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SEPTEMBER 18, 1984


This report is the result of staff findings to date, and does not
necessarily reflect the views of the Members of the Subcommittee.


This report presents in summary form the findings of examinations of Continental
Illinois National Bank (CINB) relating to its loan management and capital. CINB was
examined by the Office of the Comptroller of the Currency once every year from 1976
through the present except 1978. The examiners-in-charge of the examinations discussed
in this report were John Meade (1976), Richard Kovarik (1977 and 1982), and Allan
McCarte (1979, 1980, and 1981).
Section I provides a brief review of CINB's financial history from 1976 to 1981.
Section II discusses the findings of the OCC examiners regarding CINB's loan management
and credit quality control systems. Section III reviews OCC examiner comments about
CINB's capitalization. The boldface emphasis in some quotations has been added by staff.


In July 1976, Continental Bank's chief executive officer, Roger Anderson, announced
his intention to make Continental one of the three top U.S. banks serving industry. This
was a bold objective and Continental's starting point was not the strongest.
In 1976, CINB's ratio of classified assets to gross capital funds was 121%. This level
was viewed by examiners as troublesomely high and meant that the volume of
Continental's loans classified as "substandard", "doubtful", or "loss", was well over the loss
absorption ability of the bank. This was particularly worrisome because Continental's
classified assets to gross capital funds ratio had risen from 30% in December 1973, 63% in
September 1974, and 109% in June 1975. (See attached tables of supervisory ratios.)
Three months before Anderson's July 1976 announcement, OCC examiners had rated
the Bank's condition as only Fair and cited as matters requiring attention:
"Classified assets amount to $1.2 billion which is 121% of gross capital funds versus
109% at the time of the previous examination."

"Gross capital funds amount to 5.5% of total resources, down from 6.1% last
'The bank continues to rely heavily on purchased funds to carry its assets. As of the
examination date, 46% of net assets, as compared to 49% last examination, were
supported by funds whose cost was a money market rate. This matter and the
related issue of liquidity are of continuing concern."

"Credit files are missing, or incomplete in comments, in cases where swaps have
been entered into."
(Examiner's Comments on Matters Requiring Attention, Report of Examination,
April 1976, Comptroller of the Currency, p. 2.)
In the confidential section of the report, the OCC examiner John Meade evaluated CINB's
capital position as:
"Inadequate. Gross capital funds are loaned 10.5 times which is unchanged
from last examination and the capital/asset ratio is 5.5% versus 6.1% last
examination. However, the volume of classified continues high at 121% versus 109%
last examination. Management is seriously considering going to the capital market
before year end but nothing is definite at this time."
(Confidential Memorandum to the Comptroller of the Currency, Report of
Examination, April 1976, p. D-c.)


Meade, however,
rated both Continental's management and future prospects as
"Excellent". (Confidential Memorandum to the Comptroller of the Currency, Report of
Examination, April 1976, pp. D-a and D-d.)
Despite its weak starting point, Continental's management started out aggressively
and confidently on a path of remarkable growth and earnings increases. So taken were the
financial markets with Continental's performance, Dun's Review, a widely read financial
magazine, included Continental in its 1978 list of the five best-managed companies in
America. Dun's Review said:
"Continental Illinois has achieved one of the best and most consistent performance
records in the industry over the past five years. ... Most important to Continental
has been the growing impact of its loan business, which soared from $ 2.6 billion in
1973 to $ 4.9 billion at the end of 1977. And its domestic loan business was up 19%
over a year earlier at the end of 1978's third quarter."
("The Five Best-Managed Companies", Dun's Review, December 1978, p. 42.)
Though examiners expressed concern in every examination report about capital
adequacy and credit quality, the outward signs of portfolio soundness as bank examiners
measure it seemed to be improving steadily. Continental simply outgrew its level of
classified loans. The problem loan to capital ratio declined to 86% from its 1976 level of
121%, and continued to decline to 80% in 1979, and 61% in 1980, and rose only slightly in
1981 to 67%.
The financial markets looking at published financial statements showing steadily
increased earnings and apparent portfolio soundness, were greatly impressed with CINB
and bid its stock up accordingly.
In 1981, five years after Anderson's announcement, Continental attained its goal of
becoming one of the largest corporate lenders in the U.S. From 1976 to 1981,
Continental's total assets increased from $ 18.6 billion to $ 41.1 billion, a compound
annual growth rate of about 15%. This remarkable size increase was the result of a heavy
dedication throughout the Continental corporation to loan expansion, reflected clearly in
Continental planning and budgeting documents. The growth was made possible by a
management responsibility and accountability framework that gave individual loan
officers more lending authority than is generally found in other money center banks and
that encouraged and rewarded loan growth.
The management objectives of CINB were clearly reflected in the 1980 corporate
plan. CLNB's corporate goals were ranked as follows:

1. Earnings per share
2. Average assets growth
3. Average earning assets growth
4. Return on average stockholders equity
5. Return on average assets
6. Return on average earning assets
7. Average assets/Average total capital
8. Average earning assets/Average total capital
9. Average risk assets/Aver age equity and reserves
10. Average debt/Average total capital
11. Dividend payout

12. Internal funding rate
("Performance Relative to Corporate Goals11, Internal Competitive and Performance
Analysis, Continental Illinois Corporation, Annual 1980, p. 8)
Associated with each corporate goal was a specific and clear numerical target. In
light of CINB's later problems and the practices of other money center banks, it is
noteworthy that there was no specific target for loan quality. Though the examiners
remarked about CINB's corporate goals in examination reports, during staff interviews of
them they acknowledged that they had never actually seen CINB's planning documents.
The risks inherent in CINB's growth oriented planning became apparent in 1982. The
economic recession that gripped the U.S. economy in that year hurt all the money center
banks badly. The lending and management practices that Continental had to adopt in
order to reach its corporate goals, however, made it particularly vunerable to the effects
of the recession.
Significant credit quality and loan documentation deficiencies in Continental's oil
and gas lending were spotlighted by the Penn Square National Bank failure in July 1982.
But problems were not limited to oil and gas lending alone. Continental's 1982
examination report classified $ 3.6 billion in loans as "substandard", "doubtful" or "loss".
Of these, $ 1.2 billion were oil and gas loans with Penn Square related classified loans
totalling $ 620 million.
The causes of CINB's problems were explained by Richard Kovarik, author of the
1982 OCC examination report, this way:
"Although the level of credit problems is related, to some degree, to the general
downturn in economic activity both nationally and on a global basis, the magnitude
of existing problems must be viewed as a reflection upon management's past
decisions regarding growth and the system of decentralized authority and
'This management style has allowed, and may in fact have fostered, many of the
problems at hand, as adequate systems to insure that responsibility was being taken
were not in place...."
'The asset growth was partially the result of a goal to become one of the leading
domestic wholesale banks, but was also driven by a need to show higher earnings to
the marketplace. Although earnings growth, in dollars, has been impressive, it has
mirrored asset growth. Earnings efficiency has remained relatively unchanged over
the past five years. Therefore, in order to show better earnings (in dollar terms)
more assets had to be generated. Recent asset growth, especially over the past
year, was not generated in concert with strategies necessary to insure that the
growth was controlled from the standpoint of quality and the organization's ability
to handle the increases efficiently. It had become increasingly difficult to maintain
asset quality for a combination of reasons. First, the quality of the pool of available
assets had decreased due to economic conditions. Secondly, the internal support
staffs (operational and lending) were insufficient to properly handle the loan volume
(Letter to the Board of Directors, Report of Examination, November 1982, p. 2.)


The information in the examination reports regarding the volume and range of
classified assets was not known to the financial markets, and through the rest of 1982 and
1983, financial analysts tended to view Continental's difficulties as limited to Penn Square
related loans or to oil and gas lending generally. It was not until Continental's year-end
financial statements became available that the size of the loan loss writeoffs and their
effect on income became clear.
In the Spring of 1984, financial market concern about the true condition of
Continental became serious. Rumors abounded about potential bankruptcy, and market
confidence in Continental's financial strength declined despite the assurances of
The resulting outflow of funds necessitated quick development and
implementation of a multibiilion dollar FDIC assistance plan. It is clear that without the
federal assistance program, Continental Bank would have gone out of existence.
In hindsight, CINB required federal aid to remain in existence because (1) its loan
management system was inadequate and permitted credit problems to grow undetected,
and (2) its focus on earnings per share growth required keeping capital at a minimum.
Both of these matters were commented upon repeatedly in examination reports but their
significance was masked by the decline in the ratio of classified assets to capital.
Understanding the relationship among loan management, capitalization, and classified
loans is critical to understanding what happened to CINB.


The OCC examiners confirmed in staff interviews what is generally accepted —that
the problems associated with a bad loan generally do not appear until a year or two after
the loan is made. If a bank is growing rapidly, its problem loan levels will lag behind its
loan growth by a few years. If its loan management system is effective, the problems will
be detected early and kept within acceptable ranges. At the same time, if capital levels
are kept up as the bank grows, it will have the capacity to absorb the greater losses that
are inevitably associated with making more loans.
In CINB's case, however, high capital levels were sacrificed to enable greater
earnings per share, and in their drive for asset growth, CINB executives ignored setting
corporate loan quality standards. Consequently, as loan growth got underway and the
paperwork increased, loan management deteriorated and credit problems went
undetected. Statistically, greater lending would have resulted in greater losses in any
case, but the delays in detection and treatment of credit problems caused loan losses to
be even greater. The reduced capital position made it difficult to absorb the losses
associated with both greater lending and a deteriorating loan management system.
Adding to this, the losses associated with an economic downturn placed an impossible
burden on CINB's capital.
The failure in OCCs supervision of CINB was not appreciating the potential for
harm inherent in the combination of high growth policies and lax credit practices. The
examiners1 comments regarding loan management year-by-year are set out below.
Commenting in 1977, Examiner Kovarik said:
"Management of the loan portfolio is considered excellent* Senior positions are
staffed with well seasoned lenders and considerable depth is evidenced throughout
the various divisions. An informative system of performance evaluation is employed
for personnel and divisional units that encompasses the entire lending operation.
The committee system employed is considered sound with a majority of the
members drawn from senior levels. Sound hiring practices are pursued and a
comprehensive training program is in operation."
"The underlying causes of the present burdensome volume of criticized loans stem
from external conditions primarily. The majority of loan criticisms reflect the
effects of a period of rapid inflation followed by an economic recession. It is now
evident these external conditions are improving with a resulting direct effect upon
the troubled loan area; however, many credits have fallen into a workout condition
and will take considerable time to fully resolve. In all such cases it is evident your
bank management is moving to resolve these situations as quickly as conditions
(Loan Portfolio Management, Report of Examination, August 1977, p. 7-1.)


Kovarik also said:
The initial review of credit files revealed numerous instances of incomplete or noncurrent information. As this material was made available during Divisional loan
discussions, it is apparent that an improved system to monitor the flow of credit
information from the lending areas to the Credit Department is needed."
(Loan Portfolio Management, Report of Examination, August 1979, p. 7-1.)
At the time, Kovarik did not view the credit file situation as serious and did not include it
in his letter to the Continental board of directors. In hindsight, it may have been the
first sign of future loan management problems.
Two years later, in his 1979 examination report transmittal letter to Continental's
board of directors, OCC's Deputy Comptroller for (Multinational Banking, Billy Wood,
raised the issue of credit administration more pointedly and related it to Continental's
heavy dependence on purchased funds and its need for a strong market reputation.
"Our review of the credit administration system disclosed deficiencies relating to
the identification and rating of problem loans. Some loans were not reviewed by
bank staff in keeping with system objectives. In addition, several loans which are
internally rated "B", and which have traditionally been regarded as sound from a
review evaluation standpoint, are criticized in the report of examination. The
importance of reliability of internal loan evaluation procedures as an early warning
mechanism to control credit quality in a growth environment cannot be
(Transmittal Letter to the Board, Report of Examination, August 1979, p. 1.)
The examiner-in-charge of the 1979 examination, Allan McCarte, provided more detail on
internal credit management in his letter to the board of directors:
"Several credits which were rated f,B" by the system, and therefore expected to
possess the qualities to preclude criticism, are criticized in this report. Other
credits, which are subject to review, were found to have eluded the credit rating
process. These factors combined with the 15% growth goals cited in the strategic
plan suggest that a reappraisal of the credit rating process and systems is
appropriate. Additionally, since the bank is heavily dependent upon purchased funds
to support assets and provide liquidity, maintenance of good asset quality is
necessary to insure a continued high degree of market acceptance."
(Letter to the Board of Directors, Report of Examination, August 1979, p. 1.)
By mid-1980, Continental's total assets reached $ 39 billion and its net income was
well on its way to another annual record. Its ratio of problem loans to capital also
declined significantly from 80% the year before to 61%. In his 1980 letter to the board of
directors, McCarte said:
"While it is recognized that management is capable of successfully working down the
listing of criticized assets - and in fact has demonstrated such - it should be
recognized that the present level is still somewhat above traditional standards."
(Letter to the Board of Directors, Report of Examination, October 1980, p. 1.)


Concerning the deficiencies he had cited the year before in the area of credit
management, McCarte wrote:

Our review of the loan approval and review process was more comprehensive this
examination than in previous years and included the use of both judgmental and
statistical sampling. The results of these efforts were favorable to the bank and
revealed what is considered to be a generally efficient loan process."
(Letter to the Board of Directors, Report of Examination, October 1980, p. 1.)
McCarte took his analysis a step further and warned Continental officials about an
inherent weakness in its loan management system:
"...the results of our examination do not point to any material deficiencies
in either the original accuracy or timeliness of reports on asset quality. However,
since the integrity of these reports is partially dependent on input (Watch Loan
Report) from officers around the world, a means of periodically checking the
performance of lending personnel in this matter might be considered* This point is
raised because the existing procedure followed by the Rating Committee does not
include any "on-site" or interim independent review. Once a credit is assigned a
quality rating, unless subsequent negative press/knowledge or a watch loan report is
submitted, a deteriorating situation may go unnoticed until the next rating period.99
(Letter to the Board of Directors, Report of Examination, October 1980, p. 1.)
In light of CINB's later problems, this warning was very significant. CINB's
decentralized, growth-oriented loan management system gave individual loan officers a
great deal more independent lending authority than was or is found in other money center
banks. This was a significant competitive advantage because a borrower could get a
quicker approval from a CINB official than could be obtained from loan officials of other
money center banks who needed approvals and confirmations from higher management. If
a loan developed problems, it was the responsibility of the CINB loan officer to put the
loan on a "watch list". If the loan officer chose not to put the loan on the watch list,
senior management would not know the loan had problems until it was independently
reviewed and rated by the Loan Review Division.
An early sign of future credit problems appeared in 1980. The level of non-accrual
loans increased to $ 402 million from $ 191 million in 1979. Non-accrual loans are those
on which interest or principle payments are 90 days past due but which appear to be well
secured and are in the process of collection.
By the 1981 examination, the ratio of problem loans to capital began to rise again.
From the 61% 1980 level, it rose to 67%. Regarding this, McCarte in his letter to the
board of directors wrote:
'The majority of our efforts were again directed toward evaluating asset quality
with particular emphasis on the loan account. The reversal of an earlier trend of
decreasing classified ratios was observed across the board. In aggregate, this
examination showed the level of classified assets increasing from 61% of gross
capital funds to 67%. A more detailed analysis revealed that doubtful assets now
equate to nearly 10% of gross capital, with directed and voluntary losses this
examination aggregating $29 million. The addition of specifically mentioned items
increases the level of total criticized to 99% of gross capital funds."
(Letter to the Board of Directors, Report of Examination, August 1981, p. 1)


This examination is interesting because of two anomalies in it which cast a shadow
over its credibility. The first relates to the examiner assessment of the significance of a
near doubling in the loans going unreviewed by the bank, and the second concerns the
accuracy of the examiner review of oil and gas lending.
Regarding the first matter, McCarte wrote:
"A review of these internal reports for domestic credits only reflects a significant
increase in old-rated credits from last examination. In analyzing this report, it was
determined that approximately 375 credits, aggregating $2.* billion had not been
reviewed within one year, with fifty-five of these credits not reviewed within two
years. This compares to approximately 270 credits over one year, totalling $1.6
billion in June, 1980, with twenty-five credits not rated within two years. Responsibility currently rests solely with the divisions to provide information for re-review.
However, it is evident that no one is monitoring this situation to ensure that all
credits are receiving timely reviews, as required by the corporate office."
(Loan Portfolio Management, Report of Examination, August 1981, p. 16.)
Failing to review first $1.6 billion one year and then $2A billion the second year,
would seem to represent a significant and worsening situation in CINB's credit review and
quality control mechanism. Examiner McCarte in his letter to the Board of Directors,
however, said nothing more strongly than:
"... the issue of timeliness or frequency of review is noted since bank records
indicate a general increase in the number and volume of loans not being reviewed in
accordance with the wishes of the Corporate Office. Although this list is up from
last examination, it has not adversely impacted the reported results from Loan
Administration. It seems clear however, that any success in reducing the number of
these exceptions is dependent upon the voluntary positive responses of the many
division managers."
(Letter to the Board of Directors, Report of Examination, August 1981, p. 1.)
Regarding the system overall, Examiner McCarte said:
"We found it to be functioning well and accurately reporting the more severely rated
advances to the Board and senior management." (p.l)
(Letter to the Board of Directors, Report of Examination, August 1981, p. 1.)
When the staff interviewed the examiners, questions were posed to both Meade and
Kovarik, regarding such situations. Both responded that absent detailed information
concerning the loans not reviewed, a situation such as that described by McCarte sounded
significant. McCarte, however, viewed it as significant in retrospect, but at the time in
light of the Bank's overall declining classified loan levels and asset growth, he did not
view it as an overriding problem.


The second anomaly is the examination report's description of the oil and gas
"One of the primary growth areas within the bank over the past two years is the Oil
and Gas (O&G) division within the Special Industries Group. Domestic 0<ScG loans
now total $2,862 million and represent over 10% of the bank's total loan portfolio.
Significant growth has occurred since early 1979 to date, with O&G loans up 65%
from year-end 1978. CINB is adequately staffed with both sound lending officers and
scientific (engineers and geologists) personnel to handle current relationships and
meet continued strong growth anticipations. The bank has developed a presence in
most of the active areas in the industry through the establishment of regional
offices in Texas (which have generated loans representing 38% of O&G credits),
Denver, Colorado and Calgary, Alberta, Canada. No significant problems are
evident as noted by the fact that only two O&G credits were classified herein."
(Loan Portfolio Management, Report of Examination, August 1981, p. 13.)
In contrast, Kathleen Kenefick, a loan officer in the oil and gas division, described
the situation this way in July 1981:
"The status of the Oklahoma accounts (particularly Penn Square Bank) is a cause for
concern and corrective action should be instigated quickly to stem any future
deterioration. Potential credit problems could be going unnoticed, thus possibly
missing opportunities to improve our position and/or prevent some losses. Management of credit relationships has not consistently taken place, with minimal forward
planning of CINB and/or customer actions occurring. In some cases the initial credit
writeup had customer information missing, out of date or incorrect; in other cases
there has not been a credit writeup. Followup and accountability have been rare.
Thorough monitoring is hindered when both strengths and weaknesses of the
customer are not discussed. Housekeeping problems (missing notesheets and
approvals, documentation errors and omissions, past due principal and interest, etc.)
compound the situation. All of this may result in delayed or possibly lost income to
the bank. Potentially missed opportunities both for future business and for
correcting possible problems are the result when "reaction" is all we can handle.
The Oklahoma calling personnel continually fight to keep their heads above water,
with time spent putting out fires, and therefore falling further behind."
(Memorandum of Kathleen Kenefick, July 29, 1981, p. 1.)
Both of the above comments were written in the Summer of 1981. One year later,
the financial dimensions of the loan management and credit quality problems in the oil
and gas division were clear. From $85 million in 1981, the level of classified oil and gas
loans rose to $ 649 million in 1982. The potential deficiency in CINB's loan management
system that McCarte warned about in his 1980 report apparently became a real
Just before finishing the 1982 examination report, Examiner-in-charge, Richard
Kovarik, explained what happened to Continental and the relation to Penn Square this
"Although the Penn Square relationship accounts for a relatively small portion of
problem loans (less than 20%) the publicity surrounding its closing was surely the one
event that has done the most damage."


"It is my opinion that there are two inter-related causes of the present situation.
First, the aggressive growth philosophy of CIC was not tempered by increased
controls (loan quality safeguards) and second, the management style of great
authority and responsibility resting in individual unit managers, was without proper
supervision from their superiors."
"Although in the first instance it can be said the lack of quality control is universal
for the bank, the second cause is more localized - particularly in the Special
Industries and Real Estate Groups."
(Memorandum from Richard Kovarik to William Martin, November 15, 1982, p. 1.)
Regarding the question of whether Continental loan officers were filing watch loan
reports on their loans that had developed problems, Mr. Kovarik in the examination report
"Our review of credits criticized at this examination reflects 99 "B" rated credits.
Differences are generally due to timing in the rating system (23 had not been rated
within one year) and to subjective differences of opinion. It should be noted that
many of these credits were added to the WLR system by loan officiers at 4-30-82,
and subsequently downgraded by the Rating Committee in the normal rating process.
Of more concern is the fact that 119 credits criticized or classified did not have
WLR's. These totaled approximately $1.4 billion, compared to 34 such credits
totalling $299 million at the previous examination. The totals of these exceptions
are of such magnitude to conclude that WLR's and updated ratings are not being
provided on a timely basis."
(Loan Portfolio Management, Report of Examination, November 1982, p. 23.)
Before turning to a review of what examiners said over the years about CINB's
capitalization, one final piece of evidence concerning CINB's loan management needs to
be presented. This evidence consists of what Chemical Bank, First Chicago National
Bank, and Citibank found when they went into CINB in the Spring of 1984 to evaluate it
prior to making the FDIC a purchase and assumption offer. The individuals overseeing
each bank's review of CINB were interviewed by the staff. The findings of each of the
banks as reported to the staff tended to be identical with each other and consistent with
FDIC memoranda from which the excerpts below are drawn.

'The Latin American portfolio was mostly private sector with loans to a number of
customers with which the
people were not familiar. The same is true for
Europe; there were about 100 loans totaling $300 million to customers that
people had never heard of. There was somewhere between $2 and $2)4 billion in
charge-offs in the loans they had reviewed, concentrated in the real estate, energy,
shipping, corporate and Latin American portfolios."

"The internal loan review procedure at Continental is very similar to
's. Both
use a numbering system of 1 to 8 or 9, with one being the highest rating, and 8 or 9
being the lowest.
indicated that on the higher end of the scale, Continental
normally treated a loan one better than
would have and, at the lower end of
the scale, the difference was normally more than one."



compared their internal loan rating system (1-9) against the rating system at
Continental (1-9) on 21 borrowers which were common to both banks. Only six of
the 21 credits were given the same rating by both banks. On another 6,
Continental's rating was one better than the rating at
; on another 5,
Continental's rating was 2 better than
s and, on another four credits,
Continental's rating was 3 or more better than
s. Based upon this review,
- indicated that Continental's internal loan review process was very lenient and that
the volume of classified loans was really much higher than that presented by

"On some of the common loans at the two banks,
has taken at least partial
charge-offs, while Continental continues to carry them at full value and in a
performing status. Continental also makes new loans to customers in order to keep
the interest payments current.
people estimate that there is an additional
$650-700 million in loans which should be classified as non-performing. They also
estimate an additional $1.6 billion in non-performing loan within 12 months. "

"Other negative comments regarding Continental's lending areas included the lack of
'credit culture,' all of the reports generated are done for the benefit of the line
officers, not for the benefit of upper management. There appears to be a large
number of credits (up to $50 million each) to corporations with which the
people were not familiar."

"None of the top level people at Continental are credit people, all have come from
the funding or treasury side. There is no loan workout department at Continental;
the officers which originally made the loans are also expected to collect them."

"He indicated that the management information system at Continental is very poor.
Top management could not have been kept very well informed about what was going
on because the information system is all for the benefit of the line officers and it is
almost impossible to create useful management information reports."

"He indicated that there were 38 cases involving $ 6 million or more which the Cont.
attorneys indicated could be settled for about $175 million. He then indicated that
not included in the $175 million figure were: a $50 million dispute with the IRS; the
$60 million lawsuit regarding
, Inc.; and another $100-$ 150 million in lawsuits
with very questionable outcomes. He then stated that Continental had spent $19


million in 1983 to outside firms for litigation and the same in 1982. In comparison, —
only spent $10 million in 1983 for all legal services. Continental has set up a
reserve for litigation losses, but only $5 million in 1983 and only $8 million in 1984. attorneys expressed concern about other legal action which may be taken by

"had found two major problems: the quality of the assets and the funding
problem, which they indicated was going to get much worse during the next week or
two. They also felt that the total of non-performing loans was considerably in
excess of the $2.3 billion which Continental was reporting; probably the total was in
excess of $3 billion."

"As a result of the above, a 3une 24, 1984 meeting between
and the FDIC
closed with the comment that enthusiasm for the merger was dying at
each passing day."
The excerpts presented above indicate that the money center banks which were
interested in acquiring CINB found the situation significantly worse than they anticipated.
It is also noteworthy that the situation these banks found reflected CINB management
efforts and OCC supervisory efforts spanning almost twenty-four months since the Penn
Square Bank failure.


In 1976, CINB's capital position was rated "Inadequate" due to its absolute level and
its relation to classified assets. Some improvement by 1977 enabled Kovarik to write:
"Over the last three years, your earnings have allowed the bank's capital accounts to
be increased by $225 million through retained earnings and in 1976, $62 million was
added to the surplus account from the proceeds of a debt offering by CIC. Equity
capital at $1,049 million represents 5.1% of total resources compared to 4.6% at the
February 1976 examination. Loans to equity capital at 11.32:1 also shows improvement from 12.11:1 in February 1976. Although these improvements are viewed
positively, it must also be noted that your bank's capital ratios still remain below
the norm when compared to your peer group of banks."
(Analysis of Earnings and Capital, Report of Examination, August 1977, p. 13-1.)
CINB's subsequent growth led Deputy Comptroller Wood in 1979 to say:
"The growth in earnings has been achieved by virtue of increasing loan and asset
volume leverage. The interest margin has remained relatively level since 1977. The
ratio of equity capital/total assets has decreased significantly since 1976 in spite of
good retention of earnings. If the rate of growth continues to outpace internal
capital formation, external sources should be identified to support asset leverage."
(Examination report transmitai letter, from Billy Wood to Continental Board of
Directors, October 25, 1979, p. 2).
In 1980, in his analysis of CINB's capital position McCarte commented:
"During 1979, average equity capital equalled 3.89% of average total assets,
representing a 27 basis point decline from 1978fs position. Generally consistent with
its peer group, CIC's equity capital position has deteriorated each year since 1975,
with the greatest decline coming in 1979. The principal reason for the decrease can
be attributed to strong asset growth between March 31, 1979, and 1980 (21.3%), ...
Loan growth exceeded 26% during this period, which ranked first among the top nine
domestic bank holding companies (Continental's definitional peer group). Total
equity increased only 10.8%, ... Continued strong asset growth throughout the first
half of 1980 further perpetuated the decline in equity capital, which averages 3.65%
of average total assets, compared to 3.9*% for the first six months of 1979."
(Analysis of Earnings and Capital, Report of Examination, October 1980, p.27).
In the letter transmitting the 1980 examination report, Wood said:
"Capital is currently considered adequate. However, capital accumulation has not
kept pace with asset growth and the capital base is becoming strained. The
Directorate should be aware that capital adequacy for banks in general is a growing
concern of the Comptroller's Office. While neither the present level of capital nor
the current capital planning efforts are subject to criticism, management is


encouraged to continue seeking alternative sources of capital and to bring the
capital and asset growth rates into balance. "
(Transmittal Letter to Board of Directors, Report of Examination, October 1980,
Perhaps the most significant aspect of these comments is the degree to which
CINB's capital position was tolerated even though it was continually somewhat less than
fully satisfactory. Of additional interest are the references to CINB's "peers". So long as
CINB's capitalization was within the ranges of its peers, even though the capital of all the
peer banks was steadily declining, CINB's situation was somehow acceptable.
Despite a rise in 1981 in the ratio of classified assets to gross capital funds and a
continuation of the upward trend in CINB's dependence on purchased funds, the Deputy
Comptroller and the examiner's comments about capital remained mild and only urged the
CINB directors to give the Bank's capital their close attention.
"The rapid growth in assets has certainly contributed to earnings levels, but in terms
of a return on assets, a slight decline is noted. Continued increase in leverage
combined with the high level of classified assets cause increased pressures on
capital. In the context of capital adequacy, both balance sheet leverage and asset
quality are deserving of the Directorate's close attention."
(Transmittal Letter to the Board of Directors, Report of Examination, August 1981,
"It must be realized however, that leverage and risk ratios continue to increase thus
placing increased strain on the capital foundation of the institution. While it is
recognized and accepted that on a peer group comparison this bank is favorably
viewed in the marketplace, the evidence of increased risk is an internal view that
management must continually appraise. In light of the above, it is obvious that the
topic of capital adequacy is one that should continue to receive the high
prioritization currently being given by the Corporate Office."
(Letter to the Board of Directors, Report of Examination, August 1981, p. 2.)
For the examiners to continue to refrain from outright criticism of CINB's capital
position for so many years is difficult to understand. To continue to refrain in 1982, after
the revelations that took place that year, begins to undercut one's belief that the OCC
was truly concerned about bank capital adequacy.
Before reading the 1982 examiner's comment, it is instructive to compare
Continental's 1976 and 1982 capital and problem loan circumstances. Recall that in 1976,
Continental's ratio of classified loans to gross capital funds had reached 121% and its
ratio of total assets to total capital was 21%. Moreover, in the staff interview, examiner
Meade estimated that CINB was between 60% and 70% dependent on purchased funds. In
comparison, in 1982 the classified loan to gross capital ratio had risen to 172%, the degree
of asset to capital leveraging had risen to 25% , and dependence on purchased money was
up to 80%.
In 1976, CINB's capital was rated a clear and emphatic 'Inadequate".


In 1982, CINB's capital was commented upon as follows:
"As a result of the above factors, particularly the underlying strength of management and the recent trend of improving capital ratios, CICs capital base is
presently considered adequate. However, the inordinate level of classified assets
and the loss of confidence by the financial community lend definite reservations to
this assessment. Capital needs will continue to require close monitoring, with
returning the earnings stream to an adequate level imperative to resolve both the
loss of market confidence and as a basis for future growth." (SIC)
(Analytical Review of Earnings and Capital, Report of Examination, November 1982,
p. *1.)
This was the same examination in which the examiner said in his letter to the board
of directors, "The examination reveals the bank to be in serious difficulty," and the
Deputy Comptroller in his report transmittal letter said, "Examination results show the
condition of the institution to be seriously deteriorated."
Why and how the OCCfs capital standards have changed over the years merit close


Attachment I
1975 to 1983
(In millions of dollars)
Dates of Examinations
Substandard §/
Doubtful b/
Loss £.'
Total Classified
Assets if
Total Criticized
Assets 1!










































A Substandard classification is assigned to those assets inadequately protected by the current sound
worth and paying capacity of the obligor, or pledged collateral, if any.


A Doubtful classification is assigned to those assets that have all the weaknesses inherent in an asset
classified substandard and their collection or liquidation in full is highly questionable.


A Loss classification is assigned to those assets considered uncollectible and of such little value that
their continuance as an active asset of the bank is not warranted. Loss classification does not mean
that an asset has absolutely no recovery or salvage value.


Total Classified Assets is the sum of a, b, and c.


Other Assets Especially Mentioned are assets, not including those identified as substandard, doubtul, or
loss, that the regulator has some question about or is concerned about for any reason such as lack of
loan documentation, that if not corrected or checked may weaken the bank's credit position at some
future date.


Total Criticized Assets is the sum of d and e.


Attachment II
1975 to 1983
(In millions of dollars)

Dates of Examinations







Gross Capital
Funds (GCF) a/








Percent of
Classified Assets
to GCF









Percent of
Assets to GCF









Reserve for Possible
Losses (RPLL)









Percent of
RPLL to Total Loans


















Standby Letters
of Credit W



Gross Capital Funds represents total capital plus reserve for possible loan losses.


Standby Letters of Credit represent an obligation on the part of a bank, issuing such a document on
behalf of its customer, to a designated third party contingent upon the failure of the issuing bank's
customer to perform under the terms of the underlying contract with the third party.