
Interest rate sensitivity management, which involves the
lengthening and shortening of maturity schedules of assets
and liabilities in anticipation of interest rate cycles, is
closely related to liquidity management.
One of management's goals is to generate net interest
income growth through all interest rate cycles by managing
the relationship between rate-sensitive assets and liabilities. Allowance must be made in this process, however, for
asset and liability levels which may be determined by market demands, business constraints, regulatory restrictions,

Average Book Value Per Share

Dollars

55

48
J A M

50

42%

42

45

30

33.01

36

40

36.75

35

32%

32%
30*

30 4 /,«

30

29

33*
^30%

24

23%

23*4

24^*"

20




H
1
i

18

|

12

]
j

57'A

25

30.03
27.15

6

184
long-term marketing programs, or other factors beyond
management's immediate control.
As improved management information systems have
developed, the process of measuring interest rate sensitivity has been enhanced. Close monitoring of the interest
rate sensitivity of assets and liabilities is essential not only
because Continental uses money market borrowings as a
major funding source, but also because of the variety of
assets and pricing alternatives which these funds support.
The following table provides a breakdown at December
31, 1981, of assets and liabilities according to their sensi-

tivity to interest rate changes. These data are as of one day,
and significant swings can occur daily in the sensitivity
relationships.
The interest-sensitive structure below reflects both market forces and Continental's management of rate sensitivity. Interest-sensitive gaps within specific time frames may
be established to capitalize on anticipated interest rate
shifts within these periods. Continental's access to a variety of funding sources, in addition to its various asset pricing structures, enables it to manage these rate-sensitive
gaps effectively.

0-30 days

Earning assets:
Domestic loans
Foreign loans
Interest-bearing deposits
All other
Total

31-90 days

$11,180
4,421
1,493
756
$17,850

($ in millions)

$4,932
2,745
1,833
58
$9,568

43.9%

% ofof earnin assets
i> earning
Interest-bearing liabilities:
Short-term borrowings
Commercial CDs
Time deposits in foreign offices
All other
Total

$ 9,641
2,496
6,610
1,360
$20,107

% of interest-bearing liabilities

55.6%

Interest-sensitive gap

$(2,257)

Average Earning Assets

Other
Investment securities
Interest-bearing deposits Loans and lease receivables I

91-180 days

181-365 days

$

503
2,078
1,551
101
$ 4,233

23.5%

$

10.4%
304
1,232
3,108
583
$ 5,227

22.4%

14.5%

91
47
246
1,093
$1,447

3.4%
_$

100.0
$11,013
7,250
14,131
3,737
$36,131

4.1%

(87)_

Sources of Funds
Used to Finance
Average Earning Assets

$22,021
10,033
5,083
3,569
$40,706

19.4%

372
169
512
182
$ 1,235

$ (994)

$1,483

$4,983
412
25
2,487
$7,907

2.8%

$

$ 605
3,306
3,655
519
$8,085

Over 1 year

423
377
181
167
,148

100.0
$ 4,575

$6,430

Dn-interest bearing sources
Borrowings
Interest-bearing deposits I

37.1

40

3.5
11.7

3.2
27.4

30
223"""' ""
0.4
2.4

20
p
10

.

.

]]
-

3

*.o By,-

f V\Y

1

! 13 4
• A

f

)

1

f t
M [ i i




248

I>,

M
'1
i i
1- 1

F^Hll.8
10

K i

r**ji4.i

M
LJ U

r

i

:

;

1978

i

ii •

prr
"i

IT-117.2

• 1
1977

P^21.9

6U

2.8
5.2

20

2.4
7.8

2.7

19.8

1979

r

!

• 1

r

!

1980

1981

" '

185

($ in millions)

Maturing
Over one
Within
year but After five
one year within five
years

Total

Loans with predetermined interest
rates
Loans with floating
interest rates

$5,672

$2,332

$1,357

$9,361

9,621

7,562

3,130

20,313

Total

$15,293

$9,894

$4,487

c o m p a r e d with 4.1 p e r cent at the previous year-end.
T h e decline resulted from the transfer of ownership of the
C a n a d i a n s u b s i d i a r y from the Corporation to the Bank
in July 1981. T h i s subsidiary b e c a m e a full-service bank
in 1981 as a result of a recent c h a n g e in the Canadian
banking laws.

$29,674

A s s h o w n in the table a b o v e , at year-end 1 9 8 1 , 6 8 . 4 per
cent of all loans outstanding (excluding c o n s u m e r loans
and loans secured by 1-4-family residential properties) had
floating interest rates. A m o n g loans m a t u r i n g between o n e
a n d five y e a r s , 7 6 . 4 p e r cent h a d floating r a t e s , while 6 9 . 7
per cent of loans maturing in m o r e than five years were in
this category. Floating rate loans enable Continental to
avoid locking in d i s a d v a n t a g e o u s interest rates w h e n
extending credit, especially over long p e r i o d s of t i m e .
T h e following table presents the maturity distribution of
time certificates of deposit of $ 1 0 0 , 0 0 0 or m o r e issued by
the B a n k ' s d o m e s t i c office:
December 31
1981
1980

($ in millions)
3 months or less
Over 3 through 6 months
Over 6 through 12 months
Over 12 months

$5,527
2,047
257
56
$7,887

Total

$4,211
1,795
258
59
$6,323

A s u m m a r i z e d statement of condition for non-bank subsidiaries follows:
Combined Statement of Condition
($ in millions)

December 31
1981
1980

Assets
Interest-bearing deposits
Investment securities
Loans:
To Parent Company*
Other
Lease financing receivables

$

190
112

311
57

246
456
732

147
793
410

1,434
188
19

1,350
82
18

Net
All other a

1,227
138

1,250

Tote

$1,667

$1,741

$

386
660
10
154
261

$ 525

1,471
196

1.578
163

$1,667

S1.741

Tote
Less:
Les Unearned income
Reserve for credit losses . .

Liabilities
Deposits
Advances from Parent Company*
Short-term borrowings
Other liabilities
Bonds, mortgages, and similar debt
Tt
Capital.

Non-Bank Subsidiaries
Total assets of the consolidated n o n - b a n k subsidiaries were
3.5 per cent of total corporate assets at D e c e m b e r 3 1 , 1981,

Interest-Bearing Liabilities
(As a Percentage of Average Earning Assets)

Total liabilities and capital
Tc

.

m

'Eliminated in consolidation.

Interest income
Net interest margin
Interest expense

Quarterly Interest Comparison
(As a Percentage of
Average Earning Assets)

22
20
18
16
14
12

16.18
14.50

14.72

12.21

14.30
2.49v

2.71
2.36
^ * *
*12.14

16.30
2.12

"T^is

14.78

2nd

3rd

9.52Sn i . 8 8
1st




13.13

2 . 4 2 > <U69

12.01

8
1979

15.76
2.63

2.69

10

1978

17.33
2.55

2nd

3rd

4th

1st

4th

186
As a g r o u p , non-bank subsidiaries m a d e their largest
contribution to consolidated e a r n i n g s in 1981, and have
been profitable in each of the last five years. A significant
part of 1981 e a r n i n g s w a s generated from gains on the sale
of equity investments which a m o u n t e d to $ 3 9 . 8 million
pre-tax, c o m p a r e d with pre-tax gains of $ 6 . 7 million in
1980. Sales of equity i n v e s t m e n t s are r e c u r r i n g , n o r m a l
transactions, although the a m o u n t s vary from year to year.
A c o n d e n s e d statement of i n c o m e follows:
Combined Statement of Income
Year ended December 31 ($ in millions)

Total

Interest income
Interest expense

$248
208

Net interest income
Provision for credit losses
Other operating income
Other operating expense

40
3
43
23
57
15
42
(1)
$ 41

Income before security gains or losses . .
Security gains (losses)—after taxes . . .
Net income

$203
176

27
2
10
22
13
(1)
14
$ 14

•Less than SI million.

Fourth Quarter Summary of Operations
During the fourth quarter of 1981, lending business advanced, with relatively strong loan demand further stimulated by declining interest rates. On three occasions in the
fourth quarter, Continental Bank led the banking industry
in reducing its prime rate, as economic activity slowed and
inflation eased.
Fourth quarter income before security transactions
totaled $72.8 million, compared with $53.6 million in
1980. The higher earnings reflect gains in both net interest income and other operating income, partially offset by
increased other operating expense.
Losses on the sale of investment securities were $2.3
million, compared with losses of $807,000 in 1980, and
brought net income to $70.5 million, compared with $52.8
million in last year's fourth quarter.
Net interest income on a taxable equivalent basis totaled
$266.6 million, an increase of 27.2 per cent from the
fourth quarter of 1980. This increase in net interest income
can be attributed to a higher volume of earning assets,
coupled with a wider net interest margin. A comparative
analysis of fourth quarter net interest income may be found
on page 54.
Other operating income rose 16.5 per cent from the
fourth quarter of 1980, as increases in trust, security trading, and fee income were partially offset by declines in
foreign exchange profits and income from all other
sources.




Other Operating Income ($ in millions)
Trust income
Security trading profits and commissions .
Foreign exchange profits:
Trading operations
Translation gains (losses) net
Fee income:
Domestic
Foreign
Gains on sales of equity investments
All other income

Fourth Quarter
1981
1980
$14.6
22.4

$11.5
(0.8)

4.2
(5.8)

11.1
2.5

24.3
20.3
3.3
0.8

21.6
15.1
6.1
5.1

$84.1

$72.2

Other operating expense was up $27.2 million, with
employee-related expenses accounting for $13.5 million of
the total increase. Net occupancy expense was up $3.9
million, while equipment and other expenses increased by
$9.8 million.
The provision for credit losses was $35 million, compared with $27 million a year earlier. Net credit losses in
the period of $19.8 million compare with last year's losses
of $18.8 million.
Income taxes of $44.1 million rose $12.7 million from
the fourth quarter of 1980. Higher taxes reflect a 37.5 per
cent increase in pre-tax income, as well as adjustments
made during the quarter to bring the provision for taxes
into line with the year's results. Complete quarterly
income statements may be found on page 53.

Supplemental Information on the Effects of Inflation
The influence of inflation on business results and financial
statements has become a subject of increasing interest as
inflation itself has increased. The financial information
throughout this Report has been prepared on the traditional
historical-cost basis, in keeping with generally accepted
accounting principles, and thus does not attempt to reflect
changes in the purchasing power of the dollar over the
years.
Inflation-adjusted accounting is still an experimental
approach, and how it relates to banking industry performance is still in question, but the following supplemental
discussion may help provide some insight on inflation's
effects on business enterprise, based on two different
methods of illustration.
The first is Constant Dollar Accounting, which measures the effects of "general inflation" by applying a uniform index, the average Consumer Price Index (CPI), to
corporate financial statements. Under this method, assets
and the related depreciation expense are indexed based
upon acquisition dates, and their amounts are restated in
terms of the purchasing power of 1981 dollars. This
method assumes that the CPI is a representative index of
the overall level of inflation in the economy. Since this

187
index is consumer oriented, however (i.e., composed
of the prices of food, clothing, housing, and so forth),
it is not directly applicable to a corporation's financial
statements.
The second method, Current Cost Accounting, adjusts
financial statements to reflect the changes in "specific
prices" of assets. With the exception of internally developed data applicable to computer equipment, all specific
changes are measured using various indexes developed by
the U.S. Departments of Commerce and Labor. Since this
method allows a different index to be used to adjust buildings than the index used to adjust office equipment, the
valuation of assets under the current cost approach provides a finer estimate than under the constant dollar
approach.
Depreciation Adjustment
During periods of inflation, the value of capital assets generally will rise. However, under historical-cost financial
statements, depreciation currently charged to operations
reflects an allocation of the acquisition cost, not the anticipated cost of replacing those assets at future inflated
prices. To provide a more realistic presentation of income
and cash-flow requirements, one aspect of inflationadjusted statements entails restating reported results to
give effect to changing prices of assets.
Depreciation expense for 1981 was $35 million as
recorded in the primary financial statements. As shown
below, depreciation under the constant dollar and current
cost bases has been increased by $12 million and $8 million, respectively. Since there is no tax benefit for the ultimate increased cost of replacing a corporation's capital

Inflation-Adjusted
Net Income

Current cost
Constant dollar • •

assets, these adjustments are carried through to net income
without any change in income taxes. Absorbing this
increased cost through after-tax earnings results in an
effective tax rate of 33.2 per cent under constant dollar and
32.9 per cent under current cost, compared wim the
reported 1981 rate of 32.2 per cent.
Net Monetary Loss
One final result of inflation is the purchasing power loss
derived from the holding of assets fixed in their currency
value (monetary assets). Theoretically, the "value" of
monetary assets declines with inflation, while that of other
assets does not. Considerable controversy still exists about
the application of this concept, particularly for banks,
since much of the theory pertains to industrial firms.
Being a net holder of monetary assets does not adversely
affect the Corporation or the banking industry. Continental
generates earnings and pays dividends by making loans,
which are, of course, monetary assets. Holding monetary
assets in the form of cash is essential to the banking industry's operation. For the Corporation, the loss from holding
net monetary assets was $95 million for 1981. The calculation of the loss ignores the fact that the majority of the
Corporation's loans are issued with floating interest rates,
which serve as a partial hedge against a purchasing power
decline.
A better measure of a bank's ability to deal with inflationary trends encompasses a review of the maintenance of
its net interest margins, the rate sensitivity and maturity of
its portfolio, and its funding strategy in anticipation of rate
changes. Management believes that referencing these topics covered in the historical-cost analysis will provide further insight on the subject.

Change in CPI/Reported
Net Income

Average consumer price index
Reported net income C 3

S millions

20

400
350

H
, „ , 236.3

250

241.5 238.3

—

~«j

200
150

<

100
50




1
i

1

246.8 2 4 m

11.2 i

f^
3

\

15.3

1i

300

.

™n
1

10

5

j
i

•I

1

12.6
10.3;

188
Three-Year Analysis
The following table presents a comparison of selected
financial data for the past three years adjusted for inflation
according to the two methods discussed previously.
Prior years' data have been indexed forward by the CPI
to state these amounts in terms of the purchasing power of
1981 dollars. This procedure eliminates the effect of inflation and allows comparison with prior years' data to reflect
real growth or decline during the period.

In addition, depreciation expense has been adjusted to
reflect the changing value of physical assets, as measured
by general and specific price indexes. These depreciation
adjustments, along with the decline in the value of net
monetary assets and the increase in the value of property
and equipment, are reflected in the table's net asset figures.
T h e table indicates that the Corporation's net income in
1981 increased over net income in 1979 and 1980 under
both current cost and constant dollar methods.
Average 1981 Dollars

($ in millions, except per-share data)
Net interest and other operating income
.
Depreciation and amortization expense
Other operating expense
Total other operating expense
Income before income taxes and
security gains or losses
Applicable income taxes
Income before security gains or losses
Net gains or (losses) on security transactions
after related income taxes
Net income
Per-Share Data
Income before security gains or losses
Net income

1981
$ 1,008
43
588
63J

Adjusted for changes
in specific prices
(current cost)
1980
$ 969
$
42
582
624

377
124
253
$

(6)
247

$ 6.38
6^24

305
66
239

$ 6.10
6_1_5
$

127

373
124
249

342
106
236

300
66
234

2
241

$

1981
$1,008
47
588
635

(6)
$ 243

2
$ 238

2
$ 236

$6.29
6J4

$6.02
6JT7

$5.98
6_03

95

$ 127

$ 139

$1,780

$1,723

$1,706

$

6.10
6_15

$

139

Loss on holding net monetary assets

$

Net assets (stockholders'equity) at year-end .

$ 1,790

$ 1,741

$ 1,715

$29,585
34,513

$62,713
44,767

$21,436
44,923

$(4,928)

$17,946

$(23,487)

Increase in specific values of properties and
equipment held during the year
Effect of increase in general price level
Effect of increase in specific prices
at a rate over (below) increase in
the general price level

95

2
241

1979
892
42
549
591

1979
892
37
549
586

345
106
239
$

Adjusted for changes
in general inflation
(constant dollar)
1980
$ 969
$
45
582
627

$

Notes:
1. At December 31, 1981, the current cost amount of property and equipment was $432,663,000.
2. Inflation-adjusted depreciation has been calculated based upon the same methods
and estimated useful lives used in historical-cost financial statements.
Five-Year Analysis
To gain further perspective, an extended five-year analysis
of selected financial data is presented. The upward trend in
net interest and other operating income indicates growth at
($ in millions, except per-share data)

a rate greater than the general inflation rate in each of the
last five years. The table also shows that by periodically
increasing dividends, the Corporation has allowed the
stockholders to keep pace with inflation.
1981

'

1980

$

700
269
969

$ 632
260
$ 892

$ 620
232
$ 852

$ 581
209
$ 790

$1.90
327ia

$ 1.87
3215/i«

$1.90
34%

$1.92
35Vie

$ 1.89
39 n /i6

272.4

246.8

217.4

195.4

181.5

Net interest income after provision for credit losses
Other operating income
Net interest and other operating income

$ 686
322
$1,008

$

Per-Share Data
Cash dividends declared
Market price at year-end
Average Consumer Price Index (1967 = 100)




1979

1978

1977

189
Consolidated Statement of Condition
Continental Illinois Corporation and Subsidiaries

December 31 ($ in thousands)

.

Assets
Cash and due from depository institutions:
Cash and non-interest-bearing deposits
Interest-bearing deposits
Investment securities:
Market value: 1981—$1,903,941, 1980—$2,324,409
Trading account securities
Other short-term investments
Loans
Lease financing receivables
Total loans and lease receivables
Less: Unearned income
Reserve for credit losses
Net loans and lease receivables
Properties and equipment
Customers' liability on acceptances
Interest receivable
Other assets
Total assets
Liabilities
Deposits:
Domestic—Demand
Time
Deposits in foreign offices
Total deposits
Short-term borrowings
Acceptances outstanding
Other liabilities
Bonds, mortgages, and similar debt
Total liabilities
Stockholders' Equity
Preferred stock—without par value:
Authorized: 10,000,000 shares, none issued
Common stock—$5 par value:
Authorized: 80,000,000 shares both years
Issued and outstanding: 1981—39,601,775 shares
1980—39,337,925 shares
Capital surplus
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
Commitments and contingent liabilities (Notes 9 and 10).
See notes to financial statements.

12-745
13
 0 - 8 3


1981

$ 2,513,080
5,082,703

1980

$ 4,361,504
4,294,045

2,169,303
169,164
499,817
32,175,497
1,123,729
33,299,226
423,000
289,169
32,587,057
298,715
2,469,917
832,686
349,313
$46,971,755

2,505,924
128,065
417,207
26,909,698
720,003
27,629,701
262,663
246,413
27,120,625
276,479
1,898,071
665,775
421,713
$42,089,408

$ 4,838,568
10,124,535
14,630,902
29,594,005
11,013,222
2,477,137
1,314,402
862,297
45,261,063

$ 5,230,741
8,348,583
13,734,343
27,313,667
9,564,947
1,898,816
1,110,719
676,317
40,564,466

198,009
522,812
989,871
1,710,692
$46,971,755

196,690
517,824
810,428
1,524,942
$42,089.408

190
Consolidated Statement oj Income
Continental Illinois Corporation and Subsidiaries

Year ended December 31 ($ in thousands)
Interest and fees on loans
Lease financing income
Interest on deposits with banks
Interest and dividends on investment securities:
Taxable income. .
Income exempt from Federal income taxes
Trading account interest
Interest on short-term investments
Total interest income
Interest on deposits
Interest on short-term borrowings
Interest on bonds, mortgages, and similar debt
Total interest expense
Net interest income
Provision for credit losses
Net interest income after provision for credit losses
Trust income
Security trading profits and commissions
Foreign exchange profits
All other income
Total other operating income
Net interest and other operating income
Salaries and wages
Pension, profit sharing, and other employee benefits
Net occupancy expense
Equipment rentals, depreciation, and maintenance
Other expense
Total other operating expense
Income before income taxes and security gains or losses
Applicable income taxes
Income before security gains or losses
Security gains or (losses) less applicable income taxes of
$(5,392), $1,433. and $1,689, respectively
Net income
Income per common share:
Income before security gains or losses
Net income
Dividends declared per common share
Average shares outstanding (in thousands)
See notes to financial statements.




1981
$4,796,322
90,327
747,149

1980
$3,448,973
65,838
658,355

1979
$2,437,870
39,190
455,931

148,910
64,194
34,032
83,281
5,964,215
3,316,677
1,760,764
80,993
5,158,434
805,781
120,000
685,781
53,600
27,888
31,155
209,764
322,407
1,008,188
265,614
74,877
65,747
36,857
180,759
623,854
384,334
124,019
260,315

133,215
70,951
29,307
65,874
4,472,513
2,397,443
1,279,679
65,097
3,742,219
730,294
96,000
634,294
44,809
6,122
32,284
160,422
243,637
877,931
227,758
61,473
53,314
36,801
178,874
558,220
319,711
95,568
224,143

75,955
77,568
19,510
62,103
3,168,127
1,739,743
806,611
47,920
2,594,274
573,853
70,000
503,853
37,434
15,730
12,583
141,983
207,730
711,583
199,501
51,187
41,401
27,549
144,894
464,532
247,051
52,925
194,126

(5,692)
$ 254,623

1,798
$ 225,941

1,681
$ 195,807

$
$
$

$
$
$

$
$
$

6.58
6.44
1.90
39,537

5.70
5.75
1.70
39,256

4.95
4.99
1.52
39,195

191
Year ended December 31 ($ in thousands)

1981

1980

$254,623

$225,941

120,000
35,797
20,079

96,000
32,165
22,825

70,000
26,294
19,603

430,499

376,931

311,704

2,280,338
1,448,275
189,803

3,306,467
1,798,126
146,785

2,846,950
1,130,346
79,075

1,059,766
—
295,522
87,841
6,307

—
—
—
—
2,870

421,866
53,417
—
267,403
959

$5,798,351

$5,631,179

$5,111,720

$

—
82,610
—
5,586,432
56,228
—
73,081

$1,253,593
109,033
218,548
3,852,799
80,327
52,122
64,757

$

$5,798,351

Financial R e s o u r c e s Were P r o v i d e d B y :
Net income
Non-cash charges included in net income:
Provision for credit losses
Provision for depreciation and amortization
Deferred income taxes .

$5,631,179

$5,111,720

Financial resources provided by operations
Other sources:
Increases in:
Deposits
Short-term borrowings
Bonds, mortgages, and similar debt, net
Decreases in:
Cash and due from depository institutions
Other short-term investments
Investment and trading securities
Other resources, net
Issuance of common stock under stock option plans
Total
F i n a n c i a l R e s o u r c e s Were U s e d F o r :
Increases in:
Cash and due from depository institutions
Other short-term investments
Investment and trading securities
Net loans and lease receivables
Properties and equipment
Other resources, net
Cash dividends paid
Total

1979
$

195,807

—
—
126,712
4,870,442
56,565
—
58,001

See notes to financial statements.

Consolidated Statement of Changes in Stockholders' Equity
Continental Illinois Corporation and Subsidiaries

Year ended December 31 ($ in thousands)
C o m m o n Stock
Balance at beginning of year
Shares issued under stock option plans: 263,850 shares in 1981,
118,985 shares in 1980, and 51,215 shares in 1979
Balance at end of year
Capital S u r p l u s
Balance at beginning of year
Proceeds received over par value of shares
issued under stock option plans
Transfer from retained earnings
Balance at end of year
Retained Earnings
Balance at beginning of year
Net income for year
Cash dividends declared: $1.90 per share in 1981, $ 1.70 per share
in 1980, and $1.52 per share in 1979
Transfer to capital surplus
Balance at end of year
Total stockholders'

equity at end of year

See notes to financial statements.




1981
$

196,690

1980
$

196,095

1979
$

195,839

1,319

595

256

198,009

196,690

196.095

517,824

510,349

508,646

4,988
—
522,812

2,275
5,200
517,824

703
1,000
510,349

810,428
254,623

656.458
225,941

521,239
195,807

(75,180)
—

(66,771)
(5.200)

(59.588)
(1.000)

989,871

810.428

656,458

$1,710,692

$1.524.942

$1.362.902

192
Trust Company of Chicago and Subsidiaries

December 31 ($ in thousands)

Assets
Cash and due from depository institutions:
Cash and non-interest-bearing deposits
Interest-bearing deposits
Investment securities:
Market value: 1981—$1,670,021, 1980—$2,097,859
Trading account securities
Other short-term investments
Loans
Lease financing receivables
Total loans and lease receivables
Less: Unearned income
Reserve for credit losses
Net loans and lease receivables
Properties and equipment
Customers' liability on acceptances
Interest receivable
Other assets
Total assets
Liabilities
Deposits:
Domestic—Demand
Time
Deposits in foreign offices
Total deposits
Short-term borrowings
Acceptances outstanding
Other liabilities
Bonds, mortgages, and similar debt
Total liabilities
Capital
Common stock—$10 par value:
Authorized, issued and outstanding:
20,000,000 shares both years
Surplus
Undivided profits
Total capital
Total liabilities and capital
Commitments and contingent liabilities (Notes 9 and 10).
See notes to financial statements.
Member Federal Deposit Insurance Corporation.




1981

1980

$ 2,512,215
4,985,297

$ 4,358,860
4,016,237

1,947,710
137,313
499,817
31,285,051
391,798
31,676,849
233,127
265,280
31,178,442
232,921
2,469,917
807,717
316,962
$45,088,311

2,333,649
115,081
417,207
25,937,864
310,156
26,248,020
172,135
224,788
25,851,097
208,114
1,898,071
643,919
391,947
$40,234,182

$ 4,842,116
10,132,941
14,884,706
29,859,763
9,786,597
2,477,137
1,172,070
16,989
43,312,556

$ 5,236,866
8,353,673
13,496,667
27,087,206
8,719,859
1,898,816
971,716
12,641
38,690,238

200,000
550,000
1,025,755
1,775,755
$45,088,311

200,000
550,000
793,944
1,543,944
$40,234,182

193
Note 1—Summary of Significant Accounting Policies:
The accounting principles followed by Continental Illinois
Corporation (the Corporation), Continental Illinois
National Bank and Trust Company of Chicago (the Bank),
and other subsidiaries, and the method of applying these
principles, conform with generally accepted accounting
principles and with general practice within the banking
industry where applicable. Those principles materially
affecting the determination of financial position, changes
in financial position, or results of operations are summarized below.
Basis of Presentation: The Corporation's consolidated
financial statements include the accounts of the Parent
Company and all wholly-owned subsidiaries. The Bank's
consolidation policy parallels that of the Corporation.
Material intercompany accounts and transactions are
eliminated.
Equity investments, principally foreign investments,
representing less than 50% ownership are carried at cost,
since the Corporation's management does not control or
significantly influence the operation of any such affiliate.
Income from such investments is recognized only as cash
dividends are received.
Gains and losses on disposition of affiliates and other
equity investments are included in all other income.
Included in other assets in the Corporation's consolidated financial statements is goodwill resulting from the
acquisition of two foreign units, which is amortized over
a 40-year period.
Income per share of common stock is computed using
the weighted average number of shares of the Corporation's common stock outstanding. Dividends declared per
share of common stock are based on the number of shares
of common stock outstanding at the record date of the dividend.
Foreign Operations: Foreign operations include the activities of the International Banking Department and the
International Banking Facility in Chicago, foreign
branches, Edge Act subsidiaries, and foreign subsidiaries
of the Bank and Corporation.
Securities: Investment securities are stated at cost,
adjusted for amortization of premiums and accretion of
discounts. Net gains or losses on the sale of investment
securities other than equity investments are determined by
using the average cost and are shown separately in the
Consolidated Statement of Income as security gains or
losses. Equity securities held for investment are discussed
above under Basis of Presentation.
Trading account securities are carried at market in the
statements of condition. The trading account inventory is
maintained primarily in connection with the Bank's operations as a primary dealer in U.S. Government and state,
county, and municipal debt obligations, buying and selling
for its own account.




Purchases and sales of trading account securities are
considered to be a normal part of operations. Trading
account securities are valued to market monthly, and these
adjustments along with the results of normal day-to-day
transactions are included in security trading profits and
commissions.
Transfers of securities are not permitted between the
trading account and the investment portfolio.
Loans: Loans are stated at principal outstanding with
interest income accrued daily as earned. It is the policy of
the Corporation to stop accruing income and to place the
recognition of interest on a cash basis under the following
delinquency situations: when a domestic commercial loan
remains unpaid 30 days past its final maturity—60 days
for foreign loans and 180 days for government-guaranteed
loans—unless the delay in payment is deemed by loan
administration authority not to be an indication of uncollectibility. Loans with interest or principal installments past
due for similar periods are reviewed and placed on a cash
basis at the direction of loan administration. Once placed
on a cash basis, interest receivable which had been previously credited to income is reversed, with the effect of the
reversal reflected in the current reporting period. Reversals
of interest and charge offs of consumer installment loans
are made on a systematic basis, related to delinquency criteria of 120 to 180 days.
Lease Financing: The Bank and certain of the Corporation's non-bank subsidiaries have entered into equipment
leasing contracts under a variety of leasing arrangements
with various lessees. Lease income is recorded in decreasing amounts over the term of the contract, resulting in a
level rate of return on the net investment in the lease.
Reserve for Credit Losses: For financial reporting purposes, the provision for credit losses is based upon a credit
review of the loan and lease financing receivables portfolio, past credit loss experience, current economic conditions, and other pertinent factors which form a basis for
determining the adequacy of the reserve for credit losses.
For tax purposes, the general policy is to provide additions
to the reserve for credit losses in accordance with maximum amounts allowed under applicable tax laws.
Foreign Exchange: Foreign exchange profits include
gains or losses resulting from trading activities and from
translating foreign assets and liabilities and related hedge
contracts.
Properties and Equipment: Properties and equipment are
stated at cost, less allowances for depreciation and amortization. Provisions for depreciation and amortization
included in other operating expense are computed on the
straight-line method for properties and on an accelerated
method for equipment.

194
Income Taxes: For purposes of financial reporting, certain
items of income or expense are recognized in time periods
different from those for computing taxable income, thus
giving rise to deferred income taxes.
Investment tax credits relating to properties and equipment purchased for the Corporation's own use are included
in net income in the year of acquisition (flow-through
method). Investment tax credits relating to assets owned
by the Corporation and leased to others are amortized over
the term of the lease and are included in lease financing
income. The Corporation and its U.S. incorporated subsidiaries file a consolidated Federal income tax return, with
each unit recognizing and remitting to the Corporation its
share of the tax liability, except that tax benefits of losses
and tax credits are allocated to the unit incurring such
losses and credits to the extent they reduce taxes payable.
Pension Plan: The Corporation and certain of its subsidiaries have a non-contributory pension plan covering
substantially all full-time employees.
The Corporation's policy is to fund accrued pension
costs. Actuarially-computed contributions under the plan
are based on the unit credit method, which includes the
amortization of prior service costs over a period of 30
years and gives recognition to market value of die assets in
the pension fund.

Note 4 — L o a n s and Lease Financing Receivables:
T h e following s c h e d u l e presents loans and lease financing
receivables by type ($ in millions):
December 31

1981

Total loans
Less: Unearned income
Loans (net of unearned
income)

<>te 3—Investment Securities:
Book and approximate market value of investment securities are shown below ($ in thousands):
December 31

212
1,588
878

379
1,459
864
18,528
8,382
26,910
126

32,054

26,784

673
149

488
95

Total lease financing receivables .

822

583

32,876

27,367

Total loans and lease financing
receivables (net of unearned
income)

289

246

$32,587

Net loans and lease financing
receivables

$27,121

'Includes loans to real estate investment trusts.

During the period 1979 to 1981 loans exceeding $500,000
were outstanding to three non-officer directors. These
loans were made on substantially the same terms as those
prevailing at the time for comparable transactions with
other persons and did not involve more than the normal
risk of collectibility or present other unfavorable features.
Information with respect to these loans is presented below
($ in thousands):

1981

Book Value
U.S. Treasury and Federal agency
securities
State, county, and municipal
securities* .
Other securities
securitie:

1981
$

Balance at January 1
Additions

859,211

Market Value
U.S. Treasury and Federal agency
securities
State, county, and municipal
securities*
Other securities
..

911,121
398,971

1,008,0%
346,709

$2,169,303

Total . .

Total

$ 9,845
3,530
2,451

Lease financing receivables (net of
unearned income):
Direct financing lease receivables . .
Leveraged lease receivables

Less: Reserve for credit losses

Note 2—Pledged Assets:
At December 31, 1981, assets stated at $1,357,804,000
were pledged to secure government, public, and trust
deposits as required by law; at December 31, 1980, the
corresponding amount was $1,508,212,000.

$12,862
3,957
2,633

32,176
122

Total domestic
Foreign

1980

22,130
10,046

Loans:
Domestic:
Commercial and industrial loans . . .
Mortgage and real estate loans . . . .
Loans to financial institutions* . . . .
Loans for purchasing or carrying
securities
Consumer installment loans
All other loans

$2,505,924

$

740,956

$1,048,733

761,124
401,861

888,580
387,096

$1,903,941

$2,324,409

•Slate, county, and municipal securities of any single issuer were less
iiockholders' equity at both reporting dates.




Balance at December 31

1980

1979

$1,416
512
213

$2,642
363
1,589

$2,516
162
36

$1,715

$1,416

$2,642

195
Note 7—Short-Term Borrowings:
Short-term borrowings include Federal funds purchased
and securities sold under agreements to repurchase, which
generally mature within 30 days, and commercial paper,
which generally matures within nine months from the date
of issuance.
1981
1980
1979
Details of short-term borrowings are shown below
Continental Illinois Corporation
($ in thousands):
and Subsidiaries
Balance at January 1
$246,413 $212,180 $191,237
Provision charged to
1981
1980
operating expense
120,000
Federal funds purchased and
Recoveries on previous
securities sold under agreements
credit losses
21,108
17,040
11,904
to repurchase:
Credit losses
(92,273)
(66,108)
(73,321)
$ 7,998,482 $ 7,360,870
Other adjustments
(6,079)
11 Balance at December 31
(350)
Maximum balance at any
Balance at December 31. $289,169 $246,413 $212,180
month-end
9,149,035
8,675,572
Average interest rate:
A portion of the above reserve has been allocated to forDuring year*
16.42%
13.30%
At December 31
12.45%
21.31%
eign operations. A reconciliation of the amounts allocated
is shown below ($ in thousands):
Commercial paper:
Balance at December 31
$ 1,218,511 $ 756,061
Maximum balance at any
1981
1980
1979
month-end
1,306,962
1,011,980
Foreign Operations
Average interest rate:
Balance at January 1
$60,400 $42,100 $40,700
During year*
16.82%
13.15%
Provision charged to operatAt December 31
13.09%
16.98%
ing expense
16,000
15,300
15,200
Other borrowings:
Recoveries on previous
$ 1,796,229 $ 1,448,016
credit losses
297
3,200
1,000 Balance at December 31
Maximum balance at any
Credit losses
(8,480)
(1,000) (14,800)
month-end
2,060,034
1,948,308
Other adjustments
(6,079)
800
— Average interest rate:
$62,138 $60,400 $42,100
Balance at December 31
During year*
12.85%
10.77%
12.37%
19.59%
At December 31
Total short-term borrowings:
Balance at December 31
$11,013,222 $ 9,564,947
Note 6—Properties and Equipment:
Maximum balance at any
month-end
11,563,197
10,926,035
The gross book value, accumulated depreciation, and carAverage amount outstanding
11,022,288
9,856,568
rying value of properties and equipment are summarized
Average interest rate:
below ($ in thousands):
During year*
15.97%
12.98%
At December 31
12.50%
20.73%
Carrying 'Based on annual average balance.
Gross Accumulated
value
book value depreciation
December 31
At December 31, 1981, the Parent Company had line-of1981 ;
credit arrangements with unaffiliated banks for $381.8
Properties (including
$293,416
$ 76,794
$216,622 million. Compensating balances were not maintained in
land of $46,123)
Equipment—
support of these arrangements. There were no borrowings
124,740
70,113
54,627
furniture
under the arrangements at December 31, 1981.
Leasehold
41,808
14,342
27,466
improvements
Total
$459,964
$161,249
$298,715
Note 8—Bonds. Mort«aj»e.s. and Similar Debt:
1980
The following is a listing of the long-term notes, mortgage
Properties (including
land of $42,320)
$264,914
$ 68,200
$196,714 notes, and a capitalized lease ($ in thousands):
Equipment—
furniture
109,251
56,191
53,060
Leasehold
42,048
15,343
26,705
improvements
Total
$416,213
$139,734
$276,479
Note 5—Reserve for Credit Losses:
Presented below is a reconciliation of the reserve for credit
losses that is available for loan and lease loss charges
($ in thousands):




196
December 31
Notes due 9/7/84 (14%%)
Notes due 1984-1986 (8%%)
Notes due 11/1/85 (8%%)
Notes due 11/1/85 (13%%)
Notes due 7/1/86 (9%%) .
Notes due 5/1/87 (Floating rate) . . .
Notes due 9/15/89 (Floating rate) . .
Notes due 3/31/97 (8%%)
Other debt*
Less: unamortized discount** .. .
Total long-term notes
Mortgage notes payable*
Capitalized lease
Total

1981
$100,000
6,000
100,000
100,000
149,400
200,000
26,005
150,000
30,163
20,804
840,764
16,131
5,402
$862,297

1980
—
6,000
100,000
—
149,306
200,000
31,864
150,000
16,777
—
653,947
10,902
11,468
$676,317

$

•Long-term borrowings of the Corporation's non-bank subsidiaries not guaranteed by
the Parent Company were $13,354,000 at December 31. 1981, and $12,229,000 at
December 31, 1980.
*'Associated with notes issued during 1981.

During September 1981, a wholly-owned subsidiary of the
Corporation issued $100,000,000 of 14%% notes due
in 1984 with warrants exercisable within one year of
date of offering of the notes to purchase an aggregate of
$200,000,000 of zero coupon bonds due in 1988. Interest
on the notes is payable annually on September 7. The
bonds have been priced to yield approximately 14.50% per
annum. The notes and bonds are unconditionally guaranteed by the Corporation.
During November 1981, the Corporation issued
$100,000,000 of 13%% notes due in 1985 with warrants
exercisable within one year of date of offering of the notes
to purchase an aggregate of $200,000,000 of zero coupon
debentures due in 1989. Interest on the notes is payable
semiannually on May 1 and November 1. The debentures
have been priced to yield approximately 14.25% per
annum.
Interest rates on floating rate notes are determined semiannually according to formulas based on certain money
market rates, as specified in the agreements governing
the issues.
Interest on the $200,000,000 of floating rate notes due
in 1987 will be paid at a rate of 15.35% per annum for the
period beginning November 1, 1981, and ending April 30,
1982. The average interest rates paid for 1981, 1980, and
1979 were 14.12%, 14.13%, and 10.98%, respectively.
The notes are convertible prior to May 1, 1986, into 8%%
debentures due in 2004. The notes are redeemable at principal plus accrued interest at the option of the Corporation
in whole or in part on or after May 1, 1986.
Interest on the floating rate notes due in 1989 will be
paid at a rate of 16.80% per annum in the period from
September 15, 1981, to March 14, 1982. The average
rates paid for 1981, 1980, and 1979 were 15.09%,
11.73%, and 10.15%, respectively. At the option of the
holders thereof, the notes are repayable at principal
amounts plus accrued interest on any semiannual interest
date. As of December 31, 1981, $53,995,000 of the notes




have been repaid at the option of the holder. The notes are
redeemable at the option of the Corporation in whole or in
part at principal plus accrued interest.
The terms of the notes due 1985, 1987, 1989, and 1997
provide restrictions on the Corporation's disposition of the
shares of the capital stock of the Bank.

Note 9—Lease Commitments:
Future minimum lease payments and sublease rentals on
capitalized and operating leases at December 31,. 1981, are
as follows ($ in thousands):
Future minimum lease payments
1982
1983
1984
1985
1986
Later years
Total minimum lease payments.
Future minimum sublease rentals . .

Capitalized*
Operating
leases
lease
$1,076
$ 21,796
1,076
25,691
1,076
24,192
1,076
22,844
1,076
21,839
3,586
288,449
$8,966** $404,811
$ 565

$ 4,482

•In August 1981, a 50% interest in the property under the capitalized lease was
purchased, with a commitment to purchase the remaining 50% by 1983.
••The $8,966,000 of minimum lease payments on the capitalized lease comprises
$3,564,000 representing interest costs and $5,402,000 representing the present
value of the payments.

In addition to the amounts set forth above, certain of the
leases require payments by the Corporation or its subsidiaries for taxes, insurance, and maintenance.
Rental expense for all operating leases (including equipment rentals based on usage) in other operating expense
in the Consolidated Statement of Income amounted to
$34,264,000 in 1981, $32,720,000 in 1980, and
$22,578,000 in 1979.

Note 10—Other Commitments and
Contingent Liabilities:
At December 31, 1981, commitments under standby letters
of credit outstanding aggregated $4,304,098,000.
At December 31, 1981, the Parent Company and the
Bank subsidiary had loan commitments under master
demand notes to certain of the Parent Company's non-bank
subsidiaries aggregating $920 million, of which $653 million was outstanding. The Parent Company has agreed to
guarantee or purchase certain indebtedness of its subsidiaries up to a maximum amount of $264 million at December 31, 1981. The Corporation does not anticipate losses
as a result of these transactions.

197
The Corporation makes commitments which are contractual obligations to extend credit in the normal course of
its business. Such commitments are provided as a service
principally to corporate customers, and substantially all
commitments require a payment of a fee and have fixed
expiration dates. The Corporation also extends lines of
credit under which a customer may borrow up to a designated amount of funds on a short-term basis. Lines of
credit are not contractual obligations and are subject to
cancellation widiout notice. The Corporation generally
receives no fee for extending lines of credit. Some lines of
credit are available for short-term advances only, while
others are multi-purpose, being available not only for
short-term advances but also for bankers acceptances,
overdrafts, and letters of credit. Consequently, it is not feasible to estimate the amount of lines of credit available
only for loans.
The Corporation and certain subsidiaries, including the
Bank, are defendants in various legal proceedings. With
respect to each of these suits, it is either the opinion of
legal counsel that it is without merit or the opinion of management of the Corporation that even if the plaintiff prevails therein the disposition thereof will not have a
material effect on the financial condition of the
Corporation.

Note 11—Interest-Bearing Deposits:
The annual interest expense associated with interest-bearing deposits is shown below ($ in thousands):
1981

1980

1979

Time certificates of
deposit over $100,000. $1,136,377 $ 692,054 $ 505,423
Other time deposits
238,084
202,100
189,741
Deposits in foreign
1,942,216 1,503,289 1,044,579
offices
Total
$3,316,677 $2,397,443 $1,739,743
The aggregate principal amounts of time certificates
of deposit and other time deposits of $100,000 or more
issued by the Bank's domestic office were $7,887,433,000
and $1,278,501,000 at December 31, 1981, and
$6,323,373,000 and $1,043,018,000 at December 31,
1980.




Note 12—Stock Option Plans:
The Corporation has stock option plans under which
1,819,069 shares at December 31, 1981, and 2,174,689
shares at December 31, 1980, of me common stock of the
Corporation were reserved for issuance to key personnel.
Options available under the plans through May 20, 1981,
were bom qualified and non-qualified. Since May 21,
1981, only non-qualified options are available under the
plans and can be exercised within ten years from the date
of the grant. The plans permit the granting of stock appreciation rights to the holders of options granted under the
plans. A stock appreciation right, generally, entitles the
optionee to receive, in lieu of exercising the option, shares
of common stock with a fair market value equivalent to the
aggregate appreciation in market value over the option
price for the shares under option. Obligations arising out
of me exercise of stock appreciation rights may be settled
in cash or in some combination of stock and cash. There
are no charges or credits to expense in connection with the
grant or exercise of options without rights. With respect to
stock appreciation rights, periodic charges or credits to
expense are required to reflect changes in the amount of
potential payments for all stock appreciation rights
granted. At December 31, 1981, options granted with
stock appreciation rights attached amounted to 394,280
shares.
Data with respect to options are as follows:
1981
Shares under option at
year-end
Option price per share . . .
Options exercised during
the year*
Option price per share. . .

1,107,375
$ 12-39

1980

1979

871,495 1,069,680
$ 12-26
$ 12-26

263,690
$12-26

115,735
$12-26

51,215
$12-24

'Excludes 160 shares issued during 1981 (3,250 shares during 1980) upon exercise
of stock appreciation rights.

Note 13—Pension Plan:
The pension expense associated with the corporate plan
amounted to $14,265,000 in 1981, $12,835,000 in 1980,
and $10,927,000 in 1979.
The approximate present value of the accumulated plan
benefits (computed using a rate of return of 8.5% for 1981
and 6.5% for 1980) in comparison to the market value of
the net assets available is presented below ($ in millions):
December 31

1981

1980

$114
4

S130
6

$118

$136

$125

SI28

Actuarial present value of accumulated
benefits:

Total
Market value of the net assets available

.

198
Note 1 4 — I n c o m e T a x e s :
T h e Corporation and its U . S . incorporated subsidiaries file
a consolidated Federal i n c o m e tax return. In connection
therewith, the C o r p o r a t i o n ' s equity in net i n c o m e of
w h o l l y - o w n e d o v e r s e a s subsidiaries and affiliates and dividends from U . S . incorporated subsidiaries are excluded
from Federal taxable i n c o m e .
As the C o r p o r a t i o n ' s i n c o m e tax returns are filed a n u m ber of m o n t h s following the end of the year, the a m o u n t s
reported as current and deferred i n c o m e taxes are subject
to revision based on the actual a m o u n t s used in the C o r p o ration's returns. T h e 1980 a m o u n t s h a v e been restated to
reflect the c h a n g e s in current and deferred i n c o m e t a x e s .
Total i n c o m e taxes reported are hot affected by c h a n g e s in
current and deferred i n c o m e t a x e s .
An analysis of i n c o m e t a x e s , including the tax effect of
security gains or losses reflected in the C o n s o l i d a t e d Statement of I n c o m e , is as follows ($ in t h o u s a n d s ) :

Presented b e l o w is a s u m m a r y of the U . S . and foreign
i n c o m e tax e x p e n s e and the related pre-tax i n c o m e ($ in
thousands):
Year ended December 31

Year ended December 31
Year ended December 31
Currently payable:
Federal:
Before investment tax
credits
Investment tax credits .

1981

$ 63,050
(24,237)

$29,701
(18,862)

$(10,966)
(1,332)
(12,298)
7,567

Total
State and local

38,813
12,171

10,839
12,468

Total U.S. taxes
payable
Foreign taxes payable . . .

50,984
52,956

23,307
49,436

(4,731)
38,053

103,940

72,743

33,322

9,707
465

13,058
1,041

14,187
1,868

Total currently
payable
Deferred:
Federal (includes
investment tax credits).
Total U.S. deferred
taxes
Foreign deferred taxes . .

10,172
9,907

14,099
8,726

16,055
3,548

20,079

22,825

19,603

124,019

95,568

52,925

Total deferred

Tax effect of security gains
or (losses) currently
payable
Total

(5,392)
$118,627




1,433

1,689

$97,001

$ 54,614

1981

1980

1979

Federal income tax
expense
$ 44,611 $ 25,765 $ 3,549
State and local income tax
expense
12,206
13,617
9,577
Total U.S. income
$ 56,817 $ 39,382 $ 13,126
tax expense
Related pre-tax income
$246,430 $221,116 $186,954
Foreign income tax
expense
$61,810 $57,619
$41,488
Related pre-tax income . . $126,820 $101,826 $63,467
The components of deferred income tax expense relate to
the factors listed below ($ in thousands):

Provision for credit
losses
Lease financing income .
Investment tax credits . . .
Investment tax credit
carry-forward
Realization of investment
tax credit carryforward
Other
Total

1981
$(14,320)
18,851
16,546
—

5,085
(6,083)
$ 20,079

$

(558)
15,050
6,362

$12,020
11,156
13,172

(5,085)

(14,951)

14,951
(7,895)
$22,825

(1,794)
$19,603

A reconciliation of the i n c o m e taxes included in the
Consolidated Statement of I n c o m e to an i n c o m e tax provision c o m p u t e d by applying the statutory U . S . Federal tax
rate of 4 6 % to i n c o m e before i n c o m e taxes is as follows
($ in t h o u s a n d s ) :
Year ended December 31
Federal income tax at
statutory rate applied to
income before taxes
State and local income
taxes, net of Federal
income tax benefit . . . .
Effect of non-taxable
interest and dividend
income
Other
Total

1981

1980

1979

$171,695

$148,553

$115,194

6,591

(48,921)
(10,738)
$118,627

(52,605)
(6,300)
$ 97,001

(54,096)
(11,655)
$ 54,614

199
Investment Tax Credit: The amortization of investment
tax credits relating to assets owned and leased to others is
included in lease financing income in the Consolidated
Statement of Income, and amounted to $5,559,000 in
1981, $5,699,000 in 1980, and $5,256,000 in 1979.
Foreign Taxes: The undistributed earnings of overseas
subsidiaries are reinvested to partially finance overseas
expansion and operating requirements. Earnings of overseas subsidiaries are reported after considering the payment of taxes in the countries in which the subsidiaries are
located. If such undistributed earnings were to be distributed or otherwise become subject to U.S. income taxes for
reasons not presently contemplated, available credits
would substantially reduce the income taxes otherwise
payable. The amount of undistributed earnings was
approximately $49,081,000 at December 31, 1981,
$40,976,000 at December 31, 1980, and $28,633,000 at
December 31, 1979.

Note 15—Domestic and Foreign Operations:
Because of the integrated nature of me Corporation's business, it is not possible to separate precisely domestic and
foreign operations. Thus subjective judgments related to
the distribution of earning assets, revenue, and costs were
used to derive operating results. Rates used to determine
charges or credits for funds that were not generated by the
foreign units were based on the market cost of selected
short-term funds. Equity is not allocated to the foreign
units. Operating expense was allocated between areas for
expenses incurred by one on behalf of another. Income
taxes were adjusted for the difference between foreign and
U.S. tax rates; to conform to the 1981 presentation, certain
amounts have been reclassified. The information presented
below for foreign operations is based on the location of the
customer ($ in millions):

Earning assets
at December 31
1981
Continental Europe
Latin America/Caribbean
Asia/Pacific
United Kingdom
Other foreign countries

5,630
3,377
2,774
1,896
1,952

Operating
$

814
569
340
341
314

Operating
expense
$

766
541
323
321
294

Income
before taxes
$ 48
28
17
20
20

$ 28
18
9
10
8

15,629
25,077

2,378
3,909

2,245
3,657

133
252

73
181

$40,706

$6,287

$5,902

$385

$254

1980
Continental Europe
Latin America/Caribbean
Asia/Pacific
United Kingdom
Other foreign countries

$ 4,527
2,377
1,951
2,785
1,403

$

$

638
287
250
362
179

$ 33
23
6
32
18

$ 16
14
3
20
10

Total foreign
Total domestic

13,043
21,617

1,828
2,888

1,716
2,680

112
208

63
163

$34,660

$4,716

$4,396

$320

$226

$ 4,709
1,892
1,466
1,872
1,189

$

$

466
190
167
225
114

$ 14
9
5
14
9

$

1,162
1,967

51
196

Total foreign

1979
Continental Europe
Latin America/Caribbean
Asia/Pacific
United Kingdom
Other foreign countries
Total foreign
Total domestic .
Consolidated total




11,128
19,158

671
310
256
394
197

480
199
172
239
123
1,213
2,163

9
5
4
9
5
32
164

200
The following table presents selected asset and liability
balances attributable to foreign operations ($ in millions):
December 31
Loans:
Loans to banks
Loans to other financial institutions. . .
Loans to governments or official
institutions
Commercial and industrial loans
All other loans '.
Total loans

1981

1981

1980

$1,291
244

$

690
7,434
387
$10,046

406
6,202
518
$ 8,382

Balances with foreign banks:
Interest-bearing balances
Non-interest-bearing balances
Total balances with foreign banks.

$ 5,078
378
$ 5,456

$ 4,259
1,875
$ 6,134

Deposits:
Banks
Deposits of governments
Other foreign demand deposits
Other foreign time deposits

$ 8,244
1,374
358
5,237

$ 8,533
2,191
118
3,327

989
267

Total deposits

$15,213

$14,169

Short-term borrowings

$ 1,459

$ 1,255

Bonds, mortgages, and similar debt.

$

$

255

Below is a schedule of cash dividends paid to the Parent
Company during the past three years ($ in thousands):

164

Foreign time deposits of $100,000 or more included above
amounted to $12,750,674,000 at December 31, 1981, and
$8,057,975,000 at December 31, 1980.

Cash Dividends Paid
Bank subsidiary
Other subsidiaries
Total

1980

1979

$ —

$29,997

$49,995

$29,997

$49,995

26,465
$26,465

Note 17—Parent Company Statements:
Presented below are statements of condition, income, and
changes in financial position for the Parent Company:
Statement of Condition
December 31 ($ in thousands)
1981
1980
Assets
Cash and due from depository
institutions:
$ 457,258 $ 229,156
Bank subsidiary*
Other
94,050
35,040
Investment securities
112,247
114,673
Loans:
Loans to non-bank subsidiaries* . .
660,530
388,220
Other loans
586,344
303,281
Total loans
1,246,874
691,501
Less: Unearned income
2,248
8,439
Reserve for credit losses
5,339
3,899
Net loans
1,239,287
679,163
Investments in common stock of
wholly-owned subsidiaries*
1,977,403 1,712,397
Other assets
87,077
56,964
Total assets
$3,967,322 $2,827,393

Note 16—Dividend and Loan Restrictions:
The payments of dividends and extensions of credit by the
Bank to the Parent Company carry certain restrictions
Liabilities
under National Banking Laws. Dividends declared in any
Advances from non-bank subsidiary* . . $ 245,844 $ 147,437
calendar year cannot exceed, without the approval of the
Short-term borrowings
1,368,142
624,937
Comptroller of the Currency, the Bank's net profits (as
585,022
487,864
Bonds, mortgages, and similar debt . . .
defined) for the year along with the retained net profits for
Other liabilities
57,622
42,213
the previous two years. Loans to any single affiliate,
. . . . 2,256,630 1,302,451
Total liabilities
including the Parent Company, cannot exceed 10% of the
Stockholders' equity..
. . . . 1,710,692 1,524,942
Stockholders' equity
Bank's Capital. Loans to all affiliates may not exceed 20%.
Total liabilities iand
Total liabilities
All loans to affiliates must meet statutory collateralization
stockholders'
stockholders' equity
. . . . $3,967,322 $2,827,393
requirements. Based on these restrictions, at December 31,
'Eliminated in consolidation.
1981, the Bank could have declared approximately $647
million of dividends without approval and could have
extended loans of $189 million to the Parent Company.
The remaining portion of the Bank's net assets, $939
million, which represented 54% of consolidated net assets,
was restricted in regards to payment of dividends or
extension of loans to the Parent Company.




201
Statement of Income
Year ended December 31
($ in thousands)
Income
Interest and dividends
from subsidiaries* . . . .
Other interest income . . .
All other income
Total operating
income
Expense
Interest expense on
borrowings from nonbank subsidiary*
Other interest expense . . .
All other expense
Total operating
expense
Earnings
Income before income
taxes, undistributed
income of subsidiaries,
and security gains or
losses
Applicable federal income
tax expense (credit) . . .
Equity in undistributed
income of subsidiaries
before security gains or
losses
Income before security
gains or losses
Security gains or
(losses)
Net income

1981

1980

$148,739
83,956
772

$109,047
42,798
2,104

333,467

153,949

20,978
205,912
4,982

7,749
125,358
4,113

231,872

137,220

Statement of Changes in Financial Position
Year ended December 31
1979 ($ in thousands)
1981
1980
Financial Resources Were Provided By:
Net income
$254,623 $225,941
$109,589 Non-cash charges
(credits) included in net
24,430
income:
5,259
Equity in undistributed income of
139,278
subsidiaries
(246,230) (203,142)
Other
5,400
4,860
Financial resources
provided from
—
operations
13,793
27,659
83,485
2,375 Other sources:
Decreases in:
Investment
85,860
securities
2,426
—
Other net resources .
—
43,379
Increases in:
Advances from nonbank subsidiary ..
98,407
147,437
Short-term
borrowings
743,205
233,961
53,418
Bonds, mortgages,
and similar debt..
101,268
—
1,881
Sale of common stock .
6,307
2,870
Total
$965,406 $455,306

1,595

16,729

(6,798)

(4,973)

251,922

202,441

142,589

260,315

224,143

194,126

(5,692)
$254,623

1,798
$225,941

1,681
$195,807

'Eliminated in consolidation.




Financial Resources Were Used For:
Decreases in:
Bonds, mortgages,
and similar debt. . $
—
Other net resources .
22,482
Increases in:
Cash and due from
depository
institutions
287,112
Investment
securities
—
Net loans
563,955
Investments in
wholly-owned
subsidiaries
18,776
Cash dividends paid . .
73,081
Total
$965,406

$ 6,040
—

(144,2701
2,884|

54,421

13,594

91,102
959

S

50,3ie

41,390
113,747
162,458
66,914
64,757
$455,306

10,1(X
58,00
$282,36"

202
Management Report

Report of Independent Accountants

The financial statements and related notes appearing on
pages 32 through 44 have been prepared in conformity
with generally accepted accounting principles appropriate
in the circumstances and present fairly the Corporation's
financial position and results of operations. Where
amounts must be based on estimates and judgments, they
represent the best estimates of management. All financial
information appearing in the Annual Report and Form
10-K is consistent with that in the financial statements.
The accounting system and related internal accounting
controls are designed to provide reasonable assurance that
assets are safeguarded and that transactions are properly
executed and recorded. Emphasis is placed on proper segregation of duties and authorities, the development and
dissemination of written policies and procedures, and a
comprehensive program of internal audits and management
follow-up. Inherent limitations exist in any system of internal accounting controls based upon the recognition that
the cost of control should not exceed the benefit derived.
Recognizing the cost/benefit relationship, the system provides reasonable assurance that material errors and irregularities are prevented or would be detected within a timely
period by employees in the normal course of performing
their assigned duties.
The financial statements have been examined by Ernst
& Whinney, independent accountants who are responsible
for conducting their examination in accordance with generally accepted auditing standards. Their resulting report
appears on this page.
The Board of Directors pursues its oversight role for
accounting and internal accounting control matters through
an Audit Committee of the Board of Directors, composed
entirely of outside directors. The Audit Committee meets
periodically with management, internal auditors, and independent accountants. The independent accountants and
internal auditors have full and free access to the Audit
Committee, and meet with it privately as well as with
management present to discuss internal control, accounting, and auditing matters.

Stockholders and Board of Directors of
Continental Illinois Corporation
Chicago, Illinois




We have examined the consolidated statement of condition
of Continental Illinois Corporation and subsidiaries as of
December 31, 1981 and 1980, and the related consolidated
statements of income, changes in stockholders' equity, and
changes in financial position for each of the three years in
the period ended December 31, 1981, and the consolidated
statement of condition of Continental Illinois National
Bank and Trust Company of Chicago (a wholly-owned
subsidiary) and its subsidiaries as of December 31, 1981
and 1980. 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.
In our opinion, the financial statements referred to
above present fairly the consolidated financial position
of Continental Illinois Corporation and subsidiaries at
December 31, 1981 and 1980 and the consolidated results
of their operations and the changes in their financial position for each of the three years in the period ended December 31, 1981, and the consolidated financial position of
Continental Illinois National Bank and Trust Company of
Chicago and subsidiaries at December 31, 1981 and 1980,
all in conformity with generally accepted accounting principles applied on a consistent basis.

Chicago, Illinois
January 18, 1982

T

203
Consolidated Average Statement of Condition and Net Interest Income
Continental Illinois Corporation and Subsidiaries

1980

1981
($ in millions)

Average
balance

Interest

Average
rate

Average
balance

Interest

Average
rate

Interest-Earning Assets
Interest-bearing deposits due from depository

Other Assets
Cash and non-interest-bearing deposits
Properties and equipment
Customers' liability on acceptances
Interest receivable
Other assets
Reserve for credit losses
Total assets
Sources of Funds Used to Finance
Interest-Earning Assets
Sources on which interest is paid:
Passbook savings
Other time deposits
Time deposits in foreign offices
Total interest-bearing deposits ....
Short-term borrowings
Bonds, mortgages, and similar debt
Total sources on which interest
is paid
Other Liabilities and Stockholders' Equity
Demand deposits: Domestic offices
Foreign offices
Acceptances outstanding
Other liabilities
Stockholders' equity
Total liabilities and
stockholders' equity

98
130
40

9.63
11.57
10.71

11.14

2,511

268

10.66

17.23
16.11
16.88

16,614
7,667
24,281

2,433
1,051
3,484

14.64
13.70
14.34

17.78
16.89
14.77
16.40%

520
24,801
262
$32,979

117
115
44

2,473

276

19,541
9,061
28,602

3,368
1,460
4,828

$ 4,897
508

10.13
11.93
12.23

662
29,264
246
$37,113

98
4,926
37
$6,069

3,534
286
2,093
801
442
(265)
$44,004

$

394
8,684
12,814
21,892
11,022
722

$33,636

$

21
1,354
1,942
3,317
1,761
81

$5,159

5.20%
15.59
15.15
15.14
15.97
11.21

$

15.33%

$29,779

(1) Rates are calculated on lease financing receivable (i) balances reduced by deferred
liability for taxes and deferred investment tax credit, and (ii) income adjusted to
include amortization of investment tax credit on a fully-taxable basis

73
3,557
31
$4,580

16.78
14.39
11.68
13.92

438
7,104
11,780
19,322
9,857
600

$

23
871
1,503
2,397
1,280
65

5.2C
12.2C
12.7(
12.4C
12.9?
10.8-

$3,742

12.5(

4,252
1,379
1,733
979
1,443

$44,004

Net Interest Margin
Total interest income/average
earning assets (2)
Total interest expense/average
earning assets
Net interest margin (3)

$

3,769
249
1,726
596
476
(230)
$39,565

4,226
1,310
2,097
1,119
1,616

Net interest income




1,011
1,124
376

1,151
963
359

Total investment securities

Loans (net of unearned income):
Domestic
Foreign
Total loans
Lease financing receivables (net of
unearned income) (1)
Total loans and lease receivables .
Trading account securities, net
Total interest-earning assets

13.44'
12.95

16.12%
16.75

U.S. Treasury and Federal agency securities . .
State, county, and municipal securities

$

658
66

747
83

$ 4,633
497

$39,565
$ 910

$ 838

16.40%

13.9

13.94%
2.46%

11.3
2.5

(2) Total interest income includes taxable equivalent adjustments used in adjusting inte:
est on tax-exempt assets (primarily state, county, and municipal securities) to a
fully-taxable basis. Such adjustments are based on the prevailing U.S. Federal and

204
1978

1979

1977

Average
balance

Interest

$ 3,724
487

$ 308
39

8.66
10.68
9.25

574
1,510
281

43
147
26

7.53
9.76
9.20

222

9.96

2,365

216

13,840
6,148

1,762
704

12.73
11.44

10,723
5,026

19,988

2,466

12.33

15,749

402

44

12.54

20,390
198

2,510
21

12.34
10.51

$27,427

$3,271

Average
balance

Interest

$ 4,039
567

$ 456
62

570
1,344
319

49
144
29

2,233

Average
rate

11.28%
10.95

11.95%

506
6,460
10,230

51
139
21

7.48
8.96
8.44

9.15

2,483

211

8.50

1,069
441

9.96
8/77_

8,817
4,304

702
326

7.95
7.58

1,510

9.58

13,121

1,028

7.83

12.50
9.64
7.88

297

33

12.46

13,418
186

1,061
12

7.92
6.35

$19,885

$1,521

7.66%

$

34
269
394

5.00%
5.99
5.87

$22,841

$2,124

9.31%

2,370
136
300
193
330
(170)
$23,044

$26,965

$

26
669
1,045

5.14%
10.35
10.21

17,196

1,740

10.11

14,071

1,049

7.45

11,872

697

5.86

7,281
521

806
48

11.07
9.20

5,616
419

444
34

7.90
8.03

4,894
329

278
27

5.69
8.18

$24,998

$2,594

$20,106

$1,527

$17,095

$1,002

10.37%

$

566
5,934
7,571

$

Average
rate

683
1,552
248

38
1,548
13

$ 3,585
213

Interest

6.27%
5.57

2,865
178
539
264
454
(176)

$33,252

$

8.26%
8.04

Average
balance

225
12

347
16,096
169

3,733
209
1,054
393
633
(197)

Average
rate

$

28
457
564

5.00%
7.71
7.44

7.59%

3,646
939
541
611
1,122

4,003
1,171
1,061
725
1,294

$

677

678
4,496
6,698

5.86%

3,410
860
303
411
965

$26,965

$33,252

$

$23,044
$

597

$

519

11.95%

9.31%

7.66%

9.47%

6.69%

5.04%

2.48%

2.62%

2.62%

State of Illinois income tax rates. For 1981-1977 the adjustments, in thousands,
amounted to $104,625. $107,580. $103,533, $90,536. and $77,818




(3) Net interest margin is net interest income on a taxable equivalent basis divided by
average earning assets, including the average amount of loans and lease receivables
on a cash basis.

205

Analysis ofYear-to-Year Changes in Net Interest Income
Continental Illinois Corporation and Subsidiaries

The following table attributes changes in net interest
income on a taxable equivalent basis either to changes in
average balances or to changes in average rates for interest-earning assets and sources of funds on which interest is

paid. The change in interest due to both rate and volume
has been allocated to change due to volume and change
due to rate in proportion to the relationship of the absolute
dollar amount of the change in each.

(S in millions)
Interest-bearing
balances with
depository institutions

Assets
Change due to:
Average balance
Average rate
Total

1981/1980
Investment
and trading
securities

$(37)
126
$ 89

Loans &
leases
$ 697
672
$1,369

Liabilities
Change due to:
Average balance
Average rate
Total

Domestic
deposits
$204
277
$481

Foreign office
deposits
$ 140
299
$ 439

Short-term
borrowings
$163
318
$481

Assets
Change due to:
Average balance
Average rate
Total

Interest-bearing
balances with
depository institutions
$106
96
$202

Loans &
leases
$ 594
453
$1,047

1980/1979
Investment
and trading
securities
$ 36
20
$ 56

Liabilities
Change due to:
Average balance
Average rate
Total

Domestic
deposits
$ 61
138
$199

Foreign office
deposits
$ 173
285
$458

Short-term
borrowings
$319
155
$474

$ (5)
19
$ 14

Other
short-term
Investments

Ibtal Interestearning assets
$ 616
$(2)
19
873
$17
$1,489
Bonds, Ibtal interestmortgages, & bearing sources
of funds
similar debt
$14
$ 525
892
2
$1,417
$16
Other
short-term Ibtal interestinvestments earning assets
$ 723
$(7)
11
586
$1,309
$ 4
Bonds, Ibtal interestmortgages, & bearing sources
similar debt
of funds
$ 8
$ 546
9
602
$17
$1,148

Average Deposit Analysis
Continental Illinois Corporation and Subsidiaries
(S in millions)
Domestic Offices*
Demand deposits:
Individuals, partnerships, and corporations
Banks and bankers
Public funds
Certified and officers' checks
Total
Time deposits:
Passbook savings
Other savings
Commercial certificates of deposit
Other time
Total
T
Foreign Off
foreign Offices
Demand depo
Demand deposits
Time deposits
Time
T
Total
7
Total deposits
J
'Foreign deposits held in the Bank's domestic offices averaged S392 million
S400 million in 1980. and S409 million in 1979.

12-745

0—83-




$ 2,935
979
141
171
4,226

$ 3,047
920
141
144
4,252

$ 3,051
660
133
159
4,003

394
857
6,431
1,396
9,078

438
820
5,533
751
7,542

506
834
4,145
1,481
6,966

1,310
12,814
14,124
$27,428

1,379
11,780
13,159
$24,953

1,171
10,230
11.401
$22,370

206
Investment Securities
Continental Illinois Corporation and Subsidiaries

1981
December 31 ($ in millions)

Amount

U.S. Treasury and Federal Agency Securities Maturing Within:
0-1 year
1-5 years
5-10 years
10 years and over
Total
Average months to maturity
State, County, and Municipal Securities Maturing Within:
0-1 year
1-5 years
5-10 years
10 years and over
Total
Average months to maturity
Other Securities Maturing Within:
0-1 year
1-5 years
5-10 years
10 years and over*
Total
Total investment securities

Yield

1980
Amount

1979
Amount

$

71
508
75
205
$ 859
113

7.80%
9.93
10.32
M9
9.68 %

$ 155
682
105
209
$1,151
87

$ 151
271
—
212
$ 634
126

$

60
289
423
139
$ 911
80

11.69%
12.14
12.14
12.84
12.22 %

$

$

$102
76
99
122

14.36%
9.31
12.34
3^33

$

$ 399
$2,169

9.52 %
10.72 %

43
280
494
191
$1,008
90

91
374
547
188
$1,200
80

77
76
107
87

$'47
92
78
175

$ 347
$2,506

$ 392
$2,226

•Includes all equity investments.

The weighted average yields are calculated on the basis
of the cost and effective yields weighted for the scheduled
maturity of each issue. The yields for state, county, and

municipal securities are calculated on a taxable equivalent
basis incorporating a combined Federal and state effective
tax rate of approximately 50%.

Maturity of Loans
Continental Illinois Corporation and Subsidiaries
The following table shows an estimated distribution
of the maturity of loans excluding consumer loans and

(S in millions)
Maturity of Loans
Domestic:
Commercial and industrial loans
Mortgage and real estate loans
Loans to financial institutions*
Loans for purchasing or carrying securities
All other loans
Total domestic
Foreign
Total loans
'Includes loans to real estate investment trusts.
"Less than SI million.




loans secured by 1-4 family residential properties at
December 31, 1981.
One year
or less

One to
five years

$ 6,147
1,800

$4,421
1,103
1,139

869
206
533
9,555
5,738

6
179
6,848
3,046

$2,294

140
625

*
*

166
3,225
1,262

$12,862
3,043
2,633

212
878
19,628
10,046

207
Loans and Lease Financing Receivables
Continental Illinois Corporation and Subsidiaries

December 31 (S in millions)
Loans
Domestic:
Commercial and industrial loans
Mortgage and real estate loans
Loans to financial institutions*
Loans for purchasing or carrying securities
Consumer installment loans
All other loans

12,862
3,957
2,633
212
1,588
878

.ease Financii
Less: Unearned income
Uneame
Lease financing
Leas

18,528

16,366

12,796

10,012

8,382

6,816

5,650

4,837

26,910
126
26,784

23,182
108
23,074

18,446
56
18,390

14,849
37
14,812

1,123
301
822

Total loans and lease receiveables, net

$ 4,786
1,249
1,736
1,091
719
431

32,176
122
32,054

receivables, net

$ 6,343
1,971
1,764
993
1,029
696

10,046

Total
Less: Unearned income
Uneame
Loans,
Loan net

$ 8,221
3,123
2,117
595
1,289
1,021

22,130

Total
r
oreign
Foreign

$ 9,845
3,530
2,451
379
1,459
864

720
137
583

609
107
502

452
88
364

419
89
330

$32,876

$27,367

$23,576

$18,754

$15,142

$ 4,562
997
1,561
680
639
397

'Includes loans to real

Average Loans and Lease Financing Receivables
Continental Illinois Corporation and Subsidiaries

($ in millions)
Loans
Domestic:
Commercial and industrial loans
Mortgage and real estate loans
Loans to financial institutions*
Loans for purchasing or carrying securities
Consumer installment loans
All other loans

$10,741
3,713
2,409
336
1,447
1,002

L-e a s e F iin a n c i n g R e c e i v a b l e s
e
F nanc i
Less: Uneame
Lease financing receivables. net
Leas
Total
Total loans and lease receivables,
•Includes loans to real




16,695

13,888

10,753

8.836

7,684

6,159

5,035

4,314

28,726
124
28,602

24,379
98
24,281

20,047
59
19,988

15,788
39
15,749

13,150
29
13,121

842
180
662
net

$ 5,632
1,300
1,717
660
817
627

9,078

Total
Less: Unearned income
Unearne
Loans, net
Loan

$ 7,108
2,288
1,813
615
1,172
892

19,648

Total
:
Foreign
oreign

$ 8,637
3,288
2,121
481
1,271
897

641
121
520

497
95
402

432
85
347

375
78
297

$29,264

$24,801

$20,390

$16,096

$13,418

208
i

Analysis of Net Credit Loss Experience
Continental Illinois Corporation and Subsidiaries

Year ended December 31 ($ in millions)
Reserve for credit losses—beginning of year
Provision for credit losses
Charge offs:
Domestic loans:
Commercial and industrial loans
Mortgage and real estate loans
Loans to financial institutions
Loans for purchasing or carrying securities . . .
Consumer installment loans
All other loans
Total domestic loans
Foreign loans
Total loans
Lease financing receivables
Total charge offs
Recoveries:
Domestic loans:
Commercial and industrial loans
Mortgage and real estate loans
Loans to financial institutions
Loans for purchasing or carrying securities . . .
Consumer installment loans
All other loans
Total domestic loans
Foreign loans
Total loans
Lease financing receivables
Total recoveries
Other adjustments

1981
N

1980

1979

1978

1977

$246
120

$212
96

$191
70

$168
63

$165
54

40
5
4
—
28
6

26
6
2
—
34
4

9
6
*
—
35
1 _

8
19
11
*
11
*

12
18
23
—
5
1

83

72

51

49

59

8

1

15

9

7

91

73

66

58

66

1

*

*

—

—

92

73

66

58

66

6
3
5
1
5
1

2
1
(1)
—
6
1

1
5
7
—
3
*

11
2
*
—
2
*

7
1
*
—
4
—

21

9

16

15

12

*

3

1

1

2

21

12

17

16

14

—

—

—

—

—

21

12

17

16

14

(6)

(1)

*

•

2

1

Reserve for credit losses—year-end

$289

$246

$212

$191

$168

Net credit losses
Net credit losses as a percentage of average loans
and lease receivables

$ 71

$ 61

$ 49

$ 42

$ 52

0.24%

0.24%

0.24%

0.26%

•Less than SI million in the period




0.39%

209
Allocation of Reserve for Credit Losses
Continental Illinois Corporation and Subsidiaries

The following table shows an allocation of the reserve for
credit losses for the past five years. The reserve allocation
is based on a five-year historical credit loss experience com-

($ in millions)
Loan Category:
Commercial and industrial loans .
Mortgage and real estate loans . . .
Loans to financial institutions*...
Loans for purchasing or
carrying securities
Consumer installment loans
Other loans
Total domestic
Foreign loans
Total loans
Lease financing receivables
Allocated
Unallocated
Total reserve

1981
Reserve Reserve
amount per cent
$27
17
10

0.20%
0.42
0.37

puted as a per cent of the average annual principal. The
reserve per cent represents the allocated reserve relative to
the year-end balance.

1980
Reserve Reserve
amount per cent
$18
24
6

1979
Reserve Reserve
amount per cent

0.18%
0.67
0.24

—
31
3

—
1.95
0.34

—
25
l_

—
1.71
0.11

88
_ U

0.39
0.10

74
9

0.40
0.10

$12
23
15
—
19
1
_

1978
Reserve Reserve
amount per cent

1977
Reserve Reserve
amount per cent

0.14%
0.73
0.70

$10
15
20

0.15%
0.76
1.13

$10
9
23

0.20%
0.72
1.32

—
1.47
0.09

—
10
_—

—
0.97
—

—
5
_—

—
0.69
—

0.42
0.14

55
_12

0.42
0.21

47
_10

0.46
0.20

70
_10

99
8

0.30
0.71

83
7

0.30
0.97

80
7

0.34
1.14

67
6

0.36
1.32

57
2

0.38
0.47

107
182

0.32
0.55

90
156

0.33
0.56

87
125

0.36
0.53

73
118

0.39
0.62

59
109

0.39
0.72

$289

0.87%

$246

0.89%

$212

0.89%

$191

1.01%

$168

1.11%

•Includes loans to real estate investment trusts.

Selected Quarterly Financial Data
Continental Illinois Corporation and Subsidiaries
First
quarter

Second
quarter

Third
quarter

Fourth
quarter

$1,367,586
188,986
30,000
93,930
62,139
59,189

$1,418,025
162,237
23,000
80,250
58,053
57,798

$1,611,249
214,420
32,000
93,220
67,299
67,097

$1,567,355
240,138
35,000
116,934
72,824
70,539

$

$

$

$

($ in thousands, except per-share data)
1981
Interest income
Net interest income
Provision for credit losses
Income before income taxes and security gains or losses
Income before security gains or losses
Net income
Per Share:
Income before security gains or losses
Net income
1980
Interest income
Net interest income
Provision for credit losses
Income before income taxes and security gains or losses
Income before security gains or losses
Net income
Per Share:
Income before security gains or losses
Net income
1979
Interest income
Net interest income
Provision for credit losses
Income before income taxes and security gains or losses
Income before security gains or losses
Net income
Per Share:
Income before security gains or losses
Net income




1.57
1.50

1.47
1.46

1.70
1.69

1.84
1.79

$1,087,911
152,322
14,000
56,385
47,682
47,635

$1,165,346
190,585
30,000
95,413
65,587
67,748

$1,004,956
202,452
25,000
82,891
57,235
57,726

$1,214,300
184,935
27,000
85,022
53,639
52,832

$

$

$

1.46
1.47

$

1.36
1.34

1.21
1.21

1.67
1.73

$ 699,913
143,982
14,000
63,357
47,147
46,860

$ 728,319
138,470
14,000
57,362
45,823
47,341

$ 776,323
147,011
25,000
69,790
50,809
51,085

$

963,572
144,390
17,000
56,542
50,347
50,521

$

$

$

$

1.29
1.29

1.20
1.19

1.17
1.21

1.29
1.30

210
Consolidated Statement of Income
Continental Illinois Corporation and Subsidiaries

($ in thousands)
Interest and fees on loans
Lease financing income
Interest on deposits with banks
Interest and dividends on investment securities:
Taxable income
Income exempt from Federal income taxes
Trading account interest
Interest on short-term investments
Total interest income
Interest on deposits
Interest on short-term borrowings
Interest on bonds, mortgages, and similar debt
Total interest expense
Net interest income
Provision for credit losses
Net interest income after provision for credit losses
Trust income
Security trading profits and commissions
Foreign exchange profits
All other income
Total other operating income
Net interest and other operating income
Salaries and wages
Pension, profit sharing, and other employee benefits
Net occupancy expense
Equipment rentals, depreciation, and maintenance
Other expense
Total other operating expense
Income before income taxes and security losses
Applicable income taxes
Income before security losses
Security losses less applicable income taxes of $2,232 and $864, respectively
Net income
Income per common share:
Income before security losses
Net income
Dividends declared per common share
Average shares outstanding (in thousands)
See notes to financial statements.




Fourth quarter
1981
1960
$1,246,747
$ 950,788
26,121
21,965
215,319
165,974
38,244
15,999
7,454
17,471
1,567,355
914,093
388,337
24,787
1,327,217
240,138
35,000
205,138
14,644
22,455
(1,671)
48,749
84,177
289315
75,319
16,046
18,862
10,114
52,040
172,381
116,934
44,110
72,824
2,285
$ 70,539

35,837
16,092
5,565
18,079
1,214,300
613,703
397,932
17,730
1,029,365
184,935
27,000
157,935
11,521
(875)
13,685
47,868
72,199
230,134
63,895
13,881
14,974
9,986
42,376
145,112
85,022
31,383
53,639
807
$ 52,832

$
$
$

$
$
$

1.84
1.79
0.50
39,595

1.36
1.34
0.45
39,297

211
Consolidated Average Statement of Condition and Net Interest Income
Continental Illinois Corporation and Subsidiaries

Fourth quarter 1981

Interest-Earning Assets
Interest-bearing deposits due from depository
institutions (primarily foreign).
Other short-term investments

Fourth quarter 1980

$ 215
17

14.46

443

18

16.22

1,096
928
384

29
28
13

10.55
11.90
13.16

1,166
1,007
360

27
29
10

9.34
11.62
10.53

2,408

70

11.48

2,533

66

10.42

21,124
9,922

858
397

16.11
15.87

17,531
8,224

683
275

15.50
13.32

31,046

1,255

16.03

25,755

958

14.80

755

U.S. Treasury and Federal agency securities
State, county, and municipal securities
Other securities

$ 5,326
479

28

17.53

543

24

20.94

31,801
214

1,283
8

16.06
14.86

26,298
184

982
6

14.91
12.77

$40,228

$1,593

$34,547

$1,238

14.30%

433
7,651
11,785

236
371

5.32%
12.32
12.52

...

Loans (net of unearned income):
Domestic
Foreign
Lease financing receivables (net of unearned
Total loans and lease receivables
Trading account securities, net
Total interest-earning assets
Other Assets
Cash and non-interest-bearing deposits .
Properties and equipment
Customers' liability on acceptances . . . .
Interest receivable
Other assets
Reserve for credit losses
Total assets .
Sources of Funds Used to Finance
Interest-Earning Assets
Sources on which interest is paid:
Passbook savings
Other time deposits
Time deposits in foreign offices

15.76%

3,970
263
1,865
600
461
(246)

2,659
298
2,479
934
467
(284)
$46,781

$

370
9,607
14,316

$

5
372
537

5.19%
15.36
14.88

$

24,293

914

14.92

19,869

613

12.28

11,571
824

388
25

13.31
11.93

10,412
678

398
18

15.20
10.40

Total sources on which interest is paid

$36,688

$1,327

$30,959

$1,029

Other Liabilities and Stockholders' Equity
Demand deposits: Domestic offices
Foreign offices
Acceptances outstanding
Other liabilities
Stockholders' equity

4,223
426
2,486
1,263
1,695

Total interest-bearing deposits
Short-term borrowings

Total liabilities and stockholders' equity

Net Interest Margin
Total interest income /average
earning assets (2)
Total interest expense/average
earning assets
Net interest margin (3)
(1) Rates are calculated on lease financing receivable (i) balances reduced by deferred
liability for taxes and deferred investment tax credit, and (ii) income adjusted to
include amortization of investment tax credit on a fully-taxable basis.
(2) Total interest income includes taxable equivalent adjustments used in adjusting
interest on tax-exempt assets (primarily state, county and municipal si
a fully-taxable basis. Such adji
e based on the prevailing U S Federal

13.22%

4.559
1.608
1,867
963
1,504

$46,781

Net interest income




14.35%

$41,460
$ 266

$

209

15.76%

14.30%

13.13%

11.88%

2.63%

2.42%

and the State of Illinois income tax rates For the fourth quarters of 1981 and 1980
the adjustments, in thousands, amounted to $26,479 and $24,538, respectively.
3) Net interest margin is net interest income on a taxable equivalent basis, divided by
average earning assets, including the average amount of loans and lease receivables
on a cash basis




212
Form 10-K

Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the fiscal year ended December 31, 1981
Commission file number 1-5872
Continental Illinois Corporation
Incorporated in State of Delaware
I.R.S. Employer Identification No.: 36-2664023
Address: 231 South LaSalle Street, Chicago, Illinois 60693
Telephone: 312/828-2345
Securities registered pursuant to Section 12(b) of the Act:
Title of
each class
Common Stock—$5 par value

Name of each exchange
on which registered
New York Stock Exchange, Inc.
Midwest Stock Exchange
Pacific Stock Exchange, Inc.

Floating Rate Notes due 1987 New York Stock Exchange, Inc.
(Convertible Prior to May
1, 1986, into 8%%
Debentures due 2004)
Floating Rate Notes due
New York Stock Exchange, Inc.
September 15, 1989
%Vi% Notes due November 1, New York Stock Exchange, Inc.
1985
13%% Notes due May 1,
New York Stock Exchange, Inc.
1985
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days.
Yes
X
No
The aggregate market value of the voting stock held by
non-affiliates of the registrant as of February 26, 1982,
based on the reported closing price on that date on the
New York Stock Exchange—Composite Transactions of
$30% per share:
Common Stock—$5 par value—$1,188,032,546*
* Based on reported beneficial ownership by all directors and executive officers;
however, this determination does not constitute an admission of affiliate status for
any of these stockholders.

Indicate the number of shares outstanding of each of the
registrant's classes of common stock, as of February 26,
1982:
Common Stock—$5 par value—39,605,965 shares
Documents Incorporated by Reference
Portions of the Proxy Statement of the registrant for the
Annual Meeting of Stockholders to be held April 26,
1982, are incorporated by reference into Parts I and III.

213
10-K Cross-Reference Index

Exhibit Index

Parti

C o n t i n e n t a l Illinois C o r p o r a t i o n F o r m 10-K
F o r T h e Fiscal Year E n d e d D e c e m b e r 3 1 , 1 9 8 1 *

1 Business
Description of Business
Supplemental Financial Data
Average Balances and Net Interest Income
Analysis of Net Interest Income
Investment Securities
Loans and Lease Financing Receivables
Maturity of Loans
Interest Rate Sensitivity of Loans
Non-Performing Loans and Lease Receivables
Credit Analysis and Loss Experience
Average Deposit Analysis
Financial Ratio Analysis

8
46
48
49
SO
49
28
22
51
48
17

3 Legal Proceedings

57
57

4 Security Ownership of Certain Beneficial
Owners and Management
Executive Officers of the Registrant

14

2 Properties

Part II
5 Market for the Registrant's Common Stock
and Related Security Holder Matters

3 and Inside
Back Cover

6 Selected Financial Data
7 Management's Discussion and Analysis of
Financial Condition and Results of Operations
8 Financial Statements and Supplementary Data
Part III
9 Directors of the Registrant
Executive Officers of the Registrant
10 Management Remuneration and Transactions

17
16
32

14

*

Part IV
11 Exhibits, Financial Statement Schedules, and
Reports on Form 8-K
Financial Statements Filed:
Continental Illinois Corporation:
Consolidated Statement of Condition
Consolidated Statement of Income
Consolidated Statement of Changes in
Financial Position
Consolidated Statement of Changes in
Stockholders' Equity
Financial Schedules Filed:
All schedules applicable to the Corporation are
included in the notes to the financial statements.
Exhibits
There were no reports filed on Form 8-K during 1981.

56

•Incorporated by reference to the registrant's March 1982 Proxy Statement.

This Report on Form 10-K has not been approved or disapproved
by the Securities and Exchange Commission nor has the Commission passed upon the accuracy or adequacy of this Form 10-K.
Portions of the 1981 Annual Report to the Corporation's stockholders are not required by the Form 10-K and are not "filed"
as part of the Form 10-K. Only those sections of the Annual
Report referenced in the above index are incorporated in to the
Form 10-K.




3(a)—Restated Certificate of Incorporation of the Company, as
amended. Incorporated by reference to Exhibit 2(b) contained in
the Company's Registration Statement on Form S-7, File No.
2-61849 ($6.00).
3(b)—By-laws of the Company, as amended. Incorporated by
reference to Exhibit 2(c) contained in the Company's Registration
Statement on Form S-7, File No. 2-61849 ($2.75).
4(a)(1)—Indenture, dated as of November 1, 1981, between the
Company and Harris Trust and Savings Bank, as Trustee, relating
to the Company's 13%% Notes due May 1, 1985. Incorporated
by reference to Exhibit 2, contained in the Company's Registration Statement on Form 8-A as amended by Amendment No. 2
on Form 8, File No. 1-5872 ($10.50).
4(a)(2)—Indenture, dated as of May 1, 1979, between the Company and Harris Trust and Savings Bank, as Trustee, relating to
the Company's Floating Rate Notes due 1987 (Convertible prior
to May 1, 1986, into 8ft % Debentures due 2004). Incorporated
by reference to Exhibit (b)(2), contained in the Company's Registration Statement on Form S-16, File No. 2-64008 ($12.75).
4(a)(3)—Indenture, dated as of August 1, 1974, between the
Company and Harris Trust and Savings Bank, as Trustee, relating
to the Company's Floating Rate Notes due September 15, 1989.
Incorporated by reference to Exhibit 2, contained in the Company's Registration Statement on Form S-7, File No. 2-50246
($13.00).
4(a)(4)—Indenture, dated as of May 1, 1978, between the Company and Harris Trust and Savings Bank, as Trustee, relating to
the Company's 8Vi% Notes due November 1, 1985. Incorporated
by reference to Exhibit 2, contained in the Company's Registration Statement on Form S-7, File No. 2-61217 ($11.50).
4(a)(5)—Note Purchase Agreement, dated December 14, 1976,
relating to the Company's 8.75% Notes due March 31, 1997.
Incorporated by reference to Exhibit 1 to the Company's Report
on Form 8-K dated January 7, 1977, File No. 1-5872 ($12.50).
10(b)(1)—Copy of lease on land on which part of the Bank's
banking headquarters is located. Incorporated by reference to
Exhibit 9(b), contained in the Company's Registration Statement
on Form 10, File No. 1-5872 ($15.50).
10(c)(1)—The Company's 1979 Stock Option Plan ($1.00).
10(c)(2)—The Company's 1974 Stock Option Plan ($1.00).
10(c)(3)—The Company's 1968 Stock Option Plan ($1.00).
10(c)(4)—The Company's Excess Benefit Plan ($1.25).
10(c)(5)—The Company's Incentive Compensation Plan ($6.00).
10(c)(6)—The Company's Life Insurance Plan for members of
Senior Management ($1.00).
10(c)(7)—The Continental Illinois Deferred Compensation Plan
for Directors ($1.50).
22—List of subsidiaries of the Company ($0.25).
•Stockholders may obtain a copy of any exhibit by writing to Mr. J. Joseph Anderson. Executive Vice President and Controller. Continental Illinois Corporation.
231 S. LaSalle Street. Chicago. Illinois 60693 All requests must be accompanied
by a check or money order payable to Continental Illinois Corporation in the amount
indicated in the parentheses after the exhibit ordered. No payment is required on
orders under S2.50.

214
Legal Proceedings
Along with several other Chicago banks, the Bank was
named as a defendant in a treble damage antitrust class
action entitled Weit, et al v. Continental Illinois National
Bank and Trust Company of Chicago, et al, filed August
1970, in the United States District Court for the Northern
District of Illinois. The named plaintiffs are three individual customers of the Bank's Charge Card Division who
contend that the Bank and other banks illegally conspired
(1) to fix interest rates charged cardholders who elect to
defer payment of a portion of their charge card accounts,
(2) to fix discount rates charged merchants who participate
in the charge card program, and (3) to require such merchants, and also to require correspondent banks which participate in the charge card program, to maintain "static
accounts" with the defendant banks. Plaintiffs sued on
behalf of themselves and all other persons similarly situated. Four of the six counts in their complaint claimed
damages of $100,000,000, one count claimed damages
of $300,000,000, and one count claimed damages of
$500,000,000; in each count, judgment was sought for
three times the claimed amount. The Court certified as
a class action Counts I-IV and notice to the class issued.
The Court had previously granted summary judgment to
the defendants with respect to the "discount rate" count
(Count V, $300,000,000) and the "static account" count
(Count VI, $100,000,000). On December 22, 1978, the
District Court ordered the suit dismissed as to the Bank
and one other defendant. On September 6, 1979, the District Court entered a further order dismissing the remaining
defendants and dismissing the suit in its entirety. On February 11, 1981, the Court of Appeals (one judge dissenting) affirmed the District Court's decisions dismissing all
defendants, and on April 13, 1981, the Court of Appeals
denied plaintiffs' petition for rehearing with suggestion of
rehearing en banc. On July 10, 1981, plaintiffs filed a
petition for writ of certiorari with the Supreme Court of
the United States, seeking reversal of the judgment of the
Court of Appeals. On October 5, 1981, the Supreme Court
entered an order inviting the United States Solicitor General to file an amicus curiae brief expressing the views of




the United States on whether the petition should be granted
or denied. On February 8, 1982, the Solicitor General
filed an amicus brief recommending that the plaintiffs'
petition for writ of certiorari be denied and on March 1,
1982, the Supreme Court entered an order denying plaintiffs' petition. Under the rules of the Supreme Court, the
plaintiffs have 25 days from March 1, 1982 to petition for
reconsideration of such denial. In the opinion of management of the Corporation and of Mayer, Brown and Piatt,
counsel for the Corporation, plaintiffs' claims against the
Bank are without merit.
In Brabec, et al v. Continental Illinois National Bank
and Trust Company of Chicago, et al, last reported in the
Report on Form 10-K for the year ended December 31,
1980, the plaintiffs alleged that the Bank improperly purchased and retained or advised the purchase and retention
of certain securities for various trust and agency accounts.
The plantiffs sought damages in excess of $2,900,000 and
also asserted claims for prejudgment interest, bringing
their total claims to approximately $10,000,000. On January 28, 1982, the case was dismissed pursuant to an agreement of settlement.
The Corporation and certain subsidiaries, including the
Bank, are defendants in various other legal proceedings.
With respect to each of these suits, it is either the opinion
of legal counsel that it is without merit or the opinion of
management of the Corporation that even if the plaintiff
prevails therein the disposition thereof will not have a
material effect on the financial condition of the
Corporation.
Properties
The Bank's banking headquarters and the Corporation's
principal offices are located at 231 South LaSalle Street,
Chicago, Illinois, in a 23-story building owned by the
Bank on land of which one-half is owned by the Bank and
one-half is held under a lease expiring in 1996. Approximately 90 per cent of the building is occupied by the
Bank. The Corporation and certain other subsidiaries,
including the Bank, own directly or beneficially other
unimproved and improved land in Chicago and own or
lease office space at various locations in the United States
and in foreign countries. See Notes 6 and 9 to the financial
statements.

215
Signatures

Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Company has duly

caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Continental Illinois Corporation

By

Roger E. Anderson

Roger E. Anderson
Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange
Act of 1934, this report has been signed below by the

following persons on behalf of the Company and in the
capacities and on the date indicated.

Roger E. Anderson

Vernon R. Loucks, Jr.

Roger E. Anderson
Vernon R. Loucks, Jr.
Chairman of the Board of Directors, Chief Executive Officer and Director Director

Donald C. Miller

Frank W. Luerssen

Donald C. Miller
Vice Chairman, Principal Financial Officer and Director

Frank W. Luerssen
Director

J. Joseph Anderson

Robert H. Malott

J. Joseph Anderson
Robert H. Malott
Executive Vice President, Controller and Principal Accounting Officer Director

Raymond C. Baumhart, S.J.

Marvin G. Mitchell

Raymond C. Baumhart, S.J.
Director

Marvin G. Mitchell
Director

James F. Bere

John H. Perkins
John H. Perkins
Director

Weston R. Christopher son

Keith R. Potter

Weston R. Christopherson
Director

Keith R. Potter

Gordon R. Corey

John M. Richman

Gordon R. Corey
Director

John M. Richman
Director

Robert A. Hanson

Paul J. Rizzo

Robert A. Hanson
Director

Paul J. Rizzo
Director

William A. Hewitt

William L. Weiss

William A. Hewitt
Director

William L. Weiss

William B. Johnson

Blaine J. Yarrington

William B. Johnson
Director

Blaine J. Yarrington
Director

Jewel S. Lafontant
Jewel S. Lafontant
Director




216
Worldwide Facilities
Continental Illinois Corporation
Continental Illinois National Bank and Trust Company of Chicago

North America/United States
Chicago
Continental Illinois Corporation, Head Office
Continental Illinois National Bank and Trust
Company of Chicago,* Head Office
Continental Bank International,** Head Office
Continental Illinois Commercial Corporation,*
Head Office
Continental Illinois Venture Corporation*
Continental Illinois Equity Corporation*
Continental International Finance
Corporation**
231 South LaSalle Street
Chicago, Illinois 60693
Personal Banking Services Department
209 South LaSalle Street, Chicago
30 North LaSalle Street, Chicago
Clark and Division Streets, Chicago
(Mailing addresses: 231 South LaSalle Street,
Chicago, Illinois 60693)
Trust and Investment Services Department
30 North LaSalle Street, Chicago
(Mailing address: 231 South LaSalle Street,
Chicago, Illinois 60693)
Representative Office—Northbrook
500 Skokie Boulevard
Northbrook, Illinois 60062
Representative Office—Oak Brook
2122 York Road, Suite 340
Oak Brook, Illinois 60521
Continental Illinois Leasing Corporation,*
Head Office
209 South LaSalle Street, Chicago
(Mailing address: 231 South LaSalle Street,
Chicago, Illinois 60693)
CI General Equipment Leasing Corporation
CI Leasing Corporation
CI Transportation Leasing Corporation
231 South LaSalle Street
Chicago, Illinois 60693
Republic Realty Mortgage Corporation,*
Head Office
111 West Washington Street
Chicago, Illinois 60602
Atlanta
Regional Office of Continental Bank
260 Peachtree Street, N.W., Suite 1710
Atlanta, Georgia 30303
Republic Realty Mortgage Corporation*
Atlanta Branch
5780 Peachtree'Dunwoody Road, N.E.
Suite 350
Atlanta, Georgia 30342
Boca Raton
Continental Illinois Trust Company
of Florida, N. A.*
1499 West Palmetto Park Road
Boca Raton, Florida 33432
Cincinnati
Continental Illinois Leasing Corporation*
Cincinnati Office
580 Walnut Street, Suite 101
Cincinnati, Ohio 45202
Cleveland
Continental Bank International**
Cleveland Branch
1300 East 9th Street, Suite 711
Cleveland, Ohio 44114




Regional Office of Continental Bank
1300 East 9th Street, Suite 711
Cleveland, Ohio 44114

Regional Office of Continental Bank
510 Marquette Avenue, Suite 300
Minneapolis, Minnesota 55402

Dallas
Continental Bank International**
Dallas Branch
700 North Pearl, Suite 1700
Dallas, Texas 75201
Continental Illinois Leasing Corporation*
Dallas Office
700 North Pearl, Suite 1700
Dallas, Texas 75201

New York
Continental Bank International**
New York Branch
One Liberty Plaza, New York, New York 10006
Continental Illinois Leasing Corporation*
New York Office
277 Park Avenue, New York, New York 10172
Regional Office of Continental Bank
277 Park Avenue, New York, New York 10172

Regional Office of Continental Bank
700 North Pearl, Suite 1700
Dallas, Texas 75201
Denver
Regional Office of Continental Bank
410 Seventeenth Street, Suite 2400
Denver, Colorado 80202
Detroit
Regional Office of Continental Bank
26261 Evergreen Road, Suite 220
Southfield, Michigan 48076

Philadelphia
Continental Bank International**
Philadelphia Branch
3 Girard Plaza, 14th Floor
Philadelphia, Pennsylvania 19102
Commercial
3 Girard Plaza, 14th Floor
Philadelphia, Pennsylvania 19102
St. Louis
Republic Realty Mortgage Corporation*
St. Louis Branch
11 South Meramec Avenue, Suite 906
St. Louis, Missouri 63105

Houston
Continental Bank International**
Houston Branch
1100 Milam Building, Suite 3500
Houston, Texas 77002
Continental Illinois Energy Development
Corporation*
One Allen Center, Suite 780
Houston, Texas 77002
Regional Office of Continental Bank
1100 Milam, Suite 3510
Houston, Texas 77002
Kansas City
Republic Realty Mortgage Corporation*
Kansas City Branch
9233 Ward Parkway
Kansas City, Missouri 64114
Los Angeles
Continental Bank International**
Los Angeles Branch
515 South Flower Street, Suite 960
Los Angeles, California 90071
Leasing Representative Office
515 South Flower Street
Los Angeles, California 90071
Regional Office of Continental Bank
515 South Flower Street, Suite 900
Los Angeles, California 90071
Miami
Continental Bank International**
Miami Branch
888 Brickell Avenue, Miami, Florida 33131
Continental Illinois Commercial Corporation*
Miami Office
888 Brickell Avenue, Miami, Florida 33131
Milwaukee
Republic Realty Mortgage Corporation*
Milwaukee Branch
10701 West North Avenue
Wauwatosa, Wisconsin 53226
Minneapolis
Continental Bank International**
Minneapolis Branch
510 Marquette Avenue, Suite 300
Minneapolis, Minnesota 55402

San Francisco
Continental Bank International**
San Francisco Branch
50 California Street, Suite 1201
San Francisco, California 94111
Leasing Representative Office
50 California Street, Suite 1270
San Francisco, California 94111
Regional Office of Continental Bank
50 California Street, Suite 3010
San Francisco, California 94111
Seattle
Continental Bank International**
Seattle Branch
800 Fifth Avenue, Suite 3771
Seattle, Washington 98104
Regional Office of Continental Bank
800 Fifth Avenue, Suite 3770
Seattle, Washington 98104
White Plains
Regional Office of Continental Bank
3 Barker Avenue
White Plains, New York 10601

Canada
Calgary
Continental Illinois Bank (Canada)**
Calgary Branch
311 Sixth Avenue, S.W., Suite 1300
Calgary, Alberta T2P 3H2
Toronto
Continental Illinois Bank (Canada),**
Head Office
First Canadian Place, P.O. Box 369
Toronto, Ontario M5X 1H2
Continental Illinois Leasing Canada Limited
Subsidiary of Continental Illinois Bank
(Canada)
First Canadian Place, P.O. Box 369
Toronto, Ontario M5X 1H2
•Subsidiary of Continental Illinois Corporation
"Subsidiary of Continental Bank

217
Europe
Belgium
Continental Bank S.A.fS.W.,**Jiead
Rue de la Loi 227, 1040 Brussels
Continental Bank S.A./N. V.**
Kipdorp 10-12, 2000 Antwerp

Office

France
Paris Branch
10, Avenue Montaigne, 75008 Paris
Germany, Federal Republic of
Frankfurt Branch
Bockenheimer Landstrasse 24, 6000 Frankfurt
Greece
Athens Branch
24 Stadtou Street, Athens
Piraeus Branch
25 Akti Miaouli Street, Piraeus
Thessaloniki Branch
3 Ionos Dragoumi Street, Thessaloniki
Italy
Continental Illinois Finanziaria S.p.A.**
Via Montenapoleone, 27, 20121 Milan
Milan Branch
Via Montenapoleone, 27, 20121 Milan
Rome Representative Office
Via dei Cappuccini, 6, 00187 Rome
The Netherlands
Amsterdam Branch
Weteringschans 109, 1017 SB Amsterdam
Spain
Barcelona Branch
Avenida Diagonal, 427 bis-429
Barcelona-36
Madrid Branch
Calle Jose Ortega y Gasset No. 29, Fifth Floor
Madrid 6
Switzerland
Continental Illinois Bank (Switzerland)**
Bahnhofstrasse 18, CH 8022 Zurich
Continental Illinois Investment Advisory
Corporation (CIIAC)*
62, rue du Rhdne, CH 1204 Geneva
Geneva Representative Office
40, rue du Rhdne, CH 1204 Geneva
United Kingdom
Continental Illinois International Investment
Corporation (CHIC)*
Continental Bank House
162 Queen Victoria Street
London EC4V 4BS
Continental Illinois Limited*
Continental Bank House
162 Queen Victoria Street
London EC4V 4BS
Leasing Representative Office
Continental Bank House
162 Queen Victoria Street
London EC4V 4BS
London Branch
Continental Bank House
162 Queen Victoria Street
London EC4V 4BS

Latin America/Caribbean
Argentina
Buenos Aires Branch
25 de Mayo 537, Buenos Aires 1002




Bahamas
Nassau Branch
Charlotte House, Suite B
Charlotte and Shirley Streets, Nassau

Tokyo Branch
Mitsui Seimei Building, 2-3
Ohtemachi 1-chome
Chiyoda-ku, Tokyo 100

Brazil
Continental Illinois Leasing Do Brazil*
Avenida Brigaderio Faria Lima, 1815—
9° Andar
Caixa Postal 20.981, Sao Paulo, SP
Sao Paulo Representative Office
Avenida Paulista, 2439—6° Andar
Caixa Postal 369, 01311 Sao Paulo, SP
Chile
Chicago Continental Bank
Santiago Branch
Moneda 1138, Clasificador 233, Correo Central
Santiago
Colombia
Bogota Representative Office
Edificio Ugi
Avenida 40A No. 13-09 Oficina 17-03-04
Apartado Aereo 91966, Bogota

Korea
Seoul Branch
Daewoo Center Building, 18th Floor
No. 541, 5-KA, Namdaemoon-ro
Choong-ku 100, Seoul
The Philippines
Manila Representative Office
Solidbank Building, 8th Floor
Pasco de Roxas
Makati, Metro Manila, Philippines 3117

Mexico
Mexico City Representative Office
Edificio Plaza Comermex
Boulevard M. Avila Camacho No. 1
Mexico 10, D.F.
Puerto Rko
Puerto Rico Branch
Mercantil Plaza, Suite 813
Ponce de Leon Avenue, Hato Rey
Venezuela
Caracas Representative Office
Edificio Centra Altamira, Piso 5, Oficina 2
Avenida San Juan Bosco
Urbanizacion Altamira, Caracas

Africa/Middle East
Bahrain
Manama Representative Office
Bab al Bahrain Building
P.O. Box 5237, Manama
Kenya
Nairobi Representative Office
Prudential Assurance Building, 3rd Floor
Wabera Street, Nairobi
Lebanon
Continental Development Bank, S.A.L.,**
Head Office
Ghantous Building, Dora Boulevard, Dora

Asia/Pacific
Australia
Sydney Representative Office
Macquarie House, 7th Floor
167 Macquarie Street, Sydney 2000, N S W
Hong Kong
Underwriters Bank (Overseas) Limited**
New World Tower, Ground Floor
16-18 Queen's Road Central, Hong Kong
Indonesia
Jakarta Representative Office
Wisma Kosgoro, 14th Floor
Jalan M.H. Thamrin No. 53, Jakarta
Japan
Osaka Branch
Hasegawa Dai-Ichi Building
40, Hiranomachi 5-chome, Higashi-ku
Osaka 541

Singapore
Singapore Branch
2101 OCBC Centre
Chulia Street, Singapore 0104
Taiwan
Taipei Branch
62, Nanking East Road, Section 2
Taipei
Thailand
Bangkok Representative Office
Panunee Building, 9th Floor
518-3 Plemchit Road
Tambol Lumpini, Amphur Patumwan
Bangkok
Continental Illinois Thailand Limited**
Panunee Building, 9th Floor
518-3 Plemchit Road
Tambol Lumpini, Amphur Patumwan
Bangkok

Investments in Affiliated Banks ant
Financial Institutions
Australia
Commercial Continental Limited,
Sydney; Melbourne
Lease Industrial Finance Limited, Brisbane
Colombia
Corporacion Financiera del Valle, Cali
Ecuador
Compania Financiera Ecuatoriana de Desarroil
S.A., "COFIEC," Quito; Guayaquil
Malaysia
Malaysian International Merchant Bankers
Berh'ad, Kuala Lumpur
Nigeria
NAL Merchant Bank Limited, Lagos
Pakistan
Pakistan Industrial Credit & Investment
Corporation Limited, Karachi
The Philippines
House of Investments, Inc., Manila
Rizal Commercial Banking Corporation,
Makati, Rizal
Singapore
Private Investment Company for Asia S.A..
Singapore; Tokyo
Taiwan
China Investment and Trust Company Limited,
Taipei

•Subsidiary of Continental Illinois Corporation
** Subsidiary of Continental Bank

218

Stockholder Information

Annual Meeting
The Annual Meeting of Stockholders will be held Monday,
April 26, 1982, at 10:00 a.m. in the Columbus Drive
Auditorium of the Art Institute of Chicago, Columbus
Drive at Monroe Street, Chicago, Illinois.
Corporate Information
Additional copies of this Annual Report and Form 10-K
and supplemental financial reports published quarterly
may be obtained without charge from Corporate Affairs,
Continental Illinois Corporation, 231 South LaSalle Street,
Chicago, Illinois 60693.
The following materials also are available without charge
from Corporate Affairs:
Behind That Quiet Facade, a history of Continental Bank
from its founding in 1857 to the present.
. . . Because We Live Here, a series outlining Continental's
involvement in its communities.
Stock Listing
Continental Illinois Corporation stock is traded on the New
York, Midwest, Pacific, and London exchanges. Many
newspapers report the daily price per share of the stock as
traded on the New York exchange, commonly using the
abbreviation Contlll. The official trading symbol is CIL.
Transfer Agent
Continental Illinois National Bank and Trust Company
of Chicago
231 South LaSalle Street, Chicago, Illinois 60693
Registrar
Chicago Title and Trust Company
111 West Washington Street, Chicago, Illinois 60602
Co-registrar and Co-transfer Agent
Manufacturers Hanover Trust Company
350
 Park Avenue, New York, New York 10005


219

JML

STATE OF OKLAHOMA
CADOO COUNTY
I
°*
FILED FOR RECORO

APR 71982

.

. . . . . . .
.': i '.' • .
•.
*. *

^frf->••••••

• ">
• —r

APPENDIX

B

>V

A c c e d e d in n^p.o&#tGNMENT OF OVERRIDING ROYALTY INTERESTS
<:iork
gjfck VanDo<c^ter, Coyity/CI
_- DEP.
(SEAL)

STATE OF OKLAHOMA

SS:

KNOW ALL MEN BY THESE PRESENTS:

COUNTY OF CADDO
In consideration of the sum of One and No/100 Dollars -($1.00)
and other good and valuable consideration, receipt of which Is hereby
acknowledged, GHK EXPLORATION COMPANY, as Assignor, does hereby grant,
bargain, assigrT^ transfer, sell and convey unto Continental Leasing
Company, a general partnership, whose address 1s c/o Mr. Bill Patterson,
Penn Square Bank, P.O. Box 26208, Oklahoma City, Oklahoma, 73126, Its
heirs, successors and assigns, as Assignee, an overriding royalty Interest of one-eighth of eight eighths (l/8th of 8/8ths) of all the oil, gas
and other hydrocarbons and all other minerals produced, saved and sold,
if as and when produced, saved and sold, but not otherwise, from the
lands set out and covered by the oil and gas leases set out on Exhibit
"A" attached hereto and made a part hereof (the "Subject L e a s e s " ) .
Said overriding royalty Interest shall,- as to each Subject
Lease, be reduced by any landowner's royalty in excess of the usual
one-eighth (1/8) and any overriding royalty Interest, production payment
or any other burden upon production to which the Subject Lease 1s subject
on the date hereof.
Said overriding royalty Interest shall apply to extensions or
renewals of the Subject Leases, an extension or renewal lease being
defined as a lease acquired by Assignor, Its successors or assigns, prior
to six (6) months after the expiration or release of a Subject Lease
covering the same land, or the expiration or release of a prior extension
or renewal lease covering the same land.
Said overriding royalty Interest shall be fr&e of all development, production, marketing and operating expense; however, said Interest
shall bear and pay currently Its portion of gross production taxes,
pipeline taxes and all other taxes assessed against the gross production
subject to said overriding royalty interest. It 1s agreed that nothing
herein contained shall impose upon the Assignor, Its successors and
assigns,, any duty or obligation to develop or operate the properties
covered by the Subject Leases for oil, gas, other hydrocarbons or other
minerals not imposed by the provisions of said Subject Leases, nor to
maintain said Subject Leases" 1n .effect by the payment of delay rentals.
It is understood and agreed that the Assignor shall have the
right to pool the Subject Leases and the lands covered thereby, or any
part thereof, with other lands and leases Into voluntary units or Into
units established by ^ n y governmental authority having jurisdiction and
if the Subject Leases, and the lands covered thereby, or any part thereof
is pooled accordingly, the overriding royalty interest herein conveyed
shall be reduced in the proportion that the acreage burdened by said
overriding royalty interest bears to all the acreage included 1n any such
pooled unit.
If any Subject Lease covers less than the full interest 1n the
minerals In and under the lands (or portion thereof) covered by such
Subject Lease, then the overriding royalty Interest herein conveyed as to
such Subject Lease shall be reduced and paid only 1n the proportion that
the interest in the minerals 1n such lands or portion thereof covered by
such Subject Lease bears to the full Interest 1n the minerals 1n such
lands; and, if the Interest of Assignor 1n a Subject Lease 1s less than
the full Interest therein, the overriding royalty interest herein
conveyed shall be reduced and paid only 1n the proportion that the
interest of Assignor bears to the full interest 1n such Subject Lease.




220
820

This
or implied.

assignment

is made without warranty, either

express

All of the provisions of this assignment shall be binding
upon all the heirs, successors, representatives and assigns of the
Assignor and Assignee,

of

In witness hereof, this instrument is executed on this 7th day
April
, 1982.

G K EXPLORATION COMPANY
H

<(rfa\

By>(7\r>'Ltv
LARRY A.
ATTORNEY-

W

STATE OF OKLAHOMA
COUNTY OF OKLAHOMA

)
)
)

SSi

The foregoing instrument was scknowledged before me this 7th
day of
Anr-p
, 19 82» by 'Larry. A. Ray, Attorney-in-fact for
GHK EXPLORATION COMPANY"".

?

«f

F u f f l n g H ^ Expireai




VOTARY PUBLIC

#

221
ASSIGNMENT OF OVERRIDING ROYALTY INTEREST
THIS ASSIGNMENT dated

April 5

GHK EXPLORATION COMPANY,
an Oklahoma partnership,
6441 Northwest Grand Boulevard
Oklahoma City, Oklahoma 73116
("Assignor")

-o-f3oru>..~
STATTOFOKUHOMA"""
CADDO COUNTY

IN FAVOR OF'

FILED FOR R E C O R D

CONTINENTAL ILLINOIS ENERGY
DEVELOPMENT CORPORATION,.
a Delaware corporation,,
1 Allen Center
Suite 780
Houston, Texas 77002

,APR Si
DEF».
(SEAL)

("Assignee").
NOW THE ASSIGNOR AGREES AS FOLLOWS:
1.

INTERPRETATION.

In this Assignment, unless the

context otherwise requires:
"Affiliate" means any corporation directly or
indirectly controlling/ controlled by, or under
common control with, the Assignor.

The term "con-

trol" as used herein in relation to a corporation,
means the right to exercise, directly or indirectly,
more than fifty percent (50%) of the voting rights
attributable to shares of a corporation having ordinary voting rights for the election of directors,
"Assignee" means Continental Illinois Energy
Development Corporation and includes its successors
and assigns.

12-745 0—83
15



40"/
(S.E. Ana.)

222

408
"Assignor" means GHK Exploration Company and
includes its transferees, successors and assigns;
•Assignor's Interest" means, in respect of a
lease, the undivided interest of the Assignor in
the Working Interest of that Lease;
"Leases" means the leases described in Exhibit
A hereto and, individually, each of the Leases is
called a "Lease";
"Leased Lands" means the lands covered by the
Leases;
•Overriding Royalty Interest" means with respect
to a Lease, one percent (1%) of the Assignor's Interest in that Lease.

For example, if the Assignor

ovms the full interest in a Lease and if the royalty,
and any overriding royalty, payable to the lessor of
that Lease is 3/16ths of the production from or attributable to that Lease, the Overriding Royalty Interest in that Lease conveyed to the Assignee hereunder shall be 1% times .8125 (13/16th) of the oil,
gas and other leased substances produced from or
attributable to that Lease;
"Working Interest" means with respect to a Lease,
all oil, gas and other hydrocarbons and hydrocarbon
production from or attributable to that Lease after
deducting therefrom only the oil, gas and other hy-




2

223
drocarbons and hydrocarbon production attributable
to any royalty or overriding royalty interests of
the Lessor of that Lease, but without deduction for
(i) overriding royalty interests other than those
of the Lessor of that Lease, (ii) net profit interests, (iii) production payments, or (iv) any other
similar burdens upon production heretofore or hereafter created.
For the purpose of calculating overriding royalties, including the Overriding Royalty Interest, the oil, gas
and other hydrocarbon production shall be deemed not to include
all oil, gas, casinghead gas or other hydrocarbons from that
Lease consumed for operating, development or production purposes (including recycling or repressuring operations) or unavoidably lost, provided that any gas or casinghead gas used
for recycling or repressuring operations which is saved and
marketed from time to time shall be included in production as
of such time./
/The singular includes the plural, and vice-versa.
Sections headings are for convenience or reference
only and shall not affect the interpretation or construction
of this Assignment.
2.

ASSIGNMENT OF OVERRIDING ROYALTY INTERESTS.

For

TEN DOLLARS and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the As-




403

224
,

410

signor hereby sells, assigns, conveys, transfers and sets over
to the Assignee an Overriding Royalty Interest in each of the
Leases, TO HAVE AND TO *HOLD the Overriding Royalty Interests
for and during the terms and according to the terms and conditions of each respective Lease and according to the terms
and conditions of this Assignment.
3.

CONDITIONS OF OVERRIDING ROYALTY INTEREST.
3.1

Payment for Production.

The Assignee shall

be paid for the production attributable to the Overriding
Royalty Interest based upon the amounts realized from the sale
thereof computed at the well, provided that, if such production
is not sold or is sold to an Affiliate, payment shall be based
upon the value of the production at the well as determined for
the purposes of paying the lessor's royalty under the relevant
Lease.
3.2. Lease Terms; Provisions of Leases.

Each

Overriding Royalty Interest is assigned to the Assignee for and
during the term of the relevant Lease.
Each Overriding Royalty Interest is subject to the
terms and conditions of the relevant Lease as the same may
from time to time be amended.

The Assignor is not under an

obligation, expressed or implied, to keep or maintain any
Lease in force whether by payment of rentals, compensatory
royalties, or other payments, or by the drilling of any wells
upon the Leased Lands or lands unitized therewith.




4

225
3.3

Costs and Taxes.

The Overriding Royalty

Interests shall be free and clear of all drilling, developing
and operating costs and expenses, but the Assignee shall bear
and pay all taxes (including, without limitation, all production, severance, gathering or similar taxes) which may now or
hereafter be directly levied or directly applicable to any
Overriding Royalty Interest in the oil, gas and other hydrocarbons produced from or attributable to a relevant Lease.
3.4

Pooling and Unitization.

If the Leased

Land, or any portion thereof, is pooled or unitized for development and operation as a unit with other lands, the Overriding Royalty Interest shall be delivered and paid on that
proportion of the entire unit production which the acreage in
the Leased Lands placed ia the unit bears to the entire acreage in the Unit.
3.5

Other Overriding Royalties.

The Overriding

Royalty Interests are. in addition to any other overriding royalty interest or other payments out of production which may
burden the Leases.
4.

REPRESENTATIONS AND WARRANTIES.

The Assignor

states, based on its best information and belief after making
examination of its records and after making such other investigation as is customarily made by prudent purchasers in connection with the acquisition of similar leases, that the Assignor's Interest, expressed as a decimal fraction of the




411

226
oil, gas and other hydrocarbons and hydrocarbon production
under a Lease, is .8125 in the case of each Lease shown on
Exhibit A except those for which a decimal fraction is shown
in the column headed "Assignor's Interest" on Exhibit B hereto
and for the latter is the decimal fraction for each Lease
shown on said Exhibit B.

Assignor represents and warrants

that its title in each of the Leases is free from all liens,
charges or encumbrances created or existing by, through or
under the Assignor.

Assignor further agrees to warrant and

defend title to each and every Overriding Royalty Interest
unto the Assignee, its successors and assigns against any and
every third party lawfully claiming the same or any part thereof by, through or under any right acquired or purported to be
acquired from the Assignor.

The Assignor further represents

and covenants that it has good and legal right to grant and
assign the Overriding Royalty Interest to the Assignee.

Ex-

cept as set forth above, Assignor makes no warranty, either
express or implied,
5.

FEDERAL LEASES.

The Assignor requests the As-

signee to take cognizance of the fact that applicable Federal
law and regulations, including but not limited to Section
3103.3-6, Title 43, Code of Federal Regulations provided that
where the lessor's royalty and overriding royalties on any
lease which is subject to the Mineral Leasing Act of 1920 (as
amended) (a "Federal Lease") exceed 17.5% of the oil, gas and
other minerals produced, saved, and marketed from a well




227
thereon, such overriding royalties (to the extent in excess
of such 17.5% of the oil and liquid hydrocarbons produced)
shall be suspended when the average production of oil per well
per day, averaged on a monthly basis, is fifteen (15) barrels
or less.

Such suspension applies to any zone or portion of a

Federal Lease segregated for computing the lessor's royalty.
The Assignor also requests the Assignee to take cognizance of
the fact that certain applicable state or Indian laws and
regulations provide that where lessor's royalty and/or overriding royalties on a lease subject to said laws and regulations exceed a certain percentage of the oil, gas, and other
minerals produced, saved and marketed from a well thereon,
overriding royalties (to the extent in' excess of the specified percentage of the oil, gas or other minerals produced)
shall be suspended under certain circumstances.

It is fur-

ther requested of the Assignee that it recognize that the
aforesaid laws and regulations may be amended or revised to
change the circumstances whereupon suspension of excess overriding royalties is requires.

It is a condition of this As-

signment that in the event any portion of the Overriding Royalty Interest on a Lease is required by any present or future
laws or regulations, to be suspended by the Assignor, it may
do so.
6.

ASSIGNMENTS.
6,i

Assignor.

The Assignor may sell, assign,

convey or otherwise dispose of all or any part of its retained




413

228

interest in the Leases, provided that any instrument of sale,
assignment, conveyance or other disposition shall contain specific language which (i) subjects said instrument to the terms
of this Assignment, and (ii) refers to the pertinent recording
data hereof.
6.2

Assignee.

The Assignee may sell, assign

or otherwise dispose of all or any part of any Overriding Royalty Interest, and the terms of this Assignment shall inure to
the benefit of the successors and assigns of the Assignee.
6.3

Counterparts *

This Conveyance is being exe-

cuted in multiple original counterparts, all of which are identical except that, to facilitate filing and recording, counterparts to be filed and recorded in the appropriate records of
each county may have included in Exhibit A only the portions
of Exhibit A containing the specific descriptions of the Leases
located in said county.

Every counterpart of this Conveyance

shall be deemed an original for all purposes and all counterparts together shall constitute one and the same Conveyance.
IN WITNESS WHEREOF the Assignor has executed this
Assignment the day and year first hereinabove written.




GHK EXPLORATION COMPANY

LARtfY A^RAY, A t t o r n e y - I n - F a c t

8

229
STATE OF OKLAHOMA
COUNTY OF OKLAHOMA

)
)
)

ss.

The foregoing instrument was acknowledged before
me this
5th day of
April
/ 1982 by
Larry A.
Ray
/ as Attorney-in-Fact
on behalf of
i
GHK Exploration Company, a partnership.

My commission expires:

jttj/trrfd^Mt

Notary Public

1-28-86




9

415

230
(Cyril)
<3 *•*»
STATE OF OKLAHOMA )
S S
a a
CADDO COUNTY
S
FILED FOR RECORD

CONVEYANCE AND ASSIGNMENT

, FEB 9 1982
KNOW ALL MEN BY THESE PRESENTS:

A*£_M£__Kccofdedm
J«:k V a n D o v c r ^ CourU^CIj/k

'".v,

That THIS CONVEYANCE'AND A S S I G N M E N T 3 1 ^ ? ^ ^ - ^
^SSu*' n
'jiff's
g? / 1902 (the "Conveyance and Assignment") is
made I fcftoparts, Part I being a Conveyance of Overriding
in
h'
Royalty Interest from Robert A. Hefner III ("Assignor"), a • • "
•
single man, to U.K. Leasing Company, a general partnership* :
';
'•
created pursuant to the Uniform Partnership Act of the State .
of Oklahoma ("Assignee"), c/o Dill Patterson, Penn Square Dank,
1919 Penn Square, P. 0. Box 26200, Oklahoma City, Oklahoma
73126, and Part II being an Assignment of Oil and Gas Leases /J
from Assignor to GHK Exploration Company, a general partnership
created pursuant to the Uniform Partnership Act of the State
of Oklahoma ("Exploration")-, 6441 N.W. Grand Boulevard, Oklahoma City, Oklahoma 73116.
-

PART I
CONVEYANCE OF OVERRIDING ROYALTY INTEREST
Assignor, for and in consideration of the sun of
Ten Dollars ($10.00) and other good and valuable consideration to it paid by Assignee, the receipt and sufficiency of
which are hereby acknowledged, has BARGAINED, SOLD, GRANTED,
CONVEYED, TRANSFERRED, ASSIGNED, SET OVER and DELIVERED, and
by these presents does hereby BARGAIN, SELL, GRANT, CONVEY,
TRANSFER, ASSIGN, SET OVER and DELIVER unto Assignee, overriding royalty interests (the "Overriding Royalty Interest")
equal to 3.125 percent of 0/0ths of all Minerals in and under,
and if, as and when produced (but not otherwise) from Or attributable to the Leased Lands described in the Leases during
the terms of the Leases and any extensions and renewals thereof and the Proceeds therefrom, subject to the terms and provisions of this Conveyance, including the provisions for proportionate reduction of the Overriding Royalty Interest contained
in Section 2.01 and the provisions relating to extensions, renewals and certain new leases contained in Section 2*05 hereof. The Overriding Royalty Interest shall be applied and calculated separately as to each Lease. The words with initial
capital letters are used as defined in Article I hereof.
TO HAVE AND TO HOLD the Overriding Royalty Interest,
together with all and singular the rights and appurtenances
thereto in anywise belonging unto Assignee, its successors and




413

231
414
assigns, subject, however, to the Permitted Agreements and to
the terms and provisions of this Conveyance; and Assignor does
by these presents bind and obligate itself, its successors and
assigns, to WARRANT and FOREVER defend all and singular the
Overriding Royalty Interest unto the said Assignee, its successors and assigns, against every person whomsoever lawfully
claiming or to claim the same or any part thereof by, through
or under Assignor, but not otherwise.
ARTICLE I
Definitions
As herein used the following words, terms or phrases
have the following meanings;
SECTION 1.01. "Affiliate" means, as to the party
specified, any Person controlling, controlled by or under common control with such party, with the concept of control in
such context meaning the possession, directly or indirectly,
of the power to direct or cause the direction of the management and policies of another, whether through the ownership
of voting securities, by contract or otherwise.
SECTION 1.02. "Conveyance" means the Conveyance of
Overriding Royalty Interest which is Part I of this instrument.
' SECTION 1.03. "Effective Date" means 12:00 o'clock
midnight local time in effect at the location of each Lease on
the date of this Conveyance.
SECTION 1.04. "Leased Lands" means the tract or tracts'
of land described in each of the Leases set out in Exhibit A
hereto and shall include all gross acres included within the
boundaries of such tract or tracts without regard to the portion
of the mineral interest or leasehold interest covered by any particular Lease.
SECTION 1.05. "Leases" means the oil, gas and mineral leases described in Exhibit A hereto.
SECTION 1.06. "Minerals" means oil, gas, condensate,
sulphur and all other minerals, whether similar or dissimilar.
SECTION 1.07. "Non-Affiliate" means, as to the party
specified, any Person who is not an Affiliate of such party.
SECTION 1.08. "Permitted Agreements" means all applicable operating agreements, gas purchase contracts and unitization or pooling agreements in existence on the Effective
Date, and all applicable agreements with Non-Affiliates tc




2

232
which the Leases were subject at the time of the acquisition
by Assignor or any Affiliate of an interest in such Leases.
SECTION 1.9. "Person" means any individual, corporation, partnership, trust, estate or other entity or organization.
SECTION 1.10.

"Proceeds" means

(a) the amounts realised from the sale of Minerals
to a Non-Affiliate, determined at the well;
(b) on Minerals sold to Subject Lessee or an Affiliate and not Processed, either: (i) the market value at
the well of such Minerals, or (ii) the amount paid by
Subject Lessee or such Affiliate for such Minerals, whichever is the greater; and
(c) on Minerals (A) used off the Leased Lands described in the Lease on which the well from which such
Minerals, are produced or off lands pooled or unitized
therewith or (D) Processed by Subject Lessee or an Affiliate, the market value at the well, with market value
at the well of Minerals Processed being determined by
either: (i) amounts realized from the sale to a NonAffiliate or (ii) market value at the Processing plant
where sold or used by Subject Lessee or an Affiliate
of any and all products including residue gas resulting
from Processing, less either the: (i) actual Processing
costs, and, if not included in such costs, a reasonable
return on invested capital, and expenses incurred and
borne by Subject Lessee or an Affiliate relating to such
Minerals, or (ii) reasonable charges for Processing, relating to such Minerals, whichever is the lesser.
SECTION 1.11. "Process" means to manufacture, refine, treat for marketing, extract, absorb, or compress or
otherwise deal with Minerals in a manner which does not constitute Well Operations. "Processing" and "Processed" mean the
act of such Process.
SECTION 1.12. "Royalty Owner" means the Assignee
while it owns an interest in the Overriding Royalty Interest,
and any other Person who subsequently acquires legal title to
all or any portion of the Overriding Royalty Interest.
SECTION 1.13. "Subject Lessee" means Assignor while
it owns all or part of the Leases other than a royalty or pro-




233

416
duction payment Interest and any other Person who acquires all
or any part of the Leases other than a royalty or production
payment interest.
SECTION 1.14. "Well Operation's" means gravity separation of Minerals and other normal operations in the vicinity of the well but does vnot include compression; transportation or Processing of the Minerals, or absorption, or fractionalization, and other plant operations.
ARTICLE II
Special Provisions Relating to
Overriding Royalty Interest
SECTION 2.01. Proportionate Reductions. If any
Lease covers less than the full interest in the Minerals in
and under the Leased Lands (or portion thereof) covered by such
Lease, then the Overriding Royalty Interest as to such Lease
shall be reduced and paid only in the proportion that the interest in the Minerals in such lands or portion thereof covered by such Lease bears to the full interest in the Minerals
in such Leased Lands; and, if the interest of Assignor in a
Lease is less than the full interest therein, the Overriding
Royalty Interest shall be reduced and paitf only in the proportion that the interest of Assignor bears to the full interest
in such Lease.
SECTION 2.02. Costs and Taxes. The Overriding Royalty Interest shall not bear, either directly or indirectly,
any part of the costs or expenses of development and production
of the Minerals attributable to the Subject Interests. The
Overriding Royalty Interest shall bear its pro rata portion of
all taxes legally imposed on the Minerals attributable to the
Leases, including production, severance, ad valorem, pipeline
and windfall profits taxes but excluding any federal, state or
local income taxes.
SECTION 2.03. Minerals Lost in Production. There
shall be excluded from the Overriding Royalty Interest any
amount for Minerals attributable to the Leases unavoidably
lost in the production thereof or used by Subject Lessee in
conformity with prudent practices for drilling, production and
plant operations (including gas injection, secondary recovery,
pressure maintenance, repressuring, cycling operations, plant
fuel or shrinkage) conducted for the purpose of producing Minerals or from any unit to which the Leases are committed, but
only so long as such Minerals are so used.




4

234
SECTION 2.04. Federal Leases. So long as and to
the extent that the same may be required by applicable laws
and regulations, in the case of any Lease from the United
States of America included in the Leases from which the average production of oil per well per day averaged on the monthly
basis is 15 barrels or less, the obligation to pay and the right
of the Royalty Owner to receive the proceeds of oil produced
from such Lease shall be ratably reduced or suspended to the
extent that all presently effective lease burdens exceed 5% of
8/0th, excluding lessor's royalty, until said average production of oil per well per day exceeds said minimum amount, and
such suspension shall apply separately to any, zone or portion
of such Lease segregated for computing government royalties.
SECTION 2.05. Application to Extensions, Renewals and New Leases. The Overriding Royalty Interest shall apply
to an extension or renewal of a Lease or to a new lease, to
the extent that any such renewal, extension or new lease
covers the same interest in the same land as a Lease, which
is acquired by grant or assignment by Assignor, its successors
or assigns,, prior to a date which is six months after the
expiration or termination of the Lease or prior to six months
after the expiration or termination of any prior lease to
which the Overriding Royalty Interest applied, provided that
any such lease is acquired during the period of the life of
the last survivor of the descendants of Joseph P. Kennedy,
father of the late President of the United States of America,
living on the date of the execution hereof, plus 21 years
after the death of such last survivor.
ARTICLE III
Payment by Assignor
SECTION 3.01. Payment by Assignor. If for any
reason Assignor or its Affiliate receives any monies attributable to the Overriding Royalty Interest, Assignor shall, and
shall cause its. Affiliate to, pay by tho twenty-fifth day of
tho month following the month of receipt theroof such amounts
to tho Assignee. Prior to rocoipt by Assignee of such amounts,
Assignor or its Affiliate, as the case may be, shall hold such
amounts in trust for the benefit of Assignee.
ARTICLE IV
Non-Liability of Royalty Owner
SECTION 4.01. Non-Liability of Royalty Owner. In
no event shall Royalty Owner be liable or responsible in any




5

417

235

418
way for any production costs or other costs or liabilities incurred by Subject Lessee or other lessees attributable to the
Leases or to the Minerals produced therefrom, except for the
costs borne by the Overriding Royalty Interests under the definition of the term "Proceeds."
ARTICLE V
Unitization
SECTION 5.01. Pooled Leases. . Certain of the Leases
may have been heretofore pooled and unitized for the production of Minerals. Such Leases are and shall be subject to the
terms and provisions of such pooling and unitization agreements,
and the Overriding Royalty Interest in each such Leases shall
apply to and affect only the production from such units which
accrues to such Leases under and by virtue of the applicable
pooling and unitization agreements.
SECTION 5.02. Right to Pool* Subject Lessee shall
have the right and power, exercisable only during the period
provided in Section 5.03 hereof, to pool and unitize any of
the Leases and to alter, change, amend or terminate any pooling or unitization agreements heretofore or hereafter entered
into, as to all or any part of the land covered hereby, as to
any one or more of the formations or horizons thereunder, and
as to any one or more Minerals, upon such terms and provisions
as Subject Lessee shall in its sole discretion determine. If
and whenever through the exercise of such right and power, or
pursuant to any law hereafter enacted or any rule, regulation
or order of any governmental body or official hereunder promulgated, any of the Leases are pooled or unitized in any manner,
the Overriding Royalty Interest insofar as it affects such
Lease shall also be pooled and unitized, and in any 3uch event
such Overriding Royalty Interest in such Leaso shall apply to
and affect only the production which accrues to such Lease
under and by virtue of the pooling and unitization,
SECTION 5.03. Applicable Period. Subject Leasee's
power and right to pool and unitize the Leases and the Overriding Royalty Interest shall be exercisable and enjoyed only
during the period of the life of the last survivor of the
descendants of Joseph P. Kennedy, father of the late President
of the United States of America, living on the date of execution
hereof, plus 21 years after the death of such last survivor.




6

236
ARTICLE VI
Government Regulation
SECTION 6.01. Government Regulation. All obligations of the Subject Lessee hereunder shall bo subject to all
applicable provisions of the Emergency Petroleum Allocation
Act of 1973, the Department of Energy Organization Act, the
Natural Gas Act, the Natural Gas Policy Act of 1970 and each
other statute purporting to provide comparable regulations for
the sale of Minerals or establishing maximum prices at which
the same may be sold and all applicable laws, orders, rules
and regulations thereunder of the Federal Energy Regulatory
Commission, the Department of Energy and each other legislative or governmental body, agency, board or commission having
jurisdiction. Rates permitted under the Natural pas Act, the
Natural Gas Policy Act of 1970, the Emergency Petroleum Allocation Act of 1973 and each such other statute and the rules
and regulations thereunder to be paid for the Minerals attributable to Leases shall be controlling if lower than prices
established in contracts for the sale thereof or if lower than
the rates used in determining Proceeds. The Subject Lessee
shall be entitled to use its reasonable discretion in making
filings, for itself and on behalf of the Royalty owner, with
the Federal Energy Regulatory Commission, the Department of
Energy or any other governmental body, agency, board or commission having jurisdiction, affecting the price or prices at
which Minerals attributable to Leases may be sold.
Compliance with any now or hereafter existing statute
or law of the federal or any state government or with orders,
judgments, decrees, rules, regulations made by federal or state
courts, offices, boards, commissions or agencies having jurisdiction shall not constitute a violation of any of the terms of
this Conveyance or be considered a breach of any clause, obligation, covenant, undertaking, condition or stipulation contained herein and this agreement shall be subject to all federal and state laws, orders, rules or regulations.
ARTICLE VII
Assignments
SECTION 7.01. Assignment by Subject Lessee. Subject Lessee shall have the right to assign, sell, transfer,
convey, mortgage or pledge the LeaseB, or any part thereof,
subject to the Overriding Royalty Interest and the terms and
provisions of this Conveyance and any such assignment shall
relieve such Assignor of all obligations thereafter accruing
hereunder to the extent of the interest assigned.




7

419

237
420
SECTION 7.02. Assignment by Royalty Owner. Royalty
Owner has the right to assign the Overriding Royalty Interest
in whole or in part. However, no such assignment will affect
the method of computing the Proceeds.
SECTION 7.03. Change in Ownership. No change of
ownership or right to receive payment of the Overriding Royalty
Interest, or of any part thereof, however accomplished, shall
be binding upon Subject Lessee until notice thereof shall have
been furnished by the Person claiming the benefit thereof, and
then only with respect to payments thereafter made. Notice of
sale or assignment shall consist of a certified copy of the
recorded instrument accomplishing the same; notice of change of
ownership or right to receive payment accomplished in any other
manner (for example by reason of incapacity, death or dissolution) shall consist of certified copies of recorded documents
and complete proceedings legally binding and conclusive of the
rights of all parties. Until such notice shall have been furnished Subject Lessee as above provided, the payment or tender
of all suns payable on the Overriding Royalty Interest may be
made in the manner provided herein precisely as if no such
change in interest or owncrshp or right to receive payment has
occurred. The'kind of notice herein provided shall be exclusive, and no other kind, whether actual or constructive, shall
bo binding on Subject Lessee.
ARTICLE VIII
Miscellaneous
SECTION 0,01. Further Assurances. Should any additional instruments of assignment and conveyance be required to
describe more specifically any interest subject hereto, Assignor agrees to execute and deliver the same. Also, if any other
or additional instruments.are required in connection with the
transfer of federal or state lease interests in order to comply with applicable laws or regulations, Assignor will execute
and deliver the 3ame.
SECTION 0.02. Binding Effect. This Conveyance shall
bind and inure to the benefit of successors and assigns of Assignor and Assignee.
SECTION 0.03. Governing Law. The validity, effect
and construction of this Conveyance shall be governed by the
laws of the jurisdiction in which the Leases are located.

12-745 0—83

16




238
SECTION 0.04. Headings. Article and Section headings used in this Conveyance are for convenience only and shall
not affect the construction of this Conveyance.
SECTION 8.05. Substitution of Warranty. This Conveyance is made with full substitution and subrogation of Assignee in and to all covenants-of warranty by others heretofore
given or made with respect to the Leases or any part thereof
or interest therein.
SECTION 0.06. Limited Obligation. The Assignee and
its successors and assigns agree to look solely to the Overriding Royalty Interests for payment of the amounts herein provided to be paid, and without recourse to the Subject Lessee,
or its successors and assigns, provided that nothing contained
in this Section 8.06 shall discharge, limit or otherwise affect the Assignor's liabilities under its warranties, covenants,
agreements and other obligations contained herein.
PART II
ASSIGNMENT OF OIL AND GAS LEASES
Assignor, for and in consideration of the sum of Ten
Dollars ($10.00) and other good and valuable considerations to
it paid by Exploration, does hereby assign, transfer, set over
and convey unto Exploration all of his right, title and interest in and to the oil and gas leases described in Exhibit A
attached hereto insofar as said leases cover the lands described in said Exhibit A (the "Leases"), subject to all of
the terms and provisions of the Conveyance of Overriding Royalty Interest which is Part I of this Conveyance and Assignment and subject to the Overriding Royalty Interest conveyed
thereby, together with all personal property used or obtained
in connection therewith.
TO HAVE AND TO HOLD unto Exploration, subject to the
aforesaid Overriding Royalty Interest and to all of the covenants and conditions hereof.
This assignment is made without warranty, either express or implied, but is made with full substitution and subrogation of Exploration in and to all covenants of warranty by
others heretofore given or made with respect to the Leases or
any part thereof or interest therein.




421

239
422
All of the terms and provisions of this assignment
shall be binding upon and inure to the benefit of the parties
thereto, their heirs, personal representatives, successors and
assigns.
v
GENERAL PROVISIONS
The following provisions are applicable to, and are
a part of, each of Parts I and II of this Conveyance and As• • *
signment:
1. This Conveyance and Assignment is being executed
in multiple original counterparts, all of which are identical
except that, to facilitate filing and recording, counterparts
to be filed and recorded in the appropriate records of each
county may have included in Exhibit A only the portions of sue
exhibit containing the specific descriptions of the Leases located in said county. Every counterpart of this Conveyance
and Assignment shall be deemed to be an original for all purposes and all such counterparts together shall constitute one
and the same Conveyance and Assignment.
2. This Conveyance and Assignment and each part
hereof shall for all purposes be effective at 12:00 o'clock
midnight, local time in effect at the location of each Lease
on the date hereof, provided that Part I hereof shall be effec
tive prior to Part II, and Part II shall be subject to Part I.
IN WITNESS WHEREOF, Assignor has signed and acknowledged this Conveyance and Assignment/ify multiple originals as

STATE OF OKLAHOMA
COUNTY OF OKLAHOMA

me t h i s
••'\A^. V. W > N E R

':

The foregoing instrument was acknowledged before

<d2*uL dav ° f
III#

S-3./AAJS

*J*<

t >n A. .;. ,T#y** cc^nmiss ion e x p i r e s :




/ 1302

by

Notary

„;>/./?/V
10

ROBERT A.

Public

240
STATE OF OKLAHOMA

)
) ss.
COUNTY OF OKLAHOMA
)
BEFORE ME, the.undersigned authority, on this day
personally appeared ROBERT A. H-EFNER III, known to me to be
the person whose name is subscribed to the foregoing instrument and acknowledged to me that he executed the same for
the purposes and consideration therein expressed.
<r?*S

Given under my hand and seal of office this the
day of rpjJu^.dJy
.» 1902.

Vty''WirrRifs«ion expirest

4A

^Notary Public

'A
.




11

423

241
AS o 'Cite..

MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY
AGREEMENT AND FINANCING STATEMENT
FROM
GHK EXPLORATION COMPANY

y2«8
STATE OF OKLAHOMA I
S S.
•CAOOO COUNTY Q R R E ( 1 O R 0

TO

•UwfQ-l.Qa.v'Ollln' Trustee

y

- ^

JacyVanDovonter. County Clerk
__DEP.
lS£ALj

AND
IVtM-UlpjkiW

^ APR 2 9 1982

Trustee

AND
CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST
COMPANY OF CHICAGO, as Agent
>1

Dated as of Ann'I

£ , 19£<jl

•THIS INSTRUMENT CONTAINS AFTER-ACQUIRED PROPERTY
PROVISIONS."
•THIS INSTRUMENT SECURES PAYMENT OF FUTURE ADVANCES."
"THE OIL AND GAS INTERESTS INCLUDED IN THE MORTGAGED
PROPERTY WILL BE FINANCED AT THE WELLHEADS OF THE WELLS
LOCATED ON THE PROPERTIES DESCRIBED IN EXHIBIT A HERETO, AND
THIS FINANCING STATEMENT IS TO BE FILED FOR RECORD, AMONG
OTHER PLACES, IN THE REAL ESTATE RECORDS."
"SOME OF THE PERSONAL PROPERTY CONSTITUTING A PORTION OF THE
MORTGAGED PROPERTY IS OR IS TO BE AFFIXED TO THE PROPERTIES
DESCRIBED IN EXHIBIT A HERETO AND THIS FINANCING STATEMENT
IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL
ESTATE RECORDS."




647

242

648
MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY
AGREEMENT AND FINANCING STATEMENT.
THIS MORTGAGE, DEED OF TRUST, ASSIGNMENT, SECURITY
AGREEMENT AND FINANCING STATEMENT, dated as of Aprt'\
3 .
1982, is from GHK. EXPLORATION COMPANY, an Oklahom'a
partnership (herein called .the "Mortgagor"), to
•
Ucwro.L-. Cft/Mlo, and l^wS- M . lOtcfc.^rof Chicago, Illinois,
as Trustees (herein collectively called the "Trustees") and
CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY OF
CHICAGO, a national banking association (herein called the
"Agent"), as Agent for itself and PENN SQUARE BANK, N.A.
(CONTINENTAL ILLINOIS NATIONAL BANK AND'TRUST COMPANY OF
CHICAGO and Penn Square Bank, N.A., being herein
collectively called the "Banks").
xv"
1. The Mortgagor and the Banks have entered into a
-gguuie-d Revolving Credit Agreement, dated as of Aprt'l
5 .
1982 (herein, as the same may be amended, modified or
supplemented from time to time, called the "Loan
Agreement"), pursuant to which the Banks have agreed to lend
to the Mortgagor amounts not to exceed $50,000,000 and the
Mortgagor, to evidence its indebtedness to the Banks under
one Loan Agreement, has executed and delivered to the Banks
its_promissory notes (herein called the "Loan Notes"), dated
as of Apr*'1. h t 1982, in the aggregate principal amount of
$50,000,000, to mature on December 1, 1983, one Loan Note
being payable to the order of each of the Banks, bearing
interest at the rates provided for therein, and containing
provisions for payment of attorneys' fees and acceleration
of maturity in the event of default, as therein set forth.
2. For all purposes of this instrument, unless the
context otherwise requires:
A. "Oil and gas leases" shall include oil, gas and
mineral leases and shall also include subleases and.
assignments of operating rights.
B. "Hydrocarbons" shall mean oil, gas and other
liquid or gaseous hydrocarbons.
C. "Production Sale Contracts" shall mean contracts
now in effect, or hereafter entered into by the
Mortgagor, or the Mortgagor's predecessors in interest,
for the sale, purchase, exchange or processing of
Hydrocarbons produced from the lands described in
Exhibit A attached hereto and made a part hereof.




243
D. "lands described in Exhibit A" shall include any
lands, the description of.which is incorporated in
Exhibit A by reference to another instrument or
document, and shall also include any lands, now or
hereafter unitized or pooled with lands which are either
described in Exhibit A or the description of which is
incorporated in Exhibit A by reference.
E. "Operating Equipment" shall mean all surface or
subsurface machinery, equipment, facilities or other
property of whatsoever kind or nature (excluding
drilling rigs, trucks, automotive equipment or other
property taken to the premises to drill a well or for
other similar temporary uses) now or hereafter located
on any of the lands described in Exhibit A which are
useful for the production, treatment, storage or
transportation of oii, gas, and other liquid or gaseous
hydrocarbons, including, but not by way of limitation,
all oil wells, gas wells, water wells, injection wells,
casing, tubing, rods, pumping units and engines,
Christmas trees, derricks, separators, gun barrels, flow
lines, tanks, gas systems (for gathering, treating and
compression), water systems (for treating, disposal and
injection), power plants, poles, lines, transformers,
starters and controllers, machine shops, tools, storage
yards and equipment stored therein, buildings and camps,
telegraph, telephone and other communication systems,
roads, loading racks and shipping facilities.
F. "Mortgaged Property" shall mean the properties,
rights and interests hereinafter described and defined
as the Mortgaged Property.
G. "Indebtedness"', "Note" and "Notes" shall have the
respective meanings set forth in Section 1.2.
NOW, THEREFORE, the Mortgagor, for and in consideration
of the premises and of the debts and trusts hereinafter
mentioned, has granted, bargained, sold, warranted,
mortgaged, assigned, transferred and conveyed, and by these
presents does grant, bargain, sell, warrant, mortgage,
assign, transfer and convey unto the Trustees, for the use
and benefit of the Agent, for the pro rata benefit of the
Banks, all the Mortgagor's right, title and interest,
whether now owned or hereafter acquired, in all of the
hereinafter described properties, rights and interests; and,
insofar as such properties, rights and interests consist of
equipment, general intangibles, accounts, contract rights,
inventory, fixtures, proceeds of collateral or any other
personal property of a kind or character defined in or




244

650
subject to the applicable provisions
Commercial Code (as in effect in the
jurisdiction with respect to each of
and interests), the Mortgagor hereby
a security interest therein; namely:

of the Uniform
appropriate
said properties, rights
grants to said Trustees

(a) the oil and gas leases, overriding royalty, and
other interests which are specifically described in
Exhibit A,
(b) the presently existing unitization and pooling
agreements and the properties coVered and the units
created thereby (including all' units formed under
orders, regulations, rules or other official acts of any
federal, state or other governmental agency having
jurisdiction) which are specifically described in
Exhibit A or which relate to any of the properties and
interests specifically described in Exhibit A,
(c) the Hydrocarbons which are attributable to the
oil and gas leases and other interests described in
Exhibit A,
(d)

the Production Sale Contracts,

(e)

the Operating Equipment, and

(f)

the proceeds and products of the foregoing,

together with any and all corrections or amendments to,
or renewals, extensions or ratifications of, any of the
same, or of any instrument relating thereto, and all
contracts, operating agreements, records, logs,
rightsof-way, franchises, easements, surface leases,
permits, licenses, tenements, hereditaments and
appurtenances now existing or in the future obtained in
connection with any of the aforesaid, and all other
things of value and incident thereto which the Mortgagor
might at any time have or be entitled to,
all the aforesaid properties, rights and interests, together
with any additions thereto which may be subjected to the
lien of this instrument by means of supplements hereto,
being hereinafter called the "Mortgaged Property".
Subject, however, to (i) the restrictions, exceptions,
reservations, conditions, limitations, interests and other
matters, if any, set forth or referred to in the specific
descriptions of such properties and interests in Exhibit A
(including all presently' existing royalties, payments out of




-3-

245
production and other burdens which are referred to in
Exhibit A and which are taken into consideration in
computing the decimal or fractional interest as set forth in
Exhibit A ) , (ii) the assignment of production contained in
Article III hereof, but only insofar and so long as said
assignment of production is not inoperative under the
provisions of Section 3.5, (iii) the right in the Mortgagor
to obtain a release of the lien granted or created hereunder
pursuant to Section 2.7 hereof, and (iv) the condition that
neither the Trustees nor the Agent shall be liable in any
respect for the performance of any covenant or obligation of
the Mortgagor in respect of the Mortgaged Property.
TO HAVE AND TO HOLD the Mortgaged Property unto the
Trustees forever to secure the payment of the Indebtedness
and to secure the performance of the obligations of the
Mortgagor herein contained.
The Mortgagor, in consideration of the premises and to
induce the Bank* to make the loan above described, hereby
covenants and agrees with both the Trustees and the Banks as
follows:
ARTICLE I
Indebtedness Secured
1.1 Items of Indebtedness Secured.
of indebtedness are secured hereby:

The following items

(a) The Loan Notes, and all other obligations and
liabilities of the Mortgagor under the Loan Agreement;
(b) Any sums advanced or expenses or costs incurred
by the Trustees or the Bank (or any receiver appointed
hereunder) which are made or incurred pursuant to, or
permitted by, the terms hereof, plus interest thereon at
the rate herein specified or otherwise agreed upon, from
the date of the advances or the incurring of such
expenses or costs until reimbursed?
(c) Any extensions or renewals of all such
indebtedness described in subparagraph (a) and (b)
above, whether or not the Mortgagor executes any
extension agreement or renewal instruments.
1.2 Indebtedness and the Notes Defined. All the items of
indebtedness described in Section 1.1 hereof are hereinafter
collectively referred to as the "Indebtedness." Any
promissory note evidencing any part of the Indebtedness,




-4-

G51

246
\

652

including, without limitation, the Loan Note, is hereinafter
referred to as a "Note" and all such notes are hereinafter
referred to collectively as the "Notes."
ARTICLE II
Particular Covenants and Warranties
of the Mortgagor
2.1 Payment of the Indebtedness. The Mortgagor will duly
and punctually pay the Indebtedness, including each and
every obligation owing on account of the Notes.
2.2 Warranties. The Mortgagor warrants that (a) the oil
and qas leases described in Exhibit A hereto are valid,
subsisting leases, superior and paramount to all other oil
and gas leases respecting the properties to which they
pertain, (b) the Mortgagor, to the extent of the interest
specified in Exhibit A, has valid, defensable title to each
property right or interest constituting the Mortgaged
Property and has a good and legal right to grant and convey
the same to the Trustees, it being understood that the
Mortgagor's interest in each oil and gas lease shall exceed
the Mortgagor's net interest in production from such lease
to the extent of the Mortgagor's proportionate share of the
burden of all' royalties, overriding royalties and other such
payments out of production, (c) the Mortgaged Property is
free from all encumbrances or liens whatsoever, except as
may be specifically set forth in Exhibit A or as permitted
by the provisions of Section 2.5(e) hereof, and (d) the
Mortgagor is not obligated, by virtue of any prepayment
under' any contract providing for the sale by the Mortgagor
of Hydrocarbons which contains a "take or pay" clause or
under any similar arrangement, to deliver Hydrocarbons at
some future time without then or thereafter receiving full
payment therefor. The Mortgagor will warrant and forever
defend the Mortgaged Property unto the Trustees against
every person whomsoever lawfully claiming the same or any
part thereof, and the Mortgagor will maintain and preserve
the lien hereby created so long as any of the Indebtedness
remains unpaid.
2.3 Further Assurances. The Mortgagor will execute and
deliver such other and further instruments and will do such
other and further acts as in the opinion of the Trustees may
be necessary or desirable to carry out more effectually the
purposes of this instrument, including, without limiting the
generality of the foregoing, (a) prompt correction of any
defect which may hereafter be discovered in the title to the




-5-

247
Mortgaged Property or in the execution and acknowledgment of
this instrument, any Note, or any other document executed in
connection herewith, and (b) prompt execution and delivery
of all division or transfer orders which in the opinion of
the Bank are needed to transfer effectually the assigned
proceeds of production from the Mortgaged Property to the
Agent.
2.4 Taxes. Subject to the Mortgagor's right to contest
the same, the Mortgagor will promptly pay all taxes,
assessments and governmental charges legally imposed upon
this instrument or upon the Mortgaged Property or upon the
interest of the Trustees, the Agent or the Banks therein, or
upon the income and profits thereof.
2.5 Operation of the Mortgaged Property. So long as the
Indebtedness or any part thereof remains unpaid, and whether
or not the Mortgagor is the operator of the Mortgaged
Property, the Mortgagor shall, at the Mortgagor's own
expense:
(a) Do all things necessary to keep unimpaired the
Mortgagor's rights in the Mortgaged Property and not,
except in the ordinary course of business, abandon any
well or forfeit, surrender or release any oil and gas
lease or any rights in the Mortgaged Property or enter
into any operating agreement with respect to the
Mortgaged Property without the prior written consent of
the Trustees;
(b) Cause the lands described in Exhibit A to be
maintained, developed, protected against drainage, and
continuously operated for the production of Hydrocarbons
in a good and workmanlike manner as would a prudent
operator, and in accordance with generally accepted
practices, applicable operating agreements, and all
applicable federal, state and local laws, rules and
regulations, excepting those being contested in good
faith;
(c) Cause to be paid, promptly as and when due and
payable, all rentals and royalties payable in respect of
the Mortgaged Property, and all expenses incurred in or
arising from the operation or development of the
Mortgaged Property;
(d) Cause the Operating Equipment to be kept in good
and effective operating condition, and all repairs,
renewals, replacements, additions and improvements
thereof or thereto, needful to the production of




248
6S4
Hydrocarbons from the lands described in Exhibit A, to
be promptly made;
(e) Cause the Mortgaged Property to. be. kept free and
clear of liens, charges and encumbrances of every
character, other than (1) the lien hereof, (2) taxes
constituting a lien but not due and payable, (3) defects
or irregularities in title, and liens, charges or
encumbrances, which are not such as to interfere
materially with the development, operation or value of
the Mortgaged Property and not such as to affect
materially title thereto, (4) those set forth or
referred to in Exhibit A, (5) those being contested by
the Mortgagor in good faith in such manner as not to
jeopardize the Trustees' and the Agent's rights in and
to the Mortgaged Property, and (6) those consented to in
writing by the Trustees; and
(f) Carry in standard insurance companies and in
amounts satisfactory to the Trustees the following
insurance:
(1) workmen's compensation insurance and
public liability and property damage insurance in
respect of all activities in which the Mortgagor might
incur personal liability for the death or injury of an
employee or third person, or damage to or destruction of
another's property; and (2) to the extent such insurance
is carried by others engaged in similar undertakings in
the same general areas in which the Mortgaged Property
is located, insurance in respect of the Operating
•Equipment, against loss or damage by fire, lightning,
hail, tornado, explosion and other similar risks.
2.6 Recording, etc. The Mortgagor will promptly and at
the Mortgagor's expense, record, register, deposit and file
this and every other.instrument in addition or supplemental
hereto in such offices and places and at such times and as
often as may be necessary to preserve, protect and renew the
lien hereof as a first lien on real or personal property as
the case may be and the rights and remedies of the Trustees,
the Agent and the Banks, and otherwise will do and perform
all matters or things necessary or expedient to be done or .
observed by reason of any law or regulation of any State or
of the United States or of any other competent authority,
for the purpose of effectively creating, maintaining and
preserving the lien hereof on the Mortgaged Property.
2.7 Sale or Mortgage of the Mortgaged Property. The
Mortgagor will not sell, convey, mortgage, pledge, or
otherwise dispose of or encumber the Mortgaged Property nor
any portion thereof, nor any of the Mortgagor's right, title




-7-

249
or interest therein. Notwithstanding the foregoing the
Trustees and the Banks will provide the Mortgagor with any
necessary release of the lien granted hereunder on any of
the Mortgaged Property disposed with the consent of the
Trustees. The Trustees and the Banks will provide the
Mortgagor with such release as may be necessary in order to
permit the Mortgagor to perform its obligations to transfer
a lease or an interest therein pursuant to a farmout
agreement, provided that,
(i) the farmout agreement has been entered into in
the ordinary course of business,
(ii) there is no Event of Default or Unmatured
Event of Default (as both those terms are defined in the
Loan Agreement) in existence at the time of the
execution and delivery of the release, and
(iii) the transfer would not, other than in the
absence of this Section 2.7, constitute or create an
event of default hereunder,
(iv) the Mortgagor retains a directly mortgageable
economic interest in such Lease, and •
(v) the Trustees retain a trust and prior lien
over the interest so retained or the Mortgagor has the
legal right to grant, and contemporaneously with the
execution and delivery of the release does grant, a
first and prior lien in favor of the Trustees, for the
use and benefit of the Agent, for the pro rata benefit
of the Banks on the interest so retained.
The Mortgagor will not enter into any arrangement with any
gas pipeline company or other consumer of Hydrocarbons
regarding the Mortgaged Property whereby said gas pipeline
company or consumer may set off any claim against the
Mortgagor by withholding payment for any Hydrocarbons
actually delivered. .
2.8 Records, Statements and Reports. The Mortgagor will
keep proper books of record and account in which complete
and correct entries will be made of the Mortgagor's
transactions in accordance with generally accepted
accounting principles and will furnish or cause to be
furnished to the Banks (a) upon their request, but not more
than once a year, reports prepared by an independent person
or firm acceptable to the Bank concerning (1\ the quantity
of Hydrocarbons recoverable from the Mortgaged Property and
(2) the projected income and expense attributable to the




655

250

65G
Mortgaged Property, (b) quarterly, a report showing, on a
per well basis, (i) condensate yield, (ii) bottom hole
pressures and (iii) surface shut in tubing pressures, and
(c) monthly, a report showing, on a per well basis, (i)
gross pipeline sales information, (ii) average monthly
flowing tubing pressure, (iii) average choke size, (iv)
significant well operating problems, and (v) such other
information as the Banks may reasonably request, and (d)
such other information concerning the business and affairs
and financial condition of the Mortgagor as either Bank may
from time to time reasonably request.
2.9 Ho Governmental Approvals. The Mortgagor warrants
that no approval or consent of any regulatory or
administrative commission or authority, or of any other
governmental body, is necessary to authorize the execution
and delivery of this instrument or of the Notes, or to
authorize the observance or performance by the Mortgagor of
the covenants herein or in the Notes contained, or that such
approvals as are* required have been obtained or will be
obtained promptly.
2.10 Right of Entry. The Mortgagor will permit the
Trustees, the Agent or the Banks, or the agents of any of
them, to enter upon the Mortgaged Property, and all parts
thereof, for the purpose of investigating and inspecting the
condition and operation thereof.
ARTICLE III
Assignment of Production
3.1 Assignment. As further security for the payment of
the Indebtedness, the Mortgagor hereby transfers, assigns,
warrants and conveys to the Agent, for the pro rata benefit
of the Banks, effective as of the date hereof, at 7:00 A.M.,
all Hydrocarbons which are thereafter produced from and
which accrue to the Mortgaged Property, and all proceeds
therefrom. All parties producing, purchasing or receiving
any such Hydrocarbons, or having such, or proceeds
therefrom, in their possession for which they or others are ;
accountable to the Agent by virtue of the provisions of this
Article, are authorized and directed to treat and regard the
Agent as the assignee and transferee of the Mortgagor and
entitled in the Mortgagor's place and stead to receive such
Hydrocarbons and all proceeds therefrom; and said parties
and each of them shall be fully protected in so treating and
regarding the Agent, and shall be under no obligation to see
to the application by the Agent of any such proceeds or
payments received by it.




-9-

251
653
3-6 Indemnity. The Mortgagor agrees to indemnify the
Trustees, the Agent and the Banks against all claims, v
actions, liabilities, judgments, costs, attorneys' fee. or
other charges of whatsoever kind or nature (all hereinafter
in this Section 3.6 called "claims") made against or
incurred by them or any of them as a consequence of the
assertion, either before or after the payment in full of the
Indebtedness, that they or either of them received
Hydrocarbons herein assigned or the proceeds thereof claimed
by third persons, and the Trustees, the Agent and the Banks
shall have the right to defend against any such claims,
employing attorneys therefor, and unless furnished with
reasonable indemnity, they or any of them shall have the
right to pay or compromise and adjust all such claims. The
Mortgagor will indemnify and pay to the Trustees, the Agent
or the Banks any and all such amounts as may be paid in
respect thereof or as may be successfully adjudged against
them or any of them. The obligations of the Mortgagor as
hereinabove set forth in this Section 3.6 shall survive the
release of this instrument.
ARTICLE IV
Events of Default
4.1 Events of Default Hereunder. In case any one or
more of the following "events of default" shall occur and
shall not have been remedied:
(a) the occurrence of an event of default under the
terms and provisions of the Loan Agreement;
(b) any warranty or representation made herein shall
prove to be untrue in any material respect;
(c) failure by the Mortgagor, within thirty (30) days
after notice thereof from the Agent, to cure a default
in the due performance or observance of any covenant or
agreement contained in this instrument and not
constituting a default in the payment of principal of or
interest upon any Note or in the payment of any other
Indebtedness; or
(d) the title of the Mortgagor to the Mortgaged
Property or any substantial part thereof shall become
the subject matter of litigation which would or might,
in the Agent's opinion, upon final determination result
in substantial impairment or loss of the security
provided by this instrument and upon notice by the Bank
to the Mortgagor such litigation is not dismissed within
thirty (30) days of such notice,




-11-

252
then and in any such event the Banks, at their option, may
declare the entire unpaid principal of and the interest
accrued on the Notes and all other Indebtedness secured
hereby to be forthwith due and payable, without any notice
or demand of any kind, both of which are hereby expressly
waived.
ARTICLE V
Enforcement of the Security
5.1 Power of Sale. Upon the occurrence of an event of
default and if such e'^nt shall be continuing, the Trustees
shall have the right Vnd power to sell, to the extent
permitted by law, at one.or more sales, as an entirety or in
parcels, as they may elect, the Mortgaged Property, at such
place or places and otherwise in such manner and upon such
notice as may be required by law, or, in the absence of any
such requirement, as the Trustees may deem appropriate, and
to make conveyance to the purchaser or purchasers; and the
Mortgagor shall warrant title to the Mortgaged Property to
such purchaser or purchasers. The Trustees may postpone the
sale of all or any portion of the Mortgaged Property by
public announcement at the time and place of such sale, and
from time to time thereafter may further postpone such sale
by public announcement made at time of sale fixed by the
preceding postponement. The right of sale hereunder shall
not be exhausted by one or any sale, and the Trustees may
make other and successive sales until all of the trust
estate be legally sold. It shall not be necessary for the
Trustees to have physically present at any such sale, or to
have constructively in their possession, any or all of the
personal proper.ty covered by this instrument, and the
Mortgagor shall deliver all of such personal property to the
purchaser at such sale on the date of sale, and if it should
be impossible or impracticable to take actual delivery of
such property, then the title and right of possession to
such property shall pass to the purchaser at such sale as
completely as if the same had been actually present and
delivered.
5.2 Judicial Proceedings. Upon occurrence of an event of
default and if such event shall be continuing, the
Trustees, in lieu of or in addition to exercising the power
of sale hereinabove given, may proceed by a suit or suits in
equity or at law, whether for a foreclosure hereunder, or
for the sale of the Mortgaged Property, or for the specific
performance of any covenant or agreement herein contained or
in aid of the execution of any power herein granted, or for




-12-

253

660
the appointment of a receiver pending any foreclosure
hereunder or the sale of the Mortgaged Property, or for the
enforcement of any other appropriate legal or equitable
remedy.
5.3 Certain Aspects of a Sale. The Agent or the Banks
shall have the right to become the purchaser at any sale
held by the Trustees or by any court, receiver or public
officer, and the Agent or the Banks shall have the right to
credit upon the amount of the bid made, therefor, the amount
payable out of the net proceeds of such sale to it.
Recitals contained in any conveyance made to any purchaser
at any sale made hereunder shall conclusively establish the
truth and accuracy of the matters therein stated, including,
without limiting the generality of the foregoing, nonpayment
of the unpaid principal sum of, and the interest accrued on,
the Notes after the same have become due and payable,
advertisement and conduct of such sale in the manner
provided herein or appointment of any successor Trustee
hereunder.
5.4 Receipt to Purchaser. Upon any sale, whether made
under the power of sale herein granted and conferred or by
virtue of judicial proceedings, the receipt of the Trustees,
or of the officer making sale under judicial proceedings,
shall be sufficient discharge to the purchaser or purchasers
at any sale for his or their purchase money, and such
purchaser or purchasers, or his or their assigns or personal
representatives, shall not, after paying such purchase money
and receiving such receipt of the Trustees or of such
officer therefor, be obliged to see to the application of
such purchase money, or be in anywise answerable for any
loss, misapplication or nonapplication thereof.
5.5 Effect of Sale. Any sale or sales of the Mortgaged
Property, whether under the power of sale herein granted and
conferred or by virtue of judicial proceedings, shall •
operate to divest all right, title, interest, claim and
demand whatsoever either at law or in equity, of the
Mortgagor of, in and to the premises and the property sold,
and shall be a perpetual bar, both at law and in equity,
against the Mortgagor, and the Mortgagor's successors or
assigns, and against any and all persons claiming or who
shall thereafter claim all or any of the property sold from,
through or under the Mortgagor, or the Mortgagor's
successors or assigns. Nevertheless, the Mortgagor, if
requested by the Trustees so to do, shall join in the
execution and delivery of all proper conveyances,
assignments and transfers of the properties so sold.

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12-745 0—83

17




254
5.6 Application of Proceeds. The proceeds of any sale of
the Mortgaged Property, or any part thereof, whether under
the power of sale herein granted and conferred or by virtue
of judicial proceedings, shall be applied as follows:
First; To the payment of all expenses incurred by
the Trustees in the performance of their duties
including, without limiting the generality of the
foregoing, to the Trustees and expenses of any entry, or
taking of possession, of any sale, of advertisement
thereof, and of conveyances, and as well, court costs,
compensation of agents and employees and legal fees.
Second; To the payment of the Notes and of the
other items of Indebtedness with interest to the date of
such payment.
Third; Any surplus thereafter remaining shall be
paid to the Mortgagor or the Mortgagor's successors or
assigns, as,their interests shall appear.
5.7 The Mortgagor's Waiver of Appraisement, Marshalling,
etc. Rights. The Mortgagor agrees, to the full extent that
the Mortgagor may lawfully so agree, that the Mortgagor will
not at any time insist upon or plead or in any manner
whatever claim the benefit of any appraisement, valuation,
stay, extension or redemption law now or hereafter in force,
in order to prevent or hinder the enforcement or foreclosure
of this instrument or the absolute sale of the Mortgaged
Property or the possession thereof by any purchaser at any
sale made pursuant to any provision hereof, or pursuant to
the decree of any court of competent jurisdiction; but the
Mortgagor, for the Mortgagor and all who may claim through
or under the Mortgagor, so far as the Mortgagor or those
claiming through or under the Mortgagor now or hereafter
lawfully may, hereby waives the benefit of all such laws;
provided, however, that appraisement of any of the Mortgaged
Property located in the State of Oklahoma is hereby
expressly waived or not, at the option of the Trustees, such
option to be exercised prior to or at the time the judgment
is rendered in any foreclosure hereof. The Mortgagor, for
the Mortgagor and all who may claim through or under the
Mortgagor, waives, to the extent that the Mortgagor may
lawfully do so, any and all right to have the Mortgaged
Property marshalled upon any foreclosure of the lien hereof,
or sold in inverse order of alienation, and agrees that the
Trustees or any court having jurisdiction to foreclose such
lien may sell the Mortgaged Property as an entirety. If any
law in this paragraph referred to and now in force, of which
the Mortgagor or the Mortgagor's successor or successors




661

255
662
might take advantage despite the provisions hereof, shall
hereafter be repealed or cease to be in force, such law
shall not thereafter be deemed to constitute any part of the
contract herein contained or to preclude the operation or
application of the provisions of this paragraph.5.8 Costs and Expenses. All costs and expenses
(including attorneys', fees) incurred by the Trustees, the
Agent or the Banks in protecting and enforcing their rights
hereunder, shall constitute a demand obligation owing by the
Mortgagor to the party incurring such -costs and expenses and
shall draw interest at the rate of ten percent (10%) per
annum, all of which shall constitute a portion of the
Indebtedness.
5.9 Sale of the Mortgaged Property in Texas. If any Note
is not paid when due, whether by acceleration or otherwise,
the Trustees are hereby authorized and empowered to sell any
part of the Mortgaged Property located in the State of Texas
at public sale to the highest bidder for cash at the door of
the county courfhouse of the county in Texas in which the
Texas portion of the Mortgaged property or any part thereof
is situated, as herein decribed, between the hours of 10:00
A.M. and 4:00 P.M. on the first Tuesday of any month, after
advertising' the time, place, and terms of said sale, and the
portion of the Mortgaged Property to be sold, by posting (or
by having some person or persons acting for Trustees post)
for at least twenty-one (21) days preceding the date of the
sale, written or printed notice of the proposed sale at the
courthouse door of said county in which the sale is to be
made; and if such portion of the Mortgaged Property lies in
more than one county, one such notice of sale shall be
posted at the courthouse door of each county in which such
part of the Mortgaged Property is situated and such part of
the Mortgaged Property may be sold at the courthouse door of
any one of such counties, and the notice so posted shall
designate in which county such property shall be sold. In
addition to such posting of notice, the Bank or other holder
of the Indebtedness shall, at least twenty-one (21) days
preceding the date of sale, serve or cause to be served
written notice of the proposed sale by certified mail on the
Mortgagor and on each other debtor, if any, obligated to pay
the Indebtedness according to the records of the Bank.
Service of such notice shall be completed upon deposit of
the notice, enclosed in a postpaid wrapper properly
addressed to the Mortgagor and such other debtors at their
most recent address or addresses as shown by the records of
the Banks in a post office or official depository under the
care and custody of the United States Postal Service. The
affidavit of any person having knowledge of the facts to the




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256
effect that such a service was completed shall be prima
facie evidence of the fact of service. The Mortgagor agrees
that no notice of any sale, other than as set out in this
paragraph, need be given by the Trustees, the Agent, the
Bank or any other person. The Mortgagor hereby designates
as its address for the purpose of such notice, the address
set out on the signature page hereof; and agrees that such
address shall be changed only by depositing notice of such
change enclosed in a postpaid wrapper in a post office or
official depository under the care and custody of the United
States Postal Service, certified mail, postage prepaid,
return receipt requested, addressed to the Banks or other
holder of the Indebtedness at the address for the Agent set
out herein (or to such other address as the Banks or other
holders of the Indebtedness may have designated by notice
given as above provided to the Mortgagor and such other
debtors). Any such notice of change of address of -the
Mortgagor or other debtors or of the Agent or the Banks or
of other holders of the Indebtedness shall be effective
three (3) business days after such deposit if such post
office or official depository is located in the State of
Texas, otherwise to be effective upon receipt. The
Mortgagor authorizes and empowers the Trustees to sell the
Texas portion of the Mortgaged Property in lots or parcels
or in its entirety as the Trustees shall deem expedient; and
to execute and deliver to the purchaser or purchasers
thereof good and sufficient deeds of conveyance thereto by
fee simple title, with evidence of general warranty by the
Mortgagor, and the title of such purchaser or purchasers
when so made ,by the Trustees, the Mortgagor binds itself to
warrant and forever defend. Where portions of the Mortgaged
Property lie in different counties, sales in such counties
may be conducted in any order that the Trustees may deem
expedient; and one or more such sales may be conducted in
the same month, or in successive or different months as the
Trustees may deem expedient.
5.10 Operation of the Mortgaged Property by the
Trustees. Upon the occurrence of an event of default and in
addition to all other rights herein conferred on the
Trustees, the Trustees (or any person, firm or corporation
designated'by the Trustees) shall have the right and power,
but shall not be obligated, to enter upon and take
possession of any of the Mortgaged Property, and to exclude
the Mortgagor, and the Mortgagor's agents or servants,
wholly therefrom, and to hold, use, administer, manage and
operate the same to the extent that the Mortgagor shall be
at the time entitled and in his place and stead. The
Trustees, or any person, firm or corporation designated by
the Trustees, may operate the same without any liability to




-16-

6G3

257

GG1
the Mortgagor in connection with such operations, except to
use ordinary care in the operation of such properties, and
the Trustees or any person, firm or corporation designated
by the Trustees, shall have the right to collect, receive
and receipt for all Hydrocarbons produced and sold from said
properties, to make repairs, purchase machinery and
equipment, conduct work-over operations, drill additional
wells and to exercise every power, right and privilege of
the Mortgagor with respect to the Mortgaged Property. When
and if the expenses of such operation and development
(including costs of unsuccessful work-over operations or
additional wells) have been paid and the Indebtedness paid,
said properties shall, if there has been no sale or
foreclosure, be returned to the Mortgagor.
ARTICLE VI
Miscellaneous Provisions
6.1 Pooling and Unitization. The Mortgagor shall have
the right, and is hereby authorized, to pool or unitize all
or any part of any tract of land described in Exhibit A, in
so far as relates to the Mortgaged Property, with adjacent
lands, leaseholds and other interests, when, in the
reasonable judgment of the Mortgagor, it is necessary or
advisable to do so in order to form a drilling unit to
facilitate the orderly development of that part of the
Mortgaged Property affected thereby, or to comply with the
requirements of any law or governmental order or regulation
relating to the spacing of wells or proration of the
production therefrom; provided, however, that any unit so
formed for the production of oil shall not substantially
exceed 160 acres, and any unit so formed for the production
of gas shall not substantially exceed 640 acres, unless a
larger area is required to conform to an applicable law or
governmental order or regulation relating to the spacing of
wells or to obtain the maximum allowable production under
any applicable law or governmental order or regulation
relating to the proration of production therefrom; and
further provided that the Hydrocarbons produced from any
unit so formed shall be allocated among the separately owned
tracts or interests comprising the unit in proportion to the
respective surface areas thereof. Any unit so formed may
relate to one or more zones or horizons, and a unit formed
for a particular zone or horizon need not conform in area to
any other unit relating to a different zone or horizon, and
a unit formed for the production of oil need not conform in
area with any unit formed for the production of gas.
Immediately after formation of any such unit, the Mortgagor
shall furnish to the Trustees a true copy of the pooling




-17

258
agreement, declaration of pooling or other instrument
creating such unit, in such number of counterparts as the
Trustees may reasonably request. The interest in any such
unit attributable to the Mortgaged Property (or any part
thereof) included therein shall become a part of the
Mortgaged Property and shall be subject to the lien hereof
in the same manner and with the same effect as though such
unit and the interest of the Mortgagor therein were
specifically described in Exhibit A. The Mortgagor may
enter into pooling or unitization agreements not hereinabove
authorized only with the prior written consent of the
Trustees.
6.2 Successor Trustees. Any Trustee may resign in
writing addressed to the Bank or be removed at any time with
or without cause by an instrument in writing duly executed
by the Bank. In case of the death, resignation or removal
of a Trustee, a successor Trustee may be appointed by the
Bank by instrument of substitution complying with any
applicable requirements of law, and in the absence of any
such requirement without other formality than appointment
and designation in writing. Such appointment and
designation shall be full evidence of the right and
authority to make the same and of all facts therein recited,
and upon the making of any such appointment and designation
this conveyance shall vest in the named successor Trustee
all the estate and title of the prior Trustee in all of the
Mortgaged Property, and he shall thereupon succeed to all
the rights, powers, privileges, immunities and duties hereby
conferred upon the prior Trustee. All references herein to
the Trustees shall be deemed to refer to the Trustees from
time to time acting hereunder.
6.3 Advances. Each and every covenant herein contained
shall be performed and kept' by the Mortgagor solely at the
Mortgagor's expense. If the Mortgagor shall fail to perform
or keep any of the covenants of whatsoever kind or nature
contained in this instrument, the Agent, the Banks, or the
Trustees or any receiver appointed hereunder, may, but shall
not be obligated to, make advances to perform the same in
the Mortgagor'8 behalf, and the Mortgagor hereby agrees to
repay such sums upon demand plus interest at the rate of ten
percent (10%) per annum or, in the event any promissory note
evidences such indebtedness, upon the terms and conditions
thereof. No such advance shall be deemed to relieve the
Mortgagor from any default hereunder.
6.4 Defense of Claims. The Mortgagor will notify the
Trustees, in writing, promptly of the commencement of any
legal proceedings affecting the lien hereof or the Mortgaged




-18-

259

;

666

Property, or any part thereof, and will take such action,
employing attorneys agreeable to the Trustees, as" way be
necessary to preserve the Mortgagor's, the Trustees* and the
Agent's Banks' rights affected thereby; and should the
Mortgagor fail or refuse to take any such action, the
Trustees,the Agent or the Banks may, upon giving prior
written notice thereof to the Mortgagor, take such action in
behalf and in the name of the Mortgagor and at the
Mortgagor's expense. Moreover, the Agent, the Banks or the
Trustees on behalf of the Banks, may take such independent
action in connection therewith as they may in their
discretion deem proper, the Mortgagor hereby agreeing that
all sums advanced or all expenses incurred in such actions
plus interest at the rate of ten percent (10%) per annum,
will, on demand, be reimbursed.
6.5 The Mortgaged Property to Revert. If the
Indebtedness shall be fully paid and the covenants herein
contained shall be well and truly performed, then all of the
Mortgaged Property shall revert to the Mortgagor and the
entire estate, right, title and interest of the Trustees,
the Agent and the Banks shall thereupon cease; and the
Trustees in such case shall, upon the request of the
Mortgagor and at the Mortgagor's cost and expense, deliver
to the Mortgagor, proper instruments acknowledging
satisfaction of this instrument.
6.6 Renewalsr Amendments and Other Security. Renewals
and extensions of the Indebtedness may be given at any time
and amendments may be made to agreements relating to any
part of such Indebtedness or the Mortgaged Property and the
Banks may take or may now hold other security for the
Indebtedness without notice to or consent of the
Mortgagor. The Trustees or the Banks may resort first to
such other security or any part thereof or first to the
security herein given or any part thereof, or from time to
time to either or both, even to the partial or complete
abandonment of either security, and such action shall not be
a waiver of any rights conferred by this instrument, which
shall continue as a first lien upon the Mortgaged Property
not expressly released until the Notes and all other
Indebtedness secured hereby is fully paid.
6.7 Instrument an Assignment, etc. This instrument shall
be deemed to be and may be enforced from time to time as an
assignment, chattel mortgage, contract, deed of trust,
financing statement, real estate mortgage, or security
agreement, and from time to time as any one or more thereof.




-19-

260
6.8 Limitation on Interest, No provision of this
instrument or of the Notes shall require the payment or
permit the collection of interest in excess of the maximum
permitted by law or which is otherwise contrary to law. If
any excess of interest in such respect is herein or in the
Notes provided for,'or shall be adjudicated to be so
provided for herein or in the Notes, the Mortgagor shall not
be obligated to pay such excess.
6.9 Unenforceable or Inapplicable Provisions. If any
provision hereof or of the Notes is invalid or unenforceable
in any jurisdiction, the other provisions hereof or of the
Notes shall remain in full force and effect in such
jurisdiction, and the remaining provisions hereof shall be
liberally construed in favor of the Trustees, the Agent and
the Banks in order to effectuate the provisions hereof, and
the invalidity of any provision hereof in any jurisdiction
shall not affect the validity or enforceability of any such
provision in any other jurisdiction. Any reference herein
contained to a statute or law of a state in which no part of
the Mortgaged Property is situated shall be deemed
inapplicable to, and not used in, the interpretation hereof.
6.10 Rights Cumulative. Each and every right, power and
remedy herein given to the Trustees, the Agent or the Banks
shall be cumulative and not exclusive; and each and every
right, power and remedy whether specifically herein given or
otherwise existing may be exercised from time to time and so
often and in such order as may be deemed expedient by the
Trustees, the Agent or the Banks, as the case may be, and
the exercise, or the beginning of the exercise, of any such
right, power or remedy shall not be deemed a waiver of the
right to exercise, at the same time or thereafter, any other
right, power or remedy. No-delay or omission by the
Trustees, the Agent or the Bank in the exercise of any
right, power or remedy shall impair any such right, power or
remedy or operate as a waiver thereof or of any other right,
power or remedy then or thereafter existing.
6.11 Waiver by the Trustees. Any and all covenants in
this instrument may from time to time by instrument in
writing signed by the Trustees be waived to such extent and
in such manner as the Trustees may desire, but no such
waiver shall ever affect or impair either the Trustees', the
Agent's or the Banks* rights or liens hereunder, except to .
'
.
the extent specifically stated in such written instrument.
6.12 Action by Individual Trustee. Any Trustee from time
to time serving hereunder shall have the absolute right,
acting individually, to take any action and to give any




*

*

261

668
consent and to exercise any right, remedy, power, privilege
or authority conferred upon the Trustees; and any action
taken by either Trustee from time to time serving hereunder
shall be binding upon the,other Trustee and no person
dealing with either Trustee from time to time serving
hereunder shall be obligated to confirm the power and
authority of such Trustee to act without the concurrence of
the other Trustee.- In this instrument, the term "Trustee"
shall mean the Trustees hereinabove named, or either of
them, as the context requires, and any successor Trustees.
6.13 Successors and Assigns. This instrument is binding
upon the Mortgagor, the Mortgagor's successors and assigns,
and shall inure to the benefit of the Trustees, their
successors, and Agent and the Banks, their successors and
assigns, and the provisions hereof shall likewise be
convenants running with the land.
6.14 Article and Section Headings. The article and
section headings in this instrument are inserted for
convenience and shall not be considered a part of this
instrument or used in its interpretation.
6.15 Execution in Counterparts. This instrument may be
executed in any number of counterparts, each of which shall
for all purposes be deemed to be an origianl, and all of
which are identical except that, to facilitate recordation,
in any particular counterpart portions of Exhibit A hereto
which describe properties situated in parishes or counties
other than the parish or county in which such counterpart is
to be recorded may have been omitted.
6.16 Special Filing as Financing Statement. This Mortgage
and Deed of Trust shall likewise be a Security Agreement and
a Financing Statement and the Mortgagor hereby grants to the
Banks, their successors and assigns, a security interest in
all personal property, fixtures, accounts, contract rights
and general intangibles described or referred to in Granting
Clauses (a) through (f) herein and all proceeds from the
sale, lease or other disposition of the Mortgaged Property
or any part thereof. This Mortgage and Deed of Trust shall
be filed for record, among other places, in the real estate
records of each county in which the oil and gas leases
described in Exhibit A hereto, or any part thereof, are
;
situated, and, when filed in such counties shall be
effective as a financing statement covering fixtures located
on oil and gas properties (and accounts arising therefrom)
which are to be financed at the wellhead of the wells
located on the real estate described in Exhibit A attached
hereto (and accounts arising therefrom).




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262
6.17 Notices. Any notice, request, demand or other
instrument which may be required or permitted to be given or
served upon the Mortgagor shall be sufficiently given when
mailed by First Class Mail, addressed to the Mortgagor at
the address shown beow the signatures at the end of this
instrument or to such different address as the Mortgagor
shall have designated by written notice received by the
Agent, the Banks or the Trustees.
IN WITNESS WHEREOF, the Mortgagor has executed or
caused to be executed this Mortgage, Deed of Trust,
Assignment, Security Agreement and Financing Statement on
the day, month and year first above written.
MORTGAGOR AND DEBTOR
GHK EXPLORATION COMPANY
By GHK Gas Corporation
General Partner
Larry A. Ray

/Larri(/A. Ray
Vice-President
The address of the Mortgagor is:
6441 Northwest Grand Boulevard
Oklahoma City, Oklahoma 73316




22-

661)

263

670
SECURED PARTIES
wV

Lau

£ § / L ' - Cftvallo

Trustee
Wegleitner

kd ^S^i

7

Trusie

CONTINENTAL ILLINOIS NATIONAL BANK
AND TRUST COMPANY OF CHICAGO,
as Aaerit Patrick M. Gq

ATTEST:

'''•-•

• Monique' f Gv^ v a i v N i s p e n
faking" O f f i c e r

The

~.f)

ress of the Secured Parties is:

231 SoutH-.LaSalle Street
Chicago, Illinois ^'-60693
Attention:'"oil and Gas Group
This Instrument Was Prepared By:
Richard S. Brennan, Esq.
Mayer, Brown & Piatt
231 South LaSalle Street
Chicago, Illinois. 60604




-23-

264
STATE OF ILLINOIS
COUNTY OP C 0 0 K

)
)
)

SS.

BE IT REMEMBERED that I , ? rH\ fi t W L a
(v
Notary Public duly qualified, commissioned,
sworn and acting in and for the County and
State aforesaid, hereby certify that, on this
5th day of April 1982, there appeared before
ae severally each of the following persons,
each being either a Trustee or else the
designated officer of the partnership,
corporation or association set opposite his
name, and each such Trustee, corporation and
association being a party to the foregoing
instrument:
Larry A. Ray, Vice President of GHK Gas
Corporation, a General Partner of The GHK
'Company, an Oklahoma partnership, whose address
is 6441 Northwest Grand Boulevard, Oklahoma
City, Oklahoma 73116;
Rdr'uU iA Cro\j
Vice President and
^Aoruc^u^ & V^M AJi?vvwBanklnq Officer, of Continental
Illinois National Bank and Trust Company of
Chicago, a national banking association, whose
address is 231 South LaSalle Street, Chicago,
Illinois 60693; and
n<?r' whose
addresses are 231 South LaSalle Street,
Chicago, Illinois 60693, as Trustees.
OKLAHOMA

Before me on this day personally appeared
the aforementioned persons, to me known to be
the identical persons who subscribed the names
of the respective makers thereof to the
foregoing instrument in the capacities set
forth opposite the names of such persons above,
and each such person acknowledged to me that he
executed the same as his free and voluntary act
and deed and as the free and voluntary act and
deed of the partnership, corporation or
association set opposite his name (or of
himself as Trustee, as the case say be) for the
uses and purposes therein set forth.

TEXAS

Before ae on this day personally appeared
each such person, each of whom is known to ne




!

671

265

672
to be the person whose name is subscribed to
the foregoing instrument, and known to me to be
the designated officer of the partnership,
corporation or association set opposite his
name (or a Trustee, as the case may be) and
each acknowledged to me that he executed said
instrument for the purposes and consideration
therein expressed, and as the act and deed of
••'*\*'}Si'~''
the partnership, corporation or association set ,"•*)*.••"•-'•:{fi,;.
opposite his name (or of himself as Trustee, as /' Qr*. '•.%
the case may be).
~ . ,
/ '. ''#,-• '•<
;
•'0

^ K j j ^ - - ; / V :/:•
<•'"
Notary Public
fy. /
Q:

\>r\ ^c;, /

M commission expires:
y

'••? ^

f.'y Commission Cxpires August 18th. 1S65




2-

y

)^




FAILURE OF PENN SQUARE BANK
THURSDAY, SEPTEMBER 30, 1982
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,

Washington, D.C.
The committee met, pursuant to call, at 9:35 a.m., in room 2128,
Rayburn House Office Building, Hon. Fernand J. St Germain
(chairman of the committee) presiding.
Present: Representatives St Germain, Minish, Annunzio, Vento,
Barnard, Lowry of Washington, Stanton, Hansen, Leach, Weber,
McCollum, and Wortley.
The CHAIRMAN. The committee will come to order.
Yesterday, the committee heard from some of the country's largest and most prestigious banks who fell victim to the Penn Square
trap. This morning the committee's attention turns to yet another
facet of the complex Penn Square mosaic—how Penn Square, often
using the services of money brokers, lured millions of dollars in deposits not from large money center banks, but from comparatively
small credit unions, savings and loans and banks throughout the
country.
Through the final months of Penn Square's existence, and even
up to the last day before the bank's doors were closed, in fact, just
hours before the doors were closed, many small financial institutions were placing funds in this shopping center bank, reassured by
a Peat, Marwick, Mitchell & Co. audit that some have said gave
the bank a "clean bill of health."
So healthy did some find it that they put in sums well above the
insured amounts—in many cases running into the millions of dollars from individual institutions. All told, credit unions alone lost
$111 million in uninsured funds in Penn Square—over 20 percent
of the bank's deposits when it failed. The latest information we
have is that four or five credit unions may require assistance in the
wake of their Penn Square losses, and at least two S&L's have also
encountered serious trouble.
How is it that these relatively small institutions found themselves engulfed by the failure of this bank? In large part these
credit unions found Penn Square through money brokers, the middlemen in the CD market whose fees were paid not by the credit
unions, but by Penn Square. Money brokers are not a new phenomenon. In a world in which volatile money has become a way of life
for some financial institutions, brokers have devised ways to tap
those sources of money that seek the highest rate around. Some of
the practices of these brokers have attracted the attention of Federal regulatory authorities over the last decade, and from time to




(267)

268
time cries have arisen to regulate more closely the activities of
these brokers.
With the demise of Penn Square, those cries have been heard
again. One purpose of today's hearing is to learn more about how
these brokers operate and how they established relationships with
Penn Square and with investing credit unions and S&L's.
The credit unions and the savings and loans we have invited
here today are not being singled out for criticism for their involvement in Penn Square. With so many institutions involved, we
simply have to choose a few to relate to us the story that needs to
be told. We appreciate the cooperation that all these institutions
have shown by appearing here voluntarily today, and by working
with our staff earlier in preparing for this hearing.
In addition, both of the money brokers testifying today, who had
extensive involvement with Penn Square over a period of months,
are appearing voluntarily and we appreciate that.
At this point, I insert in the record a letter I have received from
the National Credit Union Administration describing their assessment of the impact of Penn Square's failure on the credit unions
regulated by NCUA. I also insert a map showing the locations of
federally insured credit unions with uninsured deposits in Penn
Square.
[The material follows:]




269

NATIONAL CREDIT UNION ADMINISTRATION
W A S H I N G T O N , D.C.

2045B

September 2 9 , 1982

Honorable Fernand J . St Germain
Chairman
Committee on Banking, Finance and
Urban Affairs
House of Representatives
Washington, D.C. 20515
Dear Mr. Chairman:
This is in response to your letter of September 22 requesting further
information concerning credit union losses in the Penn Square Bank failure.
pleased to provide the following information.

I am

The latest information indicates that 139 Federal credit unions had uninsured
deposits of approximately $111.5 million in Penn Square. While losses incurred in
Penn Square certainly can contribute to a weakening in financial condition, it is
impossible to attribute the overall financial condition of any credit union which may
need assistance solely to losses resulting from Penn Square. We continue to evaluate
credit union conditions and, at this point in time, it is possible that 4-5 credit
unions with assets of $204 million may require some form of NCUSIF Assistance.
Additionally, we are closely monitoring 12-13 other credit unions with assets of
$534 million which experienced Penn Square losses. However, only 4 of these credit
unions had their classification lowered since the closing of Penn Square and the
remaining 8-9 credit unions were already under a special monitoring classification.
I hope that this information together with certain other information provided to
your staff is responsive to your request.
Sincerely,

E. F. CALLAHAN
Chairman

12-745 0-83

18







! :ri>

-«n»!SS -

had uninauied dapowa m r*

271
Mr. BARNARD. Mr. Chairman, I notice in our folder this morning
there is a chart. I would like to ask staff a question if I might.
The CHAIRMAN. Certainly.
[The chart referred to by Congressman Barnard follows:]
DEPOSITS OF FINANCIAL INSTITUTIONS IN PENN SQUARE BANK

The following information for this chart has been collected from FDIC
documents and-through conversations with FDIC personnel.

Credit Unions
Number paid off
by the FDIC
Total amount
paid out as
•insured deposits

Number receiving
ard claiming FDIC
receiver's certificates
Total amount
of. these receiver' s certificates (uninsured deposits)

Savings and Loans

U35

$^3,3^0,000

1U0*

$107,720,116.30*

43

$U,800,000

U8

$22,U22,5^0.78

Commercial Banks

^9

$U,780,00(T"

^7

$21,1*17 ,186.11

*These numbers reflect credit unions with receiver's certificates of
over $5,000.

Mr. BARNARD. DO I understand this form correctly to say that
there were as many as 435 credit unions with deposits in Penn
Square Bank; 48 savings and loan associations; and 49 commercial
banks?
Mr. HOLLAR. Yes, Mr. Barnard, those figures are correct.
Mr. BARNARD. And the amount of money paid out as insured
funds is $43 million?
Mr. HOLLAR. That is correct. That is the amount already paid out
by FDIC.
Mr. BARNARD. What does the last figure represent?
Mr. HOLLAR. The last figure is the amount of receiver's certificates. Those represent the uninsured deposits.
Mr. BARNARD. $107 million?
Mr. HOLLAR. Yes.
Mr. BARNARD. $107 million? Just to credit unions?
Mr. HOLLAR. That is right.
Mr. BARNARD. $22 million in savings and loans and

in commercial banks?
Mr. HOLLAR. Yes, Mr. Barnard.

Mr. BARNARD. Thank you.
Mr. LOWRY. Mr. Chairman.
The CHAIRMAN. Mr. Lowry.
Mr. LOWERY. May I continue on that?




$21 million

272

But of this $107 million with credit unions, have they received
$107 million in receiver certificates?
Mr. Tow. Yes, that is correct.
Mr. LOWRY. They have received that in receiver certificates?
Mr. Tow. That is a combination of receiver certificates they have
already received, and some claims for receiver certificates as well.
The CHAIRMAN. SO that is not receiver certificates. That is the
total amount, and for some of that they have received certificates,
is that correct? Is that what you are saying?
Mr. Tow. Yes. The vast bulk of that amount has been received.
Mr. LOWRY. IS there a question on some of the claims as to
whether there will be
Mr. Tow. Claims represent a very small portion of the $107 million.
Mr. LOWRY. SO there either is or will be the $107 million.
Mr. Tow. Yes.
Mr. LOWRY. Then they take those receiver certificates and go to
the discount window; is that correct?
Mr. Tow. That is right.
Mr. LOWRY. They get what amount on that?
Mr. HOLLAR. My understanding, Mr. Lowry, is that they can
borrow 90 percent of the 80 percent of face value at which these
certificates are booked. In other words, they could borrow 72 percent of the face value of the receivership certificates at the discount window. I will check with the Federal regulators today and
make sure of those figures.
Mr. BARNARD. Give us a figure then as to what you suggest are
the losses people are going to experience. What will be the total
losses depositors will experience?
Mr. HOLLAR. My understanding is that that has not been determined yet. Evaluation of assets takes a long period of time. For
purposes of booking certificates, on the books of the various institutions, estimates so far have been to value assets at 80 percent of
face value. Of course, that figure eventually could be lower. It
could be higher, too. r
Mr. BARNARD. I w on't belabor the subject right now, but it appears to me that the Comptroller's estimate of necessary capital to
keep this bank going is going to be much greater than the $30 to
$40 million they were talking about.
Thank you.
The CHAIRMAN. Would all four of our first witnesses please
stand. Mr. Sayres, Mr. Loiacona, Mr. Arnold, Mr. Mangan. [Witnesses sworn.] Our first witness this morning is Mr. William J.
Sayres, general manager, IBM Poughkeepsie Employees Federal
Credit Union, Poughkeepsie, N.Y.
Mr. Sayres.




273
TESTIMONY OF WILLIAM J. SAYRES, GENERAL MANAGER, IBM
POUGHKEEPSIE EMPLOYEES FEDERAL CREDIT UNION,
POUGHKEEPSIE, N.Y.; PHILIP LOIACONA, TREASURER AND
MANAGER, BOLLING AIR FORCE BASE FEDERAL CREDIT
UNION, WASHINGTON, D.C.; JOHN ARNOLD, MANAGER, SOUTHWEST CORPORATE FEDERAL CREDIT UNION, DALLAS, TEX.;
AND JOHN MANGAN, EXECUTIVE VICE PRESIDENT, KILLEEN
SAVINGS & LOAN ASSOCIATION, KILLEEN, TEX.
TESTIMONY OF WILLIAM J. SAYRES

Mr. SAYRES. Thank you, Mr. Chairman.
My name is Joe Sayres, and I am general manager of the IBM
Poughkeepsie Employees Federal Credit Union in Poughkeepsie,
N.Y., a post I have held since 1971.
IBM Poughkeepsie Employees Federal Credit Union was chartered in 1963. We are a full-service credit union, with over 100,000
member accounts and assets in excess of $200 million.
While our services are extensive, our primary purpose—as I see
it in the historical perspective of the credit union movement—is to
lend deposits back to our members in the form of loans.
Since any funds that remain idle do not benefit the members, deposits in excess of loan demand are invested to produce additional
income.
The credit unions board of directors has delegated investment
decisions to a committee consisting of the treasurer, assistant treasurer and general manager. We adhere to guidelines set forth by
our board and by the National Credit Union Administration. The
guidelines in effect at the time of our Penn Square investment are
attached to my testimony as addendum 1.
In evaluating investments, it's our practice to: request and evaluate the institution's most recent annual report and financial statements; review various ratios; and look at any increase or decrease
in net worth, net income, deposits, assets, and reserve position.
Prior to using the investment consulting firm of Professional
Asset Management, Inc., we were aware of it and acquainted with
its vice president, William Goldsmith, through: his articles in the
trade press; his authorship of the Investment Manual for Credit
Unions published by the Credit Union Executives Society; and his
participation in numerous conferences, including those of the
League of IBM Credit Unions.
We were also aware that other credit unions were using his services.
In mid-1981 we had begun to receive from Professional Asset
Management complimentary copies of the Capital Adequacy Reports which they published four times a year, as well as market updates in the form of a newsletter to "clients and friends." It was
PAM's policy, as indicated to us, to emphasize safety first; institutions which did not meet their requirements were not even included in the Capital Adequacy Reports.
Those that did were monitored, and their financial reports were
analyzed on a quarterly basis with the resultant data, including
key operating ratios, included in the reports to clients and friends.
This indepth analysis assisted us greatly.




274
Addendum 3 contains representative mailings from PAM. Indications were that Professional Asset Management monitored all
trend areas carefully, following a 5-year trend analysis on key operating figures such as assets, deposits, loans, net worth, and profits of the institution. We also understood that personal visits were
made to these institutions, and since we could not make such visits
ourselves, this factor was instrumental in our decision to use PAM
as an investment adviser.
A PAM update received in mid-1981 advised of two additions to
PAM's list of approved institutions. That is included in addendum
4. It states:
Penn Square Bank, a national bank, has experienced outstanding growth in the
past year with strong indications that this growth will continue.
Located in Oklahoma City, Penn Square has become the leading bank in the
Southwest servicing the oil and gas industry. * * * Its total loan portfolio exceeds
$700 million, usually short term and all indexed to prime. * * * Penn Square acts
as lead bank in joint loan ventures because its prime is normally 50 or more basis
points higher than money center rates. As a result banks like Continental Illinois
will earn more participating with Penn Square than by going it alone.
We are pleased to add these two fine institutions to our list of well capitalized
banks and savings associations.

When Professional Asset Management contacted us in the fall of
1981, we had been experiencing an inflow of deposits, and sluggish
loan activity, along with the previously mentioned reductions in
savings and loan investments, so we were seeking alternative investment opportunities.
We made our first investment in Penn Square Bank on December 4, 1981. The deposit was in the amount of $500,000 for 60 days
at a rate of 13 percent.
At the time of this investment, we had $39 million in our investment portfolio. Addendum 5 outlines our portfolio at the time of
each Penn Square deposit.
In selecting any investment, we generally obtain a minimum of
five bids and then perform an institution comparison based on financial statements and annual reports. At the time of our initial
Penn Square deposit, we had rejected a higher rate from another
institution because we had no statements or annual report on
which to base our decision, nor was it listed in PAM's Capital Adequacy Report.
During the course of the next 6 months, we increased our total
deposits in Penn Square Bank to $3 million. We continued to supplement our own information with that provided by PAM and as
recently as June 10, 1981, Penn Square showed a reserve position
of 8.8 percent and a net worth to average deposit ratio of 9.95 percent.
We, along with many other investors, were completely shocked
at the news of the bank's failure on July 5 of this year, since all
indicators of which we were aware showed it to be a strong financial institution.
Mr. Chairman, I have with me copies of Penn Square's annual
report and financial statements, and a Dun & Bradstreet report.
With your permission, I would like to request that they be inserted
in the hearing record.
The CHAIRMAN. Without objection, so ordered.




275
[The Penn Square Bank Annual Report, 1981, and financial
statements, and the Dun & Bradstreet report referred to above,
follow:]
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276
MEASURES OF OUR GROWTH

Penn Square Bank's top management team. Seated, left to
right: Bill G. Patterson. Senior Executive Vice President Bill P.
Jennings. Chairman and Chief Executive Officer: Eldon L
Seller. President and ChiefAdministrative Officer. Frank L




Murphy. Vice Chairman. Standing
Williams. Ashbum H. Bywaters. R
Wingel Executive Vice Presidents: Robert C. Van Laanen
Harold D. Armstrong and Daniel W. Thompson. Senior VI

Presidents: James J. Cunter. Executive Vice President an<f
John R Preston. General Counsel Top right rendering of
Pennbank Tower. Front cover and bottom right Pennbank
Tower under a

277

5^B




nergetic growth has become a recognized
characteristic of Penn Square Bank over the
past decade. This growth can be measured
in many ways.
Since 1974 assets and stockholders' equity have
increased more than tenfold, while deposits are
more than twelve times their level of eight years ago.
Another measure of our growth has been the
continued expansion of our facilities to
accommodate increased activity and enable us to
continue to provide superior customer service.
Pennbank Tower, now under construction just
east of our present location, is a tangible symbol
that today Penn Square Bank is firmly established
as one of the major banking organizations
in Oklahoma.
Most importantly, managing this growth has
meant broadening and strengthening our
capabilities and services. In 1981, Penn Square
Bank's emphasis has been on people. We have added
to our management strength in every aspect of our
business, creating a depth of experience at the top
management level which is the equal of that found
in institutions many times our size.
Banking in the 1980s will be characterized by the
demand for more sophisticated financial services
and increased competition from many new types of
financial organizations. Penn Square Bank's growth
has meant a corresponding growth in capability,
in the form of both h u m a n and financial resources,
to meet the changing needs of our customers.

E

278
CHAIRMAN'S MESSAGE

he year 1981 may well rank as one
of the most significant periods in
Penn Square Bank's growth. It was a
year of visible progress in many areas.
We reported solid growth in assets, loans
and deposits. An infusion of $7 million
in stockholders' equity greatly strengthened
our capital structure. Earnings increased
10% over last year's record results notwithstanding the high cost of expansion into
temporary facilities, the large increase in
personnel necessitated by our growth, and
the continuation of our policy of maintaining a strong capital position and loan
loss reserve.
We were also able to implement our long
range plans to provide Penn Square Bank
with adequate facilities for future growth.
The 22-story Pennbank Tower began construction at mid-year and is due to be
ready for occupancy in 1983.
Our customer list continues to grow, a
fact we believe attests to the strong reputation for performance Penn Square Bank
has established in the community.
Moreover, we are particularly proud of
the progress we have made in expanding
our h u m a n resources during the past
twelve months. Our continuing objective
is to attract the highest caliber of professionals to our senior management staff and
board of directors. During 1981 this effort
was especially fruitful.

T




Beginning with the election of Eldon
Beller as President and Chief Administrative
Officer of the bank, we have expanded and
strengthened our top management team
with key additions in many areas. The extensive banking experience represented
by these new people gives us a breadth
and depth of knowledge unusual for an
institution of our size.
In looking to the future, we must take
note of the conditions prevailing in our
industry and in the national economy.
Two overriding concerns are continuing
inflation and the national recession which
so far, fortunately, has not seriously
affected Oklahoma's booming economy.
Changing conditions, new banking laws
and regulations have also heightened
competition within the banking industry
and from other financial institutions.

To meet these challenges, our
long range plans for growth are
aggressive, flexible, yet realistic.
We are dedicated to increasing our
capabilities to cope with rapidly
changing technology and the need
for a broader range of more sophisticated services to serve our customers
in the 1980s. We realize that adequate
management of the rapid growth
Penn Square Bank has enjoyed
makes it incumbent upon management to provide the financial
solidarity, the expanded facilities,
the technology and the quality people
who can continue to provide a superior level of services for our
banking customers.

T

XLA^

~~~r

Bill P. Jennings
Chairman

Bill P. Jennings. Chairman
and Chief Executive Officer (left)
and Eldon L Beller. President
and Chief Administrative Officer.




280
GROWING WITH ENERGY

Penn Square Bank's Energy Division serves an excellent
a pioneer in the Deep
group of independent oil producers. Among them: 1. An-Son
co Basin area. 7. Continental Drilling Company
Corporation's Carl Anderson Jr.. center, with other top company
provides contract drilling services. Energy Division executives.
executives, left to right. Ruben Osbom. Fred Standejer.
2. Russell B. Bainbridge. Phil G. Busey James R Karcher




and Gregory A Odean. 3. Seated, left to right Dennis Winget
Bill G. Patterson. Janelle Cates. Standing: Ashbum Bywaters
and Tom Swineford. 5. Janelle Cates. Dewayne Honon. Bill
Kingston. 6. Bill G. Patterson.




281

T

he oil and gas industry continues to be a
major factor in Oklahoma's burgeoning
economy. Currently, one-fifth of all the rotary
rigs active in this country are drilling in Oklahoma.
Oil and gas lending activities have been a prime
source of growth for Penn Square Bank. Our oil
and gas lending division ranks among the most
active in the state. Working in participation with
five of the largest oil and gas lending banks in the
country, and others, Penn Square Bank presently
handles more than $2 billion in oil and gas loans
and commitments.
These loans are originated and monitored by a
staff of more than 80 people, headed by Senior
Executive Vice President Bill G. Patterson. The
customers served by Penn Square Bank represent
one of the strongest groups of independent oil
producers and operators in the Southwest. We
provide these customers with a wide range of
services, including loans on production, drilling
funds, equipment and oil and gas leases.

282
FINANCING THE SEARCH FOR ENERGY

1. Continental Drillingrigin action. 2. Penn Square Bank's
Petroleum Engineering Department Foreground: Lucy Reed
and John Madison. Backgmund, left to right Annie Tegtmeier.




d. Leah Smith. Marilyn Cook. 3. Oil well pumping
lfactured by CMl Corporation, a Penn Square Bank
4. Correspondent Banking. Left to right Randy




283

enn Square Bank works closely with its oil
and gas customers and its correspondent
banks to provide the financing needed to
search out new supplies of energy.
The bank utilizes the most modern monitoring/
evaluation techniques in the banking industry to
evaluate the oil and gas reserves securing these
loans. Its petroleum engineering department
includes two full-time petroleum engineers, plus
engineering assistants. Computer and microfiche
records give this staff access to detailed
information on every producing well in Oklahoma
and eleven surrounding states. Producing wells in
loan portfolios are closely monitored to compare
estimated to actual production.
The Correspondent Banking Department also
is actively involved in this effort. Penn Square
Bank and its large correspondent banks reach dual
credit decisions, in many instances, to provide bank
consortium loans to oil and gas customers.
The bank maintains firm ties to more than 50
banks in Oklahoma and other parts of the country.
These relationships provide Penn Square Bank's
oil and gas customers with access to the capital
resources they need for their exploration and
development activities.

P

284
HELPING BUSINESSES GROW

Among the many businesses Penn Square Bank has helped
grow are several pictured on these pages 1 CMI Corporation,
manufacturers ojheavy roadmaking equipment 2. Jon
Orenstein of Creative Cookery. 3. and 4. Henson Cargill and
his new western showplace. Henson s. S. Mr Center at Wiley




Post Airport Working closely with businesses are these
members of Penn Square Banks staff 5 Phillip E. Foss and
Robert C. Van Laanen. Commercial Loan Department
6. Harold D. Armstrong Commercial Real Estate Department
7. Bill R. Blacksten and Charlcie Guthery. Real Estate and

Construction. 9. Richard T. Dunn and Kobert Williams. Loan
.Administration. 10. John Baldwin, Frankie Bumworth and
Jean Peterson. Loan Administration. 11. Bill W. Coy and Don
Chappell Installment Loan Department

285

|||tiill|iiii||i^

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12-745 0—83

19




:

286
EMPHASIZING CUSTOMER CONVENIENCE

fc Ada Carrtthers, Max Ellis. Gelene Shannon.
2. Financial Services: Ray Hicks. Norma Babb. Jim Cunter.
Arlyn HtlL 3. M. Robert Barton. Operations, and Kim HalL
4. Jerry Pendry. Administrative Services. 5. Tony Williams.




Executive Vice President of Bank Administration. 6. The Motor
Bank's consumer lobby draws many customers. 7. New Accounts:
r,—. c ,„..„ rf n^~ „
,.._ „_^.__ „ .,„_. ,__.

Operations Department 10. Jim Pitts. Co..
Department In background. 11 SusanB
operations.
PaulaTharp

and

287

S

\ ^ifi




uperior service begins by providing customer
convenience. One of our primary objectives is
making sure our customers — companies and
individuals — find it convenient to do business with
Penn Square Bank.
Our motor bank, with its drive-through service and
convenient consumer and commercial lobbies, is one
of our most popular customer areas. We provide a
wide array of services at both our motor bank and main
banking facility.
Recent changes in banking laws have given rise to
many new services for consumers, particularly in the
area of checking and savings accounts. These include
the new Individual Retirement (IRA) accounts, NOW
accounts and All-Savers Certificates as well as regular
savings accounts and certificates of deposit.
The Beep Machine, located at the Motor Bank,
provides automated teller service 24 hours a day,
7 days a week. Customers can withdraw cash or make
deposits or handle other transactions by computer.
Safe deposit boxes, for the storage of valuable papers,
art objects and silver hollow and flat ware, are another
consumer service offered by the bank.
Excellence in customer service begins behind the
scenes, with our operations staff. Currently, our
operations division employs one-third of our total
work force. Automation has played a major role in the
ability of our operations division to provide support
services for banking functions in an efficient manner.
During the past year Penn Square Bank became the
first bank in the state to automate its draft collection
system. We have also increased our transfer capacity
by 100% over the past twelve months.
In the final analysis, however, we know that people
and attitude are the vital factors in providing quality
service. We are proud of the reputation
r employees have established
for prompt and courteous
service to our customers.

288
THE MANY PHASESOF BANKING SERVICES

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s^ss




289

S

erving the needs of our customers takes many
forms at Penn Square Bank.
One important aspect is the full range of
trust and financial advisory services provided by our
Trust Division. This division is headed by two
highly respected professionals, John H. Miller and
Carolyn B. Jonas. The Trust Division provides
financial and estate planning, estate management
investment and management of funds, establish- '
ment and management of many different types of
trusts, pension plans and profit-sharing programs
and many other services for individuals
and businesses.
Another important function is provided by our
Marketing Division. It is this division's task to
anticipate changing customer needs and make new
products and services available. Changing regulations in the banking industry wiU make research
and development of new products and services an
even more important function of banking during
the 1980s. This division also sponsors a series of
financial planning seminars each year, keyed to the
needs of various groups served by the bank. These
have ranged from seminars for businesswomen
to sessions on tax shelters for various professional groups.
Penn Square Bank also becomes involved
in many activities that benefit the
community Among events sponsored by
the bank was a recent Penn Square
Bank Oklahoma Cup tennis match
featuring the Number One ranked tennis
professional, J o h n McEnroe, with a portion
of the proceeds benefiting the Oklahoma
City University tennis program.

290

STATEMENT OF CONDITION
At the Close of Business December 31, 1981 and 1980
(December Daily Averages)
1981

1980

$ 45,075,000
13,111,000
34,397,000
541,000
9,855,000
264,594,000
3,679,000
22,906,000

$ 32.095,000
8.861,000
30,124,000
235,000
8,082,000
197,815,000
2,812.000
8,235,000

$394,158,000

$288,259.000

LIABILITIES
Demand deposits
Time and savings deposits
Total deposits
Federal funds purchased
Other liabilities
Total liabilities

$147,924,000
206,859,000
354,783,000
4,760,000
4,211,000
363,754,000

$107,238,000
151,485,000
258,723,000
7.182,000
1,932.000
267,837,000

STOCKHOLDERS* EQUITY
Capital stock
Surplus
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity

1,000,000
17,516,000
11,888,000
30,404,000
$394,158,000

1,000,000
10,500.000
8.922.000
20.422,000
$288,259,000

ASSETS
Cash and due from banks
U. S. Treasury securities
State and municipal securities
Stock in Federal Reserve
Federal funds sold
Loans, net of reserve
Bank premises and equipment
Other assets
Total assets




I'V^Ai-A \L?.^

291

STATEMENT OF INCOME
Years Ended December 31

1981

OTHER EXPENSES:
Salaries and employee benefits
Occupancy and equipment expense
Other expense
Total other expense

-.

300,000
1,308,000
10,000
283,000
26,551,000

28,807,000
2,949,000
1,132,000
32,888,000
22,559,000
6,343,000
16,216,000

12,820,000
739,000
135,000
13,694,000
12,857,000
1,408,000
11,449,000

1,119,000
370,000
1,489,000

OTHER REVENUES:
Deposit fees
Other operating income
Total other income

$24,650,000

1,597,000
2,204,000
41,000
676,000
55,447,000

INTEREST EXPENSE:
Deposits
Interest on federal funds purchased
Other interest expense
Total interest expense
Net revenue from earning assets
Provision for possible loan losses
Net revenue from earning assets after provision for possible loan losses....

1980

$50,929,000

REVENUE FROM EARNING ASSETS:
Interest and fees on loans
Investment securities:
U. S. Securities
State and municipal subdivisions
Other
Interest on Federal Funds sold
Total revenue from earning assets

687,000
211.000
898,000

5,124,000
1,376,000
4,204,000
10,704,000

2,339,000
619,000
2,383,000
5,341,000

INCOME BEFORE INCOME TAXES AND SECURITIES GAINS OR LOSSES. .
7,001,000
Provision for income taxes
2,295,000
NETINCOME
$ 4,706,000




7,006,000
2,721,000
$ 4,285,000

292

Penn Square Bank Directors, left to rightRow I:Bill P. Jennings. Frank L Murphy,
Eldon L Beller, Bill G. Patterson,
John R. Preston.
Row 2: Richard T. Dunn, Ronald H. Burks,
Elizabeth Merrick Coe, Gary M. Cook,
J. C. Cravens.
Row 3: Richard C. Haugland, Ken L Kenworthy
C. F. "Tag" Kimberling, Marvin K Margo,
H. Mead Norton.
Row 4: James G. Randolph, Jerry Richardson,
W.A "Dub"Ross.
Row 5: Gene Smelser. Bill Stubbs, Carl W. Swan




293

Directors

Officers

Bill P. J e n n i n g s
Chatrman
Frank L. Murphy
Vice Chairman
Eldon L. Beller
President
Bill G. Patterson
Senior Executive Vice President
Richard T. Dunn
Executipe Vice President
J o h n R Preston
Secretary and General Counsel
Ronald H. Burks
Chairman,
Burks Investments. Inc.
Elizabeth Merrick Coe

Bill P. Jennings,
Chairman and
Chief Executive Officer
Frank L. Murphy,
Vice Chairman
Eldon L. Beller.
President and
ChiefAdministrative Officer
Bill G. Patterson,

The Merrick Foundation
Gary M. Cook
Chairman.
Trend Construction Corporation
J.C. Cravens*
Richard C. Haugland
Vice President
Citizens National Bank. Muskogee
Ken L. Kenworthy
Vice President Director
Secretary-Treasurer.
CMI Corporation
C.F. "Tag" Kimberling
Marvin K. Margo, M.D.
McBrlde Clinic. Inc
H. Mead Norton*
President
Norton Investment Co.
J a m e s G. Randolph
President
Kerr-McCee Coal Corporation
Jerry Richardson
President
Dub Richardson Ford, Inc
W A "Dub" Ross
President
Dub Ross Company
Gene Smelser
President
Val Gene's Food Service. Inc
Bill S t u b b s
Real Estate
Carl W. Swan
Independent Oil Producer
•Advlsoiy Director




Executive Vice Presidents
Tony W Williams
J a m e s J. Gunter
Richard T. D u n n
Ashburn H. Bywaters
Dennis Winget

ENERGY DIVISION
Executive Vice Presidents:
A s h b u m H. Bywaters
Dennis Winget

Vice PresidentsRussell B. Bainbridge
Janelle R Cates
Phil G. Busey
J a m e s R Karcher
Gregory A. Odean
it Vice Presidents:
Robert S. Lockard
Randy Allison
Dewayne Horton
Shari L. Mitchell
Rex M. U n d
Banking Ojjlcers:
J a n Stratz
Joy C. Lorance
Diana D. Swift
Sharon Gutierrez
Shirley Turner
ENGINEERING DEPARTMENT
Petroleum Engineers:
Jeff G. Callard
Michael R Gilbert

CORRESPONDENT
BANKING DEPARTMENT
Robert D. Kotarski,
Senior Vice President
Vice Presidents:
Billie J. Dean
Barry A. Rudy
Randal W Smith

COMMERCIAL LOAN
DEPARTMENT
Robert C. Van L a a n e a
Senior Vice President
Vice Presidents:
Phillip E. Foss

INSTALLMENT LOAN
DEPARTMENT
Bill W. Coy,
Senior Vice President
Don R Chappell,
Vice President
COMMERCIAL REAL ESTATE
DEPARTMENT
Harold D. Armstrong,
Senior Vice President
REAL ESTATE AND
CONSTRUCTION
Bill R Blackstea
. Vice President
Charlcie M. Guthery,
Administrative Officer
LOAN ADMINISTRATION
DIVISION
Richard T. Dunn,
Executfue Vice President
Vice Presidents:
J o h n C. Baldwin
Jean A Peterson
Robert J. Williams, Jr.
Assistant Vice Presidents:
Frankie L. Burnworth
Cheryl Lemmon
Loan Review Officers:
Garvin M. Chandler
M. Joseph Vercher
Joseph D. Anselmp
Banking Officers:
Daniel C. Glaspy
Becky L Smith
BANK ADMINISTRATION
DIVISION
Tony W.Williams,
Executive Vice President
OPERATIONS DEPARTMENT
Daniel W. Thompson,
Senior Vice President
J a m e s W.Pitts,
Vice President and Cashier
Vice Presidents:
M. Robert Barton
Tom Harrison
Gelene S h a n n o n

Assistant Vice Presidents:
William M. McBain
Cleda C. Owens
Carol J. Stewart
Max Ellis
Operations Ojjlcers:
Ada Carithers
Corrinna Upton
Shirley A. Vint
Karolyn J. Inman
E. Buddy Mcintosh
JoAnn Callaway
ADMINISTRATIVE SERVICES
Jerry Pendry,
Banking Officer
Michael H. Mahoney,
Operations Officer
Wayne L. Hunteman,
Purchasing Officer

TRUST DIVISION
J o h n H. Miller,
Vice President and Trust Officer
Carolyn B. Jonas,
Vice President and Trust Officer
FINANCIAL SERVICES DIVISION
J a m e s J. Gunter,
Executfue Vice President
Raymond L. Hicks,
Senior Vice President and Controller
Bert Davis, III,
Senior Vice President
Vice Presidents:
Mark T. White
Arlyn C. Hill
MARKETING DIVISION
Linda B. Belt
P E R S O N N E L DIVISION
Elaine Dake.
Vice President
Geraldine Yearley
it Vice President

BUSINESS DEVELOPMENT
DIVISION
Patricia R McFarlin,
Vice President
AUDITOR
Norma L. Babb

GENERAL COUNSEL
J o h n R Preston

294

, JHIC?

";

,n

«*>s»iwt«tf * _ , L . 1 v * " r ; * * ' I W I

-

^

•

:

-

'

^

.

*wreBai\fc A.A
JXIHtt r m * « .




295
^Statement erf Condition „

sv

, -

September 3fcft#r SeiKeoitjer 30.; / " ' p

,s -f. •Jty\±T%ffi-±-J2$*j^' Vi' -

rt»epj
47,000*000 j i ; i . t : j ? r W 0

."

;.';"-^

....

:

3i^-iibS)o'^l:. _
_

'•'.' ,-/fi<Ci 7^-ftp* i ^ ^ i - ^ t * ; * S f c ''
^ G o f y l L C i x i f c {'
^ g ; Chalmwik
j r ; > i , Jerry MctartHa . .

,*,,i. / . ^ ' Investments
M

»

Prtsjdrat" f,,^'

*K-/t *• > l>ib Kjchantiton Ford, Ine,.
<
'
Ick-nt, ,_ -'%i:_J P /, ,; :
Rwi» Company ' i . ':-i-

^ V

H-i*»^- 1 1 ;s--'., f ft| ]

,.

*-%eJ

.t
-Vi-'

Heal Estate

^^.wayvinft'
* • « • - « « - * # £ & # PwakkntV *
KWuaaSEftvfc.*" .^'i'J.'sf. .^Norton fnvrsl




#i- n i.',

.... . Prwklent,v •v-"^'*>»w - „' $ ^ ^

'-"'X^lfi;'''*,,

R«lEstate' r - ' * . . ^ ^ ^ ^ ' ^ ;




Officers:;
i m m g s . ChiU m i an ami Chlrf E \ « ntlve OillCt'C^,
Frank L. Murphy. Vice C2i.il m u t t
t*- •Better, Ilnmidmi and ChiefAdministrattvr Ofllcer v~ 1
P a t t e r s o n , S e n i o r Lxecmive Vfce Fre&ldent --^;: J"'''" ? ''Executive Vies PresklrntsW. Williams L;~
„ James J. Gunter »'• >
ardT.Dunn
Dennis Winget -_ V,:,f, •.
*
I larol d D, Armstrong k
' 7 - * i* 1,
.
V
ENERGY DIVISION
."
<.. f'-uiOTnn. &'nior£*ft-uiJi'rV'<rePnsifbvir \ , r
l>i IIJHS Wlutift. K\cculh>cViccPrc\tti4-ii
•
"" "hi Hiias IXfew11 irhml, JK>«torVu v / "res) tftvi*
- -'
l"Uv f >ra uterus.: It Kunlsndiir ,J.imrsR, Kiirrher

li ti Ihiscy
• ' r
Urti-r [), C'rawloid
AvoLsMrirl'kpPnWt'/tK
cSi^kaiU
....
!>li.irt L MiiHiftl "-_
n !\ AIUMHI
Kf < M. unii ,
ayiie Huiiou
0. Keith McK&ll
v--, *
•
tnMr.n/
t' L<IM;HT
».*l»iwlll

.

Mturon S 1(iuilernu ?. Slililt-vJ Turner ^.
DunlFlC5rrly ' ."",,

i

Engineenng [>epwtjrnem
'
''''*;.' \
It-iroleum h'nQlntviv
' "" ih - '
c .«n.tni
LJa^itli'unv
TemSmnh
jnhii M.idiswa AMLsiant X'ttf i'!fi.(iient
, »
Correspondent Banking Department

kEiix-rLL), Knt2ir>kLStvpjrtr\7ce/Y(?.r<jrnf

Consumer JU>an Department
hiIIW. Cmr- Senior Vice Pmutrnt
iXw i t C h o p r a Vice Resident

J
• ,' ,.. J t a n A. Ptf#f»on
. v .,
r Robertd.WlUtam*. Jr. • \
.. Avsistarif Vto» Presiri^nfts: ' ' -- " " - ; '"'• ^
!• I'rtnklfrUCumvk-orth
• A. Cheryl I r f m i i w n - ^
Jos*|jliD.An5cln*d
-^| ±
^_
•- • ."
IfenfclflsQj?lciera:
J
( * r \ t n M Chanrilnr
Daniel f,:. d w i w
P
M.jQwphVVrchflr
iiccky L. Smith .
BANK ADMIKISTBAIION DIVISION .
Tony W. William*. Execttttue Vice PUAUUfU
OjwrarJtmslDepartjment
J^mes W. nit-s. Vto* President rand Cns/ifrr.
. \
u, '

M. Libert Barton

TomH-imson
Ctlcne Slianiiiui
Avvtsttiiu V l « Prt"tifl<*fitsf
Cleda C. Ovriftte
Cuml J . S i f w a r t
' Max£Ut*
""."-Operations ajjteer*
, - Atla rjirlliief*
K.*foJ>nJ i n n u i i
.'
: Corrtnrwl'pton
E. Kudrtv McliilMh
JoAnnHCaDawiiy
/

_

",„ ':

"; •
J
*
[
)

"!".:.," ' '-' V i,

rwraxDrvisioN
FINANCIAL SERVICES DIVISION
Juinrs J. Gunicr, Ej^rurfw Vl«v ^ r - s ^ ^ u :
'•
Raymond L Htrln. Senior Vice Pmttdrni and Contioticr
-,...
1*«"l "a>1i*. HI, Senior Vide Pm&ldent
, \ ; ^;. J Dantr) W. ITtompson, 9ftj lor Vke President
* •"
Vice Presidents:
Mark T. White
ArlyiiCHlU
TtmW.llkx
waianiM McIteJn,As»«*rnrtiVf4vpit»,WtiU
"

.:- ? / H
Vl
"C'.Vt

Rtrtwrrt L Ol 1 \t t

„ \\

,

,

:

'

" BU&INES* DEVELOPMENT DIVISION
Palfici* R. McFarflJt Vk* Ptvsldeni

Jerry L Ford

REAL ESTATE DIVISION
Conrixicrcial Real Estate Department
' "i*^
ruld D. ArrnfUmng, CxFCufdw l^H* ftifflMden* ,,,,
Real E s t a t e «jitt Construction
nillRBli*rkstm.VJf**prrslrf«'ri*
"

KrtihKing,SartWnfl(>|fi<r*f. ,: .. . ,.,;;.
MARKKTDia DIVISION •"'_'.
" \ ' 1

UnOnB,^cKVUye
President
PHRBOKNEL DIVHUON
~
hUdin* llak*. View fITstdent
Oraisiirfce Vmrbv A * s ^ a n l Vi«- iT«*s(dent

Industrial and Leasing Department
. 11 n m« m

AdmlnlAtnuive S e r v i c e s
Officer
Jrrty fVmlry. Lkmktttg ami ikvuntij
W^yn*UHuimMna«,^4rchiJta[n^Q//[ J LVf

J o h n H Miller. Vice President aiul Ttust Officer
Canrijn B Jonna. V'U* Presided attd
ThxstOjIlcer

h

\ ice PtcMtlcitS:
"•' r
can
flurry A. Hudv
R.Jiitial W Smllti4,
K. .Un Kiser. Assistant Vtre 1 Vsfdeni.
,, , ;.. ^
COMMERCIAL LOAN DIVISION
';' "l" i
ti<rJi.«d T Dunn. EM*jifil* Virr Pnrsfeteni: , • , _ , / ' ' '
Metropolitan Drpaitisient
»\tft\G,V,\nUimrn.StwlarVtt&
President ,
l'iren»iamftf
Phillip JC Few*
D, Patrick Wk< oy Hubert T U1I11& A-vSfsfcmi v/n? /"ri»sid*»nf

* LOAN ADMINISTRATION DIVISION '-"-- . >•
• :-- •i:>hnC.Ha|dwiaV(r*Jfa*fctenf'
- : - >,,, tU>Pi^^Hetaklbefg,t<wnA«tmtni5lpaf(.>ot)flic3i?r; /..,±

First Quarter v.;;? * ^ ,

jamrrma
Niiftna L Babh.Ai*sJlft»r
r r a n m U Oray, Aurfiting Offtor
""

OEKKRAL COUNSEL
Jrfm I t Preston
"'
RlitumTJ Fbrfthre. Awifeirinr ''

"

Pem\ Square Bdi\k.




^'.T^.^w

i**£»*

Directors

j ^ '•:;• I ^Statementx)f Coiuiitiorrtjg
:^r \ Mthe Close of Business March 31* 1962 and Mureh'ai, lOSl
L

Frank L, Murphy ' y.£ ; ; r ' "!
Wrw* i^ruiff man ?'"^.-i ••
_""
EJtlon I* Ucikx S. •„ :" * "*
*•"

_jjr-*^.. =.."«&;

r.\'' - -•

Hill Ct Patterson
"
hrMiorj^TwtfivVktf Piws!d«'n( ;
Richard T, Dunn *
> •*

Roiultl H, Butks
I tin hi /;jiW"s."wnt5. Ina ,KliubrihMcnirkCuc '
>".••...(. rtt

' '

I hr Mftnt k FtfuniUHwn
I'mry M. (Nw»k
i 'lH(rrtM J H

Th'iui i'.»n»fturf(™i {Ifpiwui/ttMi
J. ('. rism-Ht*
iniv«m"-i:s
v
Kiohard (\ fM;u>tand
vu f l'ict,.i. -r.
< "(ff?f -is StUi.mat Dank. M'ih*i*(tv
Km L, Kr-nwiHihy
S*'. ir» £i.j f"( u-sufc.
f.*.fU"-rjHi-j'r-j'.

;'

/:•

IL Mr.id Sumin*
\,:wn

I'uv M.I.»"M( f>i

.."« v.

:

s
\
• ^ - - i«»a=

crr"

Cahh iintl due from banks . . . . . . , . , . , . , .
U. 5. Trc.isury MVtiritieft
t
Slate and municipal securities
S*i>ek In Fedend Reserve.
" I^Kins. nt-t ill r c - w r v c . . . . , . . • , . . , . . . " , . .
Bank premises and equipment,,,
Other assets
,
*...».......

r - - -

.

^}A •'^'••- -

- T2" eT ^"-'•196\

8 3«f726.OO0
S 30,7**4.0tH>
I4.024.OOO ,
/ 13,04UXX>
32 t 9O3.0OO '""»--s
34,067.01X1
600,000 34rj.(XX*
- 323,475,000
21**,5J43.1XX)
4,091.OOO -,
3,073.fXXl
, 22,672,000
_il.32*.>,0U0

*"
"

Total a-ssets.

S 4 36,491.POO

S311,Sb2.orm

to
I4ABILIT1E8

• %.- .

UedundDriH^tu
Time and w i n g * Mvpovitj,

Tm,»j d e b i t s

Jdm<"<> <.; K^iulotpti

Ti-

\-

1-"»
•«*

ASSETS

John R. P m t o n

D o^g^y- '&:$&
w

»,

Frdpral funds jiurt ha^ed. ,
. OUirr liabilities
Toui IiaUiliues

.'^
,,,.

;;

-

;

_ . .
f

t

;

,,,;.7;..,..,.,.,., ^
; , , . ...„.-;;„. \..'.t\\\\'t\
",.,

$127,281,000
262.757,000

aso.oas.ooo
\\\\

9 ©5^ ( V>Q
H^OOO
403.440,000

I**,".272 0(H)
271A.474 0(H)
fi.20i).ihXJ
_ _ 4,6J'J.0tKj
2O0..ii:UMi

J'". •.!..'. r t .

LI*TIV Ktrhanfenn
frt\Ui,
V
^L.ijM'.. t-L.;iLv,rt T u f l l / ' i

Gem1 Systrlser
V"<i tn'':t1si'-nvi.<|i*-T'f-f' fist'.
HiJ) S t i l t s
Wcn( f \uifc
Cart W. Swim
*.«L<tM«-U ! > ! • « » *

STOCKHOLDER'S EQUITY
<.^*piial stock
Sur[>hm
KeuutHtf Miniiit^s

,..,....

T*it*il stockholder's equiry.
Total liabilities a n d s t o c k l i o l d e r i equity. . , , , , * . „ , , , , , . .

10.000,000
10,000,000
__ 1 3 . 0 5 1 , 0 0 0
3:1.031.000
S 4 3 0 , ,49l_,000

l.OtXMKio
lO.ruVi.tMH.1
ai/jiow.tKX)




Dun&Bradstreet
DATE

The
051 TJ Dun & Bradstrcct Corporatioi

07/27/82

NET INTEREST INCOME:

NN SQUARE BANK NA

PREPARED FOR

19 PENN SQUARE

SUB: 000-00000

,

18,826,000

J HOFFMAN

EQUITY:

31,597,000

LAHOMA CITY

OK

73118

IND. ASSETS:

RST PENH CORPORATION

100 MIL. - 1 BIL.
FISCAL
STATEMENT FIGURES ARE IN THOUSANDS

NS 00-486-8659
C

/

DEC. 31, 1981 (1601 ESTAB.)

6020

7. CH.

ARTED 1960
PLOYS

FISCAL

7.

46.7

IND.

^

FISCAL

STATEMENT FIGURES ARE IN THOUSANDS

STATEMENT FIGURES ARE IN THOUSANDS

DEC. 3 1 , 1980 (1418 ESTAB.)

7.

7. CH.

7.

DEC. 3 1 , 1979 (1258 ESTAB.)

IND.

7.

7.

IND.

7.

246

SH * EQUIVALENT

87,465

18.1

11.8

59,626

110.9

18.3

11.3

25,818

16.1

11.3

CURITIES

48,056

12.7

9.9

26.5

42,627

85.5

13.1

26.9

22,983

14.3

25.5

DERAL FUNDS SOLD

53,000

231.3

10.9

5.6

16,000

999.9

4.9

5.4

1,100

0.7

4.7

270,944

37.6

55.9

51.5

196,925

86.1

60.4

105,793

65.9

54.7

XED ASSETS

3,803

55.5

0.8

2.1

2,445

27.6

0.8

2.0

1,916

1.2

2.0

HER ASSETS

21,221

159.9

4.4

2.5

8,166

184.9

2.5

2.1

2,866

1.8

1.8

TAL ASSETS

484,489

48-ZTV

100.0

100.0

325,789

103.0

100.0

100.0

160,476

100.0

100.0

MAND DEPOSITS

234,689

64.5

48.4 •

22.8

142,682

80.0

43.8

27.6

79,270

49.4

29.6

ME ft SAVINGS DEP

213,085

34-2

44.0 •

61.4

158,164

126.0

48.5

57.7

69,978

43.6

56.0

-9 0 0
4,218
31,597

9.0
-7
54.

0.9
-5
6.

0.1

104.6
128.5

-2
1.
6.3

0.1

7.3

-6 5 0
3,871
20,422

7.3

-4 0 0
1,892
8,936

-2
1.
5.6

TAL LIAB ft EQUITY...

484,489

48-2

100.0

100.0

325,789

103.0

100.0

100.0

160,476

100.0

100.0

TAL EARNING ASSETS..

376,925

T LOANS

REIGN DEPOSITS
D FUNDS PURCHASED...
AB-BORROWED MONEY...
HER LIABILITIES
BORD NOTES ft DEBENT.
UITY CAPITAL

38.5

0.2

5.6
0.5
1.9
0.4

62.5

0.2

• 52.3

4.6
0.8
1.5
0.4

255,562

0.2

0.2
4.1
0.9
1.7
0.4
7.1

129,876

LOAN SCHEDULE
AL ESTATE LOANS

50,805

39.2

72.6

(^j?",116~) ( ^ 2 7 . 6 ) C. 68.3 '. ?

MMERCIAL LOANS

29,433

111.5

14.9

39.3

13,917

13.2

39.3

37.0

145,755

94.0

74.0

35.2

75,123

71.0

33.4

28.2

17,232

16.3

30.3
1.7
3.6

NSUMER LOANS

20,628

54.2

"~7.6 •

26.4

13,375

(22.4)

6.8

HER LOANS.

20,658

74.6

7.6

1.8

11,834

388.4

6.0

1.6

2,423

2.3

(-)...

2,122

44.6

0.8

3.3

1,467

(22.8)

0.7

3.4

1,900

1.8

LOW FOR POSS LOSS(-)

4,141

106.5

1.5

1.1

2,005

100.1

1.0

1.1

1,002

0.9

1.1

270,944

37.6

100.0

100.0

196,925

86.1

100.0

100.0

105,793

100.0

100.0

EARNED INCOME

/MICH D U N e. B R A O S T R E E T . INC

I




DUNS I
• FINANCIAL I

Dun&Bradstreet
DATE

07/27/82

N SQUARE BANK NA
STATEMENT FIGURES ARE I N THOUSANDS

9 PENN SQUARE
AHOMA CITY

STATEMENT FIGURES ARE IN THOUSANDS

DEC. 3 1 , 1 9 8 1 ( 1 6 0 1 ESTAB. )

73118

(

X CH.

X

STATEMENT FIGURES ARE IN THOUSANDS

DEC. 31, 1980 (1418 ESTAB.)

IND. V.

•/. CH.

X

DEC. 31,'1979 (1258 ESTAB.)

IND.

V.

V.

I N D . y.

INCOME

56,952

107.5

100.0

100.0

27,449

116.3

100.0

100.0

12,689

100.0

100.0

INTEREST INCOME**.

18,826

33.0

33.1

39.1

14,151

96.6

51.6

45.4

7,199

56.7

49.6

i FOR LOSSES (-)...
V

6,343

350.5

11.1 •

2.1

1,408

128.9

5.1

2.4

615

4.8

I-INTEREST INCOME...

7,443

728.8

13.1 '

6.2

898

98.7

3.3

6.9

452

3.6

7.2

I-INTEREST EXP (-)..

10,702

100.4

18.8

26.9

5,341

75.6

19.5

30.6

3,041

24.0

32.9

(15.7)

4.0

1.5

2,721

155.7

9.9

2.2

1,064

8.4

2.7

AL OPERATING

2.5

:ES ( )
-

2,295

ONE BEFORE SEC G/L.

4,725

10.3

8.3

8.3

4,285

110.2

15.6

9.9

2,039

16.1

11.1

4,725

10.3

8.3

7.8

4,285

lll-I

15.6

9.7

2,030

16.0

10.9

1,050

250.0

1.8 '

3.2

300

7.1

1.1

3.5

280

2.2

3.8

MED

LQ

INCOME
'IDEUDS

(4,206)

' CHARGE-OFFS

(405)

2,204

TAX. EQUIV. ADJ

(240)

1,294

7. CH.

UQ

MED

LQ

892

'/. CH.

UQ

MED

UQ

LQ

IOS
SOLVENCY

©

3,2

8.1

7.1

6.2

6.3

12.5

8.0

6.9

6.0

IITY TO LOANS

11.7 \

12.5

11.4
68.5

16.2

13.3

11.3

8.4

15.1

12.5

10.5

(7.6)

13.6
61.7

23.8

60.5

16.8
54.9

10.4

vNS TO DEPOSITS

65.5

(7.6)

55.7

62.2

67.9

70.9

58.1

64.9

70.5

vNS TO ASSETS

55.9

(7.5)

45.6

52.3

58.2

60.4

(8.3)

47.2

53.1

58.6

65.9

49.7

56.0

61.0

(9.1)

4.3

4.4

IITY TO ASSETS

7.0

6.2

5-6

8.0

EARNINGS QUALITY
•2.0

: INCOME
iRHEAD
iRATING EFFICIENCY..

?

iQ.7

5.9

5.1

5.5

0.0

5.8

5.0

4.4

5.5

5.6

4.9

^400.0

1.0

0.7

0.5

0.4

33.3

1.0

0.7

0.5

2-3

0.9

0.6

33.3

5.0

" INTEREST MARGIN...

2.8

3.4

4.2

2.1

(8.7)

2.7

3.3

4.1

2.3

2.7

3.2

3.9

14.6

51.5

59.8

67.7

15.5

(10.6)

51.5

58.5

65.4

39.Z

51.4

58.0

64.1

0.5

0.4

LOAN QUALITY
I-6t

700.0

0.2

0.3

0.5

0.2

0.2

0.3

0.2

0.1

0.2

0.4

)V FOR LOSS/LOANS...

2-3'

£28.6

0.2

0.4

0.6

5-2

16.7

0.2

0.4

0.6

0.6

0.2

0.3

0.5

.OM FOR LOSS/LOANS..

1-5 •

50.0

1.2

1.0

0.9

1.0

11.1

1.2

1.0

0.8

0.9

1.2

1.0

0.6

r CHARGE-OFFS/LOANS.

f

0.0

PROFITABILITY
TURN ON ASSETS

1.0

0.7

1-3

0.0

1.2

1.0

1.2

1.0

TURN ON EQUITY

15.0

(28.6)

16.5

13.1

9.8

21.0

(7.9)

16.3

13.4

10.9

22-8

16.0

13.7

11.5

/IDEND PAYOUT

22-2

217.1

24.7

37.0

51.9

Z-fi

(48.9)

23.3

34.0

45.4

13.7

23.9

33.2

43.4 I

. I P M V P O N COMPILED FR(

(23.1)

1.2

0.9

0.7

1-3

0.8

300

Mr. SAYRES. Since July, we have tried to reconstruct what happened and why. And we have tried to determine how to avoid the
recurrence. Personally, I cannot help but feel that the Federal
agencies were remiss in allowing Penn Square to perform business
as usual.
We now understand that the Office of the Comptroller of the
Currency warned Penn Square as early as 1980 that the bank
lacked sufficient capital and liquidity, had loan problems, and had
violated banking laws. And in June 1981 the Federal examiners apparently uncovered $40 to $50 million in loan losses—enough to
wipe out the bank's capital and render it insolvent. Why was this
allowed to continue?
I believe that banks should be required to include a schedule of
delinquency as part of their financial statement. When a bank is
diagnosed as a troubled institution, it should be required to generate more frequent reports to the appropriate agencies and it should
not be permitted to accept deposits in excess of the insured limits.
Since Penn Square, we have supplemented our previous information sources such as Merrill Lynch and our Corporate Central with
the Dun & Bradstreet report. The investment committee has also
lowered the ceiling on new certificates of deposit with other financial institutions from $3 million to $1 million, with the exception
again of Empire Corporate Central.
The committee also recommended, and the board established, a
special reserve account as a "reserve for loss contingencies," with
10 percent of investment earnings transferred into it quarterly
until it totals 5 percent of our investment portfolio. This is in addendum 7.
While this will reduce our exposure, I am still concerned that
even with the knowledge of Penn Square's failure, when I look now
at the information available to me then I have to conclude that I
would make the same investment. There was nothing conclusive
even in the D&B report to point to the collapse. How, then, can we
invest with safety and certainty?
If I apply more rigid standards to current ratings, even our largest banks don't look secure. Even a credit union as large and sophisticated as ours cannot perform the intensive studies required
to reveal critical weaknesses in these institutions. I have to conclude therefore that the kind of information available to the regulatory agencies and Comptroller of the Currency must be made
available to potential investors in some form to help us assess a
bank's strength and help us make a more informed investment decision. It is not only the stability of my credit union that concerns
me, but the stability of the entire economic fabric of this country.
Thank you, Mr. Chairman.
[Mr. Sayres' prepared statement on behalf of the IBM Poughkeepsie Employees Federal Credit Union, and the referred-to addenda and other pertinent material follow:]




301
Testimony
of
William J. Sayres
Thank you, Mr. Chairman.
My name is Joe Sayres, and I am General Manager of the
IBM Poughkeepsie Employees Federal Credit Union in Poughkeepsie, New York, a post I've held since 1971.

I joined

the credit union as Office Manager in 1968 following ten
years with Beneficial Finance.
I also serve as an Assistant Treasurer of the credit union
and am a member of the Investment Committee.
The credit unions represented here today differ in size
and services, so I'd like to give you a thumbnail sketch of
our organization to help you put us in perspective.
IBM Poughkeepsie Employees Federal Credit Union was
chartered in 1963 to serve employees and retirees of IBM
Corporation in Dutchess County NY, and the members of
their families.

Approximately 80% of our membership is

concentrated in Dutchess and the four surrounding counties.
Currently we have over 100,000 member accounts and
assets in excess of $200 million.
We are a full-service credit union, offering regular share
accounts, share drafts, trust and custodial accounts, five
different types of certificates, Individual Retirement Accounts,
ATM service and supermarket banking centers, and a wide range
of loans, including secured 'and unsecured consumer loans,
first and second mortgages, five different education loans,
and VISA.

We also offer a range of supplementary services such

as money orders, travelers checks, consumer literature and
free educational seminars.

12-745 0—83

20




302
While our services are extensive, our primary purpose, as
I see it in the historical perspective of the credit union
movement, is to lend our deposits back to our members in the
form of loans for "provident and productive purposes."

Since

any funds that remain idle do not benefit the membership,
deposits in excess of loan demand are invested to produce
additional income.
The credit union's Board of Directors has delegated investment
decisions to an Investment Committee comprised of the Treasurer
and Assistant Treasurer (both directors) and the General Manager,
who also serves as an Assistant Treasurer.

The Investment

Committee adheres to guidelines set forth by the Board of
Directors and the National Credit Union Administration.
The guidelines in effect at the time of our Penn Square
investment are attached as Addendum 1.
The Investment Committee has further delegated certain
responsibilities to the General Manager for action on a daily
basis or as required.

These include the movement of monies

in and out of day-of-deposit to day-of-withdrawal accounts,
and the investment or renewal of certificates-of-deposit to
a maximum aggregate of $3 million at any one institution with
the exception of Empire Corporate Central Federal Credit Union.
To justify this exception, the investment policies of Empire
Corporate Central and the purpose of the U.S. Central are
included as Addendum 2.
In evaluating any prospective investment, it is our practiceto request the institution's most recent annual report and
financial statement, review various ratios, and look at any




303
increase or decrease in net worth, net income, deposits, assets
and reserve positionJust prior to our involvement with Penn Square Bank, in the
latter part of 1981, we were scaling down our investments in
Savings-and-Loan Associations because of their widely publicized
instability, and we were attempting to diversify our investment
portfolio.
We were, at this time, aware of the investment consulting firm
of Professional Asset Management Inc. (PAM) and acquainted with
its Vice President, William Goldsmith, through his articles in
the trade press, his authorship of the Investment Manual for
Credit Unions which was published by the Credit Union Executives
Society, and his attendance at and participation in numerous
conferences, including those of LICU—the League of IBM Credit
Unions.

We were also aware that other credit unions, some of

them within LICU, were using his services.
In mid-1981 we had begun to receive from Professional Asset
Management complimentary copies of the Capital Adequacy Reports
which they published four times a year, as well as market updates
in the form of a newsletter to "clients and friends."

It was

PAM's policy, as indicated to us, to emphasize safety first;
institutions which did not meet their requirements were not
even included in the Capital Adequacy Reports.

Those that did

were monitored, and their financial reports, were analyzed on a
quarterly basis with the resultant data, including key operating
ratios, included in the reports to clients and friends. This
in-depth analysis assisted us greatly.
Addendum 3 contains representative mailings from PAM.




304
Indications were that Professional Asset Management monitored
all trend areas carefully, following a five-year trend analysis
on key operating figures such as assets, deposits, loans, net
worth, and profits of the institution.

We also understood that

personal visits were made to these institutions, and since we
could not make such visits ourselves, this factor was instrumental
in our decision to use PAM as an investment advisor.
In issuing their Capital Adequacy Reports and market updates,
PAM stated that they had a commitment to offer certificates-ofdeposit from solid performers with capital adequacy far above
minimum regulatory requirements.

One update, which we received

in mid-1981, advised of two additions to PAM's list of approved
institutions, one of which was Penn Square Bank.

That mailing

included a report indicating that Penn Square had increases
from 5/31/80 to 5/31/81 of 89% in assets, 68% in earnings,
88% in deposits, and 148% in capital, with a net income-increase
of 65%. A copy of that mailing is included as Addendum 4, and
it states that "Penn Square Bank, a national bank, has experienced
outstanding growth in the past year with strong indications
that this growth will continue.
"Located in Oklahoma City, Penn Square has become the leading
bank in the Southwest servicing the oil and gas industry
Its total loan portfolio exceeds $700 million, usually short term
and all indexed to prime

Penn Square acts as a lead bank

in joint loan ventures because its prime is normally 50 or more
basis points higher than money center rates. As a result banks
like Continental Illinois will earn more participating with
Penn Square than by going it alone.




305
"We are pleased to add these two fine institutions to our list
of well capitalized banks and savings associations."
When Bill Goldsmith of Professional Asset Management contacted
us in the Fall of 1981, we had been experiencing an inflow of
deposits,and sluggish loan activity, along with the previously
mentioned reductions in Savings-and-Loan investments, so we were
seeking alternative investment opportunities.

Based on his

recommendations and information provided by PAM, including the
indicators appearing on the Capital Adequacy Report, we made
our first investment in Penn Square Bank on December 4, 1981.
The deposit was in the amount of $500,000 for 60 days at a rate
of 13%.
At the time of this investment, we had $39 million in our
investment portfolio, the balance of it distributed as follows:
$14.5 million (38%) in Savings-and-Loans, $3 million (8%) in
other commercial banks, $9 million (23%) in Empire Corporate
Central FCU.
Addendum 5 charts our deposit history with Penn Square Bank
and provides this dollar and percentage breakdown from our first
investment on December 4, 1981 to our last on June 18, 1982.
In selecting an investment, we generally obtain a minimum of
five bids and then perform an institution comparison based on
financial statements and annual reports.

The Investment Committee

guidelines require investment at the highest rate provided all
other criteria have been met; when the highest rate is not
selected, an explanation is required.




306
In the case of our December 4, 1981 deposit with Penn Square,
we had obtained seven quotes.

The 13% quote from Penn Square

considerably exceeded local institutions but was lower than that
from Southern California Savings, which quoted 13.75%.

We took

Penn Square over Southern California because we did not have
sufficient financial data on the latter on which to base a
decision; that is, we had no annual report or financial statements, nor was Southern California Savings included in. BAM-1-s—
Capital Adequacy Report.
During the course of the next six months we increased our
total deposits in Penn Square Bank from the initial $500,000
to an aggregate of $3 million, with the final investment in
the amount of $500,000 made on June 18, 1982 for 180 days at
15-1/8%.

Addendum 6 represents copies of the bid sheets for

every investment made at Penn Square Bank, reflecting the
comparative rates at all institutions contacted on the date of
investment.
During the period of December 4, 1981 through July 5, 1982,
the date on which Penn Square was closed, we had continued to
supplement our own information with that provided to us by
Professional Asset Management.

There were no indications

that the bank's financial position had changed as late as June
10, 1982, when it showed a reserve position of 8.8% and a net
worth to average deposit ratio of 9.95%.
We, along with many other investors, were completely shocked
at the news of the bank's failure on July 5 of this year, since~
all indicators of which we were aware showed it to be a strong
financial institution.




307
At that time and in the intervening months we've asked the
same questions that prompted you to hold these hearings:
"What happened and why? How can a recurrence be avoided?"
Personally, I can't help but feel that the federal agencies
were remiss in allowing this bank to perform business-as-usual
when other indicators available to them showed that it was in
trouble.

We now understand that the Office of the Controller

of the Currency warned Penn Square as early as 1980 that the
bank lacked sufficient capital and liquidity, had loan problems,
and had violated banking laws.

And in June 1981 the federal

examiners uncovered $40 to $50 million in loan losses—enough
to wipe out the bank's capital and render it insolvent.

Why

was Penn Square permitted to continue perpetuating its problems
with funds attracted from institutions like IBM Poughkeepsie
Employees Federal Credit Union?
I believe the system that allowed this to happen needs some
improvements.

Banks should be required, for instance, to

include a schedule of delinquency as part of their financial
statement, and when a bank has been diagnosed as a troubled
institution, it should not be permitted to receive deposits
in excess of the insured limits; there should also be more
frequent reports generated to the appropriate agencies, and
if an investor goes beyond the insured limits

data should be

provided with sufficient indicators to reveal that the bank
has problems.
Since Penn Square's failure, we have supplemented our previous
information sources such as Merrill, Lynch and our Corporate
Central with the Dun & Bradstreet Report to provide additional




308
data on which to base investment decisions. Also, our Investment
Committee has lowered the investment ceiling on new certificatesof-deposit with other financial institutions from $3 million to
$1 million, with the exception again of Empire Corporate Central.
The committee also recommended, and the Board established, a
special reserve account as a "Reserve for Loss Contingencies,"
with 10% of investment earnings transferred into it quarterly
until the account total represents 5% of our total investment
portfolio.
Addendum 7 documents these changes.
A primary concern of mine is that, even with the knowledge
of Penn Square's failure, when I review now the information
that was available to me then, I have to conclude that there
was nothing definitive to point to the coming collapse.

Even

the Dun & Bradstreet Report on Penn Square, which I obtained
following the bank's failure, presented no conclusive evidence.
Mr. Chairman, I have with me copies of Penn Square's annual
report and financial statements, and the Dun & Bradstreet Report
on Penn Square, and with your permission I'd like to request
that they be inserted in the hearing record at this time.
Given these circumstances, how are we to analyze with any
degree of certainty the safety of our investments in other
financial institutions?

Everything I now read casts doubt on

the stability of even the largest banks.

As recently as

September 20, the Credit Union Information Service Newsletter
reported that a study of debt and other ratios conducted by
T. J. Holt & Co., an investment advisor, revealed that "all




309
15 of America's biggest banks rank among the country's 100
weakest."
Even a credit union as large and sophisticated as ours cannot
perform the in-depth studies on every potential investment
as would have been required to detect Penn Square's weakness.
I have to conclude, therefore, that the kind of information
that was available to the regulatory agencies and the Controller
of the Currency must be made available to potential investors
in some form, to help us assess a bank's strength and make an
informed investment decision.
It is not only the stability of my credit union that concerns
me, but the stability of the entire economic fabric of this
country.
Thank you for the opportunity to address you today.




310

Addendum No. 1

•

^GflSfo>4

ITEM

IBM POUGHKEEPSIE EMPLOYEES FEDERAL CREDIT UNION SOUTH ROAD / P.O. BOX 1750 / POUGHKEEPSIE / NEW YORK 12B01

July 10, 1980
TO:

Board of Directors

RE:

Recommendations: Credit Union Investment Policy/Guidelines

FR:

Sherman L. Prosser, Treasurer

At our July 10th meeting, the Committee reviewed the current
Investment Committee Guidelines dated August 4, 1977 and CUMS Ins.
Society's request for Credit Union Investment Guidelines on certain
investments. The purpose of the guidelines is to encourage the
Credit Union Board of Directors to avoid investment practices which
are risky, speculative, unsafe and unsound.
In reviewing the current Investment Committee Guidelines, the
Committee felt that further Policy/Philosophy should be acted on
by the Board. Therefore, regarding Policy/Philosophy, the following is recommended for action at the July 16th Board meeting:
1.

FUNCTION:
Provide for adequate liquidity.
Permit the Credit Union optimal use of its residual funds,
those not currently being used in the loan portfolio.
These funds should produce the maximum level of income
consistent with both the highest degree of safety and the
satisfaction of the liquidity needs.
Provide a source of pledgeable assets to secure deposits.

2.

RESPONSIBILITY:
The Board has delegated control of all investments, other
than loans to members, to the Investment Committee.




Telephone (Area Code 914) 463-3987 or 463-3992

311
2.

RESPONSIBILITY;
b.

(continued)

The Investment Committee further delegates the following
responsibilities to the General Manager:
(1) To move monies in/out of such accounts as listed:
From Checking Accounts into D-D/D-W Accounts
From D-D/D-W Accounts into Checking Accounts
Renew and/or placing into New Certificate of Deposits
Regarding C/D's: A minimum of three (3) bids must be
obtained from financial institutions prior to final
disposition.
Monies should be placed at the highest available rate,
if not, an explanation must be submitted to the Committee.
(2) Accounts such as: Savings Accounts and Day-of-Deposit/
Day-of-Withdrawal Accounts. These accounts should be
kept at a minimum so that excess monies can be invested.

c.

'Requests From Other Credit Unions' either for loans or
share deposits, shall be brought to the Committee. The
Committee shall maintain the concept of helping other credit
unions at possibly a lower than prevailing rate.

d.

Government Securities will be considered at the recommendation
of the General Manager to the Committee.

e.

The Committee will use all means to audit and confirm that
policy is followed as stated.

(The above on 'Responsibility' is a carry-over from the 8/4/77
Investment Comm. Guidelines with minor word changes for updating)
f.

*" g.

Liquidity position and portfolio changes should be reviewed
by the Investment Committee no less than quarterly.
The Investment Committee shall provide the Board with a
written report at the regular Board meetings.

As part of the Investment Policy of this Credit Union the
Committee is recommending that the Board adopt the following
resolution: (words underscored denotes 'Definitions' that are attached)
1.

To establish a "buy and hold" philosophy in which the
credit union buys investment securities with the intention
of holding them until they mature or until they are needed
to provide liquidity.




312
2. As part of any decision to enter into a cash forward agreement
to buy, all of the following conditions must be met:
a.

Settlement period does not exceed 120 days from the
trade date.

b.

Information evidencing the credit union's liability to
purchase must appear on the credit union's financial statement

6.

If the delivery of the security is to be made beyond 30 days
from the trade date, then a written cash flow projection
evidencing available cash to purchase the security must be
made and retained in file.

d.

The credit union must plan to take delivery of the security
and hold it for at least 6 months except under adverse cash
flow conditions.

e.

The security must be an authorized investment for the CU.

3.

A Board policy prohibiting cash forward agreements to sell.

4.

A Board policy prohibiting standby commitments.

5.

A Board policy prohibiting adjusted trades.

6.

A Board policy prohibiting short sales.

7.

A Board policy prohibiting futures trading.

8.

A Board policy permitting reverse repurchase transactions with
the following restrictions:
a. No more than 40% of the funds so obtained may be used to
purchase securities.
b. The .investments/deposits made with funds obtained through a
reverse repurchase transaction or securities collateralizing
that transaction must have a maturity date not later than the
settlement date for the reverse repurchase transaction and
in no case greater than 3 0 days,
c. h plan should be in place to insure necessary funds are on hand to effect repurch
9 * Repurchase transactions are divided into "investment type" and
.
"loan type". Investment type repos are permitted. To qualify as
an investment type repurchase transaction, there must be unrestricted transfer of ownership of the security by the vendor to
the credit union or its safekeeping agent. There must be
written "bailment for hire" contract with the safekeeping agent.
All other repos are considered "loan type" repos and may only
be made to members, other credit unions and credit union
organizations.
I have also attached for your review Section 703.3 of the
Regulations.




Sherman L. Prosser
Treasurer

313
DEFINITIONS
1.

Security means a "direct" investment. It excludes certificates of deposit or deposit with, or loans to another —
credit union, savings and loan or bank.

2.

Standby commitment means an agreement to purchase or sell a security at a future date, whereby the buyer is
required to accept delivery of the security at the option of the seller.

3.

Cash forward agreement means an agreement to purchase or sell a security, at a future date, that requires
mandatory delivery and acceptance. The contract for the purchase or sale of a security for which delivery of the
security is made in excess of thirty (30) days but not exceeding one hundred and twenty (120) days from the
trade date shall be considered to be a cash forward agreement.

4.

Repurchase transaction means a transaction in which a credit union agrees to purchase a security from a vendor
and to resell a security to that vendor at a later date. A r epurchase transaction may be of two types:
a.

Investment-type
1)

repurchase transaction" means a repurchase transaction where:

The credit union purchasing the security takes physical possession of the security, or receives written
confirmation of the purchase and a custodial or safekeeping receipt from a third party bank or other
financial institution under a written bailment for hire contract identifying a specific security in its
possession as owned by the credit union;

2)

b.

There is no restriction on the transfer of the security purchased by the credit union; and

3)

The credit union is not required to deliver the identical security to the vendor upon resale.

"Loan-type
repurchase
transaction"
means any repurchase transaction that does not qualify as an
investment-type repurchase transaction. A loan-type repurchase transaction represents a lending
transaction.

5.

Reverse repurchase transaction
means a transaction whereby a credit union agrees to sell a security to a
purchaser and to repurchase the same security from that purchaser at a future date, irrespective of the amount of
consideration paid by the credit union or the purchaser. A reverse repurchase transaction represents a
borrowing transaction.

6.

Futures means a standardized contract for the future delivery of c o m m o d i t i e s , including certain government
securities, sold on designated commodities exchanges.

7.

Trade date means the date a credit union originally agreed, whether verbally or in w r i t i n g , to enter into the
purchase or sale of a security with a vendor.

8.

Settlement period means the date(s) originally agreed to by a credit union and a vendor for settlement of the
purchase or sale of a security, without any modification or extension of that/those date(s).

9.

Maturity means the date on which a security matures, and shall not mean the call date or the average life of the
security.
.".

10.

Adjusted trading means any method or transaction used to defer a loss whereby a credit union sells a security to
a vendor at a price above its current market price and simultaneously purchases or c o m m i t s to purchase from
that vendor another security above its current market price.

11.

Bailment tor hire contract means a contract whereby a third party bank or other financial institution for a fee
agrees to exercise ordinary care in protecting the securities held in safekeeping for its customers.

12.

Short sale means the sale of a security not owned by the seller.




314
CREDIT UNION INVESTMENT GUIDELINES
The Board of Directors of
part of the Investment Policy of the credit u n i o n .

eS

Credit Union agree to adopt the following guidelines as a

To pursue either (a) or (b):

b.

T o establish a "buy and h o l d " philosophy in w h i c h the credit union buys investment securities with the
intention of holding them until they mature or until they are needed to provide liquidity.
To buy each security with the intention of holding it at least six months except for maturities, equities and
unusual circumstances related to liquidity. In connection with this o p t i o n , a turnover of less than 25%each
year in investment securities (maturing in excess of one year) w o u l d be appropriate.

( 2 . ) As part of any decision to enter into a cash forwaj^^gr^menno

buy, all of the following conditions must be met:

(h.

Settlement period does not exceed 120 days from the trade date.

[b.
^

Information evidencing the credit union's liability to purchase must appear on the credit union's financial
statement.

&

If the delivery of the security is to be made beyond 30 days from the trade date, then a written cash flow
projection evidencing available cash to purchase the security must be made and retained in file.

<i\
^

The credit union must plan to take delivery of the security and hold it for at least six months except under
adverse cash flow conditions.

lei

The security must be an authorized investment for the credit union'.

3.

A Board policy prohibiting cash forward agreements

4.

A Board policy prohibiting standby

to sell.

commitments.

5.

A Board policy prohibiting adjusted

6.

A Board policy prohibiting short

trades.

7.

A Board policy prohibiting futures

8.

A Board policy permitting reverse repurchase

sales.
trading.
transactions

with the following restrictions:

a.
b.

9.

No more than 40 percent of the funds so obtained may be used to purchase securities.
The investments or deposits made with funds obtained t h r o u g h a reverse repurchase transaction or
securities collateralizing that transaction must have a maturity date not later than the settlement date for the
reverse repurchase transaction and in no case greater than 180 days.

Repurchase transactions are divided into "investment type" and "loan type." Investment type repos are
permitted. To qualify as an investment type repurchase transaction, there must be unrestricted transfer of
ownership of the security by the vendor to the credit union or its safekeeping agent. There must be written
"bailment for hire" contract with the safekeeping agent.
All other repos are considered "loan type" repos and may only be made to members, other credit unions and
credit union organizations.




315
703.1-703.3

§703.1 Certificates of Deposit.
(a) A Federal credit union may invest in or
make a deposit evidenced by a time certificate
of/deposit issued by any of those institutions
enumerated in section 107(7)(D) and 107(8) of the
Federal Credit Union Act: Provided,
(1) That such Federal credit union itself
makes the investment or deposit for which the
certificate is issued; and
(2) That no consideration is received from a
third party in connection with the making of the
investment or deposit.
(b) A Federal credit union may contract with
the issuing institution for payment of the whole
or a portion of a certificate of deposit before
maturity.
(c) Certificates of deposit issued by those
state chartered financial
institutions
enumerated in §107(8) of the Federal Credit
Union Act may be obtained by a Federal credit
union provided such institutions are operating
in accordance with the laws of a state in which
the Federal credit union maintains a facility.
For the purposes of the paragraph, the word
"facility" means the home office of a Federal
credit union or any suboffice thereof, including
but not necessarily limited to a wire service,
telephonic station or mechanical teller station.
(d) Negotiable certificates of deposit purchased under this authority may be sold by a
Federal credit union to a third party before
maturity subject to the appropriate regulations
governing the issuing institution involved.
(e) The purchase of a certificate of deposit
that does not meet the above provisions is not
authorized for Federal credit unions.

§703.2 Investment in loans to
nonmember credit unions.
(a) A Federal credit union may invest in loans
to other nonmember credit unions including
loans extended under a line of credit agreement,
provided:
(1) The aggregate amount of all loans and
credit limits established to nonmember credit
unions does not exceed 25 per centum of the*.>
vesting Federal credit union's paid-in and unimpaired capital and surplus;
JULY 1980




PART 703

INVESTMENTS AND DEPOSITS

Part 703
Investments and Deposits

(2) The maximum amount of a line of credit
shall be stated in the line of credit agreement
between the investing and borrowing credit
unions;
(3) The terms and maturities of outstanding
loans and the schedule of payments of principal
balances outstanding under a line of credit do
not exceed one year; and
(4) The investment is approved by the board
of directors, or its authorized executive or investment committee.
(b) Prior to making a loan or extending a line
of credit, and annually in the case of an
established line of credit, the investing Federal
credit union shall obtain and retain on file the
following documents from the borrowing credit
union:
(1) A current financial and statistical
report;
(2) A certified copy of the resolution of the
board of directors or executive committee
authorizing such borrowing; and
(3) A written statement from the secretary
of the borrowing credit union that the persons
negotiating the loan or line of credit and executing the note or agreement are officers of the
credit union and are authorized to act on its
behalf and that the amount of loan or line of
credit does not exceed the maximum borrowing
authority of the borrowing credit union.

§703.3 Investment Activities.
(a) Definitions.
(1) "Security"means any investment or
deposit authorized for a Federal credit union
pursuant to sections 107(7) and 107(8) of the Act.
For the purpose of this section, the definition of
703-1

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PART 703

NCUA RULES AND REGULATIONS

a security shall not mean loans to members or
loans authorized under sections 701.21-6 and
701.21-8 of the rules and regulations.
(2) "Standby commitment" means an agreement to purchase or sell a security at a future
date," whereby the buyer is required to accept
delivery of the security at the option of the
seller.
(3) "Cash forward agreement" means an
agreement to purchase or sell a security, at a
future date, that requires mandatory delivery
and acceptance. The contract for the purchase
or sale of a security for which delivery of the
security is made in excess of thirty (30) days but
not exceeding one hundred and twenty (120)
days from the trade date shall be considered to
be a cash forward agreement.
(4) "Repurchase transaction" means a
transaction in which a Federal credit union
agrees to purchase a security from a vendor and
to resell a security to that vendor at a later date.
A repurchase transaction may be of two types:
(i) "Investment-type repurchase transaction" means a repurchase transaction where:
(A) The Federal credit union purchasing
the security takes physical possession of the
security, or receives written confirmation of the
purchase and a custodial or safekeeping receipt
from a third party bank or other financial institution under a written bailment for hire contract identifying a specific security in its
possession as owned by the Federal credit
union;
(B) There is no restriction on the
transfer of the security purchased by the
Federal credit union; and
(C) The Federal credit union is not required to deliver the identical security to the
vendor upon resale.
(ii) "Loan-type repurchase transaction"
means any repurchase transaction that does not
qualify as an investment-type repurchase transaction. A loan-type repurchase transaction
represents a lending transaction and is subject
to the limitations of section 107(5) of the Act.
(5) "Reverse repurchase t r a n s a c t i o n "
means a transaction whereby a Federal credit
union agrees to sell a security to a purchaser
and to repurchase the same security from that
purchaser at a future date, irrespective of the
amount of consideration paid by the Federal
credit union or the purchaser. A reverse repurchase transaction represents a borrowing transaction and is subject to the limitations of section
'107(9) of the Act.
703-2




703.3

(6) "Futures contract" means a standardized contract for the future delivery of commodities, including certain government
securities, sold on designated commodities exchanges.
(7) "Trade date" means the date a Federal
credit union originally agreed, whether verbally
or in writing, to enter into the purchase or sale
of a security with a vendor.
(8) "Settlement date" means the date
originally agreed to by a Federal credit union
and a vendor for settlement of the purchase or
sale of a security, without any modification or
extension of that date.
(9) "Maturity date" means the date on
which a security matures, and shall not mean
the call date or the average life of the security.
(10) "Adjusted trading" means any method
or transaction used to defer a loss whereby a
Federal credit union sells a security to a vendor
at a price above its current market price and
simultaneously purchases or commits to purchase from that vendor another security above
its current market price.
(11) "Bailment for hire contract" means a
contract whereby a third party bank or other
financial institution for a fee agrees to exercise
ordinary care in protecting the securities held in
safekeeping for its customers.
(12) "Short sale" means the sale of a security not owned by the seller.
(13) " M a r k e t p r i c e " means the last
established price at which a security is sold.
(b) Limitations.
(1) A Federal credit union may contract for
the purchase or sale of a security authorized by
section 107(7) of the Act, provided that the
delivery of the security is to be made within
thirty (30) days from the trade date.
(2) A Federal credit union may not enter into a standby commitment to purchase or sell a
security.
(3) A Federal credit union may enter into a
cash forward agreement to purchase a security
provided that the period from the trade date to
the settlement date does not exceed one hundred
and twenty (120) days and the credit union has
written cash flow projections evidencing its
ability to purchase the underlying security. A
Federal credit union may not enter into a cash
forward agreement to sell a security unless it
presently owns the security. All cash forward
agreements must be settled on a cash basis at
the settlement date.
JULY 1980

317
703.3

INVESTMENTS AND DEPOSITS

(4) A Federal credit union may not enter into an investment-type repurchase transaction
unless all the conditions cited in subsection
703.3(a)(4)(i) are met. Any repurchase transaction that does not meet such requirements constitutes a loan-type repurchase transaction subject to the limitations of section 703.3(b)(5). The
purchase price of a security obtained under an
investment-type repurchase transaction must
be at the market price.
(5) A Federal credit union may enter into a
loan-type repurchase transaction only with its
own members, other credit unions, or approved
credit union organizations that are defined in
section 701.27-2 of the rules and regulations.
(6) A Federal credit union may enter into a
reverse repurchase transaction, provided that
the funds obtained are not invested under section 107(7)(I) of the Act. Furthermore, either any
investment or deposit made under sections
107(7)(B), (D), (E), (F), (G), (H) or 107(8) of the Act

JULY 1980


21
12-745 0—83


PART 703

or any security collateralizing the reverse repurchase transaction must have a maturity date not
later than the settlement date for the reverse
repurchase transaction. The maximum amount
of funds that may be borrowed under a reverse
repurchase transaction for investment or
deposit is 10 percent of paid-in and unimpaired
capital and surplus.
(7) A Federal credit union may not buy or
sell a futures contract unless the purchase or
sale is specifically authorized by a regulation
issued by the Administration.
(8) A Federal credit union may not engage
in adjusted trading as defined in section
703.3(a)(10).
(9) A Federal credit union may not engage
in a short sale as defined in section 703.3(a)(12).
(10) All purchases and sales of securities by
a Federal credit union by means of a cash transaction under section 703.3(b)(1) or a cash forward agreement under section 703.3(b)(3) must
be at the market price.

703-3

318

fii

Addendum N o .

2

I1

EMPIRE CORPORA!! CENTRAL FEDERAL CREDIT UNION

1211 WESTERN AVENUE
ALBANY. NEW YORK 12203 (518) 482-6691

August, 1982
Dear Member,
In recent weeks, we have received a number of inquiries concerning the "safety"
of funds at Empire Corporate, Empire's investment policies, even U.S. Central's investment policies, all no doubt motivated by the Penn Square Bank failure. The questions raised are those which should be addressed in every investment decision. We
are only too happy to respond to them here.
EMPIRE'S INVESTMENT POLICIES
Empire Corporate incorporates two very conservative funds management practices
right into its investment policies to assure the safety of your deposits. These are:
the "MATCHED BOOK", and a "HIGH INVESTMENT QUALITY EMPHASIS".
The MATCHED BOOK approach to managing funds basically dictates that the maturity
structure of Empire's assets is always "matched" (i.e. identical with) the maturity
structure of its deposits and certificates. Another way of looking at this is that
your maturity decision is preserved in our reinvestment. Matching protects Empire
(and your credit union) from the earnings and liquidity risks imbedded in all rate
sensitive mismatching strategies.
The QUALITY EMPHASIS insures that all funds invested by Empire-- either directly or through U.S. Central-- are diversified into high quality, well researched institutions-- at the expense of higher yields. Such quality standards afford strong
protection to Empire (and your credit union) from the risk of default.
We have enclosed pertinent excerpts from our policies plus a more detailed explanation for your review (this literature was originally sent out in the fall of 1981).
EMPIRE'S INVESTMENT PORTFOLIO
Currently, about 99% of our investable funds are being invested through U.S. Cen-A
tral Credit Union (the hub of the Corporate Network). The other 1% is held in other
(quality) banks.
Since we concentrate funds at U.S. Central, some information on their purpose,
investment policies, and practices is in order.




319
U.S. CENTRAL CREDIT UNION
As the hub of the Corporate Network, U.S. Central is the point at which credit
union surplus funds are concentrated and invested in the marketplace. U.S. Central
has a full time investment staff which does the necessary research and analysis and
the investing. The benefits of this approach to you are related to economies of
scale: better rates for larger blocks of funds, shared costs of investment analysis,
monitoring, etc.
Like Empire, U.S. Central incorporates conservative funds management right into
its policies. And like Empire, these policies are available for review.
-U.S. Central makes use of the "Matched Book" approach to funds management to insulate the Network from interest rate risk.
-U.S. Central places a strong emphasis on investment quality. U.S.
Central limits its investment possibilities basically to the top 50
domestic banks and top 80 world banks (ranked by deposits). These
possibilities are then researched (and analyzed continuously) with
particular attention to (i) financial position and results-- the ,
numbers, (ii) use of funds-- investment and loan portfolio quality,
and (iii) management quality. As an example, U.S. Central is currently using only 14 of the country's top 20 banks. Several commercial
rating agencies are used to obtain this information.
-U.S. Central diversifies its investments extensively by type of
institution as well as within type of institution.
-U.S. Central constantly publishes its financial statements and
portfolio structure.
In essence, by concentrating funds at Empire, youi* credit union accesses this
high quality, diversified portfolio.
A CONSERVATIVE STANCE
Although we have received criticism in the past by some credit unions who feel
that we should assume more risk to get-- and give-- better yields, we feel that safety must remain the top priority in our investment considerations. Credit unions who
desire a higher return must book the investments (and take the risk) themselves. U.S.
Central has always held a similar attitude. Penn Square's failure affirms the value
of this approach.
As a closing note, consider this: U.S. Central's policies and operations are so
sound that they resulted in the highest possible commercial paper ratings from both i
J
Standard § Poor's and Moody's. Only one other financial institution, Morgan Guaranty
Trust Company, currently has as high a rating.
We hope that these comments plus the enclosures have been helpful in reassuring
you and >our board of the safety of your credit union's funds. If not, please contact us with your questions. We remain confident that we will have the right answers.
Sincerely,
The Board of Directors and Management
Empire Corporate Central F.C.U.




320

fl'

EMPIRE CORPORATE CENTRAL FEDERAL CREDIT UNION
1211.WESTERN AVENUE

ALBANY. NEW YORK 12203 (518) 482-8891
Dear Member:
Recently, the growing number of reports detailing large deposit outflows and substantial operating losses at
' some financial institutions, as well as two spectacular institutional defaults, have increased credit union concerns over the safety of invested funds. We thought it would be appropriate — and reassuring — to address this
issue of safety with respect to your deposits with Empire Corporate.
EMPIRE CORPORATE'S DEPOSIT INSURANCE COVERAGE
Your credit union's aggregate deposits with Empire are insured by NCUA for the first $100,000. Amounts in excess of $100,000 are not so insured.
Empire Corporate's insurance coverage is, of course, no different than that of other insured financial institutions in this respect.
SAFETY VERSUS INSURANCE COVERAGE
Inspite of (or perhaps because of) all the recent press on troubles in some sections of the industry, safety is now
equated by some with insurance coverage. This is unfortunate because the two are not synonymous. The lack of
insurance coverage on deposits exceeding $100,000 is not an indication that these funds are not "safe". Nor is
the presence of coverage on the first $100,000 an absolute guarantee that such funds are "safe" — if by "safe"
we mean the assurance of timely return of full deposit principal and earnings. Concern for the safety of your
funds is always well founded and should be addressed in every investment decision regardless of deposit insurance.
THE SAFETY OF FUNDS AT EMPIRE
Empire Corporate was specifically designed and chartered to provide liquidity management services to the
credit unions of New York. These services include deposit/investment options (on the liability-side) and various
loans (on the asset side).
In using these services, depositing credit unions implicitly pool their surpluses at Empire Corporate to make
funds available to borrowing credit unions of New York. Funds at Empire not used for loans to member credit
unions are made available to credit unions in other states via the Corporate Central System, or finally, invested
by U.S. Central Credit Union in high quality market instruments.
Obviously, the statewide and nationwide pooling of credit union surpluses (for credit union use) would be quickly defeated by $100,000 aggregate deposit limits if dictated by account insurance coverage.
Equally obvious, however, is the need for strong assurance that the deposits are made completely safe.
The necessary assurance — or "insurance" — is provided by Empire Corporate's management philosophy
which is deliberately risk averse ("safety" oriented). This philosophy assumes substance in two major funds
management policies: a quality emphasis and a matched book approach.
The Quality Emphasis:
1) In investing credit union deposits, Empire Corporate adheres to the SLY Principle. SLY refers to a particular
ordering of the three major investment characteristics:
1st priority:
2nd priority:
3rd priority:

Safety
Liquidity
Yield

The high priority placed upon investment safety by Empire Corporate is emphasized in Empire's policies, which
greatly restrict the legal investment options to a much more select group of allowable investment options, and
which require credit analysis and suitable diversification (either at Empire or through U.S. Central). That priority
is illustrated by the fact that Empire Corporate currently has no investments — either directly or through US
Central — in savings and loans or savings banks. The SLY approach is well recognized as a very conservative
approach to placing funds.




321
2) In lending to other credit unions, Empire Corporate relies upon strict credit standards and constant monitoring to reduce the risk exposure of the funds so placed. As a last resort, Empire is protected by credit priority.

The Matched Book Approach:
Whether lending or investing, Empire Corporate matches the maturity/yield of the use of funds
(loans/investments) to maturity/cost of the source of funds (deposit), locking in a small, positive spread. This
protects depositors from adverse moves in interest rates by assuring both principal return and dividend
coverage at deposit maturity. More specifically:
• The depositor is assured that at maturity, he will be able to receive deposit principal because of a
simultaneous investment maturity.
• The depositor is assured that at maturity, full earnings will be available since those earnings are locked-in at
the time of funds commitment.
• The depositor is further assured that earnings on other accounts (such as the Daily Account) will not suffer
for certificate dividends, since the Matched Book broadly insulates Empire Corporate from "interest rate
risk".
• The depositor is finally assured that because of the marginal pricing capabilities inherent in the Matched
Book approach, the coverage of reserve costs and operating expenses can be maintained on an ongoing
basis without overcharging.
The Matched Book Approach to managing assets and liabilities is generally considered to be the most risk
averse possible. Indeed, asset/liability management strategies which do not match maturities are often labeled
"Risk-Books".
These two important policies are employed by Empire Corporate (and by U.S. Central) because of their suitability
to a corporate credit union's special (wholesale) function as a liquidity management vehicle for its member
credit unions. They form the real "insurance" for your deposits on both sides of the $100,000 government insurance limit.
THE QUESTIONABLE "SAFETY" OF INSURED DEPOSITS
Deposit insurance provides no guarantee of "safety" for funds covered by the $100,000 limit (using the definition
of "safety" set forth above). In the event of liquidation, the insurance coverage protects only the insured portion
of the deposit principal. It does not protect earned interest income, nor provide earnings during a protracted
claim settlement. Further, it definitely does not protect the credibility of the investor who placed the funds. To
rephrase this point, deposit insurance is not an adequate substitute for credit analysts — that is, determining
the safety of every investment.
THE "VOTE" FROM EMPIRE'S MEMBERS
A large number of Empire's members consider Empire a safe haven for their surplus funds. The current average
balance per credit union is over $400,000. Further, several credit unions have well over $10 million each on
deposit.
THE "VOTE" FROM NCUA
Empire Corporate received a "Code-One" rating from NCUA in its most recent examination (Dec. 1981). Special
mention was made of its financial health and strength. Empire Corporate also received an Unqualified Opinion
from Ernst and Whinney in its annual audit.
We hope that the information provided here has sufficiently addressed questions concerning the safety of funds
placed at Empire Corporate. If you have any additional questions or comments, please feel free to contact our
office.
Sincerely,

Raymond A. Johnson
President
Empire Corporate Central FCU




322

EMPIRE CORPORATE CENTRAL FEDERAL CREDIT UNION
1211 WESTERN AVENUE
ALBANY. NEW YORK 12203 (518) 482-8891
EXCERPTS FROM EMPIRE CORPORATE CENTRAL'S POLICIES*
V. ASSET - LIABILITY MANAGEMENT
General Statement of Policy
Asset management, or funds usage, should be consistent with liability management or commitments made in
acquiring funds. This is particularly true in wholesale
funds management (as exists at a corporate central).
The principal tenet underlying the asset-liability policy of this credit union is that the individual member (natural
person) is the participant in the "Credit Union Financial System" with the primary authority to dictate the
parameters of asset management. For all other tiers of the financial system, asset management policies should
preserve the integrity of this financial authority — as vested in the time/rate commitments of credit union
liabilities.
VI. LIABILITY MANAGEMENT
A. Sources of Funds — Members
Empire Corporate offers a full array of investment options to its (primary) members to enhance their flexibility in
liquidity management, as well as to encourage substantial inflows of (surplus) funds in order to build a strong
and stable financial foundation for itself and for the entire system. Member credit unions are encouraged to provide Empire Corporate with the opportunity to bid on all investable funds.
B. Other Sources of Funds
Empire Corporate may borrow funds from any source in aggregate amount not exceeding fifty per centum (50%)
of its paid-in and unimpaired capital and surplus. These funds may be borrowed with or without security and
under other such terms and conditions prevailing at the time of borrowing as deemed financially prudent by the
Board or designated management.
Empire Corporate's credit-worthiness is in large part established by its risk-averse posture in the use of funds.
In particular, its credit standing benefits from limited exposure to:
—Market risk (Interest rate risk) through the utilization of the matched portfolio concept.
—Loan default risk through both credit analysis and the rights of creditor priority/pledge of assets by
borrowing members.
—Investment default risk through policies designed to assure quality, diversification and prudent i n vestigation.
In addition, it has been Empire's experience that creditors consider loans to Empire Corporate as loans to its
members (risk diversification). These factors combine to minimize creditor risk in lending to Empire Corporate.
VII. ASSET MANAGEMENT
A. Loans To Members
Empire Corporate's loan policies are designed to accomplish the equitable distribution of available funds and
related costs based on member needs, with consideration of member commitment in assisting Empire Corporate in meeting those needs while minimizing risk. To qualify for any type of loan, a member credit union
must:
'Approved January, 1981.




323
1.

Complete all necessary documentation.

2.

Provide financial information including but not limited to balance sheets, income/expense statements and
statistical reports as established by the Board and/or Credit Committee.
B. Investments
Overview

The investment policies of Empire Corporate Central FCU begin with the fundamental premise that the priority
in utilizing the resources entrusted to it is in meeting liquidity requirements of members. Consequently, investments form a secondary or reciprocal use of funds.
The investment policies of Empire Corporate emphasize the concept of matching the maturities of sources and
uses of funds, and in so doing, give implicit recognition to the following:
1.

As a wholesale financial intermediary, Empire Corporate is subject to, and must insulate itself from a large
degree of volatility in its sources of funds. Empire must be able to assure the liquidity of those sources of
funds to its members.

2.

As a credit union, Empire does not have, nor will it ever have the accumulated reserves required to prudently
manage a "risk-book" of business. Empire must avoid the earnings risks inherent in an unmatched
source/use structure in order to assure its dividends to members.

Exceptions to the matched investment concept are limited, and may collectively be termed "Portfolio Investments." Portfolio investments are made to cover:
1.

Seasonal, short-term maturity extensions of daily sources.

2.

Purchase date/maturity date variations for anticipated loan demand and/or share withdrawals.

The investment policies of Empire Corporate further emphasize the important function that a corporate central
plays in concentrating credit union surpluses within the Corporate Central System by recognizing U.S. Central
as a primary resource for investments, and by always providing U.S. Central first opportunity to bid on all investable funds. The recognition of U.S. Central as a primary resource presumes its adherence to the matched-book concept on an on-going basis.
The investment policies of Empire Corporate finally and most importantly prioritize the safety of principal and
interest in all investment decisions.
Maximum Risk Postures
Subject to change, and to be reviewed at least annually by the Board of Directors are the following maximum
risk postures to be assumed by Empire Corporate:
Market Risk:

With the exceptions noted in "Portfolio Investments" above, Empire Corporate shall not
assume market (or interest-rate) risk in an attempt to increase return. Exposure to one form of
market risk — changes in the term structure of interest rates — is to be limited by adherence
to the "matched book" concept. Exposure to the other form of market risk — changes in the
absolute levels of interest rates — is to be limited by the avoidance of attempts to anticipate
rate level changes (i.e., "time the market").

Default Risk:

Empire Corporate shall not assume significant default risk in an attempt to enhance return.
Legal limitations have been established under the Federal Credit Union Act to define an investment universe of acceptable securities in terms of tolerable default risk (section 107-8 of
the Federal Credit Union Act). Empire Corporate shall comply with the letter of the federal law
regarding acceptable investments. In addition, to further reduce the risk of default, Empire
Corporate shall observe the following parameters in its investment activity...
To the extent practicable, management shall undertake to obtain and analyze financial
statements and other relevant information to ascertain and further reduce default risk.

Return Risk:

Empire Corporate shall invest only in term investments of "fixed income" form. That is, those
with return characteristics determinable prior to purchase.

Liquidity Risk:

Empire Corporate shall not assume significant liquidity risk in order to enhance return.




324

fl

ANOTHER CAUTION FOR CREDIT UNION INVESTORS
(Reprinted from statement mailing, February, 1982)

In a time of deepening economic distress, it becomes imperative that you affirm
the quality of all investment purchases.
We realize that you have heard this message from us many times before-- so much
so that it probably has come to sound annoyingly repetitive and self-serving. Our
purpose though is not to "cry wolf", but simply to remind you of the tremendous responsibilities that you have assumed in managing your members' money.
How do you assure the quality of your investment purchases? By doing your homework. For each institution you entrust with your credit union's tunds, you should
know (by your own investigation):
-THE INSTITUTION'S PRESENT FINANCIAL CONDITION.
Capital to asset, debt to equity, liquidity ratios are good indicators, So too are the results of current period operations-- including income, expenses and net income. This type of analysis requires
a current, complete financial statement.
-RECENT TRENDS IN THE INSTITUTION'S CONDITION AND PERFORMANCE.
These are as important as current information in determining safety and stability. This requires some historical information.
-USE OF ASSETS.
The institution's use of assets is extremely important-- and typically not to be found on the statements. Is the institution locked into
low yielding assets and/or investing in high risk assets with which it
has no experience? Find out!
-CREDIT RATING.
*
What is the credit rating?

Has it changed recently?

If you are unable to obtain this information or are uncertain about the indications, don't invest.

Why?

To most of you the above caution is nothing new; yet in some cases it is ignored.
Here are some ill-conceived reasons...
"The yield is so good." Yield is a function of time and risk. In investing you
"don't get something for nothing." Rates which are out-of-line with the market
should be a red flag that with the yield premium comes a great deal of risk. (Do
you really want to bet your credit union that your opinion is right while the rest
of the marketplace is wrong in its risk assessment?)
"I need to diversify." The purpose of diversification is to reduce risk. Rote
diversification without regard to the risk of what you're diversifying into or
what you're diversifying out of is nothing more than a handy excuse to chase yield.




325
"The investments are insured." Deposit insurance is structured to reassure the
natural person depositor-- who is assumed to be ignorant of the means of risk
assessment. It is not meant for money managers (who should know better). Nor is
it meant to cover a large number of institution failures should such a thing occui
Even if your principal is insured, your credit union might not be able to withstand
the loss of credibility in the event of a default.
The bottom line in calling these reasons "ill-conceived" is that ultimately you
bear the risk and responsibility for all of your investment choices. You cannot defer
these to a regulator, auditor, or insurance fund. If your members ever lose confidence
in their credit union because of your investment practices, excuses such as "But we got
an extra 125 basis points...", "We had to diversify...", or "Don't worry* the investments are insured..." will only hasten their flight.




326
Addendum No.

PROFESSIONAL
221 15th Street, Del Mar, California 92014 8 0 0 / 8 5 4 - 2 1 6 0 Continental U.S.
ASSET
7 1 4 / 7 5 5 - 6 6 6 1 California, Alaska, Hawaii
MANAGEMENT
INC.
THE P.A.M. PLEDGE
We are frequently asked "why should I buy certificates of
deposit using P.A.M. for assistance when I can buy them myself by going direct to a savings and loan or bank?"
You can do it yourself, but if you do you will be missing
out on a valuable service we offer - paid for not by you but
by the savings and loan or bank from which you buy the CD a service at which our staff works full time. Do you have
a staff who can devote full time to reviewing and analyzing
information concerning savings and loans and banks from which
you buy CDs? And, no matter what the size of your staff, can
you persuade the savings and loans and banks from which you
purchase CDs to pay for your staff?
Let me explain how our service works and why money brokers
have become important to many of the nation's banks and
savings and loans.
But first allow me to clear up what I preceive to be a common
misconception that only small, obscure banks and savings and
loans need and use money brokers.
Today almost all of the nation's largest 100 banks and
largest 100 S & Ls,in addition to smaller institutions,use
a variety of sources to attract deposits. These sources
include financial conglomerates such as Merrill Lynch to
specialists like Professional Asset Management.
The need to use non-traditional sources for deposits has
grown as the traditional sources of deposits have diminished.
Since the late 1970's, as regulation Q was circumvented by
money market funds,more than $200 billion in traditional pass
book savings left the nation's banks and S & Lis for more
favorable money market rates. At the same time, the asset base
of the country's banks and S & Ls has grown substantially.
As each bank's and S & L's local assets (loans) increased
while their local market deposits declined, the need for a
broader deposit base grew. In fact, just as a substantial
portion of major bank loans are made to foreign borrowers usually long term - substantial portions of major bank
deposits come from foreign lenders - usually short term.




REGISTERED INVESTMENT ADVISOR

327
Enter Merrill Lynch, Professional Asset Management and
other money brokers. There is growing evidence that when
Regulation Q is finally phased out completely, banks and
S & L's will need to rely even more on money brokers for
deposits.
Finally, all banks and S & L's have a cost of attracting
deposits whether they do so internally through a branch
system or a money desk operation or externally through
brokers. Some use all three. When money brokers are used
this cost is paid as fees. I would like to add, parenthetically, that some major brokers buy CDs from banks and S & L's
for their own inventory, receive a fee and then sell these
CDs at a premium resulting in a larger total fee for themselves and a smaller yield for the depositor. When you
use the services of P.A.M. you wire your funds directly to
the CD issuer, paying no premium to P.A.M. Our only fee is
paid by the bank or savings and loan.
Now, why use Professional Asset Management?
We seek out strong,financially sound regional independent
banks (from the more than 14,000 nationally) and savings
associations (from the more than 3800 in the U.S.) who
use external sources for raising deposits. Then, before we
add a bank or S & L to our universe, we do a five-year trend
analysis of capital adequacy and performance. We use, for
analytical purposes, statistical reports from Alex Sheshunoff
who publish semi-annual financial data on all commercial
banks in the U.S. on a state basis and similar reports from
Kaplan & Smith who publish data on all S & L's in the U.S.
on a state by state basis.
Then we review actual annual financials, lOK's, lOQ's and
interim reports from each institution and the auditor's
opinions of the annual reports.
In addition, we review documents required by Federal regulatory agencies of each institution: call reports for banks
and FHLB reports for savings associations.
In other words, before adding a bank or S & L to our universe,
we review every report available to the public and include
this information in our analysis.




328
We also monitor widely read business and trade publications
such as the American Banker and Wall Street Journal.
After we have collected, reviewed and analyzed all of this
information, we capsulize it in our well known and widely
circulated Capital Adequacy Reports. We measure for each
savings & loan and bank on our list, total assets, deposits,
net worth, net income, return on average assets, return on
average net worth, net worth/average deposits, net worth/
average assets, year-to-date changes in assets, deposits,
net worth and net income, and five year growth in assets,
deposits and net worth.
But we don't use just that information as the basis of our
report on a particular institution. Before we add any
institution to our report, we send the institution our own
carefully designed financial questionnaire, and review the
institution's response.
What else do we do? Simple. We repeat all of this work every
quarter. And, to the best of our ability, we visit each
savings & loan or bank which wants to be on our recommended
list. As best we can, we visit each institution at least
once a year.
All of this work by us - none of it paid for by you - all
of it paid for by the institutions who want to be in our
report - gets those institutions in our report if they meet
the standards which we apply to the information we have
analyzed. [The standards are the ratio averages for their
institutional peers—if they are equal to or are in excess
of those of the peers, we recommend.]
Then, each morning, our traders contact each of the institutions
on our list for their daily CD rates, EURO deposit rates and
BA inventory rates. We make these rates immediately available
to any of our more than 1000 clients who wish to contact any
of our team of highly skilled and trained investment officers.
In addition to doing all of the information gathering and
analysis that I have described in this Pledge, we calculate




329
interest accrued on your investment, monitor your maturities,
track wires from your account to the receiving bank or savings
& loan, make certain that your account is credited promptly,
monitor your investment in an attempt to assure efficient
return of interest and principal when requested, and attempt
to eliminate interest loss through effective cash management
techniques that ensure immediate investment of idle cash.
If you want to work with us, just one call to P.A.M. will
provide you with daily rates from numerous banks and savings
associations with whom we work.
Can you do what we do? Certainly - if you want to spend an
equal amount of time and effort doing it, and if you want to
pay for it. But all that time, effort and money won't get
you any better rates. It will take you longer to do it.
It will increase your costs. And, because you will have to
devote your own staff and time to doing what we do at the
expense of someone other than yourself, it will lower you
effective yield and could slow your ability to invest.
Sure you can do what we do, but we believe we can do it
better because it's a substantial portion of our business.
After all, we do it for over 1000 clients who at last count
had utilized our services in connection with their investment
of more than $2 billion. We can do the same for you.
Cordially,

Bill Goldsmith
Executive Vice President
BG/bw




330

- = ^ E E ^

PROFESSIONAL

A^SPTT
— : = = = : — z z = r V J » J L i I

2 2 U 0

Ventura

Boulevard Woodland Hills, California 91364 800/423-5877 Continental U.S.
213/888-2100 California, Alaska, Hawaii

MANAGEMENT
INC.
A N OPEN LETTER TO CLIENTS and
FRIENDS OF PROFESSIONAL ASSET MANAGEMENT:
On Tuesday, May 19, 1981, an a r t i c l e appeared in the Wall Street Journal announcing the
f a i l u r e of Economy Savings of Chicago. A t the t i m e of the a r t i c l e Economy had assets of
$88 m i l l i o n .
The a r t i c l e went on t o say that this was the f i r s t t i m e in ten years that the FSLIC had to
rescue a f a i l i n g savings association and only the 14th t i m e in the 45 year history of the
corporation.
While failures have been a rare occurence, this letter is w r i t t e n in the hope of bringing into
focus the need in these times for more than just a cursory analysis of any investment.
My urging for caution and the need to be conservative in the investment arena is not new t o
those of you who know me. As recently as September, 1980, I published an a r t i c l e in Credit
Union Management magazine (see enclosed reprint) drawing a t t e n t i o n to what I perceived to
be a potential danger.
For the past several years I have repeatedly advised in various a r t i c l e s , in speeches at credit
union gatherings and in Board of Directors' meetings w i t h management the need for a sound
investment policy on the part of all credit unions. Now, more than ever, this need is
apparent. But fiscal i n t e g r i t y for your credit union is not l i m i t e d t o investments alone. It
also includes asset l i a b i l i t y managment, spread management and pricing your services.
What happened in Chicago can happen in L.A., New York or Des Moines. What happened t o
Economy Savings & Loan can happen to your credit union.
As Vice President of Investments for t w o major Wall Street f i r m s for more than ten years, I
counseled dozens of c r e d i t unions throughout the country. Now as Vice President of my own
consulting f i r m , 1 have fewer t i m e constraints. Consequently, I am available t o those of you
who may require my assistance.
Our policy has and w i l l continue to emphasize safety f i r s t . Toward this end, we monitor on
a quarterly basis, financial reports f r o m many institutions. We analyze these reports and
send you pertinent s t a t i s t i c a l data t o complete your own analysis. Institutions that do not
meet our requirements are not included in the report.
We w i l l make every e f f o r t t o help you make the right decisions. But more i m p o r t a n t l y ,
perhaps, we make i t top p r i o r i t y to keep you f r o m making the wrong decisions.
I hope we get to talk soon. U n t i l then,
W i t h warmest regards,

Bill Goldsmith
Vice President




331
THE F I R M
Professional Asset Management, Inc. is an investment consulting f i r m specializing in
c e r t i f i c a t e s of deposit investments w i t h i n the financial community. Our goal is to assist you
in placing funds in federally-insured financial associations at the most advantageous interest
rates for the desired terms w i t h the greatest degree of safety and liquidity. We have
devised a unique network t o gather rate data f r o m financial institutions nationwide to assure
you of the most accurate and u p - t o - t h e - m i n u t e i n f o r m a t i o n .
In addition, as a f u l l service financial advisor, Professional Asset Management provides you
w i t h investment strategy and arbitrage assistance.

THE PRINCIPALS
James C . Chaffee, President, Professional Asset Management, is a graduate of Northrop
Institute of Technology and California State University, Northridge w i t h degrees in
Aeronautical Engineering and Mathematics. He was previously Vice President, Investments
for a world wide, NYSE member, investment f i r m where he acted as investment advisor to
selected corporations, c r e d i t unions, and employee benefit accounts. He has also been
a c t i v e in the real estate investment f i e l d .
William Goldsmith, Vice President, Professional Asset Management, earned his BA at
Indiana University and worked on his Masters in Economics at Northwestern University. He
is considered to be one of the most knowledgable advisors on investments in the credit union
industry. Mr. Goldsmith has conducted numerous seminars on investment practices f r o m
cash and liquidity management to issues dealing w i t h the economy and regulations. He has
been a frequent speaker at chapter meetings, educational conferences, and annual
conventions throughout the country. His articles appear regularly in credit union periodicals
and most recently authored the Investment Manual for Credit Unions published by CUES.
Ronald P. James, Vice President, Professional Asset Management, is a graduate of the
University of Georgia in accounting and finance. He was previously Investment Advisor for
a Los Angeles based investment f i r m providing financial services t o institutional and private
investors nationwide. Prior t o his association w i t h the financial c o m m u n i t y , Mr. James was
Manager of the Technical Assistance Group for the C a l i f o r n i a Credit Union League (a trade
association of 1800 c r e d i t unions). In addition, he was an International Financial Consultant
and Senior Auditor for a Fortune 100 company. In this capacity, he provided companies in
approximately 30 d i f f e r e n t countries w i t h valuable financial advice.
Stephen L. Roe, Vice President, Professional Asset Management, is a C e r t i f i e d Public
Accountant and is a member of the American Institute of C e r t i f i e d Public Accountants and
the California Society of C e r t i f i e d Public Accountants.
Prior t o his association w i t h
Professional Asset Management, Mr. Roe was President and General Partner of Roe,
O'Rourke and Clark Accountancy Corporation, a f i r m which specializes in auditing and
consulting services for over 250 credit u n i o * clients throughout the country. He was also
associated w i t h a leading Big " 8 " account** J| f i r m in San Francisco. Mr. Roe received a
Bachelor of Science degree f r o m San Jose State in 1970, and did graduate study at Stanford
University in Business A d m i n i s t r a t i o n .




332

PROFESSIONAL
ASSET
^ ^ ^

2 2 U 0

Ventura

Bo^evard Woodland Hills, California 91364 800/423-5877 Continental U.S.
213/888-2100 California, Alaska, Hawaii

MANAGEMENT
INC.
It's n o secret that the nation's savings and loan industry is in deep trouble. Even Richard Pratt, head of the
FHLB, recently stated that every day another institution sinks to zero net worth.
Now having a zero net worth is quite a bit different from having n o cash flow. Those associations with a
steady cash How from monthly mortgage payments could ride out negative net worth until interest rates
decline and net worth corrected itself. The associations in most trouble are those that ventured b e y o n d
their traditional forms of financing (buying Ginnie Maes on margin, for example) into riskier forms of
finance. The Wall Street Journal in a recent editorial questioned w h e t h e r or not the " n e w s " was placed to
influence legislation beneficial to the industry.
Now savings associations c o m e in many sizes and shapes. From the giant Home with assets near $15
BILLION to tiny Equitable with assets less than 14 million. While the industry may be in trouble there are
many well managed individual associations that are doing very well. The California S & L's for the most
part are strong because of their relative large size, their very strong balance sheets (with generally excellent
net w o r t h to asset ratios) and the fact that for many years they have been net sellers of loans while eastern
institutions were net buyers.
In spite of this, many portfolio managers are scaling d o w n their deposits in S & L's and are n o w
"reaching" for yield in the nation's banking system. Both actions, again, with little or n o investigation of
the income statements or balance sheets of the S & L's avoided or the banks used.
Now I'm not making a case for either the S & L's or for banks. / am making a case for intelligent investigation before making an investment. We p r o d u c e this capital adequacy report to assist in your investigations.
We at Professional Asset Management were a m o n g the first to speak out o n the need for caution. We are
aware of our responsibilities to you and will continue to monitor even more closely those institutions included on our " a p p r o v e d " list. We p r o d u c e our report quarterly and will include only institutions that
meet our rigid requirements. This new issue was p r o d u c e d to make it easier for you to make comparisons.
The report should not replace your o w n internal investigations. Use it as a guide. If you need our help
with your o w n work w e will be happy to assist.
While we observe some 150 ratios we closely watch only a few " K e y " ratios. We are concerned first with
safety. As a result we consider size. A minimum total asset base of $400 to $500 million if the bank or S & L
has a strong deposit base (very little foreign money). We look for net worth to assets of n o less than 4 % to
.5%. A few S & L's wholly o w n e d by large publically listed corporations are looked at o n a case by case
basis. We look for an adequate return on assets and equity. Temporary losses are not too significant in and
of themselves, unless the losses are of significant size to impair net w o r t h . The use or extent of b o r r o w e d
money (leverage) is watched. In all areas w e monitor trends carefully. For our internal use w e follow a five
year trend analysis. For purposes of the report w e reflect a year to year trend. Here we look at assets,
deposits, loans, net w o r t h , profit.
A deterioration in key liquidity or equity ratios or a significant change in an otherwise successful trend will
force us to d r o p the institution from our approved list.
O n e intangible that is difficult to quantify, but o n e which w e watch closely, is our assessment of management. We k n o w , and visit regularly with t o p management" of every bank or S & L o n our list. Through this
close personal contact w e feel we get to " k n o w " the institution and better interpret data taken from their
published reports.
O n c e an institution has been a p p r o v e d w e r e c o m m e n d the following guides: Limit y o u r i n v e s t m e n t t o
n o m o r e t h a n 1 % o f t h e i r total a s s e t s o r 5% o f their n e t w o r t h a n d n o m o r e t h a n 1 0 % o f y o u r
total p o r t f o l i o i n a n y o n e i n s t i t u t i o n .
If you find any improvement w e can make in pub**hing this report, we solicit your suggestions. We will
be happy to assist with any of your investment questions.

CowAially,

JX.
Bill Goldsmith
Vice President




PEER GROUP STATISTICS YEAR ENDING 1

Capital Adequacy Report <
o
I

RETURN ON
AVERAGE
ASSETS
AVERAGE'2
NET
WORTH

LEVERAGE

WORTH
JVERAGE
ASSETS

%
CHANGE
ASSETS

RETURN ON
AVERAGE NET
WORTH

NET WORTH
AVERAGE
ASSETS

%
CHANGE
DEPOSITS
$100 TO $250 MILLION

ALLSTATE SAVINGS & LOAN(a)
AMERICAN CITY BANK(b)

12.00%

AMERICAN NATIONAL BANK

16.80%

BARCLAYS BANK OF CALIFORNIA(c)
BENTWOOD SAVINGS & LOAN(d)

1,085

CALIFORNIA FIRST BANK

3,751

9,015

CAPITAL BANK, NA

$1 BILLION 6

2,869

CENTRAL BANK

2,626

CENTRAL FEDERAL SAVINGS & LOAN
2,452

COMMUNITY BANK
FAR WEST SAVINGS S LOAN
,

1,011

1,434

GIBRALTER SAVINGS & LOAN

3,249

3,800

GOLDEN STATE BANK(e)
* GROUP STATISTICS V

GUARANTEE SAVINGS & LOAN

< ENDING +2—Sl-81

- 70

HIBERNIA BANK

- 43

HOMESTEAD SAVINGS & LOAN

RETURN ON
AVERAGE
ASSETS

RETURN
AVERAGE NET
WORTH

NET WORTH
AVERAGE
ASSETS

- 96

IMPERIAL BANK
MERCURY SAVINGS S LOAN
ASSETS FROM
$1 TO $5 BILLION
(125 Banks)

PACIFIC FEDERAL SAVINGS S LOAN(cj)
PENN SQUARE BANK, NA

-ASSETS FROM — • •
$500 MILLION TO
$1 BILLION
(112 Banks)

SOUTHWEST SAVINGS i. LOAN
STATE SAVINGS & LOAN(h)

.81%

12.98%

5.89%

93%

6.82%

63%

/7.04A

UNION FEDERAL SAVINGS i. LOAN
UNIVERSITY SAVINGS & LOAN(i)
VALLEY FEDERAL SAVINGS i LOAN
CALIFORNIA BANKS4
NA = Not Available
1 NET WORTH = PAID IN CAPITAL +SURPLUS + RETAINED EARNINGS
2 ANNUALIZED




vS^
<V

Wholly owned subsidiary of Sears Roebuck
American City acquired by $3.5 Billion United C
Wholly owned subsidiary of $68 Billion Barclays Bank Ltd.
Wholly owned subsidiary of Jim Walter Corporation
Wholly owned subsidiary of $70 Billion Sanwa Bank Ltd.
Wholly owned by Guarantee Financial
Pacific Federal acquired Santa Fe Federal 5/15/81. Prior
figures not meaningful
Wholly owned by Financial Corporation of America
Wholly owned subsidiary of Entex Corporation

15.19%

14.18%

CO
CO
CO

334
GLOSSARY
DEPOSITS

Time deposits (including savings accounts) and demand
deposits plus deposits in excess of $100,000 will total
100%.

NET INCOME

Net current operating income after minority interest
and taxes but before securities gains and losses (if any)
and preferred dividends.

RETURN ON AVERAGE
ASSETS

Net operating income available for common (net
operating income minus preferred dividends) divided
by average assets. For purposes of our illustrations
period ending June 30, 1980 and June 30, 1981 assets
are averaged.

LEVERAGE

Average assets divided by average net worth.

NET WORTH

Total of paid in capital, surplus and retained earnings.

RETURN ON NET
WORTH

Net operating income divided by average net worth.
For purposes of our illustration period ending June 30,
1980, and June 30, 1981 net worth figures are
averaged.




335

PROFESSIONAL
A C C p T
**•'*"'''"'•""' *•

22110 Ventura Boulevard Woodland Hills, California 91364 800/423-5877 Continental U.S.
213/888-2100 California, Alaska, Hawaii

MANAGEMENT
INC.
November 12, 1981
Since the publication of our last CAPITAL ADEQUACY REPORT much has changed in the capital and money
markets. The prime rate has dropped from a near record 20.5% to a current 16.5% (a 19.5% decline), Federal Funds
have declined from 17.5% to 13.25% (a 24% drop) and 30 to 90 day CDs are now trading at 14.5% from 19.5% (a
decline of 25.6%).
The long term (capital) markets have improved dramatically too, with the popular Treasury 13.875% of 2001 at
104.15 up from 91.15, an improvement of 14.3%.
Inflation has moved out of the double digit range down to an annual rate of 7.5% in the third quarter while
unemployment is up to 8% and heading higher.
The large demands on the market by government financing are presently being more than offset by an economy
much weaker than earlier estimates. This will probably result in rates continuing to drop gradually for the next six
months or so. But the deepening recession (which reduces revenues and adds to spending), coupled with continuing
heavy demands by the Treasury to finance past deficits with a federal deficit for fiscal 1982 currently estimated to
reach a record $70 to $80 billion, plus a continued tight money policy by the Federal Reserve, could well build a
floor under both capital and money market rates at a relatively high level. If the economy begins to move upward
in the second half of 1982 a n d / o r if the resolve of the Administration, Congress and the Fed to fight inflation
weakens, interest rates could move to new record levels in the second half of 1982.
Currently there is definitely a three tier market in the C D arena. Rates paid by well capitalized S ck L's are 100 to
150 basis points higher than those paid by strong regional independent banks. The law of supply and demand has
not been repealed.
While hardly a day passes without another scare story concerning the S 6k L industry recent actions by Congress
and the Administration will provide breathing room until falling interest rates and improved portfolios of mortgages return money-losing S 6k L's to a period of growth and prosperity long enjoyed by the industry.
" . . . there is food for contrarian thought in all this woe. S 6k L's will not become wildly profitable
anytime soon, but there will not be a massive collapse," says Allan Sloan in his October 26, I u 81,
issue of FORBES.
"The key element has been the ability of the FSL1C . . . to protect its $6.7 billion insurance fund . . .
it's doing that with accounting adopted by the FHLB Board and a gimmick the FSLIC snuck into the
1981 Tax Act to make some S 6k L takeovers more attractive. The thrifts have two problems, capital
adequacy and liquidity. Capital adequacy can be more or less ignored during the current problems as
long as an institution is basically sound."
Sloan continues; "To help solve both liquidity and capital problems the FHLB Board hit upon a neat
method of accounting. It will let S 6k L'S sell mortgage loans at a loss and allow them to charge the loss
to capital over the life of the loan rather than all at once. As an example: An S &. L sells a $50,000
10% mortgage with 20 years remaining for $40,000. Normally the $10,000 loss would be charged to
capital at once. Under the new rules the S ck L can charge off just $500 a year for 20 years. The S 6k L
uses the $40,000 for a new 16% loan. The loan produces more interest than the old one: $6,400 a year
compared with $5,000. That $1,400 covers the annual $500 charge to capital with $900 left over. Is the
loss real? Yes. Is the S ck L better off? Of course.
A second action allows S 6k L's to trade a package of low yielding loans to Freddie Mac in return for a Freddie Mac
guaranteed certificate, both at market rates. The new Freddie Mac certificate has properties the individual loans do
not have: They can be used in an arbitrage strategy to increase the return or they can be used as collateral to raise
money through the sale of repos.
"Major S 6k L's whose problems can't be solved by portfolio sales may be attractive takeovers, thanks
to Section 244 of the 1981 Tax Act. That clause, pushed through by the FSLIC while no one was
looking enabled the FSLIC to unload two of its biggest problems — West Side Federal of New York
City and Washington S 6k L of Miami."




Capital Adequacy Report

P STATISTICS V
N E T WORTI'
AVERAGE
ASSETS

THOUSANDS)

CHANGE

2,289,000

CHANGE

26,772

ABILENE NATIONAL B

83.60%

67.00%

156.5

10.30%

2.50%

21.20%

16.90%

302,780

6.10'

309,343

10.10'

30.30%

28.501

705,552

8.30'

11.20%

15.501

53.00%

52.60%

818,000

BRENTWOOD SAVINC

12,631

11.80%

9.00%

4,200

3,305,402

15.70%

15.60%

16.40%
EMPIRE SAVINGS (d)

15.60

15.30%

16.40%

-7.10%

5,959

TULSA, OKLAHOMA

12.80%

(4,700)

SJi-

10.30%
27.20%
8.00%

1,151,000

GUARANTEE SAVINGS & L O A L , (t

11.20%

10.501

22.30%

01.00

1.50%

-0.60

771,773
318,230

ASSETS
000

(5,000)

36.00%

000

13,500

JRTY NATIONAL BAIiK

331

11,590

[FIC FEDERAL SAVIN

000

(1,500)

J SQUARE

OOlw

NATIONAL

4,129 ,

A S S E T S FROM
$1 T O $5 B I L L I O N
(125 Banks)

^

$500 Ml
S I BILL
(112 B
106.40%
12.80%

i LOAN(k)

RETURN
A V E R A G E NE
WORTH

18.68%

71.701
-13.701

3.501

1,57

CALIFORNIA B A N K S 4

6.501
$100 to $500 M I L L I O N
15.19%
GIBRALTAR SAVINGS I
isclosure of curr

2 ANNUALIZED




14.18%

Wholly owned subsidiary of Sears I
Wholly owned subsidiary of $68 Bi)
Wholly owned subsidiary of Jim WaJ
Wholly owned subsidiary of Baldwir
Wholly owned subsidiary of $70 Bi)
Wholly owned by Cuarantee Financii
Hibernia acquired by
=ific
»/30/81.
Prior :
Wholly owned by Financial Corpora
Wholly owned subsidiary of Entex
Applitd for change to a Stock Compi my

not meaningful
from a Mutual Company

337
Section 244 allows a healthy S 6k L who acquires a sick one to deduct the S &. L's operating losses for tax purposes
but does not require them to count FSLIC payment as income. For example, if you buy an S 6k L losing $100
million a year with a guarantee that the FSLIC will cover the loss vou can't lose . . You shell out the $100 million
loss, get a $46 million refund from the IRS and then get $100 million from the FSLIC. Net cash flow: $46 million.
"With deals like this available . . . buying troubled S 6k L's should be a growth business for the next
few years" says Sloan.
Congress is also considering a bill to permit banks to buy S 6k L's across state lines. This may be the next chapter
which leads to interstate banking and the end of the McFadden Act. Keep tuned in. When the FSLIC is finished
there will be far fewer but sounder S 6k L's.
As we warned in the September, 1980, issue of CREDIT UNION MANAGEMENT investing in S 6k L CD's can
be prudent if you invest only in the larger, better capitalized institutions. We continue to believe in the viability of
the S 6k L industry. We continue to stress safety, diversification and capital adequacy.
Our thanks to the many o( you who have- told us how much you appreciate our CAPITAL ADEQUACY
REPORT. We will continue to publish it quarterly with increased dedication. Again, if there are any improvements
or additions you'd like to see in the REPORT please let us know.
Cordially,

&m
The information included in this report is taken from financial statements published by the various institutions included herein. Copies of the actual Statement of Conditions are available on request from PAM or from any of the
institutions whose figures are included in this report.

GLOSSARY
DEPOSITS

T i m e d e p o s i t s (including savings a c c o u n t s ) a n d d e m a n d
d e p o s i t s plus d e p o s i t s in excess of $ 100,000 will total
100%.

NET INCOME

Net c u r r e n t o p e r a t i n g i n c o m e after minority interest
a n d taxes but before securities gains and losses (if any)
and preferred d i v i d e n d s .

RETURN O N AVERAGE
ASSETS

Net o p e r a t i n g i n c o m e available for c o m m o n (net
o p e r a t i n g i n c o m e m i n u s preferred d i v i d e n d s ) divided
by average assets. For p u r p o s e s of o u r illustrations
p e r i o d e n d i n g J u n e 30, 1980 a n d J u n e 30. 1981 assets
are averaged.

LEVERAGE

Average assets divided by average net w o r t h .

NET W O R T H

Total of paici in capital, surplus a n d retained earnings.

RETURN O N NET
WORTH

Net o p e r a t i n g i n c o m e divided by average net w o r t h .
For p u r p o s e s of o u r illustration p e r i o d e n d i n g J u n e 30,
1980, a n d J u n e 30, 1981 net w o r t h figures are
averaged.




338

PROFESSIONAL
A S S F X
* » • * - ' » - ' • - ' *•

22110 Ventura Boulevard Woodland Hills, California 91364 800/423-5877 Continental U.S.
213/888-2100 California, Alaska, Hawaii

MANAGEMENT
INC.

5/.

December 30, 1981

;

/ ^

;' V
Dear Friends:
A very happy holiday season to a l l .
Since the publication of our Capital Adequacy Report on November 12, 198!, we have
brought into the f o l d f i v e new i n s t i t u t i o n s :
CSfate Street BankQ^Boston^Massachusetts *
H e r i t a g e Bank - A n a h e i m T C a l i f o r n i a
Bank of Newport - N e w p o r t Beach, CaJ^fpxnifl_____^
F i r s t National Bank and Trust - L i n c o l n , Nebraska
Financial Federation - Los AngelesTCaT^rnTa
You w i l l n o t i c e f r o m the enclosed analysis t h a t they all meet the rigid c r i t e r i a we requwe
for any i n s t i t u t i o n we represent.
In addition we are studying three more national banks. If our analysis c o n f i r m s our e c r ' y
studies, we w i l l bring them on board and send you the results of our analysis as soon as
possible.
One special note.
Financial Federation is an eleven association holding ccrr.ccny.
Conseauently c e r t i f i c a i e s are insured up ?o Si.S m i l l i o n . If you 'nave any questiens, please
call.
Cordially,

\ui
B i l l Goldsmith
Vice President

BG/jr/wcp

End.




CAPITAL ADEQUACY REPORT

(additions)

For nine months ending 9-30-81 (in thousands)

Total
Assets

Bank of Newport
Financial Federation
K" First N t l . Bank & Trust
Heritage Bank
t/State Street Bank




Deposits

Net
Worth

Net
Income

$

$

156,440

$ 14,153

$

2,383,673

1,956,901

167,557

695,669

456,522

49,147

212,261

195,493

3,131,484

2,077,783

192,125

1,899

Return
On Avg.
Net
Assets

Return
On Avg
Net
Worth

1.4

19.3

NM

NM

5,750

I.I

16.5

11,599

1,554

I.I

20.8

158,283

18,717

(20,290)

.8

16.8

340

=
=

PROFESSIONAL
A ^ ^ F " T
rVkJLfl^ l

22110 Ventura Boulevard Woodland Hills, California 91364 800/423-5877 Continental U.S.
213/888-2100 California, Alaska, Hawaii

MANAGEMENT
INC.
"Registered Investment Advisor

March 10, 1982

To hear many tell it, the S & L industry is dead. Others are holding the wake BEFORE the funeral. To steal a line from another
generation, reports of this demise are greatly exaggerated. However, I think it is safe to say that 1981 was a very difficult year
for most S & L's.
You may have noticed that this report includes fewer S & L's and more banks than previous reports. The extent of the
industry's difficulties are further underscored by the number of S & L's requiring mouth to mouth resuscitation. Even the best
managed institutions sustained substantial losses and the FHLB reduced its minimum reserve requirements from 4 % of
average assets to 3%.
Hardly a day passes without an article in one or more local or national publications telling of the plight of the S & L industry and
the fact that almost daily another institution sinks to zero net worth. What isn't reported is that having a zero net worth is quite
different than having no cash flow. Those associations with a steady cash flow from monthly mortgage repayments could ride
out a zero net worth or even a negative net worth until interest rates decline and the net worth, corrected itself.
We at Professional Asset Management continue to believe in the viability of the S & L industry even though we recognize over
the near term additional surveillance and extreme caution are top priorities. Consequently, even though we have reduced the
NUMBER of S & L's on our approved list, the QUALITY of the specific institutions we follow remains extremely high. In these
difficult times SAFETY and CAPITAL ADEQUACY have no substitutes. Only those banks and S & L's that continue to meet
our rigid quality standards are included in this capital adequacy report.
Philosophically it could be argued that since the regulators have relaxed their merger requirements easing the way for
interstate mergers and inter-institution mergers, the possibility of failure for all but the smallest S & L has been reduced
significantly. It could be argued further that since Congress rescued Lockheed and Chrysler with bailout loans, can it do any
less for a large troubled thrift?
Since these are political decisions it is difficult to know with precision what this new political environment or an election year
will bring. Therefore we will not speculate in the realm of probability and consider only the land of reality, those factors that
reliably measure relative strength and capital adequacy. You will note that the banks and S & L's we have included in this
report are very profitable or at the very ieast possess capital adequacy that is more than adequate in spite of recent losses.
The banks continue to reflect both profitability and strong capital adequacy positions.
The continuing relative weakness on the part of even the strongest S & L and the strength of banks in general has created a
fairly pronounced two-tier market in the bidding for CD's. Yield differentials favoring S & L's have increased to 75 to 100 basis
points in many cases. This differential implies a greater risk plus an element of fear inherent in an S & L investment. Is the
additional premium paid by an S & L worth whatever real or imagined risk one perceives in such an investment? This is a
decision you will be forced to make with increasing frequency as this year unfolds. That is precisely the reason Professional
Asset Management brings you this report. It allows you to study 40 institutions, carefully comparing many of the key elements
of safety and capital adequacy before you make an investment.
We will not include in this report any bank or S & L whose capital adequacy do not meet rigid minimum standards. We will
augment this analysis with personal visits to each institution and personally interview top management as part of our indepth
analysis.
Separately much has been said and written of late about expanding investment regulations to permit credit unions to buy
bankers acceptances, Euro dollar CD's and commercial paper. Additional avenues for investments are needed, of that there
is little doubt. But I was around in the early 70's when many of you reading this entered the world of Ginnie Mae's after learning
only to speli the name. But at least Ginnies are guaranteed by the U.S. government. And still because of a gross lack of
knowledge and information many lost a bundle of dot_*s. You're going to have to know much more than how to spell the
names to be able to invest intelligently in BA's, Euros or commercial paper. Sadly the loudest spokesmen for increased
investment opportunities are many of the same voices who bought heavily into Ginnies and Freddies a while back. Nothing
takes the place of information. Investigate before you invest is an axiom as currant today as when it was first uttered years
ago. I will discuss BA's, Euros and commercial paper more fully in a subsequent report. However feel free to call on me any
time for assistance.







CAPITAL ADEQUACY REPORT
FOR YEAR ENDING DECEMBER 31,1981

TOTAL
ASSETS

NET
DEPOSITS

INCOME
A N D S )

( I N
424,377
3,260,475
396,444
385,751
212,824
819,326
4,620,000
921,550
916,442
681,547
1,319,753
1,038,665
2,436,805
797,564
1,642,752
2,745,700
1,294,723
5,257,234
1,800,000
3,445,086

376,804
2,269,918
343,906
336,716
176,911
723,474
3,497,000
716,364
823,963
445,164
959,712
736,300
2,059,344
631,085
1,348,228
2,009,306
1,014,403
3,525,395
1,380,000
2,552,124

27,230
150 846
17 308
26 748
14 649
56 731
184 ,300
53 ,713
45 ,650
34 ,694
57 ,549
65 ,175
137 692
52 914
84 270
40 000
78 641
216 ,828
75 ,000
167 523

5,477
(25,299)
(3,663)
5,017
2,014
100
2,680
5,228
7,189
4,654
(5,743)
(3,890)
(32,024)
8,560
21,543
19,298
11,002
(4,500)
5,800
(8.928) 1

Golden State Sanwa Bk. 6
860,000
Guarantee SSL 7
1,693,073

720,000
1,164,892

60 000
62 ,283

2,100
(6,945)

. Abilene Natl. Bank
Allstate SSL^
American City Bank
(American Natl. Bank
Bank of Newport
Barclays Bank 4
California First Bank
fr7Capital Bank, NA
Central Bank
Community Bank
Empire SSL 5
Far West 3(.L
Financial Federation
First Natl-Amarillo
(V'First Natl-Midland
First Natl-of Oklahoma
First Natl-Tulsa
First Penn Bank, NA
• Fuji Bank, N.Y.
Gibraltar SSL Hr' ston

Heritage Bank
Hibernia Bank
Homestead SSL
Honolulu Federal SSL
jTA-rfc. Imperial Bank
V Liberty Natl. Bank
Pacific Federal SSL
" B^nk, N A 9 " "
Southwest SSL^__^• State SSL*
j7x£rr|A'-State Street Bank
Sunwest bank
Union Federal SSL
University SSL 9
Valley Federal SSL
*77Wf*Westlands Bank
Gill Savings

264,464

242,600

897,339
565,880
1,464,748
1,397,317
2,266,840
1,717,853

766,406
323,120
969,283
1,172,761
1,740.164
1,249,203

12
47
23
56
65
106
70

381

2,121

ise
471
963
717
414
382

1,089
533
(9,080)
18,151
14,240
(24,625)

394,158 ^ 363,754-^ 30 404 *-^ 4,705"^
562^513. — a Z 7 ^ 0 0 7 _
25j 227
_418___
98 944
3,662,590
2,747,716
164 677
3,388,066
2,248,475
26,242
131,872
117,548
8 278
768
325 662
66,193
726,731
26 574
496.128
(6,497)
2,096,467
58 885
1,823,399
(2,985)
1,595,378
1,073,682
48 383
(12,203)
239,250
404,594

217,904
344,822

12 557
10 685

-iscal Year ending 9/30/81
ides pure >ase of Oceanside Federal
y owned subsidiary of Sears Roebuck
y owned subsidiary of $68 Billion Barclays
subsidiary of Baldwin United

1,249
5,789

RETURN ON
AVERAGE
ASSETS

tf
NET WORTH 1 NET WORTH/
1 AVERAGE j
AVERAGE
DEPOSITS / ASSETS j

RETURN ON
AVERAGE
NET WORTH

1.7%
NM
NM
1.4%
i.0%
NM
.07%
.6%
.8%
.75%
NM
NM
NM
1.2%
1.5%
.76%
.9%
NM
.4%

26.7%
NM
NM
19.5%
14.4%
.17%
1.6%
11.0%
16.7%
14.4%
NM
NM
NM
17.4%
28.7%
12.6%
14.7%
NM
10.17%

9.5%
6.6%
5.2%
8.4%
8.9%
8.1%
5.5%
8.0%
5.9%
7.8%
6.4%
9.4%
6.8%
9.1%
6.2%
8.7%
8.2%
6.1%
6.5%

NM
.26%
NM

NM
4.6%
NM

6.9%
G.9%
5.4%

.9%

20.2%

5.9.

.14%
.1%
NM
1.5%
.7%
NM

2.3%
2.3%
NM
33.8%
15.8%
NM

8.5%
7.4%
6.2%
6.5%
7.0%
6.7%

1.4%^

18.5%

.7%
.8%
.6%
1%
NM
NM
NM
.6%
2.1%

22.8%
17.0%
9.7%
21.7%
NM
NM
NM

„

13.3%
75.0%

ASSETS

% CHANGE SINCE 12/31/80 - 12/31/81
NET
NET
DEPOSITS
WORTH

5 YEAR GROWTH 12/31/77 - 12/31/81
ASSETS

DEPOSITS

NET WORTH

8.5%
4.8%
4.5%
7.3%
7.4%
7.0%
4.5%
6.2%
5.2%
5.3%
4.7%
6.7%
5.6%
7.3%
5.9%

94.0
7 .9t
5.2
12 .8
16 3
4 9%
27 6%
14 .0
7 7%
25 0%
18 7!
14 31
4 0*
22 7%
35 .8

90.0%
(2.0%)
5.2%
11.9%
15.6%
5.7%
(1.1%)
15.5%
12.9%
17.4%
15.3%
13.9%
2.8%
19.4%
29.3%

96.5% ^
(14.4%)
14.5%
9.0%
10.2%
(2.2%)
27.5%
30.7%^
13.2%
15.5%
1.2%
(5.6%)
(19.6%)
16.8%
28.3%^

90.0%
(625.0%)
(213.0%)
51.4%
(17.0%)
(96.0%)
(15.5%)
(14.4%)
30.2%
11.3%
(230.0%)
(216.7%)
(119.0%)
24.7%
49.5%

764.0%
150.0%
175.0%
71.0%
116.0%
NM
63.46%
NM
NM
147.0%
155.0%
59.3%
NM
NM
218.7%

745.0%
130.0%
159.6%
65.0%
103.0%
NM
64.0%
NM
NM
94.0%
135.0%
48.7%
NM
NM
190.9%

687.0%
85.0%
118.5%
108.0%
178.0%
NM
52.0%
NM
NM
89.0%
93.0%
31.9%
NM
NM
133.6%

6.2%
6.1%
4.0%
5.3%!
4.9%
7.6%
3.8%

48 5%
19 0%
4% )
71 0%
3 0%
19 3%
5 0%

50.0%
12.8%
(.3%)
47.9%
6.5%
11.4%
1.5%

6.0%
10.4%
.05%
92.3% 'S
(11.8%)
86.4%
(10.4%)

(14.0%)
15.5%
97.0%
65.7%
(240.0%)
(21.6%)
(223.2%)

NM
NM
NM
NM
NM
344.0%
NM

5.5%
7.2%
4.4%
4.1%
5.5%
5.3%
4.9%

41
45
10
10
41
30
3

39.0%
39.4%
2.8%
10.2%
36.4%
39.0%
0.0%

43.0%
3.0%
2.3%

39.0%
(-75%)
(92.3%)
(60.8%)
57.2%/^
39.3%
43.0% "'
35.0%
(26.0%)
(477.0%)

519.0%

NM
NM
NM
NM
NM
313.0%
NM
567.0%

NM
NM
NM
NM
NM
462.0%
NM
151.0*

103.0%
100.0%
124.0%
195.0%
128.0%
150.0% 2

95.0%
43.0%
87.8%
185.0%
125.0%
155.0% 2

26.0%
105.0%
48.9%240.5%'
127.0%
44.5% 2

48. 9 * ^
9.8%|-v
0.0%
(69.0%)
68.0% *
46.0%
15.2% * '
'
19.7%
9.7%
(58.0%)
13.8% V
28.3%
(18.9%)
(289.0%)
(6.7%)
(150.0%)
(20.0%)
(263.0%)
104.0%
44.1%
125.7%
286.0%

601.0?
152.0%
489.0%
NM
140.0%
NM
NM
160.0%
231.0%
97.0%
NM

60 5.0'
4 74.0%
NM
130.0%
NM
NM
155.0%

611.0%
37.0%
226.0%
NM
170.0%
NM
NM
211.0%

197.0%
89.0%
NM

11.0%
332.0%
NM

(

9.8% x
8.9%B;
_ ?.J2%_ ^_5.0%
4.9%
7.9%
5.1%
7.6%
6.7%
7.0%
4.9%
5.5%
3.7%
3.8%
3.0%
1
4.5%
3.2%
6.2%
5.7%
4.6%
3.9%

Wholly
Wholly
Wholly
"(holly

owned
owned
owned
owned

36
24
117
12
15
26
5
15
15
18
178

0%
0%
5%
9%
4%
0%
0%
7% < X
0%
6%
7%
0%
2%
0%
0%
4%
0%

( 4 0.6%'V^
19.1%'
113.0%
18.2%
17.0%
18.5%
7.0%
13.6%
3.0%
16.1%
176.5%

subsidiary of $70 Billion Sanwa
by Guarantee Financial
by Financial Corporation of Ameri
subsidiary of Entex Corporation

U

342
Finally, I think it is safe to say that the economic environment is uncertain at best. On one hand there is increasing evidence of
a continuing recession and reduced inflation. Conventional wisdom has it that the price of money like the price of most
commodities in a recessionary environment will soften. On the other hand we have budget deficits predicted to top $100
billion for the next three fiscal years, a strong and resolute Federal Reserve Chairman who is committed to keeping a tight
reign on the growth of money, and an election year in the face of unemployment likely to top 9.5%. It is no wonder then that a
solid consensus for either higher or lower interest rates by year's end has failed to emerge. One thing that is certain is the
uncertainty and the continuing volitility of interest rates.
My rather cloudy crystal ball tells me that since markets can accept either good news or bad news but can't stand uncertainty
the .best posture is one that keeps your portfolio fairly short and liquid.
Once again, my associates and I stand ready to assist you in any way we can. We are gratified by all of you who tell us how
much you enjoy our CAPITAL ADEQUACY REPORTS. If you have any suggestions for improvements, don't hesitate to let us
know.
Cordially,

iSkit
Bill Goldsmith
Executive Vice President

The information included in this report is taken from financial statements published by the various institutions included herein.
Copies of the actual annual reports are available on request from Professional Asset Management or directly from any of the
institutions.

T i m e d e p o s i t s (including savings a c c o u n t s ) a n d d e m a n d
d e p o s i t s plus d e p o s i t s in excess of $ 1 0 0 , 0 0 0 will total
100%.
NET INCOME

Net c u r r e n t o p e r a t i n g i n c o m e after m i n o r i t y interest
a n d taxes but before securities gains a n d losses (if any)
a n d preferred d i v i d e n d s .

R E T U R N O N AVERAGE
ASSETS

Net o p e r a t i n g i n c o m e available for c o m m o n (net
o p e r a t i n g i n c o m e m i n u s preferred d i v i d e n d s ) d i v i d e d
by average assets. For p u r p o s e s - o f o u r illustrations
p e r i o d e n d i n g J u n e 30, 4.980 a n d J u n e 30, 1981 assets
are averaged.

NET W O R T H

Total of paid in capital, surplus a n d retained earnings.

RETURN O N NET
WORTH

Net o p e r a t i r v p i n c o m e divided by average net w o r t h .
For p u r p o s e s of o u r illustration p e r i o d e n d i n g J u n e 30,
1980, a n d J u n e 30, 1981 net w o r t h figures are
averaged.

Professional Asset Management is a licensed investment advisor.




343

PROFESSIONAL
A S S F T

MANAGEMENT
INC.

22110 Ventura Boulevard Woodland Hills, California 91364 800/423-5877 Continental U.S.
vard
Californ
213/888-2100 California, Alaska, H;

March 25, 1982

IBM Poughkeepsie EFCU
Attn: Mr. Joe Say res
P.O.Box 1750
Poughkeepsie, New York 12601
Dear Mr. Sayres:
You are cordially invited to attend our second annual Financial Symposium,
Wednesday, June 2, 1982, cocktails at 5 p.m. followed by dinner at 6 p.m., to
be held at the Marina City Club, 4333 Admiralty Way, Marina Del Rey,
California.
Our keynote speaker will be Mr. Michael Flaherty, General Counsel for the
House of Representatives Committee on Banking, Finance and Urban
Affairs. Mr. Flaherty's keen analysis of financial institutions from his
prominent vantage point makes most interesting and informative listening.
In addition, we are privileged to have on the program Mr. Jason Benderly of
the Washington Analysis Corporation, a division of Bache Halsey Stuart
Shields, Inc. Mr. Benderly is a nationally recognized expert on inflation and
its causes and he is widely quoted in the major business journals.
Space is limited and we ask that you make your reservations on or before
May 25, 1982. For those of you from out of town, the Marina City Club has
rooms available. However, early reservations are recommended. Call J.R.
at (800) 423-5877 (in California, Alaska, or Hawaii call collect (213) 8882100 or drop us a line.
We look forward to seeing you on June 2.
Cordially,

Q^x
Bill Goldsmith
Executive Vice President
BG/wcn




REGISTERED INVESTMENT ADVISOR




fflp^
Ted Hruska listens to Judith Williams (which makes sense) as Dick
Lindsay listens to Ron James. Who would you listen to?

Wherever there's a pretty face, Millie Bryan, can Steve Roe be far
away?

. r *>
•t

, ' , *

=r^

H r'

-.,t""

Wl'illlllliiliiH i "'

'

ii

' "

,1*

Bill Goldsmith obviously enjoys addressing a captive audience even
though he doesn't see too well as old age creeps up on him.

i

Alan Carlson and Steve Endaya can't seem to get a word in as Dick
Haymaker makes a point.

00




Left to Right: Steve Roe and Ron James, Michael Flaherty and Jason
Benderly find something amusing to smile about after a somber
forecast by both Michael & Jason.

Bill Goldsmith can usually find something to say - even if his listeners
are attractive, like Millie Bryan and Rosalie Feiz.
CO

CJI

Larry Heitzman and John Stover from Gill Savings listen with interest
to Sonja Chase who can always find something interesting to say.

According to Jason Benderly, Chief Economist for Washington
Analysis Corp. President Reagan's economic plan... "is widening the
gap between income and expenditures... the federal deficit could
reach $250 Billion by 1985."

346

=PROFESSIONAL
A ^ I ^ F T
/"VLK^L- I

22110 Ventura Boulevard Woodland Hills, California 913o4 800'423-5877 Continental U.S.
213/888-2100 California. Alaska, Hawau

MANAGEMENT
INC.
June 10, 1982

The more things change, the more they stay the same! It seems as though some people never learn. Back in 1974-75 and again in
1977 credit unions, S&L's, yes, and even some banks started buying a government guaranteed investment called "Ginnie Mae."
Many who ventured into this market knew how to spell the name, but little else about Ginnies.
They were bought largely from unlicensed salesmen operating in little more than a "bucket shop" whose only real interest was earning a commission. It mattered little to these salesmen whether the Credit Union, bank or S&L needed or could properly fund the investment. Working from purchased lists primarily of small to medium size S&L's and credit unions who were the most unsophisticated the disembodied voices with a smooth sales pitch sold millions of dollars worth of Ginnies and Freddies (Freddie
Macs). Many who bought are still "paying the piper." Recently an article published in "CUIS" reported that a West Coast credit
union is still involved in a legal battle with a sales firm whose main stock and trade was Ginnie Maes.
Now there was and is nothing wrong with a Ginnie Mae. It does have the full faith and credit of the United States as a guarantee.
What was wrong was that too many bought too heavily from people they didn't know (or who didn't know them) knowing little or
nothing about what it was that they were buying except perhaps, that it had a government guarantee. As is often the case, history
has a way of repeating itself. And those that fail to learn the lessons of history are doomed to err again.
Many of the same people or people like them are back in business, only today they are selling SBA loans (also government
guaranteed), Agency for International Development Bonds (AID, also government guaranteed) and certificates of deposit from
small, obscure banks and S&L's from all corners of the country.
Now there isn't much wrong with an SBA loan or an Al D bond if you understand them and are sure they fit your investment objectives
and you obtain competitive bids or offers when selling or buying and you know, really know, the person and firm from whom you are
making the purchase. One should ask themselves just why is an SBA loan or an AID bond with the same guarantee as a Treasury
note or bond selling to yield, in many cases, 100 basis points or more than theT note or T bond. The plain and simple truth is that they
are not worth as much. They aren't as marketable, far less liquid - almost a blind market when buying or selling; therefore, the spread
between bid and asked prices is much larger resulting in paying more and receiving less.
Since there is no public market as in Treasury securities, frequently one or two market makers and in tight markets often none,
prices are quoted on a "what the market will bear" philosophy. Additionally SBA's and AID's are difficult if not impossible to use for
loan collateral.
Now CD's are another matter. A crop of new "money finders" have crawled out from under the woodwork operating from sales
rooms, dealing with any obscure bank or S&L who will deal with them "hawking" CD's with the same reckless abandon as their
antecedents sold Ginnies and Freddies.
Credit unions, other small banks and S&L's with plenty of cash and few places to lend it are once again buying the proverbial "pig in
a poke", investing without investigating either the "money finder" or institution from whom they are buying a CD. In many cases
because the investor is investing "only" $100 thousand per institution - the insured amount - they feel as safe as they did when they
bought the Ginnies many still own at prices at 50% and 60% of cost.
To me there seems to be a frightening similarity in this activity. Two caveats to consider BEFORE making an investment of any sort:
Buy from a recognized broker or through a registered investment advisor you know and then know what you are buying. As a
registered investment advisor our obligation and commitment at Professional Asset Management runs deep, no different from that
of a major brokerage firm.
First, it is incumbent on us to know our clients and their needs and to know well the products we offer and are satisfied that these
products fully meet the requirements of our investors. Again, take CD's for example. We only offer in the market place CD's from
banks and S&L's that meet rigid standards for performance and capital adequacy determined as a result of extensive analysis of
not only the income statements and balance sheets but also of top management as well. This analysis is done on a continuing basis
and revealed to you in our CAPITAL ADEQUACY REPORT four times a year. Then when you invest $100 thousand or $1 million you do
so after reviewing and comparing up to the minute figures. Our commitment to you is to offer CD's only from institutions with a
history of solid performance and a current capital adequacy far above regulatory minimums.
While profits and profit ratios are one measure of an acceptjfele institution, profits or lack of same are sometimes temporary in
nature. It is a profitable TREND we measure. If a bank or S&L has a history of profitable operations and one or two quarters of
unprofitable performance, this, in and of itself, is not alarming.
On the other hand, CAPITAL ADEQUACY is permanent - or should be. If a short term loss does not severely impact or permanently
damage the capital adequacy of a bank or S&L with a history of profitable performance that institution is included in our universe.




CAPITAL ADEQUACY REPORT
FOR QUARTER ENDING MARCH 31, 1982
HETURN ON
AVERAGE
ASSETS"

RETURN ON
AVERAGE
NET W O R T H • •

NET WORTH
AVERAGE
DEPOSITS

% CHANGE SINCE

NET WORTH
ASSETS

ASSETS

3/31/81

-

ASSETS

__g^^4»
143,860

(6,986)
(1,293)

5.3%

15,032

1.047

First

Bank

^ ,

T

^

14.7%

(20 000)

6.1%
(704.0%)

(.04%)

280,000

(15.2%)

NM

186,110

3 612

8.7%

5.8%

5.0%

25.9%

(24.8%)

53,833

:

> i t a l B a n k , NA J ?tf*f

1,150

9.6%

8.4%

6.5%

29.4%

15.9%

5.9%

13.0%

12.0%

6.6%

18.2%

9.1%

6.0%

16.4%

22.8%)

5.9%

4.4%

(3.3%)

(882.0%)

19.7%)

8.8%

6.2%

(12.1%)

(338.0%)

(20.5%)

(116.3%)

(4.0%)
42.9%

13.8%

(34.0%)

25.6%
1.6%

(9.3%)

21.9%

13.3%

22.0%

108.8%

1.1%

16.3%

10.2%

11.1%

11.0%

(.05%)

(10.9%)

.05%

10.3%

(1.8%)

(34.5%)

6.5%

(5.3%)

6.5%

15.1%

9.8%

121.0%

6.4%

(14.8%)

(280.6%)

48.1%

4.1%

171.2%

.02%

2.4%

8.6%

(.05%)

(13.2%)

5.1%

1.1%

Savings S&L

109.7%

1%

2.4%

(13.7%)

(471.2%)

23.1%

(85.4%)

(2.4%)

(204.5%)

5.4%

427.4%

(17.4%)

(333.0%)

35.6%

y;:
•^Penn

(4.0%)

5.8%

Square Bank. N

"/sorest

st

Instate S&L

10

Sunwest Bank
• T e x a s Commer :e Bank
Union
United

Federa

SiL

Savin s - Te




10,554,407

1^160.0

(74.0%)

10.1%

(1.298)

DEPOSITS

. 1,130.0%
_

(408.6%)

16.3%

384

56,692

lifornla

14,1*1

(16.5%)

16,141
27,858

5 YEAH CHANGE 1 2 / 3 1

3/31/82

DEPOSITS

21.4%
38.0%"
38.2%
(4.0%)
22.3%
(15.0%)
(40.0%)

8.0%
5.1%
9.9%

18.11

44.8%

67.2%

6.8%

13.31

25.0%

(33.5%)

3.6%

2.91
40.01

55.4%

5.5%

14.23

—8.4%

3.3%

126.51

72.8%

6.6%

21.31

8.8%

3.0%
18.0%

21.2%

~~~

gai n l •
156.5%
(120.6%)
34.0%

21.0%)
14.8%)

3.1%
2.7%
5.7%

(325.0%)
(280.0%)

(4.3%)

208.0%

27.3%)

(99.0%)

93.9%

(85.0%)

39.4%

(28.6%)

Member, First City Bancorp.
Comparable figures not available due to merger.
Wholly owned by FCA.
Profit for three monthes ending 5-31-82 at 25011.
Wholly owned subsidiary of Entex Corporation.

All Institutions insured t

FDIC or FSLIC

348
Then when we offer you CD's you can be comfortable with an investment of $100 thousand or up to but not more than a investment
of 5% of the net worth in any bank or S&L in our universe. Once again, when loan demand is low and cash is plentiful many
unsophisticated investors buy yield with little regard to quality.
Many small banks, S&L's and credit unions in the investing mode are still employing unknowledgeable, unsophisticated and
unthinking people to make the investments. I talked to one such person the other day, as an example. She (it could have been a he)
asked if the CD she was buying was insured by FSLIC. When I said it was insured by the FDIC she insisted that only FSLIC insured
CD's was sufficient. When I questioned her, she frankly didn't know who or what FSLIC was or for that matter FDIC.
I submit that conversations similar to this one occur with all too frightening frequency, daily, in our office. So, when I say that our
commitment and obligation to our investors runs deep - it includes informing, teaching and protecting. It's time you, the investor,
make the commitment to learn this business of investing. Once again, this process should begin with knowing your product and
knowing those you rely on for products and information. If you don't know your broker or investment advisor at least verify the
reputation and experience before dealing with a salesperson or firm that person represents. As of this writing the money and bond
markets are still confused. After a fairly strong rally the markets in all maturities has backed off sharply.
Inflation is down to an annual rate of 5% to 6% from 12.5% not too long ago but interest rates, although down from peaks in all
sector are still exceedingly high with a record inflation premium built in. Market participants seem to be saying..."we don't believe
that this present rate of inflation is sustainable," and with good cause. Record high current budget deficits and estimated future
deficits reaching $250 billion by 1985 may be the fuel to reinflate our economy.
Deflation has its price too in unemployment, lower or nonexistent corporate profits and a soft market for houses and other
collectibles. Unemployment widens the Federal deficit causing the government to borrow more and pay more for what they borrow.
Falling prices cause corporate bankruptcies and heavy corporate borrowing by firms just to stay afloat pushing up rates and
personal bankruptcies near an all-time record help to exacerbate high rates.
The evening of June 2, more than 200 of our clients from across the U.S. gathered at the Marina City Club for our Second Annual
Financial Symposium to hear Mike Flaherty and Jason Benderly. There were few dry eyes after both reflected their views that tough
times are ahead on both the regulatory and economic fronts as what should be collides with political realities. BE PREPARED are
the watch words. We hope you make next year's annual update, but as the accompanying pictures reveal, those at this year's bash
enjoyed the evening if not the news.
Finally, our clouded crystal ball tells us that interest rates in all sectors could ease for the next three or four months before heading
back up again - possibly to new record highs - by the end of the year or early 1983. Some economists of note, including Henry
Kaufman feel new records will be set. So, for the moment, if you can, extend maturities on your CD investments to the 120 to 180 day
area to protect today's relatively high rates. Then, if rates do escalate again as anticipated shorten maturity schedules.
Once again, if you have any suggestions on how we can improve our REPORT, write or call in your suggestions.
Cordially,

Bill Goldsmith
Executive Vice President

The information contained in this report is taken from financing statements published by the various institutions included herein.
Copies of actual reports are available on request from Professional Asset Management or directly from any of the institutions.
DEPOSITS

Time deposits (including savings accounts) and demand deposits plus deposits in excess of $100,000 will
total 100%.

NET INCOME

Net current operating income after minority interest and taxes but before securities gains and losses (if any)
and preferred dividends.

RETURN ON
AVERAGE ASSETS

Net operating income available for common (net operating income minus preferred dividends) divided
by average assets. For purposes of our illustrations period ending March 31,1981 and March 31,1982 assets
are averaged.

NET WORTH

Total of paid in capital, surplus and retained earnings.

RETURN ON
NET WORTH

Net operating income divided by average net worth. For purposes of our illustration period ending March 31,
1981 and March 31,1982 net worth figures are averaged.

Copyright

All rights reserved. No part of this report may be reproduced, stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical photocopying, recording, or otherwise, without the prior written permission of Professional Asset
Management, Incorporated.




Registered Investment Advisor

349
Addendum No. 4

=

PROFESSIONAL

_ _ _ A QQT-^nr
r-V^^FI^ I

22110 Ventura Boulevard Woodland Hills. California 91364 800/423-5877 Continen
213/888-2100 California. Alaska,

MANAGEMENT
INC.
TO OUR CLIENTS AND FRIENDS:
IMPORTANT MARKET UPDATE.

ADD TO YOUR CAPITAL ADEQUACY REPORT.

We have added AllState Savings and Loan and Penn Square Bank,
na, to our list of approved institutions since our most recent
capital adequacy report was mailed to y o u . It is our desire
to have you update your records as soon as possible with the
addition of the enclosed reports.
Our next complete financial adequacy report will be sent to
you just as soon as all the data can be collected for the
period ending June 3 0 , 1981.
All State is a wholly owned subsidiary of Sears

Roebuck.

Penn Square Bank, a national bank, has experienced outstanding growth in the past year with strong indications
that this growth will continue.
Located in Oklahoma City Penn Square has become the leading
bank in the Southwest servicing the oil and gas industry.
Energy related activities such as exploration, production
and servicing have been proceeding at record breaking rates.
It is anticipated that these activities will continue at
high levels for the foreseeable future. Penn Square's
growth is closely linked with the growth of the energy
industry.
It's total loan portfolio exceeds $700 million, usually
short term and all indexed to prime. It participates on
an upstream basis with its larger money center correspondent banks.
Penn Square acts as lead bank in joint loan
ventures because its prime is normally 50 or more basis
points higher than money center rates. As a result banks
like Continental Illinois will earn more participating with
Penn Square than by going it alone.
We are pleased to add these two fine institutions to our
list of well capitalized banks and savings associations.


12-745 0 — 8 3
23


Cordially,
Bill Goldsmith

350
PENN SQUARE BANK,na

(000s omitted)

For Peri'od Ending

May 31,1981

'

May 31 , 1980

% Change

$347,108

$183,470

89% +

EARNING ASSETS

297,000

176,840

68% +

DEPOSITS

300,000

160,000

88% +

TOTAL ASSETS

PAID IN CAPITAL
AND SURPLUS
NET INCOME

27,503

11 ,092

148% +

2,800

1 ,700

65% +

RETURN ON AVG.
EARNING ASSETS

2.8%*

RETURN ON AVG.
EQUITY

34.8%*

LEVERAGE

10.6%

LOAN/DEPOSITS

7 3.0%

*Annuali zed




351
ALLSTATE SAVINGS & LOAN*
(OOOs omitted)

For Peri'od Ending

3-31-81

3-31-80

% Change

$3,100,000

$2,900,000

7% +

EARNING ASSETS

2,900,000

2,700,000

7.4% +

DEPOSITS

2,300,000

2,100,000

9.5% +

170,000

172,000

TOTAL ASSETS

PAID IN CAPITAL
AND SURPLUS
NET INCOME

($4,000)

RETURN ON AVG.
EARNING ASSETS

NA

RETURN ON AVG.
EQUITY

NA

LEVERAGE

18.23

* Wholly owned by S ears Roebuck




2,000

1 %

-

300% -

Addendum No. 5

>
DATE

TOTAL INVESTMENT/
CASH PORTFOLIO

TOTAL $ AND %
IN S & L'S

TOTAL $ AND %

IN COMMERCIAL BKS. H

TOTAL $ AND % IN
E.C.C.
PENN SQ,

12/4/81

$39 mil.

$14.5 mil.
38%

$3., mil
8%

$9. mil.
23%

$500,000
1%

1/21/82

$40 m

$14.5 m
37%

$4., m
10%

$10 .5 m
27%

$1.5 mil
4%

1/29/82

$41 m

$16 m
39%

$5.,5 m
13%

$10 .5 m
26%

$2 m

$14 m
33%

$5..5 m
13%

$14 . 5 m
34%

$3 m

$14.5 m
29%

$9., m
18%

$14 .5 m
29%

$3 m

$16 m
31%

$1C).5 m
21%

$13 .5
26%

$3 m

$15.5 m
28%

$12> m
22%

$15 .5 m
28%

$3 m

$16 m
28%

$12>.5 m
22%

$16 .5 m
29%

$3 m

2/26/82

$43

3/08/82

$50

4/27/82

$51

5/07/82

6/18/82

$55

$57

m

m

m

m

5%

7%

6%

6%

5%

*excluding Penn Sq. whose figures are shown separately
During this time period our investment policy was to place no more than a maximum of $3 million in
any one institution with the exception of Empire Corp. Central




5%

00
to




353




Addendum No. 6
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370

AGENDA ITEM
Addendum N o . 7

n

IBM POUGHKEEPSIE EMPLOYEES FEDERAL CREDIT UNION SOUTH ROAD / P.O. BOX 1750 / POUGHKEEPSIE / NEW YORK 12601

J u l y 14, 1982
TO:

Board of Directors

RE:

A 'Reserve for Loss Contingencies' Account

FR:

C M . Casparian, Treasurer

Supervisory Committee

The Investment Committee recommends that the Board of Directors
authorize management to set up a new reserve account entitled
'Reserve for Loss Contingencies'.
It is further recommended that 10% of investment earnings be
transferred quarterly into this account until such time (and to
maintain) the account represents 5% of our total investment
portfolio. *
Other Committee actions from the July 12th meeting are indicated
on the attached minutes.

*For example, 10% of our current investment earnings, $600,000,
would mean a quarterly transfer of $180,000. And, with an
investment portfolio of $45 million, 5% would mean a total of
$2,250,000.

attachment




Telephone (Area Code 914) 463-3987 or 463-3992

371

n

IBM POUGHKEEPSIE EMPLOYEES FEDERAL CREDIT UNION SOUTH ROAD / P.O. BOX 1750 / POUGHKEEPSIE / NEW YORK 12601

J u l y 12, 1982
INVESTMENT COMMITTEE MEETING
Held: July 12, 1982, Monday
Via Phone:

Sayres, Casparian, Kaindl

The following recommendations were acted on:
1) Mr. Sayres recommended early redemption of three certificates of
deposit with Abilene Bank, Texas due to an unfavorable financial
position indicated during the past 90 days. Loss of interest is
approximately $57,000.00.
This recommendation was moved, seconded and Passed Unanimously by
the Committee for immediate action.
2) The Committee was in Unanimous Agreement to lower the investment
ceiling on new certificates of deposit with other financial institutions
from $3 million to $1 million, effective immediately. Currently held
certificates of deposit will be held to maturity.
3) The Committee recommends that a special reserve account be
established for "Reserve for Loss Contingencies". The Committee
further recommends that 10% be transferred quarterly from investment
earnings into "Reserve for Loss Contingencies", until such time that
this account total represents 5% of our total investment portfolio.
The Committee is to recommend this for Board action at the upcoming
July 21 Board Meeting.
Finally, the Committee was advised that management is meeting with
Merrill Lynch on Wednesday, July 14, to discuss future investment
options other than purchases of certificates of deposit.
Notes:
The Investment Committee has reviewed the entire investment portfolio
at this time and feels conrfortable with the investments now outstanding.
The above actions are excluding Empire Corporate Central.




Telephone (Area Code 914) 463-3987 or 463-3992

372
The

CHAIRMAN. NOW

we will hear from Mr. Philip Loiacona.

TESTIMONY OF PHILIP LOIACONA, TREASURER AND MANAGER,
BOLLING AIR FORCE BASE FEDERAL CREDIT UNION, WASHINGTON, D.C.
Mr. LOIACONA. Mr. Chairman, I don't have a prepared statement.
I will give a little background. I am treasurer and general manager
of the Boiling Federal Credit Union. I have 15 years credit union
experience and have been with this credit union for 5 years.
In March, before our venture with Penn Square we had assets of
$8 million. Our loans amounted to $4 million; we had 250,000 dollars' worth of Treasury bills yielding 9.3 percent. We invested in
Federal funds with the National Bank of Washington $1.5 million
yielding an average of 14.3 percent. We had CD's in $100,000 units
in various savings and loans throughout the country amounting to
$2,300,000 yielding 15.6 percent.
We used several brokers—to be exact, approximately eight—all
over the country, who made contact with us by phone offering us
various insured investments. We deposited $1 million in Penn
Square on April 8 for approximately 30 days, which we renewed
twice. Penn Square was subsequently closed on July 5. We now
hold $911,000 in receiver's certificates of which we have written off
$182,000.
The CHAIRMAN. Thank you.
Mr. Arnold?
TESTIMONY OF JOHN ARNOLD, MANAGER, SOUTHWEST
CORPORATE FEDERAL CREDIT UNION, DALLAS, TEX.
Mr. ARNOLD. Thank you, Mr. Chairman. My name is John
Arnold, manager of Southwest Corporate Federal Credit Union,
Dallas, Tex.
Southwest Corporate is a regional corporate Federal credit union.
It received its charter from the National Credit Union Administration in 1975 and serves both Federal and State chartered credit
unions located in the States of Arkansas, Louisiana, New Mexico,
and Texas.
The purpose of Southwest Corporate is to serve the financial
needs of its membership. Services to meet those needs are primarily to loan funds when needed, to act as a depository of funds from
the membership, and to provide those financial services necessary
to assist the credit unions in meeting the needs of their members.
Southwest Corporate currently has a membership of 1,575 from the
four States.
In November 1980, Southwest Corporate was determined qualified as a "bankers' bank" under regulation D and may act as a
passthrough correspondent fof other depository institutions required to maintain reserves at the Federal Reserve Bank.
The board of directors of Southwest Corporate is comprised of 11
persons elected by the membership. The responsibility of the board
is to set policies under which management functions.
The investment committee is appointed by the board of directors
and operates under policies established by the board. The committee submits to the board a detailed list of all investment transac


373
tions on a monthly basis. These reports, along with the financial,
income and expense statements, are reviewed at the monthly meetings of the board.
The investment committee performs an analysis of each institution it invests in. The audit reports of those financial institutions
and the Bankroll 1 of the Chase Manhattan Bank, N.A., are used in
making the analyses.
Southwest Corporate receives an annual supervisory examination
from the National Credit Union Administration. An annual audit
has been performed by Price Waterhouse for the past 4 years, and
Southwest Corporate received an unqualified opinion each time.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you.
[The following information was received from Mr. Arnold for inclusion in the record:]
Southwest Corporate Federal Credit Union had the following investments in Penn Square Bank:
Purchase Date

Amount

Rate

Maturity Date

4-27-82
6-14-82
6-28-82

1,000,000
1,000,000
3,000,000

. 15.00%
15.00%
15.50%

7-27-82
7-22-82
7-28-82

3,000,000
3,000,000

15.00%
15.00%

5-26-82
6-28-82

?d certificates:
4-27-82
5-27-82

The

CHAIRMAN.

Mr. Mangan?

TESTIMONY OF JOHN MANGAN, EXECUTIVE VICE PRESIDENT,
KILLEEN SAVINGS & LOAN ASSOCIATION, KILLEEN, TEX.
Mr. M A N G A N . Thank you, Mr. Chairman. I am John Mangan, executive vice president of Killeen Savings & Loan Association in Killeen, Tex.
Killeen Savings & Loan is a State-chartered capital stock association with assets of approximately $85 million. We had a certificate
of deposit with Penn Square Bank, purchased May 6, 1982. It was
our first and only transaction with Penn Square Bank. The deposit
was placed through a money broker, First United Fund, Ltd., of
Garden City, N.Y. We have used and continue to use brokers for
the purpose of placing bank CD's for our liquidity portfolio, placing
excess funds for short periods of time until the funds are required
for loan fundings.
We also on occasion use brokers to raise funds when the amount
needed to fund loans has exceeded our expectations.
Thank you.
The CHAIRMAN. Gentlemen, you have all been burned one way or
another. Do you feel, whether you have invested through a broker
1

Trademark.




374
or directly, that perhaps we should rethink this whole question of
secrecy? There are those who contend that a sophisticated investor,
as a result of seeing the Peat Marwick audit report on Penn
Square with that footnote, should have been brought up short and
taken that as a warning there was something wrong. That is again
Monday morning quarterbacking. It wasn't that big a red flag, I
wouldn't say. But do you feel that in view of the Comptroller's inability to convince management of Penn Square to set their house
in order that there should be an obligation on the Comptroller or
the appropriate regulator to inform the public, including yourselves, of the conditions that prevail in a financial institution?
Remember, when answering that question, that would mean that
if a credit union is encountering difficulties, that credit union also
would be required to disclose, or there would be required to be disclosed by the NCUA to the public, the fact that the particular
credit union is encountering difficulties.
Mr. Sayres?
Mr. SAYRES. Mr. Chairman, as I stated in my testimony, I firmly
believe that the evaluation of an annual report or a financial statement, not only in the case of Penn Square, is not going to give me
the information to make an intelligent decision. And that really
scares me. I do believe we do need some information coming out of
the Comptroller of the Currency in some manner indicating the
condition of that bank.
The CHAIRMAN. That would naturally apply to a credit union,
would it not?
Mr. SAYRES. It would apply to any financial institution, yes, sir.
The CHAIRMAN. Mr. Loiacona?
Mr. LOIACONA. NO, I don't believe that should happen. I feel insured depositors would take their money out and the bank would
soon have to close. I feel that the audit report should have been
qualified. I feel that in a case like this where there was apparent
fraud and many irregularities, that the Comptroller of the Currency or FDIC, whoever has the responsibility, should have prohibited
the bank in this situation from taking uninsured deposits.
The CHAIRMAN. If that is the case, that is fine and dandy. But
that in essence says to the public at large
Mr. LOIACONA. Excuse me.
The CHAIRMAN [continuing]. That there is something wrong.
Mr. LOIACONA. Excuse me. I meant to say from soliciting uninsured deposits. No one would know that they couldn't—in other
words, allow them to take them but not solicit them.
The CHAIRMAN. Just think that one out, sir. They are soliciting
until January 1 through brokers, through various and devious
means. You don't think that that news that has been about the
marketplace—in other words, if Bayer Aspirin stops advertising
today, do you mean to tell me that people aren't going to keep
buying Bayer Aspirin for another 2 years? Of course they are.
Mr. LOIACONA. Irregularities occurred over 2 years ago. If they
had stopped them from soliciting uninsured funds, no one would be
in this position today.
The CHAIRMAN. Mr. Arnold?
Mr. ARNOLD. I was fortunate enough to hear the testimony yesterday, and listened very carefully to what the bankers had to say



375

regarding this subject. I am not sure that I have come up with a
conclusion myself on that. Mr. Chairman, I have thought about it,
and there are pros and cons to both sides, the depositor's as well as
the lender's side. And I have not made a judgment or come to a
conclusion in my own mind about the pluses and minuses of that.
The CHAIRMAN. Mr. Arnold, you are from the great State of
Texas.
Mr. ARNOLD. Yes,

sir.

The CHAIRMAN. DO you remember the Sharpstown failure?
Mr. ARNOLD. Yes,

sir.

The CHAIRMAN. There again, that bank was in difficulty for a
long, protracted period of time. A lot of credit unions got burned
badly in that one. Do you recall that?
Mr. ARNOLD. Yes,

sir.

The CHAIRMAN. Yes, sir. And that was 1973, 1974. At least 8, 9
years ago.
Mr. ARNOLD. Yes,

sir.

The CHAIRMAN. And the same situation, with some variations,
naturally, but essentially, the pain, the suffering, the hurt, the
losses were the same there. People at Sharpstown weren't as slick
as the people at Penn Square. But the depositors that got hurt
were the same type: credit unions, the small banks, and individuals. Because back then the deposit insurance coverage was not as
high as it is today.
Mr. Mangan?
Mr. MANGAN. I believe that there should be some regulatory controls to insure that questionable loans are accurately reflected in
the bank's net worth. It is my understanding that many of the
loans that had gone bad in the failure could have been charged off
as losses quite some time before they finally were. And if they were
accurately reflected, either by actual chargeoff to loss or by reserves against losses, then credit unions and savings and loans
could have made a more accurate diagnosis of their financial statements.
The CHAIRMAN. YOU haven't answered the question. The question
is, Should there be disclosure when financial institutions are issued
a cease-and-desist order or are forced to take certain steps or are
told to take certain steps so the public at large is warned that that
institution does have difficulty and that unless it complies with the
requirements of the regulatory agency, it might well fail or be
merged or shut down?
Mr. MANGAN. If that is the case, yes, I think that there should be
disclosure. I do believe that in my earlier statement of accurate reflection of possible losses and net worth that would in fact be
The CHAIRMAN. A type of disclosure. Yes.
Gentlemen, some people have said to me that one of the reasons
that a lot of credit unions, as well as S&L's, were hurt so badly by
Penn Square is the fact that during the period of time that this occurred you, as managers, had a great deal of money with no place
to put it, because your credit union membership was not borrowing, not purchasing cars, not taking out mortgages because of the
high rates.
As a result thereof, you had money lying dormant and you had
to place it so it would work for you. Was that indeed the case?



376

Mr. Sayres?
Mr. SAYRES. Absolutely.
The CHAIRMAN. Mr. Loiacona?
Mr. LOIACONA. Yes,

sir.

The CHAIRMAN. Mr. Arnold?
Mr. ARNOLD. NO, sir. There were places to put it if not out in
loans, sir. The loan demand was not sufficient to absorb all the deposits but there were alternative places to place it.
The CHAIRMAN. YOU had to place it, other than lending it to your
membership you had to place it?
Mr. ARNOLD. Yes, sir; that is correct.
The CHAIRMAN. Because your loan demand had gone down very
low.
Mr. ARNOLD. Yes.

The CHAIRMAN. Mr. Mangan?
Mr. MANGAN. In our case the reason we placed funds in a bank
was that our liquidity requirements state that certain investments
qualify for liquidity in maintaining our requirement. Normally if
we have excess funds because of higher rates, we will place money
in savings and loan associations. In this case, since we needed an
investment to qualify for liquidity, it was placed in the bank.
The CHAIRMAN. In the submissions you gave us, Mr. Sayres,
there is "Another Caution for Credit Union Investors," reprinted
from statement mailing, February 1982. In that one it says:
How do you assure the quality of your investment purchases? By doing your
homework. For each institution you entrust with your credit union's funds, you
should know (by your own investigation): the institution's present financial condition, recent trends in the institution's condition and performance.

Then "use of assets." Under "use of assets" it says:
The institution's use of assets is extremely important—and typically not to be
found on the statements. Is the institution locked into low yielding assets and/or
investing in high risk assets with which it has no experience? Find out!

Mr. Sayres, over the years I have always felt, even before I came
on this committee, and came to the Congress, that investing in
drilling, exploration, in other words, oil and gas ventures, was like
going to Las Vegas. That is, people make fortunes but lose fortunes
overnight. It is not an exact science. At least I have never found it
to be. Perhaps the reason the tax shelters are so generous in this
area is because of the potential for loss.
That being the case, were you aware of the high percentage of
Penn Square business that was almost entirely energy related?
Mr. SAYRES. NO, Mr. Chairman. I now believe 80 percent of their
loans was in that area compared to, let's say, the other banks in
the community, around 20 percent. So I was not aware of that loan
portfolio, the makeup of the portfolio. But I was aware that they
were heavily into energy, in oil and gas, yes.
The CHAIRMAN. Mr. Sayres, you yourself just submitted this for
us as dated February 1982, right? This caution for credit union investors. That accompanies your statement?
Mr. SAYRES. Yes.

The CHAIRMAN. These cautions, wouldn't they say to you that
you should have looked at the composition of Penn Square's invest


377
ments prior to purchasing CD's, or investing that much in Penn
Square?
Mr. SAYRES. I don't believe it was possible, Mr. Chairman, for me
to make t h a t investigation at t h a t time. I don't believe, as I stated
in the testimony, t h a t there was sufficient information available to
me to evaluate t h a t part of the annual report.
The CHAIRMAN. Well, if you don't know how deep the water is
and if you don't know how to swim, should you go into the water
and take a chance on drowning just to cool off?
Mr. SAYRES. Mr. Chairman, I would believe, if I was really going
to do the investigation that most institutions do today, the relationship to the net worth average assets or the return on the average
assets, or the net worth of the banks, I would believe most managers today, whether they work for a credit union or bank, that is the
only thing that they can do when they evaluate an annual report
or financial statement. To look at a loan portfolio on a financial
statement that does not even indicate income, I feel it is impossible
to do t h a t at that time.
The CHAIRMAN. Mr. Minish?
Mr. MINISH. Thank you, Mr. Chairman.
Mr. Sayres, on page 3 at the top you say just prior to our involvement with Penn Square Bank the latter part of 1981 we were scaling down our investments in savings and loan associations because
of their widely publicized instability and were attempting to diversify our investment portfolio. What was the return to the credit
union on your savings and loan deposits?
Mr. SAYRES. Depending on when and where the deposits were
made.
Mr. MINISH. Generally.
Mr. SAYRES. Generally I would say 2 percent higher t h a n we
were able to receive on the east coast if it was made in California.
Mr. M I N I S H . TWO percent higher t h a n what, 10 percent, 11 percent?
Mr. SAYRES. Again around t h a t time I would say the rate was
probably 15, 16 percent.
Mr. MINISH. Fifteen, sixteen percent?
Mr. SAYRES. Yes.
Mr. M I N I S H . And the total deposits were insured?
Mr. SAYRES. N O . Only insured up to $100,000.
Mr. M I N I S H . I understand. Then you went from

there on the
advice of PAM to invest in Penn Square.
And you have here on page 4 one update you received, one of
which was Penn Square Bank. That mailing included a report indicating Penn Square had increases from May 31, 1980 to May 31,
1981, of 89 percent in total assets, 68 percent in earnings assets, 88
percent in deposits and 148 percent in capital with a net income
increase of 65 percent. And this—and Penn Square became a problem bank almost the beginning of 1980. It was in 1980 t h a t the
OCC supervision revealed that there was rapid and uncontrolled
growth.
In J u n e 1980 they further identified the major problem, directed
the board to, within 5 days, convene a special meeting to review
the report and take remedial action. Weren't you aware of that?
Mr. SAYRES. N O , sir.




378

Mr. MINISH. So you relied purely on PAM's mailings?
Mr. SAYRES. And my annual report and financial statements, yes.
Mr. MINISH. Annual report and financial statement of whom?
Mr. SAYRES. The first investment with Penn Square was made
December 1981. Information provided by PAM which was much
earlier was on a lot of other banks. And we weren't in with Penn
Square at that time.
Mr. MINISH. I am aware of that. But at the time PAM was issuing this glowing report about Penn Square, they were already a
problem bank.
Mr. SAYRES. I realize that now, sir.
Mr. MINISH. Thank you. That is all.
The CHAIRMAN. Mr. Weber?
Mr. WEBER. Mr. Sayres, at what rate of interest were you investing in Penn Square?
Mr. SAYRES. The first investment made on December the 4th,
1981 was for $500,000 for 60 days at 13 percent.
Mr. WEBER. What I am interested in is what—that was at 13 percent?
Mr. SAYRES. Yes.
Mr. WEBER. What

relationship does that bear to the general
market rate of interest?
Mr. SAYRES. At that time I believe that there was a rate higher
with a California bank at 13.75 percent. Because we didn't have the
information available for us to make the decision or we had not
had any report from PAM, we went with the lower rate, 13 percent.
Mr. WEBER. HOW much above the rate that other banks—do you
have figures you can give us on representative interest rates from
other banks around the country?
Mr. SAYRES. Yes, I do. I have in the addendum the complete activity of the investments made with Penn Square from the time of
the initial deposit through June 1982.
Mr. WEBER. What does that show?
Mr. SAYRES. AS an example, January 21, 1982, we deposited
$500,000 with Penn Square for 148 days at a rate of 14.5 percent.
Other rates at that time, with the six quotes that were received
that day, some with local banks in our area, and some in the State
of California, the 14.5 percent received from Penn Square was approximately 1 to 1V2 percent higher than could be received anywhere else.
Mr. WEBER. Did that indicate any type of a red flag to you, any
type of inquiry, dictate any type of inquiry as to why this bank
would be in a position to be paying 1% percent above what most
other banks were paying?
Mr. SAYRES. Not really at that time, because, as an example, the
savings and loans in the State of California, of course, are always
higher because of their interest rates being higher. I at that time
wasn't really aware of what the interest rates were in the State of
Oklahoma and I did realize, however, that with their loan volume
and assets increasing as they had that they must be putting out
everything in loans and that they had that demand for money.




379
Mr. WEBER. Let me shift the line of questioning a little bit. To
what extent did you rely on Professional Asset Management to
make up your mind as to this investment?
Mr. SAYRES. Basically the information was handy. The information made my job, let's say, easier in not having to go through the
normal calculations, even though we do before a decision is made.
PAM is basically an investment adviser and not our broker. Therefore the decision and figures we come up with basically have to be
ours.
Mr. WEBER. Your testimony says that there were indications that
PAM monitored all the trend areas carefully, 5-year trend analysis
on key operating figures and so forth. What indications were there
that they were providing those types of investment analyses?
Mr. SAYRES. I was able to, Mr. Congressman, verify from the information on hand with the financial statements received from
Penn Square, and the annual report, I was able to determine as an
example as of June 30, 1981, that Penn Square's net worth to
assets was 9.40, compared to savings and loans in a peer group at
that time, which were at 6.6 and Federal Reserve member banks
under the same peer group arrangements would probably be 7.04.
Mr. WEBER. I think maybe you are misunderstanding my question. My question was, What indications were there that Professional Asset Management had in fact performed these services? Did
they ever
Mr. SAYRES. They provided a capital adequacy report, as I indicated, probably listing 15 to 20 banks that they had approved as
strong banks, good indicators. By indicators I mean good ratios.
There was an analysis done because the ratios were there and they
were accurate.
Mr. WEBER. I will yield back the balance of my time.
The CHAIRMAN. Mr. Annunzio?
Mr. ANNUNZIO. Thank you, Mr. Chairman. You know, Mr. Chairman, since my first meeting in Oklahoma City at the hearings, I
just had a feeling at the hearings that this is probably the biggest
snow job ever perpetuated in the country. You know we have had
all kinds of swindles, millions and millions of dollars. But here are
people responsible for the moneys of other people that put in trust
deposits. These people in Oklahoma City, Jennings and the rest of
that crowd, they were super con artists. We are not talking hundreds of millions of dollars. We are talking billions of dollars that
they were able to con, not only you people representing the credit
unions who are not as sophisticated as other bankers with years
and years of experience and sophistication. They were also sucked
in.
The thing that disturbs me the most is that in 1980 there was an
agreement with the Comptroller of the Currency to prevent them
from doing certain actions, you know, like a cease-and-desist order,
Mr. Chairman. It wasn't exactly a cease-and-desist order, it was an
agreement they had with the Comptroller of the Currency, wasn't
it?
The CHAIRMAN. That is correct. I would say to the gentleman
Mr. ANNUNZIO. And here you people in 1982, 2 years later, you
represent credit unions—and I have been a long-time supporter of
credit unions—2 years later, in one of your statements, Mr. Sayres,



380
reached a total of $3 million. I mean you wonder what was going
on.
The CHAIRMAN. The thing t h a t disturbs me is t h a t these people
don't want to know. They don't want to know in the future about
the fact t h a t the Comptroller's letter of agreement was there. They
don't want to know. They want to be taken again in the future.
They were taken at Sharpstown, they were taken here, they want
to be taken again.
Mr. ANNUNZIO. That is what I am getting at. I want to know.
Listen, I have been on this committee 18 years. I am one of the
original sponsors of t r u t h in lending. I am chairman of the Subcommittee on Consumer Affairs and Coinage. I believe in full disclosures. In the United States of America today, on any loan, any
banker t h a t has been here before us will tell you, they have full
disclosures on any loan. It is the people's right to know. You know
I am getting sick and tired of being a Congressman, and I am the
only one t h a t has to undress in public. It is about time t h a t I get
some company.
Mr. BARNARD. It is cold outside.
Mr. ANNUNZIO. It's pretty damn cold by yourself, t h a t is right.
Especially when you come from the Windy City. I am going on
here.
Here is your statement, And I want you to know t h a t this was a
snow job and con artists. We are in the year of 1982 and I don't
want to go back in history to all the swindles in this country, but
they don't teach you anything because of one word: greed. How
much more can I make someplace else? That is all it is. The heck it
is; nothing else.
Somebody pays me 10 percent, but this guy is going to give me 14
percent for 180 days. Let's grab t h a t 14 percent. But I hope, I don't
think we have learned our lesson. I won't be here 10 years from
now, but there will be another guy, another genius around t h a t
will take in all the others, another con artist. We have had them
all throughout the history of the world. You say here, personally I
can't help but feel t h a t the Federal agencies were remiss in allowing this bank to perform business as usual when other indicators
available to them showed t h a t it was in trouble.
Now understand t h a t the Office of the Comptroller of the Currency warned Penn Square as early as 1980 t h a t the bank lacked
sufficient capital and liquidity, had loan problems and had violated
banking laws. And in J u n e 1981, the Fed examiners uncovered $40
to $50 million in loan losses, enough to wipe out the bank's capital
and render it insolvent.
You ask why was Penn Square permitted to continue to perpetuate its problems with funds attracted from institutions like the
IBM Poughkeepsie Employees Federal Credit Union. You go on to
say I believe the system t h a t allowed this to happen needs some
improvement. I could go on and read the rest.
I want to stop with the system, our system needs improvement.
Every time a dozen people are killed on the highways, we have to
strengthen the drunken driving laws and put everybody in jail. We
wait for a disaster to happen before we move, you know. Now we
have a disaster here. The Justice Department is looking into all the



381
aspects of conspiracy and snow jobs and whatever else these people
did in violation of banking laws.
That is not the prerogative of this committee. The prerogative of
this committee is to get all the facts out on the table so that we
can have one more law. One more law. Every time I talk tc bankers, I talk to independent bankers, commercial bankers, S&L
people, credit union people. Too much regulation. Well God forbid
we didn't have all this regulation. And you entrusted with the people's money. What the hell, it would sure be a waste. Got to have
regulations.
I ask you, Sayres, Loiacona, Arnold, and Mangan, each one of
you has an opportunity to answer this question.
Now you know what happened to you. You know how you got
sucked in. You know how you were taken. And you were taken.
The responsibility, somebody might not put it on your shoulder,
but I am going to put it on your shoulder.
When you tell me you don't want disclosure, well then, if you
don't want disclosure and you want to remain a top officer in your
credit union and you want that responsibility, you better help find
out where you put your money because it is not your money. Now,
Sayres, you are in my shoes now. You advise me. I want to correct
this thing.
Mr. SAYRES. Mr. Congressman, first I believe maybe there should
be some correction to my statement when the question was asked
by the chairperson. I do believe we need some disclosures. It indicates that in my testimony. I am certainly not shirking my responsibility to say that I did not make that investment of $3 million. I
made it. I am responsible for it.
And, yes, I was taken by somebody. I really don't know who that
somebody is right now. But I do believe that in the future in order
to be protected that I don't make the same mistake, what is in my
testimony is only my personal opinion as to what I believe should
be done. I may not be qualified any further to make any further
recommendations.
Mr. ANNUNZIO. Mr. Loiacona.
Mr. LOIACONA. I would like to back up a little bit also. My
answer on disclosure, I feel that there should be more disclosure,
but through the auditing firm. I think if they are violating rules
and regulations from the Comptroller of the Currency, there
shouldn't be disclosure. They should be closed. You asked for recommendations? All right. First of all, I think there is a problem
with the brokers. With the commission being paid from the other
side, from the people receiving the money, I think there is a problem as, you know, who is the broker's client.
Second, when I was dealing with the larger brokerage firms and
I assumed they were registered with the SEC.
Mr. ANNUNZIO. What kind of brokers for the record so we spell it
out?
Mr. LOIACONA. Well, First United and Professional Asset Management.
Mr. ANNUNZIO. YOU call them brokers, but I think the record
should show you are talking about money brokers.
Mr. LOIACONA. The problem is there is no responsibility without
being regulated.
12-745 0—83

25




382
Mr. ANNUNZIO. These are not stock brokers you are talking
about, are they?
Mr. LOIACONA. Well, I thought they would probably be registered
with the SEC. Now I understand
Mr. ANNUNZIO. YOU are talking about the money brokers.
Mr. LOIACONA. Right.
Mr. ANNUNZIO. I want to identify them. There are all kinds of
brokers. I want to pinpoint it.
Mr. LOIACONA. Well, the point is that if they were registered
with the SEC, there would be a "know your client" rule that they
would have to abide by. As far as the insurance, I think that there
is a requirement as far as theft and embezzlement insurance for
most financial institutions, but little or no requirement for a fidelity bond.
Penn Square in this case I understand had a $5 million directors
and officers and employee bond which is about 1 percent of their
assets. I feel that there should be a minimum of 10 percent. In this
case, it would be $45 million.
Accountability, I hope that CPA firms can be held accountable
for what they say in their opinion. I feel in this case, there should
have been a qualified report. I feel the CPA firms should also be
responsible for asking or commenting on the quality of the risk
assets, and any excessive concentrations of assets, their source of
liabilities, and average maturity of the various liabilities. That
way, if they had an awful lot of 30-dat CD's that they had to keep
rolling over, you would know about it.
As far as the supervising Government agencies, as I said before I
feel that if the Government agencies are not going to close the institutions down when there are serious violations or irregularities,
they should at least stop them from soliciting uninsured deposits. I
think that is obvious. I think the deposit insurance should be increased to a minimum of $200,000 and probably to $500,000. And I
think that this should be, if it is not feasible to do this across the
board, then it should be an optional coverage that the savings and
loans or banks can take with the insurance company for an additional premium.
Also I feel that by merging savings and loans and banks that the
FDIC and FSLIC are giving an implied guarantee to deposits. I feel
that it should be cut and dried. Either you are insured over
$100,000 or you are not. They shouldn't have that discretion to
decide we are going to merge this savings and loan, we are not
going to merge the others, because they are luring people into
large deposits.
There have been a lot of mergers lately with very few losses. I
think if they put everybody on notice that whether they merged it
or not that they were going to take losses, that we wouldn't have
been so gullible to rely on the insurance companies or insurance
agencies, and probably the auditing report.
[The following supplemental statement was submitted by Mr.
Loiacona for inclusion in the record:]
I am not saying that the FDIC or FSLIC should not merge banks or savings and
loans that are in trouble. But that the large depositors should either be insured or
not insured. The insurance should not depend on any decision of the insuring agencies. The insuring agencies usually take losses when they merge a financial institu-




383
tion. If uninsured depositors must share the loss of a closed institution they should
have to share the loss of an institution that is merged.
It might be that a better solution would be for the insuring agencies to take half
of the loss for uninsured deposits whether it is closed or merged. This would give
large depositors some sense of security and reduce the inequity of the current
system. I believe it would even save the FDIC and FSLIC money in the long run.

Mr.

BARNARD. Would the gentleman yield at that point?
Mr. ANNUNZIO. Oh, yes.
Mr. BARNARD. Mr. Loiacona, are you indicating that you

haven't
heard about banks failing all over the country and that savings
and loans have failed without being merged?
The CHAIRMAN. Did you hear about Economy?
Mr. LOIACONA. I heard about Economy.
Mr. BARNARD. It seems to me that you would be on notice that
the FSLIC and FDIC hadn't bailed out every situation that had
come about. In fact, we had to pass a bill this year to make it
easier for them to merge failing thrifts and failing banks, mainly
because of the number of similar problems. I think it would be selfevident that banks are in the area of private enterprise. Just like
any other business.
And they are subject to failure as much as anybody else.
The CHAIRMAN. If the gentleman would yield, there is no obligation on the part of the regulatory agencies within the statutes to
arrange a merger. You have been on notice from time immemorial,
since the FDIC insurance came into being, and FSLIC insurance
came into being, that there was a limitation on the amount of insurance.
Did you ever hear of Sharpstown and its failure?
Mr. LOIACONA. NO.
The CHAIRMAN. NO.
Mr. LOIACONA. Well,

what I am saying

The CHAIRMAN. The point, sir, is to say

Mr. ANNUNZIO. If the witness would withhold for a minute, you
talk about increasing deposit insurance. When I came to Congress
it was $25,000, $50,000, $100,000, you are now talking about
$200,000. You were suggested in by a money broker. Somebody
must have sold you a bill of goods.
How do you feel about insurance? For instance, after listening to
some of these money brokers, any institution that takes a deposit
brought in by a money broker is not insured by the Government.
How do you feel about that? No insurance. That will stop the
money brokers from selling a con job. How do you feel about that?
Mr. LOIACONA. Well, that is a possible solution.
Mr. ANNUNZIO. It is a possible solution. OK?
Mr. Arnold, will you go ahead and answer the question? I want
to give somebody else the time.
How would you go about correcting this situation?
Mr. ARNOLD. Congressman, the question that I am asking myself
under these circumstances is the degree of disclosure and specificity of that disclosure. Obviously there currently exist in the law certain disclosure statements now that are made and are available to
the public. To go beyond that I do not know to what extent we are
speaking of.



384
And I am sorry. As I indicated earlier, I just have not given it
the consideration on the specificity of what type of disclosure
Mr. ANNUNZIO. Well, you think about it and you write a statement to this committee, and Mr. Chairman, I ask unanimous consent that that statement be put into the record.
Mr. ARNOLD. Yes, sir.
Mr. ANNUNZIO. YOU can write.
Mr. ARNOLD. Yes, sir.
Mr. ANNUNZIO. We are going to study this part carefully.
Mr. ARNOLD. Yes, sir.
Mr. BARNARD. Would the gentleman yield?
Mr. ANNUNZIO. I have made a unanimous consent request

that
this statement be put into the record to my answer on disclosure.
The CHAIRMAN. Without objection.
[At the request of Congressman Annunzio, the following additional information was submitted by Mr. Arnold for inclusion in the
record:]
RESPONSE RECEIVED FROM MR. ARNOLD

In order for the depositor or investor to more clearly evaluate the strength of a
bank with which they may do business, the following additional information would
be helpful.
Types of commercial loans by broad categories.
Delinquency schedule of loans.
Number and dollars of non-performing loans, to be charged to reserve.
Institutional deposits over 100,000.00.
Full disclosure of sources of new capital (if outside or internal and whether or not
bank financed the capital).

Mr. ANNUNZIO. I will yield to my good, good friend—
The CHAIRMAN. I think the gentleman's time has expired.
Mr. ANNUNZIO. All right then, Mr. Mangan, finish the question.
Mr. MANGAN. I believe that the degree of disclosure of course
should be based on the degree of severity of violations that we are
talking about. In the case of serious violations, certainly there
should be disclosure.
Minor violations that don't affect the financial stability of an institution I think could probably be handled without disclosure with
an agreement or a cease-and-desist order, something like that.
Any problem that affects the financial position of the institution
should be accurately reflected in a net worth position so that an
investor can look at a financial statement and, if he sees what appears to be a strong net worth, then he should be able to conclude
that by regulations, by the reporting required by regulations and
authorities and by the auditors of the institution, that he is looking
at a realistic financial position. Our deposit placed with Penn
Square was based on information relayed to us by a money broker,
in this case First United Fund, and was not based on any opinion
by them but based merely on the numbers on those financial statements.
Mr. MINISH. Mr. Sayres, when Mr. Annunzio asked you if you
don't know who to blame, if you don't know I will tell you, in your
case it is Professional Asset Management. They are the ones who
misled you.
How come you say you don't know?



385
Mr. SAYRES. Mr. Congressman, I don't believe I said that I didn't
know how I got involved.
Mr. MINISH. You said you didn't know who to blame.
Mr. SAYRES. I said at this time.
Mr. MINISH. Don't you know PAM, they are the ones that sold
you the bill of goods.
Mr. SAYRES. I am fully aware of that.
Mr. MINISH. Thank you.
The CHAIRMAN. Mr. Vento.
Mr. VENTO. Mr. Chairman, thank you. I will be brief.
I appreciate the fact that
The CHAIRMAN. Take your time.
Mr. VENTO. That they have been selected for
The CHAIRMAN. At random.
Mr. VENTO. At random for review here and that probably there
are a lot of other companies with regards to the Penn Square problem. We all empathize but we are all concerned about the direction. I think most of us were startled by the fact that so many
credit unions specifically had been involved in this investment. I
think it points out a real deficiency in terms of your ability to
qualitatively look at the types of investments you are making.
I note that for instance the IBM manager here had $2.9 million
uninsured in Penn Square, Boiling Air Force Base, $900,000. The
Southwest Credit Union apparently $4.9 million. And the other
$400,000 of uninsured assets.
Do you normally have that much invested in uninsured investment, Mr. Arnold?
Mr. ARNOLD. Yes, sir.
Mr. VENTO. What percentage

of your portfolio, almost all of it or

what?
Mr. ARNOLD. Almost all of it.
Mr. VENTO. IS uninsured?
Mr. ARNOLD. Yes, sir.
Mr. VENTO. YOU relied

on what type evaluation? I know Mr.
Sayres gave us the formal statement. Did you all participate in the
statement or do you all agree with it?
Mr. ARNOLD. NO, sir. You mean Mr. Sayres' statement? I did not
participate in Mr. Sayres' statement.
Mr. VENTO. He points out, maybe he would like to answer it, and
I would like you to answer it, in evaluating any prospective investment our practice is to request the institution to look at the most
recent annual report, financial statement, review various ratios,
the increase or decrease in net worth, net income, deposits, assets,
reserve position. Those are some specific indices that you look at.
Would you have a similar checklist of things that you would look
at when you invest in these uninsured types of investments, Mr.
Arnold?
Mr. ARNOLD. Yes, sir. In my statement I indicated that there
were two basic things that we use. One is the audit report on that
financial institution. The second item we use is the Chase Manhattan Bankroll report that does the work we utilize.
Mr. VENTO. What do you pay the Chase Manhattan group for
that particular service, Mr. Arnold?



386
Mr. ARNOLD. This is a data processing report that we pay $25 per
report per institution each time we order it.
Mr. VENTO. Did you have such a report on Penn Square?
Mr. ARNOLD. Yes,
Mr. VENTO. That

sir.

is principally what you relied on as well as the

audit report?
Mr. ARNOLD. Those two specific items, yes, sir.
Mr. VENTO. DO you have any reason to believe today that those
reports misrepresented or were fraudulent in terms of the analysis
that they presented to you?
Mr. ARNOLD. The
Mr. VENTO. Your
Mr. ARNOLD. The

personal opinion.
most recent reports that we had are—available
to us was the data as of December 31, 1981. It appears from the
report that the trends were sufficiently, I think sufficiently sound
as far as the December 31 statements were concerned. When we
read the Peat, Marwick, Mitchell & Co. report, the area of the
statement regarding the previous qualification of the 1980 statements and said that that had been cleared up now, and that the
areas in which the—there was concern had been cleared. And
there was no further concern by either the regulatory
Mr. VENTO. Of course what I asked you is whether or not you
had any reason to believe that those reports were false.
Mr. ARNOLD. NO, sir, I do not.
Mr. VENTO. Or inaccurate.
Mr. ARNOLD. NO, sir.
Mr. VENTO. Today do you? You

didn't at the time but do you
today?
Mr. ARNOLD. I have no reason to believe they were inaccurate at
that time.
Mr. VENTO. In other words, you invested on reports made up in
December of 1981. What was the most recent investment made in
Penn Square based on those December of 1981 reports?
Mr. ARNOLD. April 27 was our first investment.
Mr. VENTO. That was your first investment, 4 months after the
reports?
Mr. ARNOLD. Yes, sir, the reports were—that is correct.
Mr. VENTO. In other words, you made no investment until 4
months after the report. Did you do any further checking at that
point along the lines of Mr. Sayres, the financial statement, review
of ratios, so forth. What else did you rely upon?
Mr. ARNOLD. Basically just these two reliable sources of information as we
Mr. VENTO. Well, reliable sources. What liability do they assume
in terms of the $4.9 million uninsured investment that you made?
In other words, what cause do you have or what damage do you
have against those two reports made in December of 1981?
Mr. ARNOLD. We are looking into that now to see if there are any
further actions that can be taken in that regard.
Mr. VENTO. YOU made no further review to determine anything
else? Who was it that sold you on this particular investment? Did
you have a sales task force there working on you as well, Mr.
Arnold?
Mr. ARNOLD. NO, sir.




387

Mr. VENTO. YOU had none at all. You did this all on your own?
No one recommended that you buy these particular assets or this
investment in Penn Square?
Mr. ARNOLD. I do not know of any specific recommendations
made by anyone. I have a staff of credit analysts that are on the
phone and on a daily basis that are talking to people from throughout the country about investments and investment opportunities.
From that standpoint, Penn Square was one of the names that
came up in some conversation.
We were in the process of diversifying our portfolio into regional
banks at that time. We were heavily concentrated in the money
center banks. We were diversifying and in the process of that diversification Penn Squared name came up.
Mr. VENTO. DO you have any assets in financial institutions of
similar size as Penn Square as much, say $4.9 million is what you
had, do you have a similar amount of assets in banks? I mean I
suppose in Citibank and some of the others, Chemical Bank, you
probably have some very large investments on draw.
Mr. ARNOLD. Yes,
Mr. VENTO. But

sir.

do you have similar types of instruments in
other banks like Penn Square? Do you believe you do?
Mr. ARNOLD. At that time, we had some similar type investment
in some regional banks that
Mr. VENTO. Similar instruments?
Mr. ARNOLD. Yes, sir, CD's. Probably about three or four.
Mr. VENTO. And the size?
Mr. ARNOLD. Only one other or two about that size. Approximately two or three others.
Mr. VENTO. I think we would like more specific information, Mr.
Arnold.
Mr. ARNOLD. I will be glad to provide it.
[At the request of Congressman Vento, the following additional
information was submitted by Mr. Arnold for inclusion in the
record:]
RESPONSE RECEIVED FROM MR. ARNOLD
[In millions]
Amount
invested

Bank name

Fidelity Bank, Oklahoma City
First City Bank, Dallas
National Bank of Commerce, Fort Worth
Abilene National Bank, Abilene

$679
607
523
406

$4.5
2.0
6.0
4.0

Mr. VENTO. We appreciate that.
Mr. Sayres, with respect to your evaluation of this prospective investment, did you use the indices you have at the bottom of page 2
and top of page 3?
Mr. SAYRES. Yes, sir.
Mr. VENTO. YOU utilized those?
Mr. SAYRES. Utilized them ourselves.

We were able to compare
PAM's indicators, analysis, ratios.
Mr. VENTO. What do you pay for PAM's service, Mr. Sayres?



388
Mr. SAYRES. We don't pay PAM, sir.
Mr. VENTO. YOU don't pay them. In other words, they just distributed this free; is that right?
Mr. SAYRES. They are just an investment adviser to us.
Mr. VENTO. That is a fancy name for their being out and selling
these particular CD's; is that right?
I mean in other words, they advise you but they really are not
representing you. What liability do they have in terms of, or responsibility do they have in this particular case?
Mr. SAYRES. None.
Mr. VENTO. Their advice includes entertainment, speaking engagements, inviting you to various activities, is that right, to try
and get across their message, is that an accurate description?
Mr. SAYRES. That is very possible, yes.
Mr. VENTO. Well, I mean you have that attached to your testimony here that they invited you to various luncheons and activities
and to hear notable speakers, so forth and so on. I mean is that an
assumption, that is part of your testimony?
Mr. SAYRES. That is a fact.
Mr. VENTO. I am not trying to impugn your judgment, just to
make sure we understand one another. In other words, you might
expect that there could be some credibility if they quote a figure, it
might be out of some audit report. But as far as what they are up
to, they are trying to sell these CD's for these customers, are they
not?
Mr. SAYRES. That is right, they are, yes, sir.
Mr. VENTO. SO you know when you are dealing with an institution or money broker like that you have to be careful, don't you?
Mr. SAYRES. Absolutely.
Mr. VENTO. What precautionary steps did you take to protect the
considerable purchase of CD's in Penn Square and would you take
to protect the considerable investment of CD's in other institutions
like this?
Mr. SAYRES. AS stated, Mr. Congressman, we did our own evaluation of Penn Square. Evaluated the annual reports and financial
statements we had on hand. We did not rely on the information
provided by PAM.
Mr. VENTO. IS there anything in writing on that? Do you have a
written report, $2.9 million investment in Penn Square, obviously,
you singled this institution out to invest considerable assets in.
Mr. SAYRES. Yes.
Mr. VENTO. In other

words, did you have similar investments in
other institutions and banks, similar types of instruments, of this
size?
Mr. SAYRES. Yes, we did.
Mr. VENTO. And do you have today?
Mr. SAYRES. Yes.
Mr. VENTO. The point is did you formalize

this evaluation in any
written form?
Mr. SAYRES. We normally go through at least five to six bids any
time we have money to invest on any day.
Mr. VENTO. DO you have any reason to believe that the information you received was falsified?
Mr. SAYRES. Not at this time, no, sir.



389
Mr. VENTO. YOU do not have reason to believe. Do you suspect it?
Mr. SAYRES. Not at this time, sir, no.
Mr. VENTO. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Barnard.
Mr. BARNARD. Thank you, Mr. Chairman.
Gentlemen, how many of you did business with both First United
and PAM? Mr. Loiacona, you did both? Mr. Sayres, did you do business, with which one?
Mr. SAYRES. PAM.
Mr. BARNARD. Mr.

Arnold?

Mr. ARNOLD. Neither.

Mr. M A N G A N . First United.
Mr. BARNARD. I noticed on the letterhead of one of these companies it says "registered investment advisor". What does that mean?
PAM I believe had that. Registered investment advisor.
Mr. SAYRES. Mr. Congressman, I believe it would mean they were
registered with the SEC.
Mr. BARNARD. Registered with the SEC?
Mr. SAYRES. Yes.
Mr. BARNARD. What did that really mean to you then?
Mr. SAYRES. Not really t h a t much. The association with

the
with Mr. Goldsmith, vice president, I had knowledge of Mr.
smith prior to t h a t when he worked for Bache & Co., he had
contacts with the credit union and other IBM credit unions.
Mr. BARNARD. Let me understand how this comes about.
You were on a mailing list, then, from Professional Asset
agement, is t h a t it?
Mr. SAYRES. Yes.
Mr. BARNARD. This

PAM
Goldmade
Man-

mailing list included possible investment op-

portunities?
Mr. SAYRES. Yes, it did.
Mr. BARNARD. Then in

making those investments, did you go
through PAM or did you go directly to the institution?
Mr. SAYRES. We went directly to the institution.
Mr. BARNARD. And you paid nothing for this service.
Mr. SAYRES. Nothing at all.

Mr. BARNARD. H O W did the broker, if you want to call him that,
how does he get paid for his business?
Mr. SAYRES. I understand he gets paid from the bank.
Mr. BARNARD. From the bank?
Mr. SAYRES. Yes.
Mr. BARNARD. In

other words, then, you noticed on his list that
this particular bank was paying 2, 3 percentage points more than
anybody else. Then on top of that, he was paying a fee.
Mr. SAYRES. Yes, sir.
Mr. BARNARD. That wasn't
Mr. SAYRES. N O , sir.
Mr. BARNARD. All right.

a red flag to begin with?

Mr. Loiacona, what about you? You don't think t h a t paying
above the market price is an indication of how badly a company
needs money and so forth?
Mr. LOIACONA. I don't believe we received over the market price.
Mr. BARNARD. In other words, Penn Square was paying about the
normal rate?



390
Mr. LOIACONA. We were receiving 15.6 percent on average for
$100,000 deposits and normally $1 million would be like a round
lot, and the next one would be $5 million. From $100,000 to $1 million is usually half a point higher. We received 16 percent from
Penn Square at the time we were receiving 15.6 on $100,000 investments.
Mr. BARNARD. Mr. Mangan, is First United a registered investment adviser?
Mr. MANGAN. If I recall correctly they have something like that
on their letterhead.
Mr. BARNARD. Did that mean anything, that you had more confidence in them than otherwise, or not?
Mr. MANGAN. NO, in fact I didn't receive or solicit any actual
advice from them other than just naming a bank and a rate and
giving me the figures which basically are either mailed to me or
read off a financial statement.
Mr. BARNARD. IS not the general practice of credit unions then to
ask for statements of condition or financial statements from institutions to which they are loaning money?
Mr. SAYRES. Yes, sir.
Mr. BARNARD. It is?
Mr. SAYRES. Yes.
Mr. BARNARD. What

is an illustration, for example, of institutions from which you do ask for a financial statement?
Mr. SAYRES. Any institution we made a deposit with.
Mr. BARNARD. But you didn't ask one of Penn Square.
Mr. SAYRES. Yes, we asked for the financial statement and
annual report and received them.
Mr. BARNARD. SO what you used then was their audit report?
Mr. SAYRES. Not their audit report, sir. I used their annual
report and the financial statements.
Mr. BARNARD. YOU mean their published annual report?
Mr. SAYRES. The report done by Peat, Marwick, Mitchell & Co.
was not received by us at that time.
Mr. BARNARD. There was an auditing firm—Mr. Chairman, do we
have copies of the Penn Square published statement?
Mr. HOLLAR. Yes, indeed. We have the
Mr. BARNARD. NO, everybody publishes their statement. They
have a publication. This is what you got a copy of.
Mr. SAYRES. Yes.

Mr. BARNARD. What I am trying to determine is if in that published
statement there was a letter from the auditor.
Mr. HOLLAR. Yes, I believe there was. We can get a copy for you.
Mr. BARNARD. Therefore, Mr. Sayres, you depended upon that
letter in that published financial statement?
Mr. SAYRES. I
Mr. BARNARD.

The public statements banks make are very, very
abbreviated. You don t know the quality of the assets. That is not
in there. It is strictly just figures, right?
Mr. SAYRES. That is true.
Mr. BARNARD. But do you recall in that public statement there
was a letter from an audit?
Mr. SAYRES. There was no statement from the audit firm in the
annual report.




391
Mr. BARNARD. Therefore, you were just using what the bank had
sent you?
Mr. SAYRES. That is right.
Mr. BARNARD. NO
Mr. SAYRES. NO qualification.
Mr. BARNARD. N O qualification

or really no indication that it is a
true and
Mr. SAYRES. That is right, yes, sir.
Mr. BARNARD. Mr. Arnold, what about your situation? How far
do you go in evaluating institutions?
Mr. ARNOLD. Basically, Congressman, we use the audit report,
their last audit report from their auditing firm. And the Chase
Bankroll report are two basic elements that we use or, are, if you
will, the foundation for our qualitative analysis of those institutions.
Mr. BARNARD. SO you actually used the audit report of Penn
Square?
Mr. ARNOLD. Yes, sir, that is correct.
Mr. BARNARD. Which one did you use?
Mr. ARNOLD. The one dated December 31, audit as of December
31, 1981, performed by Peat, Marwick, Mitchell & Co.
Mr. BARNARD. I don't think that is true.
Mr. ARNOLD [continuing]. And dated March 19.
Mr. BARNARD. Peat, Marwick, didn't do one as of 1981. Oh, yes,
they did. But you used the Peat, Marwick, Mitchell & Co. audit?
Mr. ARNOLD. Yes, sir, that is correct, and the Bankroll. Those are
the two basic analyses we used for—to develop the ratios and
Mr. BARNARD. YOU didn't have the previous audit?
Mr. ARNOLD. NO, sir, I did not, the 1980 audit.
Mr. BARNARD. Mr. Mangan.
Mr. MANGAN. Yes,

sir.

Mr. BARNARD. Did you require any particular financial statements?
Mr. MANGAN. The information given to us was the information
from the published financial statements of December 31, 1981, and
March 31, 1982.
Mr. BARNARD. Were any of you gentleman at any time contacted
by officials of the Penn Square Bank?
Mr. SAYRES. NO, sir.
Mr. ARNOLD. Yes, sir.
Mr. BARNARD. Mr. Arnold, you had?
Mr. ARNOLD. Yes, sir, we were.
Mr. BARNARD. HOW was that relationship developed?
Mr. ARNOLD. A S I indicated earlier, as we were diversifying

our
portfolio into regional banks, smaller, within contiguous States basically, Penn Square's name came up in part of the conversation on
data we were collecting and going through.
Contact was made. I am not sure whether they called us or we
called them. Contact was made with one of the—a senior vice president of Penn Square requesting their latest audit report. Once that
audit report was received, at the same time then, we requested the
Bankroll report. And from that point on, following the first investment which we made was April of that year, then the dialog was



392
between my investment analyst department and the officer of Penn
Square Bank.
Mr. BARNARD. Was there any other relationship between your
credit union—were any of the officials of Penn Square borrowing
money from your credit union?
Mr. ARNOLD. NO, sir, never.
Mr. BARNARD. Were any officials of your credit union borrowing
any money from them?
Mr. ARNOLD. Not to our knowledge, no, sir.
Mr. BARNARD. What about you other gentlemen, was there any
other relationship between your credit unions and
Mr. LOIACONA. We called at the time the money broker called us
with the investment and verified the information. Other than that,
I have never talked to them before or since.
Mr. BARNARD. Mr. Mangan.
Mr. MANGAN. NO, sir, no other relationship that I know of.
Mr. BARNARD. I would yield to Mr. Hansen.
Mr. HANSEN. Thank you.
I might ask, how are firms such as yours introduced to the institutions into which you arrange investments, gentlemen, whoever?
Mr. SAYRES. I don't understand your question, sir.
Mr. HANSEN. HOW are firms such as yours introduced to the institutions into which you arrange investments?
Mr. SAYRES. Well, IBM Poughkeepsie, it could be through notification, telephone call from a broker, or it could be the fact that
when moneys are on hand to invest, we may call Empire Corporate
Central, local banks and any other bank that we have information
on that may be interested in receiving the deposits.
Mr. HANSEN. A follow-up to that, and any of you may help shed
some light on this. What criteria do you use to determine, then,
whether or not an institution is financially safe and sound and
what figures do you look at? Do you in addition examine the assets
and liability portfolios of these institutions as to safety and soundness?
Mr. SAYRES. Yes, sir, and we also look for the liquidity of the
bank and equity of the bank as best as possible with the information on hand.
Mr. HANSEN. HOW would that have fallen down in this particular
instance?
Mr. SAYRES. The ratios were very high in this situation.
Penn Square's indicators indicated that the bank was operating
efficiently, growing, and making money.
Mr. HANSEN. I might ask then, when did you first begin looking
at the Penn Square Bank and what were the bank's total assets
and deposits at this time?
Mr. SAYRES. The first deposit by the IBM Poughkeepsie Employees Federal Credit Union was made December 4, 1981, for $500,000
at a rate of 13 percent for 60 days. The assets of the Penn Square
Bank at that time, according to the annual report, were $394 million.
Mr. HANSEN. The communication from PAM to you repeatedly
was that PAM required rigid criteria from any institution represented to you. Did you find out what those rigid criteria were and
did you feel Penn Square met those criteria?



393
Mr. SAYRES. Yes, especially in the area of reserves, Penn Square
appeared extremely high in relation to peer groups and we did
check those out.
Mr. H A N S E N . YOU claim now t h a t from the information available
to you at the time you were investing in the CD's, you have to conclude there was nothing definitive to point to the coming collapse.
The Capital Adequacy Reports you received from PAM showed
growth rates from Penn Square Bank, nearly all of which were
way above those of its peer group institutions. Didn't this fact perhaps portend coming problems for Penn Square, and would you say
now t h a t the data provided you by PAM was insufficient information on which to base an investment decision?
Mr. SAYRES. Did you say, sir, insufficient or sufficient?
Mr. H A N S E N . Insufficient information on which to base an investment decision.
Mr. SAYRES. I would have to state today t h a t the information
provided by PAM since Penn Square has failed had to be inadequate.
Mr. H A N S E N . Where do you see now in hindsight that this may
have been corrected?
Mr. SAYRES. I think there was no indicator in regard to the loan
portfolio, allowance for loan losses, provisions for loan losses and
delinquency.
Mr. H A N S E N . Then I might ask when was your last investment of
Penn Square? In your statement you state from December 4, 1981,
until July 5, 1982, you supplemented with your own information
provided you by PAM. What was the nature of this supplemental
information?
Mr. SAYRES. It was information gathered from a ratings service
with Merrill Lynch and the Empire Corporate Central, which was
requesting ratings from U.S. Central. Basically at that time we
were not able to get the information from Penn Square Bank.
Mr. H A N S E N . On J u n e 18, 1982, when you bought your last CD's
from Penn Square, you still didn't have the slightest hint there
was something wrong at the bank?
Mr. SAYRES. N O , sir. The reserve and equity ratios were still extremely high, much higher t h a n required. As an example of a
guideline t h a t I would use there, for a national bank, a commercial
bank, the equity would equal at least 5 percent.
In this case it was almost 9 percent.
Mr. H A N S E N . I am going to have to go to the vote in a rush, so I
am going to ask you gentlemen to stand by for a few moments. I
think the Chair will be back shortly. So I appreciate Mr. Sayres'
answers to your questions.
Thank you.
[Recess.]
The CHAIRMAN. The meeting will come to order.
Mr. Mangan?
Mr. M A N G A N . Yes,

sir.

The CHAIRMAN. What was it that encouraged you to invest the
amounts of money that you did indeed invest in Penn Square?
Mr. M A N G A N . Basically the rate of earnings and the apparent
soundness of the bank.



394
The CHAIRMAN. The rate of earnings. Was the rate of earnings a
preferential rate, or a better rate than you saw in other institutions?
Mr. MANGAN. Yes, it

was.

The CHAIRMAN. NOW, refresh my memory. I am trying to handle
a lot of things at the same time here this morning other than what
we are doing here. Did you invest independently, or with an adviser?
Mr. MANGAN. We invested the money through First United
Fund.
The CHAIRMAN. NOW, let me ask you, how does that come about?
In other words, are you a regular, would you call yourself a client
of First United Fund?
Mr. MANGAN. I suppose so. I don't think we would be classified
as a regular client. It is just periodically we do use their services.
The CHAIRMAN. When you have had extra money to invest.
Mr. MANGAN. That is correct. In this case
The CHAIRMAN. NOW did you, or do you invest both with or
through First United as well as independently?
Mr. MANGAN. Yes, we do.

The CHAIRMAN. SO you go both ways?
Mr. MANGAN. That is correct.
The CHAIRMAN. HOW did the relationship with First United come
about?
Mr. MANGAN. I believe we either received a phone call from
them initially or received a package through the mail initially describing their services.
The CHAIRMAN. Had you received similar packages or calls from
other brokers?
Mr. MANGAN. Yes, quite a few.
The CHAIRMAN. And what influenced you? I use the word in its
true context, nothing derogatory about it, but what influenced you
to determine to use First United Fund, or do you use other brokers
as well.
Mr. MANGAN. We do use a couple other brokers. First United
Fund was one of the first to contact us. I don't recall. It was probably sometime last fall. And we started with them prior to any of
the others. So we have been using them since then occasionally.
The CHAIRMAN. OK. Then as to the investment in Penn Square,
that was at the recommendation of First United Fund?
Mr. MANGAN. I don't know if I would call it a recommendation. I
called them up looking for an investment we could qualify as liquidity, a bank CD. And they quoted me rates at two or three different banks. At that time we decided to place the money with
Penn Square because the rate there was higher.
The CHAIRMAN. SO it was your choice out of the two or three recommendations. You made the decision and the choice to put the
credit union money in Penn Square.
Mr. MANGAN. Savings and loan money, yes.
The CHAIRMAN. OK. When that recommendation was made of
two or three institutions, and you made a decision to invest in
Penn Square, did First United then send you extensive information
about Penn Square, audit reports, annual reports, et cetera?



395
Mr. MANGAN. They sent us copies of the published financial
statements.
The CHAIRMAN. HOW about the auditor's report?
Mr. MANGAN. NO, sir, I did not see an auditor's report.
The CHAIRMAN. Did you ever ask for an auditor's report.
Mr. MANGAN. NO, I didn't.
The CHAIRMAN. DO you think you might in the future?
Mr. MANGAN. In the future I don't think we will deposit any
more than $100,000 in any one association.
The CHAIRMAN. That is one way to do it. Once you made that decision to invest in Penn Square, what did First United tell you
about the strength of Penn Square? Did they fill you in more thoroughly on Penn Square once you had made that decision, other
than send you the published reports?
Mr. MANGAN. NO. The decision was based strictly on the numbers on the financial statement. On the apparent strong net worth
position of the bank. In our opinion—it was a 90-day deposit, in our
opinion the bank with such a strong net worth to asset ratio could
not fail in 90 days.
The CHAIRMAN. That plus the rate of interest they were paying?
Mr. MANGAN. That is correct.
The CHAIRMAN. HOW much higher was it than the rate of other
institutions recommended to you by First United?
Mr. MANGAN. The difference was small, I think probably a quarter or a half a percent. In this case they were offering a higher rate
for a $500,000 deposit than the other institutions that were recommended, as I recall, were smaller. We were looking to deposit
$500,000.
The CHAIRMAN. Mr. Arnold?
Mr. ARNOLD. Yes,

sir.

The CHAIRMAN. YOU independently, without, I understand, recommendations from anyone else, you independently made the decision to invest funds of Southwest Corporate in Penn Square?
Mr. ARNOLD. Yes, sir.
The CHAIRMAN. When

you make an investment, do you advise
the institutions that are part of Southwest Corporate as to where
you are investing the funds?
Mr. ARNOLD. Specific financial institutions, no. We do not on a
regularly scheduled basis give them copies of our portfolio, if you
will.
The CHAIRMAN. SO that when you invested in Penn Square you
didn't put out a notice that we have invested x number of dollars
in Penn Square and that you, as one of the participants in Southwest, should know that part of your funds have been invested in
Penn Square?
Mr. ARNOLD. We do not notify the credit unions as to specific investments.
The CHAIRMAN. HOW long a period of time were you investing in
Penn Square?
Mr. ARNOLD. April 27 until its demise.
The CHAIRMAN. April 27, 1982?
Mr. ARNOLD. Yes, sir,



1982.

396
The CHAIRMAN. SO it would not follow, probably, t h a t some of
your members might have invested in Penn Square independently
as a result of the fact t h a t Southwest had invested?
Mr. ARNOLD. That is correct; they would not because of our
The CHAIRMAN. I think you realize some of your members did
indeed invest
Mr. ARNOLD. Yes, t h a t is correct.
The CHAIRMAN. We talk about double-dippers here. They were
double losers.
Mr. ARNOLD. Yes, sir.
The CHAIRMAN. DO you

have a committee, Mr. Arnold, of experts? In view of the fact t h a t yours is probably one of the largest
credit unions in the country, could you tell us who makes the decisions as to where the money will be invested on behalf of your clients, so to speak?
Mr. ARNOLD. We have two full-time credit analysts plus a secretary t h a t works in the investment department t h a t does credit
analysis on financial institutions. An investment committee t h a t
has been appointed by the board of directors, of which one of those
t h a t does the financial analysis sits on t h a t investment committee
along with myself. A third member of t h a t committee was at the
time of this investment, had just left our employment to take employment elsewhere who normally sits on t h a t committee. So we
have a three-man committee.
The CHAIRMAN. Tell me, were you aware of or had you seen the
audit reports from the independent auditing firms t h a t have been
discussed in the hearings in Oklahoma City and again yesterday?
Mr. ARNOLD. We just have a copy of t h a t in our file prior to the
time, and have done an analysis on that, as well as the Chase
Bankroll which I believe is the call report statistics analyzed and
given to us prior to the time of placing any money in any financial
institution.
The CHAIRMAN. Did any one of your experts happen to catch the
famous footnote?
Mr. ARNOLD. Which one are you speaking of? I am not sure.
The CHAIRMAN. The footnote
Mr. ARNOLD. Footnote on the financial statement? Footnote No.
4?
The CHAIRMAN. The first audit report was a qualified report.
That was by Arthur Young. Subsequently, Peat, Marwick, Mitchell
& Co. had a footnote in their report.
Mr. ARNOLD. Yes, sir.
The CHAIRMAN. Did your

consultants, economists, whatever you
want to call them, bring to your attention the qualifying letter in
the A r t h u r Young report as well as the footnote in the Peat, Marwick, Mitchell & Co. report?
Mr. ARNOLD. We discussed the fact t h a t in the letter of opinion,
the opinion letter of Peat, Marwick, Mitchell & Co., there was an
indication that the previous audit had been qualified. Based upon
the data t h a t we have and that was published in their report along
with their footnotes, their cover letter and footnotes, it indicated to
us t h a t the problems indicated the previous year that required the
qualification of t h a t report had been cleared up as far as all of the
parties involved were concerned, the Agency's internal auditors as



397
well as this, and based upon that we assumed that the error or the
cause of the problem had been corrected and that the bank had
taken the proper measures to redeem itself or make itself whole in
that area.
The CHAIRMAN. Not putting words in your mouth but just listening to that which you have just stated, in essence what you are
stating to us is that the Peat, Marwick, Mitchell performance alleviated your apprehensions and satisfied you that things were now
going in the right direction at Penn Square.
Mr. ARNOLD. That is correct. Yes, sir.
The CHAIRMAN. SO that Peat, Marwick, Mitchell & Co., as far as
Southwest is concerned, bears a rather heavy responsibility.
Mr. ARNOLD. Yes,

sir.

The CHAIRMAN. Mr. Sayres, did you independently look at these,
the Arthur Young and Peat, Marwick, Mitchell & Co., reports?
Mr. SAYRES. I did not look at the Arthur Young report, and the
Peat, Marwick, Mitchell & Co., report was not received until
March, not issued until March 1982. I believe by that time I had
over $2 million invested in Penn Square already. The note No. 4 in
the report which I received after the fact referred to the qualified
opinion in regard to allowance for loan losses. It was my understanding that Peat, Marwick, Mitchell & Co., indicated that management of Penn Square had improved on that situation and increased their allowance for loan loss and it was satisfied.
The CHAIRMAN. Therefore did that Peat, Marwick, Mitchell &
Co., report serve to placate you, make you feel as though you could
sleep better at night?
Mr. SAYRES. Definitely.
The CHAIRMAN. Therefore, would you agree with Mr. Arnold
that
Mr. SAYRES. Yes; I do.

The CHAIRMAN. That they had a responsibility that one might
question right now as to how well they had fulfilled that responsibility?
Mr. SAYRES. Yes, sir.
The CHAIRMAN. We are

not going to deny you the opportunity to
answer the same question, sir.
Mr. Loiacona?
Mr. LOIACONA. Yes. I believe Peat, Marwick, Mitchell & Co., implied in the sentences after that statement about Arthur Young
that the situation had been corrected. Also, in looking at the financial statement, auditors are—one of the things that they are supposed to be doing is to require that there is an adequate allowance
for loan losses. And with $4.7 million in their allowance for loan
loss account, I assumed by looking at the statements that this covered all of the possible losses and, you know, bad loans and so
forth.
The CHAIRMAN. Did any of you happen to look at the reports
that were filed by the First Penn Corp., the parent?
Mr. SAYRES. NO, sir.
Mr. LOIACONA. There

are some who feel that if the reports filed
with the regional Federal Reserve office had been reviewed, that
that might have given cause for apprehension.
Mr. MANGAN. NO.
12-745 0 - 8 3

26




398
The CHAIRMAN. Bill?
Mr. MCCOLLUM. I would like to ask one question of these gentlemen. Though I have missed a lot of testimony I have a bottom line
type of question I would like each of you to comment on if you
could. That is what do you think is the single most important thing
t h a t you have learned out of this whole Penn Square incident as
far as conducting the affairs t h a t you have in relationship to such
institutions as Penn Square in the future? What is the single most
important thing you think you have learned out of this?
Mr. Sayres, could you start?
Mr. SAYRES. Congressman, I hesitate on answering that. Basically in my testimony I indicated t h a t I really at this point don't still
have the information available to me to make an intelligent decision in regard to Penn Square. Everything I look at today, even
with hindsight, I would still have a problem evaluating an annual
report or a financial statement of an institution and have confidence that the ratios and figures t h a t I am looking at are going to
help me and save me from losing money.
Mr. MCCOLLUM. Are you, in essence, saying t h a t this incident
makes you more wary, but at the same time you don't feel at this
point in time t h a t you have been able to learn something about
how to protect yourself better?
Mr. SAYRES. Well, it is definite t h a t I have had to take extra
steps as indicated by the D&B report, possibly look into other firms
t h a t are offering a rating report to possibly give me more information and make me at least feel t h a t the deposit t h a t I am making is
secured.
Mr. MCCOLLUM. Mr. Loiacona, what have you learned?
Mr. LOIACONA. Well, I think there are a couple of things here.
No. 1, I have always thought t h a t the large bankers knew what
they were doing. And it appears t h a t maybe they don't. I am of the
opinion now t h a t with the economy in a recession, t h a t a large—
any bank could go under just by one of its clients going under. A
client goes under, and if it is large enough, and the bank is financing t h a t business, like if a bank is building a large building and
they have got all the financing in that, and t h a t building doesn't,
or the contractor goes under, it is liable to take the bank with it.
With insurance companies, if they are insuring a large amount,
they will lay off some of the insurance, split it up between insurance companies.
Second, I have learned t h a t you can't trust the audit reports anymore. We relied on the audit report. We relied on the fact t h a t
there is an examination by Federal examiners. I know from our
own experience t h a t the NCUA examiners do not let us get away
with anything. If they think there is something wrong, they make
you correct it. But evidently this is not true with the other financial institutions.
Mr. MCCOLLUM. Mr. Arnold, what about yourself?
Mr. ARNOLD. Several things obviously in retrospect, as we look
back upon the decision made. I think one thing t h a t it did do was
t h a t it validated the policies, however, of our board of directors and
the restraints t h a t they have on our investment committee and
others. Even though this did occur, I think it could have been a
much greater magnitude perhaps had we not had prudent decisions



399
by our board and constraints upon the investment committee, and
therefore, free rein, or whatever. So, I think it did prove and validate t h a t the board has done an excellent job in establishing certain policies and constraints within the investment committee,
minimizing potential loss to our members of any single investment
or any single loan, if you will, perhaps going under, causing irreparable damage to Southwest Corporate.
Mr. MCCOLLUM. So, you have learned your own policies were
sound is what you are saying, and t h a t is one?
Mr. ARNOLD. That is one thing. I think it has caused us to
change some internal policies insofar as the investment committee
is concerned, to go deeper into specifics, not relying on one set of
figures or two, but perhaps getting the additional support from another rating agency t h a t is totally independent from anyone else
and getting their expertise, advice, on t h a t specific financial institution.
It has caused us to rethink the size of institutions in which we
will invest our funds. We have obviously then raised t h a t limit, the
deposit size of institutions in which we will place our funds. We
probably have moved somewhat away from our regional bank concept back to the major money center banks for primary investments, recognizing t h a t many times the strengths of the national—
the large money center banks are great. That if some specific
things happen, such as one loan goes bad, there is less possibility of
the total bank going under in a large financial institution.
So, those are some of the things basically t h a t we have changed
and looked at in retrospect.
Mr. MCCOLLUM. Mr. Mangan, what would you say is the single—
my time has expired?
The CHAIRMAN. I wonder if the gentleman would be good enough
to indulge me.
Mr. MCCOLLUM. Certainly.
The CHAIRMAN. I have to go to the Rules Committee.
Mr. MCCOLLUM. Absolutely, I yield.
The CHAIRMAN. I would like to ask a few more questions, then
Mr. Leach is going to take over and finish the panel.
Mr. MCCOLLUM. Thank you. I yield back.
The CHAIRMAN. Thank you kindly.
Mr. Arnold?
Mr. ARNOLD. Yes,

sir.

The CHAIRMAN. I just tell you one thing. You say t h a t in rethinking, you are going to larger institutions, concentrating on investing
in larger institutions?
Mr. ARNOLD. That is one of the things we looked at and considered.
The CHAIRMAN. Let me give you a little caveat. The fact that
they are big doesn't mean t h a t they are all t h a t much better. Did
you see the Holt Advisory Service report t h a t came out about 3
weeks ago?
Mr. ARNOLD. N O , sir, I did

not.

The CHAIRMAN. I commend it to your reading.
Mr. ARNOLD. We shall do so.
The CHAIRMAN. YOU will find that some of the banks t h a t aren't
in such good condition happen to be some of the larger banks in



400
the Nation, according to their evaluation from the Federal Reserve
tapes.
Mr. ARNOLD. The Holder Advisory
The CHAIRMAN. Holt, H-o-l-t. I am not trying to sell anything, believe me.
Mr. ARNOLD. I understand.
The CHAIRMAN. But you might want to take a look.
Mr. ARNOLD. Yes, sir. Thank you. All the information is appreciated.
The CHAIRMAN. Let's see. Mr. Sayres, just a few questions. Do
you use more than one money broker?
Mr. SAYRES. N O , sir.
The CHAIRMAN. YOU use just one?
Mr. SAYRES. Yes, sir.
The CHAIRMAN. HOW long have you been using PAM?
Mr. SAYRES. Since the early part of 1981.
The CHAIRMAN. HOW did you happen to come upon them,

or how
was the relationship established?
Mr. SAYRES. The relationship was established, we knew Mr. Goldsmith before when he worked for another brokerage firm, Bache &
Co.
The CHAIRMAN. OK. Did you have a permanent relationship with
Mr. Goldsmith, or was it just the fact t h a t he was with Bache &
Co.?
Mr. SAYRES. It was a pure business relationship.
The CHAIRMAN. Something just popped in my mind. I go to conventions, on occasion, that have people in the financial community.
Every once in a while I would meet people who weren't members of
the industry at all. They were always there to buy a drink, provide
entertainment, and what have you. I observed this from the sidelines. I later found out they were people from X company handling
investments for S&L's and credit unions, et cetera. So, t h a t is a
common practice, isn't it?
Mr. SAYRES. That is correct.
The CHAIRMAN. YOU go to a credit union convention, and if you
are a customer of theirs, they have a nice suite, and they say:
Come up, bring the wife, have a few drinks and so forth, maybe
have a little dinner party for you?
Mr. SAYRES. Yes, sir.
CHAIRMAN. That relationship, I guess, is
Mr. SAYRES. Yes.
The CHAIRMAN. A way of doing business?
Mr. SAYRES. Yes.
The CHAIRMAN. All right. Now, with respect

The

a common thing?

to investing in Penn
Square, you heard me discussing with Mr. Mangan, when he said
t h a t they were given the names of two or three institutions and
they determined they would invest in Penn Square. Could you be a
little more specific as to your investment in Penn Square, which
was at the recommendation of Professional Asset Management,
was it not?
Mr. SAYRES. Yes, sir.
The CHAIRMAN. Did they recommend a number of institutions?
Mr. SAYRES. There were approximately 15 to 20 on the report.
The CHAIRMAN. HOW many did you invest in?



401
Mr. SAYRES. It varied, sir. Depending on the amount of money we
had to invest it was always our policy that we at least receive five
or six bids from other institutions.
The CHAIRMAN. The bids, were they coming from the institutions
or through the broker?
Mr. SAYRES. NO, this was done by our own office.
The CHAIRMAN. Your own office?
Mr. SAYRES. Yes.

The CHAIRMAN. I thought you invested in Penn Square through
the broker.
Mr. SAYRES. The information received was from the broker. Now,
we took that information and evaluated it, but also did our own
study. Then we went out and called various institutions for other
bids. Then we compared those bids to the institutions that were on
the PAM report.
The CHAIRMAN. SO what service did PAM actually provide to
you?
Mr. SAYRES. In my opinion, just as an investment adviser providing the information.
The CHAIRMAN. But you say you go beyond that and make your
own independent evaluation?
Mr. SAYRES. Oh, yes, that is required by regulation. Yes, sir.
The CHAIRMAN. Did you invest in Abilene National?
Mr. SAYRES. Certainly did, sir.
The CHAIRMAN. Let me briefly give you a little scenario. There is
a bank that shows an annual report for yearend 1981, total loans
outstanding of $286 million, of which $56,377,000, or almost 20 percent, were loans, commercial letters of credit, and standby letters
of credit to directors and shareholders. We on this committee have
found that when you see something like that—the insider lending—
you should be apprehensive. Under commitments and contingencies in the same annual report the bank stated: "In the normal
course of business there are various outstanding commitments to
extend credit which are not reflected in the consolidated financial
statements."
Those are forward commitments. The combined standby letters
of credit and commercial letters of credit at yearend totaled
$149,372,406; 38 percent of their yearend deposit base. Those are
commitments. That is a credit.
In addition, this same annual report stated that during 1981,
loans were made to the Abilene Club, a nonprofit restaurant/club
operating in the same building as, guess what, Abilene National
Bank, at below the normal interest rate charged. Several directors
and officers of the bank are directors of the club.
It sounds to me like the club was actually there for the convenience, welfare, and health of the board of directors of the bank.
As of December 31, 1981, loans totaling $1,450,000 were outstanding to the club at a 10-percent interest rate.
That is a pretty good rate, isn't it?
Mr. SAYRES. Yes, it is.

The CHAIRMAN. NOW the prime rate at the time was 15.5 to 15.75
percent. Now in this annual report you have got insider loans, a
rather disturbing amount of letters of credit and of all things, a
restaurant and club operated by the bank's officers and directors




402
that are getting a preferential interest rate. Don't you think that
those would be some red flags for somebody considering investing
in that particular institution?
Mr. SAYRES. I would have to agree with that, Mr. Chairman, yes.
The CHAIRMAN. Thank you. I will ask you to excuse me. I have to
go to the Rules Committee on some other legislation that affects
credit unions and savings and loans, rather important to you. And
I am going to ask Mr. Leach to be gracious enough to take over the
chair.
I do want to express my appreciation to you gentlemen for your
cooperation with myself, with the staff, with the committee. We realize that it is not easy for you to be here today. By the same
token, as I stated in the opening statement, you are just representatives of a group. As I stated in Oklahoma City to the board of
directors and to others who got burned, don't feel bad. Patterson
and Jennings out-slicked the city slickers. Let's face it. They took
Chase, they took Continental, they took Seattle-First. And with all
due deference to you gentlemen, those are the experts. They took
the Comptroller of the Currency for a sleigh ride. They took the
Federal Reserve Board for a sleigh ride. So when you go home to
bed tonight you can sleep well.
None of us here are trying to in any way be derogatory. We just
wanted to find out for the benefit of the committee and its work of
the future how you became involved, because I think you are all
typical.
Thank you.
Mr. SAYRES. Thank you.
Mr. LOIACONA. Thank you, Mr. Chairman.
Mr. ARNOLD. Thank you.
Mr. MANGAN. Thank you.
Mr. LEACH. Let me say the minority has a series of bills we were
thinking of bringing up at this time but
[Laughter.]
Mr. LEACH [continuing]. We will defer on that prospect. Let me
just make a couple of comments and throw out some questions.
I attended the hearings the chairman held in Oklahoma City and
yesterday's session here. In mulling over the whole situation, it
strikes me that there is a lot of blame to go around. There are
problems involving conflicts of interest, weak internal and external
audit controls, less than aggressive regulation. But it is not the
small picture that is most important at this time. It is the big picture, the notion of high-priced money seeking higher priced money,
the notion of institutions around the country no longer serving the
community, but instead putting their investments in larger institutions. Yet these larger institutions have clearly stressed growth
over prudence. Also, it would appear that the larger the loan the
less the documentation.
A truism regarding banking is that banks and banking systems
are only as strong as their customers. When you develop a system
of chain investments, however, the customers become less well
known, both in terms of their assets as well as their character.
In retrospect, I think all of us have to acknowledge that when we
entered into this period of competitively seeking money and competing with everyone to control money, we lost sight of the likeli


403

hood that some of those loans being put forth as, say, Penn Square
did at 18, 19, 20 percent premium interest, would turn sour since
American society simply is not geared to that high a rate of interest.
In addition, in retrospect, what has happened here in partial
measure is that financial institutions—whether they were credit
unions, Continental Illinois, or Seattle-First—went after oil investments. The wealth of the Midwest and Northeast has largely been
transferred to energy-producing States in recent years because of
high-priced energy. Now the savings of the Midwest and Northeast
have largely been transferred to energy producing States through
the escalated transfer of capital from institution to institution.
One of the things that I think we are going to have to be very
concerned with is whether this process made a lot of sense and
whether there are lessons here for Congress itself. For example, I
think we ought to be looking more rather than less skeptically at
proposals for interstate banking. I stress this because it is quite
clear that the large banks which have argued they are stronger
than the small banks due to their greater size and greater diversity
of portfolio in essence are not stronger. It is the smaller institutions that have stronger capital bases and that know the character
of the people they are dealing with, know their communities far
better, and are making wiser loans today.
Do you feel that you have been caught up in a system where you
have competed to attract high-priced money and where you have
stopped serving, in essence, your own constituents and started serving, in essence, people in more esoteric endeavors in more distant
parts of the country?
Mr. SAYRES. I would think, yes, we were caught up in that period
of time with the savings instruments that we had to offer to retain
our membership, retain our deposits and to retain those deposits at
the rates that we had to pay, we were forced into, I believe, investing at least at a IV2, 2 percent higher yield in an instrument such
as a certificate. Definitely. If you have approximately $70 million
in money market funds that are only out for 6 months, you definitely can't loan your money out for more than that period of time.
So you are put in the position of investing and trying to find the
highest yield.
Mr. LEACH. DO you think in retrospect that if you had simply not
sought that money that you would not have been overextended and
that interest rates would be lower in this country? It appears that
the growth orientation of large institutions which sought out this
money overrode prudence. It caused the price of money to go up at
a more rapid rate than it otherwise would have in terms of the
prime rate. It is also keeping the prime rate higher even as the
cost of money comes down because of the need to recapture losses.
I would simply stress that there appears to have been a colossal
lack of judgment, starting at the top and seeping down, stemming
from the demands of competition. Perhaps if there had been greater emphasis on simply serving a community, some of these problems would not have arisen. Is that reasonable to you?
Mr. SAYRES. Yes, I would agree with you on that.
Mr. LEACH. Would anyone else like to comment on these issues?
Mr. Weber, do you have questions?



404

Mr. WEBER. N O , I have questioned already.
Mr. LEACH. If there are no further questions, we will adjourn at
this time and reconvene at 1:30.
[Whereupon, at 11:50 a.m., the committee was recessed, to reconvene at 1:30 p.m., this same day.]
AFTERNOON SESSION

The CHAIRMAN. The committee will come to order.
Will Mr. Renda and Mr. Goldsmith please come forward.
[Witnesses sworn.]
TESTIMONY OF MARIO RENDA, PRESIDENT AND EXECUTIVE DIRECTOR, FIRST UNITED FUND, LIMITED, GARDEN CITY, LONG
ISLAND, N.Y., AND WILLIAM GOLDSMITH, EXECUTIVE VICE
PRESIDENT, PROFESSIONAL ASSET MANAGEMENT, DEL MAR,
CALIF.
The CHAIRMAN. I understand neither of you has a formal opening statement, but Mr. Renda, would you like to say a few introductory words?
If you would bring yourself close to the microphone.
TESTIMONY OF MARIO RENDA
Mr. RENDA. My name is Mario Renda, I am president of First
United Fund and First United Fund is a rate-quoting service for
CD's, bank CD's. We are registered with the Securities and Exchange Commission as broker-dealers, and we quote rates for banks
and savings and loans, thrifts, throughout the country.
The CHAIRMAN. Mr. Goldsmith.
TESTIMONY OF WILLIAM GOLDSMITH
Mr. GOLDSMITH. Mr. Chairman, I am here to answer to the best
of my ability any questions that you or your committee may have.
The CHAIRMAN. Well, let me then ask you this question, Mr.
Goldsmith.
It seems to me t h a t shortly after the impact of the Penn Square
failure, I recall reading some articles in the press wherein you had
some thoughts about the lack of information available to people
like yourself, and Mr. Renda, as well as the people who have testified this morning for whom I have a great deal of concern.
So why don't you sort of reiterate t h a t to us, for the record, at
this point.
Mr. GOLDSMITH. I am not sure
The CHAIRMAN. I have a pretty good memory. My staff accuses
me of that. It seems to me t h a t you expressed dismay with the regulators, am I not correct?
Mr. GOLDSMITH. Yes, sir.
The CHAIRMAN. That is

what I mean. If you would just for the
record here repeat that, unless you have changed your mind since
then.
Mr. GOLDSMITH. N O , sir, I haven't changed my mind.
The CHAIRMAN. I mean it seemed to me as though we were on
the same wavelength. So regale me with the waves t h a t I like to
hear.



405
Mr. GOLDSMITH. Since July 5 and as a result of two hearings held
by your committee and one by Mr. Rosenthal's committee, considerable amounts of information have been made public through the
press. From these press releases, there were reports that as early
as January or February 1980, and one report that I read either yesterday or the day before, that further, back to 1978, regulators
found irregular and unlawful banking procedures at Penn Square.
I have been privileged to hear much of the testimony before your
committee yesterday and today. And questions as to whether additional disclosure by Federal agencies should be sought. It is my
opinion, based on what I have read in the papers that had—the
marketplace is a very wonderful and orderly and very discriminating place.
It seems to me that had information been available in 1978 or
1979 as to the either unlawful or irregular banking practices, that
there wouldn't have been a Penn Square in 1982. That a $50 million shopping center bank would have remained a $50 million shopping center bank. That no one would have chosen to inflate the
assets, or inflate the funding side which enabled them to inflate
the assets, in a bank that was irregularly managed.
So yes; I heartily endorse greater accountability on the part of
those who are in office, I am wondering who they were placed
there to protect. The argument is often made that such revelation
would cause a run on a bank. In 1978, it wouldn't have been very
important because there are 14,000 other banks around. In addition, when a highly respected and highly regarded, and what I believe to be the largest bank auditing firm in the United States,
validated what the public thought was a successfully operated profitable and well-capitalized bank, I further am convinced that, and I
am referring to Peat, Marwick, Mitchell & Co.'s certified audit
which gave a clear signal that this bank was in excellent financial
health.
I am further convinced that auditing firms in some way must be
made to tell the truth.
The CHAIRMAN. Could I interrupt you at this point? I would ask
both you and Mr. Renda the same question I asked of the panel
this morning. That is, did you indeed look at those audit reports,
and as a result of examining and analyzing them do you feel at
this point in time, knowing what has come to light, do you feel as
though those reports were misleading to you in your capacity as
advisers, so to speak, or consultants, to the investors who invested
money in Penn Square?
Mr. GOLDSMITH. Was your question, sir, do I believe that these
audits were
The CHAIRMAN. That they did not contain enough information or
accurate information on the actual status of conditions at the bank,
and therefore as a consequence, it was difficult for you to properly
advise your clients because you didn't have in hand the information you should have had?
Mr. GOLDSMITH. Yes, sir, that is true.
The CHAIRMAN. Mr. Renda?
Mr. RENDA. Well, Congressman St Germain, first of all First
United is not an investment adviser. We are broker-dealers.



406
The CHAIRMAN. I am sorry I used that terminology. But let's put
it this way. It is a question of semantics.
Mr. RENDA. I understand your question.
The CHAIRMAN. I am not trying to give you a new title or anything of the sort, or new duties.
Mr. RENDA. I just would like to say that we don't advise and
therefore, a financial statement would be totally unimportant because we are not rendering financial advice.
What we are rendering is a rate quoting service, where we are
quoting rates for thrifts and banks throughout the country. We
don't know what other brokerage houses are doing, or what other
investment advisers or so-called money finders in the industry are
doing. Our function in the industry is solely that of a reporting
service to let the investors out there know which banks in the 50
States
The CHAIRMAN. Mr. Renda

Mr. RENDA. Sure.
The CHAIRMAN. I don't want to be argumentative with you.
Mr. RENDA. NO.

The CHAIRMAN. That all sounds fine, but the fact of the matter is
do you list any institution in the United States of America?
Mr. RENDA. DO we list any institution?
The CHAIRMAN. That is right.
Mr. RENDA. We don't list any institution.
The CHAIRMAN. YOU are a rate quoting service.
Mr. RENDA. We quote rates for banks seeking funds.
The CHAIRMAN. Banks seeking funds.
Mr. RENDA. Banks and thrifts.
The CHAIRMAN. OK.

If credit union Y, as a result of a quote from you, invests in bank
X, how do you make money?
Mr. RENDA. Well, we get paid from bank X certainly.
The CHAIRMAN. All right, that is my point. You list quotes for
financial institutions that are going to pay you a quarter of a point,
half a point or what have you.
Mr. RENDA. Yes.

The CHAIRMAN. Not for every bank in the United States of
America.
Mr. RENDA. That is correct.
The CHAIRMAN. Therefore, you know, you are a little more than
a rate-quoting business. You quote rates. And inform investors
where they can invest their funds.
Mr. RENDA. NO. We don't.

The CHAIRMAN. NO. They have a choice. You give them a list of
maybe 15, 20, 40 institutions. You quote rates. Correct?
Mr. RENDA. Yes, we only quote rates.
The CHAIRMAN. In return for quoting those rates, the institution
that gets that quote from you invests in an institution that you
have quoted, and you are paid a fee.
Mr. RENDA. Earn a fee, that is correct.
The CHAIRMAN. SO I get back to semantics. You can call yourself
one thing. I can look upon you as another. Someone else might look
upon you as another. But the point of the matter is, that as far as



407

you and Mr. Goldsmith are concerned, you know, the difference
isn't all that great.
Mr. RENDA. Oh, but it is, Congressman.
The CHAIRMAN. In your mind. And I don't want to argue with
you.
Mr. RENDA. I am not talking semantics as well. I am talking
about a different kind of service, a service that we could provide as
investment advisers but we don't provide as broker-dealers. We
provide very similar service as the Wall Street Journal does. We
report a composite. The Wall Street Journal every day publishes
what 30-day rates are for CD's, 60-day, 90-day, et cetera. We report
every day what some 200 or 300 different banking institutions are
quoting for 30, 60, 90 days, the same kind of rates.
The Wall Street Journal never offers advice nor do they review
financial statements, issue reports.
The CHAIRMAN. Are you telling me that you would quote rates
on an institution even though you knew it was on the problem list
and was about to go belly up?
Mr. RENDA. Our only requirement is that the institution be federally insured, FDIC insurance or FSLIC insurance.
The CHAIRMAN. Beyond that you could care less?
Mr. RENDA. Beyond the fact we do check rather thoroughly that
the institution is in fact insured and is insured with FDIC or
FSLIC.
The CHAIRMAN. That is the extent of it.
Mr. RENDA. We don't review the statement for the purpose
of
The CHAIRMAN. SO you don't have clients?
Suppose credit union X were asking you for some quotes.
Mr. RENDA. Yes.

The CHAIRMAN. Who is your client in that instance, or do you
have one?
Mr. RENDA. I assume the client or customer in this case would be
the bank, because they are paying us the fee.
The CHAIRMAN. The bank in which the funds are going to be deposited.
Mr. RENDA. That is correct.
The CHAIRMAN. SO your only obligation is to that institution, not
to the credit union looking to make an investment, looking to you
for a quote?
Mr. RENDA. Yes, well, our obligation is to offer the investor the
highest quote if that is what he is looking for.
The CHAIRMAN. All you do is give him a quote.
Mr. RENDA. That is correct.
The CHAIRMAN. SO a credit union that asks you for a quote
should know that as far as you are concerned, the only criterion is
that that institution you are quoting is federally insured?
Mr. RENDA. That is correct, that they must be federally insured.
The CHAIRMAN. SO the credit unions in the future should know
that when they go to your firm that is all they are getting and that
you are in no way implying quality as far as the institution that
you are quoting is concerned?



408
Mr. RENDA. Well, it is not the only service if we are limiting it to
that. I think the fact we are quoting an FDIC or FSLIC insured institution is a service.
The CHAIRMAN. That is all you are doing.
Mr. RENDA. Yes.
CHAIRMAN. Penn Square was insured.
Mr. RENDA. Yes, it was.
The CHAIRMAN. Sharpstown was insured.
Mr. RENDA. Yes.
The CHAIRMAN. Franklin National, Economy.

The

They were all in-

sured. They went down the tube.
Mr. RENDA.

Yes.

The CHAIRMAN. But you don't care about that, as long as they
are insured. So the credit union that goes to you looking, as I say,
for a quote, all they get is a quote and the assurance that up to
$100,000 in 1982
Mr. RENDA. We tell them that it is a $100,000 as well.
The CHAIRMAN. Up to $100,000 is insured. Beyond that they are
on their own.
Mr. RENDA. We also tell them
The CHAIRMAN. I will have to excuse myself for a vote. I will be
back in about 5 minutes.
[Recess.]
The CHAIRMAN. The committee will come to order.
Mr. Goldsmith, tell me how many employees do you have. In
other words, do you render a service or give a little more information than does Mr. Renda's firm?
Mr. GOLDSMITH. Well, sir, we have 18 or 19 employees.
The CHAIRMAN. HOW many employees do you have, Mr. Renda?
Mr. RENDA. We have a total of 40 employees.
The CHAIRMAN. Forty employees?
Mr. RENDA. That is right.
The CHAIRMAN. DO they all check to see if the institution is insured, and quote rates?
Mr. RENDA. They don't. I do myself.
The CHAIRMAN. Then what do the employees do?
Mr. RENDA. They quote rates on the phones during the day and
take rate quotes from banks that are calling in throughout the
country.
The CHAIRMAN. SO you actually have 40 people just on the
phones.
Mr. RENDA. NO.
The CHAIRMAN. In and out or do you have some on the road.
Mr. RENDA. There are some other roles, and they
The CHAIRMAN. The road, r-o-a-d.
Mr. RENDA. Other roles, r-o-l-e-s.
The CHAIRMAN. OK. What are their other roles?
Mr. RENDA. We are also government security dealers and we

and sell government securities.
The CHAIRMAN. IS that under the same title?
Mr. RENDA. Yes, First United Fund.
The CHAIRMAN. First United Fund.
Mr. RENDA.

Yes.




buy

409
The CHAIRMAN. SO you quote rates and buy and sell Government
securities.
Mr. RENDA. That is correct.
The CHAIRMAN. Local, municipal, Federal Government.
Mr. RENDA. Treasury bills, bonds, notes.
The CHAIRMAN. HOW many people work in the rate quoting as
opposed to the securities section?
Mr. RENDA. There are 15 account execs that quote rates and
accept rates during the day.
The CHAIRMAN. The balance of them work in the securities?
Mr. RENDA. Yes, we also run a back-office operation and other
related services.
The CHAIRMAN. What do they do in the back office?
Mr. RENDA. Well, they keep track of all the money movement.
They also print up confirmations. They keep track of different
rates throughout the country. Numerous services.
The CHAIRMAN. Wouldn't that be the same as
Mr. RENDA. NO.

The CHAIRMAN. The people on the phones quoting rates? Oh,
they get the rates while the people on the phones in the front office
are quoting rates to the investors.
Mr. RENDA. Yes. We have people who are calling the banking institutions and telling them about investors who might need financial statements sent to them or need specific services.
The CHAIRMAN. YOU mean to tell me that some of the people who
want to place funds, like a credit union, do at times ask for a little
more information than just rates and whether or not the institution is insured?
Mr. RENDA. They ask for a financial statement to be sent to
them 90 percent of the time.
The CHAIRMAN. Right. So you then call the institution on which
they ask for the financial statement and ask them to send it to
Happy Days Credit Union?
Mr. RENDA. That is right. Most of the time we do keep an ample
supply and we may send it directly from our office.
The CHAIRMAN. HOW do you get your fee? In other words, how do
you determine whether you are the individual who is entitled to
get the finders fee?
Mr. RENDA. The bank usually determines it. We will say, we will
call the bank and say, you know, please expect a call from Happy
Days Credit Union, and they are looking to make an investment.
And they say fine. Then what rates did you quote them? And we
recite the rates we quoted them and the bank pays us a fee.
The CHAIRMAN. But you sort of go on faith and trust because the
bank that is looking for invested funds would look at the fact that
if they would not pay you then you would not quote them in the
future.
Mr. RENDA. That is correct.
The CHAIRMAN. Otherwise, you could end up with a lot of lawsuits, couldn't you?
Mr. RENDA. We haven't had any.

The CHAIRMAN. There is a lot of faith and trust here. Now can
you tell me anything else about First United and the services it



410
renders? I am not interested in your securities business, but rather
in what you do for S&L/s and credit unions, et cetera.
Mr. RENDA. Services that we provide are we will ask the investor
what criteria he may have. So the investor will give us a list of his
criteria. The criteria might be we are looking for only national
banks. We are looking for thrifts only in our own State. We are
looking for institutions with total assets in excess of $100 million.
We are looking for net worth of X.
We enter all of that information into our computer system. So
that when that investor calls, the only rates that we will quote him
will be rates that fit his criteria.
The CHAIRMAN. But, I just want to make sure one last time: You
do not in any way, shape, manner, or fashion recommend an institution, or state: well, there might be a problem with that institution, having reviewed their financial statements?
Mr. RENDA. We do

not.

The CHAIRMAN. YOU don't take that upon yourself.
Mr. RENDA. We do

not.

The CHAIRMAN. OK. Mr. Goldsmith.
Mr. GOLDSMITH. Yes, sir.
The CHAIRMAN. YOU have how many
Mr. GOLDSMITH. I think 18 or 19, sir.
The CHAIRMAN. And you have heard

employees on your staff?

me ask Mr. Renda about his
operation. Would you be kind enough to explain yourself to me?
Mr. GOLDSMITH. Yes. We primarily specialize in certificates of deposit from what we term the middle market bank or S&L. You see,
prior to my founding Professional Asset Management, I spent approximately 7 years with Merrill Lynch and about 4 years with
Bache Halsey doing many of the same things.
It was my opinion that the large New York Wall Street firms
created a little vacuum in the market in that we were selling CD's
for the major banks, Citibank, Chase, Continental, Bank of America. And that the middle market banks which also needed to raise
money outside of their traditional market area, needed the same
assistance.
And nobody at that time or few at that time were providing it.
So when I left Bache the idea was that we would work with what
we felt were well capitalized and middle market institutions, by
that I mean from roughly $300 million in size to $3 billion in size.
Those that were largely being ignored by, as I say, the other large
brokerage houses.
The CHAIRMAN. I think I better start asking questions to give me
what I need and am looking for. When a client calls you that wants
to invest funds, say that Happy Days Credit Union calls you, do
you quote them rates, as does Mr. Renda?
Mr. GOLDSMITH. IS this a client we have dealt with before, or is it
a new client, sir?
The CHAIRMAN. Well, let's take one of each.
Mr. GOLDSMITH. All right.
The CHAIRMAN. Happy Days and Sad Days.
Mr. GOLDSMITH. Well, if it is a client that we have had previous
experience with, one of our account executives, there are 10, or 11
who will quote them rates. And since we have worked with ap-




411
proximately 50 that are on what we call a Capital Adequacy
Report—you have a copy of that I, believe.
The CHAIRMAN. Yes.
Mr. GOLDSMITH. This
The CHAIRMAN. Without

objection, we will make a copy of a Capital Adequacy Report a part of the record at this point.
[The copy of the Capital Adequacy Report follows:]




412

- = = j = ^PROFESSIONAL
= A S S F T 22110 Ventuia Boulevard
MANAGEMENT
INC.

Woodland Hills, California 91364 8 0 0 / 4 2 3 - 5 8 7 7 Continental U.S.
213/888-2100 California, Alaska, Hawaii

Registered Investment Advisor

March 10, 1982

Dear Investor,
To hear many tell it, the S & L industry is dead. Others are holding the wake BEFORE the funeral. To steal a line from another
generation, reports of this demise are greatly exaggerated. However, I think it is safe to say that 1981 was a very difficult year
for most S & L's.
You may have noticed that this report includes fewer S & L's and more banks than previous reports. The extent of the
industry's difficulties are further underscored by the number of S & L's requiring mouth to mouth resuscitation. Even the best
managed institutions sustained substantial losses and the FHLB reduced its minimum reserve requirements from 4% of
average assets to 3%.
Hardly a day passes without an article in one or more local or national publications telling of the plight of the S & L industry and
the fact that almost daily another institution sinks to zero net worth. What isn't reported is that having a zero net worth is quite
different than having no cash flow. Those associations with a steady cash flow from monthly mortgage repayments could ride
out a zero net worth or even a negative net worth until interest rates decline and the net worth corrected itself.
We at Professional Asset Management continue to believe in the viability of the S & L industry even though we recognize over
the near term additional surveillance and extreme caution are top priorities. Consequently, even though we have reduced the
NUMBER of S & L's on our approved list, the QUALITY of the specific institutions we follow remains extremely high. In these
difficult times SAFETY and CAPITAL ADEQUACY have no substitutes. Only those banks and S & L's that continue to meet
our rigid quality standards are included in this capital adequacy report.
Philosophically it could be argued that since the regulators have relaxed their merger requirements easing the way for
interstate mergers and inter-institution mergers, the possibility of failure for all but the smallest S & L has been reduced
significantly. It could be argued further that since Congress rescued Lockheed and Chrysler with bailout loans, can it do any
less for a large troubled thrift?
Since these are political decisions it is difficult to know with precision what this new political environment or an election year
will bring. Therefore we will not speculate in the realm of probability and consider only the land of reality, those factors that
reliably measure relative strength and capital adequacy. You will note that the banks and S & L's we have included in this
report are very profitable or at the very least possess capital adequacy that is more than adequate in spite of recent losses.
The banks continue to reflect both profitability and strong capital adequacy positions.
The continuing relative weakness on the part of even the strongest S & L a;d the strength of banks in general has created a
fairly pronounced two-tier market in the bidding for CD's. Yield differentials favoring S & L's have increased to 75 to 100 basis
points in many cases. This differential implies a greater risk plus an element of fear inherent in an S & L investment. Is the
additional premium paid by an S & L worth whatever real or imagined risk one perceives in such an investment? This is a
decision you will be forced to make with increasing frequency as this year unfolds. That is precisely the reason Professional
Asset Management brings you this report. It allows you to study 40 institutions, carefully comparing many of the key elements
of safety and capital adequacy before you make an investment.
We will not include in this report any bank or S & L whose capital adequacy do not meet rigid minimum standards. We will
augment this analysis with personal visits to each institution and personally interview top management as part of our indepth
analysis.
Separately much has been said and written of late about expanding investment regulations to permit credit unions to buy
bankers acceptances, Euro dollar CD's and commercial paper. Additional avenues for investments are needed, of that there
is little doubt. But I was around in the early 70's when many of you reading this entered the world of Ginnie Mae's after learning
only to spell the name. But at least Ginnies are guaranteed by the U.S. government. And still because of a gross lack of
knowledge and information many lost a bundle of dollars. You're going to have to know much more than how to spell the
names to be able to invest intelligently in BA's, Euros or commercial paper. Sadly the loudest spokesmen for increased
investment opportunities are many of the same voices who bought heavily into Ginnies and Freddies a while back. Nothing
takes the place of information. Investigate before you invest is an axiom as currant today as when it was first uttered years
ago. I will discuss BA's, Euros and commercial paper more fully in a subsequent report. However feel free to call on me any
time for assistance.




413
CAPITAL ADEQUACY REPORT
FOR YEAR ENDING DECEMBER 31,1981

TOTAL
ASSETS

DEPOSITS

NET
WORTH

NET
INCOME

RETURN ON
AVERAGE
ASSETS

RETURN ON
AVERAGE
NET WORTH

NET WOP'
AVERAGE
DEPOSIT:

1.7%

26.7%

9.5

NM
NM

NM
NM

6.t
5.:

1.4%

19.5%
14.4%

8.4
8.?

( I N T H O U S A N D S )
Abilene Natl. Bank
Allstate S&X.3

424,377

376,804

27,230

3,260,475
396,444

150,846
17,308
26,748

5,477

American Natl. Bank

385,751

2,269,918
343.906
336,716

Bank of Newport
Barclays Bank*

212,824
819,326

176,911
723,474

14,649
56,731

2,014

4,620,000

184,300

2,680
5,228

American City Bank

California First Bank

(25,299)
(3,663)
5,017
100

921,550
916,442

3,497,000
716,364
823,963

Community Bank
Empire S4L 5

681,547
1,319,753

445,164
959,712

Far West StL

1,038,665

Financial Federation
First Natl-Araarillo
First Natl-Midland

2,436,805
797,564
1,642,752

736,300
2,059,344

First Natl-of Oklahoma

2,745,700
1,294,723
5,257,234

3,525,395

216,828

1,800,000
3,445,086

1,380,000
2,552,124

75,000

860,000
1,693,073

720,000
1,164,892

60,000

2,100

62,283

Heritage Bank

264,464

242,600

Hibernia Bank

897,339

766,406

Homestead StL

565,880
1,464,748
1,397,317

323,120
969,283
1,172,761

2,266,840

1,740,164

1,717,853
394,158

Capital Bank, NA
Central Bank

First Natl-Tulsa
First Penn Bank, NA
Fuji Bank, N.Y.
Gibraltar StL Houston
Golden State Sanwa Bk. 6
Guarantee SiL 7

Honolulu Federal StL
Imperial Bank
Liberty Natl. Bank
Pacific Federal StL
Penn Square
Bank, NA

Southwest StL
562,518
State StL 8
3,662,590
State Street Bank
3,388,066
Sunwest bank
131,872
Texas Commerce Bank, NA 7,356,656
Union Federal StL
726,731
University StL 9
2,096,467
Valley Federal StL
1,595,378

53,713
45,650
34,694
57,549
65,175

1.0%
NM
.07%
.6%

11.0%
16.7%
14.4%
NM

NM

NM

9.-

NM

6.1

8,560
21,543

NM
1.2%
1.5%

17.4%
28.7%

9.:
6.:

12.6%
14.7%

8."

(5,743)
(3,890)
(32,024)

631,085
1,348,228

137,692
52,914
84,270

2,009,306

40,000

19*298

.76%

1,014,403

78,641

11,002

.9%
NM

6.^

8.:
6.:

.4%

NM
10.17%

NM

NM

.26%

4.6%

c<
.

(6,945)

NM

NM

5.-

12,381

2,121

.9%

20.2%

47,15C
23,471

1,089
533

.14%
.1%

2.3%
2.3%

56,963
65,717

(9,080)
18,151
14,240
(24,625)

NM
1.5%
.7%

NM
33.8%
15.8%

1,249,203

106,414
70,382

NM

NM

6."

363,754
377,007

30,404
25,227

4,705

1.4%

98,944
164,677
8,278
325,662
26,574

418
18,009
26,242
768
66,193
(6,497)

.08%
.7%
.8%
.6%
1%
NM

9.f
7.:

2,747,716
2,248,475
117,548
5,007,228
496,128

18.5%
1.7%
22.8%
17.0%
9.7%
21.7%

1,823,399
1,073,682

58,885
48,383

(2,985)
(12,203)

167,523

(4,500)
5,800
(8,92s) 1

239,250

217,904

12,557

1,249

Gill Savings

404,594

344,822

10,685

5,789

2.1%

For Fiscal Year ending 9/30/81
Includes purchase of Oceanside Federal
Wholly owned subsidiary of Sears Roebuck
Wholly owned subsidiary of $68 Billion Barclays Bank Ltd.
Wholly owned subsidiary of Baldwin United

12-745 0—83- -27

8.C
5.'
7.5

.8%

Westlands Bank




8.:
5.!

.75%
NM

7,189
4,654

NM
NM
.6%

(1)
(2)
(3)
(4)
(5)

.17%
1.6%.

6.5
6.<

5.
8.:
7. .
6.:
6.:
7.

4.<
7.
7 .(

7.

NM
NM
NM

5.:
3.;

13.3%
75.0%

6.:

<.'.
4.£

414

NET WORTH
AVERAGE
ASSETS

ASSETS

% CHANGE SINCE 12/31/80 - 12/31/81
NET
NET
DEPOSITS
WORTH
- INCOME

90.0%

5 YEAR GROWTH 12/31/77 - 12/31/81
ASSETS

DEPOSITS

NET WORTH

8.5%

94.0%

96.5%

90.0%

764.0%

745.0%

4.8%

7.9%

(2.0%)

(14.4%)

(625.0%)

150.0%

130.0%

85.0%

4.5%

5.2%

5.2%

14.5%

(213.0%)

175.0%

159.6%

118.5%

7.3%

12.8%

11.9%

9.0%

51.4%

71.0%

65.0%

108.0%

7.4%

16.3%

15.6%

10.2%

(17.0%)

116.0%

103.0%

178.0%

7.0%

4.9%

5.7%

(2.2%)

(96.0%)

NM

NM

NM

4.5%

27.6%

(1.1%)

27.5%