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INQUIRY INTO CONTINENTAL ILLINOIS
CORP. AND CONTINENTAL ILLINOIS
NATIONAL BANK

HEARINGS
BEFORE THE

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
SUPERVISION, REGULATION AND INSURANCE
OF THE

COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIES
HOUSE OF EEPEESENTATIVES
NINETY-EIGHTH CONGRESS
SECOND SESSION
SEPTEMBER 18, 19 AND OCTOBER 4, 1984

Serial No. 98-111
Printed for the use of the Committee on Banking, Finance and Urban Affairs




INQUIRY INTO CONTINENTAL ILLINOIS
CORP. AND CONTINENTAL ILLINOIS
NATIONAL BANK

HEARINGS
BEFORE THE

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
SUPERVISION, REGULATION AND INSURANCE
OF THE

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

SEPTEMBER 18, 19 AND OCTOBER 4, 1984

Serial No. 98-111
Printed for the use of the Committee on Banking, Finance and Urban Affairs

U.S. GOVERNMENT PRINTING OFFICE
39-133 O




WASHINGTON : 1984

HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
FERNAND J. ST GERMAIN, Rhode Island, Chairman
CHALMERS P. WYLIE, Ohio
HENRY B. GONZALEZ, Texas
STEWART B. McKINNEY, Connecticut
JOSEPH G. MINISH, New Jersey
GEORGE HANSEN, Idaho
FRANK ANNUNZIO, Illinois
J I M LEACH, Iowa
PARREN J. MITCHELL, Maryland
RON PAUL, Texas
WALTER E. FAUNTROY, District of
ED BETHUNE, Arkansas
Columbia
NORMAN D. SHUMWAY, California
STEPHEN L. NEAL, North Carolina
STAN PARRIS, Virginia
JERRY M. PATTERSON, California
BILL McCOLLUM, Florida
CARROLL HUBBARD, J R . , Kentucky
GEORGE C. WORTLEY, New York
J O H N J. L A F A L C E , New York
MARGE ROUKEMA, New Jersey
NORMAN E. D'AMOURS, New Hampshire
BILL LOWERY, California
STAN LUNDINE, New York
DOUG S. BEREUTER, Nebraska
MARY ROSE OAKAR, Ohio
DAVID DREIER, California
BRUCE F. VENTO, Minnesota
J O H N HILER, Indiana
DOUG BARNARD, J R . , Georgia
THOMAS J. RIDGE, Pennsylvania
ROBERT GARCIA, New York
STEVE BARTLETT, Texas
MIKE LOWRY, Washington
JACK EDWARDS, Alabama
CHARLES E. SCHUMER, New York
BARNEY FRANK, Massachusetts
BILL PATMAN, Texas
WILLIAM J. COYNE, Pennsylvania
BUDDY ROEMER, Louisiana
RICHARD H. LEHMAN, California
BRUCE A. MORRISON, Connecticut
J I M COOPER, Tennessee
MARCY KAPTUR, Ohio
BEN ERDREICH, Alabama
SANDER M. LEVIN, Michigan
THOMAS R. CARPER, Delaware
ESTEBAN E. TORRES, California
GERALD D. KLECZKA, Wisconsin

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS SUPERVISION, REGULATION AND
INSURANCE
FERNAND J. ST GERMAIN, Rhode Island, Chairman
CHALMERS P. WYLIE, Ohio
FRANK ANNUNZIO, Illinois
GEORGE HANSEN, Idaho
CARROLL HUBBARD, J R . , Kentucky
JIM LEACH, Iowa
NORMAN E. D'AMOURS, New Hampshire
ED BETHUNE, Arkansas
DOUG BARNARD, J R . , Georgia
STEWART B. McKINNEY, Connecticut
J O H N J. L A F A L C E , New York
NORMAN D. SHUMWAY, California
MARY ROSE OAKAR, Ohio
BILL McCOLLUM, Florida
BRUCE F. VENTO, Minnesota
BILL LOWERY, California
ROBERT GARCIA, New York
GEORGE C. WORTLEY, New York
CHARLES E. SCHUMER, New York
BILL PATMAN, Texas
DAVID DREIER, California
STEPHEN L. NEAL, North Carolina
BARNEY FRANK, Massachusetts
RICHARD H. LEHMAN, California
J I M COOPER, Tennessee
BEN ERDREICH, Alabama
THOMAS R. CARPER, Delaware




RICHARD L. STILL, Subcommittee
ill)

Staff

Director

CONTENTS
Hearings held on:
September 18, 1984
September 19, 1984
October 4, 1984
The Financial Performance of Continental Illinois National Bank: "A Chronology and Peer Group Comparison," staff report dated September 17, 1984.

Page
1
169
395
7

TESTIMONY OF
TUESDAY, SEPTEMBER 18,

1984

Kenefick, Kathleen, former employee, Continental Illinois National Bank
Kovarik, Richard, senior national bank examiner, Office of the Comptroller of
the Currency
McCarte, Allan, former national bank examiner, Office of the Comptroller of
the Currency
Meade, John, senior national bank examiner, Office of the Comptroller of the
Currency
WEDNESDAY, SEPTEMBER 19,

107
108
106

1984

Conover, Hon. C.T., Comptroller of the Currency
THURSDAY, OCTOBER 4,

95

172
1984

Dugger, Robert H., Subcommittee Deputy Staff Director; accompanied by
Gary Bowser, senior auditor, General Accounting Office
Isaac, Hon. William M., Chairman, Federal Deposit Insurance Corporation

413
456

ADDITIONAL INFORMATION AND PREPARED STATEMENTS SUBMITTED FOR
INCLUSION IN THE RECORD

Continental Illinois Corp.'s proxy statement dated August 24, 1984
Annunzio, Hon. Frank, a Representative in Congress from the State of Illinois, news release containing copy of letter sent to FDIC Chairman Isaac
asking him to clarify FDIC policy in the future regarding guarantee insurance for losses suffered by depositors
"Central Bankers Have a Hot Line Too/' article from Fortune magazine of
October 1, 1984
Congressional Budget Office:
"Analysis of the Federal Budget Impact of Assistance to the Continental
Illinois National Bank and Trust Company," report dated October 3,
1984
Letter from Rudolph G. Penner, Director, dated October 3, 1984
Conover, Hon. C.T.:
Letter to FDIC Chairman William M. Isaac, dated May 17, 1984
Prepared statement with attached appendix
Press Release dated May 10, 1984, regarding Continental Illinois National
Bank
Response to questions of:
Chairman St Germain
310,
Hon. Carroll Hubbard, J r
Hon. B i l l P a t m a n
Hon. George C. Wortley
Hon. Chalmers P. Wylie




din

188

82
379

401
400
286
194
285
364
297
375
356
294

IV
Continental Illinois National Bank Failure and Its Potential Impact on Correspondent Banks," staff report dated October 4, 1984
"FDIC Reform in the Light of the Continental Illinois Experience: A Statement of Views, With Policy Recommendations," by Albert Gailord Hart,
professor emeritus of economics, Columbia University, dated September 8,
1984
General Accounting Office, statement by the Comptroller General of the
United States
Isaac, Hon. William M., prepared statement on behalf of the Federal Deposit
Insurance Corporation (FDIC)
Kenefick, Kathleen, memorandum dated July 1982 to J.R. Lytle, division
manager, midcontinent division of the oil and gas groups, Continental
Illinois National Bank
Kovarik, Richard, memorandum dated November 15, 1982 to William E.
Martin, Deputy Comptroller for Multinational Banking
Lane Banking Group, Chicago IL, letter with attached statement dated October 19, 1984, from William N. Lane III, chairman of the board
Leach, Hon. Jim, a Representative in Congress from the State of Iowa, opening statement
Letters of invitation requesting witnesses to appear at subcommittee hearings
held on:
September 18, 1984
September 19, 1984
"Minimum Capital Ratios; Issuance of Directives," excerpt from the Federal
Register of September 4, 1984, regarding Comptroller of the Currency's
proposed rule
Office of the Comptroller of the Currency (OCC), memorandum dated J u n e 3,
1984, on the subject of "Possible OCC Action Against 'Golden Parachutes'
at Continental Illinois"
St Germain, Chairman Fernand J.:
Memorandums submitted by Robert V. Shumway, Director of Bank Supervision, Federal Deposit Insurance Corporation, regarding Continental Illinois National Bank dated:
J u n e 6, 1984
J u n e 20, 1984
J u n e 22, 1984
Quotation from Fortune magazine of October 1, 1984
Shumway, Hon. Norman D., a Representative in Congress from the State of
California, opening statement
Vento, Hon. Bruce F., a Representative in Congress from the State of Minnesota:
Documents regarding FDIC CAMEL rating of Continental Illinois National Bank
Letters from the Deputy Comptroller for Multinational Banks pertaining
to OCC examination reports transmitted to the Continental Illinois
Bank board of directors with attached replies dated from 1979 to 1982 ...
Wortley, Hon. George C , a Representative in Congress from the State of New
York, transmittal letters from the Deputy Comptroller for multinational
banks pertaining to OCC examination reports to the Continental Illinois
Bank board of directors dated 1977 and 1982
Wylie, Hon. Chalmers P., a Representative in Congress from the State of Ohio
and ranking minority member of the subcommittee:
Correspondence and FDIC Chairman Isaac's response to the committee
staff study "Continental Illinois National Bank Failure and Its Potential Impact on Correspondent Banks"
"Federal Deposit Insurance Corporation Assistance to an Insured Bank
on the Ground t h a t the Bank is Essential in its Community," study by
the Congressional Research Service dated October 1, 1984
"Internal Controls" excerpt from the Comptroller of the Currency's
report of December 6, 1982
Memoranda regarding the Unity Bank and Trust Co. case, Farmers Bank
of the State of Delaware and others dated May 17 and July 25, 1984,
with attached material providing a history of essentiality of a bank in
the community
Opening statements:
September 18, 1984
October 4, 1984




Page
418

606
625
457
100
105
618
85
168
392
383
177

598
599
600
376
91

330
313

356

592
492
165

522
76
411

INQUIRY INTO CONTINENTAL ILLINOIS CORP.
AND CONTINENTAL ILLINOIS NATIONAL BANK
TUESDAY, SEPTEMBER 18, 1984
HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON F I N A N CIAL INSTITUTIONS SUPERVISION, REGULATION AND INSURANCE, COMMITTEE ON BANKING, FINANCE AND
URBAN AFFAIRS,

Washington, DC.
The subcommittee met, pursuant to call, at 10:08 a.m., in room
2128, Rayburn House Office Building, Hon. Fernand J. St Germain
(chairman of the subcommittee) presiding.
Present: Representatives St Germain, Annunzio, Hubbard, Barnard, Oakar, Vento, Schumer, Patman, Carper, Wylie, Leach,
McKinney, Shumway, McCollum, Wortley, and Dreier.
Also present: Representatives Mike Lowry and Thomas J. Ridge
of the full committee.
Chairman S T GERMAIN. The subcommittee will come to order.
This morning we open hearings into the problems of Continental
Illinois National Bank, an institution t h a t failed to survive without
massive, record breaking, infusions of Federal moneys and credit.
Deja vu.
For a decade and a half, this subcommittee, and the full committee, have probed bank and regulatory failures—U.S. National Bank
in San Diego, the Texas Rent-a-Bank scandals, the Bert Lance playpen at Calhoun National Bank in Georgia, the Penn Square circus
in Oklahoma City. We've monitored and gathered facts about
dozens of lesser cases in all sections of the Nation.
In 1977 and 1978, we battled uphill against the combined bank
and regulatory lobby to enact an entire set of new and improved
supervisory powers—to make certain t h a t no one in the Federal supervisory bureaucracy could claim they lacked the tools.
Yet, today, we return to this forum faced with what is, for all
practical purposes, the granddaddy of bank failures, a $44 billion
money center bank t h a t rolled into the ditch uncontrolled by its
$500,000-a-year chairman and the rest of the megabucks management team—or the Federal bank supervisory system.
Minus the excitement and the "anything your heart desires" approach to Federal assistance, 56 commercial banks have slipped
quietly down the tubes this year—a failure pace rivaled only in the
dark days of the Depression. In 1983, the bank tombstones numbered 48, and in 1982, 42. Hardly ringing testimony to the strength
of the economy or the supervisory agencies.




(1)

2

No one on this committee is foolish enough to suggest that all
bank failures could or should be prevented. But it is not unreasonable to expect the regulators to identify the problems early on and,
most important, to force remedial steps with vigor and without the
long period of handwringing agonizing that allow the problems to
fester and become more expensive. When the remedial action isn't
forthcoming and when the problems are terminal, it is incumbent
on the regulators to concede the fact in a timely fashion and not
allow the gap between knowledge and action to dupe and ensnare
the public—as we saw so clearly in our Penn Square investigation.
The timidity factor in our Federal regulatory system is expensive
for the investing public and the Federal Treasury. And it breeds
contempt for a regulatory system that consults when it should condemn.
In the case of Continental, money managers and the foreign investors—about whom we have heard so much—obviously were
knowledgeable and spotted problems at the bank. When the regulators failed to force meaningful change, when there was no public
announcement or hint of vigorous action to assure the bank's improvement, the investors moved their money. A group clearly more
devoted to definitive timely action than our Federal regulators.
In the world of the regulators, secrecy cures all. In my opinion,
regulatory secrecy dupes the innocent, the unsophisticted, and
doesn't fool, for long, the wise men of international finance.
For those of us who have ridden the failed bank circuit, the deja
vu qualities of Continental are discouraging. It appears that the
only thing the regulators have improved is their ability to make
excuses.
The list of excuses will be long and varied. Some will tell us the
economy did it. I was as concerned as anyone about the recession
but it is far too simplistic to let the economic downturn be used to
paper over the deficiencies at Continental. We must have a banking system and a regulatory system for all seasons—for good times
and bad times.
Some will tell us that all would have been well—or at least undetected—had the Arabs just kept the price of oil going upward.
True, the best bets about oil and gas supplies and prices missed the
mark in the early 1980's. But prudent bankers hedge their bets and
diversify the portfolios so that even if the most expert of the experts is wrong, the bank is protected. The proof of this is the fact
that most banks, including those heavily committed institutions in
the Southwest, did survive the downturns in their oil and gas portfolios without the kind of massive help required by Continental.
And if the problems of Continental were simply an unexpected
downturn in prices of an otherwise solid oil and gas portfolio, one
must again wonder the regulator. Regulators, like prudent bankers,
presumably do watch the concentration of assets in a single industry and are in a position to demand the type of diversification that
would enable the bank to ride out unforeseen storms.
The Office of the Comptroller of the Currency is skilled in is
post-failure public relations. Officials of the agency have circulated
among the Washington press corps, offering explanations and an
occasional plea of mea culpa on some of the issues, reminiscent of
the high school student who brings home the failing marks and




3
quickly concedes he was tardy a few times in hopes t h a t his angry
parents will be diverted from asking about all those days he played
hookey.
Before these hearings are completed, I am grateful t h a t we will
have been able to sift through these excuses, rationalizations, and
wishful thinking. Some of the issues are, indeed, complex and some
of the decisions, I will concede, are easier to second-guess t h a n to
make firsthand on the firing line.
We have an enormous amount of testimony scheduled to be presented to this committee, in coming weeks, but one central theme
already stands out in the research.
In the late 1970's, the management of the bank made a conscious
decision to become more aggressive and to move Continental up in
the competition for the top rungs among money center banks. It
was a big change for an institution t h a t had a track record of moderate, if not conservative, banking. Little thought apparently went
into the consideration of strengthening the bank's internal controls
commensurate with the increased loan activity.
With the bank's growth shooting up past its peer groups among
national banks, it is presumed t h a t the alarm bells—if the system
were working—would have sounded within the walls of OCC. It
was time to move in, to demand a tough internal system of review,
and to make certain t h a t management at all levels could qualify
for jet-age banking.
It is true t h a t the examiners on the scene did spot troubles in the
internal review process in the late 1970's and early 1980's. But, it is
not apparent t h a t OCC ever really did anything about the information—anything t h a t might have forced the changes t h a t might
have negated the need for these hearings today.
In August 1981, the examiner reported the startling information
t h a t the internal review process was so badly in disarray t h a t billions in loans had never even reached the review stage within the
bank—finding $2.4 billion untouched 1 year, $1.6 billion in another
year.
"* * * It is evident that no one is monitoring this situation to ensure that all
credits are receiving timely review . . . " the examiner stated in his 1981 Examination Report.

Clearly, a dangerous situation in a bank now headed pell mell at
top speed in the big time arenas of banking.
Strangely, this same examiner—after finding this mass of loan
paper lying around unchecked—wrote the Continental board of directors this nicely perfumed note:
We found it (the internal system) to be functioning well and accurately reporting
the more severely rated advances to the Board and senior management.

What kind of timid, tip toe through the tulips signal was this
supposed to convey to the board of directors?
A little more t h a n a year later, another examiner at Continental
began to have second thoughts about the OCC's timidity.
Noting the aggressive growth policy of the bank and the lack of
increased attention to controls, Richard Kovarik wrote in the 1982
examination report:




4
The loan review function at CINB has been the recipient of criticism from the
OCC for at least three years. However as it was functioning fairly well, that criticism was not as strong as it now appears it should have been.

When we start passing out awards in the Continental case, I
want to nominate Mr. Kovarik for the prize for understatement.
Yes, Mr. Kovarik, you are right—it does indeed appear that OCC
wasn't as strong as it might have been * * * much to the sorrow of
this committee, the banking industry, and the American taxpayer.
As we proceed in these hearings it is essential that we keep in
mind the critical importance of the internal review process in
money center banks. The size of these institutions make it impossible for examiners to walk through all the loan documents—as
might be possible in a smaller institution—and thus much of the
regulatory process hinges on the integrity of internal audits,
review and control processes. When internal review is faulty, the
burden on the examiners increases dramatically.
In the case of Continental, the internal control machinery—the
process by which the bank double checked its quality standards on
loans—was manned frequently by inexperienced personnel or
worse, by people who had made the loans in the first place. In
either case, it was unworkable. It is not reasonable to expect a loan
officer who has made the judgment to grant the loan to then turn
around and conduct a harsh review and give himself or herself a
bad mark. That just isn't human nature, and it isn't sound judgment on the part of bank management to allow the review process
to be compromised in this fashion.
Overall, this case presents an unfortunate combination of aggressive, decentralized management and timid regulatory approaches.
There is no more volatile mixture in banking than aggressive management and timid regulation.
When we have pursued these banking failures in the past, we
have put a heavy emphasis on the safety and soundness of banks,
the efficacy of the regulatory process, and the need to maintain
banking services in local communities.
With Continental, we add a new ingredient—the safety and
soundness of the U.S. Treasury. For it is the Federal Government,
the American taxpayer and bank customers across the land who
will bear much of the burden for the mistakes at Continental.
The bailout—the nationalization, assistance package, whatever
name fits one's philosophical viewpoint—is enormous by any standard. Combining assistance from FDIC with the high point of the
Federal Reserve's discount window operations and the package of
loans from other banks, the bailout probably tops $15 billion.
FDIC's direct assistance includes the purchase of $4.5 billion of
the bank's bad loans and a $1 billion infusion of new capital. In
late August, the Federal Reserve's discount window had slipped
$7.2 billion into the bank and the commercial banks, at the suggestion of the regulators, had moved more than $4 billion to Chicago.
In contrast, the entire package of loans to Lockheed, Chrysler
and New York City voted by this committee did not exceed $6 billion combined.
More to the point, these instances of corporate assistance were
possible only after extended debate, investigations and majority approval of both Houses of Congress, and the President of the United




5
States. Before the Lockheed-Chrysler-New York City packages were
approved these recipients had to appear before the Banking Committees of both the House and Senate, to agree to stiff conditions
and to subject themselves to ongoing reviews by specially established oversight oversight boards within the Federal Government.
In contrast, the bailout of Continental was put together behind
closed doors by the three regulators. No public debate. No prior approval by the Congress and the President. Just an announcement
of a fait accompli by the regulators. Not even the President of the
United States, in the most dire of emergencies, can commit moneys
in this magnitude without prior approval and knowledge.
Clearly, this kind of unchecked power—and the ability to commit
the moneys and credit of the U.S. Government—cries out for the
most thorough of reviews. We will explore every aspect of the statutes which the regulators claim gave them the authority to proceed
with the Continental bailout. If, indeed, the authority is clear—as
the regulators steadfastly contend—then we have a responsibility
to review whether or not this power should remain in its unbridled
form.
Obscured in the smokescreen about insurance premiums, funny
money at the Federal Reserve and other suggestions that all this
assistance is accomplished by mirrors, the hard cold fact is that it
will have a substantial impact on the Federal budget deficit.
I have asked the Congressional Budget Office to review the transactions. CBO's final draft is not in hand, but I am sure it will be
their approach to give us a range of possible impacts based on various economic conditions and interest rate projections. Using rosecolored glasses, it might be argued that the budget impact could
dip to the vicinity of a half billion dollars. Removing those rosy
hues, it appears a more realistic range would place the estimate between $2 and $3 billion with some worst case scenarios reaching
well beyond.
And the estimates may well be only the tip of the iceberg if the
FDIC and the Federal Reserve have created—without congressional
approval—a brandnew entitlement program for money center
banks. If Continental is a precedent, the big bank fail safe security
program may, someday, rival defense outlays.
For the banking industry, the bailout presents some significant
policy questions. If the bailout program is to proceed on the basis
on bank size, there may be a substantial impact on the small and
medium size institutions across the Nation t h a t have not enjoyed
the automatic bailout features incorporated in the Continental
case. The fail-safe banks—with the Continental style 100 percent
plus insurance of everything—will clearly have a big let up in the
market in the competition for funds and investors.
Continental presents the greatest multitude of banking question
ever to come before this committee. They are of critical importance
to the Nation and are at the heart of this Committee's assigned jurisdiction and responsibility. I feel strongly t h a t we must explore
every aspect of this case. I deeply appreciate the support that this
inquiry has received from the members of this committee on both
sides of the aisle. I also want to commend the staff of both the majority and minority who have worked so well together in a tireless
effort to compile the data for the Members. These issues which




6

clearly transcend party and philosophical lines and judging from
my conversations with Members, I know there is a determined
effort to probe the Continental case with vigor and thoroughness.
[The staff reports and charts follow:]




7
THE FINANCIAL PERFORMANCE OF
CONTINENTAL ILLINOIS NATIONAL BANK;
A CHRONOLOGY AND PEER GROUP COMPARISON

September 17, 1984
STAFF REPORT
TO
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS SUPERVISION, REGULATION AND INSURANCE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS

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




8
EXECUTIVE SUMMARY
This report presents information on the financial history of Continental Illinois
National Bank and Trust Company of Chicago, discusses significant events which affected
the Bank, and compares the performance of the Bank over time to other multinational
banks and other Chicago regional banks. The report is divided into three sections. In the
first section, we present (1) a chart which provides information on the increasing number
of problem and failed banks, (2) a series of charts which highlight ratios related to
Continental's performance in comparison with its peers, and (3) the consolidated statements of income and financial position of Continental for the period from 1970 through
the first quarter of 1984. The second section presents a comparative financial analysis of
the Bank in relation to its peers. The third section discusses the economic environment
surrounding the Bank; changes in the Bank's organization and management; and the Bank's
financial performance throughout the period from 1970 to date. The section also discusses
significant events which contributed to the Bank's failure and subsequent rescue.
Continental Illinois Corporation, which commenced operations on April 1, 1969, is
dependent primarily upon the financial condition of Continental Bank, accounting for
approximately 95 percent of the holding company's consolidated assets. Through a
network of subsidiaries, branches, and representative offices, the Bank provides a broad
range of banking and related business services worldwide. At its peak in 1981 the Bank was
sixth among other multinational banks and the largest domestic commercial and industrial
lender, employing more than 12,000 employees.
The financial condition of the Corporation through 1981 was achieved primarily as a
result of annual growth in assets and loans significantly in excess of its peers. However,
by year-end 1982, the Corporation's ability to function as a viable entity was in extreme
jeopardy. During 1982 and 1983, the Bank's financial condition deteriorated severly. The
Bank's allowance for loan losses, net charge-offs, and nonperforming loans increased
dramatically. Among the factors that lead to this situation were the failure of Penn
Square Bank, the bankruptcy or depressed condition of Continental's once blue-chip
customers, and Continental's dependency on short-term rate-sensitive funds.
Significant asset quality problems in the Bank's oil and gas lending department were
highlighted by the Penn Square failure in July 1982. At year-end 1982, the provision for
loan losses amounted to $492 million, which included a $220 million provision related to
Penn Square. But, problems were not limited to just oil and gas lending alone. During
1983 and 1984, the Bank experienced significant credit quality and documentation
deficiencies in all aspects of its loan operations. As a result, more and more loans were
labeled as nonperforming. By June 30, 1984, nonperforming loans amounted to $2.7 billion.
After Penn Square failed, Continental's large uninsured depositors
became
increasingly concerned about the Bank's inordinately large amount of poor quality loans
and its viability in general. By early 1984, cash flow problems had become critical. In
May 1984, rumors of a possible failure or takeover circulated in the foreign money
markets upon which the Bank had become so dependent. Soon after, major providers of
overnight and term funds abandoned the Bank. Continental turned first to borrowing from
the Federal Reserve and then from a consortium of other large banks, but it was unable
to achieve stability. Consequently, on May 17, 1984, the Federal Deposit Insurance
Corporation arranged an interim emergency assistance program and guaranteed all
depositors of the Bank.




9
SECTION 1

Statistical Data on Problem and Failed Banks

Continental's Performance Ratios
in Comparison to its Peers

Continental's Consolidated Statements
of Income and Financial Position
for the Period 1970 Through
the First Quarter of 1984




10
SCHEDULE OF PROBLEM AND FAILED BANKS AND INSURED DEPOSITS
FROM 1974 TO 1984
Failed Banks
Number
Insured
Insured
Deposits
(millions)

Year

Number of
Problem Banks

1974

183

4

$1,575.8

1975

349

13

339.6

1976

379

16

864.9

1977

368

6

205.2

1978

342

7

854.2

1979

287

10

110.7

1980

217

10

216.3

1981

223

10

3,826.0

1982

369

42

9,904.5

1983

642

48

5,541.4

1984

745 a/

55 a/

§./ Information as of September, 1984
hf Not available at time of printing




b/

11
Performance Measures for Continental Illinois Corporation
As Compared to Other Multinational Banks From 1976 to 1983 i /
1976

1977

1978

1979

1980

1981

1982

1983

14.00
10.65

14.14
10.94

13.69
12.33

14.37
13.68

14.82
13.54

14.88
12.75

4.56
11.53

5.95
11.15

.58
.46

.55
.45

.54
.50

.55
.52

.54
.52

.54
.51

.18
.49

.26
.52

.62
.11

.45
.56

.32
.46

.29
.38

.28
.46

.29
.41

1.28
.55

1.37
.64

1.27
1.04

1.13
.99

1.01
1.00

.91
1.03

.90
1.01

.89
1.03

1.15
1.08

1.24
1.21

3.1
3.0

2.2
2.2

1.4
1.5

1.3
1.2

1.1
1.0

1.4
1.3

4.6
2.1

4.5
2.3

4.88
4.90

4.54
4.69

4.51
4.57

4.36
4.39

4.17
4.45

4.22
4.63

4.81
4.86

5.17
5.39

4.88
5.67

4.54
5.34

4.51
5.17

4.36
4.98

4.17
4.93

4.22
5.04

5.27
5.70

5.64
6.26

7.13
1.11

6.90
7.43

6.70
7.11

6.05
6.80

5.11
6.88

5.40
6.76

5.26
6.98

6.03
7.62

Profitability/Earnings
Return on Equity
Continental
Peer Group
Return on Assets
Continental
Peer Group
Asset Quality
Net Charge-offs to
Total Loans
Continental
Peer Group
Allowance for Possible
Loan Losses to Total
Loans
Continental
Peer Group
Non Performing Assets
to Total Assets
Continental
Peers
Capital Adequacy
Equity Capital
to Total Assets
Continental
Peer Group
Equity Capital +
Subordinated Notes and
Debentures to Total
Assets
Continental
Peer Group
Equity Capital
to Total Loans
Continental
Peer Group




12
Performance Measures for Continental Illinois Corporation
As Compared to Other Multinational Banks From 1976 to 1983 i '
1976

1977

1978

1979

1980

1981

1982

1983

58.35
56.19

56.88
56.27

58.93
57.00

62.92
56.74

62.77
57.15

67.40
60.34

75.79
61.53

71.72
62.25

-37.88
-16.75

-38.18
-17.75

-37.09
-21.48

-45.70
-22.30

-46.32
-25.07

-51.85
-31.55

-58.16
-31.51

-52.61
-30.88

N/A
N/A

14.44
14.83

24.73
15.83

23.03
15.36

17.32
12.78

19.84
14.59

2.70
9.26

-7.15
5.99

N/A
N/A

17.41
14.75

20.38
14.19

15.23
16.09

17.60
11.85

11.60
8.48

-8.67
7.56

-1.87
4.59

N/A
N/A

11.80
15.63

17.25
27.16

16.68
24.77

15.39
14.92

12.69
9.73

-69.41
4.19

39.07
10.79

Liquidity
Total Loans to
Total Assets
Continental
Peer Group
Liquid Assets Volatile Liabilities
to Total Assets
Continental
Peer Group
Growth
Growth in Loans
Continental
Peer Group
Growth in Assets
Continental
Peer Group
Growth in Earnings
Continental
Peer Group

U

More complete information on the composition of the ratios is contained in Section 2.




13
CONSOLIDATED STATEMENT OF INCOME
Continental Illinois Corporation and Subsidiaries
Year ended 12/31 ($ in thousands)
Interest Jc fees on loans
Lease financing income
Interest on deposits with banks
lnt.& dividends on investment
securities:
Taxable income
Income exempt from Fed.inc taxes
Trading account interest
Int.on Fed.funds sold 6c securities purchased under agreemts to resell
Total interest income
Interest on deposits
Int.on Fed.funds purch'd Jc secur.
sold under agreemts to repurchase
Interest on other borrowings
Interest on long-term debt
Total interest expense
Net interest income
Provision for credit losses
Net interest income after provision
for credit losses
Trust income
Secur. trading profits <c commissions
S
Foreign exchange profits (losses)
All other income
Total other operating income
Net int^Jc other operating income
Salaries and wages
Pension, profit sharing, other
employee benefits
Net occupancy expense
Eqpt rental$,deprec.& maintenance
Other expense
Total other operating expense
Income before inc.taxes & securities
gains or losses
Applicable income taxes (credits)
Incbefore security gains or losses
Secur.gains or (losses) less
applicable income taxes
1
Extraordinary item, net of tax
Net income
Per common share:
Income before extraordinary item
Extraordinary item
Net income
Cash dividends declared
Average common shares outstanding
(in thousands)

1983

1982

1981

1980

303,734
20,979

3,453,274
95,907
214,107

4,683,350
125,073
499,437

4,796,322
90,327
747,149

3,448,973
65,338
658,355

25,323
10,702
9,859

105,316
49,759
29,182

129,565
59,667
34,308

148,910
64,194
34,032

133,215
70,951
29,307

90,149
960.746

29,499
3.977.044

47,876
5.579.276

83,281
5,964,215

65,374
_4_t 472^513

572,309

2,191,239

3,100,409

3,316,677

2,397,443

124,932
79,046
35.219
811.506

512,868
301,163
141.632
3.146.902

1,056,749
400,266
131.252
4.688.676

1,405,311
354,953
30,993
5.158.434

1,048,795
230,884
65,097
J3,742^219

149,240
140.000

830,142
395.000

890,600
492.000

805,781
120,000

730,294
96,000

9.240
15,857
5,318
7,224
72.483
100.S82
110.122

435.142
62,369
19,648
10,587
309.525
402.129
837.271

398.600
60,428
39,882
(1,428)
221.882
320.764
719.364

685.781
53,600
27,888
31,155
209,764
322.407
1,008.188

634,294
44,309
6,122
32,284
160,422
243.637
877,931

80,702

309,639

293,575

265,614

227,758

21,250
20,134
12,475
S3.357
217.918

74,750
87,410
44,918
204.462
721.179

61,071
72,726
41,095
204.727
673.194

74,877
65,747
36,857
180,759
623.854

61,473
53,314
36,801
173,874
558.220

(107,796)
(107,796)

116,092
16,174
99,918

46,170
(38,206)
84,376

384,334
124,019
260,315

319,711
95,568
224,143

575
136,628
29.407

1,245
7,156
108.319

(6,489)

1984(3/31)

—

$
$
$
$

2.46
0.17
2.63
2.00
40,045

(5,692)

—
77.887
$

$

$
$

—
254,623

1.95

$

6.4*

1.95
2.00

$

6.<*4

39,777

$

—

1.90
39,537

Gain on sale of charge card operations.
Oue to the availability of information, certain line items have been rounded or
reasonably approximated. Also, inadequate information has prevented certain
tine items from being stated individually. In some cases, totals were used to
maintain consistency for comparative purposes.

-133

0—84

2




1,798

—

... 225,941
$
$
«
•

5.75

-5.75
1.70
39,256

14
CONSOLIDATED STATEMENT OF INCOME
Continental Illinois Corporation and Subsidiaries
Year ended 12/31 ($ in thousands)

1979

Interest <c fees on loans
J
Lease financing income
Interest on deposits with banks
Int.«5c dividends on investment
securities:
Taxable income
Income exempt from Fed.inc.taxes
Trading account interest
Int.on Fed.f unds sold & securities purchased under agreemts to resell
Total interest income

2,437,870
39,190
455,931

1,022,987
29,772
224,991

918,572
24,918
217,617

1,017,596
22,050
152,619

75,955
77,568
19,510

67,970
75,789
12,265

71,628
70,903
11,060

69,116
63,607
10,326

77,397
46,107
13,169

62,103
3,168,127

2,034,208

12,000
1,443,341

1.312,156

1,739,743

1,049,519

696,809

661,192

668,449

806,611
47,920
2,594,274

444,161
33,665
1,527,345

253,530
27,398
23,712
1,001,449

182,784
23,603
12,089
879,668

189,919
14,077
28,309

900,,754

573,853
70,000

506,863
62,500

441,892
53,500

432,488
75,000

435,,184
75,,000

503,853
37,434
15,730
12,583
141,983
207,730
711,583

444,363
34,521
11,255
15,267
105,713
166,756
611,119

388,392
34,082 '
10,954
15,005
79,395
139,436
527,828

357,488
33,618
17,299
7,152
66,953
125,022
482,510

360,,184
31.,845
,282

199,501

166,358

145,600

131,937

119,386

51,187
41,401
27,549
144,894
464,532

44,456
33,838
20,889
118,401
383,942

37,180
30,228
18,658
91,231
322,897

32,048
25,509
18,888
85,898
294,280

29,606
25,640
15,347
80,346
270,325

247,051
52,925
194,126

Interest on deposits
Int.on Fed.funds purch'd & secur.
sold under agreemts to repurchase
Interest on other borrowings
Interest on long-term debt
Total interest expense

1,496,957
34,294
307,933

227,177
58,453
168,724

188,230
57,468
130,762

195,161
76,164
118,997

Net interest income
Provision for credit losses
Net interest income after provision
for credit losses
Trust income
Secur.trading profits <c commissions
J
Foreign exchange profits (losses)
All other income
Total other operating income
Net int.& other operating income
Salaries and wages
Pension, profit sharing, other
employee benefits
Net occupancy expense
Eqpt rentals,deprec.& maintenance
Other expense
Total other operating expense
Income before inc.taxes <c securities
J
gains or losses
Applicable income taxes (credits)
Inc.before security gains or losses
Secur.gains or (losses) less
applicable income taxes
Extraordinary item, net of tax
Net income
Per common share:
Income before extraordinary item
Extraordinary item
Net income
Cash dividends declared
Average common shares outstanding
(in thousands)

1,681

;

;

204,931
60,727
144,204

(907)

--

(1,081)

--

195,807

7,000

(2,958)

--

167,817

39,195

4.49
1.32
37,336

$
$

$
$

112,890

$

4.02
1.26
35,537

3.63
1.18
35,130

Due to the availability of information, certain line items have been rounded or
reasonably approximated. Also, inadequate information has prevented certain
line items from being stated individually. In some cases, totals were used to
maintain consistency for comparative purposes.




--

127,804

4.02

$
$

(6,107)

--

143,123

$
$
5

56 r175
105,r302
,486

465

$
$

6.49
2.23

15
CONSOLIDATED STATEMENT OF INCOME
Continental Illinois Corporation and Subsidiaries
Year ended 12/31 ($ in thousands)
Interest Jc fees on loans
Lease financing income
Interest on deposits with banks
Int.ic dividends on investment
securities:
Taxable income
Income exempt from Fed.inc.taxes
Trading account interest
Int.on Fed.funds sold & securities purchased under agreemts to resell
Total interest income
Interest on deposits
Int.on Fed.funds purch'd & secur.
sold under agreemts to repurchase
Interest on other borrowings
Interest on long-term debt
Total interest expense

1,2*9,113
19,000
207,811

716,490
8,000
133,548

356,674
5,000
53,738

318,388
3,000
11,621

373,238

73,816
44,438
25,076

50,515
48,826
14,546

45,295
43,845
6,983

63,059
39,805
10,733

41,837
34,385
34,236

2,395

9,000

16,000
1,635,254

486,091
198,962

538,834
355,517
57,431
9,135
1,337, ,406

189,064
32,461
6,652
767,011

43,019
16,514
6,357
308, ,942

37,305
9,782

99,047

256,026

298.009

297, ,848
32 ,900

219,914
15,300

2 1 1 ,, 5 9 3
12 , 3 5 3

194,580
15,262

188,082
14,221

Trust income
Secur.trading profits <c commissions
5

264, ,948
31 , 4 6 5
13 ,246

31,404
9,381

199, ,240
29,' 7 7 3
2,,303

179,318
27,824
4,299

173.861
22,732

Foreign exchange profits (losses)
All other income
Total other operating income
Net int.& other operating income

64 ,000
108,,711
373 1.65?.

304,399

33 ,000
6 5 . ,076
264, ,316

26,000
58,123
237,441

17,563
40,295
214.156

105,924

89,618

77,57k

66,766

24,099
21,009
10,749
61,484
223.265

20,401
17,679
8,652
48,125
184,475

17,669
15,940
6,886
38,823
156.892

15,936
13,276
6,491
35,681
138.150

120.417

150,394
54,488
95,906

119,924
33,619
86,305

107,424
29,294
78,130

99,291
29,493
69,798

93,739
29,394
64,345

Net interest income
Provision for credit losses
Net interest income alter provision
for credit losses

S a l a r i e s and w a g e s
Pension, profit s h a r i n g , o t h e r
employee benefits
Net occupancy expense
Eqpt rentals,deprec.<5c m a i n t e n a n c e
Other expense
Total other operating e x p e n s e

74,861

I n c o m e b e f o r e i n c . t a x e s <c s e c u r i t i e s
5
gains or losses
Applicable income taxes (credits)
I n c b e f o r e s e c u r i t y g a i n s or losses
S e c u r . g a i n s or (losses) less
applicable income taxes
E x t r a o r d i n a r y i t e m , n e t of t a x
Net income
Per c o m m o n s h a r e :
Income before extraordinary item
Extraordinary item

—

Cash dividends declared

$

5.51

$

Average common shares outstanding
(in thousands)

(835)

(226)

-5.51
1.10

265

--

85.470

95.680

$
$
$

4.94

--9 4
4.
.97

_

576

—

70,374

$

4.55

$
$

4.55
.92

—

(6,815)

--

78.395

$
$
$

4.11

—1
4.1
.88

34,264

Due to the availability of information, certain line items have been rounded or
reasonably approximated. Also, inadequate information has prevented certain
line items from being stated individually. In some cases, totals were used to
maintain consistency for comparative purposes.




45,556

—

57,530

$
$
$

3.38

—8
3.3
.82

16
CONSOLIDATED STATEMENT OF CONDITION
Contine ntal Illinois C o r p o r a t i o n and Subsid iaries
1984

D e c e m b e r 31 ($ in thousands)

1983

1982

2,039,281
3,415,990

2,569,866
3,586,524

2,199,386
1,880,853

2,513,080
5,082,703

4,361,504
4,294,045

646,739
761,664
1,814,334

Assets
Cash and due from banks
I n t e r e s t - b e a r i n g deposits
Fed.funds sold and s e c u r i t i e s
purch'd under a g r m t s to resell
Trading a c c o u n t a s s e t s
Investment securities

676,774
561,589
1,762,394

444,224
853,460
2,064,744

499,817
169,164
2,169,303

417,207
128,065
2,505,924

1981

1980

Loans:
Domestic
Foreign
L e a s e financing r e c e i v a b l e s
T o t a l loans and lease
receivables

29,329,847
1,045,485

20,187,123
10,203,246
1,038,400

22,053,107
10,817,214
1,172,478

22,131,015
10,044,482
1,123,729

18,528,132
8,381,566
720,003

30,375,332

31,428,769

34,042,799

33,299,226

27,629,701

L e s s : Unearned income
R e s e r v e for c r e d i t losses
N e t loans and l e a s e receivables

267,333
401,384
29,706,615

269,720
382,565
30,776,484

322,551
381,083
33,339,165

423,000
289,169
32,587,057

262,663
246,113
27,120,625

325,599

337,045

342,241

298,715

276,479

870,015
1,870,572
41,450,809

859,318
967,377
42,097,371

690,442
1,084,909
42,899,424

2,469,917
1,181,999
46,971,755

1,898,071
1,087,488
42,089,408

10,146,083
18,132,704
28,278,787

13,527,978
15,903,490
29,431,468

12,690,041
15,484,980
28,175,021

14,963,103
14,630,902
29,594,005

13,579,324
13,734,343
27,313,667

5,192,723
2,801,843
870,015
1,231,387
1,247,881
39,622,636

4,830,645
2,677,047
870,106
1,210,578
1,255,953
40,275,797

5,920,332
4,028,928
692,788
1,100,169
1,272,291
41,189,529

7,998,482
3,014,740
2,477,137
1,314,402
862,297
45,261,063

7,361,000
2,203,947
1,898,816
1,110,719
676,317
40,564,466

89,400
200,780
526,904
1,021,457

89,400
200,780
526,895
1,014,539

199,761
525,525
989,244

198,009
522,812
989,871

(10,256)
1,828,285
112
1,828,173

(9,975)
1,821,639
65
1,821,574

P r o p e r t i e s and e q u i p m e n t
C u s t o m e r s ' liability on
acceptances
Other assets
Total assets
Liabilities
Deposits:
D o m e s t i c offices
Foreign offices
Total deposits
Fed.funds purch'd & s e c u r i t i e s
sold under a g r e e m t s to r e p u r c h a s e
O t h e r borrowings
Acceptances outstanding
O t h e r liabilities
L o n g - t e r m debt
Total liabilities
Stockholders' Equity
P r e f e r r e d stock
C o m m o n stock
C a p i t a l surplus
R e t a i n e d earnings
Accumulated translation
adjustment
Total
Less - T r e a s u r y stock a t cost
Total Stockholders' Equity
Total Liabilities &
Stockholders' Equity

'

J H , 450,, 809

42,097,371

(4,433)
1,710,097
202
1,709,895

42,899,424

--

1 , 7 1 0 ,-- 2
69

--1,524,942

46,971,755

42,089,408

1,710,692

As of March 31, 1984.

Due to the availability of information, certain line items have been rounded or
reasonably approximated. Also, inadequate information has prevented certain
line items from being stated individually. In some cases, totals were used to
maintain consistency for comparative purposes.




--

196,690
517,824
810,428

1,524,942

17
CONSOLIDATED STATEMENT OF CONDITION
Continental Illinois Corporation and Subsidiaries
December 31 ($ in thousands)
Assets

Cash and due from banks
Interest-bearing deposits
Fed.funds sold and securities
purch'd under agrmts to resell
Trading account assets
Investment securities

3,366,816
4,035,140

3,897,143
3,926,679

2,879,378
3,932,661

1,523,849

1,761,488

308,174
189,101
2,226,340

361,591
114,349
2,174,380

183,324
299,792
2,501,082

3,942,564
383,432
2,364,019

3,235,981
205,925
2,281,344

Loans:

Domestic
Foreign
Lease financing receivables
Total loans and lease
receivables

16,366,150
6,815,562
609,668

12,796,075
5,650,035
451,816

10,883,300
3,980,117
400,394

9,601,343
3,357,468
324,865

9,334,256
2,756,076
274,967

23,791,380

18,897,926

15,263,811

13,283,676

12,365,299

Less: Unearned income
Reserve for credit losses
Net loans and lease receivables

215,374
212,180
23,363,826

143,305
191,237
18,563,384

121,027
168,164
14,974,620

107,000
163,271
13,013,005

97,000
161,890
12,106,409

Properties and equipment
Customers' liability on
acceptances
Other assets
Total assets

226,842

195,579

164,966

120,850

87,596

1,092,622
981,258
35,790,119

900,405
925,155
31,058,665

255,893
608,564
25,800,280

125,515
511,265
21,984,899

176,736
360,264
20,215,743

12,517,200
11,490,000
20,007,200

12,142,717
9,017,533
21,160,250

10,089,704
8,664,081
18,753,785

8,708,640
7,108,487
15,817,127

9,351,904
5,938,481
15,290,385

5,865,470
1,901,351
1,096,924
1,026,740
529,532
34,027,217

5,143,594
1,492,881
905,557
680,202
450,457
29,832,941

4,383,055
450,272
257,764
586,259
357,050
24,788,185

3,981,529
325,028
126,269
557,280
265,293
21,072.526

2,934,426
313,159
177,268
494,900
180,000
19,390,138

196,095
510,349
656,458

195,839
508,646
521,239

177,824
428,148
406,123

177,335
427,243
307,795

173,937
42S.737
222,795

Liabilities
Deposits:
Domestic offices
Foreign offices
Total deposits
Fed.funds purch'd <c securities
5
sold under agreemts to repurcha
Other borrowings
Acceptances outstanding
Other liabilities
Long-term debt
Total liabilities
Stockholders' Equity
Preferred stock
Common stock
Capital surplus
Retained earnings
Accumulated translation
adjustment
Total
Less - Treasury stock at cost
Total Stockholders' Equity
Total Liabilities &
Stockholders' Equity

*

136

1,362,902

1,225,724

1,012,095

912,373

825,605

1,362.902

1,225.724

1.012.095

912,373

825.605

35,790,119

31,058,665

25,800,280

21.984,899

20,215,743

Due to the availability of information, certain line items have been rounded or
reasonably approximated. Also, inadequate information has prevented certain
line items from being stated individually. In some cases, totals were used to
maintain consistency for comparative purposes.




18
CONSOLIDATED STATEMENT OF CONDITION
Continental Illinois Corporation and Subsidiaries
December 31 ($ in thousands)
Assets

Cash and due from banks
Interest-bearing deposits
Fed.funds sold and securities
purch'd under agrmts to resell
Trading account assets
Investment securities

1,905,849

1,556,970

1,779,892

1,340,999

1,803,907

2,151,719
356,048
1,774,445

2,237,921
339,825
2,069,506

1,593,554
181,290
1,802,936

902,863
181,992
1,707,646

918,870
413,528
1,519,447

Loans:
Domestic

Foreign
Lease financing receivables
Total loans and lease
receivables

10,047,666
2,607,592
102,819

8,216,269
1,777,829

5,946,998
1,173,004

4,016,679
879,614

3,476,186

12,758,077

9,994,098

7,120,002

4,896,293

3,476,186

Less: Unearned income
3
Reserve for credit losses
Net loans and lease receivables

157,378
12,600,699

142,950
9,851,1*8

129,530
6,990,072

125,639
0,770,650

123,782
3,352,000

Properties and equipment
Customers' liability on
acceptances
Other assets
Total assets

58,672

49,293

46,173

40,627

32,759

271,245
522,070
19,600,747

84,930
537,637
16,727,230

111,098
194,526
12,699,941

247,597
762,729
9,955,107

202,746
445,037
8,688,698

9,752,612
5,715,562
15,068,174

8,576,870
4,021,333
12,598,203

6,936,739
3,064,436
10,001,175

5,764,402
2,691,736
8,056,138

4,980,456
2,173,969
7,150,025

1,967,516
457,403
272,013
544,029
180,000
18,889,135

2,245,659
618,406
86,445
386,557
100,000
16,035,270

(.1,502,339
116,216
301,758
100,000
12,061,088

515,345
251,468
147,717

484,807
172,646
204,159
137,771

9,370,668

8,153,808

186
173,663
425,291
152,472

186
173,095
421,170
97,509

186
172,539
393,800
71,928

186
171,359
317,227
95,667

168,643
314,357
51,890

Liabilities
Deposits:
Domestic offices
Foreign offices
Total deposits
Fed.funds purch'd & securities
sold under agreemts to repurchase
Other borrowings
Acceptances outstanding
Other liabilities
Long-term debt
Total liabilities
Stockholders' Equity

Preferred stock
Common stock
Capital surplus
Retained earnings
Accumulated translation
adjustment
Total
Less - Treasury stock at cost
Total Stockholders' Equity
Total Liabilities &
Stockholders' Equity

_
_

751,612

_
.

691,960

_
.

638,453

_
_

534,890

751,612

691,960

638,053

584,039

530,890

^9,600,707

16,727,230

12,699,901

9,955,107

8.688,698

For Continental Illinois National Bank and Trust Company of Chicago and
Subsidiaries only.

Due to lack of information in years 1974 to-1970, the unearned income line item
was netted against the Loans (Domestic & Foreign) and Lease receivables line
items. Lack of available information prevented a further breakdown of Lease
receivables for the periods 1973 through 1970.
Due to the availability of information, certain line items have been rounded or
reasonably approximated. Also, inadequate information has prevented certain
line items from being stated individually. In some cases, totals were used to
maintain consistency for comparative purposes.




—

584,439

19
CONSOLIDATED STATEMENT OF CONDITION
C o n t i n e n t a l Illinois C o r p o r a t i o n and Subsidiaries
(as percent of total assets)
D e c e m b e r 31

19841

19S3

1982

1981

1980

1979

4.9
S.2

6.1
8.5

5.1
4.4

5.4
10.8

10.4
10.2

9.4
11.3

12.5
12.6

11.2
15.2

1.6
1.8
4.4

1.6
1.3
4.2

1.0
2.0
4.8

1.1
.4
4.6

1.0
.3
6.0

.9
.5
6.2

1.2
.4
7.0

.7
1.2
9.7

Loans:
Domestic
Foreign
L e a s e financing r e c e i v a b l e s
Total loans and lease
receivables

.70.8
2.5

48.0
24.2
2.5

51.4
25.2
2.7

47.1
21.4
2.4

44.0
19.9
1.7

45.7
19.0
1.7

41.2
1.82
1.5

42.2
15.4
1.6

73.3

74.7

79.4,

70.9

65.6

66.5

60.8

59.2

Less: Unearned i n c o m e
R e s e r v e for c r e d i t losses
N e t loans and lease receivables

.6
1.0
71.7

.6
.9
73.1

.8
.9
77.7

.9
.6
69.*

.6
.6
64.4

.6
.6
65.3

.5
.6
59.8

.5
.7
58.0

2.0
2.3
100.0

1.6
2.5
100.0

5.3
2.5
100.0

4.5
2.6
100.0

3.1
2.7
100.0

2.9
3.0
)0.0

1.0
2.4
100.0

24.5
43.7
68.2

32.1
37.8
69.9

29.6
36.1
65.7

31.9
31.1
63.0

32.3
32.6
64.9

35.0
32.1
67.1

39.1
29.0
68.1

39.1
33.6
72.7

12.5
6.8
2.1
3.0
3.0
95.6

11.5
6.4
2.1
2.9
3.0
95.7

13.8
9.4
1.6
2.6
3.0
96.9

17.0
6.4
5.3
2.8
1.8
96.4

17.5
5.2
4.5
2.6
1.6
96.4

16.4
5.3
3.1
2.9
1.5
96.2

16.6
4.8
2.9
2.2
1.5
96.1

17.0
1.7
1.0
2.3
1.4
96.1

.2
.5
1.3
2.5

.2
.5
1.3
2.4

.

.

.

.5
1.2
2.3

.4
1.1
2.1

.5
1.2
1.9

.5
1.4
1.8

.6
1.6
1.7

.7
1.7
1.6

Assets
Cash and due from banks
I n t e r e s t - b e a r i n g deposits
Fed.funds sold and s e c u r i t i e s
purch'd under a g r m t s to resell
Trading a c c o u n t assets
Investment securities

P r o p e r t i e s and e q u i p m e n t
C u s t o m e r s ' liability on
acceptances
O t h e r assets
Total assets
Liabilities
Deposits:
D o m e s t i c offices
Foreign offices
Total deposits
Fed.funds purch'd & s e c u r i t i e s
sold under a g r e e m t s to r e p u r c h a s e
O t h e r borrowings
A c c e p t a n c e s outstanding
O t h e r liabilities
L o n g - t e r m debt
Total liabilities
Stockholders' Equity
P r e f e r r e d stock
C o m m o n stock
C a p i t a l surplus
R e t a i n e d earnings
Accumulated translation
adjustment
Total
Less - T r e a s u r y stock at cost
Total Stockholders' Equity
Total Liabilities &
Stockholders* Equity

4.4

4.3

4.0

3.6

3.6

3.8

3.9

3.9

4.4

4.3

4.0

3.6

3.6

3.8

3.9

3.9

100.0

100.0

100.0

100.0

100.0

100.0

100.0

As of March 3 1 , 1984.

*

Due to the availability of information, c e r t a i n line i t e m s have been rounded or
reasonably a p p r o x i m a t e d . Also, i n a d e q u a t e information has p r e v e n t e d c e r t a i n
line i t e m s from being s t a t e d individually. In some c a s e s , t o t a l s w e r e used to
maintain c o n s i s t e n c y for c o m p a r a t i v e purposes.




20
CONSOLIDATED STATEMENT OF CONDITION
Continental Illinois Corporation and Subsidiaries
(as percent of total assets)
December 31

1976

Assets
Cash and due from banks
Interest-bearing deposits
Fed.funds sold and securities
purch'd under agrmts to resell
Trading account assets
Investment securities
Loans:
Domestic
Foreign
Lease financing receivables
Total loans and lease
receivables
3
Less: Unearned income
Reserve for credit losses
Net loans and lease receivables
Properties and equipment
Customers' liability on
acceptances
Other assets
TmaJ ar-sV-s
Liabilities
Deposits:
Domestic offices
Foreign offices
Total deposits
Fed.funds purch'd A: securities
sold under agreemts to repurchase
Other borrowings
Acceptances outstanding
Other liabilities
Long-term debt
Total liabilities
Stockholders' Equity
Preferred stock
Common stock
Capital surplus
Retained earnings
Accumulated translation
adjustment
Total
Less - Treasury stock at cost
Total Stockholders' Equity
Total Liabilities &
Stockholders' Equity

1974

1975
8.7

17.9
1.7
10.8

16.0
1.0
11.3

11.0
1.8
9.0

13.4
2.0
12.4

12.5
1.4
14.2

9.1
1.8
17.2

10.6
4.8
17.5

43.7
15.3
_J_«5

46.2
13.6
1^_4

51.2
13.3
.5

49.1
10.6

46.8
9.2

0.3
8.8

C
|40.0

60.4

61.2

65.0

59.7

56.1

49.2

40.0

.5
.7
59.2

.5
.8
59.9

-

.8
64.2

-

.9
58.9

-

1.0
55.0

1.3
47.9

.5

.4

.3

.3

.4

.4

.4

.6
2.3
100.0

.9
1.8
100.0

1.4
2.7
100.0

.5
3.2
100.0

.9
1.5
300.0

2.5
7.7
100.0

2.3
5.1
100.0

39.6
32.3
71.9

46.3
29.4
75.6

49.7
29.1 .
78.8

51.3
24.0
75.3

54.6
24.1
78.7

57.9
27.0
84.9

57.3
25.0
82.3

18.i
1.5
.6
2.5
1.2
95.9

14.5
1.5
.9
2.4
.9
95.9

10.0
2.3
1.4
2.8
.9
96.2

13.4
3.7
.5
2.3
.6
95.9

5.2
2.5
1.5

5.6
2.0
2.3
1.6

^9471

~9X8

.8
1.9
1.4

.9
2.1
1.1

.9
2.2
.8

_

.
1.0
2.5
.6

_

v.
.9
2.4
.8
95.0

_

_

1.4
3.1
.6

1.7
3.2
1.0

.
1.9
3.6
.6

4.1

4.1

3.8

4.1

5.0

5.9

6.2

4.1

-

4.1

-

3.8

-

4.1

-

5.0

-

5.9

-

6.2

100.0

100-0

100.0

100.0

100.0

100.0

For Continental Illinois National Bank and Trust Company of Chicago and
Subsidiaries only.

Due to lack ol inlormation in years 1974 to 1970, the unearned income line item
was netted against the Loans (Domestic &: Foreign) and Lease receivables line
items. Lack ol available inlormation prevented a further breakdown of Lease
receivables for the periods 1973 through 1970.
Due to the availability of inlormation, certain line items have been rounded or
reasonably approximated. Also, inadequate inlormation has prevented certajn
line items from being stated individually. In some cases, totals were used to
maintain consistency for comparative purposes.




.

1.4
38.6

-

21
SECTION 2

Analysis of the Financial Condition of
Continental Illinois Corporation
as Compared with Other Multinational Banks
from 1976 to 1983




22
INTRODUCTION
In the last decade, the banking industry has been subjected to severe recessions,
inflation market shifts, increased interest rate volatility, development of new types of
assets and liabilities, and encroachment by other businesses. Furthermore, banking has
become less protected by regulation and has become more competitive at home and
abroad.
During this same period, the number of problem banks increased dramatically (from
183 at year end 1974 to 745 as of September, 1984). As described by the Federal Deposit
Insurance Corporation (FDIC), a problem institution is one that has unsafe or unsound
conditions and a relatively high possibility of failure. In most instances an increase in
problem institutions is followed by an increase in failed institutions. Such was the case
for this period. The number of failed institutions, those institutions receiving financial
assistance from FDIC, increased dramatically from 4 at year end 1974 to 42, 48, and 55 in
1982, 1983, and 1984, respectively.
But what causes an institution such as Continental Illinois National Bank to become
a problem or even a failed bank? The remaining sections of this report will attempt to
answer this question by reviewing the objectives and components of the federal regulatory
agencies' surveillance system and analyzing the financial condition/performance of
Continental Illinois Corporation from 1976 to 1983. More specifically, these sections will
focus on how well Continental has performed in comparison with other multinational
banks and what factors led to its current situation.
OBJECTIVES AND COMPONENTS OF A SUREVEILLANCE SYSTEM
Each of the three bank regulators, the Office of the Comptroller of the Currency
(OCC), Federal Reserve System (FRS), and FDIC maintain a surveillance system. A
surveillance system is designed to identify financial institutions that have or are likely to
have financial conditions that warrant special supervisory action. Prior to 1975, the
regulators determined the financial condition of a financial institution solely through onsite examinations. However, in the mid to late 1970's, each regulator designed and
implemented a surveillance screening system.
The surveillance screening systems are not intended as substitutes for bank
examinations nor are they intended to replace the skills and judgements needed to monitor
banks or resolve their problems. The primary objective of the systems is to aid the
examination process by identifying changes in the financial condition of banks and bank
holding companies between examinations.
Detection of such changes enables the
regulators to focus on a select number of banks as opposed to focusing on the total
universe. In turn, the regulators can allocate examination resources efficiently by giving
the most attention to those banks that warrant the closest scrutiny. Essentially, the early
warning system is made up of three components: (1) a computer screening program to
identify financial institutions that fail certain ratios, (2) a detailed financial performance
analysis of the institution to its peers, and (3) a notification of corrective action and
follow up of problems identified from components (1) and (2).




23
Although the regulators consider the present surveillance screening systems
extremely useful, they do have several limitations. The results of a computer screen are
only as good as the data and ratios used in the screen. A screen will not normally identify
those banks subjected to fraud, embezzlement, or other theft nor will it readily identify
understated amounts on the financial statements.
Also, screens are based on
predetermined ratios, thus they will not necessarily identify problems from an emerging
industry trend, such as problems caused by bad energy loans, unless such information has
been programmed into the computer. None of the systems are designed to predict bank
failures nor will they identify all unsound banks. The systems simply tell the regulator
that the financial condition of a financial institution has changed since the last bank
examination.
FINANCIAL RATIOS
As mentioned in the previous section, the screening of specific ratios is basically the
technique or tool used by the regulators to monitor/analyze the financial condition of an
organization. The basic component of ratio analysis is a single ratio, constructed by
dividing one balance-sheet and/or income-expense item by another. The denominator of
such ratios may be conceived as a "base" or scale factor. For example, a profitability
ratio would relate a firm's profits to its asset or equity-capital base to provide a returnon-assets or return-on-equity measure of a firm's overall performance.
It is important to recognize that ratios by themselves do not tell us much about the
financial condition of the organization. To provide a meaningful basis for evaluating an
organization's financial condition, comparisons with other organizations and/or with its
own performance at other times are required. Also, ratio analysis focuses only on
symptoms not on causes of financial difficulty. The driving force behind an organization's
performance is its management: financial planning, policies, and internal controls
ultimately determine an organization's performance.
FINANCIAL ANALYSIS
In our analysis of Continental's financial condition from 1976 to 1983, we have
basically taken the approach used by the regulators and relied upon ratio analysis. We
have selected 13 financial ratios under 5 major categories that are used to measure an
institution's financial condition. For each ratio we have compared Continental's financial
condition with two peer groups. The first peer group includes 16 multinational banking
organizations, while the second peer group includes 4 of Chicago's largest banking
organizations. The ratios used in the analysis were determined from financial information
as filed by bank holding compnies with the Federal Reserve. The data obtained is based
on year-end financial data which has not been adjusted for prior year restatements. To
supplement the Federal Reserve data, we obtained comparative ratios from an outside
consulting firm and reviewed data from the Office of the Comptroller of the Currency,
including bank examination reports of Continental Bank from 1976 to date.




24
Listed below are the 5 major categories used to measure an institution's financial
condition. Included in these categories are the 13 selected financial ratios.
Profitability/Earnings
Ratio 1

Return on Equity

Ratio 2

Return on Assets

Asset Quality
Ratio 3

Net Charge-offs to Total Loans,
Net of Unearned Income

Ratio 4-

Allowance for Possible Loan Losses to Total Loans,
Net of Unearned Income

Ratio 5

Nonperforming Assets to Total Assets

Capital Adequacy
Ratio 6

Equity Capital + Allowance for Possible Loan Losses to
Total Assets + Allowance for Possible Loan Losses

Ratio 7

Equity Capital + Allowance for Possible Loan Losses +
Subordinated Notes and Debentures to Total Assets +
Allowance for Possible Loan Losses

Ratio 8

Equity Capital + Allowance for Possible Loan Losses to
Total Loans, Net of Unearned Income

Liquidity
Ratio 9

Total Loans, Net of Unearned Income to Total Assets

Ratio 10

Liquid Assets - Volatile Liabilities to Total Assets

Growth
Ratio 11

Growth in Loans

Ratio 12

Growth in Assets

Ratio 13

Growth in Earnings

The remainder of this section analyzes each performance category and provides
specific information about Continental's financial condition as it relates to other
multinational organizations. Additional information related to the components of the
above ratios and the multinational and regional peer group data discussed below may be
obtained from the Committee upon request.




25
PROFITABILITY
Profitability ratios are designed for the evaluation of an organization's operational
performance. The ratios yield an indicator of an organization's efficiency in using capital
committed by stockholders and lenders. The ratios analyzed are return on equity capital
and return on assets.
Return on equity capital
Return on equity capital (ratio 1) is the most important measure of profitability for
shareholders because it relates net income to the book value of their claims. An analysis
of the multinational and regional data reveals that Continental's return on equity capital
for the period 1976 to 1981 was high and very stable, averaging 14.31 percent, almost 2
percentage points above its multinational peer group. This high return on equity capital
is a result of continued improvement in net income due primarily to a significant increase
in interest and fee income from an increasing volume of loans.
In 1982 and 1983, Continental's return was 4.56 and 5.95 percent, respectively. This
was 7 and 5 percentage points below the average of the multinational and 4 and 2
percentage points below the regional peer groups, respectively. In both analyses,
Continental ranked last and next to last. The extremely low return was due primarily to a
significant increase in the provision for loan loss expenses, a direct result of Penn Square's
failure and the bankruptcy and near bankruptcy of several of the Bank's large midwest and
manufacturing corporate borrowers.
Return on assets
Return on Assets (ratio 2), which measures the average profitability of the
institution's assets, is designed to indicate the effectiveness of management in employing
its available resources. An analysis of both the multinational and regional data reveals
that Continental's return on assets for the period 1976 to 1981 was high and very stable^"
averaging ,55 percent, approximately .06 percentage points above its multinational peefr
group. This high return on assets is due primarily to the continued increase in the 4pllarV
level of domestic and foreign earning assets. Also, the Bank channeled a large amount 6 ^ ^
funds traditionally held in the form of short term money market investments into loans
offering higher yields but less liquidity.
In 1982 and 1983, Continental's return was .18 and .26 percent, respectively. This
was .31 and .26 percentage points below the average of its multinational and regional
peer groups, respectively. The low return was due primarily to an increase in loans
designated as nonperforming. Continental's loan loss reserve to total loans and net
charge-offs to total loans increased significantly from .89 and .29 percent in 1981 to 1.24
and 1.37 percent by the end of 1983, respectively. Also, Continental's net interest margin,
the total cost of all its funds contributing to earning assets subtracted from the yield of
all its assets, was as much as three-quarters of a percentage point below the average for
its multinational peers.
Our financial analysis coupled with a review of bank examination reports from 1977
to 1983 showed increased earning assets in the period leading up to 1981. These higher
levels of earning assets were the result of a substantially increased loan volume which
increased interest and fee income. Also, non-interest income was increased with the




26
expansion of the credit card operation in 1978. However, in mid-1982, poor asset quality,
as evidenced by an unprecendented volume of nonperforming loans, dominated
Continental's condition. Continental's earnings became severely depressed resulting in a
significantly reduced return on assets.
ASSET QUALITY
An analysis of asset quality is of particular importance to institutions which assume
both a credit and an interest rate risk on their assets. Asset quality is mainly concerned
with the level, distribution, and severity of nonperforming assets; the level and
distribution of non-accrual and reduced rated assets; the adequacy of valuation reserves;
and management's ability to administer and collect problem credits. The asset quality
ratios analyzed are: net charge-offs to total loans, allowances for possible loan losses to
total loans, and nonperforming assets to total assets. These asset quality ratios (3, 4, and
5) focus on indicating areas of concern in the loan portfolio, since assets of a financial
institution are represented primarily by loans.
During the period 1978 to 1981, the asset quality ratios of the multinational and
regional peer groups revealed the following. Continental's ratio of allowance for possible
loan losses to total loans was as much as .09 and .25 percentage points below the average
for the peer groups. Continental's ratio of net charge-offs to total loans was consistently
below its peers, averaging .29 percent as compared to the peer group's average of .43 and
.46 percent. Finally, the Bank's ratio of nonperforming assets averaged 1.30, just slightly
above the multinational peer group.
During 1982 and 1983, Continental experienced a severe deterioration in its asset
quality ratios as compared to the multinational peer group. The Bank's allowance for
possible loan losses to total loans increased significantly from .89 percent in 1981, to 1.15
and 1.24 percent in 1982 and 1983, respectively. The Bank's net charge-offs to total loans
increased dramatically from a low of .29 percent in 1981 to 1.28 and 1.37 percent in 1982
and 1983, respectively (.73 percentage points above its peer group average of .55 and .64
for those years). Finally, Continental's ratio of nonperforming assets to total assets also
increased dramatically from an average of 1.30 in 1979 to 1981, to 4.6 percent in 1982 and
1983 (2.4 percentage points above the peer group average of 2.2 percent).
CAPITAL ADEQUACY
The primary function of bank capital is to demonstrate the ability to absorb
unanticipated losses. Capital ratios represent the primary technique of analyzing capital
adequacy. The capital ratios analyzed are: equity capital to total assets and equity
capital to total loans.
Equity capital to total assets
Equity capital to total assets (ratios 6 <c 7) indicates the percentage decline in total
5
assets that could be covered with equity capital and, where applicable, subordinated notes
and debt. The ratios are inversely related to the size of the bank. This reflects the more




27
conservative stance of small banks and the ability of larger banks to reduce their need for
capital because it is believed they can reduce the adverse effects of the default risk and
market risk through the law of large numbers. An analysis of the multinational peer group
data reveals that Continental's equity capital to total assets ratios were relatively
constant for the period 1976 to 1983, averaging 4.6 and 4.7 percent, approximately .15 and
.69 percentage points below the peer average. On the other hand, an analysis of the
regional data ranked Continental last, at least .67 and .90 percentage points below the
peer averages.
Equity capital to total loans
Equity Capital to total loans (ratio 8) also indicates the percentage decline in assets
that could be covered with equity capital. However, this ratio uses total loans in the
denominator based on the belief that the majority of the risk in total assets is in the loan
portfolio.
An analysis of the multinational peer group data reveals a steady decline in
Continental's ratio from 7.13 percent in 1976 to 5.26 percent in 1982. During this period,
its rank fell from sixth to last within the peer group. Regional data also placed
Continental last during the period, averaging 2.43 percentage points below the peer
group average.
Our financial analysis and a review of the bank examination reports from 1976 to
1982 reveals that Continental's level of equity capital over the period did not keep pace in
relation to the extremely high volume of loan and asset growth. As a result, the below
average base that existed in 1976 continued to erode. Continental was able to assume the
additional risk and maintain a strained capital base, whereas others with the same capital
ratios could not, because of its continued increase in earnings performance. However, in
1982 and 1983, when the quality of Continental's assets was determined to be poor and the
earnings on those assets were depressed, the risk of insolvency significantly increased.
LIQUIDITY
An individual bank's liquidity is its ability to meet deposit withdrawals, maturing
liabilities, and credit demands and commitments over two time periods: (1) the short-run,
a period of less than 1 year and (2) the long-run, a period influenced from cycles in
economic and financial activity and the growth in deposits and loans. Liquidity ratios
provide the primary means of judging a bank's liquidity position. The two liquidity ratios
analyzed are loans to assets, and liquid assets minus volatile liabilities to total assets.
Loans to assets
Total loans net of unearned income
institution's liquidity. An analysis of the
Continental's loans continued to increase,
assets. During the period 1976 to 1983,




to total assets (ratio 9) is a measure of an
multinational and regional data reveals that
becoming far and away its major source of
the Bank's ratio rose significantly from an

28
average of 58 percent for 1976 to 1978, to 62.8 percent for 1979 and 1980, and to 71.6
percent for 1981 to 1983, approximately 1.5, 5.S5, and 10.3 percentage points above its
peers. In general, this ratio reveals the existence of a poor liquidity position which
dictates the need to further evaluate other liquidity ratios.
Liquid assets minus volatile liabilities to total assets
Liquid assets minus volatile liablilities to total assets (ratio 10) measures the net
liquidity of a bank's total asset portfolio after making deductions for volatile liabilities.
The numerator is reduced because a significant portion of the liquid assets are pledged
against Treasury and other public debt.
An analysis of both the multinational and regional data reveals that Continental's
ratio was extremely poor during 1976 to 1983, averaging -45.97 percent, or at least 21
percentage points below its peers. Not only did Continental rank last during the entire
period, but its ratio also increased significantly (from an average of -37.7 percent for
1976 to 78 to -46 percent for 1979 to 1980 to -54.2 percent for 1981 to 1983).
Our analysis of the period from 1977 to 1983 revealed that Continental was
increasing its assets with heavy loan volume and had to finance them with more volatile,
more expensive money. Continental was not adjusting its maturities and asset and
liability composition in order to achieve a relative balance between interest sensitive
assets and liabilities. For example, to support its aggressive loan policy, Continental
maintained a high degree of rate sensitivity through the heavy use of overnight funds and
shortened CD and Eurodollar maturities. In addition, Continental began attracting
deposits of other commercial banks, particularly foreign banks, by in some cases paying
them more interest than domestic banks. At the same time, core deposits from
individuals, partnerships, and corporations remained constant during the period, lagging
behind the 8 percent growth rate reported by Continental's peer group.
GROWTH
Steady and controlled growth is a desirable characteristic for an institution. The
examination of growth ratios reveals useful information about an institution's overall
performance. The three ratios analyzed are growth in loans, growth in assets, and growth
in earnings.

A high correlation exists among all three ratios, growth in loans, assets, and
earnings (ratios 11, 12, and 13). Assets which represent Continental's use of funds have
been primarily driven by a growth in loans whose interest income has stimulated a growth
in earnings.
An analysis of these ratios from 1977 to 1981 reveals a steady growth in earnings
averaging 14.8 percent. This consistent earnings growth, mandated by Continental's
management, was driven by a 16.4 percent steady growth average in assets which was
maintained by a significant growth in loans averaging 19.9 percent. During this period,
Continental outperformed its multinational peers in both asset and loan growth by 3.4 and
5.2 percentage points, resepectively. However, the growth in earnings considered strong
by management was as much as 3.6 percentage points below its peer group.




29
In 1982 and 1983, the strong and stable growth trends were eliminated. By
late 1982 significant concern centered on the quality of Continental's assets. This
management to take an extremely cautious approach in acquiring additional loans.
number of loans were classified as nonperforming and were written off. As a
earnings from interest and fees on loans were serverly depressed.

mid to
caused
Also, a
result,

Our analysis confirmed an increase in the growth of loans, assets, and earnings for
Continental during the period 1976 to 1981. As mentioned earlier, growth in loans was a
major reason for the growth in assets and earnings. An example of the growth in loans
was shown by Continental's loan portfolio increases in overseas loans, energy loans, and
loans to lesser-developed countries. Our analysis revealed that from 1976 to early 1982,
the Bank's loans grew from 60.4 to about 79 percent of total assets. Particularly, growth
was shown in energy, specifically oil and gas loans.

39-133 0—84

3




30
SECTION 3

Financial History of
Continental Illinois Corporation
from 1970-1984

INTRODUCTION
In an attempt to protect the safety and soundness of the banking industry, the
Federal Deposit Insurance Corporation (FDIC), the Comptroller of the Currency (OCC),
and the Federal Reserve (FRS) on May 17, 1984, arranged an interim emergency financial
assistance program and guaranteed all depositors and creditors of Continental Illinois
National Bank and Trust Company (the Bank). At the time, the Bank had more than $40
billion in assets and had huge amounts of funds either loaned to or borrowed from many
U.S. banks. Regulators were concerned that if the Bank failed it could have had a domino
effect on the banking industry resulting in many other bank failures. The assistance
program was designed to alleviate the cash shortages facing the Bank so that it would
have time to recover in an orderly and permanent manner.
After an evaluation of various alternatives, the regulatory agencies on July 26,
1984, provided the Bank a permanent financial assistance program intended to restore it,
over time, to a profitable business entity. The major components of the plan, which is
subject to stockholders' approval, include (1) installing a proven internationally recognized
management team, (2) moving $4.5 billion in problem loans to FDIC, (3) infusing $1 billion
in new capital from FDIC in exchange for preferred stock convertible to 80 percent of
the equity of Continental Illinois Corporation (the Corporation) which is the holding
company for the Bank, and (4) ensuring an ongoing line of credit from the regulators and
participating banks. *

But what caused the financial condition of the Bank to deteriorate? This section of
the report presents information on the Corporation's and Bank's organizational structure
and financial history along with a discussion of relevant events from 1970 to 1984 to help
understand how the problems developed.

CONTINENTAL ILLINOIS CORPORATION
Continental Illinois Corporation was incorporated in Delaware in November 1968 and
commenced operations on April 1, 1969, after it acquired all of the outstanding stock,
except for directors' qualifying snares, of Continental Illinois National Bank and Trust
Company of Chicago. The Corporation directly or through wholly-owned subsidiaries
engages in lease and debt financing, mortgage lending and banking, financing of energy
development and exploration, asset-based financing, reinsurance of credit life and credit
health insurance directly related to extensions of credit by the Bank, fiduciary and
investment services, and merchant banking overseas. The Corporation also owns two
banks in the suburbs of Chicago, Illinois, a small business investment company, and an
equity investment company.




31
Through a worldwide network of branches, representative offices, subsidiaries, and
affiliates staffed by more than 12,000 people, Continental provides commercial, personal,
trust, and money market services to individuals, businesses, and governmental entities.
Its business units are organized according to market areas.
SUBSIDIARY ACQUISITIONS
The Corporation's significant subsidiaries as of 1984 were as follows:

Name^

Jurisdiction
of
incorporation

Percent of
voting
securities
owned

Continental Illinois National Bank & Trust
Co. of Chicago

Illinois

100(2)

Continental Bank International

Illinois

100

Continental International Finance
Corporation

Illinois

100

Continental Illinois Bank (Canada)

Canada

100

Republic Realty Mortgage Corporation

Delaware

100

Continental Illinois Leasing Corporation

Delaware

100

Continental Illinois (Delaware) Limited

Delaware

100

Continental Illinois Equity Corporation

Delaware

100

Continental Illinois Service Corporation

Delaware

100

Continental Illinois Venture Corporation

Delaware

100

Continental Illinois International
Investment Corporation

Cayman Islands

100

Great Lakes Life Insurance Company

Arizona

100

Continental Illinois Overseas Finance
Corporation, N.V.

Netherlands
Antilles

100

Continental Illinois Trust Company of
Florida, N.A.3

Florida

100

Continental Illinois Trust Company
of Sarasota, N.A.3

Florida

100




32

3urisdiction
of
incorporation

Name

Percent of
voting
securities
owned

Continental Illinois Energy Development
Corporation

Delaware

100

Continental Illinois Commercial Corp.

Delaware

100

Continental Bank of Buffalo Grove, N.A.3

Illinois

100

Continental Bank of Oakbrook Terrace^

Illinois

100

Continental Illinois Corporation
Financial Futures

Delaware

100

CONTINENTAL ILLINOIS NATIONAL BANK
The Bank, which became a subsidiary of the Corporation, has been in business for
more than 124 years. At the end of 1983, it was the largest bank in Chicago and was
seventh in size in order of both assets and deposits among approximately 15,000 national
and state banks in the United States. Operating a full service commercial banking and
trust business, the Bank serves individuals, businesses and government in the metropolitan
area of Chicago; other major metropolitan areas throughout the Nation; and overseas. It
receives deposits; makes and services secured and unsecured loans; distributes U.S.
government and municipal securities; and performs a wide variety of personal, corporate,
and pension trust and investment advisory services.
Over the past two decades the Bank changed from a conservative institution whose
principal functions were providing a safe place for people and businesses to keep their
money and lending to good credit risks, to an institution striving for constant growth at
home and abroad. During the 1960's, the Bank developed extensive international
operations; established groups to render specialized services to the Bank's oil, utility, and
finance company customers; established a unified Retail Banking Department to fully
serve the consumer and small businessperson; developed a separate Real Estate
Department to make commercial and home loans and to service the properties which the
Bank holds in a fiduciary capacity; and established a division to provide counseling to
companies wishing to relocate in the Chicago metropolitan area. The Bank has a large
network of correspondent banking relationships in the United States and throughout the
world and provides a wide variety of services for banks.




33
ORGANIZATION OF THE BANK
The organization of the Bank is built around markets it defines as groups of
customers who have common needs for the services offered. The activities of each of the
five customer-service units are summarized below.
General Banking Services
General Banking Services provides depository and financial services to corporations
and correspondent banks wherever located and to governments and their agencies outside
the United States. The responsibilities of the five units which comprise General Banking
Services are as follows:
U.S. Banking Services is divided into two areas, that generally provide commercial
deposit and loan facilities to corporations, banks, bank holding companies, other
financial institutions, and other entities not classified as multinational.^ The
Metro-Midwest Groups, which are organized to provide specialized skills adapted to
specific industries, serve customers in the greater Chicago metropolitan area, other
parts of Illinois, as well as Indiana, Michigan and Wisconsin. The National Groups,
organized on a geographical basis, serve domestic commercial customers not
classified as multinational or served by Special Industries Services, including as
many as 2,600 domestic correspondent banks^ at one point.
Special Industries Services is organized to (1) supply specialized skills adapted to
specific industries and (2) to provide credit and loan facilities to customers
worldwide in the oil and gas, mining, construction and engineering, and shipping and
marine industries. The Service also provides nationwide credit and loan facilities to
public utilities, surface transportation, and equipment leasing industries.
International Banking Services is comprised of two Edge Act*> Corporation
subsidiaries and specialized geographic groups. It is headquartered in Chicago and
has overseas branches, representative offices, and subsidiaries in 29 foreign
countries. It assists foreign correspondent banks, government entities, and
corporations not classified as multinational by providing them with international
financial services that include short- and medium-term loans, letters of credit,
acceptances, collections, remittances, deposit accounts, and foreign exchange
services.
Under the Edge Act, the Bank currently operates an Edge Act Corporation
subsidiary headquartered in Chicago named Continental Bank International, which
has branches in New York, Miami, Houston, and Los Angeles. The branches provide
international banking and financial services to corporations and correspondent banks
in their respective markets. Another Edge Act Corporation subsidiary, Continental
International Finance Corporation, also headquartered in Chicago, has investments
(ranging from 100 percent ownership to minority interests) in various foreign
financial institutions that serve to supplement the Bank's international services.




34
Multinational Banking Services provides the special expertise and worldwide
capabilities required by major corporate customers that have extensive worldwide
operations and are classified as multinational.
In addition to Chicago,
MultinationalBanking Services has personnel located in New York, London, Tokyo,
Brussels, Frankfurt, and other cities where multinational corporations are located.
Financial Services provides the other units of General Banking Services with
worldwide capability to serve clients by offering a comprehensive variety of trade
financing, global cash management, and investment banking functions, including
private placements, mergers and acquisitions, and corporate financial advisory
services.
Trust and Investment Services
Trust and Investment Services provides a variety of services to a large number of
individuals, associations, businesses, government entities, and institutions. Through it, the
Bank acts as trustee, executor, administrator, guardian, conservator, depository, transfer
agent, and registrar. In addition to the separate investment of trust assets, it maintains
collective funds for trust investment, including Continental Illinois Investment Trust for
employee benefit plans. It also offers custodian and investment counseling services, as
well as portfolio management, and financial planning and advisory services for both
domestic and international clients.
Real Estate Services
Real Estate Services makes a wide variety of residential, industrial, and commercial
real estate loans, including secured and unsecured credits, to the real estate industry.
The Bank's activities include extensions of credit to home builders and developers,
mortgage bankers, and real estate investment trusts, and the origination, sales, and
servicing of residential mortgages as well as other activities.
Bond and Treasury Services
Through Bond and Treasury Services, the Bank is a primary dealer in government and
federal agency securities as one of approximately 35 primary government bond dealers
authorized to deal directly with the Federal Reserve trading desk. It underwrites and
distributes state and local government and public housing securities, provides short-term
investment facilities to many corporations, supplies correspondent banks with services
ranging from periodic pricing of portfolios to complete portfolio management, serves the
primary banking needs of public bodies, funds the Corporation and its subsidiaries,
manages the Corporation's interest rate sensitivity program and capital account, and
controls the non-credit risk of the Corporation.
Personal Banking Services
The banking needs of individuals and households are the responsibility of Personal
Banking Services. It administers savings accounts, time deposits, checking accounts, and




35
a broad spectrum of consumer lending activities which includes personal loans, real estate
loans, and the MasterCard/Visa bank card programs until their sale in 1984. The Executive
Financial Center has been established in an effort to meet the complete banking,
borrowing, and short-term investment counseling needs of a select group of Bank
customers.
SUBSIDIARY ACQUISITIONS
The Bank has established a number of subsidiaries since 1970. Under the Edge Act,
it owns and operates Continental Bank International and Continental International Finance
Corporation.
Headquartered in New York, Continental Bank International is an
international banking organization, receiving deposits, making loans, and handling all
forms of international banking transactions. It maintains direct correspondent banking
relationships in most major countries, and its services are available to domestic and
foreign banks, corporations, and individuals. The Continental International Finance
Corporation, headquartered in Chicago, provides long-term equity and debt financing for
businesses operating abroad. The Bank also has equity interests (ranging from 100 percent
ownership to minority interests) in various foreign financial institutions located in various
countries worldwide.' These institutions supplement the Bank's international operations.
The statute limits Edge Act subsidiaries to serving foreign trade-related and other
international banking needs as opposed to U.S. banking needs.
CHRONOLOGY OF EVENTS AND FINANCIAL HISTORY
The purpose of this section is to recount the events that took place and financial
performance of the bank during the period from 1970 to the present. It is not intended to
explain why these events occurred. Early events and financial information is grouped into
two time periods —1970-74 and 1975-79. More recent events and financial information
related to the period from 1980 to 1984 is presented on a year by year basis.

1970-1974
INDUSTRY ECONOMIC CONDITIONS
During the period 1970-74, the U.S. economy was in the midst of the most prolonged
recession since 1933. Spending cutbacks by business, which reduced inventories and
shifted borrowings into the bond and commercial paper markets, caused a decline in the
volume of bank loans. In addition, the banking system was also affected by impending
industrywide problems throughout 1974 resulting from the unusual failures of two large
banks and the relatively high level of uncollectible loans.




36
BUSINESS SERVICES
In spite of the economic conditions during this period, the Bank emerged in a
position of strength and stability by expanding in many areas. As of December 31, 1974,
the Corporation and its subsidiaries had approximately 9,880 officers and employees, an
increase of 1,600, or 19 percent, from 1970. All but 220 of the officers and employees
were employed by the Bank.
The commercial banking department, which provided commercial deposit and loan
facilities to individuals and corporations, was reorganized in 1973 around industry,
customer size, and geographic markets in order to develop new markets. Represented
among the approximately 33,000 accounts in the commercial banking department were 94
of the 100 largest American corporations and 318 of the Fortune 500 list.
The international and overseas operations grew rapidly and placed greater emphasis
on regionalizing business development efforts and penetrating growth markets in each of
the countries where the Bank operated. By the end of 1974, the Bank's international
network included 122 facilities in 37 nations on six continents, making it the largest of
such networks operated by a U.S. financial institution.
Several other Bank operations grew rapidly during this period. The real estate
function expanded particularly as to lines-of-credit to home builders and developers,
mortgage bankers, real estate investment trusts, and interim construction lending; bond
operations enlarged its services to include underwriting and distributing state and local
government and public housing securities, providing short-term investment facilities to
many corporations and portfolio advisory services for correspondent banks, managing the
Bank's investment portfolios, and procuring a large share of the funds required by the
Bank; and Personal banking increased consumer credit services by implementing the
Master Charge International Charge Credit system.
SUBSIDIARY ACTIVITY
The early 1970s was a period of rapid growth in the Corporation's subsidiary
operations as evidenced by its activities. The Corporation
— participated in organizing a venture capital firm which operated under the name
of Continental Illinois Venture Corporation, in which the Corporation held 29
percent of the voting stock.
— acquired the business and properties of Republic Realty Mortgage Corporation in
June 1970 and continued to operate it as a mortgage banking firm doing business
in Illinois, Missouri, Wisconsin, and Georgia.
— acquired Group Counselors, Inc. by merger into Continental Illinois Realty
Advisors, Inc. in March 1971.




37
— entered into a joint venture with The Royal Trust Company in October 1971. The
Corporation and The Royal Trust Company then organized Builders Financial Co.
Limited and its wholly-owned subsidiaries, Builders Capital Limited and Western
Builders Capital Limited, to engage in construction and development lending and
other interim financing of Canadian real estate. The Corporation held 50
percent of the common stock and 49.9 percent of the preferred stock (voting) of
Builders Financial Co. Limited. The balance of the Builders Financial Co.
Limited stock was held by the Royal Trust Company.
~ formed Continental Illinois Leasing Corporation to engage in lease and debt
financing in March 1972.
~ formed Continental Illinois (Delaware) Limited in July 1972 to engage in
merchant banking overseas through subsidiaries chartered under the laws of Hong
Kong and the United Kingdom.
~ formed Continental Illinois Leasing and Financial Ltd. in April 1974, a Canadian
corporation, to engage in medium-term lease and debt financing in Canada.
MANAGEMENT
On March 26, 1973, Roger E. Anderson and John H. Perkins were elected by the
Board of Directors to succeed Donald M. Graham and Tilden Cummings as Chairman of
the Board and President, respectively. No other major changes occurred.
FINANCES
The financial position of the Corporation continued to improve for the fifth
consecutive year since the bank holding company was formed. The increasing demand for
loans over the previous 5 years was satisfied largely through an increased reliance on time
deposits and interest-sensitive funds of all kinds. Total deposits had increased from $8.1
billion in 1972 to $15.5 billion in 1974. Particularly noticeable was the growth in overseas
branches and subsidiaries where time deposits increased $2.5 billion from 1972 to $5.7
billion in 1974.
Dividends on common stock continued to increase in accordance with the
Corporation's policy to increase dividends as earnings increased. Dividends declared in
1974 were $2.20 per share, as compared to $1.93 per share in 1973.
Earnings
Earnings for 1974 increased 11 percent from 1973 to $95.9 million, with a 5-year
annual growth rate reaching 11.7 percent. The Bank's return on shareholders' equity in
1974 was 13.5 percent and had exceeded 12 percent annually for the fifth consecutive
year. These accomplishments for 1974 were due in part to a 33 percent increase in net
interest income, resulting from a sharp decline in interest rates during the fourth quarter.
Total operating income increased dramatically in 1974 to $1.7 billion, as compared
with $1.1 billion in 1973 and $478 million in 1972. The 1974 increase was due primarily to
interest fees on loans of $1.3 billion (representing 72 percent of total operating income)
which nearly doubled the $720 million recorded in 1973 and quadrupled the $369 million in
1972.




38
The growth in income was offset somewhat by the growth in expenses. Total
operating expenses also increased dramatically in 1974 to $1.6 billion, as compared with
$967 million in 1973 and $422 million in 1972. The 1974 increase was due primarily to
interest expenses of $1.3 billion (representing 83 percent of total operating expenses)
which nearly doubled the $767 million and quadrupled the $346 million in 1972. Other
expenses such as salaries, wages, and compensation increased from $110 million in 1973 to
$130 million in 1974.
Assets
Total assets grew at a record rate from $10.7 billion at the end of 1972 to $19.8
billion in 1974, with a 5-year annual growth rate of 20 percent. This growth in assets was
due largely to an increased demand for loans. At year-end 1973, loans were $9.9 billion,
an increase of 40.4 percent over 1972. By year-end 1974, loans increased another $2.8
billion to $12.7 billion, representing 64 percent of total assets. Domestic loans in 1974
rose to $10.1 billion, an increase of $1.9 billion from 1973, while overseas loans reached
$2.6 billion, an increase of $.8 billion.
Nonperforming Loans and Losses
The loan loss reserve for 1974 was increased to $213 million, or 23 percent, from 1973
in recognition of possible future losses in a number of areas, including the real estate
field. This increase represented 1.2 percent of gross year-end loans.
1975-1979
INDUSTRY ECONOMIC CONDITIONS
The severe recession during the prior period which created financial difficulties for
a number of companies began to recede in early 1976. The improvement in the banking
industry occurred largely as a result of an increase in business borrowing, which was
fueled primarily by a sharp rise in inflation, but also by increases in corporate spending
for new plant and equipment and a continuing downturn in corporate liquidity.
As noted above, the economy during this period experienced a sharp rise in inflation.
The consumer price index increased 13.3 percent between the beginning and end of 1979, or
11.2 percent on the average during the year, as compared with a 9.1 percent increase on
the average for 1978. Also, world oil prices more than doubled in 1979 and were still
rising, outracing the rate of inflation and fueling still more inflation.
BUSINESS SERVICES
During this period, as in the prior period, the Corporation experienced continued
growth despite the economic conditions. General Banking Services, which includes
commercial, multinational, and international activities, experienced profitable gains in
volume and market position.
New business development and increased market
penetration, together with efforts at more effective comprehensive service for
multinational customers worldwide further enhanced the Corporation's position. Results




39
in all markets reflected an announcement made on Duly 7, 1976, by Continental's
Chairman, Roger E. Anderson, that the Bank would embark on a strategy to make it one
of the three biggest lenders to industrial and commercial companies by 1981.
Commercial Banking exhibited continued growth, especially in domestic commercial
and industrial loans. In addition to competing aggressively for large loans, the Bank
opened offices in the Midwest to enhance its position among small to mid-sized
companies. International Banking increased its services during the period by opening five
new branch and representative offices and three new bank subsidiaries.
Also, a
correspondent banking relationship was established with the Bank of China to conduct
business both with its Peking headquarters and its branches.
Real Estate Services' loan portfolio continued to grow, aided primarily by the
strength in the commercial construction market. Also, asset swap and repayment
programs further improved the Bank's position and accelerated the repayment of real
estate credits.
SUBSIDIARY ACTIVITY
The Corporation, through Continental Illinois Leasing and Financial Corporation,
formed Continental Illinois Capital (Canada) Ltd. in 1975, a Canadian subsidiary, to engage
in mortgage lending in Canada, acquired all outstanding common stock of Continental
Illinois Venture Corporation in 1976; formed Great Lakes Life Insurance Company in 1977
which acts as a reinsurance underwriter of credit, life, accident, and health insurance; and
formed Continental Illinois Equity Corporation in 1979 which makes equity type
investments in unaffiliated companies.

MANAGEMENT
Executive management remained unchanged, with the exception of George R. Baker,
who was placed in charge of the Commercial and International Banking Services
consolidated under General Banking Services.
FINANCES
Continental's financial position continued developing during this period at a rate
consistent with that of the previous 4 years. Stockholders' equity increased by $137
million or 11 percent to $1.4 billion at December 31, 1979. The rate of return on
stockholders' equity has held steady over the period at 15 percent. In addition, the capital
base has provided a steadily rising dividend to stockholders. The 1979 dividend was
increased 11 percent to a new annual rate of $1.60 per share. This rate reflects a twofor-one common stock split which became effective in May, 1977.
Earnings
Income before security transactions increased 15 percent to a record $194.1 million,
for a 5-year compound growth rate of 14.2 percent, the same as in 1978. Net interest
income increased by $80 million, or 13.3 percent, to $677.3 million. Other operating
income increased by $41 million, or 24.5 percent, to $207.7 million, reflecting emphasis on




40
noninterest income. Against the $121 million gain from these two principal income
sources, other operating expenses were up $80.5 million, or 20.9 percent, to $464.5
million, reflecting business growth and the impact of inflation.
Assets
Loans and other earning assets averaged 20 percent above the 1978 level, and total
assets increased by $4.7 billion, or 15.2 percent, to $35.7 billion.
Nonperforming Loans and Losses
The 1979 provision for credit losses and net charge-offs, which are applicable to both
loans and lease financing receivables, were $70 and $49.1 million, respectively, as
compared to $62.5 and $41.4 million, espectively in 1978. In each of the prior two years
the provision had exceeded the charge-offs by approximately $21 million, thus slightly
increasing the reserve to $212.1 million at December 31, 1979. Although the reserve
increased during the period, the reserve as a percent of total loans and leased receivables
decreased from 1.27 at year end 1976, to .91 at year end 1979.
1980
INDUSTRY ECONOMIC CONDITIONS
During 1980, the banking industry's attention was directed towards the continued
concern over accelerating inflation, volatile financial markets and uncertain economic
growth. The level of economic activity for 1980 was similar to the prior year. Unlike
1979, however, when the acceleration of prices was heavily concentrated in the energy
sector, no single factor accounted for 1980's rise. The inflation rate remained high due to
a deterioration in the price situation. For example, labor costs increased due to an
acceleration of compensation per hour and a poor performance in productivity. Food
prices surged under the influence of rebounding farm prices and rising costs of marketing.
Conditions in the mortgage and housing markets deteriorated sharply. Also, inflation
produced serious problems for the nonbank thrift institution and other entities that
concentrate their holdings in longer-term instruments bearing fixed interest rates.
BUSINESS SERVICES
The Bank continued to work toward its goal of becoming one of the three top
institutions serving American and foreign-based multinational customers by further
developing its business services. General Banking Services, building on national presence
of 25 offices, opened new offices in the South and West. Four Edge Act subsidiaries based
in major cities were reorganized as branches of a single Edge corporation based in
Chicago. Selective expansion of the international network continued with the opening of
three new branches. In addition, a minority interest was purchased in a Nigerian firm, and




41
service to correspondent banks in Europe was enhanced through a newly formed European
Banking section headquartered in London.
In other areas, commercial finance activity was augmented by a new Commercial
Services unit that specialized in helping businesses, such as smaller oil and gas producers
that might not qualify for traditional bank financing, with loans secured by the value of
equipment or merchandise.
SUBSIDIARY ACTIVITY
In February 1980, the Corporation established Continental Illinois Energy
Development Corporation to make loans to energy development and exploration
companies and to service such loans; formed Continental Illinois of Florida, Inc., to
engage primarily in the marketing of trust and investment services provided by the Bank;
and funded Continental Illinois Overseas Finance Corporation N.V. in the Netherlands
Antilles.

MANAGEMENT
Donald C. Miller was permanently assigned as Vice Chairman of the Board of
Directors; Edwin 3. Hlavka was designated as the Vice President and Auditor of the
Corporate Financial Services; and Edward S. Bottum was assigned as the Vice President of
Trust and Investment Services, replacing Charles R. Hall.
FINANCES
The Corporation's financial growth continued amid 1980's high rate of inflation and
unprecedented interest rate swings. The Multinational Lending Department placed heavy
emphasis upon extending commitments to carefully identified targets and increasing these
commitments to the full lending limit. International Banking Services and the Financial
Institution Division stressed expansion of wholesale banking both nationally and
internationally.
Equity capital increased by 11.8 percent to 3.62 percent of total assets. Retained
earnings increased by $162 million, bringing the year-end total to $1.5 billion, thus
building the capital base for further growth.
Earnings
Earnings reflected continued, steady earnings on the part of major profit
contributors, General Banking Services and the Special Industries Group. The Oil and Gas
Division was the Special Industries Group's single largest source of profit for the year.
Net income was up $30.1 million, or 76 cents a share, to $225.9 million. The overall
return on assets declined by two-hundredths of 1 percent.




42
Assets
Loan volume averaged $4.2 billion and other earning assets $1.3 billion above the
1979 level, increasing net interest income on a taxable equivalent basis from this source
by $140 million, or 20.6 percent. Except for April and May, the Corporation recorded
increases in average total loans each month. Growth in loans was heavier in the second
half of the year and more pronounced in domestic loans, in contrast with the first half, in
which foreign loan growth predominated. Average total assets grew by about $6.3 billion.
The growth in assets was financed largely through higher balances of interest-bearing
liabilities.
Nonperforming loans and losses
Nonperforming credits were $444 million. Mortgage and real estate loans on a
renegotiated basis were up $21 million from the prior year. The reserve for credit losses
increased 13.9 percent from 1979. Relatively lower growth of loans in 1980, coupled with
a higher net addition (provision for credit losses minus net credit losses) to the reserve,
maintained the percentage relationship of the reserve to total credits at the 1979 yearend level.
Net credit losses on consumer installment loans were the highest single loss
category in 1980. These losses were 45.9 percent of total net charge-offs in 1980 as
opposed to 64 percent in 1979. Net losses on commercial and industrial loans were up
$15.2 million in 1980 and represented 39.3 percent of total net losses, compared with 16.5
percent in 1979.
1981
INDUSTRY ECONOMIC CONDITIONS
The year 1981 was a year of extremes for banks in a number of key areas. There
were general domestic and worldwide economic weaknesses and wide fluctuations in
interest rate levels. Furthermore, the banking industry's capitalization base was eroding
causing concern to the bank regulators.
The overall level of economic activity during 1981 accelerated and the rate of price
increases slowed, but the burden of high interest rates placed some sectors of the
economy under heavy pressure. The housing industry was devastated, many auto dealers
closed because of declining sales and the extremely high cost of financing inventories, and
many other small firms in other lines went out of business. The thrift industry
experienced a severe squeeze on earnings and high interest rates impeded the formation
of business capital needed for improving productivity performance.
BUSINESS SERVICES
The Corporation's performance in 1981 was strong and compared well with the
previous strong year, 1980. The Bank moved up in the order of banks ranked by asset size,
takin^ over the sixth position from Chemical Bank. The Corporation's performance
stemmed from its concentrating in a number of areas, including significant non-interest




43
expense restrain and substantial expansion in the size of its loan portfolio. In 1981 the
Bank became the largest domestic corporate and industrial lender in the Nation.
One of the primary growth areas within the Bank was in the Oil and Gas Division of
the Special Industries Group. By mid-year, domestic oil and gas loans totaled $2.9 billion
and represented more than 10 percent of the Bank's total loan portfolio. The Bank had
developed a presence in most of the active areas in the industry by establishing regional
offices in Texas; Colorado; and Alberta, Canada. As with the oil and gas loans,
commercial real estate loans also made up about 10 percent of the Bank's total loan
portfolio.
SUBSIDIARY ACTIVITY
New regional offices in Atlanta; Detroit; Minneapolis; and White Plains, New York,
further expanded the Corporation's U.S. network to 13 locations. Agreements were
reached to acquire two small Chicago banks.
The Corporation continued to enhance its position in the international financial
marketplace through selective foreign branch office expansion. Growth overseas was
principally related to the Multinational Banking Department and the Special Industries
Group. Branch offices were opened in Canada, Barcelona, and Puerto Rico, while satellite
facilities were closed in Dusseidorf, Edinburgh, Munich, Rotterdam, and Vienna.
FINANCES
As a concrete step toward further enhancing the attractiveness of stock as an
investment, long-range targets for two key performance measures were raised in 1981,
and new higher goals were set. The return on equity goal was raised from 15 percent to
18 percent, and return on total assets was raised to 0.65 percent, or 6 basis points 8 above
the average return of the previous 5 years. The commercial and industrial loan portfolio
grew to $12.8 billion at year-end.
Stockholders equity averaged $1.6 billion in 1981, a 12.0 percent increase from 1980,
and was 3.6 percent of total assets at year-end. Stockholders received 28.8 percent of
1981 income before security transactions in the form of dividends, while in 1980 the
dividend payout ratio was 29.78 percent.
Earnings
Attention to resource allocation, expense control, funding, and liquidity
management made an important contribution to record earnings. Income before security
transactions of $260.3 million increased 16.1 percent from the $224.1 million recorded in
1980. Net income rose 12.7 percent from the previous year to $254.6 million. Return on
total assets increased 3 basis points over 1980. Net interest income was up 8.8 percent
over the 1980 level. The increase was made possible by a 17.7 percent increase in average
loans and a 27.3 percent increase in average leases.
Assets
Average total loans increased each month, except for February, with heavier growth
occurring in the second half of the year. The commercial and industrial loan portfolio




44
grew to $12.8 billion from about $9.8 billion in 1980 and real estate loans increased by 12
percent to a total of $3.9 billion. The Bank continued to be the leading lender to domestic
energy producers. Although only sixth in assets among American banks, it loaned more
money to domestic commercial and industrial companies than any other bank in the
Nation.
During the year, Continental moved toward higher yielding earning assets with
shorter maturities. This move was in line with the Bank's interest rate sensitivity
management policy which involved lengthening and shortening maturity schedules of
assets and liabilities in anticipation of interest rate cycles. Foreign operations accounted
for kOJ percent of total assets at year-end and produced 29 percent of total net income
for the Corporation.
Average earning assets increased 12.8 percent, due primarily to growth in loans and
lease financing. The increase in average earning assets was financed primarily through
interest-bearing liabilities. These sources increased 13 percent in 1981 over the 1980
average, while interest-free funds increased 8.7 percent over the same period. The 15.2percent rate on average foreign time deposits tied the overall rate of average savings and
time deposits, and together these deposits increased 13.3 percent in 1981 over the 1980
average. The more expensive money-market liability, short-term borrowed funds, also
increased 11.8 percent over the same period.
Nonperforming Loans and Losses
As a result of high interest rate levels and an economic slowdown in 1981, the Bank
had nonperforming credits of $653 million; representing 1.9 percent of total loans and
lease receivables outstanding at year end, compared wiht $Mk million, or 1.6 percent at
year end 1980. Before this rise, nonperforming credits had declined steadily from $705
million, or 5J percent of the total loan and lease portfolio reported at year end 1975.
Net credit losses increased 15.8 percent from 1980 to $71.1 million. Increased
domestic and industrial loans and overseas loan charge-offs contributed to the entire
increase amid sluggish economic conditions.
1982
INDUSTRY ECONOMIC CONDITIONS
Persistent weakness in business activity and employment, along with high interest
rates, exerted pressure on commercial banks. Profits edged down and returns on assets
and on equity reached lows last observed in the recovery from the 1973-75 recession.
Potential losses became worrisome as the financial difficulties of some major borrowing
countries impaired their ability to maintain payments on debt owed to U.S. banks. Most
commercial banks recorded substantial profits, but the proportion of banks with operating
losses rose to nearly 8 percent, about equal to the mid-1970's peak and more than double
the recent low in 1979.
BUSINESS SERVICES
The Corporation experienced serious difficulties because of an inordinately high
level of problem assets. Significant publicity of its relationship with the defunct Penn
Square Bank caused Continental's image in the financial community to fall precipitately.
This in turn, caused a significant change in its funding profile. Because domestic




45
investors were reluctant to purchase long-term instruments, the Euromarkets were
heavily used in order to maintain a relatively stable mix between long- and short-term
funding.
Problems were evident in all lending departments with oil and gas and real estate
accounting for a large portion of the problem loans. Between 1981 and 1982, outstanding
loans in the Oil and Gas Division increased from $2.8 billion to $5.2 billion, more than 15
percent of the Bank's total loan portfolio.
Under market pressure, the Bank removed its name in late July from the list of
banks where CDs were eligible for delivery to fill Chicago Board of Trade and Chicago
Mercantile Exchange futures contracts. In early September, Standard and Poor's reduced
the Bank's credit rating for the second time.
SUBSIDIARY ACTIVITY
Growth through establishment or acquisition of subsidiaries slowed to almost a
standstill. The Corporation completed the acquisition of two smaller banks in Chicago
which it initiated in 1981 and established a subsidiary to deal in the financial futures
market.
MANAGEMENT
As a result of Penn Square problem loans, a group of the Bank's senior officers
conducted a comprehensive management review of its operation and recommended a
number of management changes. A new auditor and Executive Vice President for General
Banking Services were appointed, and a new credit risk evaluation division was created. A
special litigation committee was also appointed to assess the Bank's officers' and
directors' responsibility for the Bank's actions in connection with derivative and class
action lawsuits.
In 1983, the Bank entered into a written agreement with OCC agreeing to address
certain problems noted in OCC's 1982 examination of the Bank. Under the agreement, the
Bank was required to continue implementation and maintenance of new and strengthened
plans, policies, and procedures designed to improve overall performance in accordance
with the Bank's revised corporate objectives and to report periodically on such matters to
OCC. These actions cover such areas as asset and liability management and the Bank's
credit approval, evaluation, and collection activities. By May 1984 the Bank was
experiencing severe cash flow problems requiring assistance from the FDIC and a
consortium of United States banks.
FINANCES
The Bank began to lose its position as a top money center bank. Total assets of the
Corporation declined by S.^ percent from $46.9 billion in 1981 to $42.9 billion in 1982.
Stock prices fell from $36.90 per share to as low as $15 per share. Sources of funds
declined in all major categories except other borrowing, foreign deposits, and long-term
debt, which increased from the previous year by $1 billion, $800 million, and $400 million,
respectively. The greatest decline in source of funds was in domestic demand and time
deposits which decreased by $634 million and $1.6 billion, respectively, from 1981.

 0—84
39-133
4


46
Severe market resistance curtailed the issuance of domestic CDs and commercial
paper to such a degree that the Bank was able to rollover only about 60 percent of its
commercial paper. When sizeable amounts of term money were obtained, the Bank had to
pay substantial premiums. By September 1982, the Bank's primary incremental funding
sources were overnight Eurodollars and brokered Federal funds.
Total stockholders' equity declined by $797,000 at year-end 1982, over year-end
1981. As a result of reduced 1982 earnings and maintenance of the $0.50 a share
quarterly dividend, stockholders received 94.34 percent of income before security
transactions as dividends in 1982 compared with 28.88 percent in 1981. Retained earnings
were down by $627,000 from 1981's total.
Earnings
Net interest and other operating income was a record $1.2 billion before provision
for credit losses. But net income was the lowest in 5 years, primarily due to a sharply
increased provision for loan losses of $492 million, compared to $120 million the year
before. Both the earnings decline and the increased provision reflected a steep rise in
problem credits.
Income before security transactions totaled $84.3 million, down
substantially from $260.3 million in 1981. Net income for the year was $77.8 million,
down from $254.6 million a year earlier. Net interest income accounted for 73.5 percent
of total operating revenues before provisions for credit losses, compared with 71.4
percent a year earlier.
Assets
Average total loans increased from 1981 levels in 8 of the first 9 months of 1982 but
declined in 2 of the final 3 months for a 15.8 percent overall increase over 1981.
Commercial and industrial loans averaged $13.7 billion in 1982 and remained the largest
domestic loan category, increasing by 28 percent in 1982. Mortgage and real estate loans
rose 9.6 percent, compared with 12.9 percent growth in 1981, while loans to financial
institutions were up 11.6 percent in 1982. Average interest earning assets, reflecting
higher loan and lease receivable balances, were up 15.8 percent to $33 billion.
Nonperforming Loans and Losses
At the close of 1982, nonperforming loans totaled $1.9 billion or 5.6 percent of total
loans and leases receivables, up substantially from $653 million or 1.9 percent of 1981 loan
and lease receivables. The provision for loan losses totaled $492 million, which included a
$220 million increase in the provision for loan losses during the second quarter due to
problem credits as a result of Penn Square loans. Net credit losses were $393.2 million,
up substantially from $71.1 million in 1981. Net losses of $191 million on participations
purchased from the Penn Square Bank were a major factor in the increase.
1983
INDUSTRY AND ECONOMIC CONDITIONS
The economy in the aggregate proved strong but banks experienced fewer demands
for business loans, which in the past had been among the highest yielding assets in banks'




47
portfolios. Credit problems intensified in energy and energy related businesses as the
recession lingered in that area. Housing and consumer spending provided the main thrust
for the economy. Business spending for autos, trucks, and high technology goods
accelerated, but investment in structures and heavy machinery remained weak. Federal
government spending was stimulative, but part of this effect was offset by declines in
state and local government spending. Exports remained weak and the trade deficit
ballooned as imports responded to rising domestic demand.
BUSINESS SERVICES
The Corporation continued to experience losses especially in the oil and gas area
which accounted for a high percentage of problem loans. Between nonperforming loans
and loss provisions, the Bank was carrying close to $590 million pretax drag on earnings.
Although funding had reasosnably stabilized, resistance to the Bank was still apparent,
especially in the domestic markets. Reduced premiums on term funds and asset
reductions allowed overnight funds to decrease by about $4.6 billion. A shift to offshore
funding began in mid-1982, and in mid-1983 over one-half of term funds were obtained in
the Euromarkets.
SUBSIDIARY ACTIVITY
Subsidiaries of the Corporation, excluding the Bank, represented 5 percent of total
consolidated assets at December 31, 1983, down slightly from 5.1 percent a year earlier.
For the year the subsidiaries contributed $33 million to net income, compared with $43
million for 1982. No new acquisitions were reported by the Corporation.

MANAGEMENT
The Board and management responded to serious credit problems uncovered in 1982
by conducting an in-depth management review of operations. As a result, management
made major changes in lending policies and restructured senior management to better
define lines of authority and responsibility and provide for orderly management
succession. The "corporate office"^ concept was dissolved, with most department heads
reporting to the Chairman. In August, the Board elected Executive Vice Presidents Taylor
and Bottum to the Board. Mr. Taylor became Vice Chairman and retained his position as
head of Bond and Treasury Services, with Mr. Bottum shifting duties to become the head
of General Banking Services.
In November, the Bank realigned the investment
responsibilities and restructured the credit review function.
A Credit Evaluation
Department was created to replace the old rating committee.
FINANCES
The Corporation turned its attention to overcoming the problem of large amounts of
nonperforming loans causing depressed earnings far below that experienced during the
past few years. During 1983, the Corporation continued to pay a premium for certain of
its liabilities. Funding sources were shifted substantially to offshore markets. Foreign
deposits accounted for 38 percent of the Bank's funds, followed by 16 percent from time
deposits, and 16 percent from purchased federal funds. Subsequent to year-end 1983, one
of the major rating agencies reduced the Corporation's rating on nonredeemable preferred
stock and further reduced its rating of the Corporation's long-term debt.




48

Earnings continued to be depressed because of heavy loan loss provisions, income
reductions due to nonperforming assets, and increased funding costs. In addition, interest
expense continued to be higher than normal due to funding premiums of 25 to 50 basis
points paid on a portion of the Bank's liabilities.
Net income was $108.3 million in 1983, $30 million
one-third of 1981 net income. The return on average
percent, compared with 0.17 percent in 1982 and 0.57
income on a taxable equivalent basis declined 8.4 percent
from 1981.

greater than 1982 but only about
total assets for 1983 was 0.26
percent in 1981. Net interest
from 1982 but increased slightly

Assets
Earning assets averaged $36.1 billion in 1983 reflecting a decline of $4.1 billion or 9
percent from 1982. Of the total earning assets, $23.4 billion was domestic and the
balance, $12.7 billion, foreign. Domestic and foreign loans made up $30.8 billion of total
earning assets and of these loans $20.5 billion was domestic and $10.3 billion was foreign.
Nonperforming Loans and Losses
Loan quality continued to decline as more loans entered the nonperforming
category. Nonperforming loans totaled $1.9 billion, or 6.2 percent, of total loans and
lease receivables. This compared with 1.9 percent at year-end 1981. Nonperforming loans
included $456 million in participations purchased from Penn Square, down from $595
million at year-end 1982. Loans purchased from Penn Square in the amount of $135
million were written off during the year. The provision for credit losses was $382.5
million or 1.21 percent of total loans compared with 1.11 percent at the end of 1982. Net
loan losses for the year totaled $386.5 million compared with $393.2 million in 1982 and
$71.1 million in 1981.
1984
INDUSTRY ECONOMIC OUTLOOK
Continuing economic expansion set the stage for improved banking industry
performance in 1984. The cash flow of corporations was much improved over earlier
periods and business borrowing from banks was increasing because of low current
inventory levels. Corporations did some restocking, a process normally financed with
bank borrowings. Rising levels of industry capacity utilization and the expressed intention
of corporate executives to boost capital spending indicated an increasing demand for
funds.
Foreign loans increased in 1984, but banks shifted their emphasis from foreign to
domestic consumers. The rate of growth in consumer lending, in the form of personal
loans and mortgages, was expected to surpass all other lending categories in 1984,
according to Standard and Poor's. Personal income was up, unemployment down,
consumer confidence high, and the demand for durables and housing brisk.




49
BUSINESS SERVICES
Beginning in May 1984, the Bank experienced a serious liquidity crisis resulting from
the loss of a major portion of its funding base domestically and abroad. Major providers
of overnight and term funds failed to renew their holdings and the Bank was forced to
prepay time deposits in the Eurodollar and domestic markets and to arrange for the
replacement of CD's in the domestic, market. Because no other adequate funding sources
were available, the Bank resorted to Federal Reserve Bank borrowings which rose to an
average daily level of $2.6 billion.
SUBSIDIARY ACTIVITY
During March 1984, the Bank sold its charge card operations, and during July 1984
the Corporation sold Continental Illinois Limited, its London-based merchant bank. The
Corporation announced plans to sell its leasing company and real estate mortgage
company.
MANAGEMENT
In early 1984, Chairman Anderson was replaced by David Taylor. Edward S. Bottum
was made President. In August, Messrs. Taylor and Bottum were replaced by John E.
Swearingen (Chairman of the Board of Directors and Chief Executive Officer of the
Corporation) and William S. Ogden (Chairman of the Board of Directors and Chief
Executive Officer of the Bank).
FINANCES
The Corporation's financial position eroded rapidly in early 1984, resulting primarily
from a run-off of deposits and other funding sources starting in May 1984. Business was
sluggish because of sharply narrowed margins and the effects of a large amount of Latin
American loans classified as nonperforming. At June 30, 1984, interest bearing deposits
totaled $14.5 billion, down from $24.9 billion at December 31, 1983.
Earnings
Earnings were offset by lower net interest income, reflecting the impact of interest
earnings reversals from nonperforming credits and increases in the general level of
interest rates which raised the cost of funding and narrowed margins. Higher other
operating income during the quarter more than offset the declines in net interest income.
Net income was $29 million for the first quarter; however, it was dependent upon a
nonrecurring revenue item totaling $188 million from the sale of the Bank's credit card
operations. The Corporation would have experienced a pretax loss of $140 million without
the nonrecurring income. The second quarter net loss was $1.2 billion. Net interest
income on a taxable equivalent basis was $166 million for the first quarter of 1984, down
from $241.5 million in the prior year's quarter. The net interest margin was 1.83 percent,
compared with 2.63 percent during the same period last year.




50
Assets
Earning assets averaged $34.5 billion during the second quarter — $21.9 billion
domestic and $12.6 billion foreign — down from $36.6 billion a year earlier. A significant
portion of this decline was in reduced domestic loan volume including the sale of the
charge card portfolio. At period end, earning assets totaled $32.3 billion, including loan
balances of $29.6 billion.
Nonperforming Loans and Losses
Nonperforming loans and lease financing receivables amounted to $2.7 billion at
June 30, 1984 and represented 9.2 percent of the loan and lease portfolio. Loans and lease
financing receivables to borrowers in the oil and gas industry totaled approximately $4.7
billion of which $1.1 billion were nonperforming. The provision for credit losses was $705
million. Net credit losses totaled $748 million.




51
FOOTNOTES

Participants include 28 major American banks.
Certain subsidiaries of Continental Illinois National Bank and Trust Company
of Chicago and certain subsidiaries of Continental Illinois Corporation are omitted
because such subsidiaries, considered in the aggregate, would not constitute a
significant subsidiary.
Except for directors' qualifying shares.
A multinational business is one that serves customers in the U.S. and other
countries.
U.S. banks that provide service to other domestic banks.
A Federal statute which authorizes national banks to form subsidiary corporations
for development of overseas business.
These countries are Argentina, Australia, Austria, Belgium, Brazil, Canada, the
Cayman Islands, Colombia, Ecuador, France, Indonesia, Iran, Jamaica, Japan,
Lebanon, Luxembourg, Malaysia, Morocco, Pakistan, Peru, the Philippines,
Singapore, Spain, Switzerland, Taiwan, Thailand, and the United Kingdom.
100 basis points equals 1 percent.
The corporate office included the Chairman, Vice Chairman, and the President. The
concept provided for most department heads to report to the corporate office rather
than to specific individuals.




52
EXAMINATION FINDINGS REGARDING
CONTINENTAL ILLINOIS NATIONAL BANK'S
LOAN MANAGEMENT AND CAPITAL

SEPTEMBER 18, 198*
STAFF REPORT
TO
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS SUPERVISION, REGULATION AND INSURANCE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS

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




53
EXAMINATION FINDINGS REGARDING
CONTINENTAL ILLINOIS NATIONAL BANK'S
LOAN MANAGEMENT AND CAPITAL

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 3ohn 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.




54
SECTION I
1976 THROUGH 1981, A BRIEF REVIEW
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
examination."
'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.)




55
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 1973 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. CINB'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/Ave rage total capital
9. Average risk assets/Average equity and reserves
10. Average debt/Average total capital
11. Dividend payout




56
12. Internal funding rate
("Performance Relative to Corporate Goals", 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 vunerabie 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
responsibility/accountability."
•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
involved."
(Letter to the Board of Directors, Report of Examination, November 1982, p. 2.)




57
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
regulators.
The resulting outflow of funds necessitated quick development and
implementation of a multibillion 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.




58
SECTION II
DISCUSSION OF CINB
LOAN ADMINISTRATION AND CREDIT QUALITY SYSTEMS
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 OCC's supervision of CINB was not appreciating the potential for
harm inherent in the combination of high growth policies and lax credit practices. The
examiners' 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
permit."
(Loan Portfolio Management, Report of Examination, August 1977, p. 7-1.)




59
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
overemphasized."
(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 tc the board of directors:
"Several credits which were rated "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.)




60
Concerning the deficiencies he had cited
management, McCarte wrote:

the year before

in the area of

credit

"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."
(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)




61
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 $2.4 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.

39-133 0—84

5




62
The second anomaly is the examination report's description of the oil and gas
division:
"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 O&G 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 0<5cG 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. Ail 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
deficiency.
Just before finishing the 1982 examination report, Examiner-in-charge, Richard
Kovarik, explained what happened to Continental and the relation to Penn Square this
way:
"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."




63
"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
wrote:
"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& 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."




64

"
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
Continental."

"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




65
million in 1983 to outside firms for litigation and the same in 1982. In comparison, —
only spent $10 million in 1983 for ail 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
shareholders."

"
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 June 24, 1984 meeting between
and the FDIC
closed with the comment that enthusiasm for the merger was dying at
with
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.




66
SECTION III
REVIEW OF EXAMINATION COMMENTS ON CINB
CAPITALIZATION
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 CIO 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 transmital 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 1978's 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 3.94% 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




67
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,
p.2.)
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,
p.2.)
"It must be realized however, that leverage and risk ratios continue to increase thus
placing increased strain on the xapital 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 $0%.
In 1976, CINB's capital was rated a clear and emphatic "Inadequate".




68
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 OCC's capital standards have changed over the years merit close
study.




69
Attachment I
TOTAL CRITICIZED ASSETS

1975 to 1983
(In millions of dollars)
Dates of Examinations
Category

6/15/75

2/27/76

3/31/77

4/30/79

6/30/80

4/30/81

4/30/82

6/30/83

Substandard §J

760

n

81
4

1,025
180
29

4,113
485

!i

1,045
72
12

2,908

357

806
197
28

921

Doubtful b/
Loss c/

848
381

1,131

" 1,240

1,031

1,129

1,006

1,234

3,686

4,733

491

306

429

173

340

597

1,934

2,853

1.622

1,546

1,460

1,302

1,346

1,831

5,620

7,586

Total Classified
Assets d/
OAEM s/
Total Criticized
Assets U

548
230

135

§'

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.

W

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

SJ

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.

dl

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

1'

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.

1'

Total Criticized Assets is the sum of d and e.




70
Attachment II
SELECTED SUPERVISORY DATA
1975 to 1983
(In millions of dollars)

Dates of Examinations
Category

6/15/75

2/27/76

3/31/77

4/30/79

6/3Q/80

4/30/81

4/30/82

6/30/83

Gross Capital
Funds(GCF)a/

1,038

1,025

1,193

1,410

1,651

1,848

2,144

2,157

Percent of
Classified Assets
toGCF

109.02

120.97

86.41

80.10

60.88

66.76

171.90

219.42

Percent of
Criticized
Assets to GCF

156.27

150.85

97.23

92.33

81.50

99.08

262.19

351.72

Reserve for Possible
Losses (RPLL)

166

151

144

175

208

235

287

363

Percent of
RPLL to Total Loans

1.53

1.41

1.20

.96

.89

.89

1.22

38

513

545

1,198

2,937

5,060

4,444

Standby Letters
of Credit W

2,272

§/

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

k'

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.




Cap j t a I Adequacy
Uhange
in
Ratio*




6.8
6.4

5.2
4.8 i
4.4
4.8 i

DPeer group
• Continental
1976

1977

1978

1979
T

:#:EI.^I.J i t y

Cap. i

1980

1981

1982 1983

ear

. J ^<.jt..r.r-.d i n a t . f d
c
=.

M o * .as:

to

To taI

brouith i n Loans
Percent
Uhanqe




:-:M

25

26
15

to

10

DPeer group
•Cont inental

-10

I 7i i

17 i O

I 7i 7

1989
Year

1981

1982

1983

Net Charqe-offs to Total Loans
Change
in
Ratio




1.6
1.4
1.2
1.0
GO

8.8
9.6
0.4
8.2
8 fi

D P e e r group
• Cont mental
1976

1977

197S

1979

1980

Year

1981

1982 1988

74
Chairman S T GERMAIN. At this point, I call on the very distinguished ranking minority Member, Mr. Wylie, for a statement.
Mr. WYLIE. Thank you very much, Mr. Chairman. That was a
very far-reaching and thought-provoking opening statement, and
certainly sets the stage for this hearing this morning.
There is indeed a desire, at least on this Member's part, to proceed with vigor and thoroughness to probe the Continental case.
We do not want it to be laced with acrimony or politics, but rather
to stress the many positive aspects of this inquiry, t h a t this subcommittee is conducting into the case of Continental Illinois to ascertain if there are indeed some things that we need to learn for
the future.
I would associate myself with your compliment of our staff. They
have done an enormous amount of good, hard preliminary work
through a bipartisan effort, and with assistance of the General Accounting Office have come up with some general ground rules
which the chairman and I have discussed.
I think the delicate nature of the information in some of the documents with which we must deal has required careful coordination
between the majority and minority with respect to certain investigatory tools of the regulatory agencies; and despite some differences along the way, most of the problems have been resolved with
reference to the ascertainment of the information which will be developed before this committee in a very cooperative relationship.
I believe we all agree t h a t the purpose of this hearing is not to
engage in any political debate but to learn what factors contributed
to the deterioration of Continental Illinois to the place where Federal assistance was required, and to consider what measures might
be taken to prevent this situation from occurring again. We should
make certain t h a t we do not create the expectation that as long as
an institution is big enough, there is no limit to the amount of risk
the Federal Government is willing to go to accommodate.
As we begin these hearings, I want to stress several points t h a t
should be borne in mind throughout the long hours we will spend
on this case. This is a unique inquiry because it is being conducted
on an open bank, one t h a t we all want very much to succeed in its
efforts to restructure itself with Federal assistance. Therefore, our
inquiry is historical in nature in t h a t respect.
We should refrain as much as humanly possible from speculation
as to the current condition or future prospects of the bank, I think.
Major banks operate in an environment drastically different
from t h a t which prevailed 50 years ago when the regulatory and
deposit systems were designed by Congress. Large banks now fund
themselves twice a day. Electronic communications make it possible for institutions to raise or lose funds practically instantaneousiyThis inquiry should prod the next Congress to give urgent consideration to the forthcoming recommendations for reform of the regulation of depository to institutions be made by the Vice President's task force, as well as to the deposit insurance reforms already submitted by the regulatory agencies.
We are all aware of the need to maintain the stability of our
monetary system. Despite deposit insurance and the part it has




75
played as a central part of this effort, we do need to do other
things to maintain t h a t stability. But stability should not imply
t h a t no bank should fail. Rather t h a n that, the banks which fail
should not threaten the system as a whole. To provide absolute protection against failure would imply a degree of regulation and supervision t h a t would stifle innovation and reduce the efficiency of
the entire economy.
With respect to the particular situation involving Continental, I
think it is remarkable t h a t a small group of regulators were able to
develop a $4.5-billion rescue package without guidance or consultation with Congress. This rescue package was necessary to maintain
the stability of the domestic and international financial markets,
in my judgment.
It is unfortunate t h a t these solutions have had to be fashioned on
an ad hoc basis whenever a failure or crisis has occurred. Too often
in the past, hearings have focused on the m a n n e r in which the regulatory process functioned in a particular case without giving adequate consideration to the larger policy issue of the most appropriate needs of maintaining reasonable stability in financial markets
and who should be responsible for this and what price should be
paid.
In your statement on Continental, Mr. Chairman, you have suggested t h a t perhaps this rescue should have been debated by Congress, as was the case with Lockheed and Chrysler. But would t h a t
have been practical? Legislation to assist Lockheed was introduced
in May 1971, but was not enacted until August 1971. The Chrysler
legislation was introduced in October 1979 but was not enacted
until J a n u a r y 1980.
Continental's problem was basically a liquidity crisis prompted
by a run on the bank. In a day when funds can be transferred
internationally almost instantaneously, the bank's deposit base
would have been eliminated before we got a bill out of this committee. I think prompt action was essential. And rather than attempt
to inject ourselves into the process, which I do not believe we really
want to do, we should concentrate on providing guidance to the
regulators as to how they should proceed in the future.
Mr. Chairman, I look forward to working with you toward t h a t
end. Thank you very much.
[The opening statement of Congressman Wylie follows:]




76
STATEMENT OF

REP. CHALMERS P. WYLIE, OHIO
SEPTEMBER 18, 198^
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
HEARINGS ON CONTINENTAL ILLINOIS
MR. CHAIRMAN:

THAT WAS A VERY FAR REACHING, THOUGHT PROVOKING STATEMENT, MR.
CHAIRMAN, - - AND CERTAINLY SETS THE STAGE.

THERE IS INDEED A DESIRE ON THIS MEMBER'S PART TO PROCEED WITH VIGOR
AND THOROUGHNESS TO PROBE THE CONTINENTAL CASE.

WE DO NOT WANT IT TO BE

LACED WITH ACRIMONY OR POLITICS BUT, RATHER TO STRESS THE MANY POSITIVE
ASPECTS OF THE INQUIRY THIS SUBCOMMITTEE IS CONDUCTING INTO THE CASE OF
CONTINENTAL ILLINOIS.

THE PRELIMINARY WORK HAS BEEN CONDUCTED THROUGH A BIPARTISAN STAFF
EFFORT WITH THE ASSISTANCE OF STAFF FROM THE GENERAL ACCOUNTING OFFICE,
UNDER GROUND RULES AGREED TO BY THE CHAIRMAN AND MYSELF.

THE DELICATE

NATURE OF THE INFORMATION IN THE DOCUMENTS WITH WHICH WE MUST DEAL HAS
REQUIRED CAREFUL COORDINATION BETWEEN THE MAJORITY AND MINORITY AND WITH
THE RESPECTIVE REGULATORY AGENCIES.

DESPITE SOME DIFFERENCES ALONG THE

WAY, MOST OF THE PROBLEMS HAVE BEEN RESOLVED, AND THERE IS EVERY REASON TO
BELIEVE THAT WE CAN CONTINUE TO ENJOY A COOPERATIVE RELATIONSHIP.

I

BELIEVE WE ALL AGREE THAT THE PURPOSE OF THIS HEARING IS NOT TO ENGAGE IN
A POLITICAL DEBATE, BUT TO LEARN WHAT FACTORS CONTRIBUTED TO THE
DETERIORATION OF CONTINENTAL ILLINOIS TO THE POINT WHERE FEDERAL
ASSISTANCE WAS REQUIRED AND TO CONSIDER WHAT MEASURES MIGHT BE TAKEN TO
PREVENT THIS SITUATION FROM OCCURRING AGAIN.




WE SHOULD MAKE CERTAIN THAT

77
WE DO NOT CREATE THE EXPECTATION THAT AS LONG AS AN INSTITUTION IS BIG
ENOUGH/ THERE IS NO LIMIT TO THE AMOUNT OF RISK THE FEDERAL GOVERNMENT
WILL BE WILLING TO ACCOMMODATE.

AS WE BEGIN THESE HEARINGS I WANT TO STRESS SEVERAL POINTS THAT
SHOULD BE BORNE IN MIND THROUGHOUT THE LONG HOURS WE WILL SPEND ON THIS
CASE.

THIS IS A UNIQUE INQUIRY, BECAUSE IT IS BEING CONDUCTED ON AN OPEN

BANK, ONE THAT WE ALL WANT VERY MUCH TO SUCCEED IN ITS EFFORT TO
RESTRUCTURE ITSELF WITH FEDERAL ASSISTANCE.
HISTORICAL IN NATURE.

THEREFORE, OUR INQUIRY IS

WE SHOULD REFRAIN AS MUCH AS IS HUMANLY POSSIBLE

FROM SPECULATION AS TO THE CURRENT CONDITION OR FUTURE PROSPECTS OF THE
BANK.

MAJOR BANKS OPERATE IN AN ENVIRONMENT DRASTICALLY DIFFERENT FROM THAT
WHICH PREVAILED FIFTY YEARS AGO/ WHEN THE REGULATORY AND DEPOSIT INSURANCE
SYSTEMS WERE DESIGNED BY CONGRESS.
A DAY.

LARGE BANKS NOW FUND THEMSELVES TWICE

ELECTRONIC COMMUNICATIONS MAKE IT POSSIBLE FOR INSTITUTIONS TO

RAISE OR LOSE FUNDS PRACTICALLY INSTANTANEOUSLY.

THIS INQUIRY SHOULD PROD

THE NEXT CONGRESS TO GIVE URGENT CONSIDERATION TO THE FORTHCOMING
RECOMMENDATIONS FOR REFORM OF THE REGULATION OF DEPOSITORY INSTITUTIONS TO
BE MADE BY THE VICE PRESIDENT'S TASK GROUP.

AS WELL AS TO THE DEPOSIT

INSURANCE REFORMS ALREADY SUBMITTED BY THE AGENCIES.

WE ARE ALL AWARE OF THE NEED TO MAINTAIN THE STABILITY OF OUR
MONETARY SYSTEM.
EFFORT.

DEPOSIT INSURANCE HAS PLAYED A CENTRAL PART IN THIS

BUT STABILITY SHOULD NOT IMPLY THAT NO BANK SHOULD FAIL.

THE CONCERN SHOULD BE THAT THOSE FAILURES THAT DO OCCUR SHOULD NOT

39-133 0-84

6




RATHER,

78
THREATEN THE SYSTEM AS A WHOLE.

TO PROVIDE ABSOLUTE PROTECTION AGAINST

FAILURE WOULD IMPLY A DEGREE OF REGULATION AND SUPERVISION THAT WOULD
STIFLE INNOVATION AND REDUCE THE EFFICIENCY OF THE ENTIRE ECONOMY.
WITH RESPECT TO THE PARTICULAR SITUATION INVOLVING CONTINENTAL/ I
THINK IT IS REMARKABLE THAT A SMALL GROUP OF REGULATORS WERE ABLE TO
DEVELOP A %K.5 BILLION RESCUE PACKAGE WITHOUT GUIDANCE OR CONSULTATION
WITH CONGRESS.

THIS RESCUE PACKAGE WAS NECESSARY TO MAINTAIN THE

STABILITY OF DOMESTIC AND INTERNATIONAL FINANCIAL MARKETS.

IT IS

UNFORTUNATE/ THOUGH, THAT THESE SOLUTIONS HAVE HAD TO BE FASHIONED ON AN
AD HOC BASIS WHENEVER A FAILURE OR A CRISIS HAS OCCURRED.

TOO OFTEN IN

THE PAST/ HEARINGS HAVE FOCUSED ON THE MANNER IN WHICH THE REGULATORY
PROCESS FUNCTIONED IN A PARTICULAR CASE/ WITHOUT GIVING ADEQUATE
CONSIDERATION TO THE LARGER POLICY ISSUE OF THE MOST APPROPRIATE MEANS OF
MAINTAINING REASONABLE STABILITY IN FINANCIAL MARKETS/ WHO SHOULD BE
RESPONSIBLE FOR THIS/ WHAT PRICE SHOULD BE PAID/ AND BY WHOM.

IN YOUR STATEMENTS ON CONTINENTAL/ MR. CHAIRMAN/ YOU HAVE SUGGESTED
THAT PERHAPS THIS RESCUE SHOULD HAVE BEEN DEBATED BY CONGRESS/ AS WAS THE
CASE WITH LOCKHEED AND CHRYSLER/ BUT WOULD THAT HAVE BEEN PRACTICAL?
LEGISLATION TO ASSIST LOCKHEED WAS INTRODUCED IN MAY 1971 BUT WAS NOT
ENACTED UNTIL AUGUST 1971.

THE CHRYSLER LEGISLATION WAS INTRODUCED IN

OCTOBER 1979 BUT NOT ENACTED UNTIL JANUARY 1980.

CONTINENTAL'S PROBLEM

WAS A LIQUIDITY CRISIS PROMPTED BY A RUN ON THE BANK.

IN A DAY WHEN FUNDS

CAN BE TRANSFERRED INTERNATIONAL ALMOST INSTANTANEOUSLY/ THE BANK'S
DEPOSIT BASE WOULD HAVE BEEN ELIMINATED BEFORE WE GOT A BILL OUT OF
COMMITTEE.

I THINK PROMPT ACTION WAS ESSENTIAL.

RATHER THAN ATTEMPT TO INJECT OURSELVES INTO WHAT THE FUTURE HOLDS FOR THE
RESCUE PROCESS/ WHICH I DO NOT BELIEVE WE REALLY WANT TO DO/ WE SHOULD
CONCENTRATE ON PROVIDING GUIDANCE TO THE REGULATORS AS TO HOW THEY SHOULD
PROCEED IN THE FUTURE.
THAT END.




I LOOK FORWARD TO WORKING WITH THE CHAIRMAN TOWARD

79
Chairman S T GERMAIN. I t h a n k the gentleman for his excellent
statement. However, I would like to make a point in response to
what he said.
In my delineation of the Lockheed, New York City and Chrysler
situations, what I was illustrating was the enormity of this bailout
with no discussion whatsoever as compared to those three combined. And as we know, they hit every financial publication in the
world for months and months, as you outlined.
What I am pointing out is that in this instance we discovered
t h a t the regulators have taken unto themselves powers t h a t the
President of the United States does not have, and we have to determine whether or not this is to continue in the future. I think t h a t
is the purpose of these hearings.
Mr. WYLIE. I do think there is another dimension in the Lockheed and Chrysler case. There was obviously an instance where
there might have been some exposure on the part of the Federal
Government.
I happen to have a disagreement in t h a t respect. I think t h a t
this went through the insurance process. The FDIC does have a
fund, and perhaps this is what it is to be used for. But, in that case,
we did have to have legislation because the Federal Government
was indeed involved in the bailout. And I am pleased to say t h a t in
both cases they worked out. I supported the chairman in the case
of Lockheed and the Chrysler matter—one of the few Republicans
who did. But, in both cases, t h a t proved to be a good investment.
I thought there was a little different dimension in this case in
t h a t we do not need legislation. But, of course, that is the subject of
these hearings this morning.
Chairman S T GERMAIN. And as the case evolves, we will get more
information.
At this point, I will call on the distinguished gentleman from
Chicago, the Honorable Frank Annunzio.
Mr. ANNUNZIO. Thank you, Mr. Chairman.
Mr. Chairman, I support you in the holding of these hearings on
the subject matter under consideration. However, I have serious
reservations about the timing of the hearings. Whether or not the
Continental situation was handled properly by the banking agencies and the management of Continental is important and a subject
t h a t must be addressed. Of greater concern is whether Continental
will survive or fail. I feel certain t h a t given the new management
at the bank, the recapitalization and increased attention by the
regulatory agencies, Continental will survive. But the bank is not
completely out of the woods. I hope these hearings will not cause
damage to the bank's future.
The rescue plan for Continental, the promise of insurance guarantees, regardless of the amount of deposits, are precedent setting.
But these hearings mark the first time in history t h a t a hearing
has been held dealing with a federally insured financial institution
while that institution was open and operating.
The Congress has carefully guarded the need not to cause public
panic. Yesterday a member of this committee pointed out t h a t
these hearings are really not about Continental but rather about
the regulation of banks, and we must bear this in mind.



80
That may be the case, but in practice, it is like the father preparing to give his son a spanking who announces to the child, "Son,
this spanking is going to hurt me more than it does you."
It may be the regulators who are spanked during these hearings,
but it is Continental that will feel the pain. If Continental, its depositors, its employees, its stockholders, and the U.S. taxpayers are
injured by these hearings, then this committee must be prepared to
take the blame.
I fail to see why the timeframe under which we are holding these
hearings is so critical. And if the timeframe is indeed critical, why
these hearings could not be held in executive session the way other
hearings have been held dealing with an open institution.
Let me turn now to the question of the Continental bailout
which seems to hold most of the public interest. Twenty years I
have been a member of this committee. In that time, we have
bailed out Lockheed Corp., the city of New York on two different
occasions, the Chrysler Corporation, and the International Monetary Fund This committee has had more bailouts than the 82d Airborne Division.
Too much attention has been given to the negative side of the
bailout of Continental, but not enough to the positive side. Continental prior to the bailout had correspondent banking relationships
with some 2,200 banks. That is, banks who had deposits with Continental.
Of t h a t figure, 976 banks had deposits in excess of the federally
insured ceiling. Breaking that figure down further, 66 banks had
deposits which were more than 100 percent of their equity capital,
and 113 banks had deposits in the amount of between 50 and 100
percent of their equity capital. Had there not been a bailout plan,
not only would Continental have failed, but at least 66 other banks
in the Midwest would have failed because their capital would have
been wiped out. And, a large number of additional banks would
have gone under because much of their capital was tied up with
Continental.
On the people side of the ledger—which I have always advocated
in this committee—between 10,000 and 12,000 Continental employees would have lost their jobs, as well as the employees of the other
banks who had large uninsured deposits in Continental.
Top-level management is not out of work long in a situation such
as Continental, but it is the lower, the middle-level groups, the tellers, the clerks, the janitors, the messengers, the cleaning force, and
other administrative personnel who have the tough times. While
we cannot get too upset about losses to large and wealthy stockholders, we should be concerned about the losses to the small stockholders of the banks and the stocks held by pension plans and
other similar groups.
There is concern, and rightfully so, t h a t Continental was given a
100-percent guarantee of insurance for losses suffered by depositors
while other troubled or failed banks received no such guarantees.
While I commend the regulatory agencies for saving Continental, I
am concerned about the dual standard. On J u n e 6, 1984, I wrote to
FDIC Chairman Isaac asking him to clarify the FDIC policy in the
future.



81
I am disturbed that even today no such hard line policy exists.
The need to know the FDIC policy is more critical now than at any
time since the Great Depression. There are 750 banks on the socalled problem list, 3 years ago that figure was only 250. Bank failures for 1984 are running at record rates. Today I reiterate my request to the FDIC to give the American people a policy on deposit
insurance.
In closing, let me make it clear that I am not carrying the water
of the top-level management of Continental who failed to run the
bank properly. But I make no apology or excuses for carrying the
water of those 12,000 Continental employees and those thousands
of small shareholders, many of whom are widows and pensioners
and many, many of the pension funds involving hundreds and
thousands of workers that are on the books of the Continental
Bank.
[The following news release containing a copy of the letter sent
to FDIC Chairman Isaac on J u n e 6, 1984 by Congressman Annunzio referred to above was submitted for inclusion in the record:]




82

Congressman

FRANK
ANNUNZIO
1th Congressional District - Illinois

FOR IMMEDIATE RELEASE

CONTACT: Curtis A. Prins
Subcommittee on Cosumer Affairs and Coinage
(202) 226-3280
Wednesday, June 6, 1984
ANNUNZIO ASKS FDIC FOR GAME PLAN

The following is the text of a letter sent today by Chairman Frank Annunzio (D-Ill.)
of the House Consumer Affairs and Coinage Subcommittee to Chairman William Isaac of the
Federal Deposit Insurance Corporation:
June 6, 1984

Honorable William M. Isaac
Chairman
Federal Deposit Insurance Corporation
550 17th Street. N.W.
Washington, D.C. 20429
Dear Mr. Chairman:
While I applaud your decision to guarantee all deposits and general
creditors of the Continental Illinois bank, I am at the same time concerned
about the overall procedures used by your agency 1n dealing with bank failures.
My observations lead me to the conclusion that the Federal Deposit Insurance
Corporation operates by a "seat of the pants" technique in dealing with bank
failures. Instead of presenting a well thought out game plan on bank failures,
your team looks as if it is drawing the plays 1n the sand after each bank failure.
This approach has caused anger, resentment and frustration on the part of many
bank depositors, bank officers and bank customers.
Many of my constituents have contacted me concerning the failure of the
United of America bank, and the government assistance and guarantees provided the
Continental bank. In the United failure, your agency used the so-called "market
discipline" approach, under which depositors have received 60 percent of their
uninsured deposits. Please tell me how I can explain to my constituents that
deposits 1n one bank are not Insured the same way they are 1n another bank.
As I stated 1n the beginning of this letter, I applaud your action on
Continental, but what position will your agency take when the next bank 1s 1n
trouble or falls? Will your decision be based on size alone?
I urge you, Mr. Chairman, to develop a publicly stated position on bank
failures and troubled banks. While there may be disagreement on what that position
may be, at least bankers and their customers will know 1n advance what the rules
of the game are. If the market discipline approach 1s to be used, then use it.
If guarantees such as those used in the Continental case are to be employed, then
let everyone know that fact, but there must be a stated policy. Without such a
policy, I foresee massive lawsuits, charges of favoritism and insurance by size
rather than equity.
I urge you to adopt such a policy with the utmost speed. By the time this
letter reaches you another bank may well have failed, and the question of the
treatment of those depositors and creditors will be raised anew.
I hope you will give this your urgent and immediate attention, and that you
will favor me with a reply as quickly as possible.




Sincerely,

Frank Annunzio
Chairman

83
Chairman S T GERMAIN. I t h a n k the gentleman. I am sure he has
t h a t same feeling for the widows and the unfortunates who were
h u r t by the failure of Penn Square Bank.
Now, I call on Mr. Leach for an opening statement.
Mr. ANNUNZIO. Mr. Chairman, I would like to respond to that. I
was one of those t h a t went to Oklahoma City. I reiterated my feelings. I expressed myself to the gentleman who had lost his son in a
plane crash and received $1 million and put t h a t money in Penn
Square and thereby losing over $900,000. There is no question
Chairman S T GERMAIN. He should have put it in Continental.
Mr. A N N U N Z I O . Well, he put it in Penn Square. He came close.
But I do want to point out here, Mr. Chairman, t h a t when the Federal Deposit Insurance Corporation acted and the other regulatories, they acted under what they feel is the authority given them by
the Garn-St Germain bill that was passed and signed by the President.
So what needs clarification is the legislation t h a t you sponsored
with Mr. Garn, t h a t I voted for and the members of this committee
voted for, because we had faith in your leadership and in Mr.
Garn's leadership, and if t h a t legislation needs fixing, you will
bring it back before this committee, and we will fix it.
Chairman S T GERMAIN. Well, I will say to the gentleman, since I
indeed was responsible for writing t h a t legislation and contend
that that did not give them this authority, we will have you testify
at one of the hearings.
Mr. ANNUNZIO. I am not a lawyer, so I don't know.
Chairman S T GERMAIN. Mr. Leach, you are recognized for your
statement.
Mr. LEACH. Thank you, Mr. Chairman.
I have a lengthy statement that I would ask be submitted for the
record.
Chairman S T GERMAIN. Without objection, so ordered.
Mr. LEACH. I would just like to make a few remarks.
One, it is hard not to decide that in a free enterprise society, any
institution, no matter how large, should be allowed to fail. What
we have here is a regulatory, as well as banking scandal. The problems of this bank were largely undetected by the regulators and
loose banking practices were allowed to continue. The biggest regulatory problem of all is t h a t standard rules for large bank failures
didn't and don't now exist.
Therefore, instead of simply pointing fingers of blame at the regulators and Continental, I would hope the committee and the regulators would explore ways to prevent this from occurring again.
One approach might well be to consider guaranteeing a hefty
percentage—perhaps as much as 80—of all deposits above $100,000
in insolvent institutions, so t h a t insolvent institutions can be liquidated with a minimum disruption of the financial system.
It is quite clear t h a t the issues we face in American banking
today are question about quality of money center bank loans, the
adequacy of the capital of our larger banks and lack of uniformity
in regulation. I think it is time t h a t "get tough" policy of national
bank regulation is instituted and greater attention is given at the
larger banks to the capital adequacy problem. The big should be



84
regulated as firmly as the small and if circumstances warrant, they
should be allowed to fail.
Finally, one comment about the distinguished gentleman from Illinois' reference to the timing of this hearing. I think it is important and fair to note that what we have here are potential taxpayer liabilities. I would stress the regulators refused earlier this
summer to come before this committee to talk about this issue. So
we have postponed consideration for a number of months.
I would also stress that I don't think survival of Continental is
very much in question. The Chairman of the FDIC has announced
publicly that he is prepared to infuse new funds into Continental
and what we really have in Continental is a situation where miracle workers are not needed as they were needed at Chrysler, just
glad-handers. What we have here is a newly organized bank with a
fair capital base, few nonperforming loans—thanks to the Government—and an open-ended commitment from the FDIC to provide
more funds.
That is unlike any other bank in this country today, and I think
that what we really have here is a question of whether we embarrass the regulators, not whether we have a bank that is going to
exist. This bank has got it made.
Thank you.
Chairman ST GERMAIN. I thank the gentleman. I now would like
to put your entire statement in the record, without objection.
[The opening statement of Congressman Leach follows:]




85

Statement by
REPRESENTATIVE JIM LEACH
before the
Subcommittee on Financial Institutions,
Supervision, Regulation and Insurance
September 18, 1984

I am sure that I speak for the committee in stressing that the purpose of these
hearings is not to diminish confidence in the newly created Continental Bank nor
to unravel the FDIC rescue package, but to explore ways to prevent the need for
this type of unprecedented government intervention from recurring.
But I must confess at the outset that I have grave doubts about the wisdom of
the course of action the regulators took. In a free enterprise society, all
institutions, no matter how large, should have the right to fail.
Fifty-six banks have been declared insolvent this year and either closed or
merged. Yet Continential, the nation's eighth largest bank, has received a massive aid package that will allow it to continue to compete as a quasi-nationalized entity. This action has serious implications both for market discipline and
for large bank-small bank competition.
The Continental precedent would appear to imply that large banks have a better
brand of deposit insurance. Thus, large depositors are given an incentive to
place their funds in money center banks, no matter how imprudently managed,
rather than in small banks, which may well be on a percentage basis better capitalized. I am hopeful that one of the results of these hearings will be that
Congress redress this inequity.
One approach to this dilemma might be for the federal bank regulators to develop
uniform rules and procedures for handling bank liquidations.
In order to
assure broad confidence in the U.S. banking system, but not go to the brink of
protecting high-flying banks and high-risk depositors, they might consider
announcing a policy of guaranteeing that a hefty percent (perhaps 80) of all
deposits above $100,000 will be immediately returned to depositors in banks that
become insolvent, with assurances of the return of any additional recoverable
assets after liquidation. Such an approach would have the advantage of assuring
standard rules and orderliness, without dulling market discipline.
The bailouts of Lockheed, Chrysler and New York City stand as controversial
acts of government, but at least they were widely debated and received the
specific statutory support of Congress and the President. The bailout of
Continental is based on broad stand-by authority transferred to regulators
by previous Congresses. What makes it particularly unseemly is that the regulators
who decided on the nationalization approach are the very ones who failed to stop
the banking practices that caused the problem in the first place.
The ultimate irony may be that the only approval required for the regulator's
approach had to come from a formal vote of stockholders who were to be saved, not
from taxpayers or their representatives in Congress who potentially have to foot the
bill.




86
Chosen to head the newly reorganized bank are two distinguished businessmen —
John Swearingen, formerly Chairman of Standard Oil of Indiana and William Ogden,
formerly vice-chairman of Chase Manhattan. But the public need not hold its
breath in doubt, as it did with Chrysler, whether Continental will make it.
Unlike Chrysler and Lockheed before it, actual cash — not just a leveraged loan
guarantee -- has been infused into the bank and the most dubious portion of
Continental's liabilities assumed by the government. William Isaac, the chairman of the FDIC, even pledged at a news conference that if things do not go well
in the months ahead, his agency is prepared to give more. Survival is not in
question. Continental does not need miracle workers, just glad handers.
Swearingen and Ogden have taken the helm of a financier's Utopia: a newly organized bank with a solid capital base, few non-performing loans, and an open-ended
commitment of the FDIC for more funds. Can there be any doubt that Continental
represents as much a regulatory as a banking scandal?
A wiser approach, it would seem, would simply have been to liquidate the bank,
selling off at a discounted value its loan portfolio. The regulators argued
this would have taken years, sparked a loss of confidence in America's banking
system, and caused in a domino fashion the collapse of numerous smaller banks. I
doubt it. Give or take a few billion, what Continental represented when the
regulators stepped in was a bank with no capital base, approximately $35 billion
in responsible loans and perhaps as much as $5 billion in uncollectables.
Instead of moving to insure all depositors on May 18 and eventually making what
appears to be a $4.5 billion mistake, the FDIC could have closed the bank, sold
its loan portfolio, paid off fully the $3 billion in insured deposits, and 86C
on a dollar of uninsured deposits. The shareholders and bondholders would have
lost all, and the uninsured depositors been burned to the tune of 14 cents on
the dollar -- not an unrealistic penalty for poor risk management of funds, nor
one likely to have caused the failure of other banks or a collapse in confidence
in America's banking system. Instead of rewarding risk-prone banking practices,
the precedent established would be one of providing a firm but not panicked
warning to stockholders and depositors to watch management more carefully. All
growth is not good growth. Smaller can be more beautiful.
Rather than reinforcing the safety and soundness of the nation's banking system,
the approach federal regulators took emboldens improvidential banking practices.
The consequences for taxpayers are grave. But far graver are the consequences
for management of the money supply and, in effect, the economy itself. If banks
do not face the discipline of the marketplace and keep prudent loan portfolios,
the money supply will grow disproportionately in industries or geographic
regions where growth-at-all-eosts banking takes place.
While Continental's problems are unlike those of other money center banks in
that they largely relate to inadequately supervised domestic as opposed to
foreign loans, the Continental bailout carries with it implications for the
international lending practices of other larger banks. When lending is unrestrained by either the enforcement of an adequate capital base or, as in the
case of foreign reserve requirements, financial institutions have a tendency to
create excessive capital through the multiplier effect of making loans. The
inflation of the late 1970s as well as the overextension in foreign lending can
be traced in no small measure to the 25 percent per year growth regulators
allowed to occur in Eurocurrency financing. Since any bank can grow simply by
taking on more loans as long as depositors can be attracted and protected, it is
imperative that incentives be established for depositors to be wary of institutions like Continental. Management's decision to expand the bank's loan base at
twice the national average -- over 20 percent per year from 1977 to 1981 and to
rely excessively on high cost, short term money should have been warning enough
to depositors as well as shareholders.
Perhaps the most important reform that occurred in banking as a result of the
bank failures of the Depression was the establishment of deposit insurance,
which today covers accounts up to $100,000. But the FDIC announcement May 18
that it intended to insure all deposits of any size at Continental signalled for
the world that bankers need give little heed to risk management. Uncle Sam
would provide a safety net for the big and powerful even at a time government
agencies were given a mandate to prune programs for the weak and defenseless.
The Continental bailout could not more graphically illustrate that deregulation
is a matter of rhetoric rather than substance in Washington. If the most free
enterprise biased administration in recent history blinks in the face of political embarrassment involved in the potential folding of our eighth largest bank,
what can be said about the future of our market economy?




87
Ironically for smaller banks that have stronger capital requirements than larger
ones, the ramifications of the Continental bailout are likely to be similar to
those that occured after the Bert Lance episode. The regulation will be toughened. For larger banks, boardrooms can breathe easier. The precedent will be
comforting. Pressure to put our biggest banking houses in order will be reduced. Attention will be focused on broadening FDIC insurance coverage rather than
on the real problem, which is capital adequacy.
The scatter-gun decisionmaking that hallmarked the regulators' handling of the
Continental issue underlines the appropriateness of Congress' rethinking the
entire federal bank regulatory structure. Three separate federal agencies were
responsible for overseeing Continental, and this diffusion of responsibility may
be partially responsible for the negligence that appears to have characterized
the oversight of the bank. A single federal banking agency might have some
advantages in eliminating the problems of overlapping jurisdiction and vague
responsibility which plague the system. The burden of proof, generally speaking,
rests with those who advocate institutional change and while it may be premature
for Congress to take a definitive position, the case for a thorough review of
the regulatory system is powerful.
One footnote speaks for itself. Congress, as the elected body of the American
people empowered to make spending decisions for taxpayers, was not only not
fully consulted in advance on the policies that were applied to Continental, but
regulators refused this summer to come before the appropriate oversight committee except on the agreed upon premise that they would not respond to questions
about Continental. It is alway easy to suggest that confidence in the banking
system might have been jeopardized if the issue received a thorough review, but
this Representative is hard pressed not to wonder whether confidence in the
judgment of the regulators is not the real issue.
The bailout that is needed for our large banks is a private- rather than
public-sector one -- a recapitalization based on the selling of equity. Large
banks don't want to sell stock because it implies dilution at a time when the
vast majority of bank stocks sell for less than book value. But raising money
the old-fashioned way makes a lot more sense than relying on the government for
newfangled bailouts.




88
Chairman S T GERMAIN. Mr. Schumer has an opening statement.
Mr. SCHUMER. I have an opening statement I won't read, but I
ask unanimous consent that it be read into the record.
Chairman S T GERMAIN. Without objection.
Mr. Barnard.
Mr. BARNARD. Thank you, Mr. Chairman.
Mr. Chairman, I would just like to make a couple of observations
as we proceed with this very important hearing today.
Perhaps I am emphasizing something that Mr. Wylie mentioned
in his opening statement, but I can see t h a t the hearings beginning
today will serve a very beneficial purpose. We have had on the
menu for several years issues t h a t I think will give us further light
and edification as we begin to consider them.
One is regulatory reform. That has been a consideration and
even the vice president formed a task force. We haven't heard anything final from that task force's recommendations, but I think
these hearings will show further t h a t regulatory reform should be
a consideration of this committee in the next session.
Second, insurance reform; I think we already see t h a t the FDIC
and FSLIC can't be the sole support of risk t h a t banks take and
t h a t this is another subject t h a t needs some very definite consideration.
Three, I think possibly we need to rethink the Garn-St Germain
bill. As beneficial as t h a t was in solving the crisis of the savings
and loan industry when it was passed, perhaps these hearings show
t h a t this is a consideration t h a t we ought to also anticipate in the
next session, as to what guidelines we need to set up t h a t the regulators should follow instead of following their own desires in solving these problems.
Four, I think t h a t this also should give us an opportunity to further examine the issue of deregulation and how far deregulation
really should go and whether or not deregulation had any really
significant effect on the condition of this institution or the other
institutions t h a t have failed.
So, I summarize by saying t h a t I think these can be beneficial as
to setting us on a course of action that this committee, the Financial Institutions Subcommittee of Banking, should take in the ensuing months and years to come.
Chairman S T GERMAIN. I t h a n k the gentleman.
Mr. McKinney is recognized.
Mr. M C K I N N E Y . Thank you, Mr. Chairman.
As disagreeable a topic as Continental Illinois bailout is for us, I
am glad t h a t the subcommittee is finally moving ahead with this
oversight investigation. I find myself increasingly annoyed at what
I am reading and hearing about the way this bank conducted its
business and the role played by the regulators responsible for examining the financial condition of that institution.
My curiosity is heightened, Mr. Chairman, by the appearance in
the last few days of an interview with a senior official of the Comptroller's Office published by the Washington Post 4 days ago and a
report in the New York Times of a memorandum circulated to the
media by the Comptroller's Office. It appears to me the motivation
behind this sudden outburst is to seize the offensive before this subcommittee can ask any embarrassing questions. Why t h a t office



89
might be embarrassed eludes me since the questions have all been
asked before.
Approximately 2 years ago, in fact, we conducted hearings into
the failure of the Penn Square Bank, I would expect that Mr. Conover could come before us with boiler plate testimony today, changing only the names of the bank.
Mr. Chairman, in addition to learning how this bank fell to such
a state, I hope we focus some attention on future hearings and how
to prevent similar occurrence. I think t h a t will demonstrate there
is a relationship between poor bank management practices and potential risks involved in other business lines.Why should we trust a
banker who can't manage a loan portfolio to be able to successfully
engage in insurance, securities, or real estate?
There are several other points which need to be made during the
course of these hearings. There is a great distinction between a
congressionally approved bailout of New York City or Chrysler and
an administratively approved Continental bailout. I don't want to
abuse the kindness of the chairman and the subcommittee to elaborate, but the difference is valid and I hope, it will be made very
clear to the public as time goes on.
I would also like to find out what the regulators feel they have
done, No. 1, by creating a new class of bank in the United States of
America, a TBTF—too big to fail. What have they done to the
soundness of the funding of the Federal Deposit Insurance Corporation and its future; what have they done to the myth of the wall of
separation between the holding company and the banks since they
have really in fact saved the holding company rather than the
bank, and what have they done to determine what is a safe level of
assets in short-term foreign deposits.
If I sound as though my mind is made up on this issue, it is only
because we have been there before. No city followed New York to
ask Congress for help, no corporation came asking for the treatment we gave Chrysler. That was because no one in charge of a
city or industrial company wanted to be laced with the stringent
oversight conditions we—the Congress of the United States, acting
for the people of this country—imposed on that city and on that
corporation as a precondition for Federal assistance. Why do the
regulators treat banks differently?
It seems to me t h a t regulators have decided that, in fact, a bailout may be conducted without the consent of those who are going
to pay the bill and without stringent requirements and regulations
that we put on those other Federal assistance bills, Mr. Chairman.
In fact, it is with great interest I note that the regulators have decided that the very people who issued those rotten loans will now
manage them.
Chairman S T GERMAIN. The Chair recognizes Mr. Shumway for a
unanimous consent request, I believe.
Mr. SHUMWAY. Thank you, Mr. Chairman.
While I believe this to be largely an exercise of Monday morning
quarterbacking, I do recognize the high state of emotions on this
issue, indeed on both sides of the aisle. I share the concern regarding the timing of these hearings expressed by the gentleman from
Illinois, Mr. Annunzio.




90
Without taking further
get to the witnesses, Mr.
that my full statement be
[The opening statement




of the committee's time so that we can
Chairman, I request unanimous consent
included in the record.
of Congressman Shumway follows:]

91
STATEMENT OP THE HONORABLE NORMAN D. SHUMWAY
September 18 1984

Mr. Chairman, I commend you for calling these hearings which,
hopefully, will provide the Committee Members with a fuller
understanding of the backdrop of events occurring at Continental
which led to its recent crisis and subsequent federal intervention,
as well as the implications of these actions for the banking
industry. I am, however, concerned that the focus of these hearings
may shift away from their original goals and delve into the possible
relationship between Continental's woes and proposals now before the
House and Senate to deregulate further the banking industry.
I am all too aware that opponents of product deregulation for banks
will try to cite the Continental experience as still one more piece
of evidence that bankers are so inept at handling their own business
that it would be folly to trust them with additional powers. What
is even more disturbing to me is that these opponents are inflaming
the gereral — and largely unsophisticated — public into assuming
that Continental's problems were even attributable to the limited
deregulation that has already occurred...I would suggest that not
only are these notions fallacious but also are submitted by those
competitors of banks seeking to protect their respective turfs.
Let's examine some of the fallacies. First, I would note that
deregulation did not cause the problems of Continental when it*
troubles first became apparent. Rather, Continental's operations
were conducted in one of the most regulated states in the country,
which prohibits even branch banking. Because Continental was more
geographically limited in its deposit taking function than other
banks, it was forced to seek and to rely on high-cost — not to
mention volatile — international deposits to fund its lending
program. Further, the bank's problems appear to have been the result
of unusually poor management of a quite traditional banking function
of taking in deposits and lending them out, and not from the new
activities sought such as securities trading or investment banking.
The bank's reliance on international purchased funds, together with
non-performing loans purchased from the now-failed Penn Square Bank,
created a real drain on earnings and increased its exposure to
speculation as to the future viability of the institution.
This speculation reached a crisis level in mid-May of this year when
Continental was hit by the classic run on deposits, something, from
which, I might add, no financial depository institution is immune.
I am convinced that had the Federal regulators not stepped in when
they did, the effect on public confidence in and the stability of
our nation's financial system would have been devastating.
Just why the panic run developed when it did, the extent of
federal involvement in and the favorable treatment of Continental
will be the subject of great debate. Suffice it to say that I,
too, am anxious to have the cards put out on the table. However,
I am afraid that when all is said and done, the true culprit in
the Continental debacle will not be forced into the open. Who is
the culprit? The current system is. The laws that were designed
to regulate and restore confidence in the nation's banking
system bear a large share of the responsibility for the problems
facing the financial services industry today. This is particularly
true of federal deposit insurance, which eliminates market
discipline in- the banking industry and encourages insured
depository institutions to take additional risks. I am convinced
that until we change our perspective of providing blanket guarantees
where the institution is too large to fail and applying uniform
insurance premiums — rather than assessing premiums based upon
institutional risk of exposure — we will be faced with many more
"Continentals". We cannot let this happen to the American
depositor or to the American banking system.




92
Chairman S T GERMAIN. DO any other members of the subcommittee seek recognition?
Ms. OAKAR. Mr. Chairman. Just a brief comment.
Chairman ST GERMAIN. Mary Rose.
Ms. OAKAR. Mr. Chairman, I want to commend you for these
hearings on Continental Illinois. Hopefully, the thrust of the hearings will not be what Continental is today, because I share the gentleman from Illinois , concern about a run on the bank. Consumers
ought to know that they are probably dealing with a bank t h a t is
very well protected and assured t h a t their investments with the
bank are fine.
However, I have some concerns about the Comptroller, the primary regulator of Continental Illinois, and I think we ought to use
this hearing not so much in terms of identifying the bank but as a
point of departure, as a benchmark for how we don't want to see
banks operate. I really want to know why the Comptroller issued a
statement on May 10, 1984, t h a t he was not aware of any problems
when, 7 days later, a massive rescue program was announced.
I can understand my friend from Chicago's concern, and I hope
t h a t the focus will be on the regulators and their oversight and
what we do in the future to assure that this kind of catastrophe
doesn't happen again. Consumers should know that they are protected, which is important, for managing the situation in Chicago.
Thank you.
Chairman S T GERMAIN. Mr. Dreier.
Mr. DREIER. Thank you very much, Mr. Chairman.
Like everybody here, I am extremely concerned about the twotiered handling of the Federal insurance system, but although it is
becoming more and more difficult after having listened to my
senior colleagues on this subcommittee, I am going to try to keep
an open mind as we face the issue.
Thank you, Mr. Chairman.
Chairman S T GERMAIN. Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
I want to commend you for holding these hearings.
I frankly felt that we should have moved as quickly as possible to
evaluate this because I think there is a debate whether or not the
regulators actually had the power to do what they have done.
I think all of us recognize the volatility of this problem, the types
of concerns that affect our colleague from Illinois, which in fact affected our entire international economy with the demise of Continental Illinois.
Nevertheless, these meetings and our role as a part of representative democracy are such that we should exercise it with care and
responsibility and trust that our constituents have in us.
Mr. Chairman, I am concerned about the issue that arises with
almost 800 banks in trouble this year, many of them have been
treated far differently than this large financial institution. The
challenge to this committee fundamentally relates to these large
money center banks, megabanks, if you would, and whether or not
we are able to supervise them adequately, whether, for instance,
the FDIC action to protect consumers here has been used for a far
different purpose in essence, to reinforce and deal with a different
problem.




93
After all, the $4.5 billion t h a t we put in at the discount window
t h a t is open to all banks with the special charters t h a t banks have,
those types of loans and responsibilities and decisions to make
those loans basically on an international basis throughout our
country are decisions which we end up underwriting as a National
Government.
So we are, in essence, opening the economic book to be used in
the private sector to write a whole host of loans which are then
bought by the public sector through insurance and chartering functions we have. It is as if these private entities, the private banking
system in this country and financial institutions are absorbed and
nationalized.
And yet we have an inadequate control over the economic writing and loan capacity of these particular institutions. This is the
fundamental question t h a t we, as a committee in terms of our
charter and in terms of our relation, have to come to deal with.
I might remind the committee they are all not losers, the bondholders, those with the golden parachutes, many others t h a t benefited from these types of actions.
So I commend the chairman and look forward to working with
him and the other members of the committee as we try to resolve
these and many other questions being raised.
Chairman S T GERMAIN. Thank you.
Mr. Patman.
Mr. PATMAN. Thank you, Mr. Chairman.
I am grateful for the opportunity to attend this hearing and
listen to what I hope will be somber good testimony.
I do urge this committee press forward immediately to clarify the
rules on insurance companies for the largest banks as compared to
the insurance coverage available to the depositors in the smaller
banks.
Where is the dividing line? What are the questions? What are
the guidelines t h a t enter into the minds of those regulators who
are undertaking to determine whether or not the bank in Seminole, TX, for example, t h a t went broke a few weeks ago apparently,
has only 55 cents on the dollar for its depositors above $100,000?
What are we going to do about Financial Corp. of America
out on the west coast and these many, many other large institutions that appear to be very fragile in their financial stability?
I am hoping that we can develop the guidelines, the information
needed, for the depositors and the investors all over this Nation
and come out with legislation t h a t may be necessary in order to
strengthen the regulatory process, grant greater authority if necessary to the regulatory agencies, but do give more safety and soundness to our system of financial institutions.
Mr. SCHUMER. Mr. Chairman.

Chairman ST GERMAIN. Mr. Schumer.
Mr. SCHUMER. I can't resist making it a straight flush on the top
row by saying a few words.
I think the question we must address concerns not just the regulators, Mr. Chairman. I think the question is how many more large
money center banks will run into the same problems t h a t Continental has run into? We are in a new world of go-go banking. We
are in a world where banks are under tremendous pressure to

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0—84

7




94
maximize the return they get from loans. We have seen not just
too much money pushed into oil and gas loans, we have seen
money pushed into Third World countries and now into leveraged
buyouts.
Will we be sitting here 3 years from now having another hearing
about 1 or another of the 10 largest banks that put too much into
leveraged buyouts? One thing is clear, if a penny candy store was
r u n the way Continental was run, it would be bankrupt in 6
months. The issue is how many more banks are in this problem?
And it is our responsibility to look at that because, one, banks
are not an unregulated industry, the Federal Government gives
them all sorts of advantages; but, two, they are too important to
the lifeblood of this country to be left simply to the bankers themselves.
Chairman S T GERMAIN. The Chair would observe t h a t after my
many years on this committee, this is probably one of the most
stimulating and participatory openings of any set of hearings. It
would appear to me t h a t there is a slight bit of interest on the part
of the members of this subcommittee in these proceedings. Certainly, I have been listening attentively to my colleagues, each and
every one of them, and I appreciate the fact that they see challenges in this set of hearings and have questions about what occurred.
So all I can say is that it bodes well for the work of the committee t h a t we have so many members who are so intensely interested.
Now, we will begin the actual proceedings. I would ask Mr.
Meade, Mr. Kovarik, Mr. McCarte and Ms. Kenefick if they would
be kind enough to stand and raise their right hands.
Do you swear t h a t the testimony you are about to give will be
the truth, the whole t r u t h and nothing but the truth?
[Witnesses sworn.]
Chairman S T GERMAIN. Please be seated.
I would ask t h a t when Mr. Meade, Mr. Kovarik, Mr. McCarte are
called upon to answer their initial questions t h a t they provide for
the subcommittee the information on the sheet t h a t I have provided to you, to wit, your OCC employment background and current
employment, which examinations you served as examiner in
charge, which examinations you participated in, and whether or
not you had the opportunity to reacquaint yourselves with the examination reports, and if so, which ones?
When you are called upon for your initial answer to a question,
we would ask you to address those points for the benefit of the
members of the subcommittee and for the record.
I would like to address my first question to Ms. Kenefick.
But before I do, I would ask unanimous consent to place in the
record at the conclusion of my questioning the September 17 staff
report on Continental Bank's financial history, the September 18
staff report on examiner findings, the November 15, 1982 memorandum from Richard Kovarik to William Martin, and the July
1982 Kathleen Kenefick memorandum which will be the subject of
my questioning with Ms. Kenefick.
There being no objection, so ordered.
Ms. Kenefick, I am going to ask you to outline for us your employment history at Continental and the staff has made copies of
your July 1982 memorandum on oil and gas lending available to all



95
the members. We will ask you to describe the circumstances t h a t
led up to your writing, of this memo, we will ask you to summarize
the memo; and we will ask you to explain the following excerpts
from it: what you meant by the status of the Oklahoma accounts—
particularly Penn Square Bank—as a cause for concern; next, management of credit relationships has not taken place; next, in some
cases the initial credit writeup had customer information missing,
out-of-date or incorrect, and in other cases there has not been a
credit writeup.
Furthermore please comment on: followup of accountability
having been rare; next, housekeeping problems, missing note
sheets on approvals, documentation errors and omissions, past due
principal and interest compounding the situation. Do you consider
these housekeeping? They sound like fundamental documentation
problems. Then, the Oklahoma calling personnel continuing to
fight to keep their heads above water with time spent putting out
fires and, therefore, falling further behind.
At the conclusion of her outline or explanation of her memorandum, I would ask the examiners to reply as to whether or not they
feel the conditions Ms. Kenefick described would have been viewed
as serious by OCC examiners. In other words, please comment on
the seriousness of the conditions described in the Kenefick memorandum.
Ms. Kenefick, I would like you to address one last thing in your
reply. I would like to know if you feel—this is important to a lot of
my staff members on this side—that perhaps the memorandum you
wrote—that to many of us seemed very penetrating and well
done—perhaps due consideration was not given to this memorandum because despite the fact that a lot of people tout t h a t they
have females in high positions in their organizations, unfortunately
often times it is more lip service t h a n anything else, and I would
like to know whether you feel t h a t t h a t had any bearing on the
fact that your memorandum was not given due consideration by
upper management in Continental Illinois.
That is the conclusion of my question. You are now recognized to
reply, Ms. Kenefick.
TESTIMONY OF KATHLEEN KENEFICK, FORMER EMPLOYEE,
CONTINENTAL ILLINOIS NATIONAL BANK
Ms. KENEFICK. Thank you, Mr. Chairman.
You asked me to outline my employment history at Continental
Bank. I started in the bank in J a n u a r y 1975 as a management
trainee in the commercial lending department of the bank, and I
was in t h a t training program until late summer or early fall of
that year.
I then received my first assignment in one of the commercial
lending departments as a member of the surface transportation division. My title at that time was commercial banking associate, and
I worked in the section which was responsible for the area west of
the Mississippi River.
During t h a t time period I received two promotions from—to comercial banking officer and again in late summer or early fall of
1976, and then secondly—should I continue?




96
Chairman S T GERMAIN. Yes, please.
Ms. KENEFICK. Then to second vice president, again in late
summer or early fall of 1978. My responsibilities during t h a t time
grew as I had more experience. I originally worked assisting others
with their customers and eventually came to handle independently
my own customers and territories. I was responsible for marketing
bank products to the various customers and prospects, doing financial analysis and negotiating on behalf of the bank.
In the late fall of 1979, I was asked to take a new assignment as
a supervisor in the management training program. In t h a t responsibility I managed various associates with backgrounds from BA's to
MBA's. This is, in effect, the same training program t h a t I had
started in at the bank. I supervised, evaluated, reviewed, I also had
various administrative functions and worked on recruiting and
interviewing for the bank.
In the spring of 1981, I had completed my assignment as supervisor in the training program, and I was assigned to the midcontinent division of the oil and gas group.
I left the bank in September of 1981.
Chairman S T GERMAIN. NOW, would you continue to address the
other portions of the question? The circumstances t h a t led to your
writing the memorandum t h a t we have inserted in the record.
Ms. KENEFICK. During the time I was in the division, before writing the memo, approximately 4 months, I was trying to learn about
the oil and gas industry, and the division and the customers. I
became more uncomfortable with the decision process t h a t was
being followed in order to make the credit decisions.
I was also becoming less and less comfortable with our relationship with Penn Square Bank. I had had several conversations with
Mr. Lytle of specific instances or questions or concerns, and I felt
t h a t I wasn't
Chairman S T GERMAIN. Mr. Lytle, what was his capacity in this
area?
Ms. KENEFICK. Mr. Lytle was division manager of the midcontinent division of the oil and gas group.
Chairman S T GERMAIN. Was he the principal contact with Penn
Square?
Ms. KENEFICK. Yes, he was, Mr. Chairman.

Chairman S T GERMAIN. IS he the individual who borrowed rather
substantial sums of money from Penn Square during this period of
time, he was also pursuing participation loans from Penn Square
on behalf of Continental Illinois?
Ms. KENEFICK. Mr. Chairman, I don't have any personal knowledge of his loans.
Mr. BARNARD. Mr. Chairman, could you ask her to speak up? I
can't hear her.
Ms. KENEFICK. I am sorry.
Mr. WYLIE. If the chairman will yield so I might edify the memorandum we are talking about.
Chairman S T GERMAIN. We have placed it in the record.
Mr. WYLIE. IS this it here? There are no names on it, and it
doesn't indicate who prepared the memorandum or to whom it was
sent.




97
Chairman S T GERMAIN. The memorandum is the one we have
before us; unfortunately, the Xerox is not as good as it might be,
but it is on stationery of Continental Bank, and it says, "Oklahom a " in big letters and the first lines read "Status of the Oklahoma
accounts, particularly Penn Square Bank, is a cause for concern."
That is the memorandum.
Mr. WYLIE. I want to be sure we were referring to the same
memo. It doesn't have any identifying names on it.
Chairman S T GERMAIN. Except with the initials of Ms. Kenefick
at the end—CK.
Mr. WYLIE. Did you prepare the memorandum on your own initiative, or was t h a t at the request of someone else?
Ms. KENEFICK. Congressman
Chairman S T GERMAIN. That she is right now describing—she is
describing the circumstances t h a t led to her preparation of the
memorandum.
Mr. WYLIE. That is a good question then. OK; t h a n k you.
Ms. KENEFICK. A S I was saying, I felt t h a t I wasn't making much
progress in various conversations I was having with Mr. Lytle regarding some areas of discomfort and concern that I had, and I felt
perhaps t h a t the best way to approach it would be to put some
thoughts in writing, so Mr. Lytle and I could discuss them. Basically, t h a t is the circumstances.
Chairman S T GERMAIN. Would you just summarize the memo for
us?
Ms. KENEFICK. All right. The memo is basically five pages long; it
is a memo t h a t I wrote in July 1981 addressed to Mr. Lytle, titled
"Oklahoma." The purpose of the memo was to summarize what I
felt were various problems and the reasons for those problems that
were occurring in the midcontinent division, but the primary
reason of the memo was to propose what I felt were solutions to
the issues t h a t I raised.
Chairman S T GERMAIN. NOW, if you would explain specifically
the items I have listed under (3).
Ms. KENEFICK. The first sentence, status of
Chairman S T GERMAIN. These are excerpts from your memo.
Ms. KENEFICK. The first sentence in my memo in here is what I
am saying is t h a t the Oklahoma accounts, and particularly those
accounts where we have participated with Penn Square Bank, were
in my opinion a cause for concern.
This really just summarizes my feelings at the time.
Chairman S T GERMAIN. Next, management of credit relationships has not been consistently taking place.
Ms. KENEFICK. Again, this summarizes some of the feelings t h a t I
had at the time where I felt that we were not consistently on top of
our accounts, we were not able to anticipate future requirements
or future actions that
Chairman S T GERMAIN. What do you mean by "on top of your
accounts"?
Ms. KENEFICK. Well, to the extent that we would be managing
the credit relationship of the account, we would be monitoring the
situation, watching for certain things, anticipating the next step.



98
Chairman S T GERMAIN. Could you be a little more specific, because what you are saying is, they had not taken place. So what we
would like to know is, what was it that didn't take place?
Ms. KENEFICK. Perhaps, Mr. Chairman, I can answer it this way,
t h a t the environment of the division at the time I was there was a
very reactionary type of environment due to the growth in the division, as well as what I felt were shortages of people in the division,
and, therefore
Chairman S T GERMAIN. People or qualified people?
Ms. KENEFICK. People. People in the section, I should say, not division. And, therefore, we were not able to really take charge of
the relationship as best perhaps we could have.
Chairman S T GERMAIN. Next, in some cases, the initial credit
writeup had customer information, et cetera.
Ms. KENEFICK. This is just another one of the problems I felt
were present in the division at the time. I can't recall numerous
specific instances. I just say t h a t at the time my thoughts were,
after having reviewed various different credit writeups and things
and doing some questioning of the people t h a t had written them,
t h a t perhaps there was additional information that should have
been included, some information that was out of date.
In a couple occasions with further digging, we found information
t h a t was provided to us t h a t was not correct. In other cases, I say
there has not been a credit writeup, there were again—again, this
is a hazy memory, but I do recall that many of the credits were
approved with just a commercial reporting form which is a computer input form without a detailed note sheet in many occasions explaining the purpose of the credit.
Chairman S T GERMAIN. What size loans are we talking about
here, roughly?
Ms. KENEFICK. Most of these loans were small loans, $5 million
or under.
Chairman S T GERMAIN. Five million or under?
Ms. KENEFICK.

Yes.

Chairman S T GERMAIN. TO a lot of us, t h a t is a lot of money.
Mr. Barnard said it turned out to be housekeeping problems,
t h a t is, missing note sheets, approvals documentation, errors and
omissions, and past due principal and interest compounding the situation.
Were those really housekeeping problems and or do you think
t h a t missing note sheets, document errors—never existed?
Ms. KENEFICK. Mr. Chairman, I don't know if they never existed
or if they were missing.
Chairman S T GERMAIN. In other words, you never saw them?
They were not available?
Ms. KENEFICK. Correct.
Chairman S T GERMAIN. SO it could be t h a t they never existed.
Ms. KENEFICK. That is possible.
Chairman S T GERMAIN. And then, one more after this, the Oklahoma calling personnel continue the fight to keep their heads
above water with time spent putting out fliers and, therefore, falling further behind. Would you elaborate on that?
Ms. KENEFICK. In this sentence I was basically trying to summarize what I felt at the time the environment in the division was. I



99
felt we were short people, I felt that we were continually expected
to react in a very short timeframe. The demands for turnaround
were very quick.
Chairman S T GERMAIN. What do you mean by "turnaround?"
Ms. KENEFICK. TO make a decision on a credit request. And because we seemed to be suffering from some catchup work, we were
never able really to both catch up and go forward at the same time
with growth in the division.
Chairman S T GERMAIN. Are you essentially saying that within
that division one of the big problems t h a t you found was that you
were always appeared to be beh/nd rather t h a n acting currently, to
something t h a t had already happened, No. 1.
Second, I asked you, you said you were short of people, and I said
"qualified people" and you said "people". But is it not a fact you
need scientific personnel as well, engineers, et cetera, to go out and
look at these properties and properly evaluate them, and did they
have t h a t type of personnel available to them in sufficient numbers
to do the work t h a t had to be done in reviewing these loan applications and loan approvals?
Ms. KENEFICK. Well, Mr. Chairman, during the time period t h a t I
was in the division, there were initially two petroleum engineers
and one chemical engineer and an additional chemical engineer
was added to the division, and I do believe t h a t Mr. Lytle was looking for an additional petroleum engineer. I am not sure I am qualified to say whether that was adequate staff or not, but they were
extremely busy.
Chairman S T GERMAIN. But you did say there were not enough
people.
Ms. KENEFICK. The engineers were extremely busy individuals.
My comment about enough people was primarily relating to the account managers, people calling directly on the customers.
Chairman S T GERMAIN. Thank you, Ms. Kenefick.
[Copies of the memorandum by Ms. Kenefick to Mr. Lytle of July
1981 and the bank examination report of Mr. Kovarik dated Nov.
15, 1982, follow:]




100

'.MEMORANDUM
BlOG

11

fL . • i ' - ' NO

@ £ CONTINENTAL BANK
:}

DIVISION"

UK.LAHUMA
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 CIN'B 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. Customer dissatisfaction is a possible next occurence.
The explosive growth in the number of relationships, combined with personnel
shortages and the organizational structure followed,-"are the perceived primary
causes* In addition, however, the short term transaction philosophy (put the
loan on for 30-90 days with either a strategy or more information to follow)
adds to the problem* This builds the workload and potentially limits options*
The standards of acceptability of work, both here at CINB and from Penn Square
Bank, are other causes of the problem. The lack of control exerted over Penn
Square Bank "after the fact" is another source of concern as the situation may
change without our being aware of it*
Suggested actions address both the immediacy needed to handle the current
situation and procedures to follow in the future which try to prevent the same
problems*
It should be recognized that this redirection and reprioritizing of
efforts involves tradeoffs, primarily affecting the rate of growth of new
business at least in the short term. The long run positive effects of knowing
where we are and where we should be going should outweigh this* In addition it
should facilitate a smoother transition ot account relationships (customer
benefit) and potentially improve people development while hopefully using them
more effectively.
Short Term Proposal
Using a team of people made up ot calling personnel and administrative support,
the following steps should be tatten:
1)

Organize accounts by "family" exposure and prioritize by available
credit; make assignments of responsibility to calling persons.




101

I)

Totaiiy re-examine the relationship, i.e.:
a)

b)

critically evaluate the situation, emphasizing strengths
ana weaknesses of the credit

c)

recommend future action, both what we and the customer
should be doing to improve the relationship

d)

examine documentation, comparing what we think we have
and what we actuaily possess; determine what we need

e)
3)

verify cus turner iuf or;aat lo"., t'iiing in any raissl:*^
information or updating it as needed

present the above material in written form.

Lytle and Kenefick "reapprove" each exposure and the steps to be
taken.

4) Work with Penn Square bank, Loan Division, Collateral Vault, Credit
Files, etc. to complete our requirements.
5) Start new procedures (outlined in Long Terra Proposal) on any new
transactions that arise.
Timing of completion is impacted by the number of people and other resources
dedicated to the project, as well as the number of accounts to be examined.
The first step may take a week to ten days. It is estimated it will take one
calling officer on average Z to J full days to handle the second step per
"family" of accounts, with (2A) being potentially very time consuming. With
respect to (2d), the calling officer should work with a senior counterman to
determine what we need while the administrative people can handle the other
requirements. Step 4 may drag on for quite some tiue, potentially months.
It is suggested that a minimum of six calling personnel and three administrative
support people be assigned to the team. At least one calling person would
handle current -business, though possibly two may be needed on some days. The
remaining members would devote their time to their responsibilities connected
with this team. Travel during this phase should be limited to obtaining any
information needed, by either meeting with Penn Square Bank and/or the customer
as necessary. Other resources such as a work area away from other distractions,
storage space to accumulate materials and a designated typist or two would
speed results.




102

''MgacRANDuaa

« | K CCNTJNEJ^JTAL S A N K
C C M I M S t U ' l U t O K HMI ••*» C»!»» »l»0 ' » "St -•*««•'«»•

< -«f Ml

Suggested Members:
Kenefick, Lucas, Liddell, Sullivan, Cavallo, two banking associates, Donis,
Maliey, two operating trainees.
MOTE:

Winget and Bainbridge would be especially valuable in the early stages
so addressing tins course of action early on would be important. Their
help would facilitate the organization of accounts and assist the
development of the new banking associates.

Long Term Proposal:
Probable causes of the situation at hand should be addressed in order to attempt
to keep the same situation from happening again.
1) Rapid Growth in the number of relationships
This in itself is a benefit and a cause we don't want to change. We
should however recognize its side effects when we and Penn Square Bank
are not able to keep pace with it. We should also recognize some of
the time requirements for turnaround may be lengthened by what is
proposed here.
2)

People Shortages
It is my understanding that close to half of the available credit and
approximately two-thirds to three quarters of the borrowing accounts
are located in the Oklahoma territory. Having four people handling
this volume in the past was not adequate. The ideal would be to have
two calling personnel handling Tulsa and four handling the rest of the
state. They would report to a Sectiou head who would be able to devote
full time to their direction.

3) Organizational Structure
The account relationships should be divided among the calling personnel.
Accountability and follow thru should be more consistent as a result.
Duplication of effort and inefficient use of time may diminish. Some
of the more active and/or complex accounts should utilize a backup
arrangement. Management of the relationship, both the credit risks
and the profitability of the account, should be stressed. All credit
requests should initially be examined by the calling officer whose
responsibility it is to decide whether to proceed. They will also
have the responsibility to monitor the situation. All necessary




103

'.'•' &S2BCRANDUM.

.<$& CCfrJTINEri TAL EA^:X

I
materials to aid them (i.e., j>ast due notices, Customer balance
Reports, Loan Review writeups, etc.; should be directed to them.
Account assignments should come utter the short-term proposal is
at least assigned. We should also utiLize tie engineers properly
without confusing the (function ot the account officers, i.e.,
loans based on reserve quality suould be reviewed by the engineers
whose responsibility it is to set loan values.
4)

Transaction Philosophy
As mentioned previously, the philosophy or Keeping our customers on
a "short string" (3u-9u day transaction loans) with either a strategy
or more information to toHow adds to our problems* Besides requiring
us to look at the same transaction at Least twice, our options are
potentially limited when the money is out the door. We should strive
to match the length ot the transaction to repayment source. Strategy
and necessary information should be known up front before a decision
to lend occurs. Short term credits may make sense in situations when
a specific event is supposed to occur.

5)

Standards of Acceptability
Hopefully with additional personnel we will have the ability to improve
our output while keeping pace with new business and handling the old
effectively. Our credit proposals would be enhanced if in addition to
the purpose of the loan and possible repayment, qualitative discussion
occurred which examined both the strengths and weaknesses of the deal
before reaching a conclusion. Minimal information should include
current financial information (audited or unaudited); Other debt
especially in the event secured (and by what) should be noted. Basis
used for assets (book/market) should be included and any significant
investments should be examined, besides a balance sheet and income
statement contingent liabilities should be included (especially in the
case of individual statements). All these comments apply to both
corporate and individual statements. We should also require the
statements be signed by either the individual or an officer of the
company (if unaudited).
We should stress internally with our people and externally with Penn
Square Bank and other banks, the importance of putting the loan on
properly the first time, bunding should occur not only after we have
the proper approvals but after we have the proper documents on hand,
documents which have been approved to form by the account officer,
counterman and legal counsel. We must particularly remember to have




104

-*• MEMORANDUM

CONTINENTAL BANK
COIUIMNUt. ILLINOIS NMIONM. 9ANK A.10 TRUST COMPANY OF CHICACO

counsel approve any documents we did not draft internally. We have
to better train ourselves first and then others as to what is expected;
they won't change unless we do.
6)

Lack of Control
It is not clear whether the participation agreements are currently
drafted in a way which allows Penn Square Bank to "change" the deal
after the fact and merely inform us (rather than consult us) or that
they just do it anyway. It is thus not clear whether using a multibank
agreement would .be an advantage over a participation certificate (or
even then if they would recognize the different requirements) but it
is potentially something to consider.
In any event we should consider taking on more responsibility ourselves,
whether directly (both in terms of decision making and in terms of
adminstrative functions) or indirectly (keeping copies of everything,
"auditing" their material,'etc.). We should recognize that the problems
we have had keeping pace with the growth have been even greater at
Penn Square. We should also make sure that in the event any set-off
would take place, the banks would share pro-rata based on exposure.

Conclusion
Again the importance of recognizing tradeoffs comes to mind, both in terms of
timing and scope of actions taken and not taken. Both short term and long term
solutions should be sought. We need to get our own house in order first while
at the same time potentially changing our procedures. Only then can we get
others to change. Positive steps taken today may minimize future losses and
alleviate problems. Making sure we explore the credit request thoughtfully,
putting the loan on right the first time and then monitoring the results afterward should be re-emphasized. Having an adequate number of people to handle
the volume is also important for success. The desired results from these steps
would be to have a good understanding of what shape the current Oklahoma portfolio is in (at the same time allowing us to catch up on all of our exceptions),
a plan of action to be taken if necessary in the future, a smoother transition
of account managers, and a reduced likelihood that the current situation would
occur again.
MJH:CK
17-66




105
TO:

Hilliare E. Martin, Deputy Comptroller for hlaltinati nnal Banking

rrom:^Richard M. ItovariX, Senior national Bank Dcaminer
Oete:

Itovenber 25, 1982

Subject:Continental I l l i n o i s National Bank and Trust Co., Chlcacp, I I .
SCM^Hy OF PiTRT.r>S
Problems are centered i n heavy volumes o f problem loans which have received
wide eaqposure i n the p r e s s , and t h e i r a f f e c t on earrings which resulted in a
second quarter l o s s o f $61 m i l l i o n after a-special provision t o the BFLL of
$220 million on loans purchased from the Perm*Square Bank, N. x . Trie increasing
l e v e l s o f non-performing loans and the second quarter l o s s r e s u l t e d in a severe
blow t o CXC*s p o s i t i o n and reputation, with duties Lie investors shunning many
of CIC's l i a b i l i t y instruments.
Although the Perm Square relationship accounts for a r e l a t i v e l y small portion of
pmhlere loans ( l e s s than 20%) the publicity surrounding i t s c l o s i n g was surely
the one event that has done the most damage.
I t i s my opinion that there are b o inter-related causes of the present s i t u a t i o n .
ELrst, the aggressive growth philosophy of QC was not tempered by increased
controls (loan quality safeguards) and second, the management s t y l e of great
authority and r e s p o n s i b i l i t y resting in individual unit managers, was without
proper supervision from t h e i r superiors.
Althoutfi in the f i r s t instance i t can be said the lack of q u a l i t y control i s
universal for the bank, the second cause i s more l o c a l i z e d - p a r t i c u l a r l y i n the
Special Industries and Real Estate Croupe.
The loan Review function at CXNB has been the recipient of c r i t i c i s m from the
CCC for at l e a s t three years, However, as i t was functioning f a i r l y w e l l , that
c r i t i c i s m was not as strong as i t now appears i t should have been.
The decentralized management philosophy works well i n many areas of the bank
which i s truly the r e s u l t of having good managers e v e r a l l . In the Special
Industries Group, the chain of command from John Lytic through Gerald Bergman
was deficient in attending to matters such as c o l l a t e r a l documentation and f b l l o w i ^ /
bank p o l i c y with respect t o reporting c r e d i t s . The b i g problem here, was that there
was no system in place t o uniformly assure that managers at various l e v e l s were
taking the r e s p o n s i b i l i t y along with t h e i r authority. As long as everything appeared
t o be going along sroothly, no one bothered to check. In f a c t , when there were
signs of trouble, (bad press about Penn Square Bank and C^Q's relationship audit and operations memos discussing various operational problems with Penn
Square) no one took the steps t o independently look at the s i t u a t i o n . They
merely went to those i n charge of the area and ware reassured that things would
be/ware OR.
The bank now faces the job of rebuilding i t s image, m the present environment
t h i s w i l l prove to be a,, d i f f i c u l t task. Third quarter earnings w i l l be respectable but not overly encouraging. ^tan-performing loans w i l l h i t the $2 b i l l i o n
mark and the acme may s t i l l not have been reached, although any r i s e in the fourth
quarter I s not expected t o be steep at t h i s time.
SUBS3QUg*T SVPTTS
After becoming aware of the problemi related to Perm Square, Chairman Roger
Anderson asked the Board to form a Special Peview Conrittee c o n s i s t i n g of Directors
Robert Melott (CBD, IMZ Corporation), Blaine J. Yarrington (rfP, Standard Oil
Co. Indiana) and Chairman W i l l i s e s * 3 . Johnson (CSD, IC Industires, Inc.) to
oversee reviews to be marfc by manaoem?nfr_ H%.naosrent i s beinjsy aided i n t h e i r
reviews by acaountantsHand attorneys A^rom S n s t fc vcu-nnTO *& Mayer, Brow* &
P i a t t , both CLEW connected to CIC, however, those "outside' individuals have not
been d i r e c t l y involved with CIC i n the p a s t . Additionally, the Directors Review
Committee i s advised by independent legal counsel (a retired judge) and accounting
counsel (partner from Price Waterhouee i C o . ) .
The f i r s t phase o f management's review i s completed and has received Board approval.
This resulted in numerous personnel changes and a redistribution of r e s p o n s i b i l i t i e s
among the senior s t a f f . Phase two i s in process with preliminary r e s u l t s
encouraging. Loan review w i l l be completely revamped and numerous other internal
control changes w i l l be i n s t i t u t e d ,




106
HBCa*gNCED OJHiCLTXVC fCTZCtt
Urn situation i s scr«r«, but not bsUeued c r i t i c a l . Although msnageaent i s surely
tD blarm fer the shortcomings in the s y s t e m that allowed the present p z o b l e c s ,
th*y hawt recognized them and are taking steps to deal withtthen. htany o f the
loan problem need an improved econondc environment to turn around and u n t i l that,
happens, s i g n i f i c a n t reductions in problem a s s e t s cannot be e j e c t e d . Th« funding
problem w i l l only go away with inprov«d earnings and a s s e t q u a l i t y , although
presently i t nust be considered s t a b l e .
Sam enforcement action to r e l a t e our aonoexns i s appropriate. Zt should,
however, be i n l i n e with, and take note of, what they hare already done o r hav*
i n s t i t u t e d . Further, I have imrie a strong bid toward g e t t i n g the bank t o be
nach sore open with us. Vie should take t h i s apcortinitv to get the flow o f
infbxsBtion we need s t a r t e d .

Chairman S T GERMAIN. I now ask Mr. Meade and Mr. Kovarik
and Mr. McCarte to introduce themselves as provided for in the
outline I gave them and then to tell us whether or not Ms. Kenefick's memorandum was an accurate one from their experience.
Mr. Meade.
TESTIMONY OF JOHN MEADE, SENIOR NATIONAL BANK
EXAMINER, OFFICE OF THE COMPTROLLER OF THE
CURRENCY
Mr. MEADE. Mr. Chairman, and members of the committee, my
n a m e is John Meade, and I am from Northfield, IL. I am senior
national bank examiner with the Office of the Comptroller of the
Currency. The Office of the Comptroller of the Currency supervises
the national banking system. To perform its task, the Comptroller's
Office through its examination force, examines each of the more
t h a n 4,500 national banks located throughout the United States.
An examination may include, among other things, a review of
the bank's asset quality, liquidity, earnings, and any other areas
deemed necessary or appropriate. The end result of the examination is detailed in a report of examination.
I joined the Comptroller's Office in 1964 as an assistant national
bank examiner, and I was commissioned a national bank examiner
in 1968. From 1966 to 1969, I primarily examined the foreign
branches of national banks and the international departments of
multinational banks.
From 1970 to 1976, I examined banks of all sizes and complexity
in the Chicago area. In 1977,1 was
Chairman S T GERMAIN. Excuse me, Mr. Meade. Staff will try to
get t h a t microphone a little better placed for you.
Now, Ms. Kenefick realizes she is not the only one who has problems with the mike. Thank you.
Mr. MEADE. In 1977, I was appointed Deputy Regional Administrator in Cleveland. In t h a t position—which I held for 6 years—I
was responsible for surveillance and supervision of national banks
in Ohio, Indiana and Kentucky.
My duties included scheduling examination, monitoring and reviewing reports of examination, and initiating appropriate action
to address problems in national banks. I have been in my current
position as a senior national bank examiner in Chicago since
August 1983, currently serving as examiner in charge of multinational banks in Chicago.
Chairman S T GERMAIN. Would you tell the subcommittee what
you mean by the term "multinational banks"?




107
Mr. MEADE. Multinational banks are those generally defined in
the Comptroller's Office as the 10 or 11 largest national banks
throughout the country.
Chairman S T GERMAIN. And in Chicago there would be how
many of those?
Mr. MEADE. There would be two.
In early 1973, I was first selected to be the examiner in charge of
the examination of Continental Illinois National Bank. As examiner in charge, I was responsible for planning, organizing, directing,
and controlling the examination function.
I also supervised the examining personnel assigned to me, prepared the report of examination, and reviewed the results of the
examination with executive management. Between 1973 and mid1976, I examined the bank five times. Since t h a t time, I have participated in the summer of 1983 examination of the bank, and I
also participated in the May 1984, examination of the bank, assisting Examiner Kovarik.
I have had the opportunity to review the five reports of examination that I conducted from 1973 to 1976. At this point, I would be
happy to answer any questions you may have concerning Continental Illinois or the examination process.
Chairman S T GERMAIN. Would you just briefly tell us, when the
Comptroller's Office goes into a bank, specifically Continental Illinois, which, as you say, is one of the 10 largest banks in the country, a multinational, how many personnel do you usually have with
you and for how long a period of time does an examination ordinarily take place? What is the average time span?
Mr. MEADE. I think, Mr. Chairman, I will speak for the period
prior to 1977, because in 1977, we changed our examination procedures, and the approach was somewhat different. So for exams
prior to 1977, an examination would take approximately 2 months;
we would have a number of people assigned to us that would peak
at 50 or maybe 55 people and toward the end of the examination,
the numbers would diminish, so t h a t at the conclusion there were 3
or 4 people assigned there.
Chairman S T GERMAIN. And the frequency of examination?
Mr. MEADE. At t h a t time, we were examining the bank three
times every 2 years.
Chairman S T GERMAIN. SO actually, the exams were about 6
months out of every 36 months?
Mr. MEADE. Approximately 6 to 8 months.
Chairman S T GERMAIN. Every 6 months, thank you.
Mr. MEADE. Every 8 months.
Chairman ST GERMAIN. Mr. Kovarik.
TESTIMONY OF RICHARD KOVARIK, SENIOR NATIONAL BANK
EXAMINER, OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. KOVARIK. Thank you, Mr. Chairman.
My name is Richard Kovarik, I am senior national bank examiner with the Office of the Comptroller of the Currency from Naperville, IL.
I have been employed by the Comptroller since 1966 with my
first employment being as an assistant national bank examiner. In



108
1970, I was commissioned a national bank examiner and in 1979, I
was appointed a senior national bank examiner.
Chairman S T GERMAIN. Have you always been in the Chicago
area?
Mr. KOVARIK. Yes, sir. I have.
During my 18 years with the Comptroller's Office, I have examined a number of banks, primarily in Illinois and Michigan. I have
participated in all areas of the commercial examination process
and most recently I have been functioning as the examiner in
charge or concentrating on asset quality evaluations.
Since 1977, my primary duties have involved examining Continental Illinois National Bank and the First National Bank of Chicago.
As examiner in charge of those banks, it has been my responsibility to coordinate the examination team, ensure timely completion of those examinations, and, of course, write the resulting
report of examination.
I was first involved in the examination of Continental Illinois in
the late 1960's, and, at one time or another, I have been involved in
numerous facets of the commercial examination at Continental Illinois.
I conducted the examination as examiner in charge of Continental in 1977, 1982, 1983, and 1984. While the principal focus of these
examinations concerned asset quality, other areas such as liquidity,
earnings, capital, policy and procedure, systems and internal controls, were also reviewed.
Examination timeframes at the examinations I was in charge of
varied from 4 to 6 months, consumed as many as 2,200 work days,
and involved as many as 60 assisting examiners.
I have had an opportunity to review my 1977, 1982, and 1983 reports of examination.
Chairman S T GERMAIN. NOW, you were examining during the
period of time Ms. Kenefick wrote her memorandum. Had you been
aware of that memorandum?
Mr. KOVARIK. I was not examiner in charge.
Chairman S T GERMAIN. YOU were examining at that point?
Mr. KOVARIK. I examined in 1982, yes.

Chairman S T GERMAIN. Did you have an opportunity to review
her memorandum?
Mr. KOVARIK. I read her memorandum, I believe it was in either
July—no, it was August or September of 1982.
Chairman S T GERMAIN. And what was your reaction to her
memorandum at that time, as to its value and its accuracy?
Mr. KOVARIK. I think I said to myself I wish I would have known
this 3 months ago.
Chairman S T GERMAIN. Thank you.
Mr. McCarte.
TESTIMONY OF ALLAN McCARTE, FORMER NATIONAL BANK
EXAMINER, OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. MCCARTE. Mr. Chairman, I am Allan McCarte, former
member of the Office of the Comptroller of the Currency. I wel


109
come this opportunity to visit with you and I would like to give you
some of my background when I was employed by the OCC.
I joined the Comptroller's Office in 1963 as an assistant national
bank examiner, and was promoted to the level of commissioned national bank examiner in 1967. From approximately 1966 through
June 1981, I was involved in and responsible for a variety of assignments which included the following. I served as regional coordinator for college relations which primarily was recruitment efforts in
the States of Illinois and Michigan.
I also functioned as an administrative assistant in the regional
office and became involved in the budgeting and monitoring of
human resources as they were involved in the examination process
for Chicago and the various subregions.
Additionally, as part of my assignment as administrative assistant I was responsible for reviewing reports of examination at the
regional level. I have also been involved in the investigative process as it relates to new bank charters as well as to branch sites of
existing banks.
I was one of 3 Chicago area crew chiefs with personnel responsibility for approximately 24 assisting examiners as well as the
scheduling and examination responsibilities for approximately 50
banks, one of which was the Continental Illinois.
During the years of 1979, 1980, and 1981, I served as examiner in
charge of the Continental. The 1981 examination was commensed
in early J u n e of t h a t year and employed financial data with an "as
o f date of April 30, 1981. The examination was concluded in early
to mid-August 1981. I was scheduled to perform the 1982 examination of the bank and had gone so far as to schedule personnel and
arrange for working space and request list data when the bank approached me with an employment opportunity on J u n e 10, 1982.
Chairman S T GERMAIN. The bank approached you with an employment opportunity?
Mr. MCCARTE. Opportunity, yes, on J u n e 10, 1982. Once this
overture was made, I removed myself from the examination to
avoid a conflict of interest situation.
I would mention at this juncture t h a t at the time the Continental Bank approached me I was entertaining another employment
opportunity with another sizeable bank holding company outside of
the seventh region.
I was immediately assigned to the Chicago Office and I made the
decision to join Continental in late J u n e 1982. I have had the opportunity of reviewing the 1981 examination report in some detail
but have had lesser time to spend on the 1979 and 1980 reports.
Chairman S T GERMAIN. Thank you.
Mr. Annunzio.
Mr. ANNUNZIO. I would like to ask one question. You know, we
heard after Oklahoma City about the administration of the bank,
and the mismanagement and all the ills that led to the problems
that Continental is facing.
Are any of you—Ms. Kenefick, are you in a position to tell us
now t h a t all the ills are out in the open? What kind of position, in
your opinion, is the bank in now?
Ms. KENEFICK. Mr. Congressman, the only information I have to
reach an opinion, of course, is what I have read in the press. I am
39-133 0—84

8




110
quite hopeful for Continental Bank based on the steps t h a t have
been taken. I believe they are a strong bank and they still have a
strong management team in place.
Mr. ANNUNZIO. Thank you.
Mr. Meade, you have heard my question, and you have been examining the bank. When was your last examination?
Mr. MEADE. It was in 1976, sir.
Mr. ANNUNZIO. The last time you were there?
Mr. MEADE. 1976 was the last time I was examiner-in-charge.

I
assisted Examiner Kovarik in 1983, and 1984.
Mr. ANNUNZIO. Can you add an answer to the question t h a t I
have asked? In your opinion, what kind of situation is the bank in
today?
Mr. MEADE. I believe t h a t in light of some of the concerns raised
by members of the committee, it wouldn't be appropriate for me to
comment on this point.
Mr. ANNUNZIO. Mr. Kovarik?
Mr. KOVARIK. I would also submit t h a t it would not be appropriate for me to comment on the present circumstance of Continental.
Mr. ANNUNZIO. Mr. McCarte?
Mr. MCCARTE. Well, of course, I would be hard pressed to have
an unbiased observation, but I am personally encouraged by the
condition of the bank right now.
Mr. ANNUNZIO. Well, Mr. McCarte, when was the last time you
were in the bank to examine?
Mr. MCCARTE. A S I stated, I was there for the 1981 examination.
Mr. A N I W N Z I O . And, Mr. Kovarik?
Mr. KOVARIK. I performed the examinations in 1982, after having
done one in 1977, and also in 1983 and 1984.
Mr. ANNUNZIO. And your last examination, Mr. Meade?
Mr. MEADE. Was

1976.

When I was in charge, yes.
Mr. ANNUNZIO. When you go into these banks you have examining teams. When was the last time you were in there, Mr. Kovarik,
as a member of a team?
Mr. KOVARIK. We performed an examination starting in J u n e
1984.
Mr. ANNUNZIO. All right, t h a t is getting close. In what condition
did you find the bank in J u n e 1984?
Mr. KOVARIK. Sir, I really would rather not answer t h a t question
as far as the current status of the bank. I think the bank's circumstances have been highly publicized with the assistance package,
the number of loans being bought by the FDIC.
Mr. ANNUNZIO. We all know t h a t the bank has been reduced
from a $40 billion bank to a $25 billion institution. I thought by
having you gentlemen here you could give us some authentic information. But all the mistakes and the ills and the situations t h a t
led to the downfall of Continental have been scrutinized closely by
the regulators and certain corrections have been made and it looks
like Continental will probably come out of it, and instead of being
one of the large banks of $40 billion, it is going to be a good $25
billion bank.
Mr. WYLIE. Would the gentleman yield on t h a t question?
Mr. ANNUNZIO.

Yes.




Ill
Mr. WYLIE. I think maybe t h a t is a question t h a t more appropriately ought to be addressed to the Comptroller of the Currency. I
have visited with him about that and I think he is prepared to discuss that, Mr. Annunzio.
Mr. ANNUNZIO. Well, I do wish t h a t when the regulators get here
they will be able to shed some light. That is one of the reasons I
felt t h a t maybe we needed more time as far as the hearings are
concerned. Mr. Chairman, you can recall in Oklahoma City when
we had the members of the board of that bank there and the regulators, the people in Oklahoma City felt t h a t Penn Square was not
an institution t h a t should be closed. And if they were given enough
time they would be able to have the necessary capitalization to
keep the bank open.
There was a great deal of disagreement at t h a t point as to
whether the capital raised by the members of the board in Oklahoma City would be able to save the bank, and they accused the regulators of acting too hasty. I am not accusing anybody of acting
hasty, but I do think the committee needs a lot more information
before we can really make a judgment as to the necessary legislation and procedures we are going to follow in order to correct the
situation.
This committee, as I see it, is not interested in correcting anything at Continental, but we are interested in tightening up the authority of the regulators to do what they did with Continental and
with other multinational corporations. My time has expired.
Chairman S T GERMAIN. I assure the gentleman t h a t you will
have the opportunity to ask Mr. Conover those questions and Paul
Volcker. Paul wants to see you about that, too.
Mr. ANNUNZIO. He called me, in fact.
Chairman S T GERMAIN. I am sure he did.
Mr. Wylie.
Mr. WYLIE. Thank you very much.
Mr. Kovarik, I was interested in your comment to the chairman
a little while ago when he asked you if you had seen this Continental memorandum from Ms. Kenefick and you said t h a t you had and
you made the observation t h a t you wished you had seen it 3
months ago.
Chairman S T GERMAIN. Had seen it 3 months earlier.
Mr. WYLIE. Three months earlier.
At the time you read it you said to yourself I wish I had seen it 3
months ago.
Chairman S T GERMAIN. Earlier. He said in 1982.
Mr. WYLIE. I understand that, but earlier t h a n the time you saw
it. What would have been your reaction if you had seen it 3 months
earlier?
Mr. KOVARIK. Sir, I think after reading the memo it confirmed a
lot of our observations and the findings we came to as conclusions
in our examination and it would have helped us to focus initially
on those instead of having to start on something else and eventually getting to those conclusions.
It basically recapped a number of problems t h a t we found in the
midcontinent division and especially in the Penn Square loans.
Mr. WYLIE. What did you do about it after you read the memorandum? Did they continue the same procedure for making loans?



112
Would you describe—maybe I should ask that of Ms. Kenefick
first. Would you descirbe the procedure for making the loans?
Ms. KENEFICK. Mr. Congressman, the procedure for making the
loans wasn't necessarily the same for every loan. Primarily, the
loan requests would come from a variety of sources, either directly
from the customer or from Penn Square Bank which would make a
request either by phone or by in-person visit to the bank where
they would bring representatives from Penn Square Bank, and
they would bring with them packages of material relating to various loans that they wanted Continental Bank to participate in. The
majority of these conversations involved at some point or another
Mr. Lytle, and after some discussion, a decision was made whether
or not to partake in the particular credit request.
The normal practice in the bank was to write up the credit request in a note sheet form and then circulate it to the appropriate
people to get approval signatures on it and if those were not objective, then the loan was, in effect, approved and then input into the
loan division operations system and the funds were advanced.
Mr. WYLIE. What did it take to get a million dollar loan approved?
Ms. KENEFICK. TO get any loan approved the way the bank
system ran it took a minimum of two signatures to agree to lend
the money to the customer. It was a dual authority system as opposed to a credit committee system in other banks.
The individuals themselves, the necessary individuals were defined by memorandum—I can't remember the exact title, I refer to
it as sort of an authorization memo, which would specify what level
of credit authority was required for a $1 million loan. It may, for
instance, vary not only on the amount but also on the length of the
loan.
Mr. WYLIE. Did anyone keep track of those loans?
Ms. KENEFICK. I am sorry. I didn't understand.
Mr. WYLIE. Did any one keep track of those loans once they were
made? I understand now t h a t one person could authorize a loan,
the second person had to approve it if it was a million or more. Did
anyone keep track cumulatively, of the number of loans made?
I think in your memorandum you suggest there might have been
some internal control function t h a t was not there.
Ms. KENEFICK. Well, the loans themselves in order to be funded
had to, to my understanding, during my time at the bank, had to
be entered onto the bank's internal computer system so t h a t the
loans themselves were part of the bank's record.
Mr. WYLIE. There was some suggestion earlier by one of the witnesses, I thought it was you, t h a t maybe the internal computer
system was not all that good, that there was, in fact, some problem
with keeping track of the loans, the cumulative impact or effect of
the loans and was it possible for somebody to go to that computer
and say there are so many loans being made to Penn Square or so
many loans being made in this particular area, and then maybe
make an evaluation of the impact that t h a t loan may have?
Are you in a position to answer that?
Ms. KENEFICK. N O , I am



not.

113
Mr. WYLIE. Mr. Kovarik, when you read the memorandum what
did you do about it? Did you change your procedure for examining
these loans?
Mr. KOVARIK. If I can clarify, Congressman, I saw the memorandum in August or September 1982 which was a full year after it
was written and after Penn Square had failed. Penn Square loans
had by t h a t time basically been stopped by the bank so far as any
granting of credit to Penn Square borrowers.
Mr. WYLIE. HOW about foreign country loans?
Ms. OAKAR. Will the gentleman yield on that point just for clarity's sake? I thought the memorandum said 7-29-81: Am I correct
Mr. Chairman?
Chairman ST GERMAIN. YOU are correct.
Ms. OAKAR. Are we talking about two different memos?
Mr. KOVARIK. Perhaps I can clarify. The memo did not come to
my attention until August or September 1982 during my 1982 examination.
Chairman S T GERMAIN. YOU said you wished you had seen it 3
months earlier.
Mr. KOVARIK. At the beginning of the examination, it would
have helped me focus the examination.
Chairman S T GERMAIN. YOU said it reached the same conclusions.
Mr. KOVARIK. Yes, we did, but I think if I would have seen it earlier, it would have cut down the amount of work we had to do to
reach those same conclusions.
Chairman S T GERMAIN. What did you do about it?
Mr. WYLIE. That is what I asked him.
Mr. KOVARIK. There was not much I could do
Chairman S T GERMAIN. YOU say the memo was a good one, right?
Mr. KOVARIK. Yes, sir.
Chairman S T GERMAIN. YOU

say you reached the same conclusions, but it took you longer because it took a while for you to
focus.
Mr. KOVARIK. That is right, sir.
Chairman S T GERMAIN. Then what did you do about it?
Mr. KOVARIK. That was the conclusions we reached concerning
the Penn Square loans, and the midcontinent division were detailed in the report of examination showing the condition of that
portfolio.
Chairman S T GERMAIN. DO you feel you wrote a strong enough
critique at t h a t time? Did you suggest to your superiors t h a t they
bring it to the attention of the board of directors and have a decision as to lack of internal controls, and sloppiness of recordkeeping?
Mr. KOVARIK. That was brought out in the examination report,
sir.
Chairman S T GERMAIN. Did you recommend to your superiors
that they bring t h a t to the attention of the board of directors and
the chairman of the bank?
Mr. KOVARIK. Yes, it was.
Mr. WYLIE. Thank you very

the direction I was headed.



much, Mr. Chairman. That is exactly

114
How did you feel about what happened as a result of your recommendation? You had a strong recommendation. Were you happy
with it or disappointed or did you go back at it or what?
Mr. KOVARIK. I believe t h a t the bank at the time implemented
almost every one of our recommendations—all t h a t I can remember. In fact, they were taking steps during the examination starting in August of 1982 to institute certain changes including the formation of a new credit risk evaluation division, they had done an
internal—were working on internal review of their policies and
procedures at the same time we were conducting the examination,
and to my recollection every recommendation t h a t we made to
them in that report or with contact with the board of directors was
included and was implemented.
Mr. WYLIE. Mr. McCarte, did you see the memorandum Ms. Kenefick referred to?
Mr. MCCARTE. N O , sir. I did not. I can perhaps help on the timing
of this. The July memorandum would have been written or typed, I
think, as Ms. Kenefick said, towards the end of the examination
t h a t we were conducting in 1981.
At t h a t time we had identified or recognized the bank had a relationship with the Penn Square Bank and the credits that we looked
at during the examination of 1981 were credits t h a t were primarily
secured by standby letters of credit. This memorandum was something t h a t we had just not known about during the 1981 examination.
Mr. WYLIE. DO you have an opinion as to the internal control
mechanism of the bank, whether there were adequate internal controls as far as ending practices were concerned; do you have an
opinion?
Mr. MCCARTE. A S to adequacy of the bank's internal controls?
Mr. WYLIE. Yes.
Mr. MCCARTE. I

would say on balance t h a t we were generally
reasonably satisfied with internal controls. The internal control deficiencies t h a t we highlighted in the report in the loan area, I
think, were well founded and significant and were reported as
such.
The other internal controls with respect to the authorization of
credits as Ms. Kenefick pointed out, the bank did not have a preapproval committee, as some banks will have. They had a process
where officers, depending on their grade level, would approve credits.
Mr. WYLIE. What did you mean when you say we need to get our
own house in order while at the same time potentially changing
our procedures, Ms. Kenefick?
Mr. Kovarik and Mr. McCarte think they were adequate, internal controls, functioned properly, t h a t there was a way to evaluate
the loans.
Ms. KENEFICK. I am trying to recall exactly where this was.
Mr. WYLIE. It is on page 5, in the conclusion, it says, we need to
get our own house in order first while at the same time potentially
changing our procedures. This is back in 1981.
Ms. KENEFICK.

Yes.

Congressman, this was just a summary sentence of what I felt. I
was describing what were basically changes t h a t I was suggesting



115
in the way t h a t the division, the midcontinent division had been
run. I felt if we were to make these changes t h a t would help us
better understand where we were with respect to some of our customers.
When I say, in order first, I think I was also referencing the fact
t h a t we needed to also look to Penn Square Bank to improve t h e
information flow to us.
Mr. WYLIE. All right. My time is up, Mr. Chairman.
Chairman S T GERMAIN. Mr. Barnard.

Mr. BARNARD. Thank you very much.
Ms. Kenefick, are you presently employed with the bank?
Ms. KENEFICK. N O , I am not.
Mr. BARNARD. Good. After having

worked in such an important
phase of the bank operations at Continental, what is your general
impression of a bank exmination? Is it good? Is it thorough? Or is
it just a hit-and-miss operation? Do you find t h a t it really did uncover anything t h a t was unusual? Did you all learn anything from
bank examinations?
Ms. KENEFICK. I am afraid, Congressman, t h a t I never was directly involved with any bank examination or read any bank examination reports. So I don't know; I don't have an opinion.
Mr. BARNARD. YOU were in loan review capacity at Continental?
Ms. KENEFICK. No, I wasn't.
Mr. BARNARD. Didn't you review this particular credit and write
a memorandum?
Ms. KENEFICK. I was a vice president, commercial lending officer,
in the midcontinent division for a period of under 6 months time
and I worked for John Lytle. I was not in a loan review capacity. I
was in a commercial lending capacity.
Mr. BARNARD. A bank examiner never talked with you about
credits?
Ms. KENEFICK. N O , sir.
Mr. BARNARD. Not one time?
Ms. KENEFICK. N O , sir.
Mr. BARNARD. And yet you were

in a very critical place in this
bank where you could appraise credits.
Ms. KENEFICK. Yes.
Mr. BARNARD. YOU were. Now, this memorandum
Chairman S T GERMAIN. He is our banker in residence.
Mr. BARNARD. N O — I really am not.
Chairman S T GERMAIN. Excuse me. What I want to point

out is
that Mr. Barnard does have a good deal of experience in banking.
Mr. BARNARD. I had some. I am about to lose it.
How far did this memorandum go? Did it just go to Mr. Lytle
and then reach file 13?
What happened to this memorandum? Did it go into file 13, or
did it go into the file of the Penn Square Bank?
Ms. KENEFICK. Congressman, I can only testify to what I know
with respect to the memo. I had given a copy to Mr. Lytle and I
had given a copy to Mr. Rudnick.
Mr. BARNARD. Who?
Ms. KENEFICK. Mr. Rudnick.
Mr. BARNARD. Who is he?



116
Ms. KENEFICK. Mr. Rudnick was at one time my manager in the
bank, and at the time I gave him the memo, he was assistant to
Mr. Baker.
Mr. BARNARD. Mr. Kovarik, where did you find the memorandum?
Mr. KOVARIK. Sir, it was included in some work papers t h a t the
phase I committee for the bank had pulled together during their
review in August 1982.
Mr. BARNARD. SO it did get into the file?
Mr. KOVARIK. It was in the file of that committee's work papers.
Where they got it from, I have no knowledge.
Mr. BARNARD. What committee?
Mr. KOVARIK. The phase I review committee of the bank.
Mr. BARNARD. Was t h a t under t h e jurisdiction of Mr. Lytle?
Mr. KOVARIK. That committee, no, sir. That was set up by the
board to investigate the occurrences that brought about the Penn
Square situation.
Mr. BARNARD. SO this was after the fact, 1 year later.
Mr. KOVARIK. Yes, sir, it was.
Mr. BARNARD. Mr. Meade, I believe

you were in on the examina-

tion in 1977.
Mr. MEADE. Yes, sir—1976, sir.

Mr.

BARNARD.

1976?

Mr. MEADE. Right.

Mr. BARNARD. Did you have any inkling at t h a t time of the
emerging problems of Penn Square?
Mr. MEADE. I never heard of Penn Square until July 1982.
Mr. BARNARD. Who was in the bank now in 1978, 1979, 1980, and
1981?
Mr. MCCARTE. I was there in t h e years 1979, 1980, and 1981.
Mr. BARNARD. Mr. McCarte, were you alerted to the problems of
Penn Square in those years?
Mr. MCCARTE. I had received no communication from Washington with respect to the situation.
Mr. BARNARD. The office in Dallas never alerted the regional
office in Chicago t h a t they were having problems with Penn
Square?
Mr. MCCARTE. Not to my knowledge.
Mr. BARNARD. In other words, what happened here is, here we
have a situation in Oklahoma where the regional Comptroller of
the Currency was having meetings with the board of directors of
Penn Square threatening cease and desist, and yet at no time did
you know about that?
Mr. MCCARTE. That is correct.
Mr. BARNARD. OK.

In those years, didn't you find it highly unusual that a $400 million bank in a shopping center in Oklahoma City was selling
upward of $1 billion worth of loans to Continental Illinois?
Mr. MCCARTE. I can speak for the period of time I was at the
Continental, and when I left the bank in 1981. In completing the
examination at that time, I had been advised that there were approximately $320 million to $330 million of Penn Square-related
credits, and a great number of those credits were secured by standby letters of credit.



117
Furthermore, of course, standby letters of credit, in terms of a
collateral position, is a rather handsome one; it is nice collateral to
have. Notwithstanding the fact t h a t to a $40 billion bank, $300 million of credit is relatively small, we sent people back to look for
any kind of concentrations on the banks that may have issued the
standby LC's and the message came back t h a t in fact there were no
significant—no concentrations. And t h a t is the extent of my knowledge with the Penn Square Bank.
Chairman S T GERMAIN. He didn't answer your question.
Mr. MCCARTE. Excuse me. The growth of the portfolio occurred
subsequent to my departure from Continental.
Mr. BARNARD. In other words, what you are saying is, between
the time that you left in 1981-82 is when it moved from $300 million to $1 billion?
Mr. MCCARTE. Yes, sir.
Mr. BARNARD. Who was

from the Comptroller's Office in the
bank in between t h a t time?
Mr. MCCARTE. There was no general examination conducted
during that time period. What the Comptroller's staff did was to
have a series of visitations, and the visitations would focus on
movements of the criticized or classified total and just looked for
major type of adversity.
Mr. BARNARD. N O bank examination from 1981 to after Penn
Square?
Mr. MCCARTE. That is correct.
Mr. BARNARD. And at which time they built up a portfolio of
over $700 million in loans?
Mr. MCCARTE. Yes, sir.
S T GERMAIN.
Mr. BARNARD. Yes, sir.
Chairman S T GERMAIN.

Chairman

Would you yield to me?

That should be followed up on.
Mr. Kovarik, did the Dallas office ever inform you—because Mr.
McCarte wouldn't know this; he left the Comptroller's Office—of
the problems at Penn Square?
Mr. KOVARIK. NO, sir, they did not. I did not hear of Penn Square
until, I believe, prior to the week of J u n e 21, 1982, when I was notified by some of our people in Washington that, first of all, I was
going to take over the Continental examination, and then additionally t h a t there were problems with Penn Square. That was the first
time I had ever heard that name before.
Chairman S T GERMAIN. Mr. McCarte, one more question. You are
no longer with the Comptroller's Office, so maybe you can answer
this objectively.
Would it have helped you if the Dallas office had informed the
Chicago Office of the Comptroller of the problems of Penn Square
to not react from hindsight but rather have forward vision?
Mr. MCCARTE. I would say yes, in retrospect.
Chairman S T GERMAIN. Don't you think t h a t should have been
done, because they knew t h a t these participations were being sold
mainly to three or four large banks and t h a t they were becoming
substantial? Don't you think they should have notified the Chicago
Comptroller's office rather than keep it a secret from them?
Mr. MCCARTE. I would suppose so.
Chairman S T GERMAIN. Thank you.



118
I t h a n k the gentleman.
Mr. BARNARD. Mr. Kovarik, I believe the staff has given you a
copy of the Continental Bank examination findings. On page 11, beginning with the phrase "Our review of credits criticized * * *"—I
would like to ask several questions on that.
What do you mean by a " B " rated credit? And what is the problem if t h a t credit is criticized by the OCC?
Mr. KOVARIK. The phrase " B " credit?
Mr. BARNARD.
Mr. KOVARIK.

Yes.

That was in Continental's rating system. They had
a credit rating system t h a t ranged from A to D, A being prime
quality and D being the worst quality—four gradations in their
system.
I am sorry; I didn't catch the rest of your question.
Mr. BARNARD. That is primarily what it is. It is a rating system
t h a t the bank had, and the A is the top rated, and B is second
grade.
Is t h a t it?
Mr. KOVARIK. Yes, sir.
Mr. BARNARD. And on
Mr. KOVARIK. D.
Mr. BARNARD. OK.

down to D, E?

What is a WLR, a watch loan report?
Mr. KOVARIK. That is a report prepared by the account officer on
a loan either rated—in Continental's situation—either rated D,
where the watch loan reports were required on all loans rated D;
and they were required also on some "C" rated credits. So it would
be a quarterly report of the problem credit.
Mr. BARNARD. In t h a t examination, there are 119 criticized credits t h a t are not on the WLRL, watch loan report list. Why was
that?
Mr. KOVARIK. They were not recognized as being problems.
Mr. BARNARD. By whom?
Mr. KOVARIK. By the bank.
Mr. BARNARD. Even though the Comptroller of the Currency had
brought them to their attention?
Mr. KOVARIK. They eventually would have been placed on the
watch loan report, but they were not on the watch loan report as of
our examination date. In trying to determine whether the bank's
loan review function is operating correctly, it doesn't really give
them—you can't give them credit for putting something on after
you have told them it is a problem. You would hope they get it
there before you came in.
Mr. BARNARD. Well, 8 months later, how do you review as to
whether or not that credit has improved or whether it has gotten
on the watch loan report?
Mr. KOVARIK. Sir, you say 8 months later, how
Mr. BARNARD. Yes. Don't you all keep a record of the loans t h a t
you turned?
Mr. KOVARIK. Yes, sir. We keep records of the loans we review at
each examination.
Mr. BARNARD. SO if you had a loan that is criticized and you go
back in at the next examination, do you make note of the fact t h a t



119
the criticized loan t h a t you had in there has either improved or
asked the bank why it was not on the watch loan report?
Mr. KOVARIK. I can't remember any circumstances where we
criticized a loan and then came back the next time and criticized it
again when it was not on the watch loan report.
Mr. BARNARD. Thank you.
Chairman S T GERMAIN. M S . Oakar.
Ms. OAKAR. Thank you, Mr. Chairman.
As a followup, I would like to ask Mr. McCarte a few questions.
If you t u r n to page 7 of the staff examination findings report and
review the two quotes in the middle of t h a t page—"Our review of
the credit administration * * *" and "Several credits which were
rated 'B' * * *"—do you have the area I am speaking to?
Mr. MCCARTE. Yes, ma'am.
Ms. OAKAR. On the third quotation, what is the significance of
what is said in the first and second sentences?
Mr. MCCARTE. Where we said, "While it is recognized * * *"—
bottom of the page there?
Ms. OAKAR. Right.

Mr. MCCARTE. I think t h a t the paragraph at the bottom deals
with the fact t h a t the level of classified or criticized assets in the
corporation was above what we consider to be acceptable or traditional standards; in other words, t h a t there was greater dollar
amount of credits that we were listing as special mention, substandard doubtful, et cetera.
Ms. OAKAR. In relationship to that quote, a third quote, what did
you expect and want the board of directors to do in response to
your statement that, "A reappraisal of the credit rating process
and system is appropriate"?
Mr. MCCARTE. A S Mr. Kovarik pointed out, the B credit was normally a credit we would pass, and expect to pass, t h a t credit.
The observation I believe t h a t we are making at this time was
one that we did pick up and classify or criticize several credits t h a t
were rated a " B " t h a t were not on the watch loan reports. That is
somewhat subjective in any evaluation of any credit concerned. But
what we simply said was t h a t we have traditionally recognized
these as sound credits from an examination and evaluation standpoint status. However, we criticized them. And the point of it is
t h a t perhaps they deserve watch loan priority.
That date—looks like t h a t was 1979, to my recollection—the
volume of credits we were picking up as nonwatch loan credits and
that we would criticize was not what we would consider to be significant.
Part of the thing I think we should recognize is the fact that in a
$40 billion bank, with 800 account officers worldwide, there will be
differences due to timing differences and other matters. I think
what we try to do is put this in perspective as to just how significant is the number of credits and dollar amount we are focusing on
in terms of credits t h a t we are criticizing that perhaps have not
had watch loan recognition yet.
So what we simply said was t h a t we have observed t h a t we had
some of these—what we were basically doing is monitoring how the
watch loan system worked, how the bank's internal rating system
worked. And we were simply going to monitor, during my stay as



120
examiner in charge, what was occurring, what exceptions were we
picking up, and that was an exception we picked up.
Ms. OAKAR. Let's look at the second quote on that page. What
was meant by the last sentence: ' T h e importance of reliability of
internal loan evaluation procedures as an early warning mechanism to control credit quality in a growth environment cannot be
overemphasized/'
Is this an example of a firm warning, or what kind of warning
would you say you were trying to give them?
Mr. MCCARTE. I think we all recognized, of course, the bank was
going to engage in some significant growth. They had stated such
in press. And we knew from the internal review that we had
Ms. OAKAR. I can't hear you. Sorry.
Mr. MCCARTE. I am sorry.
We recognized and knew that the bank was embarking upon a
growth scenario. And one of the most important things in any kind
of growth environment is that the bank be fully aware and appraised of the condition of the portfolio; and since the corporate accounts were targeted for increased loan growth, we simply were reminding the bank t h a t if you are going to engage in this type of
activity, it is very important t h a t you identify problems when they
become problems.
Ms. OAKAR. Right.

So to followup this point—was the situation you found in 1979
regarding the loan ratings—rating errors, less serious than the situation you found in 1981 regarding not rating $2.4 billion worth of
loans; and, if so, why were the comments to the board more firm in
1979 than in 1981?
Mr. MCCARTE. The comments in the 1979 report deals with credits t h a t we rated as criticized or worse—special mention, or more
adverse classification—that were not on the watch loan reports.
The 1981 report focused not only on the fact that there was an
increase in credits that the examiners were criticizing as special
mention, substandard, doubtful and loss that were not on the
watch loan report—that was part of the 1981 report. Also—and this
is an area separate and distinct from the fact there were not watch
loans attached to some of these. The $2.4 billion of
Ms. OAKAR. $2.4 billion?

Mr. MCCARTE. Billion; that is correct, right—of credit that was
stale rated meant that perhaps it may have been rated by the
bank's internal loan review system, but the timing of such was not
within what was prescribed or what was wished by the corporate
office and board of directors.
Ms. OAKAR. Let me tell you my observation, based on what you
said and what Mr. Kovarik said.
I don't think you attempted to have any idea of the soundness of
what was going on. I want to refer again to Ms. Kenefick's memo,
which Mr. Kovarik says if he had received it 3 months before he
wrote his report—and according to your testimony, you got it 3
months before you mentioned you received it, in August of 1982,
and your report is dated November 15, 1982. Ms. Kenefick report
is, if somebody listened to her, pretty devastating, and apparently
the bank sat on it.



121
Is that what happened, Ms. Kenefick? Nobody really did anything about your report. Is that pretty much accurate?
You talked to Mr. Rudnick, I think you mentioned.
Ms. KENEFICK. I said earlier I really can't testify to what happened with the report after I left the bank.
Ms. OAKAR. TO your knowledge, nobody did a thing about it; they
sat on it?
Ms. KENEFICK. I don't have any knowledge.
Ms. OAKAR. Mr. Kovarik, how do you reconcile the differences in
dates here? She wrote it a year, year and a half, before; you claim
you got it almost a year to the day later, in August of 1982. You
wrote your report in November. You wish you had had it 3 months
before? You had it 3 months before.
Mr. KOVARIK. If I could clarify that.
Our examinations started, I believe, on May 24, 1984—1982,
excuse me.
Ms. OAKAR. Yes.
Mr. KOVARIK. SO

we had people in the bank since May of that
year. I arrived at the bank in late J u n e of 1982. My comment of 3
months earlier was, if I would have had it from the time I got into
the bank, as I said before, I could have targeted our review and
avoided some of the work we did t h a t may have come to a dead
end. As I say, eventually we got to the same conclusion. But if I
had known what
Ms. OAKAR. Your language is not devastating at all. I have read
your report and I read Ms. Kenefick's language, and she talks
about getting on with it quickly and the accountability. However,
your report is mild; essentially it says it is still a great management team even though there are problems. That is what I read
into your report.
I have, Mr. Chairman, one question for Mr. McCarte.
When you were preparing or reviewing the report, or any other
report regarding Continental Illinois is t h a t when Continental Illinois approached you about employment?
Mr. MCCARTE. N O , they did not. The timing, I think, was rather
explicit. What happened was, we had left the bank in August of
1981 and the bank did not come to me until J u n e 10, 1982.
Ms. OAKAR. What part of 1981 did you say?
Mr. MCCARTE. A S I said, August 1981—approximately 10 months
earlier.
Ms. OAKAR. Did they ever approach you before that?
Mr. MCCARTE. N O , they did not.
Ms. OAKAR. Did you have any idea they were interested in you as
an employee?
Mr. MCCARTE. N O , ma'am.
Chairman S T GERMAIN. Would the gentlelady yield?
Ms. OAKAR. I would be happy to yield.
Chairman S T GERMAIN. YOU said you were considering another
employment opportunity outside the areas covered by the Comptroller's Office in Chicago.
Mr. MCCARTE. Yes, sir.
S T GERMAIN.

Chairman
where?

Had you been seeking employment else-

Mr. MCCARTE. N O , sir, I had




not.

122
Chairman S T GERMAIN. They just came to you out of the blue?
Mr. MCCARTE. Yes, sir. It is not uncommon, I think, t h a t t h a t
may occur.
Chairman S T GERMAIN. I know.
Ms. OAKAR. I want to yield to my friend from Georgia, Mr. Chairman.
Mr. BARNARD. I want to ask Mr. Kovarik a question.
You say you began the examination in May 1982?
Mr. KOVARIK. The examination was begun in May 1982, yes.
Mr. BARNARD. And Penn Square failed in February 1982; is t h a t
correct?
Mr. KOVARIK. July of 1982,1 believe.
Ms. OAKAR. July.
Mr. BARNARD. We had our hearings

Ms. OAKAR. July 5, 1982.
Mr. BARNARD. But this was right in the middle of your examination, you know, t h a t all the Penn Square thing came out. You
didn't take note of that?
Mr. KOVARIK.. Yes, sir. From the time I entered the bank, as I
say at the end of June—the week of the 21st or so was the first
time I entered Continental, in 1982—I was informed by our staff in
Washington, first of all, t h a t I was to do the examination; second,
t h a t there were problems with Penn Square. From the time I entered the bank, I was in contact with people in Washington on a
very frequent basis, two to three times a day, either gathering information at Continental to help them with the Penn Square examination or with them giving me information to check out at Continental.
The period from, say, J u n e 21 to probably July 20 or 30 was a
very hectic period at Continental in our examination, and it was
constantly during t h a t period, I would say, I was involved almost
100 percent with Penn Square as it related to Continental.
Mr. BARNARD. I know my time is expired.
Chairman S T GERMAIN. GO ahead. I am being a little more liberal here, and I will use a little more of the chairman's discretion so
t h a t we will have a situation where we don't drop a trend or a line
of questioning, as too often happens. So I hope the Members will
bear with me because they will all be the beneficiaries of it, I
assure you.
Mr. BARNARD. Mr. Kovarik, in your report on page 4, it says, and
I will read:
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 lost.
Of these, $1.2 billion were oil and gas loans with Penn Square-related classified
loans.

So evidently you did pick up the Penn Square situation.
Now, the next is what I want you to explain to me. The causes of
Continental's problems were explained by Richard Kovarik, author
of the 1982 OCC Examiner's Report, in 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 deci


123
sions regarding growth and the system of decentralized authority and responsibility/accountability.

Chairman S T GERMAIN. What is the date of t h a t one again?
Mr. BARNARD. This is on page 4.
Chairman S T GERMAIN. The date of it?
Mr. BARNARD. The date is September 18, 1984. That is somewhat
after the horse is gone.
Ms. OAKAR. If the gentleman would yield back
Mr. BARNARD. A whole herd. It is the 1982 report.
Ms. OAKAR. Excuse me.

Mr. BARNARD. What you are saying, Mr. Kovarik, is as early as
1982—and this is 1984 t h a t the Comptroller's Office was alerted to
the deficiencies or to some real criticisms in bank management
Mr. KOVARIK. Yes, sir. That is from my 1982 report, which covered the period from May to November of t h a t year. It was my
findings that, although a number of the credits t h a t were problems
at the time were related to the economy, there were still—there
were also credits t h a t were related to the systems t h a t had been in
place, specifically in relation to the Penn Square loans.
Mr. BARNARD. Did this generate any new activity or discussion
between the Comptroller's Office and the management of Continental Illinois?
Mr. KOVARIK. Yes, sir, it did.
Mr. BARNARD. And what kind of discussions?
Mr. KOVARIK. There were numerous discussions

between myself
and the board, between other—from my understanding, staff in
Washington. It resulted in actions taken and recommendations
made to the bank and actions taken against the bank.
Mr. BARNARD. What kind of follow-through did the bank make in
regards to those?
Mr. KOVARIK. A S I said before, to my recollection they implemented every recommendation we made, including the establishment of a new credit evaluation division; beefing up controls;
changing the approval system on loans. A number of items were
covered.
Chairman S T GERMAIN. That is interesting because I think we
are going to have somebody in here. As you know, there were
banks t h a t went in and evaluated Continental to determine whether they would like to merge with Continental, and they were not
too impressed with some of the things you said were being improved upon. So we better be very cautious there.
Ms. Kenefick, let me ask you this: You gave a copy of your memo
to Mr. Rudnick and Mr. Lytle?
Ms. KENEFICK. Yes, sir.
Chairman S T GERMAIN. Anyone
Ms. KENEFICK. I left a copy for

else?
Mr. Goy, who replaced me in my
position. But he was out of town at the time, and I don't know
whether he actually received it.
Chairman S T GERMAIN. YOU say that—in answer to Ms. Oakar—
you don't know what, if anything, was ever done as a result of your
memo?
Ms. KENEFICK. Well, I
Chairman S T GERMAIN. Because you left shortly thereafter.



124
Ms. KENEFICK. I interpreted her question as a general, "What did
the management of the bank do?"
Chairman ST GERMAIN. Correct.
Ms. KENEFICK. In that regard, I don't know.
Chairman S T GERMAIN. Let me ask you: Once you issued the
memo, you gave it to Mr. Lytle and Mr. Rudnick, and subsequently
you left it for your successor. How many times did Mr. Lytle or Mr.
Rudnick call you to discuss the memo that you wrote and addressed to them?
Ms. KENEFICK. Well, I had one meeting with Mr. Lytle regarding
the memo.
Chairman S T GERMAIN. Did he indicate to you what he thought
he would do as a result of the memo? What changes he would implement?
Ms. KENEFICK. I don't believe at that initial meeting, but subsequent to my resignation, he did mention that he was looking to add
more people to the division. Also, one of my assignments was to
work on organizing the accounts to the extent I could, as suggested
in the memo, by family of accounts and make recommendations of
people in the division to handle those accounts. So I was aware of
those two steps being followed.
But my general impression from Mr. Lytle was t h a t he didn't
share the same view t h a t I did with respect to that.
Chairman S T GERMAIN. Let me put the question to you this way:
Did you feel that many people got motivated, excited, what-haveyou, as a result of your memorandum? Or do you think t h a t the
publisher turned it down?
Ms. KENEFICK. Mr. Chairman, I don't believe Mr. Lytle shared
the same concerns I did.
Chairman S T GERMAIN. OK. Last, you left Continental shortly
thereafter.
Ms. KENEFICK. Yes.
Chairman S T GERMAIN. HOW long after writing the memo?
Ms. KENEFICK. I left there in late September.
Chairman S T GERMAIN. And the memo was dated August?
Ms. KENEFICK. The memo was dated July.
Chairman S T GERMAIN. July.

Could you tell us what the reasons were for leaving Continental?
Are you at liberty to tell us that?
Ms. KENEFICK. Well, I was not seeking outside employment, but
an opportunity presented itself to me which I felt was a good one
and provided different challenges and greater financial rewards.
And I was not happy in the division t h a t I was in. I had some difficulty working with Mr. Lytle.
Chairman S T GERMAIN. A S expressed in your memorandum?
Ms. KENEFICK. Yes, sir.
Chairman S T GERMAIN.

Thank you.
Mr. Leach.
Mr. LEACH. Thank you, Mr. Chairman.
Ms. Kenefick, you are the most reluctant martyr this committee
has ever heard. Whistleblowers in Government are substantially
less modest, from our experience on this committee. I would like to
go to one question of procedures. You testified a minute ago t h a t
two signatures—unlike in other banks t h a t often have commit


125
tees—are enough to authorize a loan. In the Penn Square hearings,
we were also informed t h a t Continental had a unique system of offering bonuses to employees to bring in business; t h a t is, you get a
bonus if you made a loan.
Is t h a t your understanding?
Ms. KENEFICK. I don't have t h a t understanding.
Mr. LEACH. Second, let me just comment for those of us t h a t
follow Chicago banking, from the Midwest, there was kind of a feeling a few years back t h a t the bad guy of Chicago banking was
Robert Abboud of First Chicago.
As I have listened to this testimony, it appears to me he is talking on almost heroic dimensions as the tough guy who says, "We
don't want to follow the procedures of our main competitor." I
stress this because, as I review the examination reports, as put together by our staff, there are a lot of comments about peer bank
pressures and peer bank analogies. Here, let me just make a couple
analogies.
First of all, in the securities industry, many firms have many
long names to them because they were forced to merge because
they didn't get their backrooms in order. It appears t h a t Continental never got its backroom in order. There wasn't even proper accounting after fairly loose standards were used in making a loan.
But let me come back to the regulators, because I think this is
more regulatory t h a n a banking issue. One of the recommendations
that was not made in 1982, because—I stress this because, Mr. Kovarik, you mentioned t h a t the bank met most of the regulations
t h a t were made—one of the recommendations t h a t was not made
was to increase the capital ratio of the bank.
Here, let me stress for the committee t h a t on pages 14 through
16 of the committee staff report, and the two tables t h a t follow, is
an excellent summary of the capitalization problem at Continental
Bank. I would just like to briefly review one paragraph in summary of the committee report, and t h a t reads:
In 1976, Continental's ratio of classified loans to gross capital funds had reached
121 percent. Its ratio of total assets to total capital was 21 percent.

Then further on, it says:
In the staff interview, Examiner Meade estimated t h a t Continental was between
60 and 70 percent dependent on purchased funds. In comparison, in 1982, the classified loan to gross capital ratio had risen to 172 percent, the degree of asset to capital
leverage had risen to 25 percent, and dependence on purchased money was up to 80
percent.

But,
In 1976, Continental's capital was rated a clear and emphatic "Inadequate."

In 1982, the examiners concluded t h a t the capital base of Continental
Is presently considered adequate.

However, the examiners also noted t h a t an inordinate level of
classified assets and loss of confidence by the financial community
lent definite reservations to this assessment.
The point I would stress is if one is looking for a public rather
than private sector bailout of institutions in difficulty, the easy
way is to force the institutions to raise more private sector capital.
39-133 0—84

9




126
One of the questions I would just ask is—first of Mr. Meade—
Why did you determine in 1976 t h a t t h e bank's capital was inadequate; what happened after t h a t assessment; and why in 1982, in a
much deteriorated bank situation was the capital base rated as
adequate? Do you think that, first, your report in 1976 made any
difference at all? Second, t h a t the 1982 assessment of adequacy was
valid?
Mr. MEADE. I will speak to t h e 1976 examination, and I will let
one of my colleagues speak to the subsequent examinations.
In 1976, the classified assets—that is, those assets which were
rated substandard, doubtful, and loss—aggregated 121 percent of
the bank's gross capital funds. Looking beyond those numbers, I believe there was about $375 million in the doubtful category; t h a t is,
those assets which collection in full is highly problematical, $375
million amounted to roughly 35 percent of the bank's capital funds.
The 121 percent of capital—the classified assets of 121 percent of
capital was the highest I had ever seen up until t h a t time.
I will have to point out t h a t t h e bulk of those classified were centered in real estate credits, and this was during the period of high
interest rates. The problems in the real estate sector were widely
known and experienced by most of t h e multinational banks.
Chairman S T GERMAIN. Are you talking about the realty income
trusts?
Mr. MEADE. Right; t h e REIT's.
Chairman S T GERMAIN. Weren't those part of the holding company rather t h a n of the bank?
Mr. MEADE. There were loans in t h e bank—the holding company
had sponsored a REIT, but t h a t was not the problem. It was loans
to REIT's not related to Continental.
Chairman S T GERMAIN. Could the gentleman yield for half a
second?
Mr. LEACH. Of course, of course.
Chairman S T GERMAIN. The fact is, t h e bank had lent to t h e
holding company REIT. The subsidiary or affiliate—there was a
subsidy of the holding company that was an REIT; correct?
Mr. MEADE. Right.

Chairman S T GERMAIN. And Continental Bank had lent substantial sums to that REIT?
Mr. MEADE. That was not the problem, as I understand it.
Chairman S T GERMAIN. Had t h a t occurred?
Mr. MEADE. It may have occurred, but the primary problem was
t h a t it lent—REIT's which had no affiliation with Continental
Bank whatsoever.
Chairman S T GERMAIN. OK.

Mr. MEADE. They were located in New York, Florida, and California.
Chairman S T GERMAIN. Thank you.
I t h a n k t h e gentleman for yielding.
Mr. LEACH. Mr. Kovarik

Mr.

MEADE.

Did I respond to your question?

Mr. LEACH. YOU did, to my satisfaction.

Why did you conclude t h a t t h e capital was adequate? Wasn't it
in better shape than in 1976, Mr. Kovarik?



127
Mr. KOVARIK. The capital increased through retention of earnings, primarily.
Mr. LEACH. But not on percentage basis?
Mr. KOVARIK. I believe in 1982 the primary capital was well
above what it had been in the past. I believe at the time it was in
excess of its peer group. The classified assets were very heavy, as I
pointed out.
Chairman S T GERMAIN. Excuse me. I have to interrupt again.
You say in excess of its peer group. If you say that, you will have
to discuss the peer group and how adequate t h a t was. Because the
Comptroller's Office insisted they improved; right?
Mr. KOVARIK. Yes,

sir.

When I speak of peer group, I speak of multinational banks t h a t
we supervise.
The classified assets, as I pointed out, were extremely high at
t h a t time. But the majority of the doubtful and loss classifications
were related to the Penn Square. It was at t h a t point in time Penn
Square was, to me, a very isolated portion of the bank. We had
criticized, I believe, 80 percent of the loans t h a t they had purchased from Penn Square, in one way or another.
Mr. LEACH. Let me just ask another question in t h a t light.
How many banks t h a t you have ever examined had 80 percent of
their assets dependent upon basically short term large sums of
money from other banks or other large institutions?
Mr. KOVARIK. I think this is the only one that was 80 percent.
Mr. LEACH. The reason I stress that is because it is a warning
sign. As anyone who studied economics 101 or beginning theories of
banking knows the money supply can grow as banks make loans;
and, at the same time, banks can grow if they can find someone to
lend to. So t h a t if you have a situation in which banks willy-nilly
take on a lot of loans, they will grow a lot. In the 5 years prior to
your examination, Continental had grown at almost double the
rate of all other banks in the country on the average; and at the
same time, Continental had come to be very dependent on shortterm funds.
Isn't this situation a warning sign to look at the bank capital
adequacy?
Mr. KOVARIK. We look at the liquidity of the bank or its ability
to fund itself through these short-term markets. First of all, you
have to look at it historically. Have they been able to do it? Have
they met resistance in the markets?
Up to July 1982, with the failure of Penn Square, they had not
met resistance in those markets. During the examination, the stability of t h a t funding had come back to a certain extent from what
it was immediately after the failure of Penn Square. During July
and August, the funding situation was much more critical than it
was in September and October and November by the time we had
completed our examination, which I think showed to me t h a t the
bank had taken steps, gone out into the markets, told their story,
and gotten back some of t h a t confidence t h a t they had lost immediately after the failure of Penn Square.
Mr. WYLIE. Would the gentleman yield?
Mr. LEACH. Yes; of course I will yield.



128
Mr. WYLIE. HOW much confidence do you put in internal controls
when you make your examinations?
Mr. KOVARIK. How much confidence?
Mr. WYLIE. Yes.
Mr. KOVARIK. Quite a bit.
Mr. WYLIE. Quite a bit. Yes;

OK.
So if the internal controls were bad enough, then you really
don't know where you stand.
Mr. KOVARIK. If they are t h a t bad, yes, you wouldn't know where
you stood. However, if during an examination or before an examination when we plan it the internal controls are not sufficient, we
expand our examination procedures to cover areas where we felt
t h a t internal controls were not adequate.
Mr. WYLIE. What kind of red flag do you have t h a t internal controls might not be up to standard so t h a t you could place confidence in them?
I am not trying to put you on the spot here, but I go back again
to my question a little while ago when Ms. Kenefick thought
maybe internal controls weren't as good as they should be. And
you say, "I wish I had known t h a t 3 months before," and so forth.
You really didn't answer my question as to what you might have
done about that. Maybe you can answer it.
But I am trying to find out now how you can go about ascertaining whether the internal controls are adequate, whether the loans
and functions the bank is engaging in are properly evaluated by
someone.
Mr. KOVARIK. Initially in an examination we would review the
internal controls to see what controls were said to be in place. And
then during the examination we will check to make sure t h a t they
were in fact working. And depending on the area of the bank, we
would use audit reports made by internal or external auditors; we
would do our own checking as far as testing transactions.
The internal control exceptions t h a t Ms. Kenefick brought up,
and the ones we were most concerned with at the conclusion of our
examination, were the controls that—if I can say—were misutilized
in identifying problem loans.
Mr. WYLIE. Misutilized by whom?
Mr. KOVARIK. By the lending officers who were there to review
certain information that, if it would have been reviewed and acted
upon, would have said there is a problem in the midcontinent oil
division. There were reports of collateral exceptions, reports of nonrated loans, loans t h a t had not even come to the committee for
rating over a period of months, which to my recollection at least 50
percent—and I think at times in excess of 65 percent—of all exceptions for the whole bank related to the midcontinent division.
Mr. WYLIE. SO the bottom line of all t h a t is t h a t it was just bad
judgment on the part of some of the lending officers and some officers of the bank t h a t caused the problem.
Mr. KOVARIK. A S far as the exceptions I think it is the people
who were responsible for reviewing and ensuring t h a t those exceptions were cleared or t h a t if they couldn't be cleared, find out why
and put a stop to it. That wasn't being done.
Mr. WYLIE. Thank you. Thank you, Mr. Leach, for yielding.



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Mr. LEACH. Let me ask one other thing in terms of warning
flags. Continental was unique in comparison with other money
center banks in t h a t it didn't put as high percentage of its lending
abroad but it did put a very high percentage of lending in areas
outside its normal areas of jurisdiction, whether they be in Oklahoma for one type of oil lending or Florida for other types of real
estate.
Was this unusual to you and was this something t h a t was cause
for alarm?
Mr. KOVARIK. Obviously the Oklahoma section caused me alarm.
Mr. LEACH. Surely.

Mr. KOVARIK. A S far as the others, I didn't view it as being out of
the ordinary to have lending relationships throughout the country.
Most banks that I am familiar with—and I include banks t h a t I
have either read about or talked about with other examiners from
different parts of the country—have offices throughout the country
such as Continental did.
Mr. LEACH. Let me just conclude, Mr. Chairman, with the observation t h a t while the examiners are largely responsible for the financial well-being of the bank and protecting depositors' money in
terms of mandate, but they also have indirect responsibility for
money supply growth and the allocation of credit. You are going to
have more economic growth in areas where loans are made than
not.
When you have one type of bank get out front with one type of
lending and then be, in effect, protected implicitly by the U.S. Government, we have a serious problem on our hands. One way to approach this problem is to stress capital adequacy as a means of providing evenness in the system.
As I look at Continental's capital adequacy, first in comparison
with its peer group it comes out less well than otherwise; but secondly, when you compare capital adequacy to problems with the
loan portfolio it seems that in 1982, there was reason for a redder
flag to be hoisted than was the case.
I don't want to criticize one particular examination of the bank
in comparison with all others, but I would stress t h a t I think the
examiners of all national banks are going to have to apply a little
more rigid standards t h a n has been the case.
Thank you, Mr. Chairman.
Chairman S T GERMAIN. Mr. Kovarik, what did you say about the
capital adequacy of Continental in response to Mr. Leach's earlier
question relating to its peer group?
Mr. KOVARIK. I believe it was comparable and at times exceeded
its peer group during t h a t time from 1976 or 1977 through 1982.
Chairman S T GERMAIN. I would direct your attention to the chart
on the board over there, to your left. You see t h a t first chart, "Capital Adequacy?"
Mr. KOVARIK. Yes, sir.
S T GERMAIN. YOU see the red
Mr. KOVARIK. Yes, sir.
Chairman S T GERMAIN. That red line is
Mr. KOVARIK. Yes, sir.

Chairman




line?
Continental Illinois.

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Chairman S T GERMAIN. The white line, you know, the up above
part t h a t starts between 5.6 and 6, t h a t is 1976, t h a t is the peer
group. So where did you see it exceeding the peer group?
Mr. KOVARIK. I am sorry, sir; I do not know. Is your peer group
the multinational banks?
Chairman S T GERMAIN. Yes. That chart was prepared by GAO.
Mr. KOVARIK. That chart is not similar to the ones I have seen
comparing continental with its peers.
Chairman S T GERMAIN. The Comptroller's Office has to get new
chart preparers, is t h a t it?
Mr. KOVARIK. I am not sure, sir.
Chairman S T GERMAIN. NOW, one more and I will go to Mr.
Vento.
It was noted t h a t the bank was troubled by an outmoded computer system and the bank had commenced a system of design review
in 1977. Did you ever criticize the bank's computer system for
being inadequate, Mr. Meade, Mr. Kovarik, Mr. McCarte? Now, we
are talking about the computer system with respect to loan operations as being inadequate. Lytle was not alone in his perception
t h a t the loan operations exceptions reports contained errors. The
bank's management generally recognized t h a t loan operations were
troubled by an outmoded computer system.
Did any of you in your reports ever criticize their computer
system for being outmoded?
Mr. MEADE. Mr. Chairman, in some of the examinations t h a t I
conducted, it was commented on t h a t reports generated by the
system were generally not accepted by the people on the line.
Chairman S T GERMAIN. Did you point out the fact t h a t the
system was outmoded and therefore just couldn't do the job?
Mr. MEADE. I am not aware t h a t it was outmoded.
Chairman S T GERMAIN. What I am quoting from now is the
report of the loan—report of the special litigation committee of the
board of directors of Continental Illinois Corp., dated J a n u a r y 7February 8, 1983. But they did a total review and found t h a t back
then the computer system was outmoded and just couldn't keep up
on installment loans. If it was over, what, 9,999,999.99, they had to
split it down because the system couldn't take it.
Mr. Kovarik, did you ever criticize the computer system as being
outmoded?
Mr. KOVARIK. N O , sir.

Chairman ST GERMAIN. Mr. McCarte?
Mr. MCCARTE. N O , sir.

Chairman S T GERMAIN. Thank you.
Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
Let me just ask a general question to the examiners, those chief
examiners t h a t are here. When you have a bank t h a t is in an obviously aggressive growth mode as Continental Illinois National
Bank pursued, that is knowledge on the part of the examiners, you
recognize t h a t particular type of strategy, I assume. Does t h a t type
of institution receive any additional attention because of the tremendous number of decisions t h a t are being condensed within any
given time? Can any of you comment on that?
Mr. McCarte?



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Mr. MCCARTE. The field examiner as a result of that, I think if
you read the reports t h a t we prepared during 1979, 1980, and 1981,
observed t h a t t h a t was in fact about to occur. We thought it would
occur. As a result, we spent additional time in the actual reviewing
of specific credit.
Mr. VENTO. SO in other words, you make an analysis of their
ability to make credit judgments and the loans they are taking and
placing and the type of analogies of the type of deposits they are
securing?
Mr. MCCARTE. That is correct.
Mr. VENTO. In other words, you did give this extra attention. Is
that accurate?
Mr. MCCARTE. We spent a lot of time during those examinations
concentrating on determining the quality of the portfolios and
what type of credits were being booked during this growth period.
Mr. VENTO. Mr. Kovarik, you agree with that, t h a t a fast-growing institution of this size t h a t is trying to grow is receiving more
attention?
Mr. KOVARIK. Yes, sir.
Mr. VENTO. I assume, Mr.
Mr. MEADE. Yes.
Mr. VENTO. IS the size of

Meade, you agree with that as well?

this bank, did that represent special
problems, Mr. McCarte?
Mr. MCCARTE. Well
Mr. VENTO. The size of this financial institution?
Mr. MCCARTE. Everything is relative, of course, but I would say
t h a t a larger bank requires a greater staffing consideration on our
part, but also just putting an entire report together on a larger
bank is more difficult t h a n a smaller bank. But in terms of that
bank in relation to other banks that I am familiar with it was not
any more difficult t h a n other banks.
Mr. VENTO. One of the criteria—and I refer you to page 9 of the
staff examiner's findings, Mr. McCarte—I would like you to review
the first quotation on page 10 of the staff examiner's finding
report. It begins, "Review of those internal reports." The first comment is what is the significance of the increase in volume of old
credits to $2.4 billion in 1981 from $1.6 billion in 1980?
Mr. MCCARTE. What is the significance of that?
Mr. VENTO. Yes.
Mr. MCCARTE. The

significance of t h a t is t h a t the amount of
credit exceptions which is, of course, different t h a n a credit problem, has increased. The loan review function had not been able to
keep up with the volume of work or, as it was stated earlier in the
report or elsewhere in this report, that the line managers had not
submitted the appropriate information to loan review to allow
them the rating process. The combination of reasons I am sure.
Mr. VENTO. It is pretty significant. The bank had not grown by
that much. In other words, you have an increase here of almost 50
percent.
Mr. MCCARTE. That is correct.
Mr. VENTO. YOU know, of the exceptions, in just a single year.
Mr. MCCARTE. Yes. I would hasten to point out, of course, t h a t in
banking terms and in how examiners view credits there is a significant difference in a credit problem, for example a substandard,



132
doubtful or special mention or loss. But what we pointed out is the
amount of exceptions increased dramatically and we were concerned about it and this was part of the rationale
Mr. VENTO. One of the statements following is itself evidence no
one is monitoring the situation to assure t h a t all credits are receiving timely reviewed as required by the corporate office. So they
have this requirement and nobody is doing anything about it. Then
you go on, you have the statement in your letter to Continental's
board of directors, we find it, the internal rating system, to be functioning well and accurately reporting the more severely rated advances to the board and senior management.
In one case you are saying one thing, Mr. McCarte, in the other
case it seems to me that there is a problem, you know. It seems you
are pursuing serious problems, but you write to the board of directors and you seem to have backed off.
What is the reluctance on the part of an examiner to share the
unvarnished t r u t h with the board?
Mr. MCCARTE. I am glad you bring t h a t up. Let me take a few
minutes and expand on that. The $2.4 billion credit exceptions
were, in fact, credits t h a t deserved to be rated and it was the
wishes of the corporate office t h a t in fact it be done on a timely
basis, but it was not being accomplished. As a testing against
whether these in fact were credit problems versus credit exceptions, we, in fact, had reviewed approximately 60 to 70 percent of
the volume of credit outstanding at the Continental Bank which in
terms of what most examiners would do is significantly above what
you might expect in a money center bank.
And as a result of the testing t h a t we did, the sampling we had
done as well as looking at the large credits and scope of the review
we had performed in the last several exams, which was to look at
credits of $10 million and over, all C and D rated credits, past dues
and nonperforming, we also did the sample, sampled credits above
the $500,000 threshold where the bank internally rates credits and
those below $500,000 looking for exceptions. The results of our sampling reveal that the quality of the assets had not deteriorated
other t h a n the credits we had listed in the report and as you will
find in t h a t 1981 report we stated t h a t the total criticized had risen
to approximately 99 percent of the bank's gross capital funds, a reversal of what had occurred in the past.
That statistic, t h a t number was generated from the review by examiners in the various divisions, so in fact while we are talking
about a credit exception problem, we are also going through the exercise of testing t h a t and in terms of the comment we made about
the internal rating system as functioning, t h a t deals specifically
with was the bank being apprised of credits t h a t were troublesome;
t h a t is, credit problems. We did not find enough instances other
t h a n the ones cited earlier in the report.
Mr. VENTO. The point is t h a t these exceptions, you say you are
doing testing. I don't know what t h a t means. You are not testing
all of the exceptions? In other words, when you say you are testing
that, almost by definition t h a t says I am sampling some of these to
see what the quality is. But you are not doing all $2.4 billion
worth, is t h a t accurate?



133
Mr. MCCARTE. We did not do—I would have to have the work
papers, but I am sure we did not look at all the $2.4 billion. But I
am confident that a number of the credits came up in the sample.
Mr. VENTO. YOU are saying they were selected randomly and you
were doing a sample.
Mr. MCCARTE. A statistical sample was performed, done in accordance with the guidelines.
Mr. VENTO. YOU know, the thing is that that—if that were all by
itself and you said the exceptions and that, but if you look at it in
relation to some other things like liquidity position of the bank,
then I think that problems began to arise. Total loans, income to
total assets, is a measure of an institution's liquidity. An analysis
of the multinational and regional data reveals that the Continental
loans continued to increase and became far and away its major
source of assets.
During the period of 1976 to 1983, the bank's ratio rose significantly from an average of 58 percent in 1976 to 62 percent in 1979
to 71.6 percent in 1981 to 1983, placing it really in a very poor liquidity position with all these exceptions with regards to its loan
portfolio and, of course, forced it very often then into a volatile
market to raise these funds.
Wasn't that a further warning sign, even compared with its peer
group? Its peer group, analysis of both the multinational regional
data revealed t h a t the Continental ratio was extremely poor during
1976 to 1983 averaging a minus 45.97 percent, or at least 21 percentage points below its peers in terms of t h a t status. Didn't you
point these problems out to the bank? Didn't you address that in
any way, especially in light of the fact that you have all this undocumented loans coming in with this weak liquidity position represented by it?
Mr. MCCARTE. YOU were reading from some areas I am afraid I
couldn't follow you on, where you were coming from. But in terms
did we criticize the bank's liquidity, if that is your question
Mr. VENTO. Yes.
Mr. MCCARTE [continuing].

I think the answer is we did not criticize it. We recognized the fact t h a t the bank had a greater dependence on purchase funds but by the same token so did a number of
the peer groups, as was pointed out. With respect to anything
beyond that I am afraid I would have to
Mr. VENTO. Well, if the peer groups are at some value of 20-some
points difference in terms of percentages in terms of what they are
raising, an analysis of both the multinational regional data reveals
that Continental's ratio was extremely poor during 1976 to 1983
averaging a minus 46 percent or 21 percent below its peers in
terms of liquid assets, minus volatile liabilities to total assets. In
other words, you are familiar with t h a t term, aren't you? That particular definition is one t h a t I don't work with day in and day out,
but it is one, Mr. McCarte, that the examiner must. I guess not.
Mr. MCCARTE. I think we understand what liquidity means, yes,
sir.
Mr. VENTO. Can you share with us, during your period of examination, the amount of foreign bank deposits versus domestic correspondent bank activity? Can you tell us what the volume of corre


134
spondent or foreign bank deposits were at that time in 1981 when
you last did the examination, Mr. McCarte?
Mr. MCCARTE. I don't have those statistics with me. I would have
to defer on that question.
Mr. VENTO. Can you provide us with insights into the amount of
foreign bank/correspondent deposits with this institution, Mr.
Kovarik, during the period t h a t you provided examination work?
Mr. KOVARIK. I don't have anything specific on correspondent/
foreign bank deposits. Their relationships to foreign funds did increase after July of 1982, I believe at one point it reached about 50
percent of their total purchased funds.
Mr. VENTO. Fifty percent. And of course we all are aware of the
fact t h a t they were raising money on a daily basis, but t h a t of
course—I am asking about the deposits t h a t were present there
and about the correspondent banking relationship. When you
began to examine this, how do you treat this as the holding
company? Are you just looking at the bank side or at all the other
assets, Mr. Kovarik, and all activities in terms of the holding company? How is that relationship worked to the bank examination
t h a t you provided?
Mr. KOVARIK. We examine the bank, the Federal Reserve Board
examines the holding company and holding company subsidiaries.
We do work together during the examination and would share our
information as far as the quality of the bank, our view to the Federal Reserve, and they supply us with information as far as the
quality of the assets and the operations of the holding company
and its holding company subsidiaries.
Mr. VENTO. What type of communication during the periods t h a t
you are doing the examination with the holding company did you
receive from the Federal Reserve Board with regards to the holding
company?
Mr. KOVARIK. The Federal Reserve examiners were in Continental during our examinations. The examinations were conducted as
of the same dates although the Federal Reserve examiners in Continental's case were not there as long as we were. Because my
recollection is t h a t the holding company and its subsidiaries accounted for 5 or so percent of the total assets of the corporation
whereas the bank was 95 or 96 percent of the total assets.
Mr. VENTO. Mr. Kovarik, you heard my question of Mr. McCarte,
with respect to the liqudity of the bank. Do you have any comments with respect to the significant difference between the liquidity of Continental Illinois and its peers? The ratios, the assets?
Mr. KOVARIK. I believe t h a t they historically had been higher
t h a n their peers. One of the reasons was t h a t they were—they are
located in Illinois whereas a number of their peers are located in
States t h a t have the ability to branch and to garner retail deposits
throughout a greater location than Continental did. I think if you
look at the two multinationals t h a t we have in Chicago their percentage of purchased funds is higher than those banks in California of relatively the same size.
Mr. VENTO. YOU think t h a t is the major reason, is the inability to
branch t h a t causes their funding
Mr. KOVARIK. Yes, and the fact t h a t Continental is a wholesale
bank, not concentrating on consumer relationships. If I was a con


135
sumer, I wouldn't put my deposit—you know, if it wasn't convenient for me and if I wasn't assured of getting a loan from that bank
when I needed it.
Mr. VENTO. In your statement in terms of the record, I forget the
date, but you point out that less than 20 percent of the deposits of
Continental Illinois were in Penn Square. I guess that was what
you were saying. What was the exact percentage?
Mr. KOVARIK. I don't understand the question. I don't recall
saying anything about deposits in Penn Square.
Mr. VENTO. Let us see then, the statement—it says although the
Penn Square relationship accounts for a relatively small proportion
of the problem loans, less than 30 percent, the publicity surrounding its closing is surely the one event t h a t has done the most
damage.
In other words, in that case you are talking about what? You are
talking about Continental Illinois National Bank having a small
portion of the problem loans, or who are you talking about?
Mr. KOVARIK. N O , sir. I believe t h a t is talking about the total
criticized assets at Continental in my 1982 examination, and that
the Penn Square participations accounted for 20 percent of criticized assets.
Mr. VENTO. Were they 20 percent or less than 20 percent?
Mr. KOVARIK. They were approximately $820 million.
Mr. VENTO. In other words, $820 million—in multiplying that
out, t h a t indicates there are $4 billion worth of problem loans in
1982. Is that right?
Mr. KOVARIK. There were $5.6 billion—according to your page 17,
there were $5.6 billion of criticized assets at t h a t examination, so
the $820 million would have been less t h a n 20 percent—16 or 17
percent.
Mr. VENTO. It shows there were a lot of problems here. It was
just not an isolated situation.
Mr. KOVARIK. That is right. As I pointed out earlier, though, at
that point Penn Square did account for the majority of those doubtful assets and the losses at that examination. Those two categories
are the most severe.
Mr. VENTO. There is a reluctance on the part of the bank, any
bank, to write off any type of bad loan at any time, isn't there? In
other words, it is your job to begin to ferret our whether or not
some of these loans are collectible. Ultimately, if you go back and
look at those loans, the question arises in my mind that it seems
like today, after not putting out any more loans, they ended up
with 4.5 billion dollars' worth. So these loans looked to me like
they are the ones t h a t resulted in the bulk of the $4.5 billion in
loans t h a t have been declared as bad loans right now. Is t h a t accurate or not?
Mr. KOVARIK. I don't know which $4.5 billion you are referrng to.
Mr. VENTO. I mean t h a t there are some assets in the bank right
now, today, trying to make a relationship now between what occurs
today and what you discovered at that time. They had $5 billion
worth of problem loans at that time.
Mr. KOVARIK. Yes, sir.
Mr. VENTO. Thank you,




Mr. Chairman.

136
Chairman ST GERMAIN. Mr. Kovarik and Mr. McCarte, you were
scheduled to do the 1982 examination, is that correct?
Mr. MCCARTE. That is correct.
Chairman S T GERMAIN. Then on what date did you state that
you would not do it because you were under consideration by Continental?
Mr. MCCARTE. I believe I said I was approached on J u n e 10 and
it was a Thursday, and on Friday was a day off for the examiners, I
was not in the bank. Just to clear this up, we discussed it with my
wife over the weekend and on Monday, the first thing I called
Washington to advise them t h a t I had been approached, and at
t h a t time I left the bank and joined the regional office.
Chairman S T GERMAIN. Mr. Kovarik, you then were given the responsibility for that particular examination, is that right?
Mr. KOVARIK. Yes,

sir.

Chairman S T GERMAIN. On what date did you receive t h a t responsibility?
Mr. KOVARIK. I entered the bank on J u n e 21 and I think I was
notified either Thursday or Friday the week before.
Chairman S T GERMAIN. When were you told by the Washington
office of the problems at Penn Square?
Mr. KOVARIK. I think the name Penn Square came up when I received a call to tell me I was to go to the bank. But it was just—we
have got some problems with Penn Square—is my first recollection.
It was the following week, the week of J u n e 21, before I got any
information about Penn Square.
Chairman S T GERMAIN. What type of information did you get?
Mr. KOVARIK. What was going on during the examination down
there as far as losses at Penn Square, the amount of loans t h a t
Continental had purchased from Penn Square, information like
that. It had expanded over the next 2 weeks I would say, 3 weeks.
Chairman S T GERMAIN. Mr. McCarte, prior to your decision not
to conduct that examination were you advised by the Comptroller's
Office as to what was occurring at Penn Square?
Mr. MCCARTE. NO, sir.

Chairman ST GERMAIN. Mr. Schumer.
Mr. SCHUMER. Thank you, Mr. Chairman.
And my first question is directed at Mr. McCarte. If you would,
t u r n to page 10 of the examination findings. The last couple of sentences in the first paragraph you state that no significant problems
are evident as noted by the fact t h a t only two oil and gas credits
were classified herein. What do you mean by the phrase "no significant"—what you are saying is no significant problems are evident
in oil and gas loans. What do you mean by that?
Mr. MCCARTE. Well, it means t h a t if we had found a large
number of credits t h a t were—that we were reading as special mention or substandard, doubtful and loss, and it was large in relation
to the portfolio, we would have considered it to be perhaps a problem. And the observation was t h a t only two credits were cited. One
of them was a significant doubtful credit, I believe.
Mr. SCHUMER. The basic question is this: You with your team of
auditors, probably very experienced auditors, crack auditors, are
here in the bank examining the oil and gas loans at the very same
time t h a t Ms. Kenefick is issuing her report, and her report is a



137
devastating document and at the same time you are stating no significant problems are evident as noted in the oil and gas area.
How did that happen?
Mr. MCCARTE. I can't speak to—we obviously did not have Ms.
Kenefick's memo during the examination.
Mr. SCHUMER. I am not asking did you have her memo. You had
her oil and gas loans. That was one of your jurisdictions.
Mr. MCCARTE. That is right. The amount of credit t h a t Oklahoma City had generated at t h a t time was in the neighborhood of
$300 million, which in a $40 billion bank is relatively insignificant.
However, as I said before, we did send examiners back to establish
what type of credits they were. The answer came back was they
were primarily credits secured by standby letters of credit and that
type of collateral is rather good.
Mr. SCHUMER. All the things she catalogs in her report, all the
many things, do those just completely escape the eyes of auditors?
Mr. MCCARTE. I have not read Ms. Kenefick's memo in its entirety. I have not read it at all as a matter of fact. It came to me this
morning.
Mr. SCHUMER. What she is basically saying is there are hardly
even documents for any of the loans. If you are going to take a
sample of loans you are not going to find undocumented loans as
part of the sample.
Mr. MCCARTE. Perhaps we can explain the methodology of how
we examine a bank. What happens is during the examination, as
Dick Kovarik points out, the examiners will test the internal controls. The examination procedures employed in the large banks
allow for the review of the external auditor's report, we try and determine their adequacy and competency. We do the same with the
bank's internal audit report. The rationalization is t h a t examiners
will not redo good work that has already been done.
As a result of the internal control questionnaires that we were
using at the front end of the examination, we established that the
bank through its internal devices, the bank's internal auditing department, the operation of the bank, had tested and found no significant problems. What we do is review the reports of the auditors
and from t h a t basis we make a determination as to how far we are
going to go.
During the sampling technique t h a t we would employ once we
have established up front t h a t the internal controls seem to be adequate.
Mr. SCHUMER. Excuse me
Mr. MCCARTE. And from
Mr. SCHUMER. YOU are past the point I want to be and I don't
want to take up the committee's time on that.
Mr. MCCARTE.
Mr. SCHUMER.

OK.

Her report makes obvious that the internal auditing mechanism in the bank was atrocious.
Mr. MCCARTE. Her report seems to be also dealing with 300 million dollars' worth of credit, And I can't explain anything beyond
that, sir.
Mr. SCHUMER. I don't understand. You are saying if it was $3 billion you would have caught it?
Mr. MCCARTE. If it was $3 billion, I would presume it to be——



138
Mr. SCHUMER. Most of the bad loans are undocumented is what
she said. A lot of them were not there. Would you catch them?
Mr. MCCARTE. Yes, I think so.
Mr. SCHUMER. Why? You couldn't pick them from the sample?
Mr. MCCARTE. The sample did not. Neither the condition of the
banks internal controls nor the documentation of the credits would
have any bearing on whether they were selected in a sample. The
OCC sampled from outstandings and if the loans were booked on
the loan system they had the potential of beings selected. Additionally it should be noted t h a t both the number and dollar amount of
Penn Square credits was small at April 30, 1981, thus reducing
even the potential for selection.
Mr. SCHUMER. YOU approved the internal auditing?
Mr. MCCARTE. That is right.
Mr. SCHUMER. And it is clear it was junky?
Mr. MCCARTE. If I can be allowed to finish, I think what we established is the bank's internal devices had done some testing in
these specific areas and if they are coming up relatively clean and
if we can't challenge the independence and competency of a bank's
internal audit department as well as external auditors in the bank,
the guidelines require us to go no further, state we should go no
further.
At the beginning of an examination we visit with the bank's internal audit department and attempt to gauge their independence
and competency. If the scope and frequency of their work is acceptable we would shift our emphasis from operational and audit concerns to credit quality matters. Also during the early stages of an
examination the competency and independence of the external
auditors is also evaluated. It is my recollection t h a t during the
1981 examinaiton there was no grounds for concern from either of
these sectors. As such our guidelines would not require us to delve
deeply into operational matters.
Mr. SCHUMER. Then t h a t leads to my next question. But before I
get to t h a t next question which I would like to ask you, Mr.
McCarte, I want to say, and I can't speak for the committee, t h a t I
think Ms. Kenefick is the good guy in this operation. She is the
good gal—excuse me, Ms. Kenefick—and she is here, but I imagine
she has to pay a lawyer and all the expenses. It is not going to do
you much good, but my apologies. I sympathize with your situation.
You did the right thing and you are still in the soup somehow or
other.
Ms. KENEFICK. Thank you.
Mr. SCHUMER. What went wrong, Mr. McCarte? If you were sitting in my chair, what the heck went wrong? Something very badly
went wrong. What went wrong? Well, did nothing go wrong?
Mr. MCCARTE. Obviously the results of the examinations and
what was published
Mr. SCHUMER. What went wrong?
Mr. MCCARTE. I am afraid I can't give you a very thorough or
complete an explanation.
Mr. SCHUMER. I am asking you, you have had 22 years' experience both as an officer of Continental Illinois and before t h a t as an
auditor. You have to give me some answer—I am asking for your
help.



139
Mr. MCCARTE. I would suggest that perhaps it is a combination of
factors. In 1981 the Continental Bank seemed to embark upon an
agreement with or a relationship with the Penn Square National
Bank. The credits t h a t were purchased from that institution I
think translated to approximately $1.1 billion. In retrospect, those
credits were not very good with very sizable losses and doubtful
classifications eventually being rendered on those credits. Also, at
that time in late 1981, early 1982, the energy sector began
Mr. SCHUMER. Excuse me, Mr. McCarte, I wasn't clear in my
question. I don't want to know what went wrong in the energy
sector, I want to know what went wrong with the auditing procedures other t h a n t h a t what Ms. Kenefick was able to find out was
oblivious to everybody contemporaneously and later?
Mr. MCCARTE. I am afraid I can't answer t h a t question.
Mr. SCHUMER. YOU can't answer?
Mr. MCCARTE. I think what we did was totally appropriate, given
the circumstances, and I think we followed the guidelines as prescribed to the letter.
Mr. SCHUMER. What you are saying to me is that you can be
going through these same guidelines right now with other banks
and 2 months from now, we could be hearing about another problem.
If there is nothing t h a t went wrong here, and this was the typical procedure, appropriate procedure, for doing bank auditing—
right—then it could be that your colleagues, maybe Mr. Kovarik,
Mr. Meade, or thousands or hundreds of other auditors around, are
not catching the same kinds of problems, maybe not oil and gas,
maybe not Penn Square—isn't that an accurate statement?
Mr. MCCARTE. It sounds like you are asking me to guess as to
what could occur. It is only conjecture and I have been away from
the office 2 years now, and I am not thoroughly versed in what
they do.
Mr. SCHUMER. Well, from what you used to do.
Mr. MCCARTE. What we have is a situation where we have a
bank who has had sizable problems, and they are a combination of
not only
Mr. SCHUMER. Those problems are not detected by the auditors.
That is my point to you. You know, obviously, the bank has real
problems and the banking system has even more serious problems,
but all we have is you folks.
Mr. MCCARTE. The only observation I would offer is that a lot of
the problems t h a t we are discussing are not operational problems,
they are problems related to the economy.
Mr. SCHUMER. I would ask you the same question. Mr. Kovarik,
first comparing Mr. McCarte's memo and Ms. Kenefick's memo.
What went wrong? What went wrong with the auditing procedures?
Mr. KOVARIK. From
Mr. SCHUMER. Why wasn't this problem caught earlier?
Mr. KOVARIK. A S I said earlier, the mechanisms that the bank
had in place including the collateral reports and rating reports
which clearly in my examination of 1982 pointed out that there
was a problem in the midcontinent division, and Ms. Kenefick's
memo speaks of the Oklahoma portion of that midcontinent divi


140
sion—those exceptions were in my opinion clearly isolated to t h a t
one section, that midcontinent division.
As I said, my recollection is t h a t during the first 6 months of
1982, those exceptions accounted for more than 50 percent of the
total exceptions within the bank and as many as 65 percent of the
exceptions within the total bank.
So, in my opinion, there was a clearly isolated problem with the
Oklahoma portfolio or midcontinent portfolio.
Mr. SCHUMER. That was a pretty big portfolio.
Mr. KOVARIK. $1.1 billion.
Mr. SCHUMER. Yes.
Mr. KOVARIK. Again
Mr. SCHUMER. What was the capital of the
Mr. KOVARIK. Approximately $2.2 billion.
Mr. SCHUMER. SO it was 50 percent of the

bank at t h a t time?
total capital of the

bank?
Mr. KOVARIK. Yes, sir. But if you

Mr. SCHUMER. That is the book value of those loans, not the
market value.
Mr. KOVARIK. Yes, sir, but if I can go one step further, I think
Mr. McCarte said earlier t h a t when he did his examination, those
loans amounted to $330 million, and they grew substantially, especially during the last half of 1981, and first half of 1982, a time we
were not in the bank examining it.
Mr. SCHUMER. YOU wrote in
Chairman S T GERMAIN. Chuck, excuse me, do you have perhaps
the date of the last participation t h a t was purchased from Penn
Square by Continental?
Mr. KOVARIK. N O , I don't, sir.
Chairman S T GERMAIN. Would you make t h a t available to us?
Mr. KOVARIK. We can get it for

you.

Chairman S T GERMAIN. Everybody knows Penn Square failed, so
we don't have a secrecy problem there.
Mr. KOVARIK. Yes, sir.
Chairman S T GERMAIN. Thank you.
Mr. SCHUMER. I am afraid maybe some

of the people who audited
the banks didn't know it failed, even after it failed. But in any
case, Mr. Kovarik, in your November 15 memo to William Martin,
Deputy Comptroller, you said t h a t quality control problems were
endemic throughout the bank.
I am trying to find the sentences here. Quality control—it can be
said t h a t quality control is useful for the bank.
Now, when you see such problems in one area, as you called it
the midcontinent area, and you see the quality control problems
throughout in the bank, doesn't it lead you to think that problems
can occur in the rest of the parts of the bank that you may not be
detecting?
Mr. KOVARIK. Yes, sir, but we were talking specifically about internal controls and those internal controls which would have pointed out the Oklahoma portfolio is what I was referring to before.
Mr. SCHUMER. But they didn't exist for the receipt, did they?
Mr. KOVARIK. Yes, sir, they were there, and being observed by
other division heads. The fact that



141
Mr. SCHUMER. It says here t h a t quality control is useful for the
bank. Internal control and quality control are different?
Mr. KOVARIK. Yes, sir.
Mr. SCHUMER. In what
Mr. KOVARIK. Internal

way?
control can have an effect on quality, but
it is not the only—put it this way, you can make a loan that is very
good at the outset, but if you don't document it properly and your
internal controls don't catch that, it can t u r n into a problem.
You can also make a very good loan at the beginning, document
it perfectly and do everything and it can t u r n into a problem loan.
The quality control detection is after the loan is booked, are
people looking at it to make sure t h a t it is meeting the requirements and if it is not, are steps being taken
Mr. SCHUMER. YOU say both are necessary, and neither is sufficient?
Mr. KOVARIK. That is true.
Mr. WYLIE. Would the gentleman yield on t h a t point?
Mr. SCHUMER. Yes, sir.
Mr. WYLIE. I think the

testimony t h a t you have elicited here is
very revealing. From what you have said, it is possible to have as
many deficiencies in a loan approval, approval and documentation
functions as were later found in the case of Continental Illinois,
and still have a sound system of internal controls.
Is that a fair observation?
Mr. KOVARIK. N O , sir.
Mr. MCCARTE. N O .
Mr. KOVARIK. N O , I am

saying that the unsoundness of their controls was isolated to a certain segment or portfolio.
Mr. SCHUMER. Internal, not quality controls?
Mr. KOVARIK. Not quality controls, yes, sir.
Mr. SCHUMER. J u s t to clarify.
Mr. WYLIE. YOU based a lot of your determination on what was
going on in the bank on the internal controls within the bank, and
what you ascertained from those internal controls.
Mr. KOVARIK. Yes, sir. And if I can go one step further?
Mr. WYLIE. YOU must have thought those were at the time
sound.
Mr. KOVARIK. Except as they related to the midcontinent division, strictly internal controls were sound. If I could take just one
example of the collateral exceptions. The operations division of the
bank t h a t was charged with gathering all the documentation for a
loan and making sure it was all there, they would submit reports
on a monthly basis to the division heads and their superiors.
And it was the division heads' responsibility to clear those exceptions.
In the case of divisions outside of the midcontinent those were
taken care of on a very timely basis. It was rare to see more than
one or two exceptions per month in a division and the next month
t h a t exceptions would be cleared and another one, more due to
timing than anything else, would appear.
However, in the midcontinent division, the exceptions grow over
a period of time with the first ones not being corrected, a group of
other ones coming on, and then the next month those also not
being corrected, so they grew.
39-133 0—84




10

142
The fact that the division head of that midcontinent division was
not responding to his responsibility as I stated in my letter to the
board, he did not take his responsibility along with the authority
he had been granted to make sure these corrections were made.
The other breakdown, as I saw it, was t h a t his superiors also did
not take their responsibility in overseeing his job. And the other
divisions of the bank where we did not find exceptions of any magnitude at all, those division heads and their superiors were taking
t h a t responsibility, so t h a t internal control system of reporting an
exception to the officer was working in those because those other
officers were doing their job and saying here, I have an exception, I
have to do something about it and they would correct it.
Mr. WYLIE. But it wasn't working in the case of midcontinent.
Did you consider doing any additional test or examinations or establishing any different standards so that the internal control
system in the case of midcontinent would be adequate? Or is t h a t
not your function?
Mr. KOVARIK. Yes, sir. Our recommendations to improve the controls started off with, somebody had to be on top of those items to
be sure those offices were taking their responsibility along with
their authority.
Mr. SCHUMER. My colleague, Mr. Barnard, has pointed out something to me. I would like to read two sentences into the record, one
from the 1981 report, done by Mr. McCarte, and one for the 1982
report done by Mr. Kovarik.
The 1981 report stated t h a t CINB, "Continental Illinois National
Bank is adequately staffed with both sound lending officers and scientific engineers, geologists, personnel—scientific personnel to
handle current relationships and meet strong continued growth anticipations.' ' 1981. 1982: "It can be said that the lack of quality control is universal for the bank."
One has to look at those sentences and say something is rotten in
the state of the Comptroller of the Currency's Office and the way
they function. I am sure there was not a total revamping from 1981
to 1982.
And yet, you are saying complete contradictory things.
I would like to ask two more questions.
First, have any of the three auditors here been in a situation
where you saw a bank in the same kind of shape you saw Continental, where you made your audit and then as a result of your
audit, which you quietly and internally passed along to the bank,
the situation was corrected so that the bank didn't go bad, although Continental did?
Any of the three of you think of an instance of that? The banks
will be in good shape now, so you are not revealing any confidences
t h a t would lead to problems.
Because t h a t is the premise of the question. Can you think of an
example, not where each of you were personally involved, but
where this happened?
Mr. MEADE. Can you repeat the question?
Mr. SCHUMER. The question is whether you or another auditor
t h a t you know from the Comptroller's Office have ever been involved going to a bank, auditing, discovering reaL internal problems, such as have been touched on in some, though not all, of the



143
reports that we have issued here, you brought t h a t to the attention
of the bank's management, and that situation was corrected, so
t h a t a Continental did not occur.
Mr. KOVARIK. As for myself, I have been invovled in the examination, as examiner in charge or as assistant or assisting examiner
in a number of problem banks during my career, and the vast majority of those are still around today.
Mr. SCHUMER. That wasn't my question. I know that the vast majority of the banks are still around today. My question was did you
examine one of those banks, any one, and find a significant and serious problem, issue a report so, said that, and then management
took corrective action?
If so, please cite to me the bank and the instance. We want to get
an example of when this system ever works.
Mr. MEADE. I am not prepared to give you an example. But that
is the whole objective of our work, is to identify the problem
Mr. SCHUMER. I am aware of that.
Mr. MEADE [continuing]. And to prompt management to take corrective action. We have very limited resources to accomplish the
job in the 4,500 national banks. We do identify the problems and it
is management's responsibility to correct them.
Mr. BARNARD. Would the gentleman yield?
Let me phrase it a different way. How responsive was the Continental in making the necessary corrections t h a t you recommended
over the period of years? I can't ask Mr. McCarte, because he is
with the bank.
Mr. MCCARTE. I can respond for the period of time I was there, if
you like. I can respond for the period of time I was with the Comptroller's Office, if you like. I found the bank to be receptive to the
comments and had in the past demonstrated a commitment to
make change.
Mr. BARNARD. HOW can you respond, then, when there was such
a difference in the two reports, where the one you reported shows
the bank was adequately staffed, had sound lending, and so forth
and so on, and then in the next examination Mr. Kovarik found it
in disarray.
Mr. MCCARTE. I cannot speak for Mr. Kovarik.
Mr. BARNARD. What is your opinion, Mr. Kovarik? Do you feel
like the Continental responded aggressively enough to the recommendations for corrections?
Mr. KOVARIK. Yes, sir; I think they did. As I said before, I cannot
think of any of the recommendations t h a t we made in 1982 that
were not responded to positively.
If I can get into the other question about the two comments, I
think they are related to two different things. Mr. McCarte's comment is specifically to the oil and gas portfolio in 1981, and I am
talking about a breakdown in the quality, loan quality control
system that not only included Penn Square loans, but other loans
on the books at the time in 1982.
Mr. SCHUMER. If I might reclaim my time—your comment applies to oil and gas, too.
Mr. KOVARIK. Yes, sir.
S T GERMAIN. YOU

Chairman




don't have any to reclaim.

144
Mr. SCHUMER. Sorry, Mr. Chairman. I would just like the record
to state, and I will ask this tomorrow as well, instances where we
have a real dilemma, to say the least, here.
First, three points I would just like to make that I derive from
the testimony. As Mr. Barnard elicited, Continental followed all
your recommendations. That is No. 1. That means t h a t the procedures set up by the Comptroller can't avoid Continentals, and to
me, it implies if other Continentals are blooming, the Comptroller
doesn't have any power to stop them.
Chairman S T GERMAIN. He has the power.
Mr. SCHUMER. Sorry. Any ability under the present way he is
working to stop them.
The second thing which makes me think that is t h a t nobody can
seem to point out an instance where their work was able to discover problems and lead to corrective or prophylactic action so t h a t a
debacle didn't occur.
And third, which is a separate point, but I think an important
one, the contradictions between the various statements made in
1981, 1982, just alone by employees of the Comptroller of the Currency, make me feel t h a t their standards at the very least are
flimsy, if not nonexistent.
I yield back.
Mr. MEADE. May I comment on the period from 1973 to 1976?
The classified assets, as you recall, in 1976 were at approximately
120 percent, and I was very impressed with management in terms
of the responsive action they took to address those problems.
Chairman S T GERMAIN. In 1978, they embarked on their new
venture, is t h a t right?
Mr. MEADE. I think the study on the high growth scenario, I believe t h a t was undertaken in 1976. But I was very impressed the
way management jumped in and recognized problems and effected
correction.
Chairman S T GERMAIN. Well, gentlemen, Mr. Schumer made a
great point. If management did everything the Comptroller's Office
told them to do, all along the line, from 1976 to 1983, 1984, and
Continental still failed, then maybe the Comptroller's Handbook
has to be revisied to determine what it is that is not in the handbook, or whether you should be given more power and more discretion t h a n you have been given to date.
Let me ask you this: Mr. McCarte, you were informed about
problems at Penn Square when? You resigned J u n e 21, 22, right,
from the Comptroller's Office. What did they tell you about Penn
Square?
Mr. MCCARTE. When I had resigned?
Chairman S T GERMAIN. Before you left, when you were still
scheduled to be the chief examiner of Continental for the J u n e examination.
Mr. MCCARTE. I had no insights on the Penn Square, the condition of the Penn Square portfolio. The conversations that I would
have had with the Comptroller of the Currency's Office in Washington was as part of the budgeting process.
When we finished the 1981 examination, we had targeted three
areas as part of the normal budget to do next time around—which



145
areas, what type of people you want, and the like. We had targeted
at that point in time three broad categories.
One was real estate, we were in an environment of high interest
rates, the bank had problems in the past they had corrected, we
wanted to see if they continued as such.
The bank had a profit center which was primarily steel scrap
dealers, automotive suppliers, related to the Midwest type of economy, which of course we had suspicions might be under some stress,
given the recession. And we also had high classified coming out of
that particular area. So we concentrated on t h a t one. The third one
was the energy area.
As part of the scope of the next examination for 1982, we decided
that the best way to approach that was to perhaps get some expertise from an area outside of Chicago to help and assist the examiners in the Chicago district.
And what we had done
Chairman S T GERMAIN. That was in the energy area in general.
Mr. MCCARTE. I am sorry.
Chairman S T GERMAIN. YOU are talking about the energy area in
general, and not Penn Square specifically?
Mr. MCCARTE. That is correct. As I said before, we had done a
limited amount of testing, tested some of the collateral pieces on
the Penn Square related credit, and as we proceeded between
August of 1981 and J u n e of 1982, we would have a series of conversations in Washington between myself and the Washington staff,
basically fine-tuning the budget, and as part of the program we had
decided we were going to ask an examiner to come from the Southwest to assist us.
And he was going to go through the Penn Square bank and
report back to us.
Chairman S T GERMAIN. YOU did that of your own volition and
motivation as a result of your 1981 exam?
Mr. MCCARTE. Correct.

Chairman S T GERMAIN.
told you to do it?

YOU

did not do t h a t because Washington

Mr. MCCARTE. N O , sir.

Chairman S T GERMAIN. OK.

Mr. Kovarik, you took over as the chief examiner for the 1982
exam on J u n e
Mr. KOVARIK. J u n e 21, I believe it was.
Chairman S T GERMAIN. J u n e 21. All three of you still were in the
Chicago office in J u n e of 1982, right?
Mr. MEADE. N O . I was in Cleveland at t h a t time.
Chairman S T GERMAIN. SO you had departed.
Mr. MEADE. Right.
Chairman S T GERMAIN. OK.

Mr. Kovarik, it is now J u n e 21, 1982. You are now told you are
going to be the chief examiner. When did you first receive a call
from Washington—obviously, Mr. McCarte, since he did not receive
any call from the Comptroller's Office in Washington saying Penn
Square is in trouble or might be in trouble. When did you receive
that call, Mr. Kovarik? Was it a separate call or what?
Mr. KOVARIK. When I was called, the week prior to the 21st, I
believe it was either Thursday or Friday of that week, I was called




146
and informed that I would be taking over the examination and the
comment was made, we have got some problems with Penn Square,
we will talk to you about it next week.
I happened to be on vacation at t h a t time, and I think they delayed so I wouldn't get my vacation ruined.
Chairman S T GERMAIN. OK. Now, do you know if anyone else in
your Chicago office was called and told to do an examination for
Penn Square?
Mr. KOVARIK. No, I do

not.

Chairman S T GERMAIN. Would your colleagues in the Chicago
office have informed you? Was there a memorandum that came
into the Chicago office saying there were problems at Penn Square,
or was it merely on the telephone?
Mr. KOVARIK. I know of no memorandum. Continental at the
time, and still today, is under the Comptroller's supervision—of the
Multinational Division here in Washington. So, the region itself,
the seventh, the old region, now the central district, does not have
responsibility for Continental.
Chairman ST GERMAIN. If the Washington Office of the Comptroller were to say they had informed the Chicago office of the
Comptroller that there were problems at Penn Square because of
the fact they knew t h a t Continental was involved, your division
would have been informed also?
Mr. KOVARIK. I would assume so.
Chairman S T GERMAIN. The multinational, right? There is a
reason for this questioning, ladies and gentlemen? I know I have
interceded. We heard what Mr. Kovarik said earlier and Mr.
McCarte.
May 11, 1982. This is from Mr. Conover's testimony on July 15,
1982. April 1982, Penn Square Examination commenced. On May
11, 1982, Regional Administrator notified Washington office of
problems being uncovered.
May 11, 1982. OK?
Now, I asked Mr. Conover on July 15, 1982: "Now, I ask you, was
the information that was gleaned from the examination of Penn
Square forwarded to your Chicago offices so t h a t the examiners at
Continental would have knowledge of the fact t h a t some of these
participations in some of those loans which they urged to Penn
Square were as you described it in your statement, not too well-collateralized?"
He said, "I think I would like to answer the second part first.
And then I would ask Mr. Homan if he would deal with the first
part involving the transmittal of information to Chicago."
All right. We go to Mr. Homan. And I quote him. "During the
course of the examination—" t h a t commenced April 19—"as soon
as the losses and poor quality loans both in the bank and t h a t portion t h a t was participated with other banks became apparent, we
did notify all of our offices effected and particularly our larger regional office that directly supervised the Continental, Chase, and
Seattle First and a number of other participants.
"We also sent an energy examiner, one of the experts from Oklahoma, to Continental to aid our examiner in the assessment of t h a t
portfolio."



147
Now, we hear that Mr. McCarte asked for the examiner to come
in from Oklahoma. It is not that the Comptroller's Office decided
to do t h a t because of what they were finding in Penn Square. And
we find May 11, the Comptroller's Office knew about and had been
told, and they told us that on May 11, 12, 13, and 14, they informed
the Chicago office of the problems t h a t were occurring in Penn
Square.
And lo and behold, the reality is t h a t it wasn't until J u n e 17, 18,
21, that Mr. Kovarik was told there might be problems at Penn
Square. I think this puts in question some of the testimony we received on July 15, 1982, relative to Penn Square. That is why I
wondered when Continental purchased its last participation from
Penn Square.
Wouldn't it be rather sad if we were to find t h a t they purchased
one on the 30th of May, Memorial Day, or 2 days before it, 2 days
over? Wouldn't it? That would be, wouldn't it, Mr. Kovarik?
Since they had knowledge on May 11 in the Washington Office of
the problem, the severity of the situation in Penn Square. You can
answer that question, can't you, as an examiner?
Mr. KOVARIK. I guess it would.
Chairman S T GERMAIN. Wouldn't it be sad to find that out? I
know we are supposed to have a veil of secrecy. But my goodness
gracious, if there are problems in the audit department discovered
by Mr. McCarte, certainly Continental should have been told about
the Penn Square situation as soon as possible, because t h a t is in
the energy field.
Mr. Wortley?
Mr. WORTLEY. Thank you, Mr. Chairman.
I wonder if we could talk a little bit through the procedure t h a t
is followed once you put together a report. Here is 50 to 60 pages in
which you have examined the earnings and the capital, reviewed
the profit centers, loan portfolio management, liquidity, and assets.
I am looking at the December 6, 1982, report, some very damaging language in here. Second paragraph, the letter to the board of
directors, says,
The examination results show the condition of the institution to be seriously deteriorated.

Another sentence in the next paragraph starts out,
Current problems can be largely attributed to decentralization of authority without adequate policies, procedures and quality control systems, combined with a management direction that encouraged aggressive growth, but failed to hold managers
accountable.

It goes on and on with some very critical things. But once this is
completed, who do you deliver this report to in the bank? Do you
drop it off to a secretary or take it to the president of the bank, or
sit down with the board of directors or just what happens to this
report?
Mr. KOVARIK. The report, after we complete it, is, in this case,
submitted to the multinational division in Washington. A transmittal letter is prepared by the Deputy Comptroller for multinational.
It is sent to the bank and it is presented to them formally at a
board meeting held with the board of directors sometime after they
had received t h a t report.



148
Mr. WORTLEY. Do you or anybody from the Office of the Comptroller actually sit down in that board meeting and go through this
report with them, or is this something t h a t the officers are supposed to relay to the board of directors and it is part of their big
meeting agenda, and it gets 1V2 minutes of comment?
Mr. KOVARIK. No, sir. We present the report of examination to
them covering the high points or the areas t h a t we want to stress.
It includes, I think, in the case of the 1982 report, was probably a
30- to 45-minute formal presentation, and then another half an
hour or so, maybe even longer than that, of discussion after t h a t
formal presentation.
Mr. WORTLEY. SO you spent a good couple of hours with the directors, officers and directors of the bank, is t h a t correct?
Mr. KOVARIK. Yes, sir. And t h a t is just at t h a t meeting.
Mr. WORTLEY. In all cases, do you do that, or just when you have
a very critical report?
Mr. KOVARIK. N O . That would be in all cases of course, the length
of time would vary. But all reports are presented to the board of
directors.
Mr. WORTLEY. In person.
Mr. KOVARIK. In person.
Mr. WORTLEY. Did you present this one to the board yourself?
Mr. KOVARIK. Yes, sir, I

did.

Mr. WORTLEY. Did they have a lot of questions?
Mr. KOVARIK. Yes, sir. I might also say that prior to that meeting, I had held, I believe, two and possibly three meetings with the
audit committee of the board, starting in September 1982, September, October.
Mr. WORTLEY. NOW, once you have made that report to the
board, to the officers, is there any sort of a followup procedure t h a t
ensues, like in 60 days or 90 days, do you go back and ask them,
what have you done to correct this situation, or that situation?
Mr. KOVARIK. We do a quarterly visitation at all of our multinational banks, any of them. In this case, there was very frequent
conversations between our Washington office, myself, and officers
of the bank, even after the examination was presented to them.
Mr. WORTLEY. What was their response along the way? Did they
say they were pulling up their sox and taking care of this?
Mr. KOVARIK. A S I said, to my recollection they instituted every
recommendation t h a t we put into the report.
Mr. WORTLEY. They instituted all of the recommendations you
put into the report.
Mr. KOVARIK. Yes, sir.
Mr. WORTLEY. And when

you went back in 1983, did you find all
those situations corrected, or had the ship sprung a leak in another
spot?
Mr. KOVARIK. A number of the recommendations were, of course,
geared toward improvement in the operations and especially the
credit review division—the credit quality section of the bank. Those
recommendations were implemented. They were reviewing loans
more frequently, concentrating on the much more critical problem
of the problem loans.
In 1983, the condition continued to deteriorate.



149
Mr. WORTLEY. But the condition was still deteriorating. Was this
the condition of the old loans that was deteriorating or the new
loans.
Mr. KOVARIK. No, sir, it was old loans that were on the books,
and were feeling the further effects of the downturn in the economy.
Mr. WORTLEY. But most of the problem that existed in 1983 and
in 1984 you are saying were based upon old loans and not on the
current or new loans t h a t had come into the portfolio?
Mr. KOVARIK. Yes, sir.
Mr. WORTLEY. NOW, do

you exchange information in this report
with either the Federal Reserve Board or the FDIC? Do you pass
on this report of the FDIC—if there is a problem?
Mr. KOVARIK. It is my understanding that those reports do go
both to the FDIC and to the Federal Reserve Board. As I said
before, during the examinations we conducted on Continental, the
Federal Reserve was there, and I had at times daily contact with
their examiners while they were in the bank.
I am sure t h a t they are—the report in its entirety is sent to
those two agencies.
Mr. WORTLEY. I hope they exchange it more expeditiously than
you do within the Office of the Comptroller of Currency, when you
don't share information back and forth very well. In your report,
you noted t h a t although the lack of quality control is universal for
Continental Illinois, this deficiency was most notable within the
special industries and real estate groups.
In your opinion, what factors contribute to this and why were
they not detected sooner?
Mr. KOVARIK. Well, in the case of the special industries group, a
large majority of those credits were the Penn Square credits in the
midcontinent division. The system employed at Continental and in
most banks that have loan review systems relies to varying degrees
on the account officers initiating any information up through
senior management with regard to deterioration in individual
credits.
I believe in both of those areas, it was a fact that the loan officers were not as fast in putting loans on the bank's watch loan
report or bringing them up to management as problems.
Mr. WORTLEY. Was this a management problem or a personality
problem, would you say? Was the style of management adequate to
cope with this or were they just plain inept individuals not paying
attention to their business or trying to cover up their tracks, they
were hoping for something better to come along.
Mr. KOVARIK. I think the answer is all of those, depending on
which area you are looking at in Continental.
Mr. WORTLEY. But this was essentially in the special industries
area, where this problem existed.
Mr. KOVARIK. A great deal of those were in the special industries
area.
Mr. WORTLEY. What about the real estate group?
Mr. KOVARIK. I think my recollection is t h a t was the second largest, but it was much lower t h a n the special industries.
Mr. WORTLEY. YOU noted the earnings were depressed and would
remain so until at least 1985. You also mentioned Continental's



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heavy loan loss provision, income reductions due to nonperformance as either an increased funding cost all adversely affected the
ability of Continental to return to normal profitability.
Given these projections, did you recommend any critical supervisory actions be taken at t h a t particular time?
Mr. KOVARIK. I recommended t h a t we institute enforcement
action against the bank at that time, yes, sir.
Mr. WORTLEY. You could foresee the events of 1984 taking place?
Mr. KOVARIK. N O , sir, I did not foresee those, but as spelled out
in the report, there were a number of areas t h a t needed improvement and it was my recommendation t h a t t h a t be reduced to a
formal agreement between the bank and our office.
Mr. WORTLEY. Did the bank respond?
Mr. KOVARIK. I am sorry.
Mr. WORTLEY. Was the bank responsive? You made those recommendations. And did the bank take the next action t h a t you had
recommended?
Mr. KOVARIK. A S I said, they instituted those recommendations;
yes, sir.
Mr. WORTLEY. To your satisfaction?
Mr. KOVARIK. When we again examined the bank in 1983, yes,
they had complied with every aspect of our agreements with them
and all of the recommendations t h a t we had made.
Mr. WORTLEY. Thank you, Mr. Chairman.
Chairman S T GERMAIN. YOU say t h a t you share your reports with
the FDIC and the Fed?
Mr. KOVARIK. Yes,

sir.

Chairman S T GERMAIN. Does the Fed share their reports with
you of the holding company?
Mr. KOVARIK. Yes.
Chairman S T GERMAIN. YOU have seen
Mr. KOVARIK. I have, yes.
Chairman S T GERMAIN. DO you know

them?

when the practice of sharing these reports started?
Mr. KOVARIK. N O , I don't.
Chairman S T GERMAIN. DO you share them with the FDIC as
well?
Mr. KOVARIK. Our reports, yes. Yes, sir.

Chairman S T GERMAIN. Mr. Patman.
Mr. PATMAN. Thank you, Mr. Chairman.
Miss Kenefick, were you employed by the Continental Illinois
National Bank or the Continental holding company?
Ms. KENEFICK. I was, I guess, an employee of the bank directly.
Mr. PATMAN. YOU were what?
Ms. KENEFICK. I was an employee of the bank.
Mr. PATMAN. YOU say you guess?
Ms. KENEFICK. I never really thought of it in t h a t distinction. I
was an officer of the bank itself, which was a subsidiary of the
holding company.
Mr. PATMAN. Mr. Kovarik, did you examine all of these other—
do you consider this as an entity with many of its other subsidiaries, or do you simply investigate the bank itself, the Continental Illinois National Bank?



151
Mr. KOVARIK. We examined the bank and its operating subsidiaries. The Federal Reserve examines the holding company and its
subsidiaries.
Mr. PATMAN. IS it your understanding t h a t the extensions of
credit t h a t have been made will be guaranteed by the assets of all
these other entities t h a t are parts of the holding company?
Ms. KENEFICK. That is my understanding.
Mr. PATMAN. YOU don't examine at all the holding company
itself, the parent company; is t h a t true?
Mr. KOVARIK. That is true.
Mr. PATMAN. Well, does its financial solvency or prosperity enter
into your judgment about the bank itself or do you simply examine
it based on its own merits?
Mr. KOVARIK. A S I said, we do joint examinations with the Federal Reserve, and the Federal Reserve examines the holding company and its subsidiaries. They pass along their information to us.
We examine the bank and its subsidiaries and we pass along t h a t
information to them.
Mr. PATMAN. In sort of a formal hearing or get together periodically or how often?
Mr. KOVARIK. It is between the examiners in charge or other examiners on the teams. We have—I am trying to remember—I think
we have been working with the Federal Reserve in Chicago on our
two multinationals back into 1977 or 1978, sometime in that period.
But I am not sure exactly when it was.
Mr. PATMAN. And you have apprised the Federal Reserve of all
the problems t h a t have been found in the bank?
Mr. KOVARIK.
Mr. PATMAN.

Yes.

From the beginning. Apparently they go back to
1976, if not earlier; is t h a t not true? Is t h a t your recollection in
your examination of the bank, your knowledge of its background?
Mr. KOVARIK. My knowledge of its background showed t h a t it
had problems in the 1975-76 period t h a t were decreasing during
my 1977 examination.
Mr. PATMAN. M S . Kenefick, did you ever write any memorandum
about the Third World loans; did those ever concern you?
Ms. KENEFICK. N O , sir.
Mr. PATMAN. Did you

examine them? Were those a part of your
responsibility, or did you have knowledge about their previous
nature at all?
Ms. KENEFICK. They were not part of my responsibility.
Mr. PATMAN. Did you understand t h a t the bank was concerned
about those?
Ms. KENEFICK. I am trying to recall. During the time I was there,
I don't recall t h a t a major topic.
Mr. PATMAN. Tell me, did any bank employees, officers or others
have an arrangement about which they could take a proprietary
interest or an equity interest in any of these businesses to which
credit was extended?
Ms. KENEFICK. Let me answer the question perhaps a slightly different way. I believe it was either a policy of the bank or a Federal
regulation t h a t the employees were—well—the policy of the bank
was that you were not to do as you suggest. To the extent that you



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wanted a waiver, so to speak, you had to in effect get it approved.
So it was not practice then to invest in your customers.
Mr. PATMAN. But to your knowledge were waivers ever granted?
Ms. KENEFICK. I don't have any knowledge.
Mr. PATMAN. Well, you have no knowledge of any instances t h a t
were called to your attention or about which you heard reports?
Ms. KENEFICK. N O , with respect to Continental employees, no.
Mr. PATMAN. HOW about Continental Bank itself, did it have the
option and did it take advantage of its option to acquire equity interests in businesses to which it extended credit?
Ms. KENEFICK. I cannot think of an instance t h a t I was directly
involved with Continental.
Mr. PATMAN. DO you have knowledge of any instances?
Ms. KENEFICK. I have just a general knowledge t h a t in some situations with a problem loan, the bank had occasionally taken warrants, I believe, of stock as part of compensation for reducing interest terms or principal amortization. It was part of the negotiations.
Mr. PATMAN. With prospective borrowers?
Ms. KENEFICK. In the example that I am thinking of, not specific,
but in the general context, it was with loans t h a t were problem accounts and as they were trying to work out of the situation there
was a negotiation and give and take.
Mr. PATMAN. Were they in business to extend credit in circumstances where it would otherwise be regarded as risky or too risky?
Ms. KENEFICK. What I am referring to was credit was already extended and they were trying to work out of the credit.
Mr. PATMAN. And as a consideration for continuing the extension
of credit or not foreclosing, then these inducements were given,
these rewards, as you might say, were given? Were they given to
the bank or to the employees?
Ms. KENEFICK. It was part of the bank, in effect a collateral, so to
speak, security for the loan. It was not directly to the employees of
the bank.
Mr. PATMAN. Did those occur in any of the loans t h a t were made
to Penn Square?
Ms. KENEFICK. I am not aware of any.
Mr. PATMAN. TO Penn Square credits. Let me ask the other gentleman.
You have heard my questions of Ms. Kenefick. Are you familiar
with any of those instances during your examinations of the affairs
of Continental Bank or any of its subsidiaries?
Mr. MCCARTE. I think what Ms. Kenefick is referring to was, if I
can try to clarify it a little bit, is a situation where the borrower
perhaps is unable to pay the principal and interest owing. It is perhaps an occasion where the borrower will offer shares of stock in
lieu of cash or repayment.
Quite often, however, those instances were on credits t h a t actually had been charged of and perhaps it was in terms of book value
less t h a n what was originally advanced.
Mr. PATMAN. Were those standard practices? Were those wholesome practices for the banking industry?
Mr. MCCARTE. It is just a matter of trying to recoup moneys t h a t
are already out to the borrower. The cases that I would be familiar
with are instances where the loan had already been made. Now it



153
is an attempt to recover, the company cannot pay through normal
cash flow. It is a matter of how do we recover on our original advances. And at times the corporations will offer stock or warrants
in lieu of that.
But the examiners would traditionally charge those loans down
to the appropriate carrying values.
Mr. PATMAN. Let me ask you three gentlemen who have been examiners or have had occasion to examine these affairs at the bank,
and its parent holding company—I suppose not the parent holding
company. Are you aware of any employee at the Comptroller's
Office t h a t has lost his job or been promoted because of inadequacies in his performance, in this instance of the bank's obviously becoming insolvent or reaching the stage of near insolvency and
there being some oversights, if not negligence, on the part of the
employees of the Comptroller's Office who examined its affairs and
failed in some way in their obligations?
Mr. MCCARTE. Personally I am not aware of oversights nor
people losing their jobs.
Mr. PATMAN. YOU are not aware of any oversights or negligence
on the part of any of the employees of the Comptroller's Office in
their work with respect to Continental Bank. Is t h a t what your
statement is?
Mr. MCCARTE. It is a very restricted view I could offer, sir. I
could not speak for the entire office. I can just speak for
Mr. PATMAN. TO your knowledge there were not.
Mr. MCCARTE. The answer is no.
Mr. PATMAN. IS t h a t what you think, Mr. Kovarik?
Mr. KOVARIK. I have no knowledge of anyone.
Mr. MEADE. I don't either.
Mr. PATMAN. In other words, everything t h a t was done by the
Comptroller's Office and its employees was in perfect order and
fully adequate to the needs of the instance and the job that they
had in this case and in all cases regarding the Continental Bank.
Is that what you are saying?
Mr. KOVARIK. I don't know of any one.
Mr. PATMAN. All three of you? All right.
Are you aware of any person or persons in the employ of any
person who has been or is currently in political office who contacted the Comptroller's Office or any of its employees with the idea,
with the purpose of attempting to get you to modify your approach
or your judgment with respect to any matter involving the Continental Bank or its parent company or subsidiaries?
Mr. KOVARIK. I am not.
Mr. MCCARTE. Nor am I.
Mr. MEADE. I am not aware either.
Mr. PATMAN. May I continue with

one thing. Do we need any
statutory changes in your judgment in order to handle matters of
this nature, in order to protect the public and insure the public's
confidence in the safety and security of our financial institutions?
Let's take you in order from the left, Mr. Meade. Yes or no?
Mr. MEADE. N O .
Mr. PATMAN. If

you are aware of any, please provide them. How
about you, Mr. Kovarik?



154
Mr. KOVARIK. I am not aware of any and I cannot suggest any at
this time.
Mr. PATMAN. Mr. McCarte?

Mr. MCCARTE. The same.
Mr. PATMAN. Where do we draw the line on when you decide
whether or not we are going to bail out these depositors with credits above $100,000 or regular deposits with over $100,000? What
status, what bank, what status must be achieved by a bank in
order to receive that gold-plated assurance from the Federal Government or any branch of the Federal Government, t h a t the depositors will indeed be protected to the full extent of their deposits,
whether they are foreign investors, whether they are other banks,
whether they are knowledgeable people apparently taking certain
risks or what. What is the status, what is the point in the financial
status t h a t an institution has to reach in order to provide t h a t
guarantee to its depositors?
What about it, Mr. Meade?
Mr. MEADE. I am really not prepared to comment on that. It
seems like the bank lost the confidence of those t h a t were providing it with funds and I am not aware of anything t h a t could have
been done to instill confidence.
Mr. KOVARIK. I would have to respond almost in the same words.
I don't feel qualified to answer a question as to what level t h a t
should be.
Mr. PATMAN. Were you frankly surprised the Federal Government did intercede in this case, the Fed, and other parts of the
Federal Government, and provide that protection for depositors
who had in excess of $100,000 on deposit through the FDIC?
Mr. KOVARIK. No, I wasn't surprised. I don't think—at the point
where it took place, I could see, in my opinion any other course.
Mr. PATMAN. It was a decision of historic proportions, wasn't it?
Mr. KOVARIK. Yes, sir.
Mr. PATMAN. Thank you

very much, Mr. Chairman, for your indulgence.
Chairman S T GERMAIN. Mr. Hubbard. Wait a minute, Mr. Kovarik—you don't want to be Comptroller?
Mr. KOVARIK. Not tomorrow, please.
Chairman ST GERMAIN. Mr. Hubbard.
Mr. HUBBARD. Thank you, Mr. Chairman.
As this hearing nears to a close, let me express my appreciation
to the witnesses—Ms. Kenefick, Mr. McCarte, Mr. Kovarik, Mr.
Meade, for your testimony and also for your indulgence.
We have been here more than 4 hours now. We are grateful to
you.
This committee referred to Mr. Kovarik's memo which I read
with interest—your November 15, 1982, memo to William Martin
concerning Continental's condition.
In the third paragraph of t h a t memorandum you say, "It is my
opinion t h a t there are two interrelated causes of the present situation." Then I read your following sentences. Would you for the
record give those two interrelated causes of the problem.
Mr. KOVARIK. In my opinion they were the aggressive growth
philosophy, that was not tempered by the increased safeguards t h a t
obviously were needed, and second, the management style which



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gave a great deal of authority to officers and did not hold them accountable or ensure that they were taking that—the responsibility
along with t h a t authority.
Mr. HUBBARD. Again, to Mr. Kovarik, in your last paragraph of
your two-page memo to William E. Martin, you say,
Some enforcement action to relate our concerns is appropriate. It should, however, be in line with and take note of what they have already done or have instituted.
Further, I have made a strong bid towards getting the bank to be much more open
with us. We should take this opportunity to get the flow of information we need
started.

Let me just ask you a few questions. Please share with us some
information and please be open with us.
How do you require a bank to be open? Do you use the law, for
example? Do you take advantage of the law, the cease and desist
powers, or, as in this situation, are you saying "please".
Mr. KOVARIK. Yes—the cease and desist powers can be used in
that instance. My comments here relate to the fact that my prior
experiences with the bank had been t h a t although we always did
get the information we required, it was not always on a timely
basis and at times was after having to go through various levels of
management, many people in the bank, especially at the lower
levels.
What I mean by lower levels is maybe assistant vice presidents
type level—would at times when we would ask for certain information defer to their boss who would defer to his boss. During the
1982 examination t h a t changed completely and we were given
almost everything and anything we asked for immediately.
Mr. HUBBARD. But prior to 1982
Mr. KOVARIK. It was my experience t h a t we got the information,
but at times it was slow.
Mr. HUBBARD. Is that unique as to Continental Bank? Or is this
something you experience in other banks?
Mr. KOVARIK. NO; each bank is a little unique. It has been my
experience t h a t how the bank treats—that is not the right word—
but looks at an examiner and how cooperative outwardly they are
is usually a reflection on the people at the top of t h a t bank.
In a bank where the chief executive is pleased to see the examiner come in, cooperation is usually full and very timely. At the
other extreme is a bank where the president or the chief executive
officer does not want the examiners there, they are a bother to
him.
Continental fell between those two extremes, if I can put it in
that vein. I felt, though, when I wrote this t h a t we had made some
great strides during 1982. I had tremendous personal contact with
a number of officers in getting information, in getting replies to
our requests—much more quickly t h a n we had in the past.
And I wanted to see that continue because of the situation in the
bank, and I didn't think we could afford not to have complete
access to them at the time.
Mr. HUBBARD. I represent a rural area of Kentucky. If you came
to a bank, in, say, Farmington, KY, the Bank of Farmington, your
requests of them were not timely taken care of and they continued
to pass the buck there at that little bank, wouldn't this give you



156
suspicions that something was wrong there? Or does that just
take
Mr. KOVARIK. It depends on how it was. As I said, each bank is
unique. Some just are very proprietary in all their information.
Another thing is in a smaller bank a lot of things t h a t we would
ask for in a bank such as Continental, or even banks smaller t h a n
that, but still large—in a very small bank we would get ourselves,
because the information would be there, it would be very easy to
gather ourselves.
When we are talking about an institution with 10,000 employees,
at times it is just difficult to figure out or to get to which one employee or which two employees you have to see to get that information.
Mr. HUBBARD. HOW many employees does Continental Bank
have?
Mr. KOVARIK. Today I am not sure. At one time it was as high as
12,000.
Mr. HUBBARD. A S high as 12,000?
Mr. KOVARIK. That is my recollection.
Mr. HUBBARD. Quickly, and not wanting to take too much more
time, let's talk together about watch loan reports. Who was responsible for putting a loan on the watch loan report?
Mr. KOVARIK. The account officer has the responsibility. His superior would have t h a t responsibility if he felt it should be there.
The rating committee of the bank, if they rated it a " D " or if it
was a "C" rated credit, it could also ask it be placed on a watch
loan.
Any loan criticized by an examiner during his examination was
required to be placed on a watch loan.
Mr. HUBBARD. Does it make any sense to have this loan officer
who originated the loan responsible for reporting it to senior management if the loan develops a problem?
Mr. KOVARIK. Yes, sir. It does.
Mr. HUBBARD. What incentives are there for a loan officer to put
a loan t h a t he or she objected to on the watch loan report and,
therefore, bring the fact that the loan had begun to have problems
to top management's attention?
Mr. KOVARIK. First of all, it has been our experience t h a t the
sooner a loan becomes known as a problem, the better chance there
is of working that loan out and maximizing either recovery or repayment on t h a t loan.
Second, in a number of banks the fact that a loan officer would
not place something on the watch loan report would be a black
m a r k against him, as it should be. The loan officer not only has the
responsibility of making the loan, but he has the responsibility to
the bank to ensure that that loan is of the highest quality he can
possibly make it, and if it starts to deteriorate, he should let everybody up above him know as fast as he can so t h a t it can be dealt
with quickly.
Mr. HUBBARD. Are there any instances where a loan officer was
punished for putting a loan on the watch loan lists?
Mr. KOVARIK. For putting one on? Not that I am aware of.
Mr. HUBBARD. This last question—what is the importance of
having all loans reviewed on a timely basis and what was the rela


157
tionship between the loan review process and the watch loan reporting system at Continental?
Mr. KOVARIK. The second part of your question, the relationship
between the loan review and the watch loan reporting, as I said
earlier, the committee, if it rated it a " D " or if they rated it a "C",
they could require t h a t it be placed on the watch loan. Excuse
me—I forgot the first part.
Mr. HUBBARD. What is the importance of having all loans reviewed on a timely basis?
Mr. KOVARIK. In order to maintain or to attempt to maintain
that quality they should be reviewed—in most places I have seen,
and I believe annually is sufficient for a loan that has not deteriorated.
And that is the other reason that you need the loan officer to
initiate the watch loan report if it is necessary. For instance, if a
loan is reviewed by the loan review department in January, and
they call for an annual review of t h a t credit by that body, and
troubles begin in J u n e of that year, unless that officer puts it on
the watch loan report, it won't get reviewed until the next January, and you would have 6 months pass before it may be brought to
light that it is a problem.
Mr. HUBBARD. Again, t h a n k you for being with us, all four of
you.
Chairman S T GERMAIN. Ms. Kenefick, I consulted with Mr.
Wylie, and he has no further questions of you. Neither do I.
But we do want to express our deep appreciation to you. I would
ask you not to charge your attorney too much for allowing him the
honor and the privilege to come with you to this hearing, because
there are not too many attorneys from out of town who are allowed
in this room—so he is very fortunate and he should be very grateful to you.
But don't charge him too much.
Ms. KENEFICK. Thank you.
Chairman S T GERMAIN. Thank you very kindly for your assistance. You are a great citizen and a great lady. You can leave.
I am going to keep chatting with our friends here.
First of all, I would ask unanimous consent to put the charts—
capital adequacy, growth of loans, and net chargeoffs to total loans
in the record, subsequent to my first round of questioning.
Without objection, so ordered.
Second, Mr. McCarte, you went with the bank in the latter part
of J u n e 1982, as I recall, and are still there now.
Mr. MCCARTE. Correct.

Chairman S T GERMAIN. At the time you went with the bank was
it for an increase in salary, and better benefits, or were there other
reasons for your leaving the Comptroller's Office and going into
private industry?
Mr. MCCARTE. Well, for a variety of reasons, I suppose. I mean
there was the incremental increase in my salary. There seemed to
be greater opportunities for growth, not only monetarily, but nonmonetarily.
Chairman S T GERMAIN. At the time you made t h a t decision, you
obviously had another offer from outside the region, so you obviously felt in 1982 when you made t h a t decision as a bank examiner
39-133 0—84

11




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with the Comptroller's Office that Continental Illinois, as you just
stated, would be an opportunity for you to grow in many ways,
and, therefore, you must have had confidence in the condition of
Continental.
Mr. MCCARTE. That is correct.
Chairman S T GERMAIN. OK.

Mr. Kovarik, you told us about seeing the Kenefick memo in
August 1982.
Mr. KOVARIK. I believe August or September.
Chairman ST GERMAIN. HOW did that come to your attention?
She told us she had given a copy to Mr. Lytle, one to Mr. Rudnick,
and one to her successor. Did one of those gentlemen give you that
memo, or how did it come to your attention?
Mr. KOVARIK. NO, sir; I was reviewing the work papers that the
phase I review committee of Continental had done, which covered
the officers of the bank following Penn Square. Those work papers
were made available to me, and that memo was included in them.
Chairman S T GERMAIN. NOW, Mr. McCarte, you say significant
credit quality and loan documentation deviations. Talking about
Penn Square, do I get the impression t h a t in your opinion the loans
that proved to be almost worthless at Penn Square were one of the
major causes of the problems of the midcontinental division of Continental Illinois?
Mr. MCCARTE. Yes,

sir.

Chairman S T GERMAIN. The reason I ask t h a t question is because
I look here and I see t h a t significant credit quality and loan documentation deviations—which were spotlighted by the Penn Square
National Bank failure in July 1982. However, these problems were
not limited to oil and gas alone.
The 1982 Continental examination report classified $3.6 billion in
loans as substandard or as loss. Now, let's go back just to energy.
Of these, $1.2 billion were oil and gas loans with Penn Square
related classified loans totaling $620 million. Now, $620 million to
a $40 billion institutional really isn't t h a t much, is it?
Mr. KOVARIK. If you look at the portion t h a t was doubtful and
loss in t h a t $620 million, it was very significant, though. My recollection is that of the $230 million in total loss, at the 1982 examination, I believe it was approximately $150 million t h a t was related
to Penn Square.
Chairman S T GERMAIN. This is in the energy field or in the overall exam?
Mr. KOVARIK. In the overall examination, $230 million was classified as loss.
Chairman S T GERMAIN. HOW much of t h a t was in the energy
field?
Mr. KOVARIK. I am not sure how much was in the total energy
field, but I believe t h a t Penn Square's portion was $150 million, or
thereabouts.
Chairman S T GERMAIN. But obviously there were oil and gas,
$620 million related to Penn Square classified loans out of a total
of $6.2 billion, so you have approximately $500 million in energy,
oil and gas related loans other t h a n Penn Square that were classified, is t h a t correct?
Mr. KOVARIK. Yes. Was the figure used $5.6 million?



159
Chairman S T GERMAIN. N O , $1.2 billion were oil and gas loans
with Penn Square related classified loans totaling $620 million, the
difference being about $500 million.
Mr. KOVARIK. Oh, OK, yes.
Chairman S T GERMAIN. SO

that $100 million would be other
energy related loans t h a t were classified?
Mr. KOVARIK.

Yes.

Chairman S T GERMAIN. Penn Square was unique, let's face it, a
lot of banks decided not to buy Penn Square loans, right?
Mr. KOVARIK.

Yes.

Chairman S T GERMAIN. Because they met Wild Bill Patterson?
Did you ever meet Wild Bill Patterson in your examinations and
meanderings on Continental?
Mr. KOVARIK. N O , sir, I have not.
Chairman S T GERMAIN. I can't find the testimony, but someone
sat at this table and told us they by chance he met Wild Bill Patterson at the water cooler at Continental and decided to do business with him. You know, it seemed so odd t h a t t h a t chance meeting would come about in t h a t way. But it seems as though truthfully—and as you know, we looked at Penn Square thoroughly—that
Penn Square loans were pretty much reaching in like a grab bag
and hoping you got a bag t h a t had a prize in it t h a t was worthwhile.
Does t h a t tell us t h a t the energy lending department of Continental for a period of time was either understaffed or not properly
staffed, not technically qualified, technically competent or t h a t
they were just not doing the job they were supposed to do as far as
examining these loans were concerned?
Mr. KOVARIK. If we can just talk about the non-Penn Square
loans.
Chairman S T GERMAIN. Non-Penn Square, yes.
Mr. KOVARIK. Continental had a history of lending on reserves,
oil and gas reserves, as most banks had. If you remember between
1981 and 1982, there was a drop in oil prices, so the value of their
collateral was reduced, causing first t h a t diminishment of collateral; second, sales of oil and gas products were declining so these
companies were facing losses, their balance sheets were deteriorating, so t h a t the loans outside of Penn Square in my opinion were
more related to the fact t h a t the price of oil had dropped, sales had
dropped, and these companies were experiencing financial difficulty.
Chairman S T GERMAIN. Mr. McCarte, you told us t h a t you requested in your budget for the 1982 examination additional
moneys, as well as an expert from one of our other regions to look
at these energy-related loans in oil and gas, which indicates that
you must have had some evidence before you.
Was it just because of the decline in the price of oil and gas or
did you have other reasons for asking for additional funds to look
into the Penn Square loans and for asking for an expert from the
Oklahoma area on oil and gas loans?
Mr. MCCARTE. The reason we requested additional resources or
an expert, to use your term, somebody more familiar with the
energy sector, was for a combination of reasons. The energy prices
were softening, the bank was a major lender to the energy sector,



160
and the fact t h a t in the Chicago subdistrict, we did not have any
examiners with any hands-on experience in t h a t particular side of
t h e business. So the combination of all those things just justified or
seemed to suggest t h a t as we went forward t h a t we would be better
off with some outside help.
Chairman S T GERMAIN. Let me ask all three of you this question,
let's look at Continental and let's look at Penn Square, but merely
as a model or example.
You go in and you examine with a peak team of 50 at one point
in time and other times, you are down to 12, 10-12 people. How—
absent a call from the Washington Office as a result of a call from
the Dallas Office, absent t h a t type of red flag waving—how can you
discover independently the type of problems t h a t existed at Penn
Square? We keep harping on this. It is an unusual situation t h a t
these two banks are interrelated with their problems.
By the same token, it gives us a model we can look at without
having to be fearful of naming Penn Square because we have to be
cautious not to name other borrowers who may have been classified or had classified loans as Continental did. So it makes it a
little easier for us.
First, Mr. McCarte, let me ask you, in your experience as chief
examiner, how does the Comptroller's Office discover or arrive at
the fact t h a t there might be problems with these loans? We know
what happened at Penn Square. Penn Square Bank was paying the
interest on nonperforming loans, so they could continue selling
new participations to Continental without telling Continental t h a t
the previous participations were not performing.
Does the Comptroller in an examination have the capacity to discover something like that?
Mr. MCCARTE. Well, I think your question was without somebody
calling stating t h a t they have this specific problem, how would you
do that?
Chairman S T GERMAIN. Absent an indication from Penn Square,
for example? This could be Penn Square, or it could be the Zippety
Doo Dah Machinery Co. t h a t has international sales and is a heavy
borrower.
Mr. MCCARTE. Right. The primary way I think t h a t examiners
establish an asset problem is through direct review of the credits.
Now, if the scope of the review t h a t is being performed is not sufficient to encompass those credits, they could go undetected unless
the account officers would offer up a watch list report on them.
So, in other words, rephrased, in the 1981 examination, the scope
of what we did was $10 million and over, C&D rated credits, past
due, nonperforming, plus two samples taken totaling 120 outstanding items. If by chance the Penn Square credits did not fall within
the sample, over $10 million, past due, or nonperforming, they
could go undetected.
We just happened to stumble across the fact t h a t there was $300
million in the bank when they were there in June—or in 1981,
sorry.
Chairman ST GERMAIN. Mr. Kovarik.
Mr. KOVARIK. If I could answer through the sampling method, if
something like t h a t would go undetected, it would not be significant—I can't say for certain—but even the $300 million t h a t Mr.



161
McCarte looked at in J u n e 1981, I am sure some of t h a t would have
come up on the sample just because of the total size of that, so it
would have been much less t h a n t h a t for it to slip through our
sample when we are looking at somewhere in the neighborhood of
70 percent of the outstanding dollars at a Continental or a bank
t h a t size, the majority of the loans t h a t we don't look at are very
small in dollar amount. And I am talking about very small, I am
talking about less t h a n $1 million for the most part.
Chairman S T GERMAIN. YOU fellows
Mr. KOVARIK. I agree; that is not small to me personally, but in
the scheme of Continental, if you look at capital of $2.2 billion and
take a $1 million loan, how many of those $1 million loans does it
take to get up there?
Chairman S T GERMAIN. Right.
Mr. KOVARIK. I think our line cut at $10 million, and sampling
techniques gave us great coverage. I think what you are getting at
is—maybe what I am interpreting your question to be is, if nobody
would have said anything about Penn Square, say it wouldn't have
failed, would we have found it? I think we would have, yes.
Chairman S T GERMAIN. Mr. Meade?
Mr. MEADE. I might add t h a t in addition to those factors that
were enumerated before, you know, examiners are expected to be
aware of the environment in which we are operating. I mean, a
softening of energy prices is something t h a t should prompt a typical examiner to maybe pay greater attention to t h a t sector of the
portfolio.
Other factors t h a t may be a basis for looking deeper in a particular area are—as if there has been a change in management in t h a t
area, we might want to take a little closer look t h a n if, you know,
there hasn't been those changes.
Another factor may have been to look at the bank's history of
chargeoffs or in t h a t area where they generally have difficulty in
t h a t area.
Another factor would be the sheer growth and volume where you
want to look at it a little closer if it was growing real fast as opposed to a department where the outstandings were perhaps running off.
It is a lot of those factors, coupled together that—coupled with
examiner judgment which we are encouraged to use, utilize, t h a t
would probably preclude us from missing, you know, any significant amount of those credits.
Chairman S T GERMAIN. NOW the lady whom we allowed to leave
pointed to a number of deficiencies in a memorandum—but the
fact is t h a t was not news to us because those loans were the subject
of a report prepared by the special litigation committee for the
board of directors. We know this from the Penn Square hearings as
well, that the documentation and the ordinary information t h a t is
usually required was not present. The number of people who are
supposed to look into particular participations prior to committing
themselves to lending the money or making the commitment until
after thorough investigation, were not utilized. This is what occurred with the Penn Square loans.
In other words, I mean what I said earlier, they were like a grab
bag. They reached in blindly. It was more like playing t h a t game



162
where you pin the tail on the donkey. Isn't t h a t a fact, t h a t t h a t is
what many of those loans were t h a t Continental bought from Penn
Square, that they really didn't know what the quality of the loans
were, but they knew the interest rates they were getting on those
participations were high, and t h a t was sort of an incentive?
The people who made those statements and those conclusions,
are they in error, gentlemen?
Mr. KOVARIK. I don't think they are in error.
Chairman S T GERMAIN. OK. Now, t h a t being the case, absent the
Ms. Kenefick memo, which as you said, you wish you had seen
before—absent Ms. Kenefick's memo, how, under the procedures
you describe for us, do you discover the fact t h a t certain loans and
certain procedures t h a t should be followed are not being followed—
how do you conclude that?
Do you have a methodology for discovering that as well?
Mr. KOVARIK. Yes, sir. When we do an examination as we said,
we would look at certain loans. If those loans came up in any portion of the loans over our cutoff, they had been listed previously as
problem loans by the bank, were past due, nonaccrual, or came up
in our sample—and when I get to the sample I am talking about
loans below $10 million for Continental; I am talking about a loan
t h a t is not perceived by the bank to be a problem, is not past due,
is not a nonaccrual, is outwardly a good loan, OK?
If a loan would not fall into one of those categories or group of
loans would not fall in, it would be a very small portion.
Chairman S T GERMAIN. What were the total loans on, participations classified for Penn Central? Wasn't it $300 million?
Mr. KOVARIK. From Penn Square, sir?
Chairman S T GERMAIN. Yes, sir.

Mr. KOVARIK. Classified was $620 million.
Chairman S T GERMAIN. $620?
Mr. KOVARIK. Right.
Chairman S T GERMAIN. Were those loans all under $10 million
each?
Mr. KOVARIK. N O , sir.

In 1982 those would have—a number of those would have been
over $10 million. A number of those, assuming t h a t they were not
past due and knowing t h a t they were not on the watch loan report,
would have turned up in the sample and
Chairman S T GERMAIN. Were some of those in the August 1981
examination? Was it August 1981?
Mr. MCCARTE. It was April 30.
Chairman S T GERMAIN. In the April 30 examination?
Mr. KOVARIK. I have no knowledge of the oil loans on April 30,
1981.
Chairman S T GERMAIN. Were some of them there, Mr. McCarte?
I am not trying to be critical of any of you people. What I am
getting at is the procedures t h a t you are armed with—I shouldn't
say "armed with,"—that you were supplied with. Let's go back to
the 1981 examination; what were the number of classified loans in
Penn Square at t h a t point or were there any?
Mr. MCCARTE. In 1981 we had no credit from Penn Square t h a t
was classified or criticized.
Chairman S T GERMAIN. None were classified or criticized?



163
Mr. MCCARTE. Not at t h a t time.
Chairman S T GERMAIN. In that sampling, some of the Penn
Square loans fall into your sample?
Mr. MCCARTE. I just don't recall if there were any Penn Squarerelated credits t h a t came up in the sample.
I recall t h a t we had a series of credits that were secured by
standby LC's and specifically how large they were or the number of
them—I just remember the total.
Chairman S T GERMAIN. I will ask my staff to review those examination reports to see if indeed that was the case. Maybe Mr. Conover can explain t h a t to us tomorrow. I am sure he would like to
do that. Mr. Kovarik, there was a Mr. Perkins at Continental.
Mr. KOVARIK. Yes,

sir.

Chairman S T GERMAIN. M S . Kenefick and Mr. Meade.
Mr. MEADE. Mr. Perkins was the president.
Chairman ST GERMAIN. And Mr. Anderson?
Mr. MEADE. Right. They had just taken over.
Chairman S T GERMAIN. Mr. Perkins is the one who testified. He
testified on behalf of the ABA, and we were sort of contentious. In
fact, one time we had a picture taken together here and it appeared on the front page of the ABA magazine and my next opponent said because of t h a t I was a friend of the big banks.
Getting back to Mr. Perkins and Mr. Anderson, Mr. Meade, did
you ever go into the office of Mr. Perkins and Mr. Anderson to discuss your examination report with them?
Mr. MEADE. I did following each examination with one of them
or both of them.
Chairman S T GERMAIN. Mr. Kovarick explained to Mr. Wortley
the meetings with the board of directors. I didn't want to interrupt
Mr. Wortley, but I was wondering in addition to that, did you meet
with the chief executive officer ordinarily or one of them, the
chairman of the board of the president, to discuss the exam and
whatever deficiencies there were?
Mr. MEADE. Yes, very definitely.
I might point out I did not meet with the board of directors when
I did the examinations. That was not our requirement at the time
and I did not meet with them.
Chairman S T GERMAIN. When did that requirement come in?
Mr. KOVARIK. In

1976.

Chairman S T GERMAIN. 1976, just after you.
Mr. MEADE. Right about then, yes.
Chairman S T GERMAIN. Mr. Kovarik, how about you and Mr.
Perkins and Mr. Anderson?
Mr. KOVARIK. Did we meet? Yes.
Chairman S T GERMAIN. Did you meet personally with them to
discuss these reports?
Mr. KOVARIK. Yes, sir.
Chairman S T GERMAIN. Was
Mr. KOVARIK. Yes, sir.
Chairman S T GERMAIN. YOU
Mr. KOVARIK. Right at the

week of the examination.



this after each examination?
met with each of them?
conclusion probably; within the last

164
Chairman S T GERMAIN. It was part of the examination, is t h a t
what you are telling me, or did you met with them to discuss the
report of the examination?
Mr. KOVARIK. It was both, to discuss the report and also to get
their views on the future.
Chairman S T GERMAIN. And would they be receptive to your recommendations in t h e areas where you felt changes or improvements should be made?
Mr. KOVARIK. Yes, sir; they were.
Chairman S T GERMAIN. YOU had no problems with them?
Mr. KOVARIK. N O , sir.

Chairman S T GERMAIN. YOU said there were three; some, no cooperation; others, cooperation; others, very cooperative.
Mr. KOVARIK. N O .

Chairman S T GERMAIN. YOU would rate them a 10 on a Bo Derek
scale?
Mr. KOVARIK. N O , sir. On a Bo Derek scale I would not.
Chairman S T GERMAIN. I mean as to cooperation.
Mr. KOVARIK. In cooperation? As I said before, they fell somewhere between that. I mean the bank fell somewhere between t h a t
full
Chairman S T GERMAIN. On a scale of 1 to 10.
Mr. KOVARIK. Five. Before 1982.
Chairman S T GERMAIN. Right. Subsequently?
Mr. KOVARIK. Ten and a half.
Chairman S T GERMAIN. They needed you.
Mr. McCarte? Did you meet with Mr. Perkins and Mr. Anderson
in your capacity as the chief examiner at the bank?
Mr. MCCARTE. We would have had meetings, yes.
Chairman S T GERMAIN. I asked you if you did?
Mr. MCCARTE. Yes.

Chairman S T GERMAIN. OK.

Mr. MCCARTE. There may have been a meeting—at one point in
time, to be perfectly honest, maybe Mr. Perkins may have been out
of t h e bank.
Chairman S T GERMAIN. If he were not there, did you meet with
Mr. Anderson to discuss the report?
Mr. MCCARTE. Absolutely, yes.
Chairman S T GERMAIN. What was your perception of cooperation?
Mr. MCCARTE. Positive.

Chairman S T GERMAIN. Mr. Wylie.
Mr. WYLIE. Thank you, Mr. Chairman.
Our witnesses have been very patient and we t h a n k you very
much for your testimony. It has been very revealing to this
member. I think you are all to be commended for a job extremely
well done.
I a m not going to take any more of your time, but I would ask
unanimous consent of the Chair to include in the record three
pages from the Comptroller of the Currency's report of December 6,
1982, pages 42, 43, and 44, having to do with the internal controls.
[The information submitted for the record by Congressman Wylie
from the Comptroller of the Currency's report of December 6, 1982,
regarding internal controls follows:]



165
INTERNAL CONTROLS

Our review of Internal Controls reflects an overall satisfactory
condition, with regard to the accounting controls employed. However, as pointed out by recent events, the administrative controls
have not functioned properly in the lending area.
If the administrative controls had worked, the magnitude of the
Penn Square problem could have been greatly lessened. Management, in its review (Phase II) has recommended numerous changes
which, if implemented will enhance the bank's administrative control system. These include: increased monitoring of non-possessory
collateral; revised collateral deficiency requirements; enforcement
of complete collateral documentation on participation loans; reporting of participation concentrations; among many others.
Additionally, a number of recommendations were made to review
and upgrade the Management Information Systems employed and
to design additional systems to aid in monitoring global exposures,
exception and past due information, and improve accounting systems to further allocate capital and loan loss reserves to individual
lending units.
The major recommendation proposes to improve administrative
control by establishing a Credit Risk Evaluation Division. This Division would provide management and the Board an independent,
internal review of credit quality and be available to pursue special
projects for such groups as the Credit Policy Committee.
Phase II was a comprehensive review, and the recommendations
presented should be implemented wherever feasible.
INTERNAL-EXTERNAL AUDIT ACTIVITIES

The competence, independence, adequacy, and overall effectiveness of the bank's internal and external auditors were evaluated in
order to determine the acceptability of their work. As a result, both
the internal and external audit functions are considered fully acceptable.
During examination, the management team formed to review the
bank's involvement with the failed Penn Square Bank recommended that Executive Vice President William D. Plechaty replace
Edwin J. Hlavka as the bank's Auditor. Mr. Plechaty had served as
Auditor from 1969 to 1972, and more recently managed the Personal Banking Services Division.
In another change recommended by the management team, the
Loan Administration Division will report to the Auditor; however,
the manner in which this function will operate will be determined
after the management team concludes its review of the bank's policies, procedures, internal controls and practices. Aside from the integration of the Loan Administration Division, Mr. Plechaty does
not envision any other immediate, significant changes in either the
Auditing Division's structure or personnel.




166
The examination of the Auditing Division first focused on the following areas: Cash Accounts, Compliance with 31 CFR 103, Due
From Banks, Bank Premises, Other Assets/Other Liabilities, Deposit Accounts, Consigned Items, Employee Benefits, Insurance
Coverage and Review of Regulator Reports. Later the scope was expanded to include more audits performed under the supervision of
each of the four audit managers. Audit procedures, reports, and
supporting workpapers were organized and documented in accordance with divisional standards. The audit reports, which are issued
at the conclusion of each audit, are distributed to the management
of the a r e a audited. Written responses are required for all exceptions noted, and these responses become part of the permanent
audit file.
When the scope of the examination was expanded, twenty additional audits were reviewed. In two of these audits, the same or
very similar exceptions were noted in each of the last three audit
reports. In both instances the corrective action indicated in the
management responses to each of the audit reports was not implemented. While it is agreed that the continuation of these particular
exceptions is not likely to adversely impact the financial condition
of the bank, the failure of management to implement the indicated
corrective action detracts from the overall effectiveness of the audit
function. In order to insure that audits requiring the attention of
management are acted upon in a timely and uniform manner, it is
recommended that the Auditing Division clearly identify and label
all recurring exceptions, and also consider the development of a
ratings system for both individual deficiencies and the overall
audit. As part of such a system, it is recommended that management of a higher level be required to respond to deficiencies which
exceed a predetermined rating. The implementation of a ratings
system that calls for the more direct involvement of senior management would contribute towards increased accountability and a
reduction in the number of recurring exceptions.
The bank's external audit function continues to be performed by
the public accounting firm of Ernst & Whinney. The 1981 audit included a review of the bank's systems for internal control and revealed no significant weaknesses. The firm expressed an unqualified opinion on the bank's year-end 1981 financial statements, and
has been retained for the 1982 annual audit.




167
Mr. WYLIE. I would like for your specific comment on the fact
t h a t some changes were made in internal controls and were observed and noted there and maybe why changes were noted and
recommended, and if t h a t indicated that at that time there was
something wrong.
You may have noticed this morning I sort of concentrated on this
internal control operation at the bank to see if that is a place
where we should look to future endeavor, vis-a-vis, the House
Banking Committee.
So, with that, Mr. Chairman, thank you very much. I have no
further questions.
Chairman S T GERMAIN. I also want to add my thanks and my
congratulations to you. You are all in great physical condition and
you did quite well. You were very helpful and we are seriously
most appreciative.
We do have additional questions which we will submit to you in
writing, but t h a t will save you from having to sit here another 2
hours, so I figured you won't mind answering the questions in writing that are referred to you.
I would like to make a point here. I read quite a few articles discussing the fact t h a t the hearings were starting today and you read
quotes from all kinds of bankers and their opinion as to why you
were the leadoff witnesses with the delightful Ms. Kenefick.
All of their speculation was so far off target, including the financial press writers using their crystal balls, trying to decide why you
were the leadoff witnesses. Very plain and simple, you are the examiners. It makes sense—to start at the beginning and you are the
beginning.
So, to all those speculators out there and those pundits and whathave-you, gosh, they ought to relax and just look at logic, pure,
simple logic, and they wouldn't have to write these ridiculous
stories with all kinds of speculations that make me laugh.
So, gentlemen, we t h a n k you because you gave us the foundation;
you are the beginning, and we go on from here.
You have been most helpful. Thank you.
The subcommittee stands adjourned until tomorrow morning,
when we will have the Comptroller of the Currency as our witness,
at 10 o'clock.
[Whereupon, at 2:43 p.m., the subcommittee was adjourned, to reconvene at 10 a.m., Wednesday, Sept. 19, 1984.]
[A copy of the letter of invitation of witnesses to testify from the
Office of the Comptroller follows:]




168
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CHALMERS P V.'YUS. OHIO
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NORMAN D. SHUMWAY. CAL

U.S. HOUSE OF REPRESENTATIVES
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
SUPERVISION, REGULATION AND INSURANCE

BIL^ERY^
GEORGE C. WORTLEY. NY

DAV,D DREIER. CALIF.

OF THE

COMMITTEE ON BANKING. FINANCE AND URBAN AFFAIRS
NINETY-EIGHTH CONGRESS

WASHINGTON, D.C. 2 0 5 1 5

September 11, 1984

Honorable C. Todd Conover
Comptroller of the Currency
490 L'Enfant Plaza, S.W.
Washington, D.C. 20219
Dear Mr. Conover:
To assist this Subcommittee in its inquiry regarding why Continental Illinois
National Bank came to require federal assistance, you are requested to authorize
and arrange for John Meade, Richard Kovarick, and Allan McCarte to appear
before this Subcommittee on September 18, 1984, at 10:00 a.m., in Room 2128 of
the Rayburn House Office Building. Each individual is requested to provide
testimony on the examinations of Continental Illinois National Bank from 1976 to
1983 for which he served as Examiner-in-Charge.
If the individuals named have
prepared statements, you are asked, as
required by Committee rules, to deliver 175 copies of each prepared statement to
Room B303 Rayburn before 12:00 p.m. on September 17, 1984. To enable all
Subcommittee Members sufficient time for questioning, it is requested that oral
testimony be limited to 10 minutes. Each prepared statement will be distributed to
all Members of the Subcommittee in advance of the hearing and will be included in
its entirety in the hearing record.

F3StG:jOe
cc:

William Ogden
Chairman of the Board
Continental Illinois National Bank




INQUIRY INTO CONTINENTAL ILLINOIS CORP.
AND CONTINENTAL ILLINOIS NATIONAL BANK
WEDNESDAY, SEPTEMBER 19, 1984
HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON F I N A N CIAL INSTITUTIONS, SUPERVISION, REGULATION AND INSURANCE, COMMITTEE ON BANKING, FINANCE AND
URBAN AFFAIRS,

Washington, DC.
The subcommittee met, pursuant to call, at 10 a.m., in room
2128, Rayburn House Office Building, Hon. Fernand J. St Germain
(chairman of the subcommittee) presiding.
Present: Representatives St Germain, Annunzio, Hubbard, Barnard, LaFalce, Vento, Patman, Neal, Cooper, Wylie, Leach, McKinney, Shumway, and Wortley.
Also present: Representatives Kleczka and Roemer.
Chairman S T GERMAIN. There are usually few silver linings
around the edges of major bank failures. But, I will admit that failures—and the suggestion that the Congress wants to ask questions—seems to stir the sleeping giants of the Federal bank supervisory bureaucracy.
Back in 1973, I was very concerned about the plunder at U.S. National Bank in San Diego, CA, and I announced my intention to
have the Financial Institutions Subcommittee look into that failure
in detail.
No sooner was my announcement on the street than the then
Comptroller of the Currency, Jim Smith, came up with a grandiose
plan for what he called a retroactive analysis of the OCC. Eventually this analysis was turned over to a consulting firm—Haskin
and Sells—at a price. They delivered a hefty document calling for a
brandnew system for grading bank performance and what was
dubbed—in the very best public relations fashion—an * 'early warning" system.
For a long time, that "early warning" system was the centerpiece at OCC. If a problem arose in the supervision of national
banks, we were told that the "early warning" system was being developed and that in the future—unspecified, of course—that would
take care of the problem.
The committee has never been sure just what the early warning
system warned the OCC about. * * * These days OCC seldom mentions early warnings in explaining away its problems. Maybe we
should be thankful, for the sake of national security, that OCC
didn't peddle their system to the Defense Department.




(169)

170
In the wake of Continental, we see the OCC stirring once again.
At one time the mere thought of an examination report being mentioned in front of a new reporter would send the OCC into apoplexy. But, in recent days, we have been treated to the sight of
senior officials discussing the contents of examination with Washington reporters—albeit selected passages. Mimeographed documents discussing the supervisory procedures have been circulated
around the city, and the Comptroller, himself, has been out on the
hustings talking about strengthening capital, increasing disclosure,
improving examination techniques, and strict enforcement policies.
Such stirrings.
The New York Times has been so lacking in generosity as to suggest that some of this activity is designed to "preempt the congressional hearings." I won't be so unkind. I'm just happy to see the
agency talking about better supervision whatever the motivation.
But, it is not enough to gin up the supervisory vigor just while
the spotlight of congressional oversight and media attention is focussed on OCC. It has to be a full-time, 12 months a year operation.
Frankly, I am not sure that either the supervisory bureaucracy
or the banks really get the right message out of Washington.
We often see Presidents—of both parties—delay and ignore appointments to key posts in the Federal financial supervisory
system. The present Comptroller, for example, did not take office
until the last days of 1981—7 months after his predecessor had resigned. This kind of delay sends a message down through the ranks
and among the industry that OCC regulates.
In 1982, right at the height of bank problems nationwide, the
number of OCC examiners dropped to 1,835 compared with 2,282 in
1979. Apparently, alarmed by continuing supervisory problems the
number crept back up to 2,080 last year. But, these cuts in personnel couldn't have sent a message of vigor and concern to the personnel on the firing line of the examination process.
While his staff was being reduced, Mr. Conover became something of the Marco Polo of Comptrollers—appearing coast to coast
with a ready speech in hand. Many of these pronouncements
seemed less about bank supervision than they did about the big
banks' legislative wish lists in the Congress. The big concern, if one
followed Mr. Conover's trail from city to city, seemed to be about
less regulation, less Government—presumably less OCC—and more
power for the banks.
At times, Mr. Conover seemed to take on more the role of a
cheerleader for the industry than he did that of a regulator. This,
too, must filter down through the ranks of the agency. Does the examiner, about to write a sharp directive to a bank's board of directors, hear the echoes of "Get the Government off the backs of the
banks" and decide to take the softer line?
While I personally dissent, there may be some who feel that the
industry does, indeed, need a Government sponsored cheerleader. If
so, I don't think it is appropriate that cheerleading and regulating
be combined.
The highly costly nature of the sweeping bailout of Continental
should establish, once and for all time, the fact that every citizen
in this Nation has a stake in a solid regulatory system. We should




171
hear fewer arguments t h a t regulatory standards should be based
solely on industry needs and desires.
Yesterday's testimony did not increase confidence t h a t OCC has
gotten its act together. Even when the information was in hand—
the problem spotted—OCC seemed paralyzed, unable or unwilling
to force remedial action. And communication within the agency—
much less between agencies—still seems to be something t h a t predates Alexander Graham Bell. Despite our best efforts in the Penn
Square hearings and yesterday's session, we still can't be sure just
when, and how thoroughly the message about the disaster in Oklahoma City reached Chicago, Seattle and other points that had been
infected by the Penn Square plague.
Leaving aside any thought of partisanship, I am firmly convinced
that we must start sending a stronger and clearer message about
the need for no nonsense, hard-nosed regulation of financial institutions that utilize Government insurance and enjoy other Federal
subsidies. The message has to come from the top—the White House
and the Congress both. And it must be echoed—with no equivocation and no mixed messages—by the Federal regulatory agencies.
Our witness today, C.T. Conover, is an essential link in that communication link—the kind of message he sends to his troops and to
the banks has a lot to do with the quality of regulation.
The Chair now recognizes Mr. Wylie.
Mr. WYLIE. Thank you, Mr. Chairman.
I want to thank the Comptroller of the Currency for his appearance here today and for your excellent statement.
As I said in my opening statement yesterday, this is an extremely serious matter. It deserves thorough congressional oversight, and
it does raise some profound issues for this committee to explore for
the future.
I am pleased t h a t you, Mr. Conover, have acknowledged these
issues up front in your statement where you say t h a t the Continental case deserves a thorough review by both Congress and the
public. Let me say t h a t I am hopeful t h a t the administration, Members of Congress, the regulatory agencies and the public will benefit from these hearings.
In my view, we need to learn precisely what factors contributed
to the deterioration of Continental Illinois to the point where this
unique Federal assistance was required. More importantly, perhaps, we need to consider what measures might be taken in the
future as to prevent a similar situation from occurring. We should
make certain we do not create the expectation that as long as an
institution is big enough, there will be no limit to the amount of
risk the Federal Government will accommodate.
Mr. Conover, I was particularly encouraged by your statement
because on page 21 and throughout your testimony, you stress
seven key issues which not only are pertinent in Continental's
case, but also of a larger meaning for the safety and soundness of
the banking system in the United States.
I will want to return to these areas in my questions, but you
have identified the salient points. (1) supervisory techniques; (2) internal controls; (3) loan loss reserves; (4) capital levels; (5) funding;
(6) financial disclosure; and (7) enforcement policy.



172
Mr. Chairman, these hearings are unprecedented since Continental Illinois is an open, ongoing bank which should have an excellent chance to put its own house in order and rid itself of what I
am sure is unwanted Federal assistance, as well as Federal intrusion. I am sure t h a t I speak for all Members of my side of the aisle
when I say that we hope t h a t Continental prospers and likewise
t h a t we do not have to repeat this experiment.
Hopefully, these hearings will be the kind of learning process
from which we can all benefit. Thank you very much, Mr. Chairman, for affording me the opportunity to make this opening statment.
Chairman S T GERMAIN. Chalmers, I want you to know t h a t I and
the Members on our side, as well, are hopeful t h a t we need not
have another hearing of this type and t h a t we need not have another bailout of the magnitude and of the character we have seen
in this instance. So we are in total sync on this.
Mr. WYLIE. We are presenting a united front on t h a t score.
Thank you, sir.
Chairman S T GERMAIN. Would you please rise, Mr. Conover.
[Witness sworn.]
Chairman S T GERMAIN. Mr. Conover, we will put your entire
statement in the record, along with the appendages thereto. You
may proceed.
TESTIMONY OF HON. C.T. CONOVER, COMPTROLLER OF THE
CURRENCY
Mr. CONOVER. Thank you, Mr. Chairman.
Mr. Chairman, I would like to read excerpts from my written
statement as my opening remarks. And because of the importance
of this subject, I ask your indulgence as to time this morning. I
think this will take about 20 minutes.
Chairman S T GERMAIN. We agree wholeheartedly.
Mr. CONOVER. Fine. Thank you very much.
Mr. Chairman, members of the committee, I am pleased to be
here to discuss Continental Illinois National Bank & Trust Co. The
serious problems encountered by Continental and the regulators'
actions concerning Continental are obviously a matter of public
concern and deserve a thorough review by Congress and the public.
Today, I will address what happened at Continental by first describing the economic factors t h a t have buffeted Continental—and
other banks—since 1980. These include back-to-back recessions as
well as a sharply declining energy industry. Second, I will briefly
review the internal policies and practices at Continental t h a t rendered it incapable of weathering these adversities. Third, I will discuss what we could have done differently. Finally, I will focus on
what we are doing to assure the continued safety and soundness of
the banking system.
The 1980's have been difficult years for the banking industry. In
early 1980, a recession caused real economic growth to drop sharply. By mid-1980 the economy was growing again, but t h a t recovery
only lasted 12 months. In mid-1981, the economy fell back into a
recession t h a t lasted 17 months.



173
Although the economy as a whole is now experiencing a strong
recovery, the pattern of back-to-back recessions was particularly
hard on lending institutions. Loan quality typically begins to deteriorate after an economic slowdown begins, and continues to decline well into the recovery. Many loan portfolios thus have continued to deteriorate since 1980, and many banks are still having
problems stemming from the recessions.
In addition to having to contend with the effects of the two recessions, many banks have also been affected by the severe problems
in the energy industry over the last few years.
Most U.S. banks have weathered these difficulties with impressive resilience, but almost all have felt some impact. Return on
assets and return on equity are down for the industry as a whole.
Asset quality is still suffering, with net loan losses rising even
faster for large banks t h a n for small.
The difficult economic environment had a particularly devastating effect on Continental. Its problems stemmed from management
strategies and policies t h a t depended on strong growth in the economy in general and the energy industry in particular. These strategies and their consequences are detailed in the appendix to this testimony. In sum, Continental adopted a policy of rapid growth that
was not accompanied by the necessary management controls and
policies to maintain adequate asset quality in the face of an economic slowdown and a declining energy industry.
In implementing this goal, Continental adopted a strategy of decentralized lending t h a t permitted its account officers to respond to
customers and make loans more quickly and competitively. Although this approach required fewer controls and levels of review,
management believed the potential rewards of such a strategy outweighed the associated risk.
Continental's management targeted the energy sector for its
most aggressive lending expansion. During the latter half of the
1970's, the United States was attempting to develop a program for
energy self-sufficiency in the face of uncertainty about actions of
the OPEC nations. At that time, some economic analysts were projecting the price of oil to increase to some $60 a barrel.
Continental's management strategy of rapid growth with a specialty in energy was quite successful for several years. During the
late 1970's, Continental outperformed its peers in growth, earnings,
and market perception, and its loan loss record was excellent. In
1978, "Dun's Review" described Continental as one of the five best
managed companies in America.
In 1981, the very strategy t h a t generated praise began to turn
against the bank. A slowing economy meant t h a t the quality of
available lending opportunities was deteriorating at the same time
t h a t Continental was increasing its corporate lending, inevitably
resulting in the making of loans to weak borrowers. By 1982, it
became clear t h a t the bank's rapid growth had been achieved at
the expense of asset quality.
The declining energy industry in late 1981 dealt a particularly
serious blow to Continental for two reasons. First, it had a heavy
concentration in oil and gas loans t h a t left the bank extremely vulnerable to the industry's sudden decline. Second, from 1980 to 1982,
the bank had purchased a large volume of energy loans from Penn
39-133 0—84
12



174
Square Bank, N.A. The quality of these loans proved to be very
poor, particularly those loans that were purchased in late 1981 and
early 1982 when Continental's growth was peaking.
Considering the disproportionate contribution that Penn Square
loans made to Continental's losses, it is important to analyze how
such a questionable relationship could develop in a bank that had
been a top performer for so many years. It now appears that Continental's purchase of problem loans from Penn Square involved significant misconduct on the part of officers of both institutions.
However, the problem extends beyond employee misconduct.
Management processes should be in place to guard against, and
detect, employee misconduct as well as other risks.
Continental's management controls were the subject of considerable attention in our examinations over the past 6 to 10 years. Although we judged the bank's system of loan controls to be generally satisfactory, we directed a number of specific improvements. For
example, we cited, at various times during the period from 1974 to
1981, problems with the past-due loan report, the completeness of
credit files, the identification and rating of problem loans, and collateral deficiencies. Bank management was generally responsive to
our concerns and made a number of improvements in its systems
for controlling and detecting risk in the loan portfolio.
These improvements were not enough. In retrospect, it is clear
t h a t there was not sufficient management support for the control
systems. Top management had created an environment where aggressive lending was not only condoned but encouraged. In this atmosphere, a high quality system of controls was secondary. Moreover, those warning signals t h a t the existing system did generate
were ignored by senior lending officers.
In the final analysis, the bank's internal controls did not prevent
the purchase of massive amounts of bad loans from Penn Square.
With the benefit of hindsight, it is clear that our generally favorable assessment of Continental's internal controls was overly influenced by the bank's outstanding performance during the years
1974 through 1981.
It became clear, during our examination t h a t began in May 1982,
t h a t Continental's management practices and policies had led to serious loan problems. We responded to this in a number of ways. We
extended our examination through November. During the course of
the examination, we directed Continental to begin a number of corrective measures, which were immediately initiated by the bank.
We informed management of our intention to formalize these directives by placing the bank under a formal agreement, enforceable
under our cease-and-desist authority.
The agreement required improvements in numerous areas, including loan policies and procedures, asset and liability management, and funding. It also required regular reports by a board committee on the bank's compliance with the agreement. Bank management complied with the terms of the action and took significant
steps to revamp its operations. However, the loans t h a t crippled
Continental were already on the books.
Market confidence had begun to turn against the bank in July
1982 when its Penn Square loan problems surfaced publicly. Despite nearly constant OCC supervision and presence in the bank



175
over the next 2 years, and the efforts by bank management and the
board of directors, Continental was unable to fully regain market
confidence. In May of this year, the market reacted adversely to
rumors of further problems at Continental, and large depositors
began withdrawing funds. The bank was unable to stem the run,
and Federal intervention was required to prevent the bank's collapse.
An obvious question t h a t we and others have asked is whether
there was anything that the OCC should have done differently in
the course of Continental's deterioration. In addressing this question, it is important first to clarify the role of the bank supervisor.
Our charge is to maintain the safety and soundness of the national banking system. To do so requires sufficient oversight of and
interaction with bank management to minimize the likelihood of
bank failure. We do not take over and manage institutions; we
cannot substitute for private management in making lending or
any other decisions. The primary responsibility for any bank's performance rests with its management and board of directors. However, as supervisors we do monitor risk exposure, work to see that
policies and controls are appropriate to t h a t level of risk, and enforce compliance with the law. When we identify major weaknesses, we institute corrective measures, and follow up on their implementation. This results in significant improvement in the vast majority of institutions t h a t we identify as having problems.
For some institutions, even prompt and stringent corrective
measures are unsuccessful. The safety and soundness of the banking system also requires allowing such poorly managed, financially
weak institutions to disappear from the system in an orderly
manner. In an important sense, this is what has happened to Continental. The doors are still open, but the officers who allowed the
bank's deterioration are no longer part of Continental. Moreover,
those that bear responsibility for approving management policies
have paid a price. The shareholders face substantial, if not total,
loss, and the directors and former management face potential legal
liability.
Chairman S T GERMAIN. Mr. Conover, I am constrained to interrupt you at this point, because your timing is excellent because we
have a quorum call. So I am interrupting you at this point to clarify something.
I think every one should be aware of the full import of your comment about Continental management paying the price for their
mistakes. I will quote from page 17 which you just read.
"The doors are still open, but the officers who allowed tne bank's
deterioration are no longer a part of Continental. Moreover, those
that bear responsibility for approving management policies have
paid a price."
Now, Mr. Conover, again I say all should know that the full price
being paid by Continental's former management may not be as
heart rendering as you might imply. Let's take a look at the facts.
Mr. Anderson, former chairman of Continental, retired, now, let's
keep in mind, is the fellow who was the go-go-banker, the aggressive banker that really took over the reins of this institution and
decided he would make it big, and we will get to t h a t issue of bigness again later in these proceedings—but he is the fellow who



176
said, "Well, we will let lower management be responsible for
making the loans." And very frankly, I think one of the big problems here is that the top-level management just disassociated itself
and insulated itself from responsibility for many of the mistakes
t h a t were made at the lower level.
But let's look at what poor Mr. Anderson is undergoing. And I
think we should all take out our crying towels. What did he end up
with? A one-time lump sum pension supplement of $269,792. And
then a monthly consulting fee of $12,212 through July 1986. When
cited, they gave it on a monthly basis, but t h a t works out to
$145,000 a year. He received a cash payment of $77,000, reflecting
the value of forfeited shares of certain stock, about which we have
no idea what the value might be. Then certain financial advisory
services from 1 year after retirement and payment of dues to certain clubs.
Now, Mr. Perkins and Mr. Miller also received handsome separation packages when they retired from Continental. A full explanation of the termination benefits Continental's top management received are discussed in an OCC memorandum dated July 3, 1984. If
there is no objection, I shall place t h a t memorandum in the record
at this point.
Is there objection? The Chair hears none.
[The OCC memorandum of July 3, 1984, referred to by Chairman
St Germain and the Continental Illinois Corp. proxy statement,
dated August 24, 1984, follow:]




177

o

©iMMoy

Comptroller of the Currency
Administrator of National Banks

Washington, D.C. 20219
Andrea Salloom, Attorney
Enforcement and Compliance Division
Ronald Goldberg, Law Clerk\h^2£Enforcement and Compliance Division
July 3, 1984
Possible OCC Action Against "Golden Parachutes" at Continental
Illinois
Issue
Would the OCC be authorized to institute an enforcement action
against Continental Illinois Corporation (ClC^or its former
officers with respect to the "golden parachute"
retirement/termination contracts granted to three former top
officers and if so, on what basis could such an action be
sustained?
Short Conclusion
Under a different factual situation it might be possible to
compel the non-enforcement of bank employment contracts
containing unreasonably excessive compensation through a cease
and desist order under 12 U.S.C. §1818(b), alleging that such
contracts constitute an unsafe or unsound banking practice.
However, given the moderate amount of the contracts in
comparison with Continental's asset size and the industry-wide
practice with respect to such termination agreements it will be
difficult to establish a violation of either §1818 or our
interpretative ruling on the subject contained in 12 C.F.R.
§7.5220.
Scope of this Memo
This memo will discuss the validity of employment contracts
entered into by national banks and their officers or
employees. The rise of "golden parachute" contracts,
industry-wide compensation standards and the facts of CIC s
retirement settlements with three former officers will be
examined, focusing on the Comptroller's statutory authority to
act against excessive remuneration or benefits in banks
employment or termination agreements. The discussion will




178
fccus on the interaction of 12 U.S.C. §§24(5) and 1818(b) and
12 C.F.R. §§7.5220 and 563.39(a) as construed in recent cases.
The more general question of reasonableness in executive
compensation, the standards for establishing violations by
directors and officers of their fiduciary duties and the
business judgment rule will also be addressed in connection
with excessively generous compensation schemes.
The Termination Agreements at CIC
Effective April 30, 1984 Roger E. Anderson, Chairman of the
Board of Directors and Chief Executive Officer at CIC, Donald
C. Miller, Vice-chairman of the Board and John H. Perkins,
President, voluntarily entered early retirement. According to
an executive vice president at the bank, two factors led to the
decision of Miller and Perkins to retire early: (1) the
opinion of the Board of Directors that the bank's corporate
office organizational structure had not functioned as it should
have, necessitating a concentration of power in one CEO, ar>d 2)
the need to accelerate the bank's management succession
process. Negotiations for their retirement were initiated in
May 1983 and it was decided that in order to avoid the
appearance of penalizing them in any way their termination
agreements were to treat them as if they had completed their
full careers. Originally, Anderson was to remain as CEO, but
in late December 1983 and early January 1984 it had become
clear to the Board of Directors that the bank's earnings were
not rebounding as expected; visible action needed to be taken
to retain confidence in the corporation's recovery from the
Penn Square failure. After discussions with members of the
Board's Compensation and Nominating Committee, it was mutually
agreed that Anderson would also retire early. The Board felt
it was appropriate to offer Anderson terms similar to those
given Miller and Perkins since the retirement was not punitive
in nature and the Board did not wish to create more notoriety
for the corporation.
At its meeting on August 15, 1983, the Board approved the
termination packages arranged for Miller and Perkins and on
February 27, 1984, the Compensation Committee approved
Anderson's retirement agreement. According to inside sources
at the Bank, at the times these three retirement plans were
developed and approved there was no premonition of the
devastating effects of the rumors of May 1984 and no reason to
assess personal penalties against the three former officers.




179
A.

Terms of the Agreements

General Terms
Length of Service

37 years

25 years

Amount of annual
Pension Supplement
Consulting fees
(monthly)

$38,150

$12,500

5/1/84-7/1/86
$12,212;
8/1/86-6/30/88
$1500

Lump sum payment
to reflect
orfeited
restricted shares

$77,000

Membership
payments to be
made by bank

One country
club and
one luncheon
club for five
years

Office with
secretarial support
Eligibility forcorporation's
professional services
in the year of
retirement and
and the year
following retirement
Reimbursement for all
legitimate business
expenses incurred
on behalf of the bank




years

5/1/84-3/85
$15,375

$51,000

3 7 years
"121,500
9/1/84-8/30/t
$12,682
(to rise by
$1,850 if nc
elected to
Board in
1984 or 196
$57,000

One country
club and one
tennis club
for five
years

One country c
one luncheon
club for 5 ye
and Old Elm
club for life

5 years

5 years

180
B.

Industry Standards on Termination Agreements and the Rise
of "Golden Parachute" Contracts

Negotiated termination settlements such as those obtained by
Anderson, Miller and Perkins have become a standard practice in
almost all corporations. A 1983 survey conducted for The
THinc. Consulting Group International revealed the following
"standard" severance settlements for three levels of executives
in banking, insurance and service industries:
Below Mid-Range Executives;
-

Average of 6 months severance;
Benefits continuance, often structured as "Bridging Pay"
whereby the financial commitment ceases upon relocation;
Out-placement;
Off-site office with secretarial assistance when, feasible;
sometimes short-term travel/lodging allowance.
Mid-Range Executives:

-

Plus/minus 1 year of severance or 1 week per year of
service, infrequently spaced over additional years;
Benefits continuance, sometimes structured as "Bridging
Pay" whereby financial commitment ceases upon relocation;
Key executive level out-placement;
Off-site office with secretarial assistance;
Short-term travel/lodging allowance.

Above Mid-Range Executives:
Usually negotiated settlements;
Over 1 and up to 3 years of severance, sometimes spread
over 1 to 5 years;
Benefits continuance, up to 5 years bridging to early or
full retirement;
Key executive level out-placement;
Off-site office with secretarial assistanceSubstantial travel/lodging allowance.
In comparison to the "standard" termination package for
top-level executives, it would not seen that the packages
obtained by the CIC officers are unduly excessive.
According to a 1982 survey conducted by Ward Howell Infl.,
Inc. approximately 40% of U.S. corporations on the Fortune 1000
list provide employment contracts for top officers. The rise
of so-called "golden parachute" contracts are symptomatic of
the accelerating merger trend and are normally intended to both
minimize the ramifications of hostile tender offers by
protecting both the positions and responsibilities of key




181
officers, and discourage hostile tender offers through the
disincentive of large management payoffs to current officers in
the event of a takeover. Haggerty, Golden Parachute
Agreements: Cushioning Executive Bailouts in the Wake of a
Tender Offer, 57 S. John L.Rev. 516 (1983). Although normally
golden parachutes are negotiated shortly before or during the
tender offer, many corporations have given their top executives
golden parachutes despite the present threat of a takeover.
Id. at 577. Generally, "golden parachutes" have the following
characteristics:
the contracts are usually given to 2-5 top executives;
the contracts normally extend from 1-7 years;
benefits range from salary incentives to health, pension
and stock purchase plans;
over 50% of the contracts are valued at $1-5 million;
some provide for lump-sum payments, others for periodic
payments.
Cooper, "The Spread of Golden Parachutes", August 19 .
.
Institutional Investor at 65; Haggerty at 529. Given these
general characteristics of "golden parachutes" it is unlikely
one would describe the contacts obtained by Anderson, Miller
and Perkins as "golden parachutes."
C.

The Validity of Employment Contracts Entered into by
National Banks

Among the corporate powers granted to national banking
associations dating back to the National Bank Act of 1864 is
the power to "[e3lect or appoint directors...and other
officers...[and] dismiss such officers or any of them at
pleasure." 12 U.S.C.A. §24 Fifth (West Supp. 1983). Courts
have consistently interpreted this provision to allow the board
of directors of a national bank to dismiss an officer without
liability for breach of any employment agreement that the bank
might have entered into with the employee. In re Paramount
Publix Corp., 90 F.2d 441, 443 (2d Cir. 1937); Mahoney v.
Crocker National Bank, 571 F.Supp. 287, 289 (N.D. Cal. 1983);
Kozlowsky v. Westminster National Bank, et al., 6 Cal. App. 3d
Supp. 573, 86 Cal. Rptr. 52 (Cal. Dist. Ct. App. 1970). As
stated in 7A Michie on Banks and Banking, §127: "Under the
federal statute providing that a national bank shall have power
by its board of directors to appoint the president,
vice-president, cashier and other officers and to dismiss such
officers or any of them at pleasure, the board may dismiss an
officer without liability for breach of an agreement to
employ."
The Comptroller, in an interpretative ruling contained in 12
C.F.R. §7.5220 gave the boards of directors of nations' banks




182
the power to enter into employment contracts with their
officers pursuant to 12 U.S.C. §24 Fifth. However, the ability
of banks to contract for employment is qualified in that the
contracts must be entered into "upon reasonable terms and
conditions." 12 C.F.R. §7.5220 (1984). In a leading case
examining the interrelationship between 12 U.S.C. §24 Fifth and
12 C.F.R. §7.5220, a former bank president unsuccessfully
sought damages for wrongful discharge. The court held that the
power to contract for a definite term given to banks in 12
C.F.R. §7.5220 is consistent with the power to discharge an
employee before the end of that term. Kemper v. First National
Bank in Newton, 94 111. App.3d 169, 418 N.E.2d 819, 821 (111.
App. Ct. 1981). The court interpreted the various cases dealing
with both the statute and regulation and concluded that
"[ajlthough a national bank may contract to employ an officer
for a definite period of time, it may not bargain away its
right, granted by statute, to discharge those officers at
pleasure". Id. Therefore, it would appear that employment
contracts whTch are otherwise valid and enforceable may be
di^ owed by national banks without liability for wrongful
discharge. However, the decision to actively seek avoidance or
disaffirmance must be made by the board of directors.
D.

Proving a Violation of 12 C.F.R. §7.5220 — Factors
Determining the Reasonableness of Executive Compensation

Although no cases have defined the term "reasonable" as used in
12 C.F.R. §7.5220, a 1976 memorandum from Charles F. Byrd,
Assistant Director, LASD, to John E. Shockey, Deputy Chief
Counsel, concluded that unless an employment contract "is
blatantly unreasonable," an effort to prove the contract is not
within the terms of I.R. 7.5220 "would be extremely
difficult." The task of proving the unreasonableness of
employment contracts was not made easier by the defeat of a
1976 proposal to add to I.R. 7.5220 illustrations of provisions
in employment contracts that OCC would consider unreasonable.
Nevertheless, courts have had to develop guidelines for
determining the reasonableness of executive compensation in
other contexts. As noted in an American Law Reports
Annotation, the reasonableness of compensation involves a
question of fact and although generally within the exercise of
the board of directors* business discretion, courts have looked
to the actual services rendered by the officer, the financial
condition of the corporation and have made comparisons with
other officers' salaries in the same company or other firms in
similar businesses. See Annot. 53 A.L.R. 358 (1973). A
federal district court explicitly held that the reasonableness
of an officer's compensation, as approved by the board of
directors of which he was a member, may be determined in light
of the corporation's financial condition. Irwin v. West End
Deve' -^pment Co., 342 F.Supp. 687 (D.Colo. 1972), modified, 481




183
F.2d 34 (1973). As noted by another court, the salaries of
officers of an efficiently managed corporation must bear a
reasonable relation to the services rendered and the income of
the business since corporate directors and officials must have
regard for the financial condition of the corporation. Baker
v. Cohn, 42 N.Y.S.2d 159 (N.Y Sup. Ct. 1942), modified, 266
A.D. 715, 40 N.Y.S.2d 623 (N.Y. App. Div. 1943), a f F I 292 N.Y.
570, 54 N.E.2d 689 (1944). A reviewing court may look at
compensation paid by other corporations in similar businesses.
Backus v. Finkelstein, 23 F.2d 531, 536-37 (D.C. Minn. 1924).
A general guideline for determining the reasonableness of
compensation is that the remuneration must be in proportion to
the officer's ability, services and time devoted, corporate
earnings and other circumstances. Glenmore Distilleries Co. v.
Seidman, F.Supp. 915, 919 (E.D.N.Y. 1967). The Seidman court
went on to stress that "[sjalaries of officers in an
efficiently managed corporation must bear a reasonable relation
not only to the services rendered but to the income of the
business." Id. Given the inherent vagueness in a term such as
"reasonable", the preceding material is offered merely as an
indication of the types of factors a reviewing court might
consider in a determination of the reasonableness of executive
compensation agreements.
E.

Unreasonable or Excessive Executive Compensation as an
Unsafe or Unsound Banking Practice Within 12 U.S.C. 1T818

Although it would.prove difficult to establish a violation of
I.R. §7.5220 due to the ambiguity of the term reasonable, there
is substantial authority that given the proper circumstances,
excessive or unreasonable employment or termination agreements
could constitute unsafe or unsound banking practices within 12
U.S.C. §1818. Bank Circular No. 115 dated August 30, 1978,
stated that practices OCC views as unsafe or unsound include
excessive salaries and bonuses, excessive director fees and
fees paid where there is no corresponding benefit to the bank.
The legislative history of 12 U.S.C. §1818 reveals the breadth
of the term unsafe or unsound. As John F. H o m e , Chairman of
the Federal Home Loan Bank Board testified before Congress:
[d]espite the fact that the term "unsafe or unsound
practices" has been used in the statutes governing
financial institutions for many years, the Board is
not aware of any statute, either Federal or state,
which attempts to enumerate all the specific acts
which could constitute such practices. The concept of
"unsafe or unsound practices" is one of general
application which touches upon the entire field of the




184
operations of a financial institution. For this
reason, it would be virtually impossible to
attempt to catalogue within a single
all-inclusive or rigid definition the broad
spectrum of activities which are embraced by the
term. The very formulation of such a definition
would probably operate to exclude those practices
not set out in the definition, even though they
might be highly injurious to an institution under
a given set of facts or circumstances or a scheme
developed by unscrupulous operators to avoid the
reach of the law. Contributing to the difficulty
of framing a comprehensive definition is the fact
that particular activity not necessarily unsafe
or unsound in every instance may be so when
considered in the light of all relevant facts.
Thus, what may be an acceptable practice for an
institution with a strong reserve position, such
as concentration in high risk lending may well be
unsafe or unsound for a marginal operation.
Hearings on S. 3158 Before the House Comm. on Banking and
Currency, 89th Cong., 2d Sess., at 49-52 (Sept. 15-22, 1966).
An early case treating this question at a different bank found
that excessive bonuses and salaries to bank officers
constituted an unsafe and unsound practice and upheld the
Comptroller's Cease and Desist Order given the poor financial
performance of the bank. First National Bank at Eden, South
Dakota v. Department of the Treasury, Office of the Comptroller
of the Currency, 568 F.2d 610, 611 (8th Cir. 1978). The court
adopted the Comptroller's defintiion of unsafe and unsound
practices as encompassing "[w]hat may be generally viewed as
conduct deemed contrary to accepted standards of banking
operations which might result in abnormal risk or loss to a
banking institution or shareholder." Id.
In the most significant case on point the Seventh Circuit
upheld the determination of the District Court for the Northern
District of Illinois that employment agreements entered into by
a federally-insured savings association with two of its
officer-directors were null and void because they constituted
an unsafe and unsound banking practice. Federal Savings and
Loan Insurance Corporation v. Bass, 576 F.Supp. 848 (N.D. 111.
1983), app. dismissed, No. 83-3305 (7th Cir. April 28, 1984).
The agreements involved large termination payments voted by the
board of directors of Unity Savings Association at a time when
the institution was experiencing serious financial
difficulties; several board members were contract
beneficiaries. Eventually Unity became insolvent and the FSLIC




185
took over as its receiver. The court relied heavily on a
Federal Home Loan Bank Board regulation requiring that an
insured institution "[n]ot enter into an employment contract
with any of its officers or other employees if such contract
would contitute an unsafe or unsound practice." 12 C.F.R.
§563.39(a)(1983). The court also applied a Fifth Circuit
holding that restricted the breadth of the unsafe or unsound
practice formula to practices with a reasonably direct effect
on an association's financial soundness. Bass, 576 F. Supp. at
852 (quoting Gulf Federal Savings and Loan v. Federal Home Loan
Bank Board, 651 F.2d 259, 264 (5th Cir. 1981), cert, denied,
458 U.S. 1121 (1982)). The court found that "[UlnTty could ill
afford to part with $200,000 for even the best of reasons," and
certainly not to disburse funds for this "[b]latent attempt to
secure...[the officer-directors'] position at Unity's
expense." Id.
The FSLIC in its briefs before the court, argued that the
employment contracts threatened a loss of public confidence in
the entire t 'ings and loan industry by allowing officers to
remove substantial amounts of cash from an instituion as a
result of its failure. More basically, the FSLIC contended
that the agreements were inconsistent with sound financial
practices which would involve reduction rather than increase of
expenses for a financially troubled institution. What may be
more significant for future litigation involving the OCC is the
fact that the court agreed with the FSLIC that judicial
deference to bank regulators would be "particularly
appropriate" in a factual situation such as that presented by
Bass. When faced with a question of statutory construction,
the Supreme Court has mandated that federal courts accord
"CgJreat deference to the interpretation given the statute by
the officers or agency charged with its administration." Ford
Motor Credit Co. v. Milhollin, 444 U.S. 555, 566, (1980)
(quoting Udall v. Tallman, 380 U.S. 1, 16 (1965)). With
respect to the deference which has been accorded the OCC in its
interpretation of 12 U.S.C. §1818 the D.C. Circuit has held
that the Comptroller's discretionary authority to define and
eliminate 'unsafe and unsound1 conduct is to be liberally
construed. Independent Bankers' Association of America v.
Hermann, 613 F.2d 1164, 1168-69 (D.C. Cir. 1979), cert, denied,
449 U.S. 823 (1980). The Fifth Circuit has held that the
exercise of the Comptroller's discretion will not be disturbed
unless it is arbitrary, capricious or contrary to law; so long
as the Comptroller can substantiate his actions in a reasonable
manner, a reviewing court will defer to the agency's judgment.
First National Bank of Bellaire v. Comptroller of the Currency,
697 F.2d 674, 680 (5th Cir. 1983).
In light of Bass and the series of decisions stressing judicial
deference to 7ministrative agency interpretations, there is
clearly a lege, basis upon which to argue that in certain




186
circumstances, employment or termination agreements can
constitute unsafe or unsound banking practices within 12 U.S.C.
§1818. In order for a court to uphold a Cease and Desist
Order, several requirements would probably have to be met.
First, the bank's financial condition would have to be
precarious enough that the compensation would have a
"reasonably direct effect" on the institution's financial
soundness. Additionally, the contracts themselves must be
"unreasonable" in some manner. A violation of the guidelines
enumerated in Banking Circular No. 115, a financially unsound
decision to reward poor managerial performance or a contract of
the "golden parachute" genre could all fall within this
prohibition. However, when one examines the three termination
agreements for Anderson, Miller and Perkins at CIC, it is
unlikely that any action under §1818 would succeed. The
contracts were relatively meager in terms of industry
standards. Additionally, the lengths of service of the former
officers was very long while the duration of the payments was
fairly short. The net'present value of each agreement
constituted only the amount each officer would have received in
salary and benefits if he had not retired early. More
significant is the fact that a plausible argument could not be
made, given Continental's size, that the payments would have a
direct and detrimental effect on the institution's financial
soundness. In a smaller and more "insolvent" or "illiquid"
institution and under a more egregious set of facts such as
those presented by Bass, the Comptroller would have a much
better chance of sucessfully arguing that the contracts were
null and void as an unsafe or unsound banking practice.
F.

Potential Arguments that Bank Boards or Officers Might
Raise to an Action Under 12 U.S.C. §1818 Seeking a Cease &
Desist Order

Any action brought under 12 U.S.C. §1818 attempting to nullify
an employment or termination agreement will be subject, as a
first defense, to the claim that the agreement was entered into
in accordance with 12 C.F.R. §7.5000. This interpretative
ruling reads, in pertinent part:
A national bank may adopt any reasonable
bonus or profit-sharing plan designed to
insure adequate remuneration of bank
officers and employees.
12 C.F.R. §7.500 (1984) (emphasis supplied). Given the
representative standard compensation/termination practices
described in Section B, it might be difficult to argue that a
contract which is typical of those in the industry is
"unreasonable." However, a bank's challenge to an §1818 action
on this ground would probably be unsuccessful as the
Comptroller need prove only that the agreement constitutes an
unsafe or unsound practice, not that it is "unreasonable."




187
A bank board's next argument would probably focus on the
deference courts give to directors' decisions as a result of
the business judgment rule. Under the business judgment rule,
corporate directors are presumed to have acted properly and in
good faith and are called to account for their actions only
when they have acted in bad faith. Treadway Companies, Inc. v.
Care Corporation, 638 F.2d 357,382 (2d Cir. 1980). As one
court has stated, directors will be held to a standard which
requires them to exercise honest business judgment, defined as
the exercise of "[t]hat care which businessmen of ordinary
prudence use in managing their own affairs." Northwest
Industries, Inc. v. B.F. Goodrich Company, 301 F.Supp. 706, 711
(N.D. Ill. 1969) . While corporate management has a high
fiduciary duty of honesty and fair dealing with shareholders,
and it will be given wide discretion in decision-making under
the business judgment rule, Berraan v. Gerber Products Company,
454 F.Supp. 1310, 1319 (W.D. Mich. 1978), the business judgment
rule does not apply to situations involving self-dealing, where
there is a conflict of interest. Lewis v. S.L.& E., Inc., 629
F.2d, 764, 769 (2d Cir. 1980). In an action brought under the
Labor-Management Reporting and Disclosure Act, 29 U.S.C. §501
et seq. (1976), the Second Circuit held that corporate officers
could be liable for breach of their fiduciary duties by
authorizing and receiving excessive compensation for
themselves. Morrissey v. Curran, 650 F.2d 1267 (2d Cir.
1981). Similarly, if bank director-officers were to vote
themselves large employment or termination agreements, the
business judgment rule would not apply. Although the
Comptroller would probably not have standing to assert an
action for breech of fiduciary duty, any action under 12 U.S.C.
§1818 to have the contracts rescinded as unsafe or unsound
banking practices would not be subject to the business judgment
rule defense. As fiduciaries, directors and officers are
obligated to act solely to benefit the corporation and must
forego any personal advantage that may result from their
position. Pepper v. Litton, 308 U.S. 295, 311 (1939); Burden
v. Sinskey, 530 F. 2d 478, 489-90 (3d Cir. 1976).
Conclusion
It is unlikely that the Comptroller would be successful in an
enforcement action against Continental and/or Anderson, Miller
and Perkins given the nature of their contracts, the bank's
size and financial condition, and industry practices with
respect to termination agreements. As Eugene Katz, Assistant
Director, Litigation, stated in a memo to Robert Serino, Deputy
Chief Counsel, it might be advisable for the FDIC, considering
the leverage it now has over Continental, to "suggest" that
these contracts should be rescinded as they are not in the
bank'8 best interest. It is clear, however, that given a more
blatant use of insider advantage as is the case with true
"golden parachutes" at a financially troubled bank, the
Comptroller could successfully bring an action against such
agreements, alleging them to be unsafe or unsound banking
practices.
cc:

Ralph Sharpe
Robert Davis
Stacy Powers




188
FROM CONTINENTAL ILLINOIS CORPORATION'S PROXY STATEMENT DATED
AUGUST 24, 1984
Bank in the ordinary course of business during 1983. All loans and commitments included in such
transactions were made on substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons and did not involve more than
normal risk of collectibility or present other unfavorable features.
The following table sets forth all 1983 cash compensation for services rendered to CI Corp and its
subsidiaries by (i) the five most highly compensated executive officers of CI Corp and (ii) all executive
officers of CI Corp, as a group, while they held such positions.
Name and Capacities
in Which Served

Salary

Roger E. Anderson (3)
Former Chairman of the Board of Directors of CI Corp
and the Bank
John H. Perkins (3)
:
Former President of CI Corp and the Bank
Donald C. Miller (3)
Former Vice Chairman of CI Corp and the Bank
David G. Taylor (3)
Former Vice Chairman of CI Corp and the Bank
Edward M. Cummings (3)
For.ner Executi/e Vice President of CI Corp and the
Bank until December 31, 1983
All executive officers as a group (18 in number)

S 515,000

Profit
Sharing
(1)

Incentive
Compensation
(2)

514,909 ' S - 0 -

430,000

12,448

-0-

325,000

9,409

-0-

269,455

7,801

-0-

207,500

6,007

-0-

3,838,574

115,404

-O-

(1) The figures in this column represents amounts paid in 1984 for 1983 pursuant to CI Corp's
cash and deferred profit -sharing plan/
(2) The Board of Directors has determined that no awards for 1983 will be made pursuant to CI
Corp's incentive compensation plan.
(3) All of the executive officers named in the table above have resigned from CI Corp and the Bank,
except for David G. Taylor. Mr. Taylor, who served as Chairman of the Board of Directors of CI Corp and
the Bank from April 23, 1984 to August 13, 1984, now serves as a Vice Chairman of the Bank.
For a description of certain of CI Corp's benefit plans, see "Stock Options, Stock Appreciation Rights
and Restricted Stock" and "Other Employee Benefit Plans".
In addition to the amounts set forth in the table above, Mr. Perkins received during 1983 other
compensation of $31,294 in the form of dues paid by CI Corp for certain associations and clubs and the
value of financial advisory services provided by the Bank. Mr. Cummings received during 1983 other
compensation of $ 131,786 in the form of reimbursement for various expenses incurred in connection with
duties overseas during 1982, for moving expenses incurred in returning to the United States and for dues
paid by CI Corp for certain clubs. During 1983 no other executive officer named in the table received any
other compensation in an amount in excess of 525,000 and all executive officers as a group did not receive
other compensation in excess of 10% of the compensation for that group as reported in the table.
In connection with Mr. Anderson's retirement, he received (i) a one time lump sum pension
supplement of 5269,792; (ii) a monthly consulting fee of S12.212 through July 1986 and Sl,500
thereafter through June 1988; (iii) a cash payment of S77.000 reflecting the value of forfeited shares of
restricted stock to which he would have been entitled if he had retired at the age of 65; (iv) certain
financial advisory services until one year after retirement and (v) payment of dues for certain clubs.
In connection with Mr. Perkins' retirement, he received (i) an annual pension supplement of
S19,720; (ii) a monthly consulting fee of S14,532 through August, 1986; (iii) a cash payment of
557,000 reflecting the value of forfeited shares of restricted stock to which he would have been entitled




68

189
if he had retired at the age of 65; (iv) certain financial advisory services until one year after retirement
and (v) payment of dues for certain clubs.
In connection with Mr. Miller's retirement, he received (i) an annual pension supplement of
SI2,500; (ii) a monthly consulting fee of $15,375 through March, 1985; (iii) a cash payment of
551,000 reflecting the value.of forfeited shares of restricted stock to which he would have been entitled
if he had retired at the age of 65; (iv) certain financial advisory services until one year after retirement
and (v) payment of dues for certain clubs.
CI Corp directors who are not regular salaried officers of CI Corp or its subsidiaries receive an
annual retainer of $15,000, a fee of S600 for each board meeting attended, a fee of S500 for each
committee meeting attended, and an annual fee for service on committees as specified below. The
Chairman and each other member of the Audit Committee receive an annual fee of S7,500 and 54,000,
respectively. The Chairman and each other member of the Compensation and Nominating Committee
receive an annual fee of 55,000 and 53,000, respectively. Each member of the Board Credit Committee and each member of the Bank's board's Committee on Private Banking, Trust and Investment
Services receives an annual fee of 53,000. Directors may elect to defer payment of any of their director
fees, which then accrue earnings at a rate determined from time to tims by the Compensation and
Nominating Committee. Deferred fees are paid in a lump sum or in installments, generally commencing after a director ceases to be a director of CI Corp and the Bank.
Stock Ownership of CI Corp
CI Corp has been advised by Dean LeBaron, doing business as Bat.urymarch Financial Management
("Batterymarch"), 600 Atlantic Avenue, Boston, Massachusetts 02210, that as of June 30, 1984,
Batterymarch was the beneficial owner (as defined by the Securities and Exchange Commission) of
2,057,050 shares, representing 5.1% of the outstanding shares of Common Stock of CI Corp. Batterymarch has sole voting power with respect to 623,500 shares and has sole investment power with respect to
2,057,050 shares. CI Corp does not know of any other person who is the beneficial owner of more than 5%
of its Common Stock.
The following table sets foi.h the beneficial ownership of Common Stock of CI Corp and
directors' qualifying shares of the Bank as of August 20, 1984 (i) by each director, and (ii) by all
directors and officers of CI Corp as a group. As of that date, each director of CI Corp beneficially
owned less than .1%, and all directors and officers as a group owned less than 1%, of the outstanding
shares of Common Stock of CI Corp.
CI Corp

John E. Swearingen
William S. Ogden....
Raymond C. Baumhart, SJ
James F. Bere
Weston R. Christopherson
William B. Johnson
7
Jewel S. Lafontant
Vernon R. Loucks, Jr
Frank W. Luerssen
Robert H. Malott
Marvin G. Mitchell
John M. Richman
Paul J. Rizzo
Thomas H. Roberts, Jr
William L. Weiss
Blaine J. Yarrington
All directors and officers as a group
(33 in number)

*.".

.
69

39-133 0—84

13




100
100 ..
None
1,000
200
1,220
400
200
200
1,000
1,000
200
200
200
248
1,000
356,484(1) (2)

Bank

100
100
100
100
100
100
100
100
100
100
100
100
100
100
100
100

190
Chairman S T GERMAIN. I simply want the record to reflect that,
yes, Mr. Anderson has paid a price since he no longer earns
$515,000 a year. But the man has apparently not been left to pauperism, or destitute since his departure from Continental.
The subcommittee will be in recess for 10 minutes in order to
allow the Members to answer the quorum call. Then we will
resume Mr. Conover's testimony.
[Recess.]
Chairman S T GERMAIN. The subcommittee will come to order.
Mr. Conover, you may proceed.
Mr. CONOVER. Thank you, Mr. Chairman.
The demise of Continental was clearly not desirable. It would
have been far better if management had made better decisions and
taken actions that would have been more appropriate for the ensuing circumstances. It would also have been preferable if we as supervisors could have done something to change the course of Continental.
As we review the history of Continental, it is possible to identify
several points in time and ask whether it would have been appropriate for the supervisors to step in forcefully to change the course
of the bank's direction. We did this, of course, after our 1982 examination when we took a formal enforcement action against the
bank. Most banks, including Continental, respond to this type of
corrective measure. What made Continental different from most of
these cases was that the market did not wait for the bank's recovery plan to restore it to health.
I am persuaded t h a t since mid-1982, there was nothing more t h a t
we could have done to speed Continental's recovery and thereby increase market confidence.
We have asked ourselves whether we should have taken action
as early as 1976 to prevent Continental from embarking on a
course of rapidly becoming a top lender to corporate America. In
my view, it would have been inappropriate to have done so. It is
not the proper function of regulators to decide what business strategy an individual bank should undertake. The regulator's role is to
see t h a t whichever business strategy a bank chooses, it has the
mechanisms in place to implement t h a t strategy in a safe and
sound manner.
In retrospect, it is clear t h a t management, buoyant with the
bank's years of financial success, placed too little value on risk control mechanisms in the implementation of its strategy.
If there is anything t h a t OCC could have done differently, I believe it would have been to place more emphasis on our evaluation
and criticism of Continental's overall management processes. Had
we done so, we might have been alerted to management's lack of
commitment to controlling risk sooner than 1982. Had we been less
swayed by management's successful track record from the early
1970's through 1981 and its previous responsiveness to our supervision, we might have been able to see more clearly the risks inherent in its rapid growth strategy.
Continental's demise has highlighted the need for banks and supervisors to continue to work to maintain the public's confidence in
individual banks and the banking system as a whole.




191
Supervisory techniques continue to be improved. The OCC's supervisory process has continued to improve as technological innovations have been made and industry conditions have changed.
Our supervision of banks of all sizes has been enhanced by the
establishment of an Industry Review Program. This program includes a computerized information system to collect data on industry concentrations in individual bank portfolios and the banking
system as a whole. Our examiners will use the information in their
analyses of individual banks to identify concentrations and to help
position banks to withstand problems emerging from them.
The near-complete development of two additional computer systems will provide us with a much improved ability to respond to
examination needs and follow up on examination results.
We have also taken steps to ensure communication within the
OCC of examination findings on individual banks t h a t may affect
other banks in the system. These steps include changes in OCC internal procedures, examination manuals, and training.
Our multinational bank program has been expanded, and we are
examining multinational banks more frequently t h a n in the past.
Our examinations are targeted on the areas of supervisory concern
and take place two to three times a year, rather t h a n annually.
Moreover, we have reorganized and significantly increased our resources committed exclusively to the supervision of our largest
banks. In addition to the more frequent examinations we have undertaken, the examiners will also monitor trends and developments
in the banks between examinations. This new approach results in
near-constant supervision of each of our large banks.
Second, internal controls must be emphasized. The OCC is placing more emphasis in the examination process on banks' internal
controls and systems. This includes increased testing of control procedures and their application and more stringent follow-ups to
ensure t h a t internal control deficiencies are corrected. In addition,
we have issued specific procedures t h a t banks must follow when
they purchase loan participations.
Three, loan loss reserves are being evaluated. Since the allowance for possible loan losses [APLL] is the first line of defense
against loan deterioration, we are taking additional steps to assess
the adequacy of a bank's APLL relative to the total risk in its portfolio. We are concerned t h a t for some banks, increases in the APLL
have not kept pace with increases in nonperforming and classified
loans. We are addressing this concern by developing more specific
criteria for use by our examiners in evaluating the adequacy of reserves and by focusing our examinations of large banks to make
sure t h a t reserves are adequate.
Four, capital levels are being increased. Congress reemphasized
the critical role of capital in maintaining the safety and soundness
of the banking system when it enacted in 1983 the International
Lending Supervision Act t h a t authorizes the banking agencies to
enforce capital requirements. Under regulations proposed by the
OCC and the FDIC, all banks, regardless of size, would be required
to maintain a minimum ratio of primary capital to total assets of
5.5 percent and a total capital ratio of 6 percent.
The implementation of this standard would not replace our supervisory evaluation of capital adequacy. Banks of all sizes will be




192
encouraged to maintain higher capital levels. Furthermore, the
OCC retains the right to impose higher ratios for banks whose circumstances necessitate a stronger capital base.
Five, sources and uses of funds are being scrutinized. The OCC is
devoting more resources to monitoring regional and multinational
banks' global funding. Banks will be placed under special surveillance if they are especially vulnerable to eroding market confidence or reliance on particular funding markets is deemed to be
excessive. Where we find a high volume of volatile liabilities, we
will require a larger percentage of liquid assets.
Six, increased financial disclosure is being promoted. The market's evaluation of the banking system depends, in large part, on
the information t h a t is publicly available. To enhance the credibility of bank financial statements and reduce the likelihood t h a t the
market will overreact to incomplete information, the OCC is considering requiring increased disclosure of information about banks.
To t h a t end, it is seeking public comment on increasing the disclosure requirements for banks via an advance notice of proposed
rulemaking.
Chairman S T GERMAIN. If I may for a moment, Mr. Conover, I
want to encourage you in t h a t area. Unfortunately, we had thought
we would see t h a t earlier, as you recall, right after or during Penn
Square I made the point t h a t increased disclosure was very, very
essential. I got the impression that the FDIC was going to really
move in t h a t direction.
But the movement has been very slow. So I really encourage and
commend you on t h a t point, because I think it is most important,
and on capital adequacy, you do recall that, as I think you stated,
the International Lending Supervision Act as a result of this committee's insistence, required this increase in capital.
Mr. CONOVER. Correct.

On the subject of increased disclosure, we have been pushing for
t h a t for some time. I think the action we are taking now is significant because it is not jawboning. It is not a voluntary thing. We
are talking about putting a firm regulation in place.
Chairman S T GERMAIN. Well, that is very gratifying.
Mr. CONOVER. The seventh area we have been focusing on is
maintaining a strict enforcement policy. We have been utilizing
our enforcement power more vigorously to correct violations of law
and imprudent banking practices. For instance, last year we took
274 formal actions against national banks compared to 156 for the
previous year and only 65 in 1978. The total for the first 8 months
of this year is 250 formal actions. These actions have been taken
against banks of all sizes. We have outstanding enforcement actions against 17 percent of the banks with assets over $1 billion
and 12 percent of the banks with under $1 billion in assets. Last
year, we also imposed civil money penalties against 127 bank officials. To put t h a t into perspective, in 1981 we imposed only 19.
In summary, Continental pursued a growth strategy without adequate controls t h a t proved to be its downfall in adverse economic
circumstances. Management has been removed, and shareholders
have incurred substantial losses. At the same time, we have avoided major disruption to the financial system. Upon implementation
of the long-term solution, Continental will be well capitalized and



193
have stronger assets and management. It will be returned to private ownership at the earliest possible date.
We continue to focus our supervisory efforts on enhancing the
ability of banks to remain sound even under difficult circumstances. Such action will strengthen the banking system and assure
the continuing confidence of depositors.
Mr. Chairman, that concludes my prepared remarks. I will be
happy to answer questions.
[Mr. Conover's prepared statement follows:]




194
Statement of
C. T. Conover
Comptroller of the Currency
Before the
Committee on Banking, Finance, and Urban Affairs
U. S. House of Representatives
September 19, 1984

Mr. Chairman, members of the Committee, I am pleased to be
here to discuss Continental Illinois National Bank and Trust
Company (Continental)• The serious problems encountered by
Continental and the regulators1 actions concerning Continental
are obviously a matter of public concern and deserve a
thorough review by Congress and the public.

It is my hope

that these hearings will generate a broader understanding of
the bank regulatory process, and the events surrounding the
financial deterioration of Continental and the ensuing federal
assistance,

I would like to express my appreciation to the

members of the Office of the Comptroller of the Currency (OCC)
staff as well as the other financial regulatory agencies who
have devoted countless hours in working toward a resolution of
Continental's difficulties.




195
-2-

In the Spring of 1984, Continental began experiencing
liquidity problems that reached crisis proportions in May.
The liquidity problems resulted from a rapid decline in
market confidence brought about by severe deterioration
in the quality of Continental's loans.

On May 17, a temporary assistance program was implemented
by the federal regulators to allow time to work out a solution
while minimizing any adverse impact on global financial
markets.

The long-term solution, which was announced July 26

and on which shareholders will vote on September 26, is
intended to restore Continental to health and allow it to
continue to serve its marketplace without interruption.

I fully appreciate the Committee's need to receive full
and complete information on this Office's supervision of
Continental.

For that reason, we have provided the

Committee's staff complete access to all OCC documents
relating to the condition of Continental and our supervision
of the bank.

At the same time, we have been careful to

protect the legitimate rights to privacy of bank customers
and other third parties.

I hope that these hearings will

also contribute to the Committee's understanding of what
happened at Continental.




196
There are many important aspects to the Continental
situation that need to be aired at these hearings.

I can best

contribute to the process by focusing on the bank itself, and
this Office's supervision of it.

I understand the FDIC will

discuss the temporary assistance plan and subsequent long-term
solution.

Similarly, the holding company/ Continental

Illinois Corporation, and certain aspects of the federal
assistance plan are more appropriately discussed by the
Federal Reserve.

Today, I will address what happened at Continental by
first describing the economic factors that have buffeted
Continental —

and other banks —

since 1980. These include

back-to-back recessions as well as a sharply declining energy
industry.

Second, I will briefly review the internal policies

and practices at Continental that rendered it incapable of
weathering these adversities.

Fundamentally, the bank

undertook an aggressive growth strategy without adequate
safeguards against the ensuing adverse events.

Third, I

will discuss what we could have done differently.

Finally,

I will focus on what we are doing to assure the continued
safety and soundness of the banking system.

The Appendix

includes a ten-year chronology of Continental's internal




197
policies, strategies, and decisions; describes the prevailing
economic environment; and details this Office's supervisory
involvement with the bank.

ECONOMIC PROBLEMS HAVE IMPAIRED BANK PERFORMANCE

The 1980s have been difficult years for the banking
industry.

In early 1980, a recession caused real economic

growth to drop sharply.

By mid-1980 the economy was growing

again, but that recovery only lasted 12 months.

In mid-1981,

the economy fell back into a recession that lasted 17 months.
This latter recession proved to be deep and pervasive, with
virtually no sector of the economy left untouched.

It was a

particularly difficult recession because unlike most, it was
not accompanied by declining real interest rates.

Although the economy as a whole is now experiencing a
strong recovery, the pattern of back-to-back recessions was
particularly hard on lending institutions.

Loan quality

typically begins to deteriorate after an economic slowdown
begins, and continues to decline well into the recovery.
When the 1981 downturn occurred, banks were still dealing
with increasing loan losses from the 1980 recession.




The

198
second downturn not only added new problem loans, but hindered
attempts to work out existing problem loans. Many loan
portfolios, thus, have continued to deteriorate since 1980, and
many banks are still having problems stemming from the recessions.

In addition to having to contend with the effects of the
two recessions, many banks have also been affected by the severe
problems in the energy industry over the last few years. Oil
prices began to drop sharply in early 1980. Although they rose
again during the last half of 1980, by 1981 oil prices were
clearly on a downward spiral.

This caused a sudden and unexpected

decline in the profitability of energy exploration and production
in late 19"81. Banks that had lent money to a booming industry
suddenly found many of their customers facing severe financial
difficulty, and in many cases, bankruptcy.

The energy sector

continues to be a problem area for lenders today, as oil prices
continue to soften.

These economic factors have posed challenges to all bankers.
In an earlier era of strong domestic and international economic
growth and relatively stable interest rates, bank managements1
abilities were not sorely tested.

However, over the last few

years, the margin for error in banking has shrunk dramatically.




199
Most U.S. banks have weathered these difficulties
with impressive resilience, but almost all have felt some
impact.

Return on assets and return on equity are down for

the industry as a whole.

Asset quality is still suffering,

with net loan losses rising even faster for large banks than
for small.

One important consequence of the industry's problems
has been a heightened public concern about the condition
of U.S. banks.

Market confidence is an unpredictable but

crucial element in the stability of individual banks and the
banking system as a whole.

Whether a bank survives adverse

circumstances is often a matter of whether the market allows
it the needed time to work out problems.

In the case of

Continental, the market didn't provide this needed time.

WHAT HAPPENED AT CONTINENTAL?

The difficult economic environment had a particularly
devastating effect on Continental.

Its problems stemmed

from management strategies and policies that depended on
strong growth in the economy in general and the energy
industry in particular.




These strategies and their

200
consequences are detailed in the Appendix to this testimony.
In sum, Continental adopted a policy of rapid growth that
was not accompanied by the necessary management controls and
policies to maintain adequate asset quality in the face of
an economic slowdown and a declining energy industry.

Management Strategy Showed Early Signs of Success
Continental management announced its decision in 1976
to become one of the top three banks lending to "Corporate
America".

Located in the heart of industrial America,

Continental was already the leading commercial lender in
the Midwest.

Moreover, because it could not establish a

significant retail customer base due to state restrictions
on branching, the bank's corporate lending function was a
natural area for expansion.

Continental set out to quickly

become a major lender to corporate customers.

In implementing this goal, Continental adopted a strategy
of decentralized lending that permitted its account officers
to respond to customers and make loans more quickly and
competitively.

Although this approach required fewer controls

and levels of review, management believed the potential
rewards of such a strategy outweighed the associated risk.
Management felt confident about the depth and experience of
the bank's staff and its analysis of the direction of the
economy.

Obviously, this judgment proved to be incorrect.




201
Continental's management targeted the energy sector for
its most aggressive lending expansion.

During the latter half

of the 1970s, the United States was attempting to develop a
program for energy self-sufficiency in the face of uncertainty
about actions of the OPEC nations.

The 1973 oil embargo had

propelled energy independence to the forefront of our national
goals.

Prices were skyrocketing and gas lines forming when

Continental targeted energy lending as an area for growth.
The federal government was giving serious consideration to gas
rationing and even printed a million rationing coupons.

The Administration and Congress in 1977 emphasized the
critical nature of energy to the United States by establishing
a separate Department of Energy.

At that time, some economic

analysts were projecting the price of oil to increase to some
$60 a barrel.

In June 1980, Congress enacted the Energy

Security Act establishing the Synfuels Corporation and
authorizing $20 billion for synthetic fuels development.

Continental's management strategy of rapid growth with a
specialty in energy was quite successful for several years.
During the late 1970s, Continental outperformed its peers in
growth, earnings, and market perception, and its loan loss
record was excellent.

In 1978, Dun's Review described

Continental as one of the five best managed companies in
America.




202
Asset Quality Ultimately Deteriorated
In 1981, the very strategy that generated praise began to
turn against Continental.

A slowing economy meant that the

quality of available lending opportunities was deteriorating
at the same time that Continental was increasing its corporate
lending, inevitably resulting in the making of loans to
weak borrowers.

In addition, many of Continental's existing

corporate borrowers were seriously affected by the
back-to-back recessions; existing loans to these companies
became problems.

By 1982, it became clear that the bank's

rapid growth had been achieved at the expense of asset quality.

The declining energy industry in late 1981 dealt a
particularly serious blow to Continental.

The end of the

energy boom put a severe strain on the bank's energy-producing
borrowers.

Many of Continental's energy loans, which had been

performing well and had been extremely profitable, suddenly
turned into serious collection problems.

Continental's problems in the energy area were two-fold.
First, it had a heavy concentration in oil and gas loans that
left the bank extremely vulnerable to the industry's sudden
decline.

Since July 1982, oil and gas loans have accounted

for approximately two-thirds of the bank's losses, although
those loans have averaged only about 20 percent of the total
loan portfolio.




203
Second, from 1980 to 1982, the bank had purchased a large
volume of energy loans from Penn Square Bank, N.A.

The

quality of these loans proved to be very poor, particularly
those loans that were purchased in late 1981 and early 1982
when Continental's growth was peaking.

Loans purchased

from Penn Square constitute a disproportionate amount
of Continental's losses.

During our May - November 1982

examination, for example, Penn Square loans accounted
for approximately 3 percent of all Continental's loans.
However, they accounted for 16 percent of classified loans
and 65 percent of the charge-offs directed by our examiners.

Inadequate Management Controls Permitted Huge Losses
Considering the disproportionate contribution that Penn
Square loans made to Continental's losses, it is important
to analyze how such a questionable relationship could develop
in a bank that had been a top performer for so many years.
It now appears that Continental's purchase of problem loans
from Penn Square involved significant misconduct on the part
of officers of both institutions.

There are also indications

that criminal fraud may have been involved.

In fact, on

September 10, 1984, William G. Patterson, the former head
of Penn Square's energy lending division, was brought to
trial on a 34-count indictment that charged, among other
things, that he engaged in deceitful and fraudulent conduct




204
to conceal his illegal banking practices from OCC examiners
and the banks that purchased loans from Penn Square,

However, the problem extends beyond employee misconduct.
Management processes should be in place to guard against, and
detect, employee misconduct as well as other risks. These
include policies and controls governing loan approval, review,
and classification; mechanisms for determining provisions
for losses; loan workout functions; management information
systems; and loan officer compensation systems.

For banks

such as Continental that undertake aggressive growth
strategies, top quality controls are essential.

Continental's management controls were the subject of
considerable attention in our examinations over the past
eight to ten years.

Although we judged the bank's system

of loan controls to be generally satisfactory, we directed
a number of specific improvements.

For example, we cited,

at various times during the period from 1974 to 1981, problems
with the past-due loan report, the completeness of credit
files, the identification and rating of problem loans, and
collateral deficiencies.

Bank management was generally

responsive to our concerns and made a number of improvements
in its systems for controlling and detecting risk in the loan
portfolio.




205
These improvements were not enough.

In retrospect, it is

clear that there was not sufficient management support for the
control systems.

Top management had created an environment

where aggressive lending was not only condoned but
encouraged.

In this atmosphere, a high quality system of

controls was secondary.

Moreover, those warning signals

that the existing system did generate were ignored by senior
lending officers.

In the final analysis, the bank's internal controls did
not prevent the purchase of massive amounts of bad loans from
Penn Square.

With the benefit of hindsight, it is clear that

our generally favorable assessment of Continental's internal
controls was overly influenced by the bank's outstanding
performance during the years 1974 through 1981.

Continental Was Dependent on Volatile Funds
Although Continental was weakened by asset deterioration,
its losses never exceeded capital, and thus it never reached
book insolvency.
funding problems.

Rather, its near-collapse was triggered by
Beginning in the second half of 1982, the

bank was forced to rely increasingly on foreign funding, as
federal funds and certificates of deposit rapidly eroded.

39-133 0—84

14




For

206
almost two years, the overseas funding provided Continental
with relatively stable, much needed liquidity.

It also made

the bank vulnerable to the liquidity problems that occurred in
May 1984 when uncertainty about Continental's condition caused
the overseas markets to close completely.

Clearly Continental's reliance on uninsured, short-term
funds meant that it was particularly vulnerable to a loss of
confidence.

However, Continental's earlier decision to become

a major corporate lender made the wholesale market a natural
funding source.

The wholesale market was practically a

necessity given the restrictive branching statutes in Illinois
that made establishment of a broad retail customer base
difficult.

Although reliance on uninsured, short-term funds makes a
bank sensitive to market perceptions, it is not by itself an
imprudent banking practice.

If a bank maintains sufficient

liquidity and asset quality, periodic shortfalls in funding
can be readily accommodated.

In Continental's case, the heavy reliance on wholesale
funds was not accompanied by enough liquidity to sustain it
through funding shortages.




The bank's aggressive lending

207
strategy was pursued to the exclusion of sufficient liquidity,
resulting in a higher proportion of loans relative to assets
than any of its peers.

Even an extremely conservative

liquidity position would not have protected Continental
from the major funding crisis it experienced last spring.
Nevertheless, it is an area we could have paid more critical
attention to; we are doing so in large banks now.

Continental Never Regained Lost Confidence
It became clear, during our examination that began in
May 1982, that Continental's management practices and policies
had led to serious loan problems.
a number of ways.
November.

We responded to this in

We extended our examination through

During the course of the examination, we directed

Continental to begin a number of corrective measures, which
were immediately initiated by the bank.

We informed

management of our intention to formalize these directives by
placing the bank under a Formal Agreement, enforceable under
the cease and desist authority of 12 U.S.C. 1818.

My staff

and I met several times with senior management and board
members over the next few months to discuss the bank's
condition and the impending Agreement.




208
The Agreement required improvements in numerous areas,
including loan policies and procedures, asset and liability
management, and funding.

It also required regular reports by

a board committee on the bank's compliance with the Agreement.
Bank management complied with the terms of the action and took
significant steps to revamp its operations.

However, the loans

that crippled Continental were already on the books.

Market confidence had begun to turn against the bank in
July 1982 when its Penn Square loan problems surfaced publicly.
Despite nearly constant OCC supervision and presence in the bank
over the next two years, and the efforts by bank management and
the board of directors, Continental was unable to fully regain
market confidence.

In May of this year, the market reacted

adversely to rumors of further problems at Continental, and large
depositors began withdrawing funds.

The bank was unable to stem

the run, and federal intervention was required to prevent the
bank's collapse.

WHAT COULD HAVE BEEN DONE DIFFERENTLY?

An obvious question that we and others have asked
is whether there was anything that the OCC should have done




209
differently in the course of Continental's deterioration.

In

addressing this question, it is important first to clarify the
role of the bank supervisor.

The Supervisor's Role is to Maintain Systemic Soundness
Short of nationalizing the banking system, no bank
regulatory system can prevent all bank failures.

I do not

believe that the American public would support either the
cost or the kind and degree of regulation and supervision
that would eliminate all possibility of failure.

To do so

would require removing all risk-taking from banks, and would
make banks unable to carry out their role as financial
intermediaries in fueling the nation's economic growth.
At the same time, however, it is clear that the nation is
not well-served by a banking industry where the potential
for failure is unrestricted.

Our charge is to maintain the safety and soundness of
the national banking system.

To do so requires sufficient

oversight of and interaction with bank management to minimize
the likelihood of bank failure. We do not take over and
manage institutions; we cannot substitute for private
management in making lending or any other decisions.




The

210
primary responsibility for any bank's performance rests with
its management and board of directors.

However, as supervisors

we do monitor risk exposure, work to see that policies and
controls are appropriate to that level of risk, and enforce
compliance with the law.

When we identify major weaknesses,

we institute corrective measures, and follow up on their
implementation.

This results in significant improvement in the

vast majority of institutions that we identify as having problems.

For some institutions, even prompt and stringent corrective
measures are unsuccesful.

The safety and soundness of the

banking system also requires allowing such poorly managed,
financially weak institutions to disappear from the system
in an orderly manner.

In an important sense, this is what

has happened to Continental.

The doors are still open, but

the officers who allowed the bank's deterioration are no longer
part of Continental.

Moreover, those that bear responsibility

for approving management policies have paid a price.

The

shareholders face substantial if not total loss, and the
directors and former management face potential legal liability.

Could OCC Have Taken Other Actions?
The demise of Continental was clearly not desirable.
It would have been far better if management had made better
decisions and taken actions that would have been more appropriate




211
for the ensuing circumstances.

It would also have been

preferable if we as supervisors could have done something
to change the course of Continental.

As we review the history of Continental, it is possible to
identify several points in time and ask whether it would have
been appropriate for the supervisors to step in forcefully to
change the course of the bank's direction.

We did this, of

course, after our 1982 examination when we took a formal
enforcement action against the bank.

Most banks, including

Continental, respond to this type of corrective measure. What
made Continental different from most of these cases was that
the market did not wait for the bank's recovery plan to
restore it to health.

I am persuaded that since mid-1982, there was nothing more
that we could have done to speed Continental's recovery and
thereby increase market confidence.

One possible action was

to force out top management in addition to those dismissed
following the failure of Penn Square.
this, for several reasons.

We decided not to do

First, existing management had

proven more capable than most at bringing the bank out of the
serious difficulties that many large banks faced following the
REIT problems of 1975 and 1976.

Second, management recognized

the bank's problems in 1982 and put a program in place to




212
identify and correct them.

Finally, a thorough, independent

management review undertaken by the board of directors in
mid-1982 had indicated which officers had been directly
responsible for the Penn Square loans, and those officers
were removed.

One other possibility would have been to force the bank
to curtail dividend payments.

However, management and the

board of directors felt that maintaining dividend payments
was crucial to regaining market confidence and to raising
additional capital.

Moreover, the amount of money involved

would not have added appreciably to capital.

In all, once the

bad loans were on the books, OCC -- and the bank -- took every
action that could have been reasonably expected to restore
Continental to health.

We have asked ourselves whether we should have taken
action as early as 1976 to prevent Continental from embarking
on a course of rapidly become a top lender to Corporate
America.

In my view, it would have been inappropriate to

have done so.

It is not the proper function of regulators

to decide what business strategy an individual bank should
undertake.

The regulator's role is to see that whichever




213
business strategy a bank chooses, it has the mechanisms in
place to implement that strategy in a safe and sound manner.

In retrospect, it is clear that management, buoyant with
the bank's years of financial success, placed too little value
on risk control mechanisms in the implementation of its
strategy.

Continental's record shows that neither financial

success nor the esteem of the financial community that flows
from that success can substitute for sound and effectively
enforced controls.

If there is anything that OCC could have done differently,
I believe it would have been to place more emphasis on our
evaluation and criticism of Continental's overall management
processes.

Had we done so, we might have been alerted to

management's lack of commitment to controlling risk sooner
than 1982.

Had we been less swayed by management's successful

track record from the early 1970s through 1981 and its
previous responsiveness to our supervision, we might have
been able to see more clearly the risks inherent in its rapid
growth strategy.




214
SAFETY AND SOUNDNESS MUST BE MAINTAINED

Continental's demise has highlighted the need for banks
and supervisors to continue to work to maintain the public's
confidence in individual banks and the banking system as a
whole.

All reasonable steps must be taken to strengthen the

ability of banks to weather adverse circumstances and thereby
earn the continuing confidence of depositors.

I would like to

focus briefly on seven areas where the OCC has taken steps to
enhance its examination and supervision and to strengthen the
banking system.

1.

Supervisory Techniques Continue to be Improved

The OCC's supervisory process has continued to improve
as technological innovations have been made and industry
conditions have changed.

In the aftermath of Penn Square's

failure and the problems experienced since mid-1982 by
Continental and other banks, we have made a number of
improvements in our supervision of national banks generally,
and of large banks in particular.

Our supervision of banks of all sizes has been enhanced
by the establishment of an Industry Review Program.

This

program includes a computerized information system to collect
data on industry concentrations in individual bank portfolios




215
and the banking system as a whole.

Through the use of outside

information sources we are monitoring significant industries
in an attempt to better anticipate developments that might
result in problems for banks.

Our examiners will use the

information in their analyses of individual banks to identify
concentrations and to help position banks to withstand
problems emerging from them.

Industry analyses and developments will be available to
each examining team through its own portable microcomputer.
Each team is being provided with extensive training in the
full range of analytical techniques and will be equipped to
perform more sophisticated analyses of banks1 activities than
were possible previously.

The near-complete development of two additional computer
systems will provide us with a much improved ability to
respond to examination needs and follow up on examination
results.

The first will facilitate examination scheduling by

establishing system priorities.

The second is our Supervisory

Monitoring System, an automated tracking system that provides
our examiners with access to all supervisory information
sources, particularly examination findings and recommended
actions.

This will require a more orderly tracking and

efficient follow-up of important supervisory concerns.




216
We have also taken steps to ensure communication within
the OCC of examination findings on individual banks that
may affect other banks in the system.

These steps include

changes in OCC internal procedures, examination manuals, and
training.

A newly developed course for evaluation of problem

banks, in particular, addresses this concern.

Our multinational bank program has been expanded and we
are examining multinational banks more frequently than in
the past.

Our examinations are targeted on the areas of

supervisory concern and take place 2 to 3 times a year,
rather than annually.

Moreover, we have reorganized and

significantly increased our resources committed exclusively
to the supervision of our largest banks.

A corps of our

best and most senior examiners has been devoted solely to
supervision of the multinational banks.

In addition to the

more frequent examinations we have undertaken, the examiners
will also monitor trends and developments in the banks between
examinations.

This new approach results in near-constant

supervision of each of our large banks.

We are now better able to identify and devote attention
to items of supervisory concern in individual large banks and
significant practices emerging in the large bank population as




217
a whole. We are committed to continually improve our
supervisory process and to maintaining an examination force
that, in its training, support systems and overall quality
is of the highest caliber.

2.

Internal Controls Must be Emphasized

The OCC is placing more emphasis in the examination
process on banks1 internal controls and systems.

This

includes increased testing of control procedures and their
application, and more stringent follow-ups to ensure that
internal control deficiencies are corrected.

To accomplish this, we are focusing our examiners1
attention to four basic control questions:

o

What systems are in place to permit early detection
of actions or trends that, if continued, might
seriously affect the bank's condition;

o

What actions are taken by senior management once
adverse trends and deficiencies are disclosed;

o

What individuals in the bank are in a position to
materially affect the accurate recording of
transactions; and,




218
o

What safeguards are in place to mitigate the chance
that individuals could conceal irregularities from
their superiors, bank auditors, and examiners.

These questions are particularly important in the area of
problem loan identification systems and will receive greatest
attention in that area.

In 1983, the OCC issued specific procedures that banks
must follow when they purchase loan participations.

The

circular spells out that the purchase of loans and
participations in loans may constitute an unsafe and unsound
banking practice in the absence of documentation, credit
analysis, and other controls over risk.

The circular also

warns banks that the absence of satisfactory controls over
risk is unacceptable and may cause the OCC to seek appropriate
corrective action through enforcement actions.

3.

Loan Loss Reserves Are Being Evaluated

Since the allowance for possible loan losses (APLL) is
the first line of defense against loan deterioration, we are
taking additional steps to assess the adequacy of a bank's
APLL relative to the total risk in its portfolio.




We are

219
concerned that for some banks, increases in the APLL have
not kept pace with increases in nonperforming and classified
loans.

We are addressing this concern by developing more

specific criteria for use by our examiners in evaluating the
adequacy of reserves and by focusing our examinations of large
banks to make sure that reserves are adequate.

4.

Capital Levels Are Being Increased

Congress reemphasized the critical role of capital in
maintaining the safety and soundness of the banking system
when it enacted in 1983 the International Lending Supervision
Act that authorizes the banking agencies to enforce capital
requirements.

Under regulations proposed by the OCC and the

FDIC, all banks, regardless of size, would be required to
maintain a minimum ratio of primary capital to total assets
of 5.5 percent.

The implementation of this regulation will

require over 200 national banks to raise a total of over
$5 billion in new capital.

The Federal Reserve has proposed

similar guidelines on capital.

Stricter regulatory capital requirements will strengthen
the trend towards stronger capitalization of the nation's
largest banks.

For example, in the first quarter of 1984 the

average ratio of primary capital to total assets stood at 5.67




220
percent for the holding companies of the 11 multinational
banks supervised by the OCC.

This is almost 16 percent higher

than the average level at those banks two years ago.

Adoption of this standard would not replace our
supervisory evaluation of capital adequacy.

Banks of all

sizes will be encouraged to maintain higher capital levels.
Furthermore, the OCC retains the right to impose higher ratios
for banks whose circumstances necessitate a stronger capital
base.

As another means of ensuring adequate capital, OCC will be
scrutinizing each bank's dividend payout policies in light of
its overall capital structure.

We will not hesitate to

restrict dividend payments when necessary.

5.

Sources and Uses of Funds are Being Scrutinized

The OCC is devoting more resources to monitoring regional
and multinational banks1 global funding.

Banks will be placed

under special surveillance if they are especially vulnerable
to eroding market confidence or reliance on particular funding
markets is deemed to be excessive.




A key element in our

221
increased supervision of funding is constant monitoring of the
attitudes and concerns of market participants.

Supervisory

actions on individual banks will vary but, at a minimum,
they are expected to include the development of alternative
funding plans.

In some cases, supervisory actions could also

constrain growth.

Finally, where we find a high volume of

volatile liabilities, we will require a larger percentage
of liquid assets.

6.

Increased Financial Disclosure is Being Promoted

The market's evaluation of the banking system depends,
in large part, on the information that is publicly available.
To enhance the credibility of bank financial statements and
reduce the likelihood that the market will overreact to
incomplete information, the OCC is considering requiring
increased disclosure of information about banks.

To that

end, it is seeking public comment on increasing the disclosure
requirements for banks via an advance notice of proposed
rulemaking (ANPR).

The ANPR highlights questions such as what additional
information is needed; who should have the responsibility of
making information public; and how the integrity of financial
statements used for disclosure should be maintained.

39-133 0—84

15




222
The OCC has also taken steps to enhance the accuracy of
information that is already disclosed.

Recently OCC took

enforcement actions against six major banks and required them
to restate some of their financial information to eliminate
"window dressing" that could mislead depositors, investors,
and the regulatory agencies.

In addition, along with the Federal Reserve Board, the OCC
issued a statement on June 11, 1984 reaffirming its policy on
nonaccrual loans.

Such loans must be placed on nonaccrual

status (by virtue of being more than 90 days past due) on
contractual dates and must be brought current before being
returned to accrual status.

Finally, we are continuing to

work with other federal banking agencies and the Securities
and Exchange Commission to review additional means of
improving bank disclosure.

7.

Strict Enforcement Policy is Being Maintained

We have been utilizing our enforcement power more
vigorously to correct violations of law and imprudent banking
practices.

For instance, last year we took 274 formal actions

against national banks compared to 156 for the previous year
and only 65 in 1978.




These actions have been taken against

223
banks of all sizes. We have outstanding enforcement actions
against 17 percent of the banks with assets over $1 billion
and 12 percent of the banks with under $1 billion in assets.
Last year, we also imposed civil money penalties against 127
bank officials.

To put that into perspective, in 1981 we

imposed only 19.

Over the last several years our enforcement actions have
covered a wide variety of banking activities.

In the large

banks alone, we have recently taken a number of enforcement
actions following targeted examinations that found inadequate
loan losses reserves.

In one instance, we took formal

enforcement actions against some 21 national bank subsidiaries
of a regional company to prevent improper transactions among
affiliates.

In addition to numerous cases addressing problem

assets, lending controls, capital and management, actions
against large banks have also been directed at inadequate
procedures governing banks1 securities activities. Moreover,
we have worked jointly in enforcement actions with the SEC and
have made referrals to the SEC when it appeared that holding
companies failed to make adequate disclosure of OCC's
enforcement actions on a subsidiary bank.




224
CONCLUSION

In summary, Continental pursued a growth strategy without
adequate controls that proved to be its downfall in adverse
economic circumstances.
consequences.

The bank has suffered the

Management has been removed, and shareholders

have incurred substantial losses.

At the same time, we have

avoided major disruption to the financial system.

Upon

implementation of the long-term solution, Continental will be
well-capitalized and have stronger assets and management.

It

will be returned to private ownership at the earliest possible
date.

We continue to focus our supervisory efforts on enhancing
the ability of banks to remain sound even under difficult
circumstances.

Such action will strengthen the banking system

and assure the continuing confidence of depositors.

* * *

Mr. Chairman, that concludes my prepared remarks.
be happy to answer questions.




I will

225
Appendix to
Statement of C. T. Conover
Comptroller of the Currency
Before the
Committee on Banking, Finance, and Urban Affairs
U. S. House of Representatives
September 19, 1984

CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY
TEN-YEAR REVIEW

This Appendix provides a ten-year historical overview of
the principal events leading up to the federal rescue of
Continental Illinois National Bank and Trust Company.
Continental's history, for this purpose, falls naturally into
two distinct time periods:

the period from 1974 through 1981

when Continental grew rapidly and acquired many loans that
ultimately turned into losses, and the period from the
beginning of 1982 until July 1984 in the aftermath of the
discovery of significant loan problems.

This Appendix reviews

the effects of the U.S. economy on the bank, significant
actions taken by the bank, and OCC's supervisory involvement.
The discussion and accompanying charts relate to the bank and




226
not the bank holding company.

Unless otherwise indicated, the

peer group referred to in the charts and analysis is composed
of eight wholesale money center banks.*

CONTINENTAL;

1974 - 1981

Located in America's industrial heartland, Continental
historically focused on domestic corporate lending.

Because

state restrictions on branching limited the establishment of a
significant retail customer base, corporate lending was a
natural area for Continental to emphasize.

As the U.S.

emerged from the 1974 - 1975 recession, economic growth was
strong and many new lending opportunities emerged.

Roger E. Anderson became Chairman and Chief Executive
Officer in 1973.

He and his new management team set ambitious

strategic business goals to make Continental a world class
bank.

In describing those goals, a bank executive was quoted

in a 1980 Institutional Investor article:
We're a country bank. . . What we would like to do is
demonstrate that a Midwestern country bank can become
the most magnificent force in the banking world.

*The eight wholesale money center banks included in the peer
group are Bankers Trust, Chase Manhattan Bank, Citibank, First
National Bank of Boston, First National Bank of Chicago,
Irving Trust Co., Manufacturers Hanover Trust Co., and Morgan
Guaranty Trust Co.




227
Between 1974 and 1981, Continental's assets grew an
average of over 13% per year.

Its $45.1 billion in total

assets at year-end 1981 made it the sixth largest bank in the
nation, up from the eighth largest in 1974.

Continental's Year-end Total Assets

$ Billioni

50 T
$45.1

45
$40.3

40

PI

$34.3

35
$29.9

30

20

$19.1

$19.8

10
5

w

Source: Call Reports




$21.4

H

15

0

•
1 111
• 1i i
i i
$25.0

25

^

•

•
W-M

• I
^ 3

MO.;

ll

If

11

I

228
As illustrated in the following chart, Continental generally
grew faster than other wholesale money center banks during
this period.

Growth in Sotal Assets
Index of Total Assets
(1974-100)
250 1
225

CONTINENTAL / '

^--.

/

200

/

^*~—

PEER

175

/

150-

/

/
125 i

s,

/,

S,

— r ^ L ^ ?>

1O0

75 J

•
74

—•-

75

-—
»
76

'
«
77

*

I

78

79

I

•

I

80

81

i

82

|

83

Source: Coll R e p o r t • . OCC

Beginning in 1973, Continental embarked on an aggressive
assault on selected segments of the banking market.
rapidly built up its consumer loan portfolio.

The bank

A private

placement unit was created that secured a foothold in the
market by arranging placements of debt for small companies.
Its international effort was expanded by structuring




i

229
syndicated Eurodollar loans, making advances in direct lending
to European multinational companies, and becoming active in
project financing.

Like most banks, Continental suffered during the collapse
of the real estate investment trust industry in the
mid-1970s.

Continental's management, however, handled this

problem well; recovered the bank from its real estate problems
more successfully than most other large banks with similar
problems.

As a result, Continental continued to remain active

in real estate lending throughout the 1970s.

Its mortgage and

real estate portfolio grew from $997 million at the end of
1977 to approximately $2.3 billion at the end of 1979.

Continental emerged from the 1974 - 1975 recession with
one of the best loan loss records among its peer group,
reflecting management's ability to steer the bank through
economic downturns.

Financial problems at some of

Continental's prime competitors in the late 1970s also
provided the bank with a competitive opportunity to increase
its market share and become the "premier bank in the
Midwest."

OCC's assessment of Continental's management and the
bank's performance during the eight examinations conducted by




230
this Office in the 1974 - 1981 period was favorable.

The bank

was particularly strong as it emerged from the 1974 - 1975
recession.

Earnings were rising and the bank's handling of

its problem loans following that recession was superior to
that of most other wholesale money center banks.

In 1972, the bank expanded individual lending officers'
authority and removed the loan approval process from a
committee framework.

Continental revamped its organization in

1976 and eliminated more of the "red tape" in its lending
procedures.

Major responsibility was delegated to lending

officers in the field, resulting in fewer controls and levels
of review, in order to provide lending officers with the
flexibility to rapidly take advantage of lending opportunities
as they arose.

While decentralized lending operations were

common among money center and large regional banks,
Continental was a leader in this approach.

Management

believed that this organizational structure would enable
Continental to expand its market share and eventually meet its
goal of becoming "one of the top three banks lending to
corporate America."




231
In light of Continental's rapid growth, OCC examiners
stressed the importance of adequate controls, especially in
the loan area.

Certain internal control problems within the

bank were noted by examiners.

In particular, exceptions were

noted in the timeliness of putting problem loans on the bank's
internal watch list.

In reaction to these criticisms, management implemented
new control features, including computer-generated past due
reports and a system to track exceptions in the internal
rating process.

Given the bank's historical loan loss

experience and proven ability to deal with problem situations,
supervisory concerns were not of a serious nature.

During the period from 1974 - 1981, Continental sought to
spur loan growth by courting companies in profitable, although
sometimes high risk businesses.

Lending officers were

encouraged to move fast, offer more innovative packages, and
take on more loans.

This aggressive lending strategy worked

well for the bank; Continental's commercial and industrial
(C&I) loans expanded from $4.9 billion in 1974 to $14.3
billion in 1981. Moreover, it was able to expand its market
share during a period in the late 1970s when many other major
U.S. banks experienced declining market shares because of




232
increasing competition from foreign banks, the commercial
paper market, and other nontraditional lenders.

By adding

numerous multinational and m : '"die-market companies that
previously did no business wiuh the bank, Continental's share
of the domestic C&I loan market rose from 3.9% at the end of
1974 to 4.4% at year-end 1981.

Commercial and Industrial Loan Growth
Index of CSc\ Loans
(1974-100)
325 T
300 +
275 +
250 +
225 +
200 +
175 +
150 +
125 |
100 +

75 - L
82
Source: Call Reports, OCC




233
As part of its corporate expansion, Continental became
particularly aggressive in the energy area.

The bank created

a special oil-lending unit in the early 1950s —

reportedly

the first major bank to have petroleum engineers and other
energy specialists on staff.

The economic consequences of the

1973 oil embargo and the resulting four-fold increase in world
oil prices pushed energy self-sufficiency to the forefront of
our national goals.

A number of actions were taken by various

Administrations and Congress following the first embargo and
subsequent oil price hikes to both reduce U.S. energy
consumption and to increase domestic production.

The

Department of Energy, created in 1977, sought to develop ways
of encouraging higher investments in U.S. exploration,
development, production, and refining capacity.

Cultivation

of this niche had made Continental a premier energy lending
bank and contributed significantly to its rapid, and
profitable, expansion.




234
Continental's C&I loans, including its energy loans,
produced high returns for the bank.

Average yields were

consistently higher than those of other wholesale money center
banks.

Average Annual yield on C&I Loans

Percent
20 i

18.5
18 f

CONTINENTAL

16
14 +

14.9
14.0

17.5
15.2 I i L i
%

14.4

12.3
10.9 11.3

12 f
10
8
6
4

2t
79
80
Peer group includes only national banks.
Source: Coll Reports

The financial markets reacted favorably to Continental's
aggressive growth strategy.

In 1978, Dun's Review described

Continental as one of the five best managed companies in
America.

Many analysts regarded it as a preeminent wholesale




235
money center bank, citing its stable asset and earnings
growth, its excellent record in loan losses, and its expertise
in energy lending.

Continental Illinois Corporation's ratio

of market price to book value, which had lagged behind other
money center bank holding companies in the early 1970s, began
rising in 1976.

Market Price/Book Value
Ratio
2.0 T

O J—•—I—I—•—I—I—I—I—I—I—I—I—l-H—I—•—I—l-Hh-H—I—I—I—I—I

74Q4

75Q4

76Q4

77Q4

78Q4

79Q4

I t — I » I I- < I I I t

80Q4

8104

I I

82Q4

I—»—I

83Q4

SOURCE: D a t a R a a o u r c a s . Inc.

With limited access to retail banking markets and core
deposit funding because of restrictive branching statutes in
Illinois, Continental funded its rapid growth through




236
purchased wholesale money such as federal funds, negotiable
certificates of deposit, and the interbank market.

Its

reliance on purchased funds, approximately 70% of total
liabilities, was much higher tnan its peer group average.

Continental's Liability Distribution

76

77

78

79

80

81

82

83

Source: Call Reports

Concerns were raised by OCC examiners in the 1976
examination over the bank's liquidity and its reliance on Fed
Funds, foreign deposits, and negotiable CDs.

By the time of

the summer 1977 examination, Continental had improved its
liquidity position and had enhanced its monitoring systems.




237
OCC examiners concluded that the Office's funding and control
concerns were being adequately monitored by the bank. The
bank was requested, however, to submit quarterly status
reports on classified assets over $5 million and monthly
financial statements.

Continental's heavy reliance over this period on purchased
money, which had a higher interest cost than retail deposits,
offset much of the gain that accrued from Continental's higher
loan yields.

High funding costs reduced Continental's net

interest margin to a level well below its peer group.

Net Interest Margin
Percent
* T
PEER

3+
CONTINENTAL

82
Net Interest Margin — Net Interest Income (TE) to Average Earning Assets
Source: Call Reports

39-133 0—84


238
Continental was, nevertheless, able to maintain its
superior earnings growth because of low overhead and
non-interest expenses.

The absence of domestic branches and

relatively few foreign branches, compared to other money
center banks, held down Continental's overhead expenses and,
therefore, compensated for some of its high funding costs. As
illustrated in the following chart, Continental's ratio of
non-interest expenses to average assets was far below its peer
group average.

Non-Interest Expenses/Average Assets
Percent
3.0 i

PEER

CONTINENTAL

74

75

Sourct: Coll Reports




76

78

79

80

81

239
As a consequence, through 1980, Continental was able to
achieve one of the best and most consistent performance
records among money center banks.

Its ROA was consistently

above the average of other wholesale money center banks.

Return on Average Assets

Percent
.8 i

.6 +

•5 t
.4
.3

CONTINENTAL .

.2
.1

83
Source: Call Reports




240
The bank showed record earnings while its assets grew to a
high of $45.1 billion in 1981.

As shown in the following

chart, net income rose rapidly before peaking at $236 million
at year-end 1981.

Continental's Net Income
$ MILLIONS
300T

74

75

76

77

78

79

80

81

82

83

Net Income After Tax, Before Securities Transactions and Extraordinary Itens
Source: Coll Raports

As noted earlier, in the examinations conducted by this
Office in the 1974 - 1981 period, Continental's overall
condition was found to be good and it generally compared well
with other multinational banks under our supervision.

In

addition to liquidity and internal controls, our concerns
during this time period centered on capital adequacy and asset
quality.




241
While Continental's capital to asset ratio compared
favorably to other money center banks, OCC examiners expressed
concern throughout the late 1970s about the bank's ability to
generate sufficient capital to keep pace with its rapid
expansion.

Primary Capital to Total Assets

Percent
7-

ii

5+

2 T

I

Source: Coll Reports

75




I
76

PEER

CONTINENTAL

77

I
i

[
i

83

242
During the 1976 examination, the Office pointed out that
unlike most other large national banks, Continental had no
definite capital growth plan.

As a result, the bank prepared

a three year capital plan and took immediate measures to
increase capital, including cutting the size of its 1976
dividends to the holding company, by $15 million, to $45.6
million.

In addition, the bank holding company issued debt

and used the proceeds to inject $62 million into the bank's
surplus account.

Despite these efforts, capital failed to

keep pace with asset growth and continued to decline through
1980.

Continental had an excellent loan loss experience, with
one of the lowest percentages of nonperforming assets and net
loan losses in the industry.

Asset quality, which was a major

concern at most money center banks in the 1975 - 1976 period,
showed steady improvement at Continental throughout the late
1970s.

Its classified assets decreased dramatically following

the recession, demonstrating management's ability to deal
effectively with problem assets.

By the end of 1977,

Continental had classified assets representing 86% of gross
capital, down from 121% of capital the previous year.




In the

243
1975 - 1977 period, Continental's ratio of net loan losses to
average total loans and leases was 25% lower than the average
of other wholesale money center banks.

Net Loan Losses/Average Total Loans and Leases

74

75

76

77

78

79

80

81

Source: Call Reports

OCC's 1979 examination of Continental noted continuing
improvement in asset quality.

Classified assets had declined

from 86% to 80% of gross capital funds.
considered adequate at this time.




Liquidity was also

Some problems, however,

244
were noted in the bank's internal credit review system.
Deficiencies were cited in the identification and rating of
problem loans and the completeness of credit files.

In light

of the bank's rapid asset growth, OCC examiners once again
emphasized the importance of building a strong capital base.

Similar conclusions were drawn during the 1980
examination.

Liquidity was still considered acceptable.

Asset quality continued to improve; classified assets as a
percent of gross capital funds declined to 61%. Management
was encouraged to perform some type of on-site review of
information submitted to the loan review committee, such as
periodic visits to foreign offices and other loan origination
sites.

Although not keeping pace with asset growth, capital

was considered adequate.

The bank was thought to have

sufficient capability to meet external pressures and to fund
projected growth.

In its response to the 1980 examination, Continental
management indicated that although they believed the bank's
present internal credit review system had been successful,
some type of on-site review might be appropriate, particularly
in light of the bank's expansion.

Accordingly, management had

been exploring various methods of accomplishing this shift in




245
a cost-effective manner.

An experimental field review was

subsequently conducted.

During the 1981 examination, the OCC placed special
emphasis on the review of Continental's energy and real estate
lending, since the bank was targeting these areas for
additional growth.

Continental's energy portfolio nearly

doubled between 1979 and 1980 and increased by an additional
50% the following year.

By 1981, energy loans represented 20%

of Continental's total loans and leases and 47% of its total
C&I loans.

With energy prices skyrocketing and drilling and

exploration activity booming, Continental was well-positioned
to meet the burgeoning credit demands for development of
energy sources.

Continental historically had made loans to energy
producers that were secured by "proven reserves" or by
properties surrounded by producing wells that were almost
guaranteed to produce oil and gas.

As part of management's

intensified commitment to energy lending in the late 1970s,
the bank had begun expanding its energy portfolio, including




246
making loans secured by leases on undeveloped properties with
uncertain production potential.

The bank also became

particularly aggressive in extending loans to small,
independent drillers and refiners.

Energy Share of Continental's C&I Loans
$ Billions
20 i

18

$16.2
16

$14.3

$14.3

14 +
12

$11.0

$9.3

10 -J8

OTHER
C6c\

wx

532

642

591

6 f
4

742

Mm
412 mm

2

26% E$2.4 \

m

$6.7

$4.5 4

f $5.8

362

| »5.2

OILdcGAS

36Z

1979
Source: OCC

In 1981, Continental had over $6.7 billion in oil and gas
loans outstanding.

Despite this high commitment to a single

sector of the economy, Continental's management felt confident
about the strength of the energy industry and its knowledge of
specific oil fields and companies.




Losses from Continental's

247
energy loans had consistently averaged less than half the net
loan losses from its non-energy loans.

According to Gerald

Bergman, former head of Continental's Special Industries
lending department, the bank was simply demonstrating "a
reasonable way to leverage [its] expertise in the oil
industry"

(American Banker, August 25, 1981).

While conducting the 1981 examination, which used
information as of April 30, 1981, OCC examiners noted a
significant level of participations from Penn Square that were
backed up by standby letters of credit.

Recognizing that the

amount of these loans was large in comparison with Penn
Square's size, additional time was spent examining them.

The

OCC's review determined that these standby letters of credit
were issued by banks other than Penn Square, including several
money center banks, alleviating our concerns.

Moreover, since

the energy industry still appeared strong and the energy loans
were continuing to perform, we saw no cause for concern at
that time.

In all, only two oil and gas loans, totaling $85

million were classified.

Neither loan had been purchased from

Penn Square.

As part of the 1981 examination, OCC examiners sampled new
account relationships, in particular, and devoted further
efforts to judging the quality of the credit rating system.
Classified assets as a percent of gross capital had increased




248
from 61% at the previous examination to 67%. The trend, which
was also noted at other large banks, however, was attributed
by OCC examiners to deteriorating economic conditions rather
than a relaxation of credit standards,

OCC examiners again reviewed Continental's internal loan
review systems during the 1981 examination.

Although

examiners did classify several loans for which watch loan
reports had not been prepared, each of these loans had been
internally rated in accordance with bank policy.

Neither the

dollar amount nor the number of these loans was considered
significant.

However, it was noted that approximately 375

loans, totaling $2.4 billion, had not been reviewed by the
bank's rating committee within one year; 55 of these had not
been reviewed within two years. Management was aware of these
exceptions and was in the process of reassessing its loan
review system.

Continental's quality and consistency of earnings were
considered good at the time of the 1981 examination.
Examiners noted that a program of holding down dividends had
resulted in a steady source of capital augmentation, but that
capital still needed to be brought in line with asset growth.
Liquidity was considered sufficient to meet any external
pressures.

Suitable systems for managing funding and rate

sensitivity were found to be in place.




249
In response to the 1981 examination, Continental's
management indicated that they did not feel there was a
problem with the loan portfolio quality, in light of the
economic environment at that time.

In fact, management

expressed surprise that more difficulty had not surfaced,
given the prolonged period of record high interest rates and
the state of the economy.

Nevertheless, they stated that

close, continued attention would be provided to the quality of
the portfolio.

Management further stated that the issue of

loans not being reviewed on schedule for rating purposes was
receiving attention and that improvement was expected.

Through most of 1981, the majority of Wall Street analysts
believed that Continental would continue to experience
superior growth due to its position as a prime lender to the
energy industry, its potential for improved return on assets,
and its record of loan losses.

The Wall Street Transcript

gave its silver runnerup award for outstanding money center
bank CEOs to Roger Anderson in June of 1981.

Bank analysts

strongly supported the selection, with one analyst noting:
I give Continental credit for doing what they do best, and
that is lending money. They've been able to pick out
certain niches. I'm continually amazed by their reception
as energy lenders. They positioned themselves well early
on, and they have been reaping the benefits of that. I
used to be skeptical that they could manage their costs
when things slowed down, but they've shown me recently
that they've done a good job of managing people and costs
and pushing employees toward productive areas.




250
Another analyst commented that:
With Continental possessing one of the best loan loss
records among money center banks, one can assume it is
carrying the same credit standards into the current period
of economic weakness as it did in the prior period and
will not suffer large loan losses.
CONTINENTAL:

JANUARY 1982 - JULY 1984

To fully understand the demise of Continental, it is first
necessary to review the history of Penn Square Bank's
involvement with Continental.

Penn Square was one of the most

aggressive lenders in one of the hottest energy drilling areas
of the country.

Because its loan generating ability exceeded

its legal lending limit as well as its funding ability, Penn
Square would originate loans and then sell them to other
banks, including Continental and Seattle First National Bank.

Although Continental began purchasing loans from Penn
Square as early as 1978, significant growth in loan purchases
did not occur until the beginning of 1981.

For example, as of

the end of 1980, Continental had purchased energy loans from
Penn Square totaling only $167 million.

By the conclusion of

this Office's 1981 examination of Continental in August, loans
purchased from Penn Square were in excess of $500 million.
From that time period until the start of the 1982 examination,
another $600 million in participations from Penn Square loans




251
were booked at Continental, bringing the total amount to $1.1
billion.

At their peak in the Spring of 1982, Penn Square

loans represented 3% of Continental's total loans and leases
and 17% of its total oil and gas loan portfolio.

Major Purchases of Penn Square
Loans Occurred Between Examinations

Growth in Purchased Penn

81Q1

81Q2

81Q3

81Q4

Square Loans

82Q1

82Q2

82Q3

82Q4

Source: OCC

In a quarterly visit with Continental management in March
of 1982 prior to the general examination, OCC examiners




252
discussed the general health of the energy industry.

Since

the end of 1981, the energy industry, as represented in the
following chart showing drilling activity, had declined
significantly.

Drilling Rigs Operating in the U.S.

jg 3000 +

O 2000

-t

1 —
— I

1

t

i

t

*

1

1 2 3 4 1 2 3 4 1 2

1973

1079

K—I

3

1980

H-

-H

1

»

»
—

-I

1

1

1—I

1

1-

4 1 2 3 4 1 2 3 4 1 2 3 4 1 2

1981

1982

1983

1984

SOURCE: STANDARD & POOR'S

In spite of this decline, bank officials said
they felt comfortable with their expertise in the energy
area and planned to continue to stress it.

Notwith-

standing the thorough review of the energy portfolio in




253
the 1981 examination, the intervening decline in the oil and
gas industry made energy a principal focus of the OCC's 1982
examination scheduled to begin in May.

At the request of the

examiner-in-charge of the Continental examination, an energy
lending specialist from the OCC's Southwestern District was
assigned to assist in the 1982 examination of Continental.

Our concerns became serious when OCC examiners in Penn
Square learned that Continental had purchased a significant
quantity of bad loans from Penn Square.

An examination of

Continental was underway and OCC examiners in that bank were
immediately informed of irregularities in the Penn Square
loans.

The OCC responded to this in a number of ways.

After

informing Continental's management in June of the serious
condition of Penn Square and its implications for
Continental's loan portfolio, the OCC extended its examination
through November and worked closely with Continental's
internal auditors and independent accountants to assess the
damage.

On July 5, 1982, Penn Square Bank failed.

Continental's serious condition prompted the OCC to direct
a number of corrective measures, which were immediately
initiated by the bank.

3 - 3 0-84
913
17



The OCC informed management in August

254
of its intention to formalize these directives by placing the
bank under a Formal Agreement, enforceable under the cease and
desist authority of 12 U.S.C. 1818.

The Comptroller and his

staff met several times with senior management and board
members over the next few months to discuss the bank's
condition and the impending Agreement.

Continental moved quickly to determine the extent of its
exposure in loans originated by Penn Square, to get a fix on
the size of the loan loss provision necessary for the second
quarter, and to stabilize funding.

OCC examiners also

reviewed all of the loans Continental had purchased from Penn
Square and evaluated their effect on Continental's loan
portfolio and provision for loan losses.

Our examiners held

numerous meetings with Continental's Board of Directors to
discuss the bank's provision for loan losses and its recovery
effort.

OCC's 1982 examination determined that many of the loans
purchased from Penn Square, particularly in the months just
prior to Penn Square's failure, had failed to meet
Continental's typical energy-lending standards.

Many were

also poorly documented and were, therefore, not being
internally rated in a timely manner.

Accordingly, increasing

numbers of these loans appeared on Continental's late rating
reports.

In addition, numerous loans had appeared on




255
Continental's internally-generated collateral exception
report.

The reliability of Continental's internal reporting

systems, however, had been spotty in previous years.

As a

consequence, officers in the Special Industries Division who
were purchasing the loans from Penn Square were able to
persuade senior lending officers to disregard the internal
reports.

Early internal warning signals were, therefore,

largely ignored.

During the office's 1982 examination, OCC examiners also
learned that a team of internal auditors had been sent twice
in 1981 by Executive Vice President Bergman, head of
Continental's Special Industries Group, to review the Penn
Square loans Continental was purchasing.

The auditors' report

on their first visit in September 1981 noted several items
that they felt merited "special attention", including:
incomplete and inaccurate records, questionable security
interests, and a high level of loans to parties related to
Penn Square.

The Special Litigation Report of the Board of

Directors issued in 1984 concluded that this audit report,
although submitted to Bergman, was not seen by senior
Continental management prior to the collapse of Penn Square.

The written report of the bank auditors' findings of their
second visit to Penn Square in December 1981 expressed




256
concern with loans secured by Penn Square-issued standby
letters of credit (representing approximately one-third of
that bank's equity), questionable lien positions, and several
loans in which the bank had purchased more than Penn Square's
current outstanding balance.

This audit also uncovered

$565,000 in personal loans from Penn Square to John R. Lytle,
manager of Continental's Mid-Continent Division of the Oil and
Gas Group, and the officer responsible for acquiring the Penn
Square loans.

The Special Litigation Report once again indicated that
while senior Continental management did receive news of these
loans to Mr. Lytle, they once again did not receive the full
auditors' report from the December review of the Penn Square
lending operations.

No action was taken by Continental to

remove or discipline Mr. Lytle until May of 1982.

In July of 1982, following the collapse of Penn Square,
Continental sent a staff of experienced energy lenders to
Oklahoma City to review Penn Square's records and assess the
dimensions of the problem.

Each of the loans Continental

purchased from Penn Square were reviewed during the first two
weeks of July.

After analyzing the probable risk associated

with each credit, senior Continental officers recommended an
addition to loan loss reserves of $220 million.




This Office,

257
as well as the bank's accounting firm of Ernst & Whinney,
reviewed this figure and concluded that it was supported by
the information available at that time.

This figure was then

published on July 21 along with a full statement of
Continental's second-quarter results.

Continental auditors, supported by accountants from Ernst
& Whinney, remained in Oklahoma City reconciling Continental's
records with Penn Square data, assisting in the Penn Square
portfolio assessment program, and preparing the loan
workouts.

OCC examiners also reviewed in late August and

early September each loan purchased from Penn Square and
discussed their findings with senior Continental management
before release of third quarter earnings.

That review

resulted in an additional $81 million being added to the
bank's provision for loan losses in the third quarter, as
reported in Continental Illinois Corporation's October 14
press release.

The holding company also indicated that its

nonperforming assets had reached $2 billion as of September
30, 1982, up $700 million from the previous quarter.

Simultaneously with the credit review, Continental
undertook an extensive review of the people involved in the
Penn Square relationship and the lending policies, procedures,
and practices which might have contributed to the crisis. In




258
its first phase, an independent review committee appointed by
Continental's Board of Directors recommended a series of major
staff changes beginning with the July 14 suspension of John R.
Lytle.

Mr. Lytle was permanently released from the bank on

August 30.

Resignations and early retirements, including

those of Executive Vice President Bergman and his superior,
Executive Vice President George Baker, soon followed.

In

addtion, various other bank personnel were reassigned.

In its second phase, the internal review committee
assessed bank policy and recommended:
o

codification of bank lending policies and procedures;

o

enhancement of secured lending and related support
systems;

o

improvement in cooperation between loan operations
and the line;

o

revision of loan operations activity to improve its
reliability and productivity; and

o

formulation of a Credit Risk Evaluation Division, as
had been recommended by the OCC, to strengthen the
bank's credit rating system and enhance credit risk
identification, evaluation, reporting, and monitoring.

Following the Penn Square collapse, the domestic money
market's confidence in Continental was seriously weakened.




259
The bank's access to the Fed Funds and domestic CD markets
quickly dried up.

As illustrated below, Continental lost 40%

of its purchased domestic funding in 1982.

Continental's Domestic Purchased Funds

76
S o u r c e : Call

77

78

79

80

81

82

83

Reports

Continental moved quickly to stabilize and restore its
funding.

Meetings were held with major funds providers,

rating agencies, and members of the financial community.
Public disclosures were periodically issued to correct
misinformation.

In the fall of 1982, liquid assets were sold

or allowed to mature.




As the domestic funds market dried up,

260
Continental shifted to the European interbank market for
funding.

Foreign liabilities soon began to approach 50% of

the bank's total liability structure.

Continental's Foreign Liabilities/Total Liabilities

Poreont of
Total Liabilities
50 1

46%
45 +

40 I
35%
35
30

111
2755

25 +
20 +
15 +
10
5
0

I

i

•

H
75

40%

i

37%
34%

1i 1

1I •

m H m

Iim
W74

362

1
1i
I
m •
n

78

^

I

Source: Colt Reports

48%

1
^
^

1

1

I

Continental's parent holding company maintained its $0.50
per share dividend on common stock in August 1982. While the
dividend may not have been merited by the earnings level,
holding company management felt it was a necessary step in
attempting to restore the confidence of the financial markets
and to raising capital in the marketplace.




261
Despite these actions, Continental's condition
deteriorated throughout 1982. Many of its energy loans that
had performed well and been extremely profitable in the 1970s
and well into 1981 were now serious collection problems.

Nonperforming assets at the holding company level, which
totaled $653 million at the end of 1981, grew to $844 million
at the end of the first quarter of 1982. While most of these
nonperforming assets were concentrated in real estate loans
and nonenergy-related corporate loans through the first
quarter of 1982, this changed dramatically in the following
quarters when a number of energy loans were nonperforming.
the end of 1982, close to half (over $900 million) of
Continental's nonperforming assets were energy-related.

$ Mnos
iin

Nonperforming Assets by Industry

2000 T

.

1 800 J

1600 J

|

1400 +

I
I

1200 {

i

1979
Sourca: O C C




1980

1981

1982

0,L*GAS
I

I

I

!

I

I

1983

By

262
In all, $1.2 billion in nonperforming assets were added in
1982, bringing them up to nearly 6% of the total loan
portfolio.

Continental's Nonperforming Assets

10

9t
8
7

6.6
5

6t

-9

,7

IN
•

5
4
3

2

3.7 Kg ^
ill i i
1 i i
ill

-°
ill^ H
ill
111

2+
1 |
80Q4
Source: OCC




111

61

6.6

HI

II
III

i
m

v&

«
^

^

1
nil

263
Continental's net loan losses reached $371 million by
December 1982, nearly a five-fold increase over the previous
year's losses.

Despite an improving economy in 1983, many of

Continental's borrowers continued to experience difficulties
and Continental's losses remained high.

Continental's Net Loan Losses

74

75

76

77

78

79

80

81

82

83

Source: Call Reports

Energy-related loans represented a disproportionate share
of Continental's loan losses. While oil and gas loans
comprised approximately 20% of Continental's average total




264
loan portfolio in 1982 and 1983, they represented
approximately 67% of its June 1982 through June 1984 loan
losses.

Composition of Continental's June 1982
through June 1984 Loan Losses

SHIPPING 5%

T%Vv»n
RE 4%

PENN SQUARE

OTHER 0 * G

NOTE: OCC estimate baaed on a review of losses in excess of $2 million
per loan taken between June 30, 1982 and June 30, 1984

Most of Continental's oil and gas loan losses were a
direct result of its purchase of loans from Penn Square.
Although loans purchased from Penn Square averaged less than
3% of Continental's total loans over the past 2 1/2 years,




265
they accounted for 41% of the bank's losses between June 1982
and June 1984.

Penn Square loans have thus far resulted in

nearly $500 million in loan losses for Continental.

Continental's Losses Since June 30, 1982
Compared to Average Outstandings

OTHER LOANS

OTHER C&l

LOANS
LOANS - Annual Average 1 9 8 2 - 1 9 6 3
LOSSES — Losses since June 1 9 8 2
Source: OCC




266
As illustrated in the following chart, most of
Continental's loan losses since June 1982, including those
purchased from Penn Square, were from loans that originated in
1980 and 1981.

Origination Date of Continental's
Post-June 1982 Loan Losses

OTHER LOANS
OTHER C8c\

OTHER OIL Sc GAS

PENN SQUARE

PRE-/8
Source: OCC




78

267
These loan quality problems caused Continentalfs earnings
to collapse.

The bank's provision for loan losses consumed

93% of its 1982 operating income, reaching $476.8 million.
Resulting net income fell from $236 million in 1981 to $72
million at year-end 1982.

Continental's Loan Loss Provision
Percent of
Operating Income
100 T

74

75

76

77

78

79

80

81

82

83

Source: Cnll Reports

The collapse of Penn Square and the energy industry forced
Continental's management in 1982 to reassess the bank's




268
overall direction.

Continental's Credit Risk Evaluation

Division, which had been created at the urging of the OCC in
the fall of 1982r was strengthened in early 1983 to provide
improved risk evaluation and to report regularly to the Board
of Directors and senior bank management.

The Division also

monitored the effectiveness of Continental's early warning
credit quality systems and served as an important check on
corporate lending activities.

The Formal Agreement, signed on March 14, 1983, primarily
covered asset and liability management, loan administration,
and funding.

It required the bank to continue to implement

and maintain stronger policies and procedures designed to
improve performance.

In addition to quarterly progress

reports regarding compliance with the terms of the Agreement,
Continental was also required to report periodically to this
Office on its criticized assets, funding, and earnings.

In April 1983, OCC examiners visited Continental to review
the first quarter financial results.

Nonperforming assets, at

$2.02 billion, were higher than anticipated by the bank, but
market acceptance had improved and premiums on funding
instruments had declined.




269
Continental submitted the first quarterly compliance
report required by the Formal Agreement to this office in May
1983.

It indicated that appropriate actions required by the

Agreement were being taken by the bank.

Continental's 1983 recovery plan called for a reduction in
assets and staff and a more conservative lending policy.

Two

executive officers, David Taylor and Edward Bottum, were
appointed to Continental's Board of Directors in August of
1983.

Immediately after their appointment, they instituted

key management and organizational changes to further lay the
groundwork for recovery.

External market conditions during

the second half of 1983, however, slowed Continental's
recovery.
margins.

Increasing interest rates squeezed net interest
Loan demand was weak.

Nonperforming energy loans

rose further as the energy industry continued to decline.

The general sentiment of bank analysts toward Continental
in 1982 was negative following Penn Square.

It had become

apparent to bank analysts by early 1983 that Penn Square
wasn't Continental's only problem.

Few analysts felt that

Continental stock had any short-term turnaround potential.

39-133 0-84

18




270
Robert Albertson of Smith, Barney, Harris, Upham & Co. in the
March 28, 1983 Wall Street Transcript summarized these
opinions:

Continental Illinois1 problems are something that, in
retrospect, we perhaps should have been better prepared
for than we were. Recognizing how fast they grew should
have alerted us to the fact that at least the potential
for unusual problems was definitely there . . . The most
disconcerting thing about [Continental's difficulties] is
the fact that the worst hit occurred in its principal area
of expertise. Therefore, I have to remain uncertain as to
where Continental will be going in the near term.

The 1983 examination of the bank's condition as of June
30, focused on energy and real estate credit, overseas
exposure, funding, earnings, capital adequacy, and compliance
with the Formal Agreement.

The overall condition of the bank

had further deteriorated since the 1982 examination.
quality and earnings remained poor.

Asset

Capital was adequate on a

ratio basis, but under pressure due to asset and earnings
problems.

Funding had improved, but was still acutely

sensitive to poor performance and other negative
developments.

The bank was found to be in compliance with the




271
provisions of the Formal Agreement.

Following completion of

the examination in December 1983, the Comptroller and senior
OCC staff met with Continental's Board of Directors on January
23, 1984 to discuss these findings.

A revised recovery plan for 1984 called for a further
reduction in assets, enhanced capital-raising efforts, and a
reduction in non-interest expenses and staff.

Non-essential

businesses, such as real estate and the bank's credit card
operation, would be sold to improve capital and refocus the
bank on wholesale banking.

Merger alternatives would be

pursued wih the assistance of Goldman, Sachs & Co. which had
been retained in September 1983.

Plans were also accelerated

to transfer additional responsibilities to Taylor and Bottum.

On January 31, 1984, OCC staff met with Continental's Vice
Chairman and its Controller to review the bank's 1983
performance, the 1984 recovery plan, and contingency
planning.

Part of the discussion concerned the bank's own

strategy for a "good bank/bad bank" separation, similar to
that eventually provided for in the long-term assistance
program.

David Taylor replaced Roger Anderson as Continental's CEO
in February of 1984 and Edward Bottum was elected President.
External events in the first quarter of 1984, however,




272
produced further problems for this new management team.

Asset

quality continued to deteriorate and Continental recorded an
operating loss for the first quarter of 1984.

Continental's condition as of March 31, 1984 remained
poor.

An OCC examination begun March 19 and targeted at asset

quality and funding, concluded that continued operating losses
and funding problems could be anticipated unless the bank's
contingency plan to sell nonperforming assets was successful.
Details of this plan were not, however, available at the close
of the examination on April 20.

The Comptroller and his staff met with Continental's
Chairman/CEO and President on May 2 to discuss the bank's
dividend policy and contingency plan for selling nonperforming
assets.

It was the Comptroller's conclusion following the

meeting that our approval of the payment of the bank's second
quarter dividend to the holding company, in part, depended on
the successful implementation of the provisions contained in
the contingency plan, specifically the sale of nonperforming
assets.

Later that month, market confidence in Continental slipped
even further as rumors about the bank's impending bankruptcy
were fueled by two erroneous press reports on May 8 that




273
concerned the purchase of or investment in the bank.

Prom

that point onf the Office was in constant contact with the
bank and other bank regulatory agencies, particularly the
FDIC.

On May 10, the OCC issued a news release stating that

the Office had not requested assistance for or even discussed
Continental with any bank or securities firm and that the
Office was unaware of any significant changes in the bank's
operations that would serve as the basis for rumors concerning
the bank's fate.

OCC examiners established an onsite presence in
Continental's trading rooms in Chicago and London on May 10 to
more closely monitor the bank's rapidly deteriorating funding
situation.

Initial reports from OCC examiners indicated that

major providers of overnight and term funds were failing to
renew their holdings of the liabilities of the bank and
Continental Illinois Corp.

The bank was forced to prepay the

deposits in Eurodollar and domestic markets and seek
replacement of the CD funding in the domestic market.

Because

other funding sources were not available, the bank resorted to
borrowings from the Federal Reserve Bank of Chicago.

From May 12 - 14, a safety net of 16 banks put together a
$4.5 million line of credit for Continental.

But, by May 15,

the safety net began to unwind due to a heightened lack of




274
confidence.

The Comptroller and staff held meetings on May 16

and 17 with Continental, other money center banks, and
regulatory agencies in Chicago, New York, and Washington to
consider alternatives.

These meetings resulted in the

formation of the "temporary assistance package".

Under the temporary assistance plan publicly announced on
May 17, Continental received a $2 billion subordinated loan
for the period necessary to develop permanent sources of
funds.

The loan was evidenced by a demand subordinated note;

$1.5 billion was provided by the FDIC, with the balance
provided by a group of seven major U.S. banks.

In addition, a

consortium of 28 banks provided Continental with a $5.5
billion standby line of credit.

By virtue of this capital

injection, the FDIC in effect provided assurance that
Continental's problems would not be resolved through a pay-off
of insured depositors.

It, therefore, also provided assurance

that the funds of all depositors, both insured and uninsured,
were thereby fully protected.

During the next two months, the regulators held meetings
with both domestic and foreign financial institutions and
other parties interested in merging with or investing in
Continental.

It became apparent fairly early on in these

discussions, however, that it would be difficult to arrange a




275
completely private sector solution.
private sector/government-assisted

Furthermore, proposed
transactions were likely to

be too costly to the FDIC.

The regulators' efforts were, therefore, directed toward
devising a permanent solution to Continental's problems that
was not dependent on private sector investment.

Small working

groups comprised of representatives from all three bank
regulatory agencies met on a daily basis to develop and refine
a long-term solution.

At the same time, a search began to

find new management for the bank.

The Comptroller and other

senior officials met at least weekly with the FDIC to discuss
planning details; telephone contact between the principals
occurred frequently.

Continental's financial situation, while stable for most
of June, began to deteriorate again in July.

Despite FDIC

assurances, there was unease about just how the FDIC
"assurances" would be honored if Continental failed.

As a

result, many large depositors began to again withdraw their
funds as they matured.

During the 60 days after the erroneous press reports,
Continental's deposits, Fed Funds, and repos had fallen nearly
$10 billion.

By July, Continental had borrowed $4 billion




276
from 28 banks, another $3.55 billion from the Federal Reserve
Bank of Chicago, and $2 billion more from the FDIC and the
seven banks holding subordinated notes.

Throughout this period, OCC held several meetings with
senior bank management and with various members of the bank's
Board of Directors.

Numerous meetings were held internally to

analyze and refine the proposed plan.

Intensive monitoring of

the bank's funding continued and a joint OCC/FDIC review of
the loan portfolio was conducted.

The long-term solution, announced on July 26 and subject
to shareholder approval on September 26, is intended to
restore Continental to health and allow it to continue to
serve its marketplace without interruption.

It entailed two

key elements: top management changes and substantial financial
assistance.

The solution will result in the creation of a smaller and
more viable Continental.

Management has been removed, and

shareholders have incurred substantial losses.

At the same

time, major disruption to the financial system has been
avoided.

Upon implementation of the long-term solution,

Continental will be well-capitalized and have stronger assets
and management.

It will be returned to private ownership at

the earliest possible date.




277
Chairman S T GERMAIN. Thank you, Mr. Conover.
Now, Mr. Conover, immediately after the Penn Square failure,
Continental's management began an in-depth review of its operations. And in 1983, the Office of the Comptroller of the Currency
required Continental to enter into a supervisory agreement. Almost
2 years after Penn Square, and a year after the supervisory agreement was signed, banks t h a t went into Continental to evaluate its
merger potential, last May, found conditions t h a t surprised them.
What they reported to the FDIC is recorded in two FDIC memoranda. To preserve the identity of the banks whose officials commented to the FDIC, I will refer to them simply, all of them rather
simply as the "X-Y-Z" bank. Let me cite two of the recorded comments.
And I quote:
X-Y-Z banks compared their internal loan rating system on a scale of 1 to 9
against the rating system at Continental, 1 to 9, on 21 borrowers who were common
to both banks. Only 6 of the 21 credits were given the same rating by both banks.
On another situation, Continental's rating was one better than the rating at X-YZ. On another five, Continental's was two better t h a n X-Y-Z, and on another four,
Continental's rating was three or more better t h a n X-Y-Z.
Based on this review, X-Y-Z indicated t h a t Continental's internal loan review
process was very lenient and that the volume of classified loans was really much
higher than presented or contended by Continental.
On some of the common loans at the two banks, X-Y-Z bank has taken at least
partial chargeoffs while Continental continues to carry them at full value and in
performing status. Continental also makes new loans to customers in order to keep
the interest rate payments current. X-Y-Z people estimate t h a t there is an additional $650 to $700 million in loans that should be classified as nonperforming. They
also estimate an additional $1.6 billion in nonperforming loans within 12 months.

Now, from the information developed yesterday, it is clear that
examining and supervising a large money center bank is a difficult
task. From the evidence reflected in the FDIC memos from which I
have just quoted, it appears it takes a long time for a large bank to
correct its problems. And I believe you sort of indicated that in
your testimony as well.
I am confident t h a t with its new management, Continental will
quickly become a strong bank once again and its problems will be
solved. However, we need to know whether the length of the time
Continental is taking to correct its operating practices is normal.
How long does it usually take for a large money center bank to
correct the problems cited by your examiners? And would you
please provide the subcommittee with a tabulation of the length of
time it takes national banks to move from the lowest soundness
category to one we view as acceptable? On the second, naturally, I
expect you to submit t h a t for the record.
May I just add t h a t in regard to this issue of bigness, in 1976,
management determined t h a t they would become very aggressive,
and they would become the third largest commercial lender in the
United States of America. Why? Why did they feel this need?
They were doing fine. It was a strong bank. It was a well-run
bank. In order to accomplish this they used some very innovative
practices. They said that, from here on in, as you cited earlier, loan
decisions will be made at the lower level and we will insulate ourselves from that. Then they were aggressive in seeking funds, actually hot money, a lot of money.



278
You wonder why. What is the motivation? What is it? I shouldn't
say a disease, but it seems to be an addiction of some in the banking industry to get bigger and bigger. So I ask you again, how long
does it usually take a large bank, one of the money center banks,
to correct the problems cited by your examiners in the Continental
situation? What is the normal period of time?
Mr. CONOVER. Mr. Chairman, I am not sure I can give you a precise answer to that. It will depend on the nature of the deficiency,
how widespread it was, whether it means changing behavior
throughout the bank or simply modifying a practice in a particular
department, and so forth. Since the situations are so different, I am
not sure that I can tell you t h a t it takes a month or 2 months or
whatever.
What we generally do, and I intend to do in the future with more
vigor, is to identify clearly the specific actions we want banks to
take and have a followup mechanism in place to assure t h a t those
corrections are being made between examinations. One of the early
steps in the followup examination will be to go back and review the
banks progress in taking corrective actions.
Chairman S T GERMAIN. Mr. Conover, Acting Comptroller Bloom,
and we have had a lot of acting Comptrollers, in a 1976 appearance, had this to say and I quote:
Now, I would like to turn to the new system which we are developing which we
hope will give us an earlier and clearer and more accurate way of singling out
banks for special supervision. The new system will be a computerized early warning
system called the National Bank Surveillance System, which we call NBSS. NBSS will
help in detection of impending problems before they become serious cases. It should,
however, substantially aid in the prevention of future bank failures.

Now is NBSS still in operation and alive and well at the Comptroller's Office?
Mr. CONOVER. Yes; it is. It is alive and well. It has been improved
several times, and we have plans for improving it in the future.
Chairman S T GERMAIN. Was NBSS utilized in the case of Continental?
Mr. CONOVER. The NBSS system is really more appropriate for
evaluating the vast number of smaller banks. We have in place a
multinational bank division t h a t gets much more complete information on multinational banks, not just information from call reports and examination reports, which are the primary data sources
for the NBSS. For the multinational banks, then, we use a separate
information system and do separate analysis of those banks directlyThus, the NBSS system is alive and well and being improved.
But it really isn't the most appropriate mechanism for tracking a
bank like Continental.
Chairman S T GERMAIN. Are you saying NBSS does not have the
capacity to take the input that you would get from a multinational
bank?
Mr. CONOVER. I am saying it is designed to take information on
4,700 banks and that we have a much more precise and direct way
of getting and manipulating data on the 11 multinational
Chairman S T GERMAIN. Are you telling me that the methods you
use for the 11 multinationals is superior to NBSS?




279
Mr. CONOVER. Yes, I am, because there is more information that
is available for examination and analysis.
Chairman S T GERMAIN. Well, in view of that statement, this
question arises in my mind, if the system utilized for the multinationals is superior to the NBSS system, what do you feel happened
at Continental? It seems as though, as I recall, what was the date
of that reassuring statement you gave to the world at large? Was it
May?
Mr. CONOVER. May

10.

Chairman S T GERMAIN. May 10. Now as I recall in that statement, you said that everything was fine at Continental and that no
one should be perturbed and people shouldn't remove their funds.
So that means as of May 10, 1984, the superiority of the NBSS
system utilized for the multinational banks did not indicate any
problems at Continental Illinois. Well, t h a t being the case, I have
to scratch my head and say how much faith can we put in NBSS
and the superior system utilized for the multinationals as an early
warning system? Or is it perhaps that when you get to the multinationals that they are so big that there is no way to really and
truly and effectively have an early warning system?
Mr. CONOVER. N O , I don't think that is the case.
Chairman S T GERMAIN. Because, remember at Franklin National
the examiners were in Franklin National. They had left one section of the bank; its operations. It was so vast that they were in
another section of the bank's operations when all of a sudden the
Federal Reserve Board said, hey, come on now. We have pumped
enough money into this situation. Let's find a merger partner.
Some of the examiners who were working in the bank at that
time didn't know how bad Franklin National was. With these large
money center banks is it perhaps that there is no way to really
know?
Mr. CONOVER. No, I don't think that is true. I think we get a sufficient amount of information. The information we get and the
analysis we do, don't enable us to reach a conclusion, per se, about
the situation in the bank, but they do raise red flags. They help
identify areas that ought to be looked at in greater depth.
Chairman S T GERMAIN. Where were the red flags on May 10,
1984? Were there no red flags flying?
Mr. CONOVER. Let me clarify what I said in the release on May
10, because I think there has been a significant amount of misunderstanding.
I did not say t h a t the bank was just fine, thank you. What I did
say was that the Comptroller's Office was not aware of any significant changes in the bank's operations that would serve as a basis
for the rumors that were being circulated. The release also denied
a report that had been carried by a Japanese news service that our
office had discussed the bank with or requested aid for Continental
from any Japanese bank or securities firm.
Obviously, the condition of the bank, as was reported in its financial statements, was well-known to the banking industry and to the
public at large. We were not denying that the condition of the bank
was poor or shaky. We were simply saying that we knew of no
change in its condition, the condition that everybody knew about,




280
t h a t could have served as the basis for those rumors t h a t were
flying around all over the place.
Chairman S T GERMAIN. Excuse me. Are you telling me t h a t John
and J a n e Q depositor, who were constituents of Mr. Annunzio in
Illinois—this is the little old man and the little old lady who have
worked hard all their lives, and as a result of very penurious
living, they happened to have, instead of $100,000, they have
$150,000 in Continental Illinois.
Now do we expect t h a t these unsophisticated day laborers read
the financial reports in such a m a n n e r as to be able to reassure
themselves of the fact t h a t Continental did have problems? Because
as Comptroller of the Currency, you issued a statement. I know
how to make these statements, too. You can make a statement t h a t
really is designed to do one thing, but you have got yourself covered so t h a t if the implications t h a t are derived therefrom are
what you want them to be, but yet are not accurate, then you can
say, well, here is what I said exactly.
Mr. Comptroller, as a matter of fact, word went out to the effect
t h a t you, the Comptroller, said t h a t there were no big problems
t h a t people should be concerned about at Continental. That was
the interpretation of your statement. That was on May 10, 1984.
Now if you or one of your successors should make that type of
statement in the future, how much credence do you think will be
given to it?
That is my concern in this instance. Again, where were the red
flags?
Mr. CONOVER. The words in the statement were carefully chosen
to have only the meaning t h a t they had.
Chairman S T GERMAIN. OK, how about
Mr. CONOVER. There was no intent on our part to give any other
meaning to any potential reader of t h a t statement as to the condition of Continental Illinois.
Chairman S T GERMAIN. Was this before or after, help me out
here, the statement by Bill Isaac stating all accounts would be covered?
Mr. CONOVER. Oh, this was before.
Chairman S T GERMAIN. Before.
Mr. CONOVER. That statement was not made until the temporary
assistance package had been put together, around May 7.
Chairman S T GERMAIN. The purpose of this, then, obviously, was
to attempt to stem the outflow of funds, right?
Mr. CONOVER. It was to indicate t h a t there were rumors t h a t
clearly were bashing Continental and t h a t in our view those
rumors were unjustified. We didn't know what the basis of them
was.
Chairman S T GERMAIN. Excuse me, Mr. Conover. My question is,
wasn't it the purpose of this to stem the outflow of funds t h a t were
occuring at that time in a very dramatic way?
Mr. CONOVER. It was intended to say, again, t h a t we knew of no
basis for the rumors so t h a t the run, if you like, t h a t was the result
of those rumors, would stop.
Chairman S T GERMAIN. YOU were attempting to stop the run on
the bank?



281
Mr. CONOVER. We were attempting to provide accurate information to the marketplace so t h a t any run t h a t was based on misinformation would stop.
Chairman S T GERMAIN. And you feel t h a t this was accurate information? It is a cute statement. It says there haven't been any
significant changes; right, essentially it says this.
Mr. CONOVER. That is what it says.
Chairman S T GERMAIN. N O significant changes. It doesn't say,
however, t h a t there should be some significant changes so t h a t
there wouldn't be a reason for a run.
Mr. CONOVER. Of course it doesn't say that. That wasn't the situation we were in.
Chairman S T GERMAIN. It wasn't?
Mr. CONOVER. N O ; the point, Mr. Chairman
Chairman S T GERMAIN. Well, if t h a t is the case why did we put
new management in? Why did we get rid of Mr. Taylor and all
those wonderful things?
Mr. CONOVER. The point was t h a t the bank was having funding
difficulties as a result of rumors and t h a t we had no knowledge of
any reason t h a t those rumors were circulating.
Chairman S T GERMAIN. Mr. Conover, I have got
Mr. CONOVER. The alternative was not to issue the statement.
Chairman S T GERMAIN. That's right. But, remember, the rumors
t h a t gave rise to funding difficulties came about as a result of
actual factual information t h a t international money managers and
domestic money managers were aware of. Is t h a t not the case?
Mr. CONOVER. I wouldn't put it t h a t way, sir. I would say t h a t
the rumors had the effect they did because the bank was in fact
extremely vulnerable to rumors due to its financial condition, due
to the known weaknesses in its loan portfolio, and due to its funding strategy. Where the rumors started from and why they started,
I don't know to this day.
Chairman S T GERMAIN. But the rumors were not inaccurate?
Mr. CONOVER. Sure they were. There were rumors t h a t were circulating and had circulated in the previous several days, for example, that the bank was going to declare bankruptcy. That got a
little coverage in the press. Anybody who knew anything about
how
Chairman S T GERMAIN. Why would t h a t type of rumor arise?
Mr. CONOVER. Mr. Chairman, I don't know how the rumor arose.
Chairman S T GERMAIN. Because some financial analysists in
New York a year previously had said they wouldn't even analyze
t h a t stock any further and they wouldn't recommend its purchase
by anyone. Isn't it things like t h a t t h a t led to this eventually?
Mr. CONOVER. Well, we can speculate as to what the cause and
source of the rumors were. But I don't know to this day what they
were.
Chairman S T GERMAIN. DO you to this day feel comfortable with
the statement t h a t you issued on May 10, 1984, to the world at
large?
Mr. CONOVER. I am comfortable t h a t the statement t h a t was
issued on May 10, 1984 was accurate based on the information t h a t
I knew at that particular time.



282
Chairman S T GERMAIN. And you are comfortable with the fact
t h a t it didn't accurately document the situation—accurate and as
you agree, meaning carefully worded? You are comfortable with
the fact t h a t it could not have misled people?
Mr. CONOVER. It certainly was not intended to mislead anybody.
Chairman S T GERMAIN. Whether it was intended
Mr. CONOVER. Whether it did or not, I obviously couldn't control.
As I said at the outset when we touched on this subject, I think
t h a t t h a t particular statement has been widely misinterpreted.
Chairman S T GERMAIN. Well, Mr. Conover, you have got to be
very cautious when you are in a position of the Comptroller of the
Currency or chairman of the Banking Committee.
Mr. CONOVER. I am
Chairman S T GERMAIN. YOU

have got to be very careful about
what you say.
Mr. CONOVER. I am well aware of that.
Chairman S T GERMAIN. Because people will try to inter pet anything. They try to interpret me even when I don't speak.
Mr. CONOVER. The fact t h a t it was rumored t h a t our office was
actively engaged in meetings and discussions with Japanese banks
or securities firms to try to arrange a sale of Continental was one
of the things t h a t caused me to decide t h a t it was appropriate at
t h a t time to make an exception to a longstanding policy of not
making statements about individual banks and t h a t we ought to
put t h a t issue to rest then and there.
Mr. A N N U N Z I O . Will the chairman yield?
Chairman S T GERMAIN. Sure, Mr. Annunzio.
Mr. ANNUNZIO. Mr. Conover, when we are talking about rumors,
isn't it true t h a t there were rumors in the Chicago paper about the
First National Bank of Chicago having an interest in taking over
the Continental Bank? There were rumors of an Arab group. There
were rumors of a Japanese group. There were rumors of Citicorp.
There were all kinds of rumors.
Every day there was a rumor of a new group t h a t was ready to
take over Continental, because Continental was ready to close its
doors.
Mr. CONOVER. Yes, t h a t is true.
Mr. ANNUNZIO. I feel, personally, t h a t what really destroyed confidence in Continental were these rumors. And no one knows
where they really got started.
Chairman S T GERMAIN. Incidentally, Mr. Conover, the rumors of
the possible purchase or merger of Continental with all these institutions was not all—these were not all t h a t inaccurate because we
know of the fact, don't we, t h a t three major banks went in and
spent substantial amounts of time, effort, and manhours analyzing
Continental to determine whether or not they indeed did wish to
make a merger offer.
Mr. CONOVER. Oh, yes, we do. That was after the temporary assistance package was announced.
Chairman S T GERMAIN. Yes. Let's look at a letter dated May 17
from the Comptroller to Mr. Isaac:
This is to inform you of developing circumstances which may soon threaten the
solvency of Continental Illinois National Bank and Trust Co. of Chicago, Charter



283
No. 13539. As of March 31, 1984, the bank had assets of approximately $40 billion
and deposits of $28 billion.
The bank is with the exception of directors' qualifying shares, wholly owned by
Continental Illinois Corp. There are over 21,000 shareholders of Continental Illinois
Corp. None own over 5 percent of the common stock of the corporation. Both the
bank and Continental Illinois Corp. own a significant number of subsidiaries.
On March 14, 1983, the bank entered into a formal agreement with the Office.

This is 14 months prior to the May 10 statement. The bank entered into a normal agreement with the office. That means the
Comptroller's Office.
However, the bank's condition has continued to deteriorate. An examination as of
J a n u a r y 31, 1984, revealed that nonperforming assets had reached approximately
$2,300,000,000. Although, the bank's capital structure appears sufficient to absorb
the probable losses in its portfolio, rumors and speculation regarding the bank's condition have received prominent coverage in the news media. As a result, the bank
has experienced increasing problems in meeting its short term funding needs. Reflecting this fact the bank's borrowings from the Federal Reserve System have increased from $850,000,000 on May 9, 1984, to $4,700,000,000 on May 16, 1984.

That was the day before your letter. That was typed in, I guess,
so you could fill in the blanks.
If the bank's ability to obtain funding continues to deteriorate, the bank may
become unable to meet its obligations as they become due.

Now t h a t is 7 days after your May 10 statement. And it appears
to me t h a t this letter probably was written a few days before May
17, because there were blanks left for the May 16 insertion of the
borrowings from the Fed.
So you are telling us that in 7 days the condition changed that
dramatically?
Mr. CONOVER. First of all, the letter was written on May 17. And
the fact t h a t there were blanks left in it was simply so that those
numbers could be filled in as soon as we had them accurately. That
letter was a standard kind of letter in which we request the FDIC
to consider providing assistance under 13(c) of the Federal Deposit
Insurance Act. That type of letter is written a number of times a
year when a bank is in jeopardy and the FDIC awaits official notification from the primary supervisor
Chairman S T GERMAIN. Mr. Conover, I am sure you don't write
this type of letter several times a year. Maybe this form, but not
this type of letter. I think the magnitude of this one is not a
common occurrence, is it?
Mr. CONOVER. Of course not, because this is the biggest
Chairman S T GERMAIN. This is the biggest biggy ever.
Mr. CONOVER. Absolutely.
Chairman S T GERMAIN. Right. So
Mr. WYLIE. Will the chairman yield?
Chairman S T GERMAIN. Sure.
Mr. WYLIE. Isn't it part of your role to try to maintain some confidence in the banking system and to try to maintain confidence in
Continental Illinois, in this case? And wasn't t h a t the case on May
10, 1984? You were trying at that particular time to make something out of this to try to see that the Continental Illinois was to
continue as an ongoing financial institution.
Wasn't it your role to be optimistic rather than to view it with
alarm, which would have only made matters worse?



284
Mr. CONOVER. Well, it certainly is our responsibility to try to
maintain the health of the system and of individual banks within
it. Because we felt that the bank was being battered unfairly due
to the rumors t h a t were circulating, we issued the statement t h a t
we did.
Now, between May 10 and May 17 a lot of things happened. The
bank continued to have serious funding difficulties- A temporary
funding arrangement put together with a number of banks to the
tune of $4.5 billion began to unravel by May 15. That led to discussions between myself and Chairman Volcker and Chairman Isaac
and a number of banks in New York, which ultimately resulted in
the temporary assistance package.
The statement issued on May 10 did little, as it turned out, to
calm the marketplace. The bank continued to have funding difficulties. The so-called safety net t h a t had been put together over t h a t
weekend, I don't recall what day of the week the 17th was, began
to fall apart, or there was good evidence t h a t it had fallen apart by
Monday noon. So we were dealing with a very rapidly changing situation. This letter was written as one of the things that had to be
done in order to put the temporary assistance package into place.
Chairman S T GERMAIN. Mr. Conover, do you at this point feel
t h a t this press release was wholly consistent with the unpublished
information t h a t your office had concerning the condition of Continental Illinois?
Mr. CONOVER. Yes; I do.
Chairman S T GERMAIN.

All right. Now, I agree with Chalmers
t h a t you do have a duty to try to maintain confidence in the
system, as well as in individual institutions. And it is for t h a t
reason t h a t I am concerned about this particular statement, its
timing, the fact that 7 days later a letter that is—it is not a usual
letter. It is an unusual letter because it served to trigger one of the
biggest bailouts—the first nationalization in many, many years of a
bank in the United States of America.
My concern is that in the future, when the Comptroller, as I
stated earlier, either yourself or one of your successors, attempts to
make this type of statement, the marketplace, and this is very important as you are dealing in big numbers, is going to say:
Aha, is this another carefully worded pronouncement that can give no more credence to than we should have given to that one of May 10, 1984 with respect to
Continental Illinois? Is it a repeat?

That is my concern.
Mr. CONOVER. I share your concern about any decision to make a
similar statement in the future and how the marketplace might
react to t h a t statement. I just want to make it absolutely clear t h a t
in issuing the statement we did, we acted with the full knowledge
of the facts t h a t were available to us at the time. And there was
never any intent to mislead anybody as to the condition of Continental Illinois.
[Under unanimous consent the press release dated May 10, 1984,
and the letter to FDIC Chairman Isaac dated May 17, 1984 from
Comptroller Conover referred to by Chairman St Germain are
placed in the record at this point:]



285

Comptroller of the Currency
Administrator of National Banks

Washington, D.C. 20219
^r

immediate Release

Dt May 10, 1984
ae

Statement on Continental Illinois
A number of recent rumors concerning Continental Illinois
National Bank and Trust Company have caused some concern in the
financial markets. The Comptroller's Office is not aware of
any significant changes in the bank's operations, as reflected
in its published financial statements, that would serve as the
basis for these rumors.
Contrary to a report carried on a Japanese news wire service,
the Comptroller of the Currency has not discussed Continental
with or requested aid for Continental from any Japanese bank,
any other bank, or any securities firm.
Continental Illinois Corporation, the parent of the bank, is
the eighth largest bank holding company in the U.S. As of
tdarch 31, its assets totaled $41.4 billion. Total equity for
the corporation exceeded $1.8 billion, and its reserves for
possible loan losses totaled more than $400 million, or 1.32
percent of total credits. Total primary capital was $2.2
billion. Continental's equity-to-asset ratio was 4.41 percent,
and its ratio of primary capital to total assets had increased
to 5.84 percent. These ratios compare favorably to those of
other major multinational banks.

# *# *

39-133 0--84

19




286

o
Comptroller o1 ttw Currency
Administrator of National Banks
Washington. DC. 20219
May 17, 1984

The Honorable William M. Isaac
Chairman of the Board
Federal Deposit Insurance Corporation
550 17th Street, N.W.
Washington, D.C. 20429
Dear Mr. Isaac:
This is to inform you of developing circumstances which may soon
threaten the solvency of Continental Illinois National Bank and
Trust Company of Chicago, Charter No. 13639. As of March 31,
1984, the bank had assets of approximately $ 40,000,000,000 and
deposits of $28,000,000,000. The bank is, with the exception of
directors' qualifying shares, wholly owned by Continental
Illinois Corporation. There are over 21,000 shareholders of
Continental Illinois Corporation. None own over 5% of the common
stock of the corporation. Both the bank and Continental Illinois
Corporation own a significant number of subsidiaries.
On March 14, 1983, the bank entered into a formal agreement with
the Office. However, the bank's condition has continued to
deteriorate. An examination as of January 31, 1984, revealed
that non-performing assets had reached approximately
$2,300,000,000. Although the bank's capital structure appears
sufficient to absorb the probable losses in its portfolio, rumors
and speculation regarding the bank's condition have received
prominent coverage in the news media. As a result, the bank has
experienced increasing problems in meeting its short term funding
needs. Reflecting this fact, the bank's borrowings from the
Federal Reserve System have increased from $850,000,000 on
May 9, 1984, to $ 4,700,000,000
on May 16, 1984
If the bank's ability to obtain funding continues to deteriorate,
the bank may become unable to meet its obligations as they become
due.
Further administrative action by this Office will not alleviate
the bank's immediate funding problems. Therefore, the Office
suggests that the Corporation consider providing appropriate
assistance to the bank under Section 13(c) of the Federal Deposit
Insurance Act. Among many possibilities under the Act, this
assistance may be in the form of a purchase by the Corporation of a
demand subordinated note which would be treated as an increase in
the bank's capital account. Such a note could be retired on the
demand of the FDIC. To this end, this Office has issued, a letter
to the bank granting approval of any decrease in capital which
would result from such a demand by the Corporation.
As always, we will respond to any informational requests or provide
assistance as you deem necessary. Should that be the case, please
feel free to contact National Bank Examiner James w. McPherson or
National Bank Examiner Bobbie Jean Brookins in our Multinational
Banking Department at (202) 447-1522.
Sincerely,

C. T. Conover
Comptroller of the Currency




287
Chairman ST GERMAIN. Mr. Annunzio.
Mr. ANNUNZIO. Thank you, Mr. Chairman. Mr. Chairman, I
would like to ask unanimous consent t h a t I been given an additional 5 minutes for a total of 10. I want to be fair to the other members. Please keep the time for me. Mr. Conover, there has been
much criticism leveled at the regulatory agencies for saving Continental. Will you please tell me and this committee what would
have happened if Continental was not saved?
I am interested in the 12,000 jobs t h a t would have been lost and
the 66 banks t h a t have deposits, t h a t have more t h a n 100 percent
of their equity capital on deposit in Continental. What would have
happened to those banks, and what would have happened to all
those employees, and to the banking communities in the Midwest
where these 66 banks are located?
Mr. CONOVER. Sixty-six banks, as you know, had deposits in Continental in amounts in excess of the total net worth of the bank.
Another 113 banks had deposits in Continental amounting to between 50 and 100 percent of their net worth. If Continental had
failed and had been treated as a payoff, certainly those 66 banks
would have failed and probably a goodly number of the other 113
would have failed, if not immediately thereafter, then certainly
within some period of time afterward. So let us say that we could
easily have seen another hundred bank failures.
Mr. VENTO. Will the gentleman yield to me to that? I have just a
short question, an informational question.
Mr. ANNUNZIO. I yield to Mr. Vento briefly because I still want
to get my answer on these people losing their jobs.
Mr. VENTO. Yes, OK. I just would like to know for the record,
Mr. Conover, how many foreign banks were involved and what percentage of the assets were affected by the actions taken in terms of
the agreement? That is a question I asked yesterday and your examiners couldn't answer it. So I want to again state it for the
record.
I thank the gentleman for yielding.
Mr. CONOVER. The 66 and the 113 t h a t were cited are domestic
banks. I do not have available right here the number of foreign
banks t h a t might have been impacted, but I will be happy
Mr. VENTO. And the deposits.

Mr. CONOVER. I would be happy to provide that information for
the record.
Returning to Mr. Annunzio's question, it happens that of those
66 banks, 54 were in Illinois, and 70 of the 113 were in Illinois. The
impact would have been much greater t h a n simply t h a t of an additional number of bank failures.
There could also have been a significant number of corporate
bankruptcies t h a t would have resulted as depositors were unable to
get their cash and given receivership certificates in their place. It
is difficult to buy not only groceries but industrial equipment as
well, with receivership certificates.
We debated at some length how to handle the Continental situation—whether it ought to be done on an open bank or a closed
bank basis, what the consequences of a payoff might be, and so
forth. Participating in those debates were the directors of the
FDIC, the Chairman of the Federal Reserve Board, and the Secre


288
tary of the Treasury. In our collective judgment, had Continental
failed and been treated in a way in which depositors and creditors
were not made whole, we could very well have seen a national, if
not an international, financial crisis the dimensions of which were
difficult to imagine. None of us wanted to find out.
Mr. A N N U N Z I O . Mr. Conover, what you are telling the committee
is that without action, there would have been sweeping repercussions in the entire economy of the country and in the banking
system of this country. Is there any way t h a t you can tell this committee how much money would have been lost by closing these 179
banks. How much money would have been lost to the corporations
in this country, to the individuals in this country, to the individual
job holders I described yesterday?
I am not interested in upper echelon bankers. I am talking about
the cashiers, janitors, clerks, and the lower echelon people in all of
these institutions throughout Illinois. Are there any figures available as to what has been lost? What I am trying to point out is t h a t
the biggest factor in every one of the bailouts of various companies
by this committee, as far as I was concerned, was saving jobs of
people and keeping them working in private industry, off of the unemployment compensation roles where it would be like a double
taxation.
And this could have happened in this case. Now if it is possible, I
would like you to supply some kind of a dollar figure. But before I
end my question, I want to say that, fortunately, this committee
has a 100-percent track record in every one of the bailouts, including the two bailouts for New York City. All loans have been paid
back, and the Government actually made money, Mr. Barnard, just
like we did on our George Washington commemorative coin where
we made millions of dollars on t h a t particular silver coin.
And for the first time it was designated, in a bill, t h a t the profit
be used to repay the national debt. So what I would like to know
from you is, what is your feeling about—we will call it a bailout.
We will call it whatever you want to call it. But in the end, what is
the dollar amount that would have been lost? Do you feel t h a t we
are in the ballpark? J u s t like the Cubs ball team, you know, on its
way to winning a pennant, are we in the ballpark to really pull
this off with Continental and keep it going on a sound basis in the
city of Chicago?
Mr. CONOVER. Let me try to provide some perspective in response
to your question. In the case of the 66 banks t h a t I referred to t h a t
had more than 100 percent of their equity deposited in Continental,
their total assets were approximately $4.8 billion. In the case of the
113 banks t h a t had between 50 and 100 percent of their eqi ity on
deposit in Continental, their total assets were $12.3 billion, t don't
know what portion of the $12.3 billion to count, nor do I have a
way of assessing the impact of lost jobs in those institutions or in
businesses t h a t were customers of those institutions. But I think it
is safe to say t h a t we are clearly dealing in this case with a multibillion-dollar situation in which many people, many businesses, and
many financial institutions could have well have been h u r t to a significant degree.
Now let's look at the condition of Continental today. Assuming
t h a t shareholders approve the deal on September 26, it will be an



289
institution under a new management team with a substantially improved asset portfolio, with a sound balance sheet in terms of the
proportion of capital to assets, and with the continued support of
the FDIC and Federal Reserve System. Another way of describing
all t h a t is to say it is probably the safest bank in the world to deal
with today.
The regulators, working together, put this package together over
a period of several months. I think t h a t the American public, the
banking community, and the international financial community
ought to take some solace from the fact t h a t the U.S. Government
has stood behind its banking system, t h a t the regulators have
worked together effectively to accomplish this goal. The package is
not without some weaknesses, however, and we can discuss those
later, if you like. But I think the important thing is that the overall goal of maintaining the financial stability of the Nation's banking system has been achieved.
Mr. ANNUNZIO. I have tried to get a loss figure. And I realize
how difficult t h a t is. But would you estimate t h a t the Government
placed about $16 billion in Continental?
Mr. CONOVER. I heard the chairman refer to t h a t number yesterday, and I am not quite sure where he got it. I understand the $4.5
billion in loans t h a t are being purchased by the FDIC.
Chairman S T GERMAIN. The discount window.
Mr. CONOVER. Discounted loans.
Chairman S T GERMAIN. Discount window. The Fed.
Mr. CONOVER. OK, the billion dollars of capital infusion and the
x billion—what number do you want to use for the discount
window?
Chairman S T GERMAIN. Well, it varies constantly. It was up to
$7.5 billion
Mr. A N N U N Z I O . Say they used $10 billion. Ten and $4.5 billion is
$14.5 billion.
Mr. CONOVER. I get up to about $12.5 billion in t h a t case.
Chairman S T GERMAIN. HOW about the other banks t h a t have
put funds in?
Mr. CONOVER. The other banks have provided an additional $5.5
billion.
Chairman S T GERMAIN. Doesn't t h a t come to $17 billion?
Mr. CONOVER. All right. That comes to $17 billion.
Chairman S T GERMAIN. I add pretty good, Mr. Conover.
Mr. CONOVER. YOU did just fine.
Chairman S T GERMAIN. I add pretty good. If the fellows at Continental, before we put in this good managing team added as well, it
would be great.
Mr. A N N U N Z I O . The chairman is absolutely right. We will say
$17 billion. Now, my question to you, Mr. Conover, is what would
the total loss have been to all these institutions, jobs, welfare, unemployment compensation, the American people if we hadn't put
this $17 billion in?
Mr. CONOVER. I don't know how to come up with t h a t number.
But let me go back to the $17 billion because the presumption is
t h a t the $17 billion has been spent and is gone, and I don't believe
t h a t is the case. The FDIC will work out the $4.5 billion loan portfolio. That is not 100 percent loss; they would not tell you t h a t it is.



290
The $7 billion loan at the discount window is secured by quality
assets t h a t the Federal Reserve Bank of Chicago has on assignment
there. The $5.5 billion t h a t has been provided by the other banks
as an overnight funding facility is, in the first place, not free. The
banks are earning a market rate of return on those funds and have
every intention of being repaid.
Of course, this is all going to take some time. Continental has got
to get back on its feet. It needs to start reporting profits on a quarter-to-quarter basis.
Mr. ANNUNZIO. We have to find some way to end rumors which
destroy confidence.
Mr. CONOVER. I agree with that.
Mr. ANNUNZIO. Confidence is the one thing t h a t the people have
always had in the banking system of this country. What makes
banks institutions that are respected by people, is the amount of
confidence t h a t they have.
We cannot destroy confidence in the banking system. What the
regulators tried to do is save t h a t confidence.
My time is almost up.
Mr. BARNARD. Will the gentleman yield?
Chairman ST GERMAIN. Mr. Barnard.
Mr. ANNUNZIO. Yes.
Chairman S T GERMAIN.

Mr. Annunzio, we are going to give you
another opportunity. Your time is up now.
Mr. ANNUNZIO. I just have one more question. That is all.
You have already made the statement that Continental, in your
opinion, at this time, is a sound institution. And that in your judgment, Continental will survive.
Mr. CONOVER. Yes, I

did.

Mr. A N N U N Z I O . All right.
Chairman S T GERMAIN. Mr. Conover, t h a t was a delightful exchange. But did you ever stop to estimate how much grief and how
many lost jobs occurred when W.C. Grant went down the tube?
How many banks were affected? How many developers and shopping centers went into dire difficulty and how many actually
failed? How about WPPSS?
How many senior citizens who put their life's savings into
WPPSS have been destroyed? How about Baldwin-United? We
could have gone in and saved all those people. And Penn Square.
How many people ended up with no money and, therefore, couldn't
buy the groceries, like you said in your answer?
What we have to look at in this instance is, and certainly it is
laudable t h a t you can save these banks from failing, t h a t these
banks have more t h a n a $100,000, far in excess of t h a t obviously,
and large portions of their assets were in Continental Illinois.
These were Illinois banks you told us. Quite a few of them.
Sure, t h a t is unfortunate. But you have to question the judgment
of those bankers, as well.
Maybe they should have known a little more or paid a little
more attention to their deposits and investments. But the big question is, what do we do with the next big bank that ends up in this
situation? Do we have to come in and do the same thing all over
again?



291
How do we say no in the future? That is what we have to address.
I don't have any time right now, but I couldn't let t h a t go.
I ask unanimous consent, incidentally, t h a t at the end of my first
round of questioning where I was citing the press release and letter
to Mr. Isaac from Mr. Conover t h a t these be placed in the record at
t h a t point.
Without objection, so ordered.
[The press release and letter referred to may be found on pages
285, 286.]
Chairman S T GERMAIN. Mr. Wylie.
Mr. WYLIE. Thank you, Mr. Chairman.
I was beginning to think it was my turn. There are a couple of
points t h a t I want to clear up. The chairman made much of the
letter of May 10, 1984 and some of the rumors t h a t surrounded
that.
I think the point to be made there is t h a t you were still trying to
work something out between May 10 and May 17. Things happened
very quickly and very rapidly there.
Is t h a t a fair statement?
Mr. CONOVER. Yes, it is. During t h a t time period we were monitoring Continental's funding situation not just on a daily basis, but
literally on an hourly basis, and tracking its funding from the Far
East through Europe, as well as domestically. The conditions t h a t
the bank was facing in funding itself were changing rapidly. So
while the time between May 10 and May 17 may seem short in
terms of 7 days, t h a t was an eternity in terms of what was happening to the funding position of the bank.
Mr. WYLIE. Exactly right. Then when you weren't able to work
something out within the existing frame work, you came up with
the package which you say now you have reason to be optimistic
about again, t h a t Continental Illinois will indeed be an ongoing institution.
And you have expanded on t h a t sufficiently. The impression has
been left, it seems to me, t h a t somebody came up with a $17 billion
gift to Continental Illinois. I want t h a t to be cleared up.
In the first place, a part of t h a t comes out of FDIC, which is insurance money, not taxpayer money. Another part comes out of the
discount window which has to be repaid. The other part of it comes
from other banks.
But the point there is, and you make in your statement, t h a t although Continental was weakened by asset deteriorations, its losses
never exceeded capital and thus it never reached book insolvency.
Rather, its near collapse was triggered by funding problems.
Would you like to expand on that?
Mr. CONOVER. That is correct. At the time t h a t the final package
was put together, Continental's losses had still not wiped out its
capital. We were confident of t h a t because the 1984 examination
was done jointly by the Comptroller's Office, the FDIC, and the
Fed. We reached a uniform agreement as to the classification of
the loan portfolio, including the losses t h a t were to be charged.
Even after those losses were taken, I believe the bank published
some pro forma statements as to what its balance sheet would look
like after the deals were consummated, and there was at least $600



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million of shareholders' equity remaining in the bank. So the bank
never reached book insolvency.
Mr. WYLIE. It was never insolvent, so this $17 billion is, in
effect—is this the proper word—it was collateralized.
Mr. CONOVER. The $17 billion is not an appropriate measure of
the cost of this transaction. It would be nice if we could know the
costs instantaneously, but we can't. We won't know them until the
loans purchased by the FDIC are worked out and we are able to see
what kind of proceeds they yield. As I said, the $5.5 billion to the
banks will be paid back with interest. I think t h a t the Fed's loan
will also be paid back with interest. The FDIC could very well
break even and could even make a profit on this deal.
Mr. WYLIE. Perhaps a more important issue which the chairman
touched on, Mr. Conover, and there has been much debate surrounding Continental and the fact t h a t there was a serious policy
question which had to be resolved, simply stated, does a dual
system exist—and this may be difficult for you to answer—but does
a dual system exist for deciding if banks are allowed to fail, or are
given a chance to survive?
The Federal regulatory agencies that have come to the assistance
of a $45 billion Continental Bank, one of the largest money center
banks in the world in its heyday, while smaller community banks,
as has been pointed out, in the Midwest have been allowed to fail.
Have the agencies been able to promulgate a dual policy and do
we now have a policy where banks or savings and loan associations
above $5 billion, $10 billion, or $25 billion simply are not allowed to
fail or cannot be allowed to fail no matter for what reason?
I think this policy question has implications for all depositors
and for the insurance agencies and for the monetary and financial
stability and for consideration of the Financial Institutions Subcommittee.
Mr. CONOVER. I would agree with you, Mr. Wylie, that t h a t is an
important question. And let me say at the outset t h a t I think it is
essential t h a t we have a policy and practices in place to handle
large bank failures and small bank failures in a consistent way.
Now, let me talk about what was done at Continental versus how
small banks have been handled. In the Continental case, although,
as was just pointed out, the bank never became technically insolvent, it was treated as if it had failed. Management has been removed. Shareholders face a major, if not total, loss, just as they
would if the bank had been declared insolvent. And managers and
directors face potential liability because I am sure the FDIC intends to pursue action against them.
Chairman S T GERMAIN. Excuse me. You say the shareholders
face a total loss if this bailout plan succeeds?
Mr. CONOVER. The shareholders' interest has immediately been
diluted by 80 percent. They face the risk of losing the remaining 20
percent.
Chairman S T GERMAIN. HOW would t h a t happen?
Mr. CONOVER. It would happen if the FDIC's losses in the liquidation of the $4.5 billion portfolio t h a t they purchased exceed the remaining shareholders' equity in the bank.



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The shareholders are totally at risk in this case, just as they
would be if the bank's doors had been closed and it had been technically declared insolvent.
Mr. WYLIE. But on the other hand, they have a chance of coming
out of it.
Mr. CONOVER. They have a chance, t h a t is true.
When the FDIC infused the $2 billion of subordinated capital
notes as part of the temporary package on May 17, t h a t immediately created a condition. That condition was t h a t any action other
t h a n a payoff would be $2 billion cheaper to the FDIC than a payoff.
We discussed whether to leave t h a t condition for people to try to
analyze and interpret or whether the FDIC ought to make an explicit statement saying what the effect of t h a t capital infusion was.
In order to avoid confusion, the FDIC elected to make an explicit
statement, that the bank would be handled in a way t h a t all depositors and creditors would be made whole in the final long-term
solution. That statement has been widely misunderstood and misinterpreted to mean t h a t the FDIC extended, perhaps illegally, deposit insurance to amounts above $100,000. That was not the case.
Chairman S T GERMAIN. Because the bank was not closed.
Mr. CONOVER. That is correct.
Chairman S T GERMAIN. But had the bank closed, then you would
have had a difficult situation. You would have to look into the legality of living up to the Bill Isaacs' commitment.
Mr. WYLIE. Right.

Mr. CONOVER. Had the bank closed, the FDIC would have taken
the action which was the least costly to it. By virtue of putting in
$2 billion into the bank, t h a t meant t h a t doing a payoff had a $2
billion disadvantage compared to alternative actions.
Now, let's contrast t h a t situation with what has happened in
small banks. I think we are up to 57 bank failures this year. That
means that since J a n u a r y 1982, we have had 147 bank failures—
approximately 1 percent of the total number of banks in this country.
The vast majority of those—well in excess of 80 percent of the
147—have been handled through purchase and assumption transactions. In those transactions, the bank is sold to another bank and
usually opens its doors on the following morning. And the effect is
that all depositors and creditors remain whole. So Continental's depositors and creditors were treated in a way t h a t was certainly consistent with the way 80 percent of the small banks t h a t have failed
during t h a t time period were treated.
Now, if we look at the remaining 20 percent t h a t were treated
differently, they fall into three categories. The first category would
be those in which there was some massive fraud or contingent liability in existence such that the FDIC felt that it could not put
the risk on the insurance fund, and so a payoff was arranged. A
second category would be where an attempt was made to arrange a
merger with another bank, which usually involves having people
submit bids, and no bids were forthcoming. Again in t h a t case, a
payout was arranged.
The third category would be eight banks where in 1984 the FDIC
experimented with something known as a modified payout. In



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those cases when the bank failed, rather than providing the uninsured depositors with receivership certificates for the total amount
in excess of $100,000, a payout was made based on an estimate of
what
Chairman ST GERMAIN. YOU may proceed.
Mr. CONOVER. In the modified payout case, a partial payment
was made to uninsured depositors based on an estimate made by
the FDIC of what they would be able to garner through liquidation
of the bank's loan portfolio. There were eight of those, which were
done as an experiment. In some of them, a complete payout was
probably more appropriate. The FDIC is writing up the results of
t h a t experiment, but I have not yet seen the final report.
The bottom line on all this, however, is that those who say t h a t
large banks, specifically Continental, have been treated significantly differently from the way small banks have been handled, at
least during the period from 1982 to the present, are incorrect. Basically, the treatment of large banks has been consistent with the
way small banks have been treated.
Mr. WYLIE. My time has expired, and I think that has been very
elucidative and information we can use. One-hundred-fifty-seven
banks have failed. Now t h a t doesn't mean that any depositors have
lost money, and most of those institutions have been folded into
some other institution.
How many new banks have been chartered by the OCC in t h a t
time period?
Mr. CONOVER. I don't have t h a t number at hand, Mr. Wylie, but
there were a good number of them. I am sure there were enough
t h a t the total number of banks has not declined.
Mr. WYLIE. That is the point. Can you provide t h a t for the
record?
Mr. CONOVER. I certainly will provide t h a t for the record.
[In response to the request of Congressman Wylie, the following
information was submitted for the record by Mr. Conover and may
be found on page 366.]
Chairman ST GERMAIN. Mr. Hubbard.
Mr. HUBBARD. Thank you, Mr. Chairman.
Thank you, Mr. Conover, for being with us today. I listened to
your comments in response to what Mr. Wylie asked. There were
54 small banks across the United States forced to close thus far
this year. There were 48 small banks closed last year. The theory I
am told for closing small banks is that it is cheaper to liquidate the
bank, sell its assets and pay off the depositors.
J u s t 1 minute ago I heard you say t h a t you didn't treat Continental any differently than you do these small banks t h a t were
forced to close. Forgive me, but I didn't catch your thinking on
that. How is the continuation of Continental Illinois National Bank
justifiable to a Member of Congress from a State like Kentucky
where we have had several bank closings and where we have seen
several of our banks collapse because of the Butcher empire in Tennessee? A lot of people in my State were put out of work too.
Of course, I don't represent Chicago, but I represent Mayfield,
KY, where jobs are just as important to us as they are in Chicago.
Mr. CONOVER. I understand, Mr. Hubbard, but I am afraid I have
to take exception to your initial statement, which was, I think, t h a t




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when a small bank fails, the preferred or cheaper way is to pay off
the insured deposits, liquidate the bank, and provide the depositors
having in excess of $100,000 with receivership certificates so they,
in effect, see what they get over time.
In my exchange with Mr. Wylie, I think I pointed out t h a t well
over 80 percent of the small bank failures in the last three years
have not been handled that way at all. In fact, the vast majority of
failed banks have been merged with another bank, or, where State
laws don't permit that, they have been sold to a bank newly chartered to take over the failed bank. In the vast majority of cases,
this happens on a Friday night or over the weekend, and they open
for business Monday morning under a different name. I can't
assure you, however, t h a t t h a t has happened in every case in your
State over the last 30 or so months.
Mr. HUBBARD. What about the other 20 percent? Could you tell
us what is happening there?
Mr. CONOVER. Yes; I said t h a t the other 20 percent fell into three
categories. The first category would be those situations in which
there was significant fraud or contingent liability t h a t the FDIC insurance fund would have to face such t h a t in the FDIC's judgment,
it was cheaper to do a payoff of insured
Chairman S T GERMAIN. By that, you mean they shut the bank
down, people lost their jobs and couldn't buy their groceries in
many instances; right?
Mr. CONOVER. That is correct.
Chairman S T GERMAIN. Sure. Let's put it in factual language,
rather t h a n the
Mr. CONOVER. That is
Chairman S T GERMAIN. Those people took a hit.
Mr. CONOVER. They did. That is absolutely right.
Chairman S T GERMAIN. TO say to those people t h a t took the hit,
Well, too bad for you, buster. And your bank wasn't big enough,
you see. You weren't a Continental Illinois. That is what Mr. Hubbard is concerned about.
Mr. CONOVER. I understand that, but t h a t isn't the reason, in the
case I am citing, t h a t those banks would have been paid off by the
FDIC. They would have been paid off because there was significant
fraud or other contingent liability such t h a t it was cheaper for the
FDIC to pay off insured depositors in order to comply with their
statutory mandate.
Mr. HUBBARD. Up to $100,000.

Mr. CONOVER. They have to meet a cost test in dealing with
failed banks. One of the costs they take into account is the potential claims against the insurance fund.
Mr. HUBBARD. What were the results of the cost tests regarding
Continental Bank?
Mr. CONOVER. It was very clear t h a t the way to deal with Continental was not to do a payoff of insured depositors.
Chairman S T GERMAIN. If the gentleman would yield, when was
the cost test performed on Continental, and when can we have the
results of t h a t test?
Mr. CONOVER. I believe cost analyses of the various alternatives
were carried out between the time the interim assistance package



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was put together and the final one was enacted—between May and
July of this year.
Chairman S T GERMAIN. Our staffs have not been able to get any
copies of these cost tests. Do you mean you ran the models on various alternatives that you have described to us, in very much detail
just now?
Mr. CONOVER. They were evaluated.
Chairman S T GERMAIN. They were evaluated the same way as
you evaluate those little banks.
Mr. CONOVER. Exactly.

Chairman S T GERMAIN. Determining what the cost would be—
why is it we haven't been able to get copies of those evaluations?
Mr. CONOVER. I don't know, Mr. Chairman. You will have to ask
Mr. Isaac about that.
Chairman S T GERMAIN. My staff tells me that no one has been
able to locate them. Did you see them?
Mr. CONOVER. Yes, I

did.

Chairman S T GERMAIN. YOU saw the actual computer runs? [Witness
nods yes.]
Gentlemen, maybe you could find out for us where they are, because no one has been able to locate them.
Mr. CONOVER. A S I said, they are not in our files, they are in the
files
Chairman S T GERMAIN. But they do exist?
Mr. CONOVER. There are cost analyses
Chairman S T GERMAIN. Of the same type you have described just
now for the smaller banks?
Mr. CONOVER. Of the same type.
Chairman S T GERMAIN. And scope?
Mr. CONOVER. But recognizing t h a t in the case of Continental,
the long-term solution that was put into effect hadn't been tried
before.
Chairman S T GERMAIN. I want to know how much a payoff would
have cost. Therefore, if they exist, perhaps you could help us to
find them.
Mr. CONOVER. I believe they do exist, and I believe I recall
seeing
Chairman S T GERMAIN. And you saw them. So, then, we can continue to pursue those. I t h a n k the gentleman for yielding.
Mr. HUBBARD. Reclaiming my time, Mr. Conover, what would
have been the liquidation value of Continental Bank approximately?
Mr. CONOVER. I am not sure precisely what you mean by the
term.
Mr. HUBBARD. Could the depositors be paid off on liquidation?
Mr. CONOVER. There were roughly $3 billion of insured deposits
in the bank. That means that there were roughly $37 billion of uninsured deposits in the bank. That leads rather quickly to the conclusion that you couldn't pay off the bank. You could pay off the $3
billion. Then you would be in the position of liquidating $37 billion
worth of assets. And, as I indicated earlier, that would have had a
tremendous effect on a large number of other banks and borrowers
and on the national financial system, if not the world's. Nobody
wanted to find out what the full effect was.




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Chairman S T GERMAIN. DO you, when you are closing a small
bank, take a look into the effect it would have on other banks and
borrowers, and all the borrowers? That happens in every bank,
doesn't it?
Mr. CONOVER. Yes.
Mr. HUBBARD. Mr.

Conover, let me say there is that feeling in
rural America that these small banks that have been closed, 48
last year, 54 thus far this year, are indeed treated differently than
the FDIC and OCC treated Continental Illinois National Bank because it was so big and because in Chicago, and an important State,
this particular year, et cetera.
But in rural America, we are also confused as to how the OCC
and FDIC could not find earlier than we did the gross problems involved with the Butcher banks, the United America Bank of Knoxville and all those banks under it. That, of course, is in east Tennessee, and I represent the western part of Kentucky, the most
western area, but its ripples definitely affected several banks and
depositors in my area.
Just these few questions, and I will conclude. On page 9 of your
statement, Mr. Conover, you describe the difficulties Continental
had in its oil and gas portfolio 2 years ago. Can you say to what
extent the problems with these oil and gas loans were attributable
to the fact that Continental was extending loans or participating in
loans for which the collateral was oil rigs, undeveloped property,
lease line arrangements or other nontraditional, to say the least,
types of collateral?
Mr. CONOVER. Yes, we have that information. I do not have it
here, but we would be happy to provide it.
[In response to the request of Congressman Hubbard, the following information was submitted for the record by Mr. Conover and
may be found on page 366.]
Mr. CONOVER. There is a chart on page 40 of the appendix that
indicates the composition of Continental's losses from J u n e 1982
through J u n e 1984. Some two-thirds of the losses charged to the
bank were the result of oil and gas loans. Approximately 41 percent was attributable to Penn Square loans, and 26 percent was attributable to other oil and gas loans. As I say, we have the breakdown by category of oil loan if that is of interest to you, and we
would be happy to provide it.
Mr. HUBBARD. On page 21 of the appendix, you also point out
Continental began to lend to small independent drillers and refiners more aggressively in the late 1970's. This, of course, was a
factor in Continental's problems. With respect to these new forms
of collateral and lending to smaller companies, to what extent was
OCC aware of these trends?
Mr. CONOVER. We were aware that Continental had focused on
energy lending. The bank had developed a reputation as an energy
lender from the early 1950's and had had many years of profitable
results from its energy lending. In 1979, 1980, and 1981, however,
two things happened. Their lending standards changed. And the internal controls that might have been effective in enabling them to
make loans under new lending standards were either not developed
or were developed and subsequently ignored by Continental management.




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Mr. HUBBARD. Did OCC issue any warnings about these trends,
given the concentration of oil and gas in Continental's portfolio?
Mr. CONOVER. Your question deals with two factors, I think: concentrations and internal controls. Let me deal with concentrations
first.
It is our responsibility to identify and point out concentrations to
the bank. We criticize them if we think there is a problem in the
way they are dealing with the loans they are making and if their
policies and practices need strengthening. We have to be careful in
the concentration area, however, because some concentrations are
inevitable. For example, in some parts of the country, you almost
can't avoid having a concentration in agricultural loans, auto-industry-related loans or forest product loans. We don't want to be in
the business of allocating credit. If we do choose to criticize a concentration, we ask management and the board to reconfirm their
policy or change it. If they decide to change it, we ask them to develop a strategy and a timetable for reducing their concentration.
Given the emphasis on energy self-sufficiency and the like at the
time, and Continental's expertise and good track record in the
energy industry, we did not criticize them for their concentration
in oil and gas lending. In retrospect, I think t h a t we should have
criticized them, at least for their Penn Square exposure and for aggressively making oil and gas loans without adequate controls.
Did I answer your question?
Mr. HUBBARD. Right. You did.
Let me please ask you this. Was Continental solvent?
Mr. CONOVER. It was and is.
Mr. HUBBARD. Does t h a t mean it has
Mr. CONOVER. That depends.
Mr. HUBBARD. Why does it depend?

a positive liquidation value?

Can't you give me a yes or
no on t h a t simple question? Does t h a t mean Continental has a positive liquidation value?
Mr. CONOVER. It depends on the time over which the liquidation
would take place. Just as with any corporation, if you liquidate it
on a fire sale basis, you may not have a positive liquidation value.
If you liquidate it carefully and prudently over time, getting the
best price for your assets, you may very well have a positive liquidation value. So I am not trying to duck the question. I just think
it really can vary.
Now Continental had, subsequent to the assistance package but
not including the capital t h a t was infused as part of it, a remaining
net worth of some $600 million. In that sense, Continental was and
is solvent.
Mr. HUBBARD. Continental was and is solvent. Assuming it has a
positive liquidation value, doesn't that mean that you could have
paid off the depositors under those circumstances, assuming it was
solvent?
Mr. CONOVER. N O , I don't think it does. If you pay off the depositors under those circumstances, one of the things you do immediately is have a big impact on t h a t liquidation value. For example,
an awful lot of those borrowers, who may be perfectly good borrowers, may require additional funding in order to complete projects
t h a t they have underway. They may be depending on t h a t funding
from the bank under a commitment t h a t would not be honored by



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the FDIC because the FDIC does not make additional loans to customers, and the like.
Mr. HUBBARD. Lastly, just let me say t h a t there still is t h a t feeling in rural America t h a t the smaller banks are treated differently
than the OCC and FDIC did in regard to Continental Illinois. There
were 22 banks closed in Kentucky and Tennessee in 1983 and 1984.
Twelve of these banks were closed last year. Ten of these banks
have been closed this year. Of course, we realize Chicago is big. I
guess it is the same thing t h a t we have when a small corporation
in Russellville, KY closes and is forced to close, and they are gone.
But the Federal Government also bailed out Chrysler Corp. in big
Detroit.
Mr. CONOVER. Mr. Hubbard, let me say t h a t I understand the
feeling still exists in rural America, as you say it does. And I think
we need to work toward some mechanism—I will be the first to
admit t h a t I don't have t h a t mechanism in my hip pocket—so t h a t
we do treat large banks and small banks in a consistent way t h a t is
fair to both of them. The Continental situation and how we dealt
with it was obviously influenced by our judgment as to the impact
of failure on the Nation's, if not the world's, financial system.
Mr. HUBBARD. Forgive me for saying this, but folks in rural
America also think the decision was influenced by the 1984 Presidential election.
Mr. CONOVER. Sir, I can assure you t h a t the 1984 Presidential
election never came up, was never discussed. We didn't take it into
account for 1 second.
Chairman S T GERMAIN. Mr. Conover, where does Continental Illinois' rank in size among the banks of the United States of America? Is it 11th, 10th, 9th, 8th?
Mr. CONOVER. It seems to be moving.
Chairman S T GERMAIN. Where was it?
Mr. CONOVER. It was eighth, approximately.
Chairman S T GERMAIN. Number eight?
Mr. CONOVER.

Yes.

Mr. WYLIE. YOU have 11 multinationals?
Mr. CONOVER. Right.
Chairman S T GERMAIN. All right.
Ever see the fellow who is painting himself into t h a t corner? He
doesn't realize there is no door back there. And there is less floor
for him to walk over. I got news for you. You are painting yourself
in a corner because my question now is: Can you foresee, in view of
all the reverberations internationally t h a t you described, had Continental Illinois been allowed to fail, and all those people put out of
work and all those corporations out of money and all those other
banks t h a t would have failed, in view of that, can you ever foresee
one of the 11 multinational money center banks failing? Can we
ever afford to let any one of them fail?
Mr. CONOVER. The answer to that, Mr. Chairman, is that we
have got to find a way to. In order
Chairman S T GERMAIN. YOU are not answering.
Mr. CONOVER. In order to have a viable system.
Chairman S T GERMAIN. Mr. Conover, you said you don't have in
your hip pocket the solution for the small banks, and you are never
going to have it.



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The fact of the matter is, as a practical matter, neither you nor
your successors are ever going to let a big bank the size of Continental Illinois fail.
Mr. CONOVER. Mr. Chairman, it isn't whether the bank fails or
not. It is how it is handled subsequent to its failure t h a t matters.
And we have to find a way. I admit t h a t we don't have a way right
now. And so, since we don't have a way, your premise appears to
be correct at the moment.
Chairman S T GERMAIN. That is one of the prime reasons for
these hearings. We have quite a few, but one of our principal reasons is we have to make a decision. Do we allow, ever, a large bank
to fail?
Mr. Barnard.
Mr. CONOVER. I think it is important that we find a way to do
that.
Mr. BARNARD. Thank you.
Mr. M C K I N N E Y . Would Mr. Barnard yield for a moment so I
could follow through on the chairman's statement?
Mr. BARNARD. I want to follow through too, if you don't mind.
Mr. M C K I N N E Y . With all due respect, I think seriously, we have
a new kind of bank. And today there is another type created. We
found it in the thrift institutions, and now we have given approval
for a $1 billion brokerage deal to Financial Corporation of America.
Mr. Chairman, let us not bandy words. We have a new kind of
bank. It is called too big to fail. TBTF, and it is a wonderful
bank.
Chairman S T GERMAIN. The time of the gentleman has expired.
Mr. Barnard.
Mr. BARNARD. YOU know, I have six questions. I am sure I am
not going to cover all six. But each time I add one to the top.
Here is what concerns me, Mr. Chairman. All of a sudden, I am
having to do these in inverted order. What happens to t h a t resolution Congress passed in 1982 t h a t says t h a t the full faith and credit
of the U.S. Government is behind the insurance fund?
Chairman S T GERMAIN. Maybe we ought to repeal it.
Mr. BARNARD. Anyway, though, I think in a way t h a t has a relationship as to why the big banks don't fail. How do you respond to
that, Mr. Comptroller? Do you all take t h a t resolution into consideration?
Mr. CONOVER. N O , not really.
Mr. BARNARD. It just didn't make any difference, did it?
Mr. CONOVER. N O .
Mr. BARNARD. Well,

that is good. That solves that one.
You know, I want to draw a scenario. Here is a bank t h a t is a
good bank, a survivable bank. All of a sudden a rumor begins. It
starts to rumbling. This is a big bank. All of a sudden, the international press grabs hold of this. Here is a bank that is subject to
bankruptcy. Here is a bank subject to insolvency. Here is a bank
t h a t is going to be taken over by a foreign government. And it hits
the press. East, west, across the Pacific, into Japan, across to
China. Here we go. Aleutian Islands, Alaska, and Australia.
But here we go, all across the world, t h a t this bank is failing.
What is your remedy? Is there a remedy in law, especially when
the information is false?




301
Mr. CONOVER. When the information is false, you get into the dilemma t h a t I found myself in.
Mr. BARNARD. But you don't have a remedy in law, do you?
Mr. CONOVER. NO, I don't believe we do.
Mr. BARNARD. There are some State laws which say that anyone
who starts rumors t h a t cause failure of a bank can be prosecuted,
isn't that true?
Mr. CONOVER. I understand that t h a t is true in several States. It
is, as I understand it, not a Federal law.
Mr. BARNARD. Isn't it just as serious in this instance?
Mr. CONOVER. Absolutely.
Mr. BARNARD. A S crying "fire" in a crowded theater?
Mr. CONOVER. It is. You may not solve t h a t problem, however, by
simply passing a law t h a t says if you yell the equivalent of "fire"
in a movie house or a church, t h a t becomes a crime because it is
virtually impossible to trace the source of rumors and how they get
started, just as it is virtually impossible to find a leak that originate in your agency.
Mr. BARNARD. Are you telling us t h a t in this instance, though,
there had to be unusual steps taken because of this singular situation with Continental?
Mr. CONOVER. Oh, absolutely.
Mr. BARNARD. Although Continental had been rumored previously not to have been in the greatest of condition, on the other hand,
the rumors you feel like were tantamount to causing a run on the
bank?
Mr. CONOVER. The condition of Continental was well known. It
had not only been reported in the business press but had been reported in the popular press, in newspapers and magazines throughout the country.
Mr. BARNARD. YOU know, the thing about it t h a t concerns me,
though, as common as this practice could be, do you think we need
some Federal laws addressing unfounded rumors?
Mr. CONOVER. I think it would be wonderful to have them if they
could be crafted so t h a t somehow you were able to track down how
the darn thing got started. I guess I would like to have the tool. I
am uncertain as to how effective it would be in a lot of cases.
Mr. BARNARD. My question number three. One of the things that
is hard to understand, and I think this hasn't come up yet, I believe is an unusual treatment of the Continental Bank holding
company. You know, I can see for my own benefit that what was
done, as far as the bank was concerned, was to save the bank, to
save the depositors and look after their interest.
Wasn't there some unusual aspect of the refinancing as far as
the holding company was concerned?
Mr. CONOVER. Yes, there was. As a result of this transaction,
there was one undesirable outcome t h a t I will describe. In order to
do so, I have to step back and describe the two options that we had
available to us.
Mr. BARNARD. Mr. Chairman, since this is so important, I don't
think this ought to count against my time. Thank you.
Mr. LEACH. Mr. Chairman, on behalf of the minority, I think we
ought to have a semblance of some order, but I would certainly
hope that t h a t order would include full response to the gentleman
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from Georgia's question, which is so important, and certainly in relation to any other question any other member has, I am sure more
important.
Mr. BARNARD. Well, t h a n k you. Thank you, Mr. Chairman, and
Mr. Leach.
Proceed, Mr. Conover.
Chairman S T GERMAIN. Don't press your luck.
Mr. CONOVER. We had two options. One option would have
been
Mr. BARNARD. NOW, my question was, wasn't there some unusual
feature of the holding company?
Mr. CONOVER. That is correct. I will get to that. It may take me a
while, but this is an important
Chairman S T GERMAIN. Mr. Conover, if you take too long, you
will run out of time. I think you want him
Mr. CONOVER. This is important for the committee to follow because it may be t h a t there is some potential legislation t h a t should
grow out of this particular situation to correct the problem at
hand.
We had two options. We could put capital in the form of debt directly into the bank. We couldn't put preferred stock into the bank
because there were covenants in the bond indentures of the holding
company which said you couldn't do that unless you had the permission of the bondholders. In this case, they were holders of
bearer bonds which had been sold in Europe. Since we didn't have
a chance of getting the bondholders' approval, the FDIC could not
have acquired preferred stock in the bank. Its only alternative was
to put debt into the bank.
The disadvantage of putting debt into the bank was t h a t we
would have ended up with a very strange looking balance sheet.
There would have been a little bit of the remaining shareholders'
equity and a big pile of debt. We figured t h a t it was not going to
help the bank recover as it published its quarterly financial statements to have a balance sheet t h a t didn't look like a bank balance
sheet ought to look.
So we considered the other option—buying preferred stock in the
holding company and having the holding company downstream it
into the bank in the form of common stock equity. That satisfied
our goal of having a sound looking bank balance sheet when the
bank's financial statements were published. It had the undesirable
feature of propping up the holding company bondholders and commercial paperholders.
We knew t h a t at the time, and there was significant debate back
and forth about which was the preferable way to go. The Treasury
Department felt, and several memos were written to Mr. Volcker
and Mr. Isaac and myself, t h a t the alternative of putting debt into
the holding company was the preferable one because you could
always say "Oh, look, the Federal Government is standing behind
this bank, anyway." I felt and my fellow directors at the FDIC felt
and Mr. Volcker felt t h a t the appropriate way to go was the way
we went—buying preferred stock in the holding company.
Mr. BARNARD. Isn't that a dangerous precedent, though?
Mr. CONOVER. It is a dangerous precedent. It is bad public policy
as far as t h a t particular item goes. It can be corrected in one of two



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ways. Since we knew there was a way to correct it, we thought we
ought to do what was right for Continental, then discuss the problem and identify the ways to correct it and see if we could get some
corrective action taken.
There are two ways to correct it. One is that you can simply prohibit those kinds of covenants in bond indentures of holding company
Mr. BARNARD. Why would a bank want to issue bearer bonds?
Mr. CONOVER. The holding company issued the bearer bonds.
Mr. BARNARD. Why would the holding company want to issue
bearer bonds? Does it need money t h a t bad?
Mr. CONOVER. I don't know. That was a technique they used
in
Mr. BARNARD. IS t h a t a common practice with bank holding companies?
Mr. CONOVER. I am not sure how common a practice it is.
The second way t h a t you could deal with t h a t problem is simply
to grant the FDIC the authority to purchase preferred stock, or
common stock for t h a t matter, in a bank when certain emergency
conditions exist. In other words, the FDIC would be able to do t h a t
without getting a vote of either the bondholders or stockholders because of the emergency situation and because it was essential to
save the banking institution. The language t h a t would be required
to enact t h a t into law can be put on one side of one piece of paper.
It is a minor change in the Federal Deposit Insurance Act. That is
something t h a t you may as a committee want to consider discussing thoroughly.
Chairman S T GERMAIN. Excuse me. Hopefully, we won't have to
because we won't have another Continental Illinois. Then why
should we need this?
Mr. CONOVER. That is true, Mr. Chairman, but I think you also
want to make sure t h a t you have a regulatory system that is
armed with appropriate arrows and quivers to deal with any circumstance that might arise.
Mr. BARNARD. Mr. Conover, in your first classification of banks,
which have not been supported and which have been permitted to
fail, you mentioned fraud and similar
Mr. CONOVER. Ones t h a t have significant amounts of contingent
liability that might fall to the fund.
Mr. BARNARD. Does Penn Square fall into t h a t category?
Mr. CONOVER. It certainly does. The primary reason Penn Square
was treated as a payoff was t h a t there were massive contingent
claims well in excess of $l-$2 billion. Of course, because they were
contingent, no one knew what the total downside risk might have
been.
Mr. BARNARD. Mr. Comptroller, what has been done to correct
the problems of communications t h a t developed between the divisional supervisors of the Comptroller's Office in regard to Penn
Square and Continental?
Mr. CONOVER. Mr. Barnard, we were criticized, as you know, 2
years ago for a weakness in communications between our Dallas
office and the examiners who were dealing with Continental. We
achnowledged the weaknesses in the system at the time and took
corrective action as follows. First, we made changes in the call



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report. As of J u n e 1983, the call report contains a figure for participations sold, a clear flag we can look at to see if there are banks
t h a t have a significant amount of participations sold. Second, reorganizing our field offices into six districts enabled us to more conveniently get the deputy comptrollers who run those six districts
together. They meet monthly and discuss managerial and administrative problems, as well as problems of a supervisory nature involving individual banks where a problem in one bank might spill
over and become a problem at another bank. Third, we have issued
specific written procedures in 1983 and 1984 to examiners, as well
as to banks, on how to deal with these kinds of problems. Finally,
we have included these kinds of instructions in a training course
we give our examiners on how to deal with problem banks. So, as I
said, t h a t was a weakness we were criticized for 2 years ago. We
recognized it, and it has been fixed.
Mr. BARNARD. What about brokered funds? Do these call reports
also identify the amount of brokered funds that banks are negotiating?
Mr. CONOVER. At the moment, the call reports provide information as to certificates of deposit of over $100,000, but they are not
broken out by source. That is an improvement that would be helpful to us in monitoring banks which suddenly start taking on
Mr. BARNARD. YOU do support further disclosure of brokered
funds by financial institutions?
Mr. CONOVER. In a big way. Yes, I do.
Mr. BARNARD. I am interested in knowing

what part is played by
the individual audits of banks, the outside directors' audits? I
mean, why weren't some of these difficulties with Continental
alerted through the internal audit? And did you get to see a copy
of the internal audit? I mean of the audit?
Mr. CONOVER. Of the external audit?
Mr. BARNARD.
Mr. CONOVER.

Yes.

We normally get to look at both internal and external audit information. As to why the external auditors didn't
uncover something that would have been helpful in the Continental case, or in any other case for that matter, I am not sure. I think
there is a
Mr. BARNARD. YOU know, we found some continuity in t h a t problem. We found the problem in Penn Square. We found the problem
in the United American, where they were certified as a good, sound
institution. Two weeks later they were closed.
You know, this disturbs me. Is there a point in time when we
need to impose liability on these certified public accountants for
t r u t h in auditing?
Mr. CONOVER. Well, I think there is a liability that gets imposed
upon them in the form of suits that are filed against them in exactly those kinds of cases. I am sure t h a t the firms you have alluded
to in both the Penn Square and the Butcher cases are involved
right now in litigation that could be quite costly to them.
Mr. BARNARD. What about in the Continental situation?
Mr. CONOVER. I think that remains to be seen.
Mr. BARNARD. DO you think there is a possibility?
Mr. CONOVER. I don't really know. I think, if anything, the FDIC
may



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Mr. BARNARD. There have to be actual losses and
Mr. CONOVER. The FDIC may pursue a claim. I am not sure.
Chairman S T GERMAIN. Excuse me. Maybe they ought to at least
file suit now in the event that the nationalization bailout doesn't
work. Then there will be a loss to the FDIC, and we don't want the
statute of limitations to run.
Mr. CONOVER. Usually, as you know, Mr. Chairman, the FDIC
sues everybody in sight.
Chairman S T GERMAIN. All right.
Mr. BARNARD. Mr. Chairman, I appreciate the time.
Chairman S T GERMAIN. NOW, the moment we have all been waiting for.
Mr. Leach.
Mr. LEACH. The minority does appreciate the chance to participate at the hearings, Mr. Chairman. So I t h a n k you.
I would like, just for a moment, to begin at the beginning and
plough over some of the ground that has been covered before. As I
listened to your very careful testimony, Mr. Conover, I am struck
by the justification, which I think is plenty for the Continental
bailout.
But the question still remains whether there is any justice in it.
Can you, as Comptroller of the Currency, tell us explicitly whether
in your view the big, as well as the small, have the right to fail,
whether there are absolute guarantees t h a t exist today for big
banks that don't apply to small? And don't you see some irony in
the notion that, if a big bank gets into trouble and oversteps itself,
punishment will be in the form of Federal aid to compete against
rivals as a quasi-nationalized entity?
Mr. CONOVER. I am not sure what the question is, Mr. Leach.
Mr. LEACH. Can you tell
Mr. CONOVER. IS there equity today between small and large
banks?
Mr. LEACH. Yes.
Mr. CONOVER. I

have said I think there ought to be, which, I
think, implies t h a t there probably isn't at present.
Mr. LEACH. Second, are you implying a large bank does not have
the right to fail? That the repercussions are too great?
Mr. CONOVER. Well, I would say t h a t Continental did fail in several major respects. Remember, when a bank fails, the shareholders get wiped out. That applies to Continental. Management
Mr. LEACH. Not as yet.
Mr. CONOVER. Not as yet.
Mr. LEACH. There has been

an 80 percent dilusion of stock, but
that was already reflected in the market. If this bank survives,
there is some prospect t h a t the stockholders will
Mr. CONOVER. There is some chance.
Mr. LEACH. I understand your reluctance to answer specifically.
But let me go on then a little bit more. As you know, this Congress
and this committee had major jurisdiction over a lot of this, funded
legislation to bailout Lockheed, Chrysler, New York City.
These acts were very controversial, but they were debated. They
received the support of Congress. They received the signature of
the President of the United States.



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Do you see any irony or unseemliness in the fact t h a t the only
approval required for the regulator's approach is a formal vote of
the shareholders of the bank to be saved rather than from the taxpayers and their representatives in Congress who may have to foot
the bill.
Mr. CONOVER. I certainly see it as ironic that the shareholders,
acting last, seem to have the final word in effect on whether the
deal as proposed goes through.
What I thought you were going to get at was the fact t h a t in the
Lockheed, the New York City, and the Chrysler cases, those things
were debated before the Congress and signed by the President. In
this particular case, as the chairman has pointed out, this was
done, in effect, without such a process; the regulators got together
and did it.
Do I see anything inappropriate about that? Frankly, I don't. But
what I am relying on is the fact that Congress established a mechanism to deal with exactly these kinds of problems. There was no
mechanism established in law with a long-time organization in
place to deal with a Lockheed, a Chyrsler, a New York City, et
cetera. The FDIC and the Fed did, in this case, what Congress set
them up to do. Now if you want to, I suppose we could have a
debate on t h a t and rethink what the role of FDIC and the Fed and
the Comptroller's Office ought to be.
Mr. LEACH. Let me approach it in a different way. I think you
have a valid point. What we are dealing with is valid legislation on
the books granting the regulators wide discretion in how they deal
with book failures.
Here, then, the question is whether Congress should continue to
grant the regulators such broad powers and should pass sense of
the Congress resolutions stating that full faith and credit of the
U.S. Government rests behind the deposit insurance fund. And so
one of the interesting questions is to ask, why the problem in the
first place.
Second, what to do about this or similar problems in the future?
Let me in terms of confidence in Congress go back to why the
problem. And then talk a little bit about the future.
In terms of why the problem, it appears we had a bank t h a t enjoyed rather rapid growth. It was defined as a "go-go" bank.
The regulators weren't the only ones fooled. Duns Review mentioned it as one of the five best managed companies in America. So
it isn't just that the regulators alone were out of step.
Perhaps the press had as poor judgment as a Federal bureaucrat.
But it should be stressed t h a t Continental didn't operate just as
any other bank.
As this committee looked at Penn Square, we found it was unusual in t h a t it operated as a merchant bank rather than commercial bank and it didn't have particular adequate safeguards. With
regard to Continental, it appears what we have is a merchant
bank's bank. Also, without adequate safeguards.
And yet, despite the unusualness of both of these banks, but I
don't want to put Continental quite in the same category as Penn
Square, the examiners gave an "A OK" approval to the adequacy
of the capital ratios. And I just think it isn't good enough for you
to imply in your statement today t h a t you didn't foresee, as many



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in the economy didn't foresee, a downturn in oil prices. Regulators
clearly missed the mark.
If Continental had had the same capital ratios as the superintendent of Iowa Banking requires for Iowa banks, that is, about 9
percent, and if the bank had been forced to writeoff loans as rigorously as the superintendent of Iowa banks requires of Iowa banks,
this problem would not have existed.
That is why we are where we are today. The way you solve the
solvency problem is with more capital and this committee certainly
feels very strongly t h a t the private sector solution is better than
the public and t h a t is t h a t the regulators simply demand that
banks have a stronger capital base.
Mr. CONOVER. I couldn't agree more. I am sincere in that. We
have been working to increase capital levels in the multinational
banks for some time. And, as you know, we are about to take the
next step in t h a t regard.
Mr. LEACH. Let me stress under your leadership that has been
happening and this committee and the Congress is observing that.
And I would only add as a footnote t h a t the strongest and the most
secure way you add to capital is the old fashioned way.
That is selling equity. One of the odd ironies in the capital base
calculation is t h a t items t h a t are debt reserve are allowed to be
called capital. This raises some doubts in the views of some t h a t
have looked carefully at the issue.
I would certainly stress to you t h a t what is happening at this
time under your leadership is to be appreciated. I would also stress
that as we look back over the last decade, it appears that the
Comptroller's Office, to some degree, has been caught with its
pants down. It isn't a wild, new phenomenon t h a t was not observed
7, 8 years ago, whether it be in Congress or by a number of observers of the banking system, t h a t problems were bound to arise when
you had 25 percent real growth in Eurocurrency markets and large
banks growing at a faster rate than their capital base.
So what you are doing now is catching up with what I think was
a little bit of looseness in past years, t h a t 1975 to 1982 period, in
particular. So what you are doing now is correct.
But let's not assume t h a t regulators have anything but a little
bit of blot on their record. Let me just come back to the issue
which I think is the most important one for this committee, and
t h a t is where we go from here.
From several of your statements, but more importantly, from a
number of comments t h a t have been made privately, as well as
publicly, it appears t h a t one of the reasons t h a t is really at the
forefront for moving in on Continental the way you did is concern
about this international issue of what do we do if one of our banks
fails and a lot of international banks lost a lot of money?
Do we have a real confidence crisis in international banking, per
se? Here I would only suggest that there is more than one way to
skin a cat.
That is, a 100-percent security for 100 percent of depositors
makes sense only if there is no clearly understood alternative in
advance t h a t is well worked out internationally.
In t h a t regard, it strikes me that if there is a little bit of a failure in the regulators approach up to this point in time, it has been



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t h a t there has been no clear standard or alternatives, and no preparation in the sense of a warning to international depositors as
well as domestic that in essence, management of funds involves
risks.
When you take risk, you may lose something. That is why it
strikes me t h a t the regulators might well want to consider the
notion that, in the event of a large bank insolvency or failure, perhaps the role of the FDIC should be to step in and guarantee a percentage or pro rata portion immediately of deposits t h a t are uninsured.
And, for example, if you take the Continental issue, you have
argued to this committee—and I am not, frankly, totally persuaded
t h a t basically at all times you had a solvent institution. If it were
terribly solvent, one presumes the marketplace would have vindicated it and another bank or private investors would have come in
and taken it over.
So at least the marketplace disagrees with that assessment. In
any regard, most who have looked at the bank think it might have
been insolvent at the most up to about $5 billion. Five out of forty
would imply that the most t h a t would have been lost would have
been 15 cents on the dollar for the uninsured depositors.
Therefore, if the regulators had in place a mechanism t h a t everyone knew and understood in advance t h a t there would be a payout,
and let's say it is 80 cents on the dollar for uninsured deposits, you
would have a system by which there would be risk management of
funds in which risks would be taken and in which the FDIC would
not be on the line which the taxpayer also would not be on the
line.
And I think t h a t type of approach ought to seriously be considered by the regulators. And let me just ask, are there other alternatives that are being considered? Or is a 100-percent payout the
only thing t h a t you are considering at this time?
Mr. CONOVER. I agree with you if we can design such a system
and put it in place so that everybody knows in advance. I am not
sure exactly how you do that, but you say starting J a n u a r y 1, 1986,
we are putting you all on notice that it is going to be like this from
now on. Of course, nobody will believe you until the first one is
really done that way.
You have touched on the fact that the deposit insurance system
needs to be reevaluated and perhaps revamped. We think so, too.
The approach that we tried as an experiment in 1984—the so-called
modified payout system—was an attempt to provide some market
discipline on the part of large depositors by letting them know in
advance t h a t they were going to be subject to some loss in the
event t h a t a bank failed.
There has been a lot of hue and cry about that particular practice. And, as I say, I haven't seen the final report on the evaluation
of it. But it was an attempt to try something different, to see if we
couldn't get large depositors to pay more attention to where they
were putting their funds and thereby provide leverage on the management of those institutions to keep their house in order and run
their affairs in a prudent way.
I think t h a t is still a fundamentally sound principle. Whether
the modified payout practice is the one t h a t ends up being adopted,



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I am not prepared to say. But we need something like that, and we
need to implement it carefully over time, in a way t h a t does not
provide a tremendous shock to the system and does not have people
screaming, "Gee, we didn't know."
Mr. LEACH. I appreciate t h a t and I couldn't agree more fully
with what you have just said. Let me conclude, Mr. Chairman, with
the observation we all know t h a t there is some concern in the financial community t h a t gets quickly reflected in this committee
between divergences between small banks and big banks and their
guarantees.
But I would like to move away from t h a t and stress two things.
One, t h a t there are implications for how the money supply is managed if one doesn't have a given kind of prudence in the banking
system.
But, second, in a way, more importantly, there are implications
for where there is economic growth in the economy, nationally and
worldwide. Let me just give a contrast.
I have a hometown called Davenport t h a t has a marvelously safe,
dominant bank. It makes few loans, has an exceedingly high capital ratio.
But, in a way, the bank has operated for less growth and more
security, and the community itself has somewhat suffered in comparison with a larger community t h a t has a less safe bank and
more growth in the banking system.
And as we look at where the growth in banking is, it is not too
foolish to suggest that, if you allow bank growth abroad, you, in
effect, allowing foreign governments to grow at a pace faster—foreign economy at a pace faster t h a n the domestic and t h a t the real
issue is not so much the big bank/small bank contrast in terms of
who gets the earnings, but who gets concerned.
And in t h a t service area, all of us have a great deal of concern.
That is why I think it is so important t h a t regulation be evened
out, not so much for small banks to compete in an earning sense
with large banks, but for small communities to compete and receive funds in comparison with the larger communities, or in the
case of the last several decades, with other countries who are being
better served by the American banking system t h a n the hinterland
parts of this country, all as a function of regulation.
In other words, t h a t you, sir, as Comptroller of the Currency,
have governed the largest amount of foreign aid ever given by this
country, including the Marshall plan, including the sum total of
AID, as a function of regulation.
That may be good, or it may be bad. But I think we have to understand t h a t what regulation is all about is where money flows.
And if you regulate in one direction, it flows one way. If you regulate in another, it flows another.
And t h a t is the primary reason I think this committee ought to
be very concerned about evenness and fairness in the actions and
rules and regulations t h a t you as Comptroller of the Currency put
forth.
Mr. CONOVER. I agree with you, Mr. Leach. I think you may have
just given a very strong argument for interstate banking. Many of
those



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Mr. LEACH. The argument I have given is for fairness in regulation.
Mr. CONOVER. I would agree with that, but I think fairness in
regulation also means having the freedom to operate in domestic
geographic markets. Many of our banks which are being criticized
for having gone overseas and made loans overseas did so because
they didn't find domestic outlets and domestic opportunities.
Chairman S T GERMAIN. And they didn't do so because the interest rates were so much higher, and the potential profits so much
larger.
Mr. CONOVER. I am sure t h a t had something to do with it, but
t h a t changes over time, too, as you know.
Chairman S T GERMAIN. Incidentally, how many oil and gas wells
are there in Chicago, IL?
Mr. CONOVER. None that I know of.
Chairman S T GERMAIN. YOU know, earlier you said in answer to
one of the questions that it was inevitable that banks go into certain areas of lending, like forestry, agriculture, automobiles, steel,
and so forth.
That is why I wondered, how inevitable was it for Continental
Illinois to go into lending on oil wells and gas fields. I think they
did t h a t by choice because they were looking for a high return.
My next question is going to be to you, for the record, I would
like to know, what amount of the loan portfolio was lent within the
city limits of the city of Chicago, IL, by Continental Illinois Bank?
Mr. CONOVER. I think we can provide you with that.
Chairman S T GERMAIN. YOU can provide t h a t for us?
Mr. CONOVER. Yes.
Chairman S T GERMAIN.

I think some of my colleagues, one in
particular might be interested in that. He and I, I bet, would enjoy
that.
It goes beyond the trivial pursuit question.
Mr. CONOVER. Yes, I understand. I think you will find t h a t it will
be a relatively small percentage.
[In response to the request of Chairman St Germain, the following information was submitted for the record by Mr. Conover and
may be found on page 367.]
Chairman S T GERMAIN. Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
Mr. Conover, maybe now you understand why I would like t h a t
information on foreign investment in the bank and loans t h a t we
are talking about in terms of this particular problem.
I followed with interest some of your responses. I can't really let
the problem pass in terms of suggesting you treated both the small
and large institutions similarly in terms of the past 2 years.
The fact is that this bank has been nationalized, with 80 percent
of the stock in the holding company and the downstream method
t h a t you commented about. The question is whether you took 80
percent of the small banks. Instead you provided for merger, that
was a market type of transaction, other than whatever the value
was to expand t h a t bank into t h a t marketplace.
Is t h a t accurate?
Mr. CONOVER. Yes, t h a t is accurate. In this particular case,
we




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Mr. VENTO. Where is the market test in this?
Mr. CONOVER. The only market test in this is that we tried very
hard for a private sector solution before we ended up
Mr. VENTO. I mean the point is this is far and away different. I
understand that, but this is far and away different to any type of
comparable treatment to what was divied out to the others when
there were mergers. Whether or not there should have been mergers is a different question.
This is far different treatment. There is no market test in this
particular example, is that accurate?
Mr. CONOVER. Well, I agree with that in that, as I said, we looked
for a private sector solution and didn't find one.
Mr. VENTO. HOW long will it be before the nationalization of this
bank is concluded? How many years into the future are we going to
have this 80 percent stock in this bank?
Mr. CONOVER. It is hard to say. Here is what I think has to
happen. First of all, obviously, the stockholders need to approve the
deal. Then the bank has to get back on its feet in a way that will
attract the marketplace back to it. It has to start reporting quarter
to quarter profits. It ought to be positioned to do that because we
positioned it t h a t way. Then it is a question of how many quarters
of profitable operations have to pass until it makes sense
Mr. VENTO. What is the order of payout t h a t will occur?
I assume you or someone else will be doing the voting in the national government from the regulatory standpoint; is that accurate? You will be voting that 80 percent stock in the holding company?
What would happen first? Will the discount window be paid off
first? How will this work? Will the FDIC get their billion dollars
back first? What is the order of managing this particular matter?
Mr. CONOVER. The order is that the shorter term debt will get
paid first, debt to the Fed and the banks, because that is debt. And
the FDIC has a preferred stock investment in the holding company.
Now as the bank gets healthy, and let's say it reports x quarters of
good earnings and it pays back the Fed borrowings and the bank
borrowings, there comes a time when it is appropriate for the FDIC
to make the bank private again. It has several options in doing that.
No. 1, it could sell what is then a healthy institution to another
domestic or foreign bank. No. 2, if it seemed like it would get a better
price, it could hold a public offering. It would have an underwriting
and sell the shares to the public, thereby returning the bank to total
widespread private ownership.
The intent is to return the bank to private ownership as soon as
possible.
Mr. VENTO. Can you give us any type of timeframe at all, Mr.
Conover?
Mr. CONOVER. I think you are going to get different judgments on
this. You ought to ask Bill Isaac for his and Paul Volcker for his.
As far as I am concerned, I think we are looking at a couple of
years of reported profits before it would make any sense to
Mr. VENTO. What is the position of the bearer bonds you talked
about in the bank t h a t are held by a multiplicity of individuals?
What would have been the loss if the bank, if you had permitted
the bank to fail?




312
Mr. CONOVER. The bearer banks were in the holding company.
And if the bank had failed, chances are the holding compay would
have become bankrupt. The assets and liabilities of the holding
company were a close, but not an identical, match.
Mr. VENTO. HOW much?
Mr. CONOVER. I said a close, but not an identical, match, so t h a t
there probably would have been some loss to those bearer bond
holders.
Mr. VENTO. I was trying to get an amount.
Mr. CONOVER. I don't have it.
Mr. VENTO. YOU have no idea how much we are protecting in
t h a t instance. One of the nagging problems this obviously is the supervisory role t h a t you played.
I am sure it is troublesome to you and to your predecessor with
regards to Continental Illinois. After all, it involved a supervisory
agreement. It involved management.
In a sense, I suppose one might say t h a t really you had your shot
in terms of trying to correct this bank, but for some reason t h a t
didn't happen. I would like to try and establish some of the problems t h a t existed, Mr. Conover.
As you know, the national bank examination reports are transmitted to the bank board of directors with a cover letter from the
Deputy Comptroller for Multinational Banks which sets forth these
matters upon which the board is expected to act.
It is our understanding the board is supposed to review the
transmittal letter and the examination report and reply in a timely
fashion. Mr. Chairman, I have a series of those letters t h a t will be
presented to the members t h a t are still with us.
I would like them to be made a part of the record. They result
from materials starting in 1979, I think, going all the way through
1982.
Chairman S T GERMAIN. The gentleman asks unanimous consent.
Is there objection?
The Chair hears none.
[The material submitted for the record by Congressman Vento
follows:]




313
PERTAINING TO OCC EXAMINATION
COMMENCED: May 21, 1979
CLOSED:
August 3, 1979

Washington, DC, October 25. 1979.
BOARD OF DIRECTORS,

Continental Illinois National Bank and Trust Company of Chicago,
Chicago, IL.
LADY AND GENTLEMEN: This letter is supplemental to, and part
of, the enclosed combined specialized report of examination. The
examination, performed by National Bank Examiner Allan J.
McCarte, was concluded on August 3, 1979. The purpose of this
letter is to highlight matters in the examination report which deserve the attention of the Board of Directors. Since it is part of the
report of examination, its content is to be treated with the same
degree of confidentiality. The report is divided into five sections:
Commercial, International, Trust, Electronic Data Processing, and
Consumer Affairs. Each director is requested to review this report
with particular emphasis on the examiner's Letter to the Board of
Directors and letters to management accompanying individual sections. Viewed in the aggregate, the examination results reflect favorably on management, however, we direct your attention to the
certain areas warranting attention.
Classified assets remain high equaling 30% of gross capital
funds. This figure does not include [words deleted] and related lines
which were classified as Uniform National Credits subsequent to
the close of the examination. While the decrease in assets classified
as doubtful and loss is favorable and encouraging, intensified efforts on the less severe classifications are important in view of current economic uncertainty.
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 were 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 overemphasized.
Another area of concern is the credit card program. The mass
mailing of credit cards produced significant growth in outstandings,
but also resulted in a number of problems. A breakdown in controls at the inception of the program was a contributing factor in
the S10MM in charge-offs recorded in the first four months of this
year. While management expects a substantial moderation of these
losses through the remainder of the year, careful monitoring of the
program will be required.




314
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.
The bank has developed a well-managed program for funding
purposes. Liquidity world-wide is satisfactory. Vulnerability to a
high level of purchased rate sensitive funds is regarded as a part of
the bank's funding environment.
There were a number of violations of law and regulation cited in
the report of examination. Violations of the consumer laws has resulted in uncertainty regarding overcharges to some of your customers. Violations outlined require remedial attention.
Several parcels of other real estate owned are cited in the report
which are carried in excess of the appraised value. In accordance
with Interpretive ruling 7.3025(e), carrying values which exceed appraised values must be charged-off.
For the purpose of monitoring compliance with laws and regulations, please provide a response outlining action taken or contemplated to correct violations. In addition, please indicate the dates
on which entries are processed for the amounts classified as loss in
the report of examination, and respond to Other Matters Requiring
Attention in the Trust section of the report of examination.
All correspondence should be addressed to Comptroller of the
Currency, Administrator of National Banks, Attention: Billy C.
Wood, Deputy Comptroller for Multinational Banking, Washington,
D.C. 20219, with a copy to Rufus O. Burns, Jr., Regional Administrator of National Banks, Sears Tower, Suite 5750, 233 South
Wacker Drive, Chicago, Illinois 60606.
Sincerely,
BILLY C. WOOD,

Deputy Comptroller for Multinational

Banking.

Enclosure.
CONTINENTAL BANK,

Chicago, IL, June 13, 1980.
Mr. BILLY C. WOOD,

Deputy Comptroller for Multinational Banking,
Office of the Comptroller of the Currency,
Washington, DC
DEAR MR. WOOD: AS requested, we are writing in response to the
last Combined Report of Examination reflecting work done by your
staff at our Bank. As agreed in advance with you, we are responding to the comments referenced in your transmittal letter which
accompanied the Report.
It was noted that classified assets "remain high equaling 80% of
gross national funds." Recognition was also given to decreases in
the more severe classification categories, but current economic uncertainties were also noted. We are heartened by the substantive
reduction in the ratio of classified assets to capital that has occurred since the high point of 1977 las reported in the examination
of that year), and with the noted shift into the less severe catego-




315
ries, but we are by no means satisfied with the ratio level as reported in the current examination. Further, we share your concerns about the effects of a probable recession. Please be assured of
management's continual and close attention to this matter.
Comment was made about the credit review system with respect
to both the identification of, and the rating of, loans. In addressing
the first comment, concerning unrated credits, we have implemented a control feature which includes a periodic reporting mechanism
to monitor unrated credits. We feel the mechanism is working well.
The second comment, concerning the rating of loans is more difficult to address because of the subjective nature of the evaluation
and rating process. A review of the specific loans in which there
was material evaluative difference disclosed an appreciable incidence of timing difference. That is, there had occurred a change in
the borrower's fortunes of a material nature between the time the
credit had last been rated internally and the time the examiners
rated it; for those cases, our credit review team would agree that
the examiners' rating constituted a more adequate evaluation with
the benefit of the information obtained subsequent to the internal
rating date. There were, however, several instances in which the
rating differences appear to stem from judgmental positions. We
must confess that, in retrospect, we were somewhat surprised that
such instances of judgmental differences have not been noted in
the past. Given the necessarily subjective element in a credit
rating process, occasional differences of opinion would perhaps not
be unusual. We would anticipate, however, that such instances
would involve rather narrow judgmental differences and would in
all cases call for re-review by the internal rating staff.
Your letter commented on the level of charge-offs in the Credit
Card program and acknowledged managment's expectation of a
moderation in the loss factor. We are pleased to report the loss
levels have moved approximately as we anticipated.
Mention also was made of a decrease in the ratio of equity capital to total assets since 1976, and the observation was made that if
the rate of growth continues to outpace internal capital formation,
external sources should be identified to support asset leverage. We
consider the issue of capital adequacy and the leveraging levels to
be matters of paramount importance and they remain under constant review and analysis. Be assured we continue to seek opportunities to take advantage of favorable market situations.
We are pleased to advise you that all amounts classified as "loss"
or which were directed to be charged off were charged off shortly
after receipt of the Combined Reports of Examination. Thus, all
charge-offs were reflected in our 1979 Financial Statements.
The Trust Section of the Report contained a comment on the
"Other Matters Requiring Attention" page concerning the manner
in which the Trust Department fulfills the obligation to audit or
review individual Trust accounts. The thrust of the comment concerned a discrepancy between the written policies and procedures
of the Trust Department, and the policies and procedures of the
Auditing Division. We are pleased to advise you that the written
procedures in the Trust Department have been brought up to date
and now agree with the written procedures of the Auditing Division.




316
A number of instances of non-compliance with regulations were
noted in the Consumer Section of the Report. We are pleased to
report that corrective action has been taken for each instance of
noted non-compliance. Also, the examination noted three violations
of the Municipal Securities Rule Making Board rules; we are
pleased to report that all have been corrected. To return to the
area of consumer protection, we have completed a review of our
consumer protection law compliance mechanism, and we are revising our internal structure and methodology better to assure an acceptable level of compliance in the future.
We would like to take this opportunity to offer some observations
on the new Combined Examination concept which, on the whole,
we consider beneficial and which we encourage you further to
follow and develop. We do feel unused lines of credit should be excluded from reports of classified credits and from country outstandings. As you know, our feelings is that, as a practical matter, banks
will take appropriate action when either an individual credit or a
country deteriorates in credit quality, and unused lines (which we
differentiate from unused legally binding commitments) should not
be included in evaluative totals. While the absolute dollar diference
caused by this definitional difference is not great with respect to
our Bank, we made the suggestion, both as a matter of principal
and of practicality.
Finally, the Trust Section of the Report contains a full reproduction of the annotated list of pending litigation facing our Trust Department. The criteria used to develop this list was, by decision of
the examiners involved, different than the criteria used to request
similar litigation reports for the Bank as a whole. We suggest that,
first, the criteria for Trust be the same as for the rest of the Bank,
and second, that the entire list of Trust litigation not be reprinted
in the Report. Our concern here revolves around the continuing
erosion we observe in the confidentiality of Examination.
If you have any questions, please do not hestitate to call.
Sincerely,
DONALD C. MILLER.
COMPTROLLER OF THE CURRENCY,
ADMINISTRATOR OF NATIONAL BANKS,

Washington, DC, June 20, 1980.
Mr. DONALD C. MILLER,

Vice Chairman Continental Illinois National Bank and Trust Company of Chicago, Chicago, IL,
Dear Mr. Miller:
Thank you for your letter responding to the combined Report of
Examination of May 21, 1979. We have noted those areas in which
corrective action has been initiated or effected and took note of
your concerns.
With regared to your response to the comment on the credit
review system, we acknowledge that the process of evaluating
credit quality contains a fair measure of subjective analysis. However, one of your comments cause us particular concern. You state:
"A review of the specific loans in which there was a material
evaluative difference disclosed an appreciable incidence of timing
difference. That is, there had occurred a change in the borrower's




317
fortunes of a material nature between the time the credit had been
last rated internally and the time the examiners rated it; for those
cased, our credit review team would agree that the examiners' ratings constituted a more adequate evaluation with the benefits of
the information obtained subsequent to the internal rating date."
We feel that this situation reflects a need to focus on the timeliness of your problem loan identification system. It is important to
identify potential deterioration at the earliest possible time in
order to respond appropriately. The full impact of the current recession is unknown at this time, however, we do know that detection of financial deterioration of borrowers generally lags behind
economic indicators. Based on this knowledge, an increase in loan
problems can be expected in the months ahead. Generally, the
credit officer is the first to become aware of changes in a company's financial condition. In order to improve the timeliness of the
credit rating system, the credit officers coilld serve as the vanguard
of an early warning system to alert management and the Loan
Rating Committee of impending problems.
A copy of your letter has been forwarded to the examiner-incharge of the 1980 examination. Your comments will be given full
consideration during the examination.
Sincerely,
BILLY C. WOOD,

Deputy Comptroller for Multinational

39-133 0—84

21




Banking.

318
PERTAINING TO OCC EXAMINATION
COMMENCED:
JUNE 23, 1980
CLOSED:
OCTOBER 30, 1980

Washington, DC January 13, 1981.
BOARD OF DIRECTORS,

Continential Illinois National Bank and Trust Company of Chicago, Chicago, IL. •
MEMBERS OF THE BOARD: Enclosed with this letter is the combined report of examination which was completed on October 30, •
1980 by Senior National Bank Examiner Allan J. Mc Carte. The
purpose of this letter is to highlight matters discussed in the report
which deserve your attention. Since it is part of the report of examination, this letter is to be treated with the same degree of confidentiality. The report is comprised of four sections: Commercial,
which also includes comments on International Operations; Trust;
Data Processing; and Consumer Affairs. Each director is requested
to review this report with particular emphasis on the examiners •
Letter to the Board of Directors and letters to management accompanying individual sections.
The results of the examination indicate that, overall, the institution is sound and well managed. Although no major problems were
disclosed, there is concern over asset quality and the several violations of regulation in the trust area. Earnings have reached new*
highs, primarily on increases in assets; such growth has also resulted in increased leverage.
The level of criticized assets remains high at 82% gross capital
funds. Although the preponderance of such assets do not carry a
high loss potential with actual classifications declining since the
previous examination, there are, nevertheless, continuing significant losses from the consumer portfolio, especially credit cards.
It is recognized that reduction of criticized totals may be difficult
given the current environment. In this context, appropriate consideration should be given to the comments concerning the internal
credit review program which appear in the examiner's "Letter to
the Board."
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.
Earnings, the primary source of the institution's capital, continue
to reach new highs. However, the increases have emanated primarily from higher levels of earning assets. On a quarterly basis for
1980, earnings have fluctuated significantly. The unprecedented
movements in interest rates were a major factor in those results.
Such volatility also underscores the importance of quality in earn


319
ings and the need to continue considering alternative sources of
capital.
For the first time, all three of the primary segments of trust activities were examined: domestic, stock transfer and international.
The results indicate there is a need to enhance the audit process
and improve certain operational controls in several areas both domestically and overseas. There were several violations of regulation
dealing with administration of fidiciary powers, funds awaiting investment and records accessibility.
In Consumer Affairs, several violations of the regulations were
disclosed. Progress achieved to date in improving the compliance
performance should be continued. The bank's community reinvestment program is conducted satisfactorily with no noncompliance
situations disclosed.
The Data Processing function was found to be managed satisfactorily. Threats posed by a major disaster involving data processing
activity are recognized by management and while steps have been
taken to minimize the risks, it is an area deserving continued
awareness.
Several violations of law or regulation other than those mentioned before are noted in the commercial and consumer affairs
areas. All such citings require remedial action.
For the purpose of monitoring compliance with laws and regulations, please provide a response outlining action taken or contemplated to correct violations. Also, please furnish responses to comments in the examiner's Letter to the Board of Directors and Matters of Major Importance Requiring Attention in the Trust section.
All correspondence should be addressed to Billy G Wood, Deputy
Comptroller for Multinational Banking, Comptroller of the Currency, Washington, D.C. 20219, with a copy to Rufus O. Burns, Jr., Regional Administrator of National Banks, Sears Tower, Suite 5750,
233 South Wacker Drive, Chicago, Illinois 60606.
Sincerely,
BILLY C. WOOD,

Enclosure.

Deputy Comptroller for Multinational Banking.
CONTINENTAL ILLINOIS NATIONAL BANK
AND TRUST COMPANY OF CHICAGO,

July 9, 1981.
Mr. BILLY C. WOOD,

Deputy Comptroller for Multinational Banking, Office of the Comptroller of the Currency, Washington. DC
DEAR MR. WOOD: We are writing in response to Combined Reports of Examination tas of June 30, 1980) sent to us by your office.
Our response includes, but does not repeat in detail, the discussion
you had with our Directors' Audit Committee and with our Corporate Office, and it includes the results of the meeting in your offices between Messrs. Bottum, Hlavka, Miller, Johnson, and you.
As is customary, we are touching upon the the comments referenced in your letter of transmittal.
The Reports noted that criticized assets totaled 82% of gross capital funds, and the percentage was referenced with a comment
about concern over asset quality. The level of criticized assets has




320

been declining for five years in terms of absolute dollars, in terms
of relationship to gross capital, and in terms of severity of classification. We hope to see the trend continue as it is our goal to have
the lowest possible level of criticized assets consonant with a balanced portfolio that provides an adequate return while providing
our customary level of service to an expanding market share.
Comment was made that we have experienced ". . . continuing
significant losses from the consumer portfolio, especially credit
cards." The consumer banking credit losses in 1980 totalled $27.6
million vs. $30.2 million in 1979, and the 1980 experience indicated
a quarter-to-quarter declining trend over the year. We anticipated
an increase in losses at the time we embarked on a program of national expansion. Frankly, what we did not anticipate was the
effect of the economic turn-down and the sharp rise in bankruptcies because of the new Federal law. Overlayed on those market
factors were some unexpected developments such as problems in
our collection unit and problems with changes in technology. The
combined result has been a loss factor greater than we anticipated.
We think we have overcome the internal factors, especially by restaffing our collection unit in suburban locations, a move which is
showing very positive results. The level of losses and delinquencies
are coming down slowly, but they are still well in excess of the
levels we desire. This will continue to be a priority effort in the
Personal Banking department.
The Examiners' comments regarding our internal credit review
and rating system indicated it is functioning very well and appears
to be cost effective. The comment was, 'V. . raised because the existing procedure followed by the Rating Committee does not include any on-site or interim independent review." This comment
contains two points. The first refers to our program of having documentation sent to Chicago from branch and subsidiary units, with
all credit rating work being done there. Because of our genesis as a
unit bank, the natural evolution of the loan evaluation process was
a highly centralized effort. To date it has been successful and cost
effective, and we do not see any particular stresses or inadequacies
resulting from it. We do recognize, though, that as our business becomes more complex and we continue to expand with other offices,
the time may well come when it will be more appropriate to shift
to some form of on-site reviews. To that end we have been exploring the methodologies and examining the specific mechanisms by
which this can be done in a cost effective way. We contemplate an
experimental field review run some time in the next six to twelve
months. The second point in the Examiner's suggestion, that of interim review, relates to the practice of preparing a quarterly
Watch List report in which the individual lending officers submit
information on all deteriorating credits they are handling. In
almost all cases the individual lending officer is the first one to
spot potential problems, or a deteriorating situation, and we concur
in recognizing the importance of inducing the individual lending officers to report deteriorating situations as soon as possible so that
appropriate steps can be taken, but we feel the best way to elecit
appropriate behavior is through the commercial banking line organizations as opposed to the credit rating staff function. We will continue to stress this with our lending officers.




321
Your letter of transmittal comments that capital adequacy for
banks in general is a matter of growing concern to the Office of the
Comptroller. It was noted that our current level of capital is ". . .
considered adequate," but that the asset structure has been growing more rapidly than the capital base, and that for the past two
years capital generation has occurred through retained earnings.
You call on management to continue seeking alternative sources to
bring the capital and asset growth rates into balance. We have
been to external markets, notably debt markets, a number of times
in the past ten years, and we will have no hesitancy in going again.
Unfortunately, market conditions have ranged from bad to disastrous, and we prefer not to go until conditions are favorable.
The Combined Reports of Examination cite three violations of
law and regulation in the commercial section and several in the
consumer section. Needless to say, any such violations at Continental Bank are inadvertant. We are pleased to report that all citations have been corrected. The corrective action relating to the consumer affairs findings were as outlined in the Report itself. The actions taken with respect to the findings in the commercial section
were appropriate to the nature of the items (Board resolution,
property appraisal, etc.)
The Turst Examination portion of the Reports contains several
comments and recommendations which we accept, and concerning
which corrective action has been taken. There are, however, several comments with which we must respectfully disagree. A number
of alleged violations of Regulation subsidiaries; legal counsel advises us that Regulation Nine does not apply to the trust activities
of these foreign subsidiaries. The possibility exists, of course, that
new trust business in those subsidiaries may well bring Regulation
Nine into force at some future time, and—even currently—Nine is
one of several possible standards for use as a managerial tool; accordingly, we are making a study of these subsidiaries' trust activities using Regulation Nine as one of the evaluative yardsticks.
In the domestic trust Report a request was made that income
cash be reinvested for the time period between receipt and periodic
distribution to income beneficiaries. After careful study by management, we conclude such reinvestment at bank discretion is inappropriate under Illinois law.
A request was made for the internal auditors to increase the
number of so-called "administrative audits" performed and to
review our Law Department's work safeguarding against conflict of
interest and self-dealing in the Trust Department. Both of these citations and requests were made because of lack of conformity with
the "guidelines" contained in the Examiners Handbook. As we
have discussed with you at length, both in our offices and in yours,
we feel we have been undertaking actions in appropriate places in
our organization that more than adequately meet the underlying
needs that are the basis of the "guidelines" themselves. As we
agreed, the 1981 examination effort will, we hope, demonstrate this
to our mutual satisfaction.




322
If you have any questions, or if we may be of further assistance,
please let us know.
Sincerely,
DONALD C. MILLER,

Vice Chairman.
COMPTROLLER OF THE CURRENCY,
ADMINISTRATOR OF NATIONAL BANKS,

Washington, DC July 22. 1981.
Memorandum to Thomas M. Fitzgerald, Director, Multinational
Examinations.
From: Bruce Ellard, National Bank Examiner.
Subject: Continental Illinois—Report response.
The recently received response to the June 30, 1980 examination
does not address all matters highlighted either in the transmittal
letter or in McCarte's Letter to the Board. In several cases, the responses are simply a statement of disagreement; no comments are
given in particular instances although no critical issues were left
unaddressed. The letter appears to have been put together hastily—bank personnel apparently were embarrassed when it was realized a response had not been prepared. Also, the letter does not
follow directly either one of our pieces. While the letter is not fully
responsive, any follow-up would be better handled through the current examination. McCarte has a copy of the letter and has been
monitoring concerns from the previous examination. Our lingering
questions, generally, can thus be easily answered through McCarte.
Major outstanding items continue in the Trust area: (1) applicability of Regulation 9 to overseas subsidiaries of the holding company or bank, (2) investment of income cash and (3) administrative
audits. Number 1 has been referred to Doyle for clarification;
number 2 represents a point of contention between this Office and
several banks—a call for legal briefs seems to be the next step; and
number 3 awaits, at the least, bank submissions to the Trust examiner which the bank hopes will fulfill our requirements in a less
onerous fashion.




323
PERTAINING TO OCC EXAMINATION
COMMENCED: JUNE 1, 1981
CLOSED:
AUGUST 21, 1981

Washington, DC October 19, 1981.
BOARD OF DIRECTORS,

Continental Illinois National Bank and Trust Company of Chicago,
231 South LaSalle Street, Chicago, IL^OMS*DEAR BOARD MEMBERS: Enclosed with this letter is the combined
report of examination completed August 21, 1981 by Senior National Bank Examiner Allan J. McCarte. The results of the examination show the institution has sound management and good earnings. There are, however, areas of concern including the high level
of classified assets.
The primary focus of the examination again was on an evaluation of the credit portfolio. That credit review revealed a deterioration in the level of classified assets to 67% of gross capital funds
(GCF) and criticized assets to 99% of GCF from 61% and 82% respectively the previous examination. A significant increase was
shown in the level of doubtful assets which more than doubled. The
sharp increase is primarily attributable to one large credit which
was entering bankruptcy at the time of the examination. Management reports that, since that time, collateral documentation has
improved and the balance reduced significantly. While Continental's historical loan loss experience is among the best of the multinational banks, the current level of classified assets is quite high.
Continued close monitoring will be required to reduce classified to
a more satisfactory level.
The system for internally identifying problem credits works reasonably well; however, a number of credits are criticized/classified
in the report which do not appear on the bank's "Watch Loan
Report." While neither the number nor dollar amount of those
loans is currently a cause for concern, we feel the system could be
strengthened by performing random supplemental reviews in addition to the scheduled reviews as they are now performed. The examiner indicates that the Rating Committee is considering initiating on-site loan reviews. As part of those reviews, it is suggested
that a random sampling of loans, not appearing on the " Watch
List," be tested for credit quality.
In the installment lending area, no formal charge-off policy has
been formulated. Such a policy should be developed and implemented in the context of the policy of this Office as stated in Banking Circular 140.




324
Earnings continue at record levels on an absolute basis. Also, the
quality of those earnings appears to be good. 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.
The examination of the Data Processing function disclosed no
significant problems. The area has sound controls and is well managed. Management is encouraged to continue, without delay, the
development of measures to be taken in the event of major disruption or disaster with respect to data processing capability.
The Trust Department is operating under sound fiduciary principals. While the level of administrative audits is acceptable, given
the present scope of those audits, management is encouraged to increase the number of those audits.
The institution conducts a satisfactory program with respect to
Consumer Affairs and Community Reinvestment. There were no
noncompliance situations cited.
Please outline the remedial steps taken with respect to the violations of law cited in the report of examination and furnish the date
requested charge-offs were effected. A copy of a formal installment
loan charge-off policy should be provided when adopted. Also, provide responses to comments in the examiner's Letter to the Board
of Directors, Matters of Major Importance Requiring Attention in
the Trust Section, and Conclusions in the Data Processing Section.
Responsses should be directed to Billy C. Wood, Deputy Comptroller for Multinational Banking, Comptroller of the Currency, Washington, D.C. 20219 with a copy to Rufus Burns, Regional Administrator of National Banks, Suite 5750, Sears Tower, 233 South
Wacker Drive, Chicago, Illinois 60606. As this letter is part of the
report of examination, it should be treated with the same degree of
confidentiality.
Sincerely,
BILLY C. WOOD,

Deputy Comptroller for Multinational

Banking.

Enclosure.
CONTINENTAL BANK,

Chicago, ILf February 19, 1982.
Mr. BILLY C. WOOD,

Deputy Comptroller for Multinational Banks, Office of the Comptroller of the Currency, Washington, DC.
DEAR MR. WOOD: AS requested, we are writing in response to the
last Combined Report of examination reflecting work done by your
staff at our Bank. As directed in your transmittal letter which accompanied the report, we are responding to the comments you
have referenced.
It was noted that "this examination showed the level of classified
assets increasing from 61% of gross capital funds to 67%" and "the
level of total criticized to 99% of gross capital funds." We are concerned with monitoring the level of classified loans in the portfolio,
and keeping them to a minimum without establishing overly re-




325
strictive credit policies. We do not feel there is a problem of loan
portfolio quality, either in absolute terms or in terms of trend
when one considers the current state of economic environment.
Indeed, given the prolonged period of record high interest rates and
the state of the economy, it is surprising that more difficulties have
not surfaced. You may be assured that mangement will provide
close, continued attention to this matter.
Comments regarding the loan review system were generally very
positive in nature: however, three suggestions for improvement
were offered. In addressing the first comment, regarding credits
not rated on schedule, this matter has been receiving attention and
we expect to see imporvement. We have emphasized to lending personnel the need to address and resolve in an expedient manner
loans not rated on schedule. Furthermore, consideration is being
given to the need to review certain types of credits as frequently as
they have been in the past, thereby allowing the staff more time to
review other credits that will benefit from increased coverage. The
second suggestion concerned the strengthening of reports to the
Board by including, "A total stratification of the remaining assets
by quality rating." We feel this comment is due in large part to the
fact that our internal loan rating categories do not coincide with
categories used by your examiners. The quarterly reports currently
received by the Board track quite closely the more severe rating
categories and the movements "in" and "out" of those categories.
The cost/benefit to modify our operating systems to compile the information necessary to aggregate loans by ratings and to track
rating histories is unclear to us. The final suggestion deals with
your examiners feeling that a form of independent review by Loan
Administration, such as on-site reviews of loans made from nonChicago offices, could be instituted to insure the accuracy and timeliness of information presented to them. As you will remember, all
loans over $500,000 have always been reviewed by the staff here in
Chicago. The Loan Administration Division performed its first experimental on-site review at the Continental Bank International
Miami Branch Office in October, 1981. Additional exercises are
being scheduled, and an on-site review is currently underway in
Taiwan.
Your examiners comments regarding installment lending indicated that "A formal realistic charge-off policy should be developed."
This comment stems from a sector of the examination in which we
did not communicate with your examiners as effectively as we
should have. The Bank does, in fact, have a written policy governing the charge-off of installment loans. This policy is under revision, and the lending area is following an approximation of the anticipated revised policy; however, some of the credits cited by the
examiners should have been charged-off sooner. This matter will be
put in order in the near future.
Comments regarding capital adequacy identified the need to
"Bring capital growth in line with asset growth." Management recognizes the need to keep the Bank's leverage position within reasonable constraints. A great deal of time has been spent on this
issue in the past, and it is an implicit part of our strategic planning. This issue will continue to receive priority attention in the
years ahead.




326
The cited violation of the U.S. code involving unsecured credits
to affiliates and violations of the Municipal Securities Regulatory
Board rules were noted. Management has taken appropriate steps
to ensure that these violations do not reoccur.
We are pleased to advise that all credits classified as "Loss" in
the Report of Examination were charged off during the examination or in the third or fourth quarters. Thus, all charge-offs are reflected in our 1981 financial statements.
The Trust section of the report contained two comments requiring response. The first comment indicates that the Trust Department should be temporarily investing income cash generated in
trusts, whether or not the governing instrument authorizes it to do
so. Management continues to feel that under Illinois law, a fiduciary has no authority to invest income cash. This position has been
supported by legal opinions from our own Legal Department and
the Corporate Fiduciaries Association of Illinois. In the final point,
your examiners have again recommended that the Audit Division
should monitor the outside interests of Trust Department officers
and managers. We continue to feel that the annual survey and
monitoring of all officers' and managers' outside business interests
performed by the Law Department adequately addresses this issue.
It makes more sense for attorneys, rather than accounting graduates, to review questions concerning conflict of interests.
If you have any questions, please do not hesitate to call.
Sincerely,
DONALD C. MILLER.

Copy to Mr. Rufus O. Burns, Jr., Regional Administrator of National Banks, Sears Tower, Suite 5750, 233 South Wacker Drive,
Chicago, Illinois 60606.




327
Mr. VENTO. I am sure you are aware of the concerns we have
here. We are especially concerned about the lack of a timely response, it seems to me, with regards to receiving the letter and the
response from the board. Continental Illinois Bank took 8 months
to reply to a Deputy Comptroller Billy Woods' letter in 1979 transmittal letter, 7 months to reply to his 1980 letter and 5 months to
respond to a letter in 1981. Are these time periods comparable to
length of time other large multinational banks take?
I state this in the context of your pointing out how important 6
days were in terms of your impression of what was going on.
Mr. CONOVER. I understand. Those were rather longer response
times than we would normally expect from other multinational
banks.
Let me make a couple of points about something you said earlier.
The banks are required to read not only the letter of transmittal
but the examination report, period, all of it. In addition, with the
multinational banks, we meet with the board of directors, or its auditing and examining committee, and present the results of the examination. At least since I have been here, this is usually done
with a slide presentation given by the examiner in charge, who
conducted the examination. We spend several hours with them, discussing points in the examination, corrective actions that need to
be taken, and so forth, so that in many cases the actions that we
are proposing they take have been taken long before we get the
written response from the board.
Mr. VENTO. That is very interesting because in some of these letters—look them over—it seems first of all that some of the transmittal letters at least are very specific, but that the tendency is
that many of the key points are either not responded to or are
downplayed in terms of their importance.
I call to your attention that the first letter there was also from
Mr. Wood, October 1979, examination report, put Continental's
board of directors on notice regarding significant problems in the
bank's system for identifying rating problem loans—I quote. "The
importance of reliability of internal loan evaluation procedures, as
is an early warning mechanism, to control credit quality in a
growth environment cannot be over emphasized."
It took Miller of Continental 8 months to reply to that and come
up with, in his reply, as I said, it downplayed the significance of
Mr. Wood's comments. Mr. Woods' 1981 transmittal letter contained a variety of comments to the board regarding such matters
as the 1982 percent ratio of criticized assets to growth capital
funds. In fact, the capital had not kept pace with the asset growth.
Internal Office of Comptroller of Currency memorandum, July
22, 1981, said regarding Continental's response sent 7 months later;
this is what it said:
The recently received response, dated June 30, 1980, does not address all the matters highlighted either in the transmittal letter or in Mr. McCarte's letter to the
board. The letter appears to have been put together hastily. Bank personnel were
apparently embarrassed when it was realized the response had not been prepared.

So I think the point is that they are not even responding to some
of the concerns or many of the key concerns that are being raised.
How would you answer that particular type of criticism, Mr. Conover?



328
Mr. CONOVER. I would agree with you that incomplete responses
and responses that downplay something that we think is important
for the bank to do certainly call for us to tighten our procedures
and approaches to identify clearly what it is we want the bank to
do and to follow up to ensure that the bank does it.
Mr. VENTO. DO you think you have the leverage to get banks to
respond? We have a lot of money center banks in the country. It
appears to me you either don't have the will, determination or ability perhaps. And I probably chose the latter. The Government
simply is trying to deal with the large institutions, money center
banks; simply has been too timid.
Even as I look at some of the transmittal letters, they seem to
me to say on this hand you have serious problems. On the other
hand, they seem to be taking a different attitude. Let me get to a
different problem that points up
Mr. CONOVER. May I answer your question?
Mr. VENTO. Yes.
Mr. CONOVER. We

have the capability, and we have the will, and
we are in the process of doing just that.
Mr. VENTO. Well, the thing is you had supervisory agreements
t h a t were in place. I want to refer to one other instance. That deals
with the ratings of Continental and a dispute that occurs with
regard to what they call the CAMEL rating between the FDIC and
Office of the Comptroller. I am sure you are familiar with that dispute. It is a CAMEL rating of three or four and, of course, the Office
of Comptroller of the Currency is on the liberal side in terms of
trying to provide a more generous rating than the FDIC.
Here is what your Mr. Martin said with regard to the FDIC. Mr.
Martin, of course, who is working for the Office of the Comptroller
of the Currency,
The FDIC has no appreciation of the understanding of the strength and staying
power of large institutions, but rather continues to make assessments based upon
unclassified assets as a percentage of capital.

It sounds as though you are suggesting that a more generous
rating is in line. This is occurring in 1983, Mr. Conover, in light of
the whole record that existed. Maybe you ought to explain to the
committee what a CAMEL rating is and why Mr. Martin took the position t h a t he took with regards to this issue and what do you
mean by strength and staying power of money center large
banks—what Mr. Martin meant in that instance.
Mr. CONOVER. First of all, there is a uniform CAMEL rating system
t h a t is used by all the bank regulatory agencies as a way of describing and classifying individual banks. Ratings are assigned for
capital, asset quality, management, earnings, and liquidity. Then a
composite rating is developed out of the previous five ratings.
We provide all of our examination reports as a routine matter to
the FDIC. Included in those examination reports are the CAMEL ratings.
Mr. VENTO. Are there frequent differences betwen FDIC and
yourself with regards to these issues?
Mr. CONOVER. Occasionally that happens, just as you would
expect t h a t it would. After all, we are talking about a shorthand
method of putting a grade on a bank that was developed as a mech-




329
anism for communicating among bankers. It is not unreasonable to
expect t h a t one agency might in certain circumstances come up
with a different rating t h a n the other. I can't cite for you how
many times t h a t happens in a given year, but it is probably relatively few. Nevertheless, it is not a totally abnormal kind of thing
to have happen.
In the case of the dispute, if you will, our office in the person of
Mr. Martin and the FDIC went back and forth over the CAMEL
rating of Continental. At the time, we felt Continental warranted a
three rating. The FDIC felt it warranted a four rating. We felt t h a t
they were focusing more intently on the asset quality of the bank
in assigning t h a t rating. We were focusing more on the definition
of the rating, which indicated t h a t in a four-rated bank there was
significant probability of failure. So a number of memos were written by the two agencies. The fact t h a t t h a t occurred did not have
any impact on the m a n n e r in which we dealt with the bank.
Mr. VENTO. Except t h a t
Mr. CONOVER. In fact, at the end of the 1982 examination, we
downgraded the bank's CAMEL rating to four. I think the difference
of opinion on this subject has been overplayed.
Mr. VENTO. Mr. Chairman, I ask unanimous consent to have the
documents placed in the record.
Chairman S T GERMAIN. Without objection.
[The following documents in regard to the CAMEL rating of Continental Illinois National Bank were submitted for the record by
Congressman Vento:]




330

FEDERAL DEPOSIT INSURANCE CORPORATION^Vaihington. DC. 20429

OFFICE OF DIRECTOR -DIVISION OF BANK SUPERVISION

Kav 2 / 1 9 8 3

Mr. H. Joe Selby
Senior Deputy Comptroller
Office of the Comptroller of the Currency
Washington, D.C. 20219

A
RECEIVED

m s 1?#

Dear Mr. Selby:
This is in response to former Deputy Comptroller Martin's March 31,
1983 letter relative to conversations with Review Examiner Ralph
Hartman and Associate Director Stanley J. Poling, with respect to
the Continental Illinois National Bank of Chicago.
The primary issues, as I see it, are the composite rating definition
and how the FDIC distinguishes the differences between a "3" and "A"
rated bank. It is obvious from the rating which we have assigned to
the subject institution that we feel "there is an immoderate volume
of asset weaknesses or a combination of other conditions that are
unsatisfactory — they could reasonably develop into a situation
that could impair future viability and a potential for failure is
present but is not pronounced." That-is precisely the reason for
the rating assigned. We 4o oot feel that the rating assigned is
inconsistent with the composite definition contained in the Guidelines and Procedures for the Uniform Evaluation and Rating of Banks
(CAMEL).
The other issue discussed in Mr. Martin's letter is, and I quote,
"the side issue of the problem that could occur if composite ratings
by total assets are published by the two agencies." This concern is
valid and one vhich we share. However, to allow a fear of public
disclosure to mitigate the application of consistent standards would,
to a large degree, compromise our efforts to measure the risk to the
deposit insurance fund.
We are certainly willing to discuss this situation further with you
and attempt to reconcile our differences. We^should* Jiowavar^-xacognize.that our agencies will continue to have honest differences of
opinion.




331

o

EM]©[FM»™

Comptroller of the Currency
Administrator of National Banks

Washington, DC-20219
T The F i l e s
O
*** William £ . Kart
o,,,
SMM.I

February 1 8 , 1983
Continental Illinois National Bank
In late December I was contacted by Ralph Bartman of the FDIC
who stated that they had reviewed the Continental Illinois
report and had concluded that it should be accorded a composite
rating of 4. Mr. Bartman stated he was contacting me for the
purpose of getting my reaction. I asked him on what basis he
had reached that conclusion and he stated that he had "looked
at the loans and they don't look too good and the classified
was high." I asked him if he had recently familiarized himself
with the definition of a composite 4 and he stated that he
reviews it every day. I asked him if he felt the bank was in
danger of failure on the fairly near term and he stated no.
I then asked if he had focused on the prospect of failure
language that is contained in the definition and he said yes
but he was unable to reconcile his two statements. Mr. Bartman
at no time mentioned funding as an issue but rather said that
asset quality was the basis for his determination. I asked him
if he gave any credence at all to the fact that the bank made ^
an extraordinary loan provision of I482MM pre-tax and still
resulted in a profit for the year of $81 million and he stated
he was unaware of the full year's earnings for the bank but was
working with third quarter figures. Be was unimpressed with
the fact that the earnings trend had absorbed the massive
losses. I stated that before he reached his final
determination, I felt that we should make sure he had as
complete a picture as possible and perhaps we could sit down
and talk about it and he agreed.
About two weeks ago, X spoke with Jim Sexton and told him that
there seemed to be some disagreement on this and I felt that
perhaps the FDIC was limiting its views strictly to total
classified rather than looking through to the real threat to
solvency that such classified might present. X stated that I
would appreciate the opportunity to sit down and discuss it
before final determination was made and he agreed.




332
Yesterday Z received a call from Bob Ahrens who stated that
Stan Poling had phoned and stated that he was sending over a
letter stating their disagreement with the composite 3 and that
they were signing a composite 4. This morning I spoke with
Stan and related to him that both Ralph and Jim had agreed that
we would sit down and discuss the matter and I was a little
surprised that they had chosen to go ahead and stick with their
4 rating and merely submit a letter to us. Be stated that he
viewed it as a 4. I again asked him about the definition of
composite 4 and the bank's prospects of failure. Be also
stated he really didn't think the bank would fail but he felt
the ingredients in the bank were sufficient to justify the
rating and he further stated that he felt that they used a
different standard for assigning 4 ratings and since that was
their conclusion, he really didn't see any value to
discussion. I reminded him that the definition of a composite
4 was subject to interagency agreement but he again stated that
they viewed the rating system somewhat differently. Be then
suggested that we might discuss it in Tucson next week but
clearly that indicates they have no intention of seriously
discussing it if he expects it to take place in that remote
location without benefit of records. We did tentatively agree
that we would get together at a future time to discuss it.
I raised this issue by memo for two reasons: First, if the
agencies ever report composite rating categories by asset
totals there will be a substantial discrepancy which will no
doubt be easily traced to Continental. Second, I do find the
FDIC's attitude slightly shocking in that they admit that they
are applying a different set of standards for assigning such a
rating rather than following the definition which was arrived
at through interagency agreement. And third, it confirms for
me again, that FDIC has no appreciation or understanding of the
strength and staying power of large institutions but rather
continues to make assessments based upon classified assets as a
percentage of capital.
I am surprised that they did not follow through with our
agreement to discuss the matter and when they did decide
discussion was appropriate obviously indicated a cursory
meeting at a remote location, I see no need to have a formal
meeting later and do not intend to follow up.
This morning I was speaking with Jack Ryan on a number of items
and told him of the disagreement over the rating and he told me
his concern was that if those numbers ever got reported by
asset size that Continental would stick out and we would have
disclosed the rating for that institution and students of that
rating system would certainly perceive the insolvency
implications.
cc:

B. Joe Selby
William Robertson
Michael Patriarca




333
Mr. VENTO. In other words, you are suggesting—obviously, Office
of Comptroller is taking the attitude that the strength and power of
that bank is such that they deserve a lower rating simply because
they are a large institution. That is what this statement says, of
course. It may be taken out of the total letter.
The point is that is what it says. Obviously, you are aware of it.
And that is the attitude, I guess. Is t h a t right?
Mr. CONOVER. The letter says what it says. The judgment made
at that particular time was that the bank was more appropriately
rated three for the reasons spelled out in Martin's memo. As I say,
I think much too much is made of this because it didn't have any
impact on the manner in which Continental Illinois was supervised
from that point on.
Mr. VENTO. Thank you, Mr. Chairman.
Chairman S T GERMAIN. Mr. Conover, did you, meaning you and
your very excellent personnel, at any point, have reason to suspect
that there was insider abuse at Continental? Frankly, I am referring to Mr. Lytle, who as we found out, was the man who was
doing the Tennessee Waltz with Bill Patterson.
Mr. CONOVER. We certainly didn't suspect that there was any insider abuse on the part of the top management of Continental. As
far as Mr. Lytle goes, I am not sure what his current status is.
Chairman S T GERMAIN. I am asking
Mr. CONOVER. I know he has been dismissed by the bank.
Chairman S T GERMAIN. When did you and your office discover
that indeed there was some hanky-panky going on?
Mr. CONOVER. Probably not until after the Penn Square Bank
had failed and the investigation took place as to the manner in
which the loans
Chairman S T GERMAIN. Remember, we had our hearings at the
time and brought out the fact Mr. Lytle
Mr. CONOVER. I am aware of that.
Chairman S T GERMAIN. Would t h a t be about the correct date?
Mr. CONOVER. I would think so. I don't think we suspected or
knew t h a t there was any potential insider abuse on Mr. Lytle's
part, or anybody else's part in the bank, prior to the Penn Square
Bank failure and the subsequent hearings relating to it.
Chairman S T GERMAIN. At that point, did you insist that he be
removed from office?
Mr. CONOVER. We didn't need to. The bank removed him from
office.
Chairman S T GERMAIN. In a timely fashion?
Mr. CONOVER. I believe he was let go in July 1982.
Chairman ST GERMAIN. Mr. McKinney?
Mr. M C K I N N E Y . Thank you, Mr. Chairman. Mr. Comptroller
Chairman S T GERMAIN. Wait a minute, Mr. McKinney, I have to
say this. I want you to know that we have been in contact with the
FDIC's office. We informed them t h a t the computer runs on what
the alternative costs would have been for infusing capital or the
bailout, had you allowed Continental to fail.
They tell me they are looking for it. That was at a quarter to 1.
So I am going to give you every half hour a report on how we are
doing with this. Let me ask you this: I will bet you could find it

 0—84
39-133
22


334
within your files within a matter of minutes, right, because of the
efficiency of your office?
Isn't t h a t an important document?
Mr. CONOVER. My colleagues are laughing because of the piles of
things t h a t are stacked in my office.
Chairman S T GERMAIN. But whatever important things are
stacked, I promise you can.
So, too, in mine, Mr. Conover, but no matter how high they are
stacked I can tell you I can find them in a moment's notice.
Mr. CONOVER. If you want to look into the evaluation of different
potential courses of action vis-a-vis Continental and why the decision was made to go as we did, you would probably want access to
those documents.
Chairman S T GERMAIN. I think they are rather important documents. I just want you to know they are looking for them. Mr.
McKinney?
Mr. M C K I N N E Y . Mr. Chairman, if they should be as fast as the
Defense Department, you will still be here next Christmas.
Mr. Comptroller, I think whatever they want to concentrate on,
we have been through all the implications. It is semi-staggering
what has happened, and I will stay away from my diatribe on the
two types of banks. What I really want to look at are two aspects of
the situation. One, why didn't we move faster, and, two, just what
can you do? I know on page 19 you say we have asked ourselves
whether we should have taken action as early as 1976 to prevent
Continental from embarking on a course of rapidly becoming a top
lender to corporate America.
In my view it would have been inappropriate to have done so. It
is not the proper function of regulators to decide what business
strategy an individual bank should undertake. A regulator's role is
to see t h a t whichever business strategy a bank chooses, it has the
mechanisms in place to implement t h a t strategy in a safe and
sound manner.
Then we move over to pages 25, 26, and 27. On page 27, you list a
whole pile of things t h a t could be done and you say there is another means of insuring adequate capital, OCC will be scrutinizing
the pay out policies in light of its overall capital structure. We will
not hesitate to restrict dividend payments when necessary. There is
a great deal of talk about the adequacy of capital, but then I go
back to Penn Square.
When Penn Square failed I asked the direct question. I asked
why, in fact, did Seafirst which no longer exists except as part of
Bank of America and Continental draw into Penn Square so heavily when the Chases and Citibanks and the rest were not?
I was told by many people including my New York banker cons t i t u e n t s that, Seafirst was a poorly run bank and had to be taken
over and, in fact all of this was an aberration with Penn Square.
You go back to articles in the newspapers of July and August 1982,
"Business Week," 1982, October, "Continental Illinois' Most Embarrassing Year" and so on.
What is our problem in not getting t h a t red warning flag up
sooner? We certainly knew Penn Square was in trouble a long time
before it collapsed. Far more important, when the red flag goes up,
what can you really do or what are you able to do? It seems to



335
have you in the same spot as the high sheriff on the highway without the powers of arrest, and t h a t really makes your job somewhat
superfluous.
Mr. CONOVER. In terms of the red flags, most of Continental's
loan purchases from Penn Square took place in late 1981 and early
1982. In fact, they took place between examinations. It happened
very quickly. If you recall from the Penn Square discussions, it was
at precisely t h a t time t h a t Penn Square went on a lending binge of
the first order. They must have sold virtually all of the loans t h a t
they produced during t h a t time to Continental.
Now, we have done some things since then to improve the red
flag system. One of the things we did, as I indicated earlier, was to
change the call report so we get some information on participations
for review quarterly.
Mr. M C K I N N E Y . Let me stop you in the process. We have gone I
think, from roughly $300 million invested in Penn Square to over
$1 billion, correct?
Mr. CONOVER. Yes.
Mr. M C K I N N E Y . Over
Mr. CONOVER. About

how many months?
$300 million in April 1981. By the fall of
1981, we are talking about $500 million and by March 1982, $1.1
billion.
Mr. M C K I N N E Y . I really want to find out this answer because we
are going to have to legislate something in here sooner or later.
What blows a whistle? Suddenly you have a storefront bank in a
shopping center in Oklahoma t h a t borrows $800 million from a big,
supposedly sound fiduciary bank in roughly a very short period of
time.
Does a whistle blow somewhere in your organization to alert you
to this unusual activity?
Mr. CONOVER. The whistle blows if you know about it. And we
now have the mechanism for knowing about it.
Mr. M C K I N N E Y . All right, now you have the mechanism to know.
I have a degree in history from Yale which doesn't help me here
but the minute I see the participation there I say there is something wrong. If there is something wrong with the energy loans
from Continental there has to be something wrong with the energy
loans period.
So the whistle blows in your office. What do you then do?
Mr. CONOVER. YOU have to get into, in this case, Continental
Bank and take a very long hard look at the loan portfolio including
the loans participated out from Penn Square which you focus on
first. And then you ask the obvious question or make the obvious
observation, which you just made, t h a t if the oil and gas loans they
are getting from Penn Square are bad, the other oil and gas loans
are probably bad, too. That turned out to be the case.
Mr. M C K I N N E Y . We have done t h a t in a miraculous 30 days investigation. We are quite right. The loans stink. Now what do you
do?
Mr. CONOVER. At t h a t point, if they are on the books, you have
got a problem. One thing you can do is change all the policies and
procedures and restrict further purchases and the like. That is no
problem. The question is what do you do with the loans t h a t they



336
already bought when their system was either out of control or they
were being defrauded.
If they were being defrauded
Mr. M C K I N N E Y . It is tougher to find.
Mr. CONOVER. It is tougher to find, but it may also provide them
with some recourse. Once the loans are on the books, you are in a
workout situation.
Mr. M C K I N N E Y . But you say the loans were on the book. Continental continued on the same—I mean $800 million is an awful lot
for, as I say, a shopping center bank which has all of a sudden gone
crazy in Oklahoma. Can you issue a cease and desist order on any
further energy loans until such time as or something of t h a t sort?
Mr. CONOVER. Oh, sure, you can say don't make any more energy
loans. But you almost don't have to at t h a t point. I mean, there
isn't any point.
Mr. M C K I N N E Y . But you see, I don't want to get to t h a t point.
That is my big problem. I have a bank in Oklahoma operating out
of an old storefront in a shopping center. All of a sudden it expands and I see a supposedly prestigious bank t h a t has increased
its loans by $800 million.
They shouldn't be able to make t h a t increase of $800 million
without a whistle blowing somewhere. They shouldn't have gotten
past the
Mr. CONOVER. Oh, t h a t is correct. I agree with you on that. The
control mechanisms broke down in Continental, and we didn't have
a mechanism for discovering participations then. We do now.
Mr. M C K I N N E Y . Let me tell you what I think is the crux for this
committee. What can you really do in cases like this and how fast
are you going to find out about it to be able to do anything in time?
You know, we all know and we don't talk about it much. We have
this wonderfully cozy system.
We have the internal auditor, whom we find out is next to
worthless at Continental followed by the external auditor, who in
the case of Continental got paid $3V2 million for writing his report
with the internal auditor. Then we have the internal auditor who
also is being investigated, who checks whether or not the bank is in
debt and what is the collateral positions, which most people ignore
and big borrowers can phone in.
You say we may have been carried away by the fantastic growth
and success in the seventies of Continental Illinois. We may have
been carried away by its management mystique. But is it possible
for a mere human being working for a division of the Federal Government to come in at t h a t salary level? Could he walk into Walter
Wriston and stop Mr. Wriston lending to Brazil? I doubt it.
Mr. CONOVER. YOU are raising another question—whether examiners in general and the Comptroller's Office in particular have the
chutzpah, if you like, to walk into top management and say, "Stop,
or we are going to take some action against you." There is no doubt
in my mind that the examiners in the Comptroller's Office—and I
have been involved in meetings with them in an awful lot of banks
in the last couple of years—have the guts to say directly to the top
management of any bank you want to name that they have got a
problem in a particular area. "It is wrong." "It has got to be fixed,
et cetera." They grow up on that.



337
Mr. M C K I N N E Y . What if management says buzz off, which is
what they did at Penn Square?
Mr. CONOVER. It depends on how management says buzz off. If
management says buzz off where they are literally trying to defraud you by pretending they are doing something t h a t they are
not doing, t h a t makes it very difficult to uncover the wrongdoing.
On the other hand, if you have a management t h a t says go away, I
don't agree with you, we have ample power, and we use that power
to get them to do what we want them to do.
Mr. M C K I N N E Y . YOU see, I see
Mr. CONOVER. YOU needn't be concerned about that.
Mr. M C K I N N E Y . I am not firing at you.
Mr. CONOVER. I understand.
Mr. M C K I N N E Y . It seems the Comptroller of the Currency

at the
present time has two big problems. First, the speed alarm on his
speedometer isn't working to tell him he is about to get arrested
for going too fast and No. 2, he is like the sheriff with a gun without any bullets or car without any tires because essentially your
people were in Continental Illinois every 90 days and missed this
one.
Continental Illinois management knew they were making some
rotten loans. Sometimes I feel the quality of management, the
three-piece suit and Chicago Club and marble overcomes the fact
that it is still a pretty rotten institution. And I don't know what
you need, so this kind of thing doesn't happen again because, you
see, I have a different theory t h a n a lot of people.
I listened to Mr. Rohatyn and a few others in New York and
read what they said in the New York Times. They said, "Well, this
isn't the taxpayers' money." Sorry. It is the taxpayers' money.
Every single American taxpayer who has a depository account with
an FDIC or FSLIC insured institution is paying higher bank
charges because those banks and institutions are paying higher insurance premiums.
So we are dealing with the taxpayers' money in every sense of
the word. It is just a different form of taxation. It is called an insurance premium rather than a tax. You say in your testimony
that there is a low margin of error allowable in the financial world.
Mr. CONOVER.

Yes.

Mr. M C K I N N E Y . What do you need from the Congress of the
United States, No. 1, to give you a system t h a t works better; and,
No. 2, what do you need from the Congress of the United States so
that you can do something instantaneously? The saddest picture
has got to be the 1V2 years of wobbling around in Oklahoma before
the crash hit.
Everybody isn't saying it is a rotten bank. It is a classified bank.
The loans are still no good. And it is still bouncing around on a
day-to-day basis. Recently one of my banking friends said, "Well,
Stewart, you are proposing we nationalize a bank." I said, "No, we
already have nationalized a bank, so t h a t is no longer an issue."
Mr. CONOVER. I think the machine on which the red flag goes up
is fixed. The mechanism is in place so that we can get information
on significant changes in bank activity, in their balance sheets, et
cetera, t h a t will raise questions t h a t require followup.



338
Now, I have to put one caution on that. That—going back to the
question of fraud again, somebody who willfully wants to get his
bank in trouble. The fact of the matter is t h a t if you owned a bank
today, you could go home to Connecticut and fail t h a t bank before
anyone would know, if you really wanted to.
Mr. M C K I N N E Y . In a heartbeat.
Mr. CONOVER. You really could. And the problem there is t h a t
any regulatory system t h a t would keep you from doing t h a t would
be an incredible system. I don't think you or I want t h a t kind of
system.
Mr. M C K I N N E Y . I agree.
Mr. CONOVER. SO I would say, first of all, that we have the tools
to get the information that we need.
Do we need any new enforcement powers or tools of t h a t nature?
I honestly don't think so. I will engage in all kinds of conversations
with you to get different points of view on the subject, but we have
cease and desist powers, civil money penalty powers, authority to
remove officers.
Somebody asked me the other day if we shouldn't have a system
where we don't have to wait until the bank fails or almost fails to
take some action, where we could go in much, much earlier. That
sounds good except when you start defining what t h a t trigger point
would be. You could say t h a t when you get to 3 percent capital, the
regulators can go in and seize the bank. We are seizing private
property if we do that. When classified loans get to a particular
level do you then, through some emergency power granted to the
regulators, automatically let us go in and do something we couldn't
otherwise do? Those are possibilities. But they would have to be
thought through very carefully.
Mr. M C K I N N E Y . Thank you. My time has run out and I am sure
we will be having many discussions over the ensuing months.
Chairman S T GERMAIN. History at Yale University. We are impressed.
Mr. M C K I N N E Y . I might add that the Comptroller and was 2
years behind me.
Chairman S T GERMAIN. YOU know, Mr. Comptroller, and believe
me, I am going back to many Comptrollers. You are not the first
one to sit in this particularly comfortable chair that you are ensconced in at the moment, and the thing that bothers me is t h a t
each and every time we go through hearings like this we are told,
"Well, we now have it in hand. It won't happen in the future. We
will be able to detect this ahead of time in the future. The early
warning system, the NBSS, it is really going to function."
Now let me ask you this, Mr. Conover. We now know we have
got to watch out for the energy-related loans. But one of the new
fields I have been reading about is genetic engineering. You have
heard about that. All right. Now suppose you find an institution
t h a t suddenly decides to go into genetic engineering and they go
belly-up, too.
Are we going to be told, "Well, we really didn't have enough information on genetic engineering or whether or not there was concentration on genetic engineering loans." What assurance do we
have t h a t 6 months, a year or, 2 years from now you or your sue


339
cessor won't be here telling me, "Well, we have got it in hand this
time. It won't happen again."
Mr. CONOVER. First of all
Chairman S T GERMAIN. That is a sincere question.
Mr. CONOVER. I understand it is. First of all, there are no absolute, 100 percent guarantees so I can't promise you t h a t t h a t could
never happen. Taking the example you cite, however, let me tell
you about the mechanism we have put in place to try to deal with
that problem.
When we reorganized our field structure and our Washington
office structure, we did two things. We created an industry review
program in the Washington office which looks at particular industries where banks may have some significant concentration, traces
through the potential problems t h a t might develop in those industries, and translates them into the potential impact on the banking
system. We have done a lot of studies, for example, as to the
impact on the banking system if oil were to fall to $25 a barrel or
$20 a barrel. At the same time, we have established in our district
offices an important position responsible for more local industry
analysis. For example, the industry analyst in a particular office
might take a look at the local real estate market, assessing whether the area is being overbuilt and whether banks have a number of
commitments outstanding to fund buildings t h a t either may never
get built or, if they get built, are going to end up sitting vacant and
be a terrible drain on their owners for some time.
The mechanisms are in place. The challenge to us is to be sure
we use them well. And we have a commitment to doing so.
Chairman S T GERMAIN. Thank you. Mr. Schumer, the word t h a t
was used, I didn't want him to repeat it then because I wanted to
use it now. Now we have our chutzpah kid.
Mr. CONOVER. Did I mispronounce the word, Mr. Schumer? I
apologize.
Mr. SCHUMER. I am sure Mr. McKinney didn't learn this in his
history courses at Yale, but the word is chutzpah.
Mr. CONOVER. I stand corrected.
Mr. SCHUMER. It will serve you well in the future to learn the
correct pronunciation. Anyway, I have a group of questions. The
first question I have relates to something Mr. McCarte told us
about yesterday. It seems to us he was the auditor of Continental
in 1979, 1980, and 1981. Then in 1982 he was no longer auditor. He
was left the job kind of suddenly because he acquired a new position, working for the Continental Illinois Bank.
I imagine he got a nice increase in salary. I didn't want to put
him through questions like this. He had had a tough day. But I
imagine he got a nice increase in salary, et cetera.
Don't you think t h a t it is a bad policy to allow auditors of a bank
to then immediately thereafter go and work for the bank? Doesn't
it tend to create conflicts of interest?
Mr. CONOVER. The alternative would be to restrict people's postGovernment employment opportunities and to tell bank examiners
that they can't go to work for a bank.
Mr. SCHUMER. Plus the bank that they have examined within the
last 3 years.



340
Mr. CONOVER. I don't think that that is a problem. We have specific procedures for dealing with cases like that. When Mr.
McCarte was approached by the bank, and, incidentally, the bank
asked his supervisor first if they could approach him, he made t h a t
approach known immediately to his supervisor and informed his
supervisor t h a t he would pursue those conversations. We have
looked very carefully at the practice to see if there were any improprieties, et cetera and our conclusion is that it ought to be written
up as a model for how Government employees are to deal with
those kinds of situations.
I don't think there ought to be restrictions on post-Government
service employment by bank examiners. I can tell you t h a t is
where we have lost most of our bank examiners. Banks hire them.
Now, I don't know the exact breakdown.
Mr. SCHUMER. You are helping me make my point, but I am not
objecting to banks hiring. What I am saying is t h a t to go immediately of from auditing a bank, to working for that bank, wouldn't it
put strains on Mr. McCarte?
What about the next guy who comes in and audits Continental or
the people with him? They ought to be asking themselves at least
subliminally, "where are my job opportunities if I am not going
any further in the Comptroller's Office? I can go right to this
bank." Yesterday, we talked about the difficulty for an examiner to
go to a board of directors or go to his superiors and say, this bank
is in trouble. I can understand that and sympathize with that. It
seems to me, however, t h a t this puts an undue strain on the examiner. Take your own job, for example, you can't go work for a bank
for 2 years after you leave this job, am I correct in that?
Mr. CONOVER. That happens to be true, not by virtue of being
Comptroller, but by virtue of being a Director of the FDIC.
Mr. SCHUMER. In other words, it seems to me t h a t you should
consider the problem because, given all the difficulties t h a t we
have, it just creates an appearance of impropriety.
There may be none in reality, but more importantly t h a n that,
when you are dealing in such a subjective area as bank examination—and it is a subjective area in terms of the the judgments t h a t
people have to draw from the specifics they find—that it just
makes no sense to allow somebody who has examined a bank 3
years in a row to then go immediately and work for t h a t same
bank. I don't think t h a t this should just apply to bank examiners.
I think it should be a rule t h a t applies to public service commissioners. They should not be allowed to go to work for the utility
immediately thereafter. I think we do have such a rule, in New
York State, for the Public Service Commissioners.
It is something that I think is wrong, but I guess you don't agree
with me on that,
Mr. CONOVER. I understand your point and the sensitivity of it. I
think it might cause us a lot more problems than it would provide
benefits. If the banking industry is one of the places t h a t people go
when they leave the Comptroller's Office, and that is particularly
true in certain parts of the country where there are a lot of unit
banks, I think it would significantly limit our ability to attract and
hold people if t h a t restriction were put in place. There are two
sides to the coin.



341
Mr.
Mr.

SCHUMER.
CONOVER.
Mr. SCHUMER.

I understand that.
That is all.
OK

The second question. I asked this yesterday and was kind of perplexed t h a t I couldn't get much of an answer, and it is a general
question and your testimony doesn't quite answer it, but it touches
on it.
What went wrong? What went wrong in the Comptroller's Office
t h a t allowed Continental to go under 2 years after you knew there
was a problem?
Mr. CONOVER. In order to answer t h a t question, I have to give a
quick overview of what went wrong with Continental per se.
Mr. SCHUMER. That I am pretty much aware of, and I think the
committee is.
Mr. CONOVER. If you combine the bank's strategy and either the
lack of controls or lack of commitment to those controls, and add to
that the two recessions, the energy focus and the energy downturn,
and the funding situation of the bank, t h a t is how the bank got
into the position t h a t it did.
As to our office's handling of the situation, I think there are several instances in my prepared testimony where I said that, with
the benefit of hindsight, we could have been more forceful in dealing with the internal control system.
Mr. SCHUMER. That is after 1982 or before?
Mr. CONOVER. Before 1982. I think t h a t is where you break it: up
to 1982—Penn Square—and then subsequent to 1982. I think the
seeds were very well planted prior to 1982. I think they go all the
way back to 1976.
Mr. SCHUMER. Mr. McCarte, who did the examination in 1979,
1980, and 1981, seemed to have no idea t h a t anything was wrong
with the internal control system.
Mr. CONOVER. I think he indicated t h a t there were weaknesses in
the internal control systems in specific areas and then made an
overall judgment, which I think one tends to do, to try to put the
whole thing in perspective and say net you are probably OK, although you need to make corrections in these five areas.
Now, I indicated
Mr. SCHUMER. He didn't say you are probably OK. He gave it a
much cleaner bill of health t h a n that as I remember his language.
Mr. CONOVER. Nevertheless, he made a statement which was intended to put his specific criticisms in perspective. I have already
indicated t h a t I thought the judgments t h a t were made about the
bank and its control system in those years were swayed by the performance of the bank and the responsiveness t h a t management
had displayed in dealing with criticisms we had made in the past.
Mr. SCHUMER. I take real dispute not with what happened before
1982, but what happened—in terms of what the Comptroller's
Office did—between 1982 and 1984. You say in your statement that
you are persuaded t h a t since mid-1982 there was nothing more that
we could have done to speed Continental's recovery, and thereby
increase market confidence.
You admit t h a t it was the lack of market confidence that finally
caused Continental to fall in 1984?
Mr. CONOVER.



Yes.

342
Mr. SCHUMER. You are saying then t h a t there was nothing the
Comptroller could have done to help bolster t h a t confidence, is t h a t
correct?
Mr. CONOVER. I think it is.
Mr. SCHUMER. Then let me ask a couple of questions.
Don't you think that changing management, not just the Penn
Square people, but management at the top, would have helped restore confidence, and don't you think the Comptroller's Office was
much too timid?
I know t h a t the president of Continental was known as a very
nice man and all of that. I don't think t h a t enters into it, at least
objectively, but I talked to some experts in the field and they say
t h a t the Comptroller's Office was terribly remiss, once the 1982
damage was done, in not replacing top level management because,
first of all, even though, as you testified they had done a good job
of bringing the bank back to health before any management t h a t
had no internal control system had to have something severely
wrong with it even beyond its Penn Square Loans. That ill existed
for an area of lending beyond Penn Square.
No. 2, when you replace management, you are telling the world,
OK, things are new. We can have new confidence in this bank.
Mr. CONOVER. YOU may also be telling them that things are a lot
worse t h a n
Mr. SCHUMER. They couldn't be worse than they ended up being.
Mr. CONOVER. That is certainly true, but you have got to put this
in perspective of what was known at the time. You may be telling
the marketplace t h a t things are a lot worse than they are.
Mr. SCHUMER. I look at Continental's sister big bank, First Chicago, and wonder why you didn't follow t h a t pattern. There were all
sorts of rumors earlier t h a t First Chicago was in trouble. I don't
know the details, and I don't know what the Comptroller's role was
either, but I do know t h a t when the president of that bank was replaced, it seemed t h a t the markets gained a great deal of confidence in First Chicago. Is there an analogy there?
Mr. CONOVER. There may be, but in this particular case I think
you have to go back and consider what was known at that particular time. I think what we had was a management which had been
responsive to criticisms in the past, had gotten the bank out of the
1975-76 problems with the REIT's, had recognized the problems of
1982, and had put in place a mechanism using outside directors,
lawyers, and accountants to figure out what had happened and
what they ought to do about it.
Why did the thing break down? There was evidence that management was committed to doing something about it, and I realize
t h a t two different minds can have a different view.
Mr. SCHUMER. It just seems to me if the bank didn't fail or come
as close to failing as it did, let's not get into semantics at the
moment, but it seems to me that if there were 2 years between the
time you knew there were real problems and the time the crisis of
confidence wave undid everything that there might have been
more things that your office could have done.
We have had our dispute on that. You can answer t h a t and this
question.



343
In effect, what you have said is, there was no reason to suspect
anything was wrong with Continental before 1982, and nothing
could have been done about it after 1982. You have made a very
persuasive argument t h a t your whole operation of bank examination is useless.
Mr. CONOVER. No; I don't think so. I think you are overstating
the case rather dramatically.
Mr. SCHUMER. That is because I think you did when you said
those two things.
Mr. CONOVER. Well, all right. I have outlined in the testimony
what our role is as bank supervisor. I have also indicated precisely
what the causes of this particular situation were, noted t h a t there
were some weaknesses in the way we handled it, and identified the
improvements that we have made in our process for the future.
Now, I don't think you can take the particular case at hand and
extend it logically to a conclusion t h a t you ought not to have a
Comptroller's Office or a bank regulatory function, or whatever because it can't get the job done. I think t h a t before even entertaining such a judgment you have to consider the condition of the rest
of the banking system and the timely corrective actions t h a t have
been taken by the regulators vis-a-vis any number of other problem
banks t h a t have restored them to health.
Mr. SCHUMER. Can you give me an example?
Mr. CONOVER. I will not give you an example.
Mr. SCHUMER. That is the problem.
Mr. CONOVER. Let me finish what I was going to say. I will not
give you an example of a specific bank because I don't want to
name a bank t h a t is open today, and by definition we are talking
about a bank t h a t is open today. I will, however, provide you with
the following information.
As of 1980, when Penn Square became a 3-rated bank originally,
there were some 250 banks t h a t were also rated 3 at that particular time. We have gone through and traced exactly what has happened to those banks since then, and I will provide this to you in
writing. Now, recognize t h a t you could do this for banks t h a t were
rated 3 or 4, or whatever, at any point in time. The data for t h a t
particular group of banks indicates that some 65 percent of them
have been returned to health and are now rated 1 or 2. Another
very large number of them remain rated 3 today but have not deteriorated from t h a t status. A much smaller percentage have declined to 4 or 5 or have failed.
Mr. SCHUMER. HOW many have been money center banks or extremely large banks? You never let us see the details so we are sort
of groping in the dark here too, but it is my hunch t h a t you do a
much better job in examining little banks than big banks.
I mean, the people here yesterday didn't even know what was
going on in the oil and gas division of midcontinental division of
Continental Illinois until it was in their words "too late."
How many were large banks? How many of those banks were in
the top 50 banks of this country?
Mr. CONOVER. I don't know off the top of my head.
Mr. SCHUMER. Could you get me that?
Mr. CONOVER. I will.
Mr. SCHUMER. Was it more t h a n one?



344
Mr. CONOVER. As I said, I don't know. I will provide you with
t h a t information.
Mr. SCHUMER. My guess is it wasn't very many.
My time has expired.
Chairman S T GERMAIN. Mr. Conover, we have been in touch
through staff with the FDIC and I will ask Mr. Dugger on our staff
to tell you what we determined.
Mr. DUGGER. Basically, Mr. Northup and Mr. U n t h a n k do not
have a clear idea of what you mentioned, the exact analysis you
talked about.
Chairman S T GERMAIN. YOU asked for what?
Mr. DUGGER. I asked them pursuant to the chairman's request,
t h a t a copy of the analysis
Chairman S T GERMAIN. What type of analysis? Be specific.
Mr. DUGGER. A payoff analysis or liquidation value analysis, a
purchase and assumption analysis, comparable to what is done
with banks in terms of analyzing whether they should be liquidated, assisted, or merged.
Chairman S T GERMAIN. And the answer was?
Mr. DUGGER. The answer is t h a t while they have looked and
looked, they don't have any specific formal analysis of that sort.
Chairman S T GERMAIN. And then they asked Mr. Isaac.
Mr. DUGGER. Mr. Northup asked Mr. Isaac. Mr. Isaac said he was
not aware of one. I am reporting what Mr. Northup said.
Chairman S T GERMAIN. What type of analysis did you see, Mr.
Conover?
Mr. CONOVER. Well, there were analyses t h a t were performed
as
Chairman S T GERMAIN. SO you can be more specific with the
FDIC.
Mr. CONOVER. I don't think we are going to reach a conclusion on
t h a t while we are sitting here today.
Chairman S T GERMAIN. I don't want to wait too much longer. We
have been trying for 3 or 4 weeks now to get this.
Mr. CONOVER. I understand.
Chairman S T GERMAIN. And I am looking to you to help me.
Mr. CONOVER. I think what we are talking about are analyses of
the impact on the insurance fund of alternative ways of handling
Continental in terms of a payoff, in terms of a merger with other
banks, and in terms of the final solution t h a t was put in place.
Chairman S T GERMAIN. All right.
Mr. CONOVER. That information exists.
Chairman S T GERMAIN. OK, because you saw those analyses.
Mr. CONOVER. It may not be on the same form t h a t is normally
used when the FDIC calculates the cost of doing a purchase and
assumption.
Chairman S T GERMAIN. For a smaller bank, because this is a
great big institution?
Mr. CONOVER. That is correct.
Chairman S T GERMAIN. SO it would seem to me it would be
easier to find.
Mr. CONOVER. But the substance of t h a t information is available.



345
Chairman S T GERMAIN. The substance. I hope you are not saying
t h a t the analysis couldn't be made because there isn't substantive
information available to make the analysis.
I am hoping t h a t the analysis was made.
Mr. CONOVER. No; I am not saying that. I am saying the information is available. I am saying don't be surprised if it isn't on the
same form t h a t is normally used when an evaluation of a bank is
being made.
Chairman S T GERMAIN. NOW I will ask Mr. Dugger to go back
and maybe we will have Mr. Northup here with Mr. Isaac so he
can talk to the Comptroller before he leaves.
Mr. Patman.
Mr. PATMAN. Thank you, Mr. Chairman.
Mr. Conover, is it correct to say t h a t the decisions made on what
the Government would and would not do with respect to Continental Illinois and its holding company, those decisions were made by
yourself, Mr. Volcker, Mr. Regan, and Mr. Isaac?
Mr. CONOVER. Yes; t h a t is correct.
Mr. PATMAN. Did you have any communication with the White
House or Executive Office building during this time that you were
working on this issue?
Mr. CONOVER. N O ; we did
Mr. PATMAN. YOU didn't

not.

have any idea about the White House

position on this?
Mr. CONOVER. N O ; we didn't.
Mr. PATMAN. None of you did to your knowledge?
Mr. CONOVER. That is correct.
Mr. PATMAN. Each one of you is a White House appointee?
Mr. CONOVER. That is correct.
Mr. PATMAN. YOU didn't check to make sure you were doing
what the White House wanted you to do in this?
Mr. CONOVER. That is correct. We were operating under statutory authority contained in the various acts that grant the FDIC and
the Fed powers in such situations, and there wasn't any particular
reason to contact the White House since we knew t h a t the right
way to handle it was in a way t h a t was totally devoid of any political input.
Mr. PATMAN. I don't know that you can say it is totally devoid of
any political input. You are all political appointees, but let me ask
you was there any dispute among you about what should be done?
Mr. CONOVER. Was there any dispute among us? There were conversations throughout the process as to what the right way to go
was.
Mr. PATMAN. And there were differences of opinion?
Mr. CONOVER. And there were differences of opinion throughout,
just as you would expect there to be.
Mr. PATMAN. Who came up with this solution?
Chairman S T GERMAIN. Mr. Patman, why don't you ask if it was
an opinion whether or not they should bail it out or let it fail?
Mr. PATMAN. That is what I would like to get to.
Who came up with the final decision t h a t was adopted for the
final proposal?
Mr. CONOVER. Well, the FDIC
Mr. PATMAN. Did you do it or did the FDIC?



346
Mr. CONOVER. The FDIC played the lead role in negotiating with
the banks and structuring the deal.
Mr. PATMAN. Did any of the four of you suggest t h a t the bank
should be allowed to fail?
Mr. CONOVER. We talked at some length as to whether the bank
should be closed or not.
Mr. PATMAN. Did one or two of you or three of you perhaps advocate t h a t the bank be closed?
Mr. CONOVER. NO; I don't think so.
Mr. PATMAN. Did any of you ask and strongly recommend t h a t
the bank be closed?
Mr. CONOVER. We laid out and discussed the pros and cons of
doing it open versus doing it closed. There were differences of opinion as to the importance of various pros and cons. When all was
said and done, there was a unanimous conclusion t h a t the bank
ought to be handled through an open bank transaction, as it was,
in fact, handled.
Chairman S T GERMAIN. Bill, ask about Secretary Regan. What
was his opinion?
Mr. PATMAN. Did not Secretary Regan put out a statement at
one time casting strong doubt as to the legal basis for any takeover
of the bank, or what you did?
Mr. CONOVER. Secretary Regan's statements focused not on
whether the bank ought to be provided with assistance in an open
bank fashion, but on whether the FDIC ought to buy preferred
stock in the holding company or debt of the bank, a highly technical aspect of the deal t h a t we had discussed at some length earlier.
Mr. PATMAN. Were you prevented from extending a loan to the
holding company? Why buy prefered stock where you have a place
in line behind the bondholders?
Mr. CONOVER. That was precisely the technical issue t h a t was
brought up.
Mr. PATMAN. In other words, they could not issue preferred stock
because of some agreement with the bondholders, and furthermore,
they could not issue additional bonds, is t h a t what you are saying?
Mr. CONOVER. They could not issue preferred stock in the bank,
where it would have been preferable for the FDIC.
Mr. PATMAN. Right, but did you take preferred stock in the holding company or the bank?
Mr. CONOVER. We took preferred stock in the holding company,
with the negative result t h a t it provided a direct propping up of
holding company bondholders and commercial paper holders.
Mr. PATMAN. Could you not have taken a position as a bondholder to the holding company?
Mr. CONOVER. NO; t h a t wouldn't have worked because we wanted
to gain 80 percent control of the shares in the overall corporation.
Mr. PATMAN. But you have the power to take complete control
over the bank; do you not?
Mr. CONOVER. In what sense? By closing the bank, sure.
Mr. PATMAN. DO you not also have the power to remove the officers and substitute others of your choice?
Mr. CONOVER. Yes.
Mr. PATMAN. IS that



not taking over the bank?

347
Mr. CONOVER. Well, t h a t was done as part of the agreement with
the FDIC.
Mr. PATMAN. IS your power limited to simply closing the bank?
Is that what you want us to think? Were you limited in the
powers?
Mr. CONOVER. I am not sure whether you are focusing on what
the Comptroller's Office powers are or whether you are talking
about the structure of the deal.
Mr. PATMAN. All of the powers really, but first of all, the Comptroller's Office doesn't have sufficient powers in your judgment.
Mr. CONOVER. I didn't say that.
Mr. PATMAN. With respect to the holding company.
Mr. CONOVER. The Comptroller's Office doesn't have any power
with respect to the holding company.
Mr. PATMAN. Then the only powers you have in this four-part
agreement came from the Federal Reserve, is t h a t true?
Mr. CONOVER. The deal was struck between the Federal Deposit
Insurance Corporation and the bank.
Mr. PATMAN. Does the FDIC have any powers over the holding
company?
Mr. CONOVER. They have the power under the Federal Deposit
Insurance Act to provide aid to the holding company if it is pursuant to the rescue of an insured bank.
Mr. PATMAN. But would you not say then t h a t your agency, the
FDIC and the Treasury Department have no powers with respect to
holding companies as far as compelling the performance of certain
things you would like to see performed by the holding company?
Mr. CONOVER. That is correct.
Mr. PATMAN. Only with the Fed do you get any power in this
case?
Mr. CONOVER. The FDIC had powers vis-a-vis the holding company in this particular transaction, as I have just indicated. The Fed,
of course, has authority over the holding company as its primary
Federal regulator.
Mr. PATMAN. DO they have as many powers as you do over the
bank, over the holding company?
Mr. CONOVER. DO they have as many powers over the holding
company?
Mr. PATMAN. DO they have fairly complete powers?
Mr. CONOVER. As I understand it, they do.
Mr. PATMAN. With the holding company.
Chairman S T GERMAIN. Bill, would you yield for a second?
Mr. PATMAN. Yes, sir.
Chairman S T GERMAIN.

I think I would
trend along with you.
Mr. CONOVER. Please.
Chairman S T GERMAIN. The FDIC now
many shares of stock?
Mr. CONOVER. Oh, I don't remember the
amounts to 80 percent.
Chairman S T GERMAIN. That is what I
stock.
Mr. CONOVER.




Yes.

like to pursue the same
owns, or will own, how
number of shares, but it
mean, 80 percent of the

348
Chairman S T GERMAIN. Therefore, they appoint a new board of
directors.
Mr. CONOVER. Well, not precisely. The bank will elect the board
of directors.
Chairman S T GERMAIN. Who elects the board of directors? The
shareholders?
Mr. CONOVER. The shareholders.
Chairman S T GERMAIN. And who owns 80 percent of the shares?
The FDIC?
Mr. CONOVER. The FDIC does.
Chairman S T GERMAIN. SO who is going to elect the board of directors?
Mr. CONOVER. I am not sure how the FDIC exercises its voting
rights.
Chairman S T GERMAIN. And if Ogden and Swaringen don't perform well, the FDIC, I hope will remove them and replace them?
Mr. CONOVER. That is correct.
Chairman S T GERMAIN. Because of the moneys involved?
Mr. CONOVER. That is correct.
Chairman S T GERMAIN. IS t h a t what you are looking for?
Mr. CONOVER. That is correct, but not because of the moneys involved—because they were not doing the job in turning the bank
around t h a t they ought to be doing.
Chairman S T GERMAIN. The fact of the matter is, because 80 percent of the shares have been purchased by the FDIC, all of the billions of dollars going in there are from the FDIC.
Mr. CONOVER. That is correct.
Chairman S T GERMAIN. SO they better watch over it. If the bank
starts going to energy loans again, the FDIC will say stop; won't
they?
Mr. CONOVER. The FDIC has said t h a t it will exercise its rights
as a shareholder, that it will try not to interfere in the day-to-day
management of the bank.
Chairman S T GERMAIN. But the shareholders control the board of
directors.
Mr. CONOVER. That is right.
Chairman S T GERMAIN. The board of directors have a fiduciary
responsibility?
Mr. CONOVER. That is correct.
Chairman S T GERMAIN. Therefore, they run the bank?
Mr. CONOVER. That is true.
Chairman S T GERMAIN. SO the FDIC, the Federal Government is
running t h a t bank. Amen.
Mr. Patman.
Mr. PATMAN. The preferred stock, does it have any voting
powers?
Mr. CONOVER. I don't remember.
Mr. PATMAN. Just confirm t h a t it does not. It does not, right?
All of these money center banks, whether they are called Chase
Manhattan, Citicorp, or what have you, are holding companies, are
they not?
Mr. CONOVER. They all have holding companies, yes, sir.
Mr. PATMAN. And they are parts of holding companies?
Mr. CONOVER. Banks are parts of holding companies, yes.



349
Mr. PATMAN. The only way that you can really effectively control one of these bailouts, if you want to call it that, and I doubt
that you do, would be to have some access to control over the holding company or regulatory authority over it, is that not true?
Mr. CONOVER. I am not sure what you are getting at. We were
dealing with the bank and not with the holding company.
The fact t h a t the holding company owned the bank wasn't a
problem except to the degree that there were some restrictive covenants in the indentures on some of the holding company bonds.
We knew that was a problem, and, as I have indicated earlier, we
know how to correct it so t h a t it won't be a problem in the future.
Mr. PATMAN. The assets of the holding company are not subject
to the debts of the bank, is that true?
Mr. CONOVER. The assets of the holding company? That is correct.
Mr. BARNARD. Mr. Patman, would you yield?
Mr. PATMAN. Yes, sir.
Mr. BARNARD. This is

not the first time that the FDIC has taken

stock in a bank, is it?
Mr. CONOVER. N O , it is not.
Mr. BARNARD. In other words,

there is a precedent for this type
of settlement as far as a bank is concerned as opposed to a holding
company.
Mr. CONOVER. I believe that is correct. I think it has been done
two, possibly three times. One was in the case of the First National
Bank of Midland, TX and one in the case of a New York savings
bank.
Mr. BARNARD. In the Pennsylvania bank though they took warrants, I believe.
Mr. CONOVER. That is correct.
Mr. BARNARD. And they still own those warrants.
Mr. CONOVER. They own a portion of the original warrants that
they took, yes.
Mr. PATMAN. A S a part of this bailout procedure, do you enter
into a contract with the holding company whereby the holding
company permits you to enter into the management of the holding
company or influence decisions by the holding company on its management? Or did you simply buy preferred stock?
Mr. CONOVER. YOU don't enter into a contract with the holding
company whereby you influence the management decisions of the
holding company. But, as the chairman has pointed out, the FDIC
has the authority to eliminate the top management of the holding
company any time it wants to, and it happens to have the signed
resignations of each member of the board of directors, which can be
executed at any time.
Mr. PATMAN. Let me ask you—we know that the depositors of
over $100,000 were protected under the arrangement that was
made. How about the bondholders and the short-term paperholders; were they protected also, in both the holding company and
the bank?
Mr. CONOVER. All the creditors of the bank were protected. The
bondholders and the other creditors of the holding company ended
up being protected by virtue of the way the transaction was struc23
39-133
0—84


350
tured, and that is the one thing we have all agreed is an undesirable outcome and ought to be corrected so it can't happen again.
Mr. PATMAN. And if there is a loss taken by the Federal Government because it is up to $3 billion, because of this potential of
credit of $15 billion or so, will some of those bondholders be able to
come out whole and not suffer a penalty, conceivably?
Mr. CONOVER. That is possible in the holding company
Mr. PATMAN. IS it possible t h a t the taxpayers take the hit and
not any bondholder?
Mr. CONOVER. That the taxpayers take the hit? I am not sure.
Chairman S T GERMAIN. Could we ask it another way. If, God
forbid, the FDIC's plan that has been agreed to by the Comptroller
and the Fed were to fail, and despite all efforts Continental still
failed, then there would be a loss to the FDIC, and then a potential
loss to the taxpayers, but the bondholders of the holding company
would be protected? In other words, they would not lose anything.
Isn't t h a t the problem with this? They get preferred treatment?
Mr. CONOVER. They get preferred treatment, but if the bank
were to fail thereby wiping out the investment of the holding company in the bank, chances are t h a t the holding company would
have to declare bankruptcy anyway. At t h a t point, whether the
bondholders got out scot free would depend on the value of the
other assets in the holding company.
Chairman S T GERMAIN. But you did tell us earlier this morning—it has been a delightful sojourn here—that even if you hadn't
nationalized Continental Illinois National Bank, t h a t the bondholders were in good shape anyway, so t h a t we didn't do them t h a t
much of a favor. I am at a loss to understand this now.
Mr. CONOVER. The distinction is t h a t with the way the transaction was done, the preferred stock is directly junior within the
holding company to the bondholders. If we had been able to buy
preferred stock in the bank, the holding company by definition
would have been strengthened because its primary asset would
have been strengthened. So it is a question of whether you have a
direct or an indirect benefit to the holding company bondholders.
Clearly, in my mind, the indirect benefit was better t h a n the direct
benefit from a public policy point of view.
Mr. PATMAN. Are you aware that Continental Illinois, the bank,
guaranteed the repayment of certain bonds issued by what has
been called WPPSS, Washington
Mr. CONOVER. NO, I am not aware of that.
Mr. PATMAN [continuing]. Power companies?
Mr. CONOVER. NO, I am not aware of that.
Mr. PATMAN. HOW about asking your staff if they are aware of
that?
Mr. CONOVER. NO, they are not.
Mr. PATMAN. I understand they did, and in large measure
Mr. CONOVER. That is probably why you asked the question.
Mr. PATMAN [continuing]. Approximately three-eighths of 1 percent of, perhaps, indebtedness. Would you check into that?
Mr. CONOVER. Yes, I certainly will.
Mr. PATMAN. And report back to us.
Are you aware of any other large bank
Mr. CONOVER. What was guaranteed?



351
Mr. PATMAN. Guarantee the repayment of certain bond issues by
what is commonly called WPPSS.
Mr. CONOVER. Yes.
Mr. PATMAN. And some

of those different subdivisions of WPPSS,
whether they be one, two, three, four, five.
Mr. CONOVER.
Mr. PATMAN.

OK.

And so you will check on that, and also do you
know of other banks t h a t have guaranteed the obligation of municipalities or other bond-issuing agencies, whether they are public
or private? Are you concerned about t h a t type of exposure of risk,
and do you ask the banks to report such exposures in your periodic
reports t h a t you require?
Mr. CONOVER. It is a fairly common practice for banks to issue
standby letters of credit in certain municipal financing transactions. Those are treated just like any other credit during an examination and are classified as nonperforming or nonaccrual, or whatever the case may be. If you are asking me whether I see that as
being a significant problem in bank loan portfolios throughout the
country, I don't.
Mr. PATMAN. Fine. But you will check into this?
Mr. CONOVER. On the WPPSS question, we will look into that
and get back to you with an answer.
Mr. PATMAN. A S to the nature and extent.
Mr. CONOVER. Yes.
Mr. PATMAN. Amount
Mr. CONOVER. Yes.
Mr. PATMAN. Did you

and quantity.

attempt to get others to make statements
favorable to Continental?
Mr. CONOVER. N O , I didn't.
Mr. PATMAN. YOU didn't ask Paul Volcker to make a statement
favorable to the condition of the bank?
Mr. CONOVER. I talked with Paul Volcker about whether he
would make a statement, and I discussed with him the statement
that I made. He indicated t h a t he would not make a statement regarding the condition of the bank.
Mr. PATMAN. Was he more doubtful about the bank t h a n you
were?
Mr. CONOVER. N O . YOU will have to ask him that. I think
that
Mr. PATMAN. What did he tell you?
Mr. CONOVER. He told me t h a t he didn't want to make a statement.
Chairman S T GERMAIN. HOW about Bill Isaac; the same thing?
Mr. CONOVER. At t h a t time, Bill Isaac was not in an official position to make a statement regarding the bank, so the issue never
came up.
Chairman S T GERMAIN. Mr. Barnard suggested we rename the
bank Continental National National Bank.
I am a little intrigued here. You say everybody was on the same
wavelength here about what you did? Those aren't the stories t h a t
I was getting, and I know they might have been rumors. It seems
to me—didn't Secretary Regan, who I think under whom you serve,
have a legal opinion prepared as to whether or not 13(c) or 13(c)(1)
was applicable?



352
Mr. CONOVER. Yes, he

did.

Chairman S T GERMAIN. And didn't he have t h a t done because he
was upset about what was happening, and he didn't want this
course of action to be taken?
Mr. CONOVER. He had a legal opinion prepared by the Office of
Legal Counsel in the Justice Department.
Chairman S T GERMAIN. N O , he had one out of his own office. You
see, I have read them all.
Mr. CONOVER. He also had one done by his own office.
Chairman S T GERMAIN. Yes, sir.

Mr. CONOVER. But if you get to the underlying reason for that, it
all had to do with the technical structure of the transaction t h a t
we have already discussed.
Chairman S T GERMAIN. He was concerned about whether or not
it could be done at all under 13(c) and 13(c)(1).
Mr. CONOVER. But, Mr. Chairman, the underlying reason for the
preparation of those opinions was t h a t the Treasury Department
did not like the technical structure of the transaction in which preferred stock was going to be taken in the holding company. They
were doing everything they could at t h a t particular time to express
t h a t point of view as forcefully as they could, to get it structured in
a different way.
Chairman S T GERMAIN. And Mr. Volcker, as I understand it—I
am going to ask him the same; but you were there so I am sure you
had discussions. Wasn't Paul Volcker concerned primarily with the
holding company aspect and the effect of allowing the bank to fail
and therefore the holding company to go bankrupt on all other
holding companies around the country?
Mr. CONOVER. He was.
Chairman S T GERMAIN.

Indeed he was. And now Mr. Conover,
are you telling me it is ab initio, t h a t Mr. Isaac was all excited and
enthused about the course of action t h a t eventually was taken,
after having bitten the bullet in Penn Square?
Mr. CONOVER. I am sorry, I didn't understand your point.
Chairman S T GERMAIN. Bill Isaac, ab initio—that means from
the very beginning—was he all excited about taking the course of
action that was eventually taken, in view of the fact t h a t he had
bitten the bullet hard on Penn Square and delivered a message to
this banking world: If you don't manage properly we are going to
shut you down, stockholders and others are going to take the
losses.
Mr. CONOVER. If your question is whether Bill Isaac was in favor
of doing a payoff of the bank, certainly not to my recollection.
Never in the course of the discussions, t h a t I can recall, did he express an opinion t h a t
Chairman S T GERMAIN. Right from the beginning he felt t h a t
Continental should be kept open at all costs?
Mr. CONOVER. A S I indicated earlier, we evaluated the pros and
cons of an open bank versus a closed bank transaction, as anyone
would expect us to.
Chairman S T GERMAIN. NOW, how did you evaluate that?
Mr. CONOVER. By sitting down and literally preparing a list of
the advantages and disadvantages of each course of action.
Chairman S T GERMAIN. Bill Isaac and who else sat down?



353
Mr. CONOVER. We prepared such a list in our office, and discussed it with people from the FDIC.
Chairman S T GERMAIN. But I thought you said you sat down and
looked over the alternatives?
Mr. CONOVER. Well, if you
Chairman S T GERMAIN. Did you sit down with Bill Isaac?
Mr. CONOVER. Yes.
Chairman S T GERMAIN. And who else?
Mr. CONOVER. There were meetings
Chairman S T GERMAIN. Excuse me, was

Was Paul Volcker there?

Paul Volcker there when
you had this discussion?
Mr. CONOVER. N O , I don't believe he was.
Chairman S T GERMAIN. Just you and Bill
Mr. CONOVER. N O .
S T GERMAIN [continuing].
Mr. CONOVER. N O .
Chairman S T GERMAIN. Well, who

Chairman

As principals?

was the other principal involved?
Mr. CONOVER. Sprague, as the other FDIC Director.
Chairman S T GERMAIN. OK.

Mr. CONOVER. And staff from the Comptroller's Office and the
FDIC.
Chairman S T GERMAIN. DO you know which staff from the FDIC
was there?
Mr. CONOVER. N O ; I don't. Those meetings tended to take place
with a horde of people present.
Chairman S T GERMAIN. All right, because I have staff from the
FDIC on their way up here right now, so we can find out.
Are you now telling me t h a t it wasn't a computer one, it wasn't
only the ordinary analyses done for the small banks, but rather
just sitting down and writing down on a memo pad what you
thought the costs would be?
Mr. CONOVER. We are shifting gears now, right?
Chairman S T GERMAIN. I don't know who is shifting the gears.
You are the one t h a t just told me.
Mr. CONOVER. I think you just shifted the gears from a discussion
of whether it would be an open bank versus a closed bank transaction.
Chairman ST GERMAIN. Correct.
Mr. CONOVER. TO what the costs of the various alternative ways
of handling the bank might be.
Chairman S T GERMAIN. Doesn't t h a t come into the decisionmaking process?
Mr. CONOVER. Yes; t h a t is part of it, but there are other considerations besides the pure numbers.
Chairman S T GERMAIN. The FDIC Act requires t h a t the least
costly method be utilized, does it not?
Mr. CONOVER. Yes; it does.
Chairman S T GERMAIN. What is the citation here? Section
13(c)(4)(a) says the least costly method should be utilized. Now, how
can you know what the least costly method is t h a t is being utilized
unless you perform the actual analyses, rather t h a n just sitting
down with a memo pad?
Mr. CONOVER. I agree with that.



354
Chairman S T GERMAIN. OK. Was t h a t done?
Mr. CONOVER. There were cost analyses t h a t were performed,
and they were looked at.
Chairman S T GERMAIN. Cost analyses were performed by the
FDIC?
Mr. CONOVER. Yes; by the FDIC.
Chairman S T GERMAIN. Because you said you didn't have them
in your shop.
Mr. CONOVER. That is correct.
Chairman S T GERMAIN. Mr. U n t h a n k and Mr. Graham Northup
are on their way. Maybe we can tell them what we are looking for
and seeking.
Mr. PATMAN. Mr. Chairman, may we ask for the record t h a t he
present such memorandums as he does have in his possession?
Chairman S T GERMAIN. We have those people coming here. Mr.
Wortley.
Mr. WORTLEY. Thank you, Mr. Chairman.
We are coming into the grand finale here, Mr. Conover. I am
worn out listening. I would just like to follow up on my line of
questioning from yesterday regarding the transmittal of the examination findings. It is my understanding t h a t the national bank examination reports are transmitted to the bank's board of directors
with a cover letter from the Deputy Comptroller of Multinational
Banking which sets forth those matters upon which the board is
expected to act.
It is my understanding t h a t the board is supposed to review the
transmittal letter and the examination report and reply in a rather
timely fashion to the items noted in t h a t letter. Continental Bank
took 8 months to reply to Deputy Comptroller Billy Wood's 1979
transmittal letter. It took 7 months to reply to his 1980 letter, and
it took 5 months to respond to his 1981 letter.
Are these time periods comparable to the length of time t h a t
other large multinational banks would take or consume?
Mr. CONOVER. N O ; they are not. They are too long.
Mr. WORTLEY. Did you do anything to prompt them along? What
is the normal period of time a multinational bank would take to
respond?
Mr. CONOVER. It depends a little bit on the date you begin measuring from. The report is normally submitted to the board, then
there is a board meeting held at which representatives from the
Comptroller's Office—that includes me—present the examination
findings and discuss them with management and the board. It is
unlikely t h a t the bank would respond prior to t h a t meeting. If you
measure the lapsed time from the date on the letter signed by the
Deputy Comptroller for Multinational Banking to the date on the
letter in which the bank responded, you get a distorted picture because sometime after the report is given to the board, anywhere
from 4 to 6 weeks later, we would have this face-to-face meeting.
Mr. WORTLEY. Does the board have two meetings on this letter?
In other words, they receive it at one board meeting. They talk
about it, and then at a subsequent board meeting a representative
of the Comptroller's Office sits down and reviews it with them, and
they respond to some of these critical



355
Mr. CONOVER. The report is distributed to them, and they read it.
Whether they choose to discuss it among themselves prior to our
meeting is up to them. So they may very well end up having a discussion on the subject at the board level on two different occasions.
In any event, after they have received it, have read it, and have
had a chance to digest it, we have a meeting with them in which
usually a slide presentation is given by the examiner in charge. In
the most recent case of Continental t h a t would have been Mr. Kovarik.
Mr. WORTLEY. This was 7 to 8 months we are talking of?
Mr. CONOVER. I understand what you are saying, and I said t h a t
that was too long, and I am just indicating t h a t there is
Mr. WORTLEY. What is the normal timespan?
Mr. CONOVER. A more normal timespan would be about 2
months.
Mr. WORTLEY. About 2 months?
Mr. CONOVER. Yes.
Mr. WORTLEY. Mr.

Woods' October 25 examination report transmittal letter puts Continental board of directors on notice regarding significant problems in the bank system of identifying and
rating problem loans. I quote him: "The importance of the liability
of the internal loan evaluation procedures as an early warning
mechanism to control credit quality in a growth environment
cannot be overemphasized."
It took Mr. Miller of Continental Bank 8 months to reply to that
letter, and in his reply he downplayed the significance of Mr.
Woods' comments.
Mr. Woods' 1981 transmittal letter contained a variety of comments to Continental's board regarding such matters as the 82 percent ratio of criticized assets-to-growth capital funds, and the fact
that capital had not kept pace with the asset growth. An internal
Comptroller memorandum of July 22, 1981, said regarding Continental's response 7 months later, and I quote:
The recently received response to the J u n e 30, 1980, examination does not address
all matters highlighted either in the transmittal letter or in Mr. McCarte's letter to
the board. The letter appears to have been put together hastily. Bank personnel apparently were embarrassed when it was realized a response had not been prepared.

Now, is a 7 months' delay in a cursory written response the
normal pattern for money center banks?
Mr. CONOVER. N O , it is not the normal pattern. Responses need to
be made in a more timely fashion by all money center banks. Certainly the particular case you cite is unacceptable.
Mr. WORTLEY. Would it be advisable to give institutions a specific
period of time in which to respond, so situations like this do not
drag on?
Mr. CONOVER. Yes, it would. Yes, it will.
Mr. WORTLEY. YOU will, t h a n k you.
I think these letters and responses of Continental Bank and the
Comptroller's assessment of those responses ought to be made a
part of the hearing record, and I would ask unanimous consent
that the 1977 and 1982 letters and responses be placed in the
record at the proper place.
Chairman S T GERMAIN. Along with the others t h a t have already
been entered.



356
Mr. WORTLEY. With 1979, 1980, and 1981.
Chairman S T GERMAIN. IS there objection?
The Chair hears none. It is so ordered.
[In response to the request of Congressman Wortley, the transmittal letters pertaining to OCC examinations dated 1977 and 1982
were submitted for the record by Mr. Conover:]




357
PERTAINING TO OCC EXAMINATION
COMMENCED:
April 25, 1977
CLOSED:
March 31, 1977

LETTER TO THE BOARD OF DIRECTORS

A general examination of your bank commenced April 25, 1977
using financial information as of March 31, 1977. The examination
was conducted in accordance with standard examination procedures of the Office of the Comptroller of the Currency. This report
consolidates information from the International Report of Examination, which should also be reviewed and referred to for more detailed information concerning your International activities.
The level of criticized assets continues to be of concern, even
though a reduction is shown. $1,459 million or 122% of gross capital funds are subject to criticism at this examination compared to
$1,546 million or 151% at the Februaary 1976 examination. Meaningful reductions are noted in the level of the most severely classified assets, with the doubtful and loss categories comprising $224
million compared to $391 million at the previous examination.
These reductions are a result of an improving economy and the
positive steps taken by management to reduce exposures. The majority of your problem assets remain centered in the real estate
area where continued emphasis must be placed on seeking final
resolution to the numerous workout arrangements already begun.
Your management team has taken, an aggressive stance in its attempts to reduce the bank's exposure to loss in this area, and,
given the proper environment, should be able to reduce these problem assets to more reasonable proportions.
Your recent capital augmentation and continued earnings retention have allowed the equity accounts to increase to a level more in
keeping with the growth attained in recent years. The capital plan
set forth through 1979 should provide sufficient amounts to sustain
your projected growth over the period; however, continued monitoring of the relationship between capital and other balance sheet categories is necessary.
The violations of regulations revealed by this examination have
been discussed with management and corrective action has been
promised in each instance.
The examination disclosed on other matters worthy of comment
which were not satisfactorily remedied during the examination.
The comments and criticisms included in the comment section of
this report should receive the attention of the board as considered
appropriate in the circumstances.




RICHARD M. KOVARIK,

Examiner-in-Charge.
(By) BILLY C. WOOD,

Regional Administrator.

358
PERTAINING TO OCC EXAMINATION
COMMENCED: April 30, 1982
CLOSED:
November 19, 1982
COMPTROLLER OF THE CURRENCY,
ADMINISTRATOR OF NATIONAL BANKS,

Washington, DC December 6. 1982.
BOARD OF DIRECTORS,

Continental Illinois National Bank and Trust Company of Chicago.
221 South LaSalle Street,
Chicago, LL
MEMBERS OF THE BOARD: The purpose of this letter is to highlight
conditions noted in the accompanying combined report of examination completed November 19, 1982, under the supervision of Senior
National Bank Examiner Richard M. Kovarik. This letter is considered a part of the examination report and is to be treated with the
same degree of confidentiality.
Examination results show the condition of the institution to be
seriously deteriorated. While the bank enjoyed a large degree of
success during the past five years through a policy of aggressive
pursuit of dominance in domestic corporate lending, the portfolio
generated during that period is failing to weather the test of a
severe and prolonged recession. This has produced unsatisfactory
performance and a weakened condition which adversely reflects on,
and is the responsibility of both management and the board. While
we are confident the institution possesses sufficient management
expertise to lead the bank through this current period of difficulty,
a comprehensive reassessment of corporate objectives, style, and
philosophy is required. Management's and the directorates expressed willingness and apparent ability to initiate appropriate corrective measures are viewed favorably.
Current problems can be largely attributed to decentralization of
authority without adequate policies, procedures and quality control
systems, combined with a management direction that encouraged
aggressive growth but failed to hold managers accountable. Several
large lending relationships raise prudency questions given that one
of the most basic fundamentals of banking is the diversification of
risk. The magnitude and severity of existing deficiencies do not
lend themselves to short-term resolution. And given the current
economic outlook, there remains concern that Continental's problems have not yet peaked which creates uncertainty regarding
even further impact on the institution.
A program of enhanced supervisory oversight is being implemented by the Office of the Comptroller of the Currency. It will address matters detailed by Examiner Kovarik throughout the report
of examination. Matters of serious concern include but are not limited to: inordinately high level of classified and criticized assets
(172% and 262% of Gross Capital Funds, respectively): unprecedented volume of nonperforming loans (S2 billion at 9/30/82); seriously elevated loan losses: doubtful assets approximating onefourth of primary capital; inadequate loan support systems, including internal credit review; the need for a separate loan workout department; diminished earnings with mediocre prospects for near
term recovery; inability to attract market rate funding from cradi-




359
tional sources: liability structure and balance sheet mix; the serious strain placed on capital and the loan loss reserve by deteriorating asset quality; acute need to reassess and revise, as necessary,
corporate goals and objectives and internal policies and procedures
especially as they apply to lending, internal controls, and certain
internal audit procedures; CINB's tarnished reputation in the
global marketplace resulting primarily from asset problems and
the bank's relationship with the defunct Penn Square Bank, N.A.
Violations of law listed in the report of examination should receive immediate attention. Of specific concern are possible violations of 12 U.S.C. 84 (lending limits) and 12 C.F.R. 9.10 (investment
of income cash generated by fiduciary relationships). You should be
aware that resolution of this latter item could possibly involve disclosure, and/or restitution, to affected beneficiaries. The bank's
legal staff has provided responses to the above matters and both
are currently under review by this Office.
While the overall assessment of the bank's data processing function was favorable, the inadequacy of hardware back-up and contingency planning in key areas was noted. Further, there is a continuing need to clarify corporate policy regarding data file retention.
The results of the Consumer Affairs examination indicate a high
level of compliance in most operating areas of the bank, including
a favorable CRA assessment. However, cited violation of Federal
Reserve Regulations B and Z point up a need to further improve
the internal compliance system.
Please direct your response to matters cited in the examination
report to the Comptroller of the Currency, Administrator of National Banks, Attention: Duputy Comptroller for Multinational
Banking, Washington, D.C. 20219 with a copy to the Regional Administrator of National Banks, Seventh National Bank Region,
Sears Tower, Suite 5750, 233 South Wacker Drive, Chicago, Illinois
60606.
Sincerely,
WILLIAM E. MARTIN,

Deputy Comptroller for Multinational Banking.
Enclosures.
LETTER TO THE BOARD OF DIRECTORS

A consolidated examination commenced May 24. 1982 using financial information as of April 30, 1982. In order to reduce duplication of efforts and to facilitate a more intense review of specific
areas, a portion of our work was limited to a review of internal
audit reports and work papers. Where significant exceptions were
noted in these audits, additional reviews were made to insure that
proper corrective actions were being taken. Areas of interest such
as Commercial Lending, Funding, Earnings, Capital. Reserve for
Possible Loan Losses and International/External Audit received examination in accordance with the General Examination procedures
prescribed by the Comptroller of the Currency.
The examination reveals the bank to be in serious difficulty. Experiencing an inordinately high level of problem assets and a sig-




360
nificant volume or adverse publicity occasioned by problem loans
(more specifically, the relationship with the defunct Penn Square
Bank, N.AJ, the bank's image in the financial community has
fallen precipitously.
Criticized assets have increased substantially to $5.6 billion and
now represent 262% of Gross Capital Funds (GCF), compared to
99% ($1.8 billion) at our previous examination. Even absent the significant portion of criticized assets related to participations purchased from Penn Square ($821 million), criticisms still equal 223%
of GCF. Either of these levels is much higher than any of your
peers, and the highest level ever witnessed by the bank.
Even more important is the increased volume of more troublesome assets (Doubtful and Loans) which amount to $778 million,
compared to $209 million at April 30, 1981. All losses listed in this
report have been charged-off as of September 30, 1982. Those assets
classified doubtful ($548 million) carry significant potential for
future loss. The Reserve for Possible Loan Losses, considered adequate at September 30, 1982, must continue to receive close scrutiny to insure its continued adequacy. The increased provision taken
in the third quarter, together with management's commitment to
closely monitor the reserve, should aid in restoring a cushion to
absorb unforeseen problems.
Beginning with the effects of the failure of the Penn Square
Bank in July, significant change in the Corporation's funding profile has taken place. The effects of the bank's relationship with
Penn Square on second and third quarter earnings, together with
heightened adverse publicity concerning Continental Illinois Corporation, have added to the ongoing change in the funding profile.
Because domestic investors are reluctant to purchase long term instruments, the Euro markets are being heavily tapped in order to
maintain a relatively stable mix between long and short term funding. At this time, the funding situation has stabilized and, absent
any growth (presently undersirable) or further adverse occurrences,
the Corporation should continue to be able to fund itself without
significant discount window borrowings. A return to more normal
earnings, reductions in the level of problem assets, and a more conservative growth objective for the Corporation, will be necessary to
regain investor confidence.
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 responsibility/accountability.
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. This occurred primarily in the Oil and Gas Department of the Special Industries Group," which accounted for the majority of total loan
growth over the past year and is the major contributor to the increased problem assets" noted at this examination. Certainly, many
bank units have operated effectively and have been able to maintain satisfactory asset quality. This is a reflection on the many
good managers in place. There are, however, certain bank units




361
(Oil and Gas and Real Estate Services) where this is not the case.
The system of "checks and balances" must be predicated on increased levels of responsibility. Since the responsibility was percieved in some cases to rest solely at the orginating unit, the
system was compromised. Internal reports reflected growing problems with respect to the Penn Square participations, but these signals were not heeded by management personnel who were responsible for overseeing lending activities.
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 organizations 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 volume involved.
The lack of adequate support has resulted in increased exceptions to proper credit and collateral documentation, most particularly in the Mid-Continent Division of the.Oil and Gas Department,
which housed the Penn Square participations. Without complete
and proper documentation, quality is difficult to judge, and more
importantly nearly impossible to maintain: '
The system of monitoring credit quality also suffered as numerous problem loans were not brought to management's attention.
This was witnessed by the increased disparity between both internal ratings and Watch Loan Reported loans, and CCC criticized
loans. The need for an improved system to monitor loan quality
has been discussed in prior examination reports, and is even more
apparent now. Management has now recognized the need for a
strong, independent internal review process to augment the officerinitiated Watch Loan Reporting System and serve as the "check"
for Senior Management and the Board.
As stated previously, the bank's image has suffered greatly. As
steps are taken to restore that image, it is essential that a rethinking include reviews of the proper type and mix of assets: funding
sources available and/or desirable to compliment the asset portfolio; and adequate capital requirements for the furture. Then, actions must be taken to insure that everyone is working in a way
which will achieve the position desired" with the least degree of
risk, and efforts can be intensified to strive for regaining the image
which is so important to a money center bank. Because much of
that image is dependent upon a consistent, quality earnings
stream, a major factor in future strategy will have to be restoring
. overall asset quality.
Leverage ratios compare favorably with your competitors: however, as the problem asset levels far exceed the norm, the capital




362
base is under increased pressure. Presently capital is considered
adequate to support operations but is not sufficient to provide for
further growth. As noted above, needs and sources of additional
capital should be considered in the assessment of the future of the
bank.
The examination of the Trust, Electronic Data Processing (EDP)
and Consumer Compliance areas generally reflect satisfactory conditions. In the Trust area, the major item of contention is the ongoing failure to invest income cash as prescribed by OCC regulations.
A formal interpretation of this matter is expected shortly. Progress
has been made in upgrading disaster/recovery contingency plans
for EDP operations; however, continued emphasis on this endeavor
is needed to insure that ail processing areas can deal effectively
with disruptions.
The Consumer Compliance examination revealed violations of
Regulations B and Z of the Federal Reserve Board. Although the
violations of Regulation Z did not result in reimbursement being
required, the violations of Regulation B do require the bank to
notify affected customers. Steps should be taken to prevent the occurrence of consumer violations, as the effect on the bank could be
both embarrassing and costly.
Other violations of Law, Regulation and Ruling are listed in the
Commercial section of the report. Action should be taken to correct
these violations, and the Deputy Comptroller for Multinational
Banking should be notified when corrections have been affected. A
potential violation of the legal lending limit (12 U.S.C. 84) was discovered during the examination. A formal ruling on this matter
has been requested.
The bank is facing a most challenging period in its history. Management is considered sufficiently talented to deal effectively with
the problems at hand. Senior Management and the Board of Directors have reacted appropriately to identify, isolate and deal with
the shortcomings of the past. The improvements recommended in
this report, and those contained in management's internal review,
should aid in returning the bank to a sound condition.




RICHARD M. KOVARIK,

Senior National Bank Examiner.
WILLIAM E. MARTIN,

Deputy Comptroller for Multinational Banking.

363
Mr. WORTLEY. I yield back the balance of my time.
Chairman ST GERMAIN. The subcommittee will be in recess for 3
minutes.
[Recess.]
Chairman ST GERMAIN. The subcommittee will come to order.
Mr. Conover, as you have heard in our discussion, the FDIC officialdom is going to provide me with an analyses personally.
I can then determine whether the requirements of 13(c)(4)(a)
were met. Remember, I asked you a question, you said you would
submit for the record about how many loans were made by Continental within the city limits of the city of Chicago.
Mr. CONOVER. Yes.
Chairman ST GERMAIN. YOU

said you would be submitting it for
the record. That is going to be most interesting to me, because the
requirements of 13(c)(4)(a) states, "* * * no assistance shall be provided in accordance with this section/'
If the analysis was made, how could anyone say they complied
with that first part of 13(c)(4)(a)? Then we go to the next phrase.
"Except that such restrictions shall not apply in any case in which
the corporation determines that the continued operation of such
bank is essential to provide adequate bank services to its community.
We did indeed amend that a little bit because of the savings
bank situation in New York, stating it would be hard to say that
without a particular savings bank—New York City would go down
the tube. So we amended it slightly, but still said the community.
Since I wrote this, it is my bill, the community I thought about
was not—I was thinking about Chicago Bank, Chicago; Woonsocket
Bank, Woonsocket, and Providence Bank, Providence. But the community did not extend to the whole Continental United States of
America as well as all of its possessions and territories. So that is
why I think that that should have been met, that requirement, the
analyses should have been done.
Mr. Barnard has a question, then I will go to Mr. Leach.
Mr. BARNARD. On that particular question, Mr. Chairman, Mr.
Conover, what in the Community Reinvestment Act reports identify the loans being made to the local community? Every bank is
supposed to file a community
Mr. CONOVER. Yes, they would.
Mr. BARNARD. Would those reports be available for the file?
Mr. CONOVER. Yes, we will answer the question, so that you will
know what volume of loans was made within Chicago, assuming
the data are available to do so, and I believe they are.
Chairman ST GERMAIN. If you would yield, staff informs me that
the examination reports state they were in full compliance with
the Community Reinvestment Act. However, I guess we don't have
the material on which they based that conclusion. So I know, if the
gentleman will yield, we are going to want that.
Mr. BARNARD. On a separate examination, if I could get the attention of the staff, it seems at the regular examination, or special
examination, the Community Reinvestment Act files are examined,
and report filed. Am I wrong there, Mr. Comptroller?
Mr. CONOVER. NO, that is correct.



364
Mr. BARNARD. That might be helpful in answering the chairman's
Chairman S T GERMAIN. In my letter of September 11, you have
been most cooperative, really and truly, in assisting us, as has been
the FDIC, but in the letter of September 11, I did ask for the provision of a tabulation of the annual rates of asset growth, the ratio of
primary capital—or comparable measures in earlier years—to total
assets, the ratio of classified assets to gross capital funds,- the ratio
of purchased funds to total deposits, the ratio of rate sensitive deposits plus purchased funds to total deposits, the ratio of reserve
for possible loan losses to total loans, and the return on average
assets, since 1970 for CINB, for its peer money center banks as a
group, and for all national banks as a group.
I am sure it was an oversight. We would appreciate your supplying t h a t for the record.
Mr. CONOVER. If there are any questions that we haven't answered today
Chairman S T GERMAIN. That is what we are aware of.
[In response to the request of Chairman St Germain, the following information was submitted for the record by Mr. Conover and
may be found on page 369.]




365

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

October 5, 198 4
The Honorable Fernand J. St Germain
Chairman
Committee on Banking, Finance
and Urban Affairs
U. S. House of Representatives
Washington, D. C. 20515
Dear Mr. Chairman:
At the September 19, 1984 hearing on Continental Illinois National
Bank, I was asked to provide certain information for the record.
That information is as follows:
Question 1: Tabulation of the time it takes national banks with
the lowest ratings (i.e., CAMEL ratings of 3, 4, and 5) to become
sound.
The following is a tabulation of the average number of months it
has taken to rehabilitate and restore to a sound condition those
banks that were under special supervisory attention. The data
encompass all those banks that were removed from "problem status"
for the period covering 12/31/81 through 7/31/84.
Total Assets

Number of Banks

$100MM and under
$100MM to $300MM
$300MM and over
Overall average

Question 2:

Average Number of
Months to Rehabilitate

146
14
7

3D. 3
39.7
57.3
32.2

The extent of Continental I l l i n o i s ' foreign exposure.
3-31-84

12-31-83
Average foreign loans
as a % of average
total loans

($10,258MM)

34.1%

($10,433MM)

34.7%

Average foreign
deposits as a % of
average total deposits

($15,288MM)

47.9%

($16,378MM)

49.5%

Average number of foreign banks with
deposits in Continental, May 1984 * 461

39-133 0—84

24




366
Question 3; Dollar loss to individuals, corporations, etc., if
Continental Illinois had been paid out.
It is not possible to quantify all of the losses that a payout of
Continental Illinois would have caused. The most direct and
immediate losses would be those incurred by creditors of the bank
and the holding company — i.e., the bond holders and uninsured
depositors. However, some of these funds would be recovered as
the PDIC liquidated the bank.
A large number of banks had uninsured deposits at Continental
Illinois. Had the bank been paid out, some portion of those funds
would have been lost, and some of the small banks with a sizable
percentage of their equity capital on deposit would have failed.
Other possible losses include the ripple effect of bankruptcies
that might have resulted from losses borne by uninsured commercial
depositors at Continental and the other failed banks.
Finally, the pay-off of Continental Illinois could have sent
shock-waves through the international money markets if holders
of jumbo CDs decided not to renew their deposits at other U.S.
money center banks. Again, no ready estimate of the losses such
a reaction might cause can be made, but the danger to the U.S.
banking system could have been sizeable.
Question 4;

The number of national banks chartered since 1982.

The number of national banks chartered between January 1, 1982 and
June 30, 1984 is 561.
Question 5: A breakdown of Continental Illinois' oil and gas
portfolio by type and collateral.
Type
Rigs
Undeveloped Leases
Refineries
Service & Supply
Oil & Gas Reserves
Integrated Companies
Transmission &
Miscellaneous

($MM's)

454
90
866
362
3,160

438
549

Collateral
secured by rigs
secured by leases
secured by refineries,
receivables, etc.
various collateral
secured by reserves
generally unsecured
to the "majors"
secured and unsecured

5,919
(Figures are as of year end 1983 and include letters of credit.)




367
Question 6; The amount of the loan portfolio within the city
limits of Chicago.
($000's)
Consumer loans in Chicago
Commercial loans in Chicago
Total

136,943
4,916,513
5,053,456

Savings deposits from Chicago

642,079

Checking deposits from Chicago

942,903

Total

1,584,982

(From information obtained during the 1983 Consumer Examination.)
Question 7; The amount of the shortfall to corporate bondholders
if the holding company had been liquidated.
This question is best answered by the Federal Reserve Board since
they are most knowledgeable about the assets of the holding
company, including its real property assets.
Question 8; Of the 61% of banks rated "3" in 1980 that have
returned to health since then, the number which were among the top
fifty banks.
Of the 61% of banks rated "3" in 1980 that have returned to health
since then, five were institutions having assets of $1 billion or
more.
Question 9:

Whether Continental Illinois guaranteed WPPSS bonds.

Our examiners could find no evidence that Continental Illinois
guaranteed, i.e., issued standby letters of credit for, WPPSS
bonds.
Question 10; The statistical information you requested in your
September 11, 1984 letter.
See Attachment.
Question 11;
save a bank.

Considerations that enter into making a decision to

There are many ways to handle a failing bank. The most common
method is through a purchase and assumption by another bank.
Second is liquidation, which involves a payout to the insured
depositors.




368
Although Continental was not handled using either of these
methods, the solution had virtually the same effect on depositors,
shareholders, and management as a purchase and assumption.
A number of factors were weighed in making the decision regarding
Continental Illinois. Each was considered in conjunction with all
the others since they are clearly interrelated. These factors
included; overall cost to the FDIC, impact on financial markets
and on confidence in the U.S. banking system, legal impediments,
impact on borrowers who need further funding to continue their
business activities and impact on other depository institutions
with deposits in the failing institution.
Similar considerations would prevail in dealing with the failure
or near-failure of any large bank.
Question 12; The statistical information requested by Congressman
Barnard.
See Attachment.
Question 13; The date the last Penn Square Bank loan was sold to
Continental Illinois.
The last Penn Square Bank loan was purchased by Continental
Illinois on June 18, 1982.
I hope this information is helpful to the Subcommittee.
Sincerely,

C. T. Conover
Comptroller of the Currency




369
ATTACHMENT
C O N T I N E N T A L

I L L I N O I S

N A T I O N A L

B A N K

Comparative Data*
ASSETS ($ BILLIONS)
National
Peer
CINB
Group
Banks

CINB

GROWTH RATE
Peer
Group

National
Banks

1970

$8.8

$101.7

$371.7

15.8%

8.0%

11.5%

1971

10.0

110.4

418.2

13.6

8.6

12.5

1972

12.3

133.1

489.4

23.0

20.6

17.0

1973

16.4

166.4

569.5

33.3

25.0

16.4

1974

19.1

202.9

629.5

16.5

21.9

10.5

1975

19.8

203.0

653.7

3.7

0.0

3.8

1976

21.4

221.8

704.3

8.1

9.3

7.7

1977

25.0

256.8

796.8

16.8

15.8

13.1

1978

29.9

289.4

892.2

19.6

12.7

12.0

1979

34.3

334.0

996.2

14.7

15.4

11.7

1980

40.3

371.1

1,095.1

17.5

11.1

9.9

1981

45.1

387.2

1,200.9

11.9

4.3

9.7

1982

41.3

415.0

1,297.2

-8.4

7.2

8.0

1983

40.7

417.3

1,392.8

-1.5

0.6

7.4

*The eight wholesale money center banks included in the peer group are
Bankers Trust, Chase Manhattan Bank, Citibank, First National Bank of
Boston, First National Bank of Chicago, Irving Trust Co., Manufacturers
Hanover Trust Go., and Morgan Guaranty Trust Co.




370
C O N T I N E N T A L

I L L I N O I S

NATIONAL

BANK

Comparative Data
PRIMARY CAPITAL / ASSETS 1/
CINB

Peer
Groupg/

National
Banks J/

CINB

National
Banks 3/

1970

7.45%

6.85%

8.80%

21%

12%

1971

6.93

6.65

8.55

22

12

1972

6.75

5.99

8.29

17

11

1973

5.45

5.18

8.49

21

11

1974

5.09

4.81

8.93

65

16

1975

5.22

5.20

8.86

109

18

1976

5.44

5.17

8.80

121

19

1977

5.03

4.82

8.55

86

19

1978

4.67

4.65

8.70

86

19

1979

4.52

4.41

8.92

80

18

1980

4.39

4.38

9.14

61

21

1981

4.52

4.61

9.37

67

26

1982

5.19

4.69

9.70

172

38

1983

5.41

5.19

9.61

219

52

Primary Capital = Equity Capital + Allowance for Possible loan Losses.
In 1976 the definition of the allowance for possible loan losses, a
component of primary capital, was changed. Data prior to that year may
not be comparable with later data.
2/

unweighted average of individual bank ratios.

3/

Unweighted average data from individual bank examinations.




371
C O N T I N E N T A L

I L L I N O I S

N A T I O N A L

B A N K

Comparative Data
PURCHASED FUNDS / ASSETS
Peer
National
CINB
Group
Banks

RATE SENSITIVE /' DEPOSITS
National
Beer
CINB
Group
Banks

1970

N.A.

N.A.

N.A.

52.5%

44.5%

30.3%

1971

N.A.

N.A.

N.A.

56.9

47.7

32.6

1972

N.A.

N.A.

N.A.

60.4

52.1

33.2

1973

N.A.

N.A.

N.A.

67.1

61.7

35.0

1974

67.4%

61.1%

9.2%

73.0

66.3

36.6

1975

68.1

61.1

8.5

72.1

66.1

36.8

1976

68.8

62.0

9.0

73.0

63.8

36.4

1977

70.1

62.1

9.4

72.5

64.3

36.4

1978

70.7

64.3

11.2

74.0

67.3

38.4

1979

71.9

64.5

11.8

76.1

67.5

43.5

1980

73.4

66.0

12.6

79.1

71.7

48.6

1981

75.0

70.1

14.1

82.5

79.6

52.6

1982

76.2

69.3

14.7

83.2

80.0

52.2

1983

74.6

65.0

14.0

81.1

76.7

46.5

Purchase Funds = Large CDs + Federal Funds and Repurchase Agreements + Foreign
Office Deposits + Other Liabilities for Borrowed Money.
Rate Sensitive - Total Deposits - Demand Deposits - Savings Deposits.




372
C O N T I N E N T A L

I L L I N O I S

NATIONAL

BANK

Comparative Data

APLL / TOTAL LOANS
National
Peer
CINB
Group
Banks

RETURN ON AVERAGE ASSETS
Peer
National
CINB
Banks
Group

1970

2.77%

2.16%

1.58%

1.10%

1.00%

1.18%

1971

2.14

1.89

1.51

0.97

0.93

0.98

1972

1.81

1.73

1.45

0.90

0.87

0.93

1973

1.69

1.42

1.41

0.74

0.88

0.93

1974

1.64

1.26

1.42

0.63

0.60

0.86

1975

1.73

1.32

1.42

0.65

0.55

0.82

1976

1.20

0.85

0.97

0.65

0.52

0.87

1977

1.06

0.79

0.92

0.61

0.47

0.92

1978

0.99

0.84

0.96

0.58

0.53

1.06

1979

0.88

0.88

1.00

0.57

0.56

1.09

1980

0.88

0.87

1.06

0.59

0.58

1.03

1981

0.86

0.92

1.08

0.55

0.60

0.98

1982

1.14

0.94

1.13

0.17

0.60

0.83

1983

1.23

1.02

1.18

0.25

0.59

0.75

APLL - Allowance for Possible Loan Losses.




373
Chairman S T GERMAIN. Mr. Leach.
Mr. LEACH. I would just like to probe, if I could, for a minute one
further factor I have heard no discussion of today, but there were
some hints of in earlier press releases about the issue. That is
when you were considering your various options with regard to
Continental, did the factor of concentration or antitrust enter into
your thinking?
That is, was there a desire to save the bank in order to have
greater competition in banking within the city of Chicago?
Mr. CONOVER. Discussion arose as to whether it would be appropriate for the bank to merge with the First National Bank of Chicago, for example. And in any consideration of t h a t issue, the subject of competition and antitrust would naturally have been raised.
But it never became a live issue.
Mr. LEACH. It never was a reason for saving Continental in the
first place?
Mr. CONOVER. N O . It really never was a reason for saving Continental in the first place.
Mr. LEACH. In terms of American banking and Chicago banking,
is there any reason for the existence of Continental?
Mr. CONOVER. In what sense do you mean that?
Mr. LEACH. Let's say Continental could be liquidated at no cost
to anyone. Is there a loss to society?
Mr. CONOVER. If Continental could be liquidated? Maybe that is
not the right word, but we will use it anyway for purposes of discussion. If liquidated in a way in which there was no cost to
anyone means t h a t all existing customers have a satisfactory alternative way of being served and so forth, then there isn't a reason
for Continental. But you can also say there is no reason for any
other bank.
Mr. LEACH. The point I am making is t h a t sometimes there is an
argument on size grounds to save something t h a t is truly important, a national resource. You wouldn't argue t h a t Continental is
of t h a t standard?
Mr. CONOVER. N O , we never thought Continental was important
as a national resource. We were concerned about the impact t h a t a
failed Continental would have on the Nation's financial system.
But no one ever said there needs to be this thing called Continental
Illinois because it is an old, treasured building and has a long history to it and the world would be terrible without it.
Mr. LEACH. SO, it wouldn't be analogous, for example, to losing
this committee. I mean, if the Banking Committee went out of existence, I mean there would be a great national calamity. But you
wouldn't say t h a t would be the case with Continental. No.
Mr. Chairman, I yield back the balance of my time.
Chairman S T GERMAIN. Mr. P a t m a n for 5 minutes.
Mr. PATMAN. Mr. Chairman, I just want to ask Mr. Conover if he
would help us in outlining the guidelines, rules or other considerations that show which other banks or holding companies would or
likely would receive the same treatment as Continental Illinois and
its holding company. Is it size, purely?
Mr. CONOVER. The presumption is t h a t we have established a
precedent t h a t all banks or bank holding companies of a particular



374
size or particular nature are going to be treated this way in t h e
future. I don't buy t h e fundamental premise.
This case was handled in the way it was because of the peculiarities of this particular situation. The bank got to where it was because of its peculiarities as a bank, and we have traced through all
t h e forces t h a t came together to cause t h e bank to be in t h e nearly
failed condition that it was.
Mr. PATMAN. What, in other banks, is similar in t h e way of particular peculiarities, perhaps? Or financial institutions.
Mr. CONOVER. There are other banks which, in terms of size or
type of lending, or number of offices or number of employees, or
any number of things, have some similar characteristics to Continental. But
Mr. PATMAN. What would impel you as an individual to ask for
consideration to be given to other large financial institutions of
any kind in America similar to this?
Mr. CONOVER. What would impel me?
Mr. PATMAN. Yes. What, in your judgment, would w a r r a n t doing
the same thing for another institution?
Mr. CONOVER. Under the present set of laws and the present deposit insurance scheme, I think if we found a situation similar in
characteristics to this one, in which we could find no buyer, and
the only alternative was to provide direct Federal assistance
through the FDIC and the Fed or pay off the bank and r u n t h e risk
of jeopardizing in a very serious way t h e Nation's entire banking
and financial system, we might
Mr. PATMAN. If any of the banks got themselves in the same predicament as Continental Illinois, you would anticipate we would do
the same thing for them, wouldn't you?
Mr. CONOVER. I didn't say it precisely t h a t way.
Mr. PATMAN. IS there any one of them t h a t you would not do it
for?
Mr. CONOVER. I certainly wouldn't answer by identifying one. If
conditions existed as in this case, since I think this was a good, sensible solution to the problem at hand, it would make sense to deal
with it in the same way.
Mr. PATMAN. For any of the other large money center banks?
Mr. CONOVER. For any whose failure might have the same impact
on the Nation's financial system as we thought this one could have.
Mr. PATMAN. TO your way of thinking, wouldn't you say t h a t any
of the others, upon failing, would have the same impact?
Mr. CONOVER. That is probably true.
Mr. LEACH. Would the gentleman yield?
Mr. PATMAN. What about the next tier down?
Chairman S T GERMAIN. Bill, we have "Alive at Five" going. I
think you have made your point.
Mr. PATMAN. May I ask for the record he submit to the committee the factors that enter into his judgment on cases of this nature?
Chairman S T GERMAIN. A S to how far down they go?
Mr. PATMAN. That is right, and what guidelines
Mr. CONOVER. N O , I can't submit a list of banks. I certainly don't
want to do that.
Chairman S T GERMAIN. Not t h e banks.
Mr. PATMAN. N O . The considerations.



375
Mr. CONOVER. The considerations that went into this deal?
Mr. PATMAN. Just give me 25 considerations that should go into
any sort of consideration of this type. Or 10, or whatever you think
would adequately cover what you think of when you make your
dicision.
Mr. CONOVER. All right.
Mr. PATMAN. Thank you very much.
[In response to the request of Congressman Patman, the following information was submitted for the record by Mr. Conover and
may be on page 367.]
Chairman S T GERMAIN. Mr. Conover, as a matter of fact, the
answer to the question, absent anything occurring statutorily or
any other way, were there within the next month, 2 months, 6
months or 1 year to occur another situation such as you faced at
Continental, you would not have any alternative
Mr. CONOVER. YOU would have to deal with it in the same way.
Given the current laws
Mr. LEACH. May I ask one followup? There is one thing to say,
that one might have to save a particular banking operation. But
one of the issues this committee has raised and has been raised in
other ways by members of the administration is how you handle
every part of the package. For example, would you tell the committee that you must protect bondholders of all types, whether they be
of the bank or of the
Mr. CONOVER. Absolutely not. I mean, I would not do that. That
is what
Mr. LEACH. SO you might, in reviewing the situation, you might
well take a little bit different approach.
Mr. CONOVER. Well, if
Mr. LEACH. YOU are not saying that you did everything right.
Would you want to suggest to the committee maybe if you did it
over, you would do it a little differently?
Mr. CONOVER. NO; I am not suggesting that, Mr. Leach. I am
saying that there were some outcomes of the way we did it that
were undesirable. But by virtue of the structure of the beast we
were dealing with, they were unavoidable under the circumstances,
such as propping up of the bondholders in the holding company.
Mr. LEACH. That was unavoidable?
Mr. CONOVER. Unavoidable and clearly undesirable as far as I
am concerned.
Mr. LEACH. Thank you, Mr. Chairman.
Chairman S T GERMAIN. Mr. Conover, are you familiar with the
Committee on Banking Regulations and Supervisory Practices an
international body known as the Cooke Committee?
Mr. CONOVER. Yes; I am.
Chairman S T GERMAIN. Are you familiar with its functions?
Mr. CONOVER. Yes.
Chairman S T GERMAIN. Are any American regulators members

of that committee?
Mr. CONOVER. Yes.
Chairman S T GERMAIN. Which are?
Mr. CONOVER. The FDIC, the Comptroller's Office, and the Fed.
Chairman S T GERMAIN. For how long? Are they recent members?




376
Mr. CONOVER. The FDIC is a recent member. The Comptroller's
Office and the Fed go back 6 or 7 years.
Chairman S T GERMAIN. With respect to Continental, did you or
anyone in your office have any contact with the Cooke committee
relative to the Continental situation?
Mr. CONOVER. NO; we didn't have any contact with the Cooke
committee. Prior to the consummation or announcement of the
deal, we advised the Bank of England as to what was about to transpire. And after the fact, we had two representatives go to London
and meet with a group of British bankers and people in the London
market
Chairman S T GERMAIN. Was one Joe Selby?
Mr. CONOVER.

Yes.

Chairman S T GERMAIN. YOU are aware of his statement t h a t the
Cooke committee had a better insight into what was happening
t h a n we did here in Washington in relation to Continental? Selby
was referring to Continental. Do you agree with Mr. Selby's statement?
Mr. CONOVER. I wasn't aware of Mr. Selby's statement until you
just read it.
Chairman S T GERMAIN. IS t h a t Mr. Selby?
Mr. CONOVER. Mr. Selby tells me he thinks t h a t is a misquote,
t h a t what he did was call Peter Cooke to find out what the reaction
of the London marketplace was to the Continental deal. Since Continental had been funding itself in Europe and, more specifically,
in the London markets for some time, and since t h a t was where
the crisis in confidence occurred, it was of natural interest to us to
find out the reaction of t h a t marketplace to the deal after it was
announced. So Mr. Selby talked to Peter Cooke and asked him t h a t
question.
Chairman S T GERMAIN. Maybe Mr. Selby could correct the Fortune magazine article where he contends they misquoted him. I
mean Fortune
Mr. SELBY. The Fortune article did not say that I talked to the
Cooke committee. It said that I talked to Peter Cooke and the Bank
of England.
Chairman S T GERMAIN. If t h a t be the case, we will correct our
record.
[The following quotation is taken from the Fortune magazine article referred to:]
[From Fortune magazine, Oct. 1, 1984]

As concern mounted last spring about Continental Illinois's problems, Joe Selby
in Washington was on the telephone to Cooke at the Bank of England to find out
what was being said on Threadneedle Street. "They had a better insight into what
was happening than we did here in Washington," Selby remarks. At the Federal
Deposit Insurance Corporation, Robert Shumway, director of the division of bank supervision, fielded questions from Cooke Committee members in Ottawa, Brussels,
and London, cities in which the Chicago bank had offices. The conversations was
frank and functional, participants say, and the callers trusted one another with
their deepest secrets because they had come to know one another through the Cooke
Committee. Once again the U.S. government passed word via the Cooke Committee
t h a t it intended to bail out a bank. The result in effect was a nonevent: bankers
shook their heads over Continental Illinois, but the international banking system
took it pretty much in stride.



377
Chairman S T GERMAIN. On page 7 of your statement, you say,
"This is easy, Continental management announced its decision in
1976 to become one of the top three banks lending to corporate
America/'
For the record, I wish you would tell me what motivates these
people to want to be the top 10 or top 5 or top 3? You know, go, go,
go. Is there something hyper about these people t h a t they want to
be the biggest?
I talked to some of the English bankers. The fellow who heads up
Barkleys, a big institution, he makes I think maybe $80,000 a year.
He is underpaid, like you. The fellow at Continental, he is making
a half million. Maybe t h a t is one of the motivations.
I believe you have a golden parachute question, Mr. Barnard?
Mr. BARNARD. Mr. Comptroller, I wanted to congratulate you and
your staff on a very excellent brief on the question of the golden
parachute in this particular situation. And I know t h a t the decision not to void this came about because it said that, given the—
industrywide practice with respect to such termination agreements,
it will be difficult to establish a violation of either paragraph 18 of
our interpretive ruling on the subject contained in 12 CFR. It
would be interesting to me to know how much you feel would have
been excessive in t h a t situation.
At the same time, the last and real conclusion, said it is unlikely
the Comptroller would be successful in an enforcement action
against Continental and/or Anderson, Miller and Perkins given the
nature of their contracts. The bank size, financial condition and industry practice—memo to Robert Serino, it might be advisable for
the FDIC, considering the leverage it now has over Continental, to
suggest t h a t these contracts should be rescinded as they are not in
the bank's best interest. Is t h a t your recommendation?
Mr. CONOVER. I think we have to break the compensation provided to the individuals into two parts. One is normal retirement; the
other is the 2- or 3-year consulting contracts. I have talked both to
the subsequent management of the bank and the FDIC, about this
subject. I believe the FDIC is at least considering taking, and probably will take, some action regarding those contracts.
Mr. BARNARD. In the event these contracts were in the vicinty of,
say, $1 or $2 million in separation, what do you think your decision
would have been in that instance?
Mr. CONOVER. I don't think the decision is really any different
whatever the amounts are. I think the important point is t h a t
either the bank, itself, or the FDIC is in a better position to do
something about this problem than we are. I think they ought to go
ahead and do it.
Mr. BARNARD. Of course, the safety and soundness of the bank is
the main issue of whether or not these parachutes threaten—I
think that is one of the criteria.
Mr. Comptroller, I don't expect an answer here now. But we
need to put this Continental situation in perspective to the total
banking system. One of the questions t h a t the committee has asked
of you, which I hope t h a t you will reconsider and try to furnish us,
is if you can provide us information which would aid this committee in assessing the overall financial strength of the financial institutions over which you have regulatory responsibility. And if you



378
could do that, I think it would help us in evaluating the total financial system, and not just get an impression of what it is, compared to the condition of one's institution.
Mr. CONOVER. I think t h a t is appropriate.
Mr. BARNARD. In t h a t I would like for you to include the current
trends among national banks with regard to the following financial
measures: ratio of primary capital to total assets, ratio of classified
assets to gross capital funds and ratio of purchased funds to total
deposits, and what is the current overall condition of the banking
industry which your office is responsible.
I will be glad to give you t h a t in writing.
Mr. CONOVER. Fine.
[In response to the request of Congressman Barnard, the following information was submitted for the record by Mr. Conover:]
Chairman S T GERMAIN. The time of the gentleman has expired.
Mr. Conover, we want to t h a n k you for a sterling appearance
and I will bet while you were at Yale 2 years behind Stu McKinney, you never in your fondest dreams would have thought t h a t
you would spend a day with such congenial company as you have
here today.
Mr. CONOVER. YOU are absolutely right, Mr. Chairman.
Chairman S T GERMAIN. We want to t h a n k you for your assistance and cooperation, not only today but in preparing for these
hearings, and we hope we can continue to have the same spirit of
cooperation.
The subcommittee is in recess subject to the call of the Chair.
[Whereupon, at 3:10, the subcommittee was recessed subject to
the call of the Chair.]
[The following additional information: an article entitled "Central Bankers Have a Hot Line, Too" from Fortune magazine of October 1, 1984; an except from the Federal Register regarding the
Comptroller of the Currency's proposed rule on "Minimum Capital
Ratios; Insurance of Directives"; and the subcommittee's letter of
invitation to the witness Comptroller of the Currency the Honorable C. Todd Conover to testify follow:]




379
MONEY & MARKETS

CENTRAL BANKERS
HAVE A
HOT UNE TOO
It connects a worldwide old-boy network of banking regulators known as the Cooke
Committee. So far, however, this secretive group has been considerably better at
crisis management than at crisis prevention.
• by Stephen Fay

E

VERY SO OFTEN Fernand St
Germain, the powerful chairman of the House Banking
Committee, publicly denounces
a mystery-cloaked international body,
the Committee on Banking Regulations and Supervisory Practices. Since
no snappy acronym can be formed
from those initials, almost everyone
knows it as the Cooke Committee, after its chairman, Peter Cooke, a Bank
of England official. Among the things
that arouse St Germain's ire about the
Cooke Committee, an arm of the Bank
for International Settlements in the
prosperous and discreet Swiss city of
Basel, is the secrecy with which it operates. "I'm not telling you a goddamn
thing about the Cooke Committee," a
Washington member of the group
barked at a reporter this summer.
The mystery surrounding the committee is diminishing somewhat, but
Peter Cooke says: "I will defend to the
death keeping a very large part of what
we discuss secret." His committee is
one of the few international organizations that produces no annual report.
The document describing the committee's working arrangements and responsibilities, known as the Basel Concordat, was not published until 1981,
six years after it took effect.
Even more than the Cooke Committee's secrecy, St Germain resents its
lack of accountability ;to the U.S. Congress and his House Banking CommitRESEARCH ASSOCIATE Susan Caminiti




tee, along with what he regards as its ings of the Banking Committee,
failure to do anything constructive Cooke's upper lip unstiffened. "I
about the reckless expansion of inter- would not accept that as a statement of
national bank lending, especially to what I actually said," he commented
Latin American nations that have tartly. Cooke says his committee sent
proved reluctant or unable to pay off a paper to commercial banks in March
monumental debts.
1982 on managing international lendSt Germain talks about the Cooke ing. Obviously, many banks ignored
Committee in terms of an international the sensible advice it contained, such
banking conspiracy, a bankers' plot to as the suggestion that small banks takobscure the need for proper regulation ing part in a syndicated overseas loan
of international banking. He has held should make their own assessments of
congressional hearings on the Cooke risk and not just accept the lead bank's
Committee, and at his order the Gen- criteria.
eral Accounting Office is even now inCooke is unequivocal: the commitvestigating the group. Last year the tee could do no more. The committee
staff of St Germain's House Banking cannot say to banks, "Thou shalt not
Committee wanted to haul P e t e r lend to this country or that," he exCooke in to explain himself and his plains, "because that introduces politicommittee—a proposal; that central cal judgment and it sets up all sorts of
bankers, proud of their freedom from shocks and tremors. Who am I to say
political oversight, found abhorrent
whether the. judgment is right or
A compromise was arrived at: the wrong politically? Supervisors don't
next time he was in Washington, want to get into the business of runCooke would pay a courtesy call on St ning banks for bankers."
Germain. The meeting took place in
What then is the Cooke Committhe spring of 1983. St Germain de- tee—St Germain's sinister agglomerascribed it: "When Cooke stopped by to tion of faceless bankers or, as Peter
chat with us he pointed out that Bank Cooke and his colleagues would have
for International Settlements data indi- it, a useful bureaucratic tool? Orgacated in advance the growing debt situ- nized in 1975 by central bankers,
ation in developing countries. I asked the Cooke Committee is made up of
him what international banking regula- bank regulators and supervisors from
tors did to slow the growth rate re- around the world, who use it as a sort
vealed by BIS data. Very frankly, he of hot line for reliable information to
said [they did] really nothing or very help them deal with banking problems
little, except to discuss i t "
and troublesome rumors of problems.
Reading this in the published hear- "It serves to make the world a little

380

Beyond Peter
Cooke, chairman of
the Cooke Committee,
looms the round
tower of the Bank for
International
Settlements in Basel.

PHOTOGRAPHS BY RALPH CRANE




OCTOBER 1, 1984 FORTUNE

139

381
MONEY & MARKETS

Central bankers
relax in Basel on a
warm summer
Sunday. From left:
Gerald Bouey of the
Bank of Canada; Erik
Hqffmeyerofthe
Danish National
Bank; Henry Wallich
of the U.S. Federal
Reserve Board; and
Lord Richardson,
former Governor of
the Bank of England
and the man
responsible for the
founding of the Cooke
Committee.

140

smaller," says an American member,
H. Joe Seiby, senior deputy comptroller for bank supervision in the Comptroller of the Currency's office.
Making the world smaller means, in
banking, making it safer. In March
1980, American regulators used the
Cooke Committee to spread the confidential word to central banks abroad
that the comptroller had determined to
save First Pennsylvania Bank of Philadelphia, 'ifter this word was spread,
the outflow of foreign funds from the
bank diminished, giving the rescuers
time to restructure the bank. Similarly,
when the U.S. froze Iranian assets
during the hostage crisis that same
year, the Cooke Committee was able
to flash the reassuring message that
the U.S. was determined, despite its
action, not to disrupt the system of international settlements.
As concern mounted last spring
about Continental Illinois's problems,
Joe Selby in Washington was on the
telephone to Cooke at the Bank of
England to find out what was being
said on Threadneedle Street. "They
had a better insight into what was happening than we did here in Washington," Selby remarks. At the Federal
Deposit Insurance Corporation, Robert Shumway, director of the division
of bank supervision, fielded questions
from Cooke Committee members in
Ottawa, Brussels, and London, cities
in which the Chicago bank had offices.
The conversations were frank and

FORTUNE OCTOBER 1, 1984

39-133 0—84

25




functional, participants say, and the
callers trusted one another with their
deepest secrets because they had
come to know one another through the
Cooke Committee. Once again the
U.S. government passed word via the
Cooke Committee that it intended to
bail out a bank. The result in effect was
a nonevent: bankers shook their heads
over Continental Illinois, but the international banking system took it pretty
much in stride.

P

ETER COOKE, at least, is not
a secret. He is 52 and an associate director of the Bank of
England, where he is in charge
of banking supervision. He works
overlooking the bank's garden court in
an office with a fine molded ceiling
over the fireplace and landscapes on
the walls. His red leather desk is scrupulously tidy. A history major at Oxford, Cooke was hired by the Bank of
England some 30 years ago and developed a taste for international economic
administration, working first at the
BIS and then in Washington at the International Monetary Fund. Eventually, he became a banking supervisor—a
specialist occupation, the delicacy of
which is illustrated by the legendary
bank supervisor's prayer: "Oh Lord,
let there be failures, but let them be
small ones." Small failures are instructive; large ones are embarrassing.
It was a big failure that led to the establishment of the Cooke Committee:

the 1974 collapse of the Herstatt Bank,
which threatened to spill over not just
into the rest of the West German
banking system but across national
frontiers. That, coupled with frequent
disruptions in international markets in
the new era of floating exchange rates,
led the Governor of the Bank of England, Gordon (now Lord) Richardson,
to expound the doctrine that even
good supervisory systems in individual countries are not enough to regulate international banking.
The first meeting was held in January 1975 with members drawn from
the inner circle of BIS members
known as the Group of Ten—the U.S.,
the United Kingdom, France, Germany, Italy, the Netherlands, Belgium,
Sweden, Canada, and Japan. Switzerland and Luxembourg were also present, since they are important centers
of international banking.
The U.S. was represented at that
first meeting by the Federal Reserve
Board, though the U.S. is not exactly a
member of the BIS. It has no voting
rights and no members on the board,
but when the central bank governors
meet in Basel each month to mull over
the state of the world's economies, the
Federal Reserve Board's representative, Henry Wallich, has his feet under
the table. The regulators and supervisors from Washington are accommodated on the Cooke Committee in the
same informal way. The Federal Reserve Bank of New York joined shortly
after the committee was organized in
1975. The Comptroller of the Currency's office came aboard in 1978, the
FDIC in 1984. The U.S. now has more
representatives than any other country on a subcommittee of an organization of which it is not a member.
In the few months between Richardson's getting the idea and the committee's first meeting, the Franklin National Bank collapsed in New York,
emphasizing the need for an international banking intelligence network
that might try to spot and correct
bad banking behavior.
The first task, Cooke recalls, was
for the supervisors to get to know one
another's systems; the next was to get
to know one another. Once they did
so, it was clear that the formal meetings were less productive than telephone conversations between supervi-

382

MONEY & MARKETS
sors who had already met in Basel.
"Banking supervision is often very
sensitive, very confidential, often involving secrecy laws. Personal trust is
very important in getting the dialogue
going," says Cooke.
John Heimann was the first Comptroller of the Currency to take part in
the Cooke Committee's informal international network. Now deputy chairman in New York of Becker Paribas,
an investment banking firm, which is
being sold to Merrill Lynch, he remembers: "The meetings were on a
totally apolitical basis, and they created an ambiance of trust and understanding so that any one of us could
pick up the phone at any time. I might
say to a colleague, 'Look, no memos,
no attribution, but I'm scared to death
of this position. What have you
heard?'"

" I might say
to a colleague,
'Look, no
memos, no attribution, but
I'm scared
to death of
this position.
What have
you heard?'"

One of the Cooke Committee's
darker secrets was discovered by
Richard S. Dale, an English banker
who turned academic for a time. Leafing through documents he obtained
from the Federal Reserve Board in
1982 under the Freedom of Information Act, Dale found that the committee's members were confused about
the division of responsibility in international banking supervision. He unearthed four different analyses of
where primary responsibility lay for
bank activities outside a bank's own
country—an ambiguity that suggested
the Cooke Committee was more a network than a safety net. This conclusion was reinforced by the 1982 failure
of Milan's Banco Ambrosiano, which
had connections with the Vatican bank.
Most public speculation about the
case concentrated on the bank's president, Roberto Calvi, who was found
hanging from Blackfriars Bridge on the
River Thames in London. But the
Cooke Committee's private damage
report revealed that whatever wickedness Calvi might have contrived, bank
supervisors had done nothing to prevent default on loans of $400 million by
a Luxembourg subsidiary of Banco
Ambrosiano. Luxembourg's bank supervisors thought Italy bore responsibility, while the Italians denied accountability. That was embarrassing.
What was worse for creditors was that
no central bank was willing to act as
lender of last resort, and there was no

142

FORTUNE OCTOBER 1, 1984




institution capable of bailing out the
bank and protecting victims. (The Vatican eventually did the decent thing,
partially satisfying claims from more
than 100 banks in July 1984; after all,
Calvi was known as God's banker.)
Last year the committee's members
agreed on a principle called consolidated supervision, which amounts to this:
foreign offices of an American bank
ought to be supervised by Washington, a British bank's offices by the
Bank of England, and so on. Naturally,
supervisors keep an eye on foreign
banks operating in their territory, reporting any bad news.

T

HIS PRINCIPLE is expected to
bring a change in West German
banking laws. West German
banks have been able to use
Luxembourg as their base for "offshore" business, effectively avoiding
supervision of their international activities by regulators at home. The Cooke
Committee, says one member, "has
pushed the Germans along" toward
embracing consolidated supervision
by making banks register their offshore offices with West Germany's
Federal Banking Supervisory Office.
The Cooke Committee also stated
that regulators can forbid a foreign
bank to open an office in their countries if they are not satisfied with tl.e
quality of supervision in the bank's
home capital. Britain has already made
use of consolidated supervision. South
Korean banks reportedly were told
that they would not be allowed to operate in London unless Korea's domestic regulators in Seoul pulled up
their socks—which presumably happened: the Bank of Seoul & Trust still
has an office in London.
The concordat fixing supervisory
responsibility is "a guideline and an
understanding," says Cooke, who is
trying to make sure that it is understood in places like Southeast Asia, the
Caribbean, and South America. Since
Cooke is anxious not to enlarge the
committee, the message is preached at
conferences for nonmember regulators and supervisors, such as one in
Rome in September.
New banking centers like Hong
Kong and Singapore have been cooperative in following the principle of
consolidated supervision, but prob-

lems in the Caribbean persist. Frederick Dahl, the Federal Reserve Board's
representative on the Cooke Committee, notes: "When one island tightens
up, there's always another to go to." If
awkward questions are asked about
accounts opened by drug traffickers on
one island, they can move on to another water-locked haven.
But committee members are also
concerned about some big recent decisions by U.S. bank regulators. The
worries center on an intriguing philosophical principle established in the
insurance industry known as moral
hazard. This principle states that increasing insurance serves to heighten
chances of loss because the players
feel they can afford to take imprudent
risks. In banking this means that if
commercial bankers believe they will
eventually be bailed out by the lender
of last resort—a central bank or a body
like the FDIC—they will be led to behave less prudently.
Because of moral hazard, a central
banker who privately admits that a
bank as large as Continental Illinois
cannot be allowed to fail will publicly
reject the logical conclusion that the
role of the lender of last resort is to dig
up cash to prevent all big failures.
"Our message is, 'You can't rely on
us,' " says one of Europe's senior central bankers. "We have to leave the
banks in the optimum degree of doubt
about how or when or to what extent
we'll bail them out."
On the day late in July that the FDIC
announced in Washington its plans to
become the custodian of Continental
Illinois, Joe Selby of the comptroller's
office was in London talking to supervisors and regulators from the world
over. Having listened to Selby, one
member of the Cooke Committee concluded that because Continental Illinois had been bailed out, it does not
follow that the next big American bank
to be threatened by collapse will be
bailed out too.
But is that conclusion really true? If
one large, troubled financial institution
after another wobbles into the emergency room—Financial Corp. of America, owner of the U.S.'s biggest thrift,
was the latest—and none is turned
away, it will get harder to keep 'em
guessing, as the Cooke Committee
likes to do.
O

383
Federal Register / Vol. 49. No. 172 / Tuesday, September 4, 1984 / Proposed Rules
redemption charges which are
applicable in accordance with § 1421.733
and $ 1421.753. Except for wheat, barley,
sorghum, or rye, commodities which are
reconcentrated shall be transported
without cost to CCC. CCC shall increase
or decrease the loan to the producer by
the amount by which the loan value of
the commodity stored in the subsequent
warehouse is greater than or less than
the value of the original warehouse
storage loan. The maturity date of the
new warehouse storage loan shall be the
maturity date applicable to the original
warehouse storage loan.
8. In § 1421.19, paragraph (a) is
revised to read as follows:
§1421.19 Liquidation of farm storage
loans.

(a) General. In the case of farm
storage loans, the producer is required
to repay the loan or deliver to CCC a
sufficient quantity of the eligible
commodity having a price support value
equal to or greater than the outstanding
balance of the loan. Deliveries may be
either of the identical commodity which
is subject to the note and security
agreement or of other eligible
commodities of the same kind.
Deliveries shall be made in accordance
with written instructions issued by the
county ASCS office which shall set forth
the time and place of delivery. CCC will
not accept delivery of any quantity in
excess of the larger o£ (1) 110 percent of
the measured or certified quantity, or (2)
a sufficient quantity of the commodity
having a settlement value equal to 110
percent of the loan value being settled.
Settlement of the quantity delivered
shall be made as provided in § 1421.22.
If the producer fails to deliver to CCC
the commodity pledged as price support
loan collateral by the date specified by
CCC on Form CCC-691, Commodity
Delivery Notice, and if the producer
subsequently redeems the collateral by
repaying the loan before delivery is
accomplished, liquidated damages shall
be assessed, in addition to any
applicable interest due on the loan, on
the quantity of the commodity
redeemed. Such liquidated damages
shall be assessed beginning on the date
following the required delivery date and
shall continue until the loan is repaid.
Liquidated damages shall be computed
by multiplying the loan principal on the
repaid quantity by SO percent of the rate
of interest charged by CCC with respect
to delinquent debts on the date the
failure to deliver occurred.
a In 11421.22, paragraph (a) is
revised to read as follows:




§1421.22 Settlement

(a) General. Settlement with
producers for commodities acquired by
CCC as a result of loans made or under
purchase agreements entered into under
this subpart shall be made as provided
in this section and in the applicable
commodity regulation. The price support
rate at which settlement shall be made
shall be determined in accordance with
the provisions of the applicable
commodity regulations. Settlement shall
be made on the basis of the grade,
quality, and quantity of the commodity
delivered by the producer. In the case of
farm-stored peanuts and farm-stored
tobacco, paragraphs (b), (c), and (e) of
this section shall not apply. In the case
of farm-stored rice, paragraphs (b) and
(c) of this section shall not apply.

*, * • * • *

10. A new § 1421.29 is added to read
as follows:
§1421.29 Paperwork Reduction Act
assigned numbers.

The Office of Management and Budget
has approved the information collection
requirements contained in these
regulations in accordance with 44 U.S.C.
Chapter 35 and OMB Numbers 05600087 and 0560-0040 have been assigned.
Signed at Washington, D.C., on August 28.
1984.
Everett Rank,
Executive Vice President, Commodity Credit
Corporation.
IF* Doc. M-23317 Filed B-U-M MS am|
pa | mfl COOK 3410-QSHI

DEPARTMENT OF THE TREASURY
ComptroUer of The Currency
12CFRPart3
[Docket No. 84-291

Minimum Capital Ratios; Issuance of
Directives
AGENCY: Comptroller of the Currency.
Treasury.
ACTION: Proposed rale.
SUMMARY: Section 980 of the

International Lending Supervision Act of
1983 (Pub. L. 98-181, Title IX, 97 Stat.
1153) condified at 12U5.C 3907, directs
the Comptroller of the Currency to
establish minimum levels of capital for
national banks and to require them to
achieve and maintain adequate capital.
The Office also is required to analyze
capital adequacy in taking action on
various types of applications such as
mergers and branches and in conducting
the Office's supervisory activities
related to the safety and soundness of

individual banks and the banking
system. This proposal: (a) Defines
capital; (b) establishes required
minimum capital ratios; (c) establishes
procedures to set higher required
minimum capital ratios for an individual
bank; and (d) establishes procedures for
issuing a directive to require a national
bank to achieve and maintain the
minimum capital ratios applicable to it.
DATE: Comments must be received by
November 5,1984.
ADDRESSES: Comments should be sent
to Docket No. 84-29, Communications
Division. Office of the Comptroller of the
Currency, 490 L'Enfant Plaza, S.W.,
Washington, D.C. 20219. Attention:
Lynnette Carter. Comments wiii be
available for inspection and
photocopying.
Comments specifically addressing the
information collection requirements in
§§ 3.7 and 3.12 should be submitted to:
Office of Management and Budget, 726
Jackson Place, N.W., Washington, D.G.
20500, Attention: Desk Officer for the
Office of the Comptroller of the
Currency. Those comments also should
be directed to the Comptroller's Office
at the above address.
FOR FURTHER INFORMATION CONTACT:

Susan K. Fetner, National Bank
Examiner, or John H. Noonan, Director,
Commercial Examinations Division (202
447-1164), or Dorthy A. Sable. Senior
Attorney (202 447-1880).
SUPPLEMENTARY INFORMATION:.

Background
Capital performs several very
important functions in banking
institutions. It absorbs losses: helps to
maintain confidence in individual banks
and the banking system as a whole; and
supports growth. Capital also provides
protection to depositors in the event of a
threatened insolvency.
The Office of the Comptroller of the
Currency (Office) has always had a
strong concern for the maintenance of
adequate capital in individual banks
and in the banking system. The
protection of depositors and fostering of
stability in the financial system are
critical to the mission of the Office and
capital adequacy plays a key role in the
policies and programs used in
performing the Office's supervisory
functions. A determination of capital
adequacy in one of the major objectives
of a bank examination and is one of the
five components which form the basis of
the Uniform Financial Institution Rating
System used by the Office in
determining the condition of individual
banking institutions. Additionally, by
enacting the International Lending

384
Feafcgai Register / Vol. 49, No. 172 / Tuesday, September 4. 1984 / Proposed Rules
Supervision Act of 1983 (12 U.S.C. 3901
et seq.) (ILSA) Congress has explicitly
recognized the importance capital
adequacy assumes in the safe and sound
operation of the nation's banking
system.
Although there is widespread
agreement as to the importance of
adequate capital, there has been
vigorous debate over the years among
regulatory authorities, bankers, industry
analysts and other regarding what
constitutes and adequate level of
capital. There is general agreement that
the capital of any given bank should be
sufficient to maintain public confidence
in the institution; support the volume,
type and character of the business
conducted; provide for the possibilities
of loss inherent therein: and permit the ,
bank to continue to meet the reasonable
credit requirements of the area served.
The quantification of this into an
appropriate capital ratio has, however,
been the subject of much controversy.
Bank capital ratios, relating the
amount of bank capital to bank assets,
vary in response to differential growth
rates in the numerator—bank capital,
and the denominator—bank assets. The
growth rate of bank assets is affected by
the rate of inflation, credit demand,
innovations in bank asset and liability
management, and the real rate of growth
in the economy. The growth rate of bank
capital is a function of the rate of return
on assets, the retention rate of earnings,
and net new issues of capital securities.
The "adequacy" of these bank capital
ratios is affected by the economic
environment in which banks operate
and the magnitude of risk inherent in the
structure and operating characteristics
of individual institutions.
Several factors have emerged over the
past few years which are accentuating
the potential demands on bank capital.
The decrease in banks' net interest
margins, together with a weakening of
loan portfolios brought about by shocks
in the domestic and world economy
have caused a decline in bank .
profitability and increased levels of risk
within the system. The competition for
financial services has intensified on
both an intraindustry and interindustry
basifc placing additional pressures on.
bank profitability. Further, because of
the growing interdependehcy within the
system, problems in one institution can
have repercussions on other institutions,
arguing for stronger capital levels in
both individual banks and the system as
a whole. Increasing levels of off-balance
sheet risks are also a factor in the need
for higher capital.
The Comptroller, the Board of
Governors of the Federal Reserve
System (FRB) and the Federal Deposit




34839

provide protection against unforeseen
Insurance Corporation (FDIC) have
adversities.
previously adopted and published
capital guidelines which, together with
The Proposal
the efforts of banks to achieve them,
-v The regulation would apply to
have been successful recently in
national banks and banks located in the
preventing a decline in bank capital
District of Columbia. The regulation
ratios. These policies, while similar,
would not apply to bank holding
have not been completely uniform and
companies; however, when considering
have allowed for some disparity in the
the condition of or an application from
treatment of federally regulated banks.
banks which are subsidiaries of holding
Section 908 of ILSA (12 U.S.C. 3907)
companies, the activities and condition
directs the federal banking agencies to
(including capital adequacy) of the bank
"* * * cause banking institutions to
holding company will be considered by
achieve and maintain adequate capital
the Office. Although the proposed
by establishing minimum levels of
capital for such banking institutions and regulation would not apply to federal
branches and agencies, the Office is
by such other methods as the
considering imposition of a comparable
appropriate Federal banking agency
capital equivalency deposit requirement
deems appropriate." ILSA also
for federal branches and agencies (see
encourages uniformity among the
Issues for Comment No. 10).
agencies in imposing requirements
under the Act. Therefore, pursuant to
Under the proposed regulation, the
the Office's authority under ILSA and
minimum acceptable ratio of total
the authority contained in the National
capital to total assets would be*
Banking Act, the Office is proposing a
established at six (6) percent (%) and the
regulation on capital requirements. The
minimum ratio of "primary " capital to
FRB and the FDIC also have issued
adjusted total assets would be
similar capital proposals for comment.
established at five and one-half (5 %)
The proposed regulation is intended to
percent (%). These ratios would apply to
implement the provisions of the ILSA,
well-managed banks of all sizes which
foster further improvement in bank
have no material weaknesses. Based on
capital ratios, and eliminate the
the December 31.1983 Call Reports,
disparities in treatment of federally
approximately 95% of all national banks
regulated banks with respect to capital
had a primary capital ratio in excess of
adequacy. The proposed regulation also
6%, a level which would exceed the
sets forth the procedures, pursuant to
primary capital requirement established
the authority contained in ILSA, for
by this regulation. In addition, most of
issuing directives to require banks to
the larger multinational and regional
achieve and maintain adequate capital.
banks (which generally have lower
capital ratios than smaller banks) had
The proposed regulation will
primary and total capital ratios which
supplement rather than replace, the
would exceed the minimum
Office's supervisory evaluations of
requirements. A few large banks will be
capital adequacy. The process of
faced with a relatively large dollar
determinig the adequacy of a bank's
shortfall in their capital accounts. While
capital on an ongoing basis begins with
the OCC expects that all banks will
a qualitative evaluation of the critical
make every effort to achieve compliance
variables that directly bear on the
as rapidly as possible, the Office will
institution's overall financial condition.
consider the individual circumstances
These variables include the quality,
and the ability of each bank to achieve
present value, type and diversification
compliance.
of assets; historical and prospective
earnings; liquidity (with emphasis on
The proposed regulation represents a
asset/liability management); the quality
change from the interagency guidelines
of management; and the existence of
issued by the OCC and the FRB in
other activities which may expose the
December 1981 and amended in June of
bank to risks, including off-balance
1983. Regional and multinational banks
sheet items, the degree of leverage and
would be subject to an increase in the
risks undertaken by the parent company primary capital ratio from 5% ot 5 Ve
f%
or other affiliates. Banks with significant while community banks would have
weaknesses in one or more of these
their minimum primary capital ratio
areas will be expected to maintain
lowered from 6% to 5Vt%. The new total
higher capital levels than the minimums
capital ratio, as proposed, would be 6%.
set forth in the regulation. In addition,
Previously, the guidelines had used a
the OCC stresses that the capital
zone concept based on asset size, to
requirements set forth in this proposed
determine the nature and intensity of
regulation are minimums and that all
supervisory action for a particular
banks are encouraged to maintain
institution. Multinational and regional
higher levels of capital in order to
banks were presumed to have

385
34840

Federal Register / Vol. 49, No. 172 / Tuesday, September 4, 1984 / Proposed Rules

inadequate total capital if below a 5Vfe%
ratio, and community banks were
presumed under capitalized if below 6%
total capital. The zone concept provided
some guidance for bankers and
regulators in monitoring total capital
levels and consideration is being given
to continuing use of the zones in
conjunction with a minimum capital
requirement. (See Issues for Comment,
No. 9).

Because not all banks will have the
secondary capital differs from that
required ratios at the time the final rule
contained in 12 CFR 7.1100 (See Issues
becomes effective, or be able to achieve
for Comment, No. 1).
the ratios quickly thereafter, the rule
Minimum Capital Ratios
provides that a bank in compliance with
The proposal would require banks to
an acceptable plan to achieve the ratios
have and maintain a ratio of total
will not be considered to be in violation
capital to total assets (as defined) of at
of the regulation.
least 6% and a ratio of primary capital to
Finally, the Office has reserved the
adjusted total assets of at least 5Y2%.
authority to permit a bank to operate
These ratios would apply to all national
with capital ratios below the minimums
banks, regardless of size. However, the
when, in the opinion'of the Office, the
Primary Capital Definition
Office would retain the right to establish circumstances justify such action. This
higher ratios for individual banks whose provision might apply for example, to a
Primary capital in the proposed
circumstances warrant a stronger
regulation is defined as the total of
situation in which a bank in compliance
capital base. In addition, banks which
common and perpetual preferred stock,
have entered into, or subsequently enter with the minimum ratios would not be in
capital surplus, undivided profits,
into a written agreement or which are or compliance if it undertook a proposed
contingency and other capital reserves,
acquisition which would dilute its
become subject to a cease and desist
a limited amount of mandatory
capital or increase its assets. Such an
order under 12 U.S.C. 1818 (b) or (c)
convertible debt (as defined), minority
acquisition,,however, may be necessary
requiring higher minimum capital ratios
interests in consolidated subsidiaries,
or desirable to alleviate a troubled or
net worth certificates and the allowance for die bank, must achieve and maintain emergency situation involving another
1
those higher ratios. Similarly, if higher
for loan and lease losses; minus
minimum capital ratios have been or are bank. In such circumstances, when the
intangible assets. The term mandatory
Office believes that the acquisition
required as a condition for approval of
convertible debt is defined to include
should be approved, it may specifically
an application, the bank will be
only those subordinated debt
authorize the acquiring bank to have
governed by those ratios.
instruments that mandatorily convert
capital ratios below the minimums
into the issuing bank's common or
The ratios must be achieved as of
during a specified period of time, i.e., the
perpetual preferred stock. The definition each Call Report date and will be
time necessary for the bank to absorb
intentionally doesjiot include
calculated in terms of the bank's
the acquisition and increase its capital
subordinated debt that merely requires
reported total capital to its reported
to again meet the minimums specified in
the issuer to sell stock in sufficient
average total assets and its primary
the regulation. This provision is not
capital to average total assets as
amounts to replace the debt obligation,
intended to authorize banks below the
adjusted. During the following quarter,
even though these instruments are
required minimums to continue to
the bank must maintain this ratio. If
considered as primary capital under
operate with lower capital ratios or to
total assets increase, on average, during
OCCs present guidelines. Furthermore,
authorize banks to reduce their capital.
the quarter, the bank must increase- its
for purposes of meeting the minimum
capital (unless it is already above the
primary capital requirements of this
Minimum Capital Ratios for an
minimum) before the upcoming Call
proposed regulation, mandatory
Individual Bank
(
convertible debt would be included only Report date, in order to be in
As noted above, the general minimum
to the extent of 20% of primary capital
compliance with the required ratios as
captial ratios are intended to apply to
exclusive of such debt The proposed
of the Call Report date for that quarter.
sound banks without any significant
regulation limits the amount of
Banks which are not able to achieve
risks or problems. Higher minimum
mandatory convertible debt that-would
.the ratios by the effective date of the
captial ratios may be appropriate or
be included in measuring primary
final rule will be required to submit to
capital because, while these instruments the Office an acceptable plan to achieve necessary for individual banks
depending upon their circumstances.
the minimum capital ratios within a
contain many of the features of equity
The International Lending Supervision
reasonable time. The plan itself must be
capital, they do not represent equity
Act specifically provides the
submitted within 60 days after the
until actually converted.
Comptroller with the authority "to
effective date of the final rule and must
The proposed definition of primary
establish such minimum level of capital
set forth the means and time frames in
capital thus also differs from that
for a banking institution as the [Office],
which the bank will achieve the
contained in 12 CFR 7.1100 which
minimum ratios. The Office understands in its discretion, deems to be necessary
defines capital for statutory and
- or appropriate in light of the particular
that banks that will need to raise or
supervisory purposes. The Office willgenerate a substantial amount of capital circumstances of the banking
amend that interpretive ruling upon
institution." 12 U.S.C. 3907(a)(2). Higher
to achieve the ratios will require a
adoption of a final regulation under this
reasonable period of time in which to do minimum ratios may be estabished for a
proposal (see Issues for Comment No.
bank and required as a part of a written
so and the Office will take this into
1).
agreement or a cease and desist order
account in reviewing individual bank
Secondary Capital Definition
under 12 U.S.C. 1818 (b) or (c). or as a
plans. Rather than a formal approval or
condition for approval of an application.
acceptance process, the proposed rule
The definition of secondary capital
In addition, the proposed rule
provides that the bank may consider its
would include mandatory convertible
establishes a procedure for setting
plan acceptable to the Office unless it is
debt that is not included in primary
higher required minimum capital ratios
notified to the contrary. It should be
capital (in excess of 20%), intangible
for an individual bank. This part of the
noted, however, that under this
assets, and, subject to certain
rule sets out examples of situations
restrictions in 12 CFR 7.1100, limited life provision, the Office may subsequently
when higher minimum capital ratios
require changes in a bank's plan, such
preferred stock and subordinated notes
may be necessary or appropriate and
as an acceleration of the time schedule,
and debentures. As in the case of
examples of the factors which the Office
in the event of changed circumstances.
primary capital, the definition of




386
f e d e r a l Register / Vol. 49, No. 172 / Tuesday. September 4, 1984 / Proposed Rules
may consider in deciding what a bank's
minimum capital ratios should be. These
examples are not intended to be
exclusive because it is not possible to
predict in advance each situation in
which higher capital ratios may be
necessary or every factor which should
be considered in a particular situation.
The procedure provides for written
notice from the Office to the bank
indicating the capital ratios which the
Office believes are appropriate for the
bank, the date when they should be
achieved, and an explanation of why
those ratios are considered appropriate.
The bank will have thirty days in which
it may respond to the Office in writing.
After the close of the bank's response
period, or after the bank's response is
received, if sooner, the Office will
consider any response from the bank.
Unless further information or
clarification of the bank's response is
required, or the time periods are
extended for good cause, the Office will
reach a decision within thirty days after
the close of the response period and will
advise1 the bank in writing whether
higher capital ratios will be required for
it and. if so, what those ratios are and
when they must be achieved.The Office
also may require the bank to submit an
acceptable plan to achieve the required
ratios established for it. This procedure
is intended to provide an informative
and fair, but relatively uncomplicated
and prompt method of addressing an
individual bank's need for higher capital
levels.

provisions for the directive; and/or may
include a plan to achieve the bank's
required minimum captial ratios. The
response should include any information
which the bank would have the Office
consider in deciding whether to issue a
directive or what the provisions of the
directive should be. Failure fo respond
within the allotted time period will be
deemed to be a waiver of any objections
to the proposed directive. After the close
of the bank's response period, or after
receipt of the bank's response, if sooner,
the Office will consider the bank's
response and will decide whether to
issue the directive as originally
proposed or in modified form. Unless the
time periods are extended by the Office,
for example, in cases where additional
information or a clarification of the
bank's response is needed, the Office
will issue the directive, or notify the
bank that a directive will not be issued,
within thirty days after the close of the
bank's response period.
The terms of the directive will vary in
each individual case. The directive may
order the bank to achieve and maintain
its required minimum capital ratios-by a
specified date; comply with a previously
submitted plan to achieve those ratios;
submit and comply with an acceptable
plan to achieve the ratios; reduce assets
or the rate of growth of assets, or restrict
dividends in order to achieve its
required capital ratios; or a combination
of any of the above or similar actions.
A directive, or any plan submitted
pursuant to a directive, is enforceable to
the same extent as an effective and
Directives
outstanding order issued pursuant to 12
A directive is a form of order
U.S.C. 1818(b) which has become final
specifically authorized under the
In addition, violation of a directive may
International Lending Supervision Act,
result in civil money penalties against
12 U.S.C. 3907(b)(2). Issuance of a
the bank or its officers, directors,
directive of discretionary when a bank
employees, or other persons
does not have or maintain capital at or
participating in the conduct of its affairs.
above the level required for it, whether
Because of the critical importance of
under the general minimum capital
adequate capital to the soundness of a
ratios set forth in the rule, under a
bank's operations, the procedure for
decision establishing higher minimum
issuance of a directive has been
capital ratios for the bank, under the
designed to reach a resolution in a
terms of a written agreement under 12
prompt, but fair manner and the Office
U.S.C. 1818(b). or as a condition for
intends to actively seek enforcement of
approval of an application. A directive
directives in the event of
also may be issued when a bank has
noncompliance.
failed to submit or is not in compliance
Issues for Comment
with an acceptable plan to achieve its
required minimum capital ratios.
Comments are requested on the
Under the proposal, the Office will
proposal and specifically on the
notify a bank in writing of the Office's
following issues:
intention to issue a directive to the
(1) Whether the definitions of capital
bank. The notice will include reasons for and its components should be the same
the action and the contents of the
for the purposes of determining capital
proposed directive. The bank will have
adequacy and for statutory purposes,
thirty days in which to respond in
such as the lending limits in 12 U.S.C. 84.
writing to the notice. The response may
The Office adopted one definition for
state why a directive should not be
both purposes in Interpretive Ruling 12
issued; may propose alternative
CFR 7.1100 and believes that the




34841

definitions in this proposed regulation
also should govern the determination of
capital for both supervisory and
statutory purposes since a common
definition would avoid complexity and
confusion.
(2) Whether higher minimum capital
ratios are appropriate or feasible. The
Office believes that the minimum capital
ratios proposed are appropriate for the
banking industry in general and are
feasible to achieve and maintain.
However, the Office solicits comment on
whether higher minimum ratios than
those proposed should be required now
or required in the next year or two, and
whether and when it would be feasible
for banks to achieve such higher capital
levels.
(3) Whether the proposed regulation
should "grandfather" capital
components now-considered primary
capital but which would not be included
in primary capital under the proposed
regulation. The proposed regulation
would not change a bank's total capital.
However, some items currently included
in primary capital—by Interpretive
Ruling 12 CFR 7.1100 or bank practice—
would instead be included in secondary
capital. One such item is mandatory
convertible debt which must be repaid
through the sale of common or perpetual
preferred stock. This type of mandatory
convertible debt, commonly referred to
as "equity commitment notes" has been
issued by sorae>national banks with the
Office's approval. Under the proposed
regulation, this type of debt would
continue to be counted as capital but it
would be considered secondary capital
The Office believes that banks should
be able to continue to include in their
primary capital, previously approved
and issued equity commitment notes or
other similar instruments. Therefore, as
a transitional rule, such instruments
would be included in primary capital to
the extent previously authorized, during
the original effective term of the
instruments.
The other item included in secondary •
capital in the proposed regulation is
intangible assets. While the Office has
not ruled previously that this item is
included in primary capital the Office is
aware that banks commonly do not
exclude intangible assets in calculating
primary capital. Comment is requested
on the effect on individual banks if
intangible assets are excluded from
primary capital and, alternatively, the
extent to which intangible assets should
be includable in primary capital.
(4) Whether the reserves for loan and
lease losses should be excluded from
capital. Since the amount of a bank's
reserve for loan and lease losses is

387
34842

. Federal Register / Vol. 49, No. 172 / Tuesday, September 4, 1984 / Proposed Rules ,

specifically tailored to its loss
While asset composition, including risk
experience as well as estimated
and liquidity, will be considered in an
potential losses on particular assets, it
Office decision to require capital ratios
can be argued that all or at least a
above the minimums for an individual
portion of the reserve should not be
bank, the Office solicits suggestions on
considered as capital because it will be
ways in which the general minimum
depleted. Traditionally, however, these
requirements or other regulatory
reserves have been-considered as
requirements could encourage high
capital since they perform one of
quality, liquid bank assets. For example,
capital's primary functions, i.e., to serve
should relatively risk free or liquid
as a cushion against losses. The Office
assets be excluded or discounted in
requests comment on whether all or any computing total assets, with higher
portions of loan and lease reserves
minimum capital ratios required for the
should be excluded from the definition
remaining risk assets?
of capital
(8) Whether the capital ratios should
be calculated on the basis of average or
(5) Whether limits should be placed
actual total assets. The proposed ratios
on the amount of subordinated notes
are minimum^ and banks are
and debentures and limited life
encouraged to maintain higher levels of
preferred stock that is included in
capital However, the Office does not
secondary capital. Limits may include
want to require banks at the margin to
such factors as requiring a minimum
make calculations prior to each increase
original maturity, discounting the
in their asset portfolios. Similarly, the
amount that is included in secondary
capital based on the remaining maturity, Office wishes to minimize the likelihood
of inadvertent or technical violations.
and a percentage limit on the aggregate
Therefore, in order to avoid these
^amount that can be included in
problems, yet assure that the ratios are
'secondary capital. Certain limits now
maintained on a relatively constant
are imposed in 12 CFR 7.1100 and the
basis, total and primary capital would
Office believes that those or similar
be computed as of each Call Report date
restrictions should be placed on these
and the capital ratios calculated based
types of instruments when they are
on average total assets (or average total
included in a bank's capital
assets less intangible assets) for that
(6) Whether limits should be placed
Call Report period. Capital and average
on the amount of secondary capital that
total assets already are required to be
can be included in total capital For
stated in Call Reports, however, the
example, should secondary capital be
limited to an amount equal to 50 percent capital ratios would not need to be
stated.
of primary capital as is now the case
under 12 CFR 7.11007 Because the
During the following quarter, to
components of secondary capital do not
comply with the regulation, the bank
provide the same degree of protection
need only maintain its capital at the
obtained through primary capital the
levels necaessary to meet the minimum
Office believes that a limit on secondary ratios based on the average total-assets
capital is warranted, at least when
figure in its most recent Call Report
determining total capital (capital and
However, if the bank's assets, on
surplus) for statutory purposes. (See
average, increase during the quarter, it
Issue no. 1). The Office requests
must correspondingly increase its
comment on the effects such a limit
capital (if at the minimum level) before
would have, given the proposed
the end of the quarter so that it will be
definitions of primary and secondary
in compliance with the required
capital.
minimum ratios as of the Call Report
date for that quarter. Use of the average
(7) Whether the minimum capital
total assets figure therefore, should
requirements should be tailored to the
risk composition and liquidity of assets. eliminate the potential for inadvertant
violations and simplify banks' internal
The proposed minimum capital
requirements are neutral with respect to procedures for compliance.
the composition of a bank's assets, i.e.,
The Office is concerned, however,
the same capital ratio is required for
that some banks may have total assets
both liquid and illiquid assets and for
as of the Call Report dates or otherwise
both high and low risk assets. The
that are substantially higher than their
average total assets so that the bank,
Office is concerned that this neutrality
while technically in compliance with the
may not provide an incentive for banks
regulation, actually is defeating its
to enhance or maintain the liquidity or
purpose, i.e., to assure that banks have
quality of their assets. Asset liquidity is
the minimum adequate level of capital
important since it offers banks an
to support their operations. Therefore.
alternative to reliance on short term
Call Report and examination data on
funding, with its inherently volatile
total assets will be reviewed and
conditions, to meet liquidity needs.




compared with the reported average
total assets figure, where there is
significant disparity-between these
figures on a repeated basis, the bank
may be required to maintain its
minimum capital ratios on a constant
basis in relation to its actual total
assets. The Office seeks comment on the
average total asset method or
alternative methods to achieve
compliance with the regulation.
(9) Whether the zone concept provides
useful guidance to banks. The Office is
considering whether to issue guidelines
in conjuction with the final version of
the regulation concerning the degree and
type of administrative action which
would correspond to particular capital
ratio zones. Although these guidelines
would be primarily for internal agency
purposes, they would be published for
the information of bank management.
Under the zone concept, the Office
would consider banks having a total
capital ratio in excess of 7% to be
adequately capitalized, absent special
circumstances. Banks having a total
capital ratio between 8-7% would be
monitored to determine whether their
capital is adequate in light of the quality
of assets, management strength, and
other factors. Banks having a total
capital ratio of less than %% (the
minimum required in the regulation)
would be presumed to be
undercapitalized and would be subject
to appropriate supervision and
administrative action.
The proposed regulation itself
indicates the range of adminsitrative or
supervisory actions which the Office
may take if a bank does not have the
minimum capital ratios required for it or
has not submitted or complied with an
acceptable plan to achieve those ratios.
Since the appropriate supervisory action
necessarily must be determined on a
case-by-case basis, the zone concept as
a guide for adminstrative actions may
not be particularly useful. However,
comment on the past or possible future
usefulness to the banking industry of the
zone would be of assistance to the
Office.
(10) Whether the minimum capital
requirement should apply to federal
branches and agencies. Under 12 U.S.C.
3102(g), federal branches and agencies
are required to maintain capital
equivalency deposits which, at a
minimum, equal 5% of liabilities. The
statutory minimum is roughly equivalent
to the 5% minimum primary capital
requirement for regional and
multinational banks in the Office's
current guidelines. However, the
International Banking Act oi 1978 (IBA)
also mandates competitive equality

388
Federal Register / Vol. 49, No. 172 / Tuesday, September 4, 1984 / Proposed Rules
between national banks and federal
branches and agencies. Because the
operations of federal branches and
agencies are not inherently either more
or less risky than those of national
banks, the Office believes that federal '
branches and agencies should be subject
to comparable capital adequacy
requirements. However, since the IBA
requires that the capital equivalency
deposit consist of cash or investment
securities and be computed as a percent
of liabilities, a capital-to-assets ratio
would be difficult to implement.
Alternatively, comparability could be
attained by requiring capital
equivalency deposits for federal
branches and agencies equal to at least
5 V % of liabilities, rather than the
2
current 5%. The Office requests
comments on this and other means of
establishing relatively comparable
capital requirements for federal
branches and agencies.
Regulatory Flexibility Act
Pursuant to section 605(b) of the
Regulatory Flexibility Act (Pub. L. 96354. 5 U.S.C. 601 etseq.) the Comptroller
of the Currency has certified that the
proposed regulation, if adopted, will not
have a significant economic impact on a
substantial number of small entities
since nearly all small banks (those with
total assets of less than $1 billion)
already meet or exceed the primary and
total capital ratios proposed in the
regulation.
Executive Older 12291
The Comptroller of the Currency has
determined that the proposed regulation
is a "major rule" and a regulatory
impact analysis has been performed in
connection with the Office's
consideration of this rule. In reviewing
the impact of the proposal, the analysis
considered that:
(1) 151 national banks have a
shortfall, at a minimum, of $3.3 billion in
primary capital;
(2) 89 of those banks, plus an
additional 111, have a shortfall, at a
minimum, of $2.4 billion in secondary
capital;
(3) 266 national banks meet both
minimums, but face credit and other
risks that warrant higher capital ratios
(the amount of capital they must raise
cannot be easily estimated);
(4) Underwriting costs associated with
raising needed capital could approach
$200 million, the precise amount
depending on the volume of funds raised
in capital markets as opposed to the use
of retained earnings; and
(5) Until capital ratios are met,
dividend payouts could be lower than
historical averages.




34843

Sec.
However, OCC believes the costs of
the proposed mandatory minimum
3.4 Reservation of Authority
capital ratios are outweighed by the
benefits. These benefits cannot be easily - Subpart B—Minimum Capital Ratios
3.5 Applicability
quantified, but include:
3.8 Minimum Capital Ratios
(1) An increased capacity, especially
3.7 Plan to Achieve Minimum Capital Ratios
among large banks, to withstand losses
3.8 Reservation of Authority
associated with credit and other risks
Subpart C—Establishment of Minimum
that are a normal part of banking;
Capital RatkM for an Individual Bank
(2) Increased stability in our financial
3.9 Purpose and Scope
system; and
3.10 Applicability
(3) Increased capacity to fund
3.11 Standards for determination of
economic growth.
Appropriate Individual Minimum Capital
The Office is especially interested in
Ratios
receiving additional information bearing 3.12 Procedures
on the benefits and costs of this
3.13 Relation to Other Actions
proposal. A copy of the regulatory
impact analysis may be obtained from
3.14 Remedies
the Office's Communications Division
under procedures set forth in 12 CFR
Subpart 6—Issuance of a Directive
4.17 and 4.17a.
3.15 Purpose and Scope
3.16 Notice of Intent to Issue a Directive
Paperwork Reduction Act
3.17 Response to Notice
The potential paperwork burdens
3.18 Decision
3.19 Issuance of a Directive
contained in this rule pertaining to: (1)
340 Amendment of Time Periods
The preparation of a written plan to
3.21 Change in Circumstances
increase capital by a national bank that
3.22 Relation to Other Administrative
does not have the minimum capital
Actions
ratios specified in the regulation or
Authority: 12 U.S.C 1 et seq.; 12 U.S.C 93a.
individually required for it and (2) the .
161 and 1818; and 12 U.S.C 3907 and 3909.
written response which a bank may
Subpart A—Authority and Definition*
make to the Office when notified that
higher minimum capital ratios may be
§3.1 Authority.
required for it; have been submitted to
This part is issued under the authority
the Office of Management and Budget
of 12 U.S»C 1 et. seq., 93a, 161 and 1818;
for review pursuant to 44 U.S.C. 3504(h).
and the International Lending
List of Subjects in 12 CFR Part 3
Supervision Act of 1983 (Pub. L. 98-181,
Tide IX, 97 Stat 1153), 12 U.S.C. 3907
Banks, Banking, Primary, Secondary
and 3909.
and total capital, Minimum capital
53-2 Definition*
ratios, Procedures for establishing
higher minimum capital ratios for an
For the purposes of this Part
individual bank, Enforcement of
(a) "Bank" means a national banking
minimum capital ratios, Issuance of
association or a District of Columbia
directives.
bank.
This proposal does not duplicate,
(b) "Intangible assets" means those
overlap, or conflict with any existing
assets within the definition of this term
federal laws and regulations governing
in the "Instructions—Consolidated
national banks with the exception of
Reports of Condition and Income" (Call
Interpretive Ruling 12 CFR 7.1100 which
Report).
will be amended accordingly following
(c) "Mandatory convertible debt"
adoption of the final version of this
means subordinated debt instruments
proposed regulation.
which require the issuer to convert such
offerings into either common or
Authority and Issuance
-perpetual preferred stock by a date at or
Accordingly, pursuant to authority
before the maturity of the instrument.
under 12 U.S.C. 93a, 3907, and 3909. the
The maturity of these instruments must
Comptroller of the Currency proposes to be 12 years or less.
add a new Part 3 to Title 12 of the Code
(d) "Primary capital" means the sum
of Federal Regulations, as follows:
of (1) and (2) below, minus intangible
assets:
PART 3—MINIMUM CAPITAL RATIOS;
(1) Common stock, perpetual preferred
ISSUANCE OF DIRECTIVES
stock, capital surplus, undivided profits,
Subpart A—Authority and Definition*
reserves for contingencies and other
capital reserves, net worth certificates
Sec.
issued by the Federal Deposit Insurance
3.1 Authority
Corporation, minority interests in
3.2 Definitions
consolidated subsidiaries, and
3.3 Transitional Rule

389
34844

• Federal Register / Vol. 49, No. 172 / Tuesday, September 4, 1984 / Proposed Rules

allowances for possible loan and lease
losses; and
(2) Mandatory convertible debt to the
extent of 20% of the sum of (1);
(e) "Secondary capital" means the
sum of: mandatory convertible debt that
is not included in primary capital,
intangible assets, and limited life
preferred stock and subordinated notes
and debentures having an original
weighted average maturity of at least
seven (7) years, subject to the
amortization schedule set forth in 12
CFR 7.1100(f)(2).
(f) "Total assets" means the average
total assets figure required to be
computed for and stated in a bank's
most recent quarterly "Consolidated
Report of Condition and Income" (Call
Report), plus the allowance for possible
loan and lease losses. "Adjusted total
assets" means total assets minus
intangible assets.
(g) 'Total capital" means the sum of
primary capital and secondary capital.
§3.3 Trsminonel Rule.
Funding instruments approved by the
Office as primary of secondary capital
and issued prior to the effective date of
this regulation may continue to be
included, to the extent previously
authorized, in a bank's primary or
secondary capital as the case may be,
during the original effective term of the
instrument.

§3.6 Minimum Capitai Ratios.

A bank must have an maintain total
capital equal to at least 6 percent of
total assets and primary capital equal to
at least 5Vfc percent of adjusted total
assets.
§3.7 Plan to Achlava Minimum Capitai
ratios.

Any bank having total or primary
capital ratios less than the minimums
set forth in § 3.6 shall, within 60 days of
the effective date of this regulation,
submit to the Office a plan describing
the means and schedule by which the
bank shall achieve the minimum capital
ratios. The plan may be considered
acceptable unless the bank is notified to
the contrary by the Office. A bank, in
compliance with an acceptable plan to
achieve the minimum capital ratios will
not be deemed to be in violation of § 3.6.
}3J

Reservation of Authority.

When, in the opinion of the Office the
circumstances so require, a bank may be
authorized to have less man the
minimum capital ratios in § 3.6 during a
time period specified by the Office.
Subpart C—Establishment of Minimum
Capital Ratios) for an Individual Bank

Notwithstanding the definitions of
"primary capital" and "secondarycapital" in § 3.2 (d) and (e), the Office
may find that a newly developed or
modified funding instrument constitutes
or may constitute "primary capital" or
secondary capital" and the Office may
permit one or more banks to include
funds obtained through such instrument
as primary or secondary capital,
permanently or on a temporary basis,
for the purposes of compliance with this
Part or for other purposes.

S3.9) Purpose and Scope.
The rules and procedures specified in
this subpart are applicable to a
proceeding to establish required
minimum capital ratios for an individual
bank above the ratios that would
otherwise be applicable to the bank
under i 3.6. The Comptroller is
authorized under 12 U.S.C. 3907(a)(2) to
establish such minimum capital
requirements for a bank as the Office, in
its descretion, deems necessary or
appropriate in light of the particular
circumstances of that bank. Proceedings
under this subpart may be initiated to
require a bank to maintain existing
capital ratios which are above those set
forth in § 3.6 or other legal authority, as
well as to require a bank to reach higher
minimum capital ratios.

Subpart B—Minimum Capitai Ratios

§3.10

§3.4 Reservation of Authority.

§3.5 Applicability.

This subpart is applicable to all banks
unless the Office determines, pursuant
to the procedures set forth in Subpart C.
that different minimum capital ratios are
appropriate for an individual bank
based upon its particular circumstances,
or unless different minimum capital
ratios have been established or are
established for an individual bank in a
written agreement or a temporary or
final order pursuant to 12 U.S.C. 1818 (b)
or (c), or as a condition for approval of
an application.




Applicability.

Higher minimum capital ratios may be
required for an individual bank when
the Office believes that the bank's
capital is or may become inadequate in
view of its circumstances. For example,
higher capitai ratios than those required
in § 3.6 may be appropriate for.
(a) A newly chartered bank;
(b) A bank in need of special
supervisory attention;
(c) A bank which has or is expected to
have losses resulting in capital
inadequacy;
(d) A bank having a high proportion of
off-balance sheet risk in relation to

other assets and liabilities or a low
proportion of liquid assets;
(e) A bank undergoing expansion,
either internally or through acquisitions;
or
(f) A bank which may be adversely
affected by the activities or condition of
its holding company, affiliate(s), or other
persons or institution which which it has
significant business relationships.
§ 3.11 Standards for Determination of
Appropriate Individual Minimum Capital
Ratios,

The appropriate minimum capital
ratios for an individual bank cannot be
determined solely through the
application of a rigid mathematical,
formula or wholly objective criteria. The
decision is necessarily based in part on
subjective judgment grounded in agency
expertise. The factors to be considered
in the determination will vary in each
case and may include, for example:
(a) The conditions or circumstances
leading to the Office determination that
higher mimimum capital ratios are
appropriate or necessary for the bank;
(b) The exigency of those
circumstances or potential problems;
(c) The overall condition, management
strength, and future prospects of the
bank and, if applicable, its holding
company and/or afnHate(s);
(d) The bank's liquidity, capital and
other ratios compared to the ratios of its
peer group; and
(e) The views of the bank's directors
and senior management.
§3.12 Procedure*.

(a) Notice. When the Office
determines that minimum capital ratios
above those set forth in % 3.6 are
necessary or appropriate for a particular
bank, the Office will notify the bank in
writing of the proposed minimum capital
ratios and the date by which they
should be reached (if applicable), and
will provide an explanation why the
ratios proposed are considered
necessary or appropriate for the bank.
(b) Response. (1) The bank may
respond to any or all of the items in the
notice. The response should include any
matters which the bank would have the
Office consider in deciding whether
individual minimum capital ratios
should be established for the bank, what
those capital ratios should be. and, if
applicable, when they should be
achieved. The response must be in
writing and delivered to the designated
OCC official within 30 days after the
date on which the bank received the
notice.
(2) Failure to respond within thetime
period specified in paragraph (b)(1) of

390
Federal Register / V o l 49, No. 172 / Tuesday. September 4. 1964 / Proposed Rules
this section shall constitute a waiver of
any objections to the proposed minimum
capital ratios or the deadline for their.
achievement.
•
(c) Decision. Within 30 days after the
close of the bank's response period, the
Office will decide, based on a review of
the bank'8 response and other
information concerning the bank,
whether individual minimum capital
ratios should be established for the bank
and. if so. the ratios and the date the
requirements will become effective. The
bank will be notified of the decision in
writing. The notice will include an
explanation of the decision, except for a
decision not to establish individual
minimum capital requirements for the
bank.
(d) Submission of plan. The decision
may require the bank to develop and
submit to the Office, within a time
period specified, an acceptable plan to
reach the minimum capital ratios
established for the bank by the date
required.
(e) Amendment of time periods. The
Office may shorten the time periods
specified in this subpart (1) When, in
the opinion of the Office, the condition
of the bank so requires, provided that
the bank is informed promptly of the
new time periods; or (2) with the consent
of the bank. In its discretion, the Office
may extend the time periods for good
cause. In particular, the time period for
the Office's decision may be extended if,
after receipt of the bank's response,
further clarification or information is
required, or there is a material change in
the circumstances affecting either die
bank's capital adequacy or its ability to
achieve the proposed minimum capital
ratios by the proposed date.
(f) Change in circumstances. If. after
the Office's decision in paragraph (c) of
this section, there is a change in the
circumstances affecting the bank's
capital adequacy or its ability to reach
the required minimum capital ratios by
the specified date, either the bank or the
Office may propose to the other a
change in the minimum capital ratios for
the bank, the date when the minimums
must be achieved, or the bank's plan (if
applicable). The Office may decline to
consider proposals that are not based on
a significant change in circumstances or
are repetitive or frivolous. Pending a
decision on reconsideration, the Office's
original decision and any plan required
under that decision shall continue in full
force and effect.
§3.13

Relation to other action*.

In lieu of. or in addition to. the
procedures in this subpart, the required
minimum capital ratios for a bank may
be established or revised through a




written agreement or crease and desist
proceedings under 12 U.S.C. 1818(b) or
(c) (12 CFR 19.0-18.21), or as a condition
for approval of an application.

§3.1*

34845

Notice of Intent to issue a directive.

The Office will notify a bank in
writing of iis intention to issue a
directive. The notice will state:
(a) Reasons for issuance of the
Subpart D—Enforcement
directive; and
(b) The proposed contents of the
§ 3.14 Remedies.
A bank mat does not have or maintain, directive.
the minimum capital ratios applicable to § 3.17 Response to notice.
it, whether established in Subpart B of
(a) A bank may respond to the notice
this regulation, in a decision pursuant to
by stating why a directive should not be
Subpart C, in a written agreement or
temporary or final order under 12 U.S.C. issued and/or by proposing alternative
contents for the directive. The response
1818 (b) or (c), or in a condition for
should include any matters which the
approval of an application, or a bank
bank would have the Office consider in
that has failed to submit or comply with
an acceptable plan to attain those ratios deciding whether to issue a directive
and/or what the contents of the
will be subject to such administrative
directive should be. The response may
action or sanctions as the Office
include a plan for achieving the
considers appropriate, including
minimum capital ratios applicable to the
issuance of a Directive pursuant to
bank. The response must be in writing
Subpart E. other enfoscement action,
and delivered to the designated OCC
assessment of civil money penalties, official within 30 days after the date on
and/or the denial, conditioning, or
which the bank received the notice.
revocation of applications. Failure to
achieve or maintain the minimum
(b) Failure to respond within the time
primary capital ratio also may be the
period specified jn paragraph (a) of this
basis for an FDIC action to terminate
section shall constitute a waiver of any
federal deposit-insurance. See 12 CFR
objections to the proposed directive.
325.4(c).
§3.18 Decision.

Subpart E—Issuance of a Directive
§3.15 Purpose and Scope.

-This subpart is applicable to
proceedings by the Office to issue a
directive under 12 U.S.C. 3907(b)(2). A
directive is an order issued to a bank
that does not have or maintain capital at
or above the minimum ratios set forth in
§ 3.6, or established for the bank under
subpart C by a written agreement under
12 U.S.C. 1818(b). or as a condition for
approval of an application, A directive
may order the bank to (a) achieve the
minimum capital ratios applicable to it
by a specified date: (b) adhere to a
previously submitted plan to achieve the
applicable capital ratios; (c) submit and
adhere to a plan acceptable to the Office
describing the means and time schedule
by which the bank shall achieve the
y
applicable capital ratios; (d) take other
action, such as reduction of assets or the
rate of growth of assets, or restrictions
on the payment of dividends, to achieve
the applicable capital ratios; or (e) a
combination of any of these or similar
actions. A directive issued under this
rule, including a plan submitted under a
directive, is enforceable in the same
manner and to the same extent as an
effective and outstanding cease and
desist order which has become final as
defined in 12 U.S.C. 1818(k). Violation of
a directive may result in assessment of
civil money penalties in accordance
with 12 U.S.C. 3909(d).

After the closing date of the bank's
response period, or receipt of the bank's
response, if earlier, the Office will
consider the bank's response, and may
seek additional information or
clarification of the response. Thereafter,
the Office will determine whether to
issue the directive as-originally
proposed or in modified form. A
directive will be issued, or the bank
advised that the Office has decided not
to issue a directive, within 30 days after
the closing date of the bank's response
period as set forth in § 3.17 unless the
response period, or the time for the
Office's decision, is extended under
§ 3.20.
§ 3.19 Issuance of s directive.

(a) A directive will be served by
delivery to die bank. It will include or be
accompanied by a statement of reasons
for its issuance.
(b) A directive is effective
immediately upon its receipt by the
bank, or upon such later date as may be
specified therein, and shall remain
effective and enforceable until it is
stayed, modified, or terminated by the
Office.
§ 3^0

Amendment of time periods.

(a) The Office may shorten the time
periods specified in this subpart:
(1) When, in the opinion of the Office,
the condition of the bank so requires,
provided that the bank shall be

391
34846

Federal Register / Veil. 49. No. 172 / Tuesday, September 4, 1984 / Proposed Rules

informed promptly of the new time
periods;
(2) With the consent of the bank; or
(3) When the bank already has
advised the Office that it cannot or will
not achieve its applicable minimum
capital ratios.
(b) In its discretion, the Office may
extend the time periods for good cause.
In particular, the time period for the
Office's decision may be extended if,
after receipt of the bank's response,
further clarification or information is
required, or there is a material change in
the circumstances affecting either the
bank's capital adequacy or its ability to
achieve the minimum capital ratios
applicable to it by the specified date.
§ 3.21 Change in Circumstances.
Upon a change in circumstances, a
bank may request the Office to
reconsider the terms of its directive or
may propose changes in the plan to
achieve the bank's applicable minimum
capital ratios. The Office also may takesuch action on its own motion. The
Office may decline to consider requests
or proposals that are not based on a
significant change in circumstances or
are repetitive or frivolous. Pending a
decision on reconsideration, the
directive and plan shall continue in full
force and effect
S&22 Rtatton to Other A d m t i t l t u B y
Action*.

A directive may be issued in addition
to. or in lieu of, any other action
authorized by law, including cease and
desist proceedings, civil money
penalties, or the conditioning or denial
of applications. The Office also may, in
its discretion, take any action
authorized by law, in lien of a directive,
in response to a bank's failure to
achieve or maintain the applicable
minimum capital ratios.
Dated: August 29.1984.
C. T. Conover,
Comptroller of the Currency.
(FR Doc M-233U Fifed «~31-«.-ft4»aal
MUlNQ COCC 4S10-3S-M

DEPARTMENT OF TRANSPORTATION
Federal Aviation Administration
14 CFR Part 71
[Airspace Dock* No. 84-AGL-7]

Proposed Alteration of Transition Area
AQINCV: Federal Aviation
Administration (FAA), DOT.
ACTION: Notice of proposed rulemaking.




S M A Y . This notice proposes to alter
U MR*
the Monroe, Michigan, transition area to
accommodate a new RNAV Runway 20
instrument approach to Custer Airport.
The intended effect of this action is to
insure segregation of the aircraft using
these approach procedures in instrument
weather conditions from other aircraft
operating under visual weather
conditions in controlled airspace.
OATC Comments must be received on or
before October 4.1984.
ADDftiss: Send comments on the
proposal in triplicate to FAA Office of
Regional Counsel, AGL-7, Attention:
Rules Docket Clerk, Docket No. 84AGL-7,2300 East Devon Avenue, Des
Plaines, Illinois 6001&
The official docket will be available
for examination by interested persons in
the office of the Regional Counsel,
Federal Aviation Administration. 2300
East Devon Avenue, Des Plaines, Illinois
60018.
An informal docket will also be
available for examination during normal
business hours in the Airspace,.
Procedures, and Automation Branch, Air
Traffic Division, Federal Aviation
Administration, 2300 East Devon
Avenue, Des Plaines, Illinois 60018.
PON RJRTHIft INFORMATION CONTACT:

Edward R Heaps, Airspace, Procedures,
and Automation Branch, Air Traffic
Division, AGL-630, FAA, Great Lakes
Region, 2300 East Devon Avenue, Des
Plaines, Illinois 60018, telephone (312)
694-7360.
SUPPCIMSNTANV INWMWsATHWC The

development of a new RNAV instrument
approach procedure requires that the
FAA alter die designated airspace to
ensure that the procedure will be
contained within controlled airspace.
The additional airspace designated will
be approximately a 1.5 mile expansion
to me existing transition area excluding
that portion which overlies the Detroit
Michigan, 700-foot transition area.
The minimum descent altitudes for
this procedure may be established
below the floor of the 700-foot controlled
airspace.
Aeronautical maps and charts will
reflect the defined areas which will
enable other aircraft to circumnavigate
the area in order to comply with
applicable visual flight rule
requirements.
Comments Invited
Interested parties are invited to
participate in this proposed rulemaking
by submitting such written data, views,
or arguments as they may desire.
Comments that provide the factual basis
supporting the views and suggestions
presented are particularly helpful in

developing reasoned regulatory
decisions on the proposal. Comments
are specifically invited on the overall
regulatory, economic, environmental,
and energy aspects of the proposal
Communications should identify the
airspace docket and be submitted in
triplicate to the address listed above.
Commenters wishing the FAA to
acknowledge receipt of their comments
on this notice must submit with those
comments a self-addressed, stamped
postcard on which the following
statement is made: "Comments to
Airspace Docket No. 84-AGL-7." The
postcard will be date/ time stamped and
returned to the commenter. All
communications received before the
specified closing date for comments will
be considered before taking action on
the proposed rule. The proposal
contained in this notice may be changed
in the light of comments received. All
comments submitted will be available
for examination in the Rules Docket
both before and after the closing date
for comments. A report summarizing
each substantive public contact with
FAA personnel concerned with the
rulemaking will be filed in the docket
Availability of NPRM
Any person may obtain a copy of this
notice of proposed rulemaking (NPRM)
by submitting a request to the Federal
Aviation Administration, Office of
Public Affairs, Attention: Public
Information Center. APA-430.800
Independence Avenue. SW.,
Washington. D.C 20591, or by calling
(202) 426-8058. Communications must
identify the notice number of this
NPRM. Persons interested in being
placed on a mailing list for future
NPRM's should also request a copy of
Advisory Circular No. 11-2, which
describes the application procedures.
The Proposal
The FAA is considering an
amendment to § 71.181 of Part 71 of the
Federal Aviation Regulations (14 CFR
Part 71) to alter the transition area
airspace near Monroe, Michigan.
Sections 71.171 and 71.181 of Part 71
of the Federal Aviation Regulations
were published in FAA Order 7400.6,
Part 1 dated January 3,1984.
List of Subjects in 14 CFR Part 71
Transition areas, Aviation safety.
The Proposed Amendment
PART 71—(AMENDED)
Accordingly, pursuant to the authority
delegated to me. the Federal Aviation
Administration proposes to amend

392
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SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
SUPERVISION, REGULATION AND INSURANCE

OAV.OORE.ER. CALIF.

BRUCE F VENTO. MINN

GEORGE C WORTLEY NY

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COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS

THOMAS H CARPER, DEL

NINETY-EIGHTH CONGRESS

WASHINGTON, D.C. 2 0 5 1 5
S e p t e m b e r 1 1 , 1984

Honorable C. Todd Conover
Comptroller of the Currency
490 UEnfant Plaza, S.W.
Washington, D.C. 20219
Dear Mr. Conover:
To assist this Subcommittee in its inquiry into the circumstances that made it
necessary to provide federal assistance to Continental Illinois Corporation (CIC)
and Continental Illinois National Bank (CINB), you are asked to appear before the
Subcommittee on Financial Institutions Supervision, Regulation and Insurance on
September 19, 1984, at 10:00 am, in Room 2128 of the Rayburn House Office
Building.
In your testimony, you are requested to provide the information and respond
to the questions enumerated below:
(1)

Provide a tabulation of the annual rates of asset growth, the ratio of
primary capital (or comparable measures in earlier years) to total
assets, the ratio of classified assets to gross capital funds, the ratio of
purchased funds to total deposits, the ratio of rate sensitive deposits
plus purchased funds to total deposits, the ratio of reserve for possible
loan losses to total loans, and the return on average assets, since 1970
for CINB, for its peer money center banks as a group, and for all
national banks as a group.

(2)

What is the current condition of the portion of the banking industry for
which you, as Comptroller of the Currency, are responsible?

(3)

After the failure of Franklin National Bank, the Office of the
Comptroller of the Currency undertook an extensive internal review of
its examination and supervision practices and procedures. One of the
principal recommendations of the Haskins and Sells study was the
establishment of the National Bank Surveillance System. How was this
system applied in the examination and supervision of CINB? Do you
intend to modify the NBS System as a result of the CINB experience?
What modifications do you anticipate will be made?




393
(4)

As required by the provisions of the International Lending Supervision
Act of 1983, the OCC has recently announced a proposed rule
addressing the capitalization of national banks. Under the proposed
rule, what amounts of capital would be regarded as adequate, marginal,
or inadequate?

(5)

With respect to each examination of CINB since 1977, how was CINB's
high growth corporate plan announced in 1976, its growing dependence
on purchased funds, and its high level of criticized and classified assets
incorporated in evaluating its capital adequacy both in absolute terms
and with respect to its peer money center institutions? Do you intend
to modify OCC capital adequacy evaluation standards as a result of the
CINB experience? If so, what modifications do you expect will be
made?

(6)

The management practices and financial soundness of Penn Square
National Bank had a significant effect on the well-being of CINB. The
problems in Penn Square were well known to OCC supervisory officials
two full years before it failed. Explain in detail the examination
findings and supervisory actions taken to correct Penn Square's
problems in the three years preceding its failure and what actions OCC
took to isolate Penn Square's problems from other commercial banks.
What actions, for example, did your office take to notify OCC
examiners working in banks with close ties with Penn Square of the loan
management and soundness problems in that bank?

(7)

Possibly the most knowledgeable individual in the OCC concerning
CINB is Senior National Bank Examiner, Richard Kovarick. He was
Examiner-in-Charge of the 1977 and 1982 examinations and
participated in the 1979 and 1981 examinations. In his 1982 Letter to
the Board of Directors, he wrote:
"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
responsibility/accountability. 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."




394
The problems referred to by Mr. Kovarick were noted repeatedly by
earlier examiners but were not viewed as being significant. What
actions are being taken within OCC to assure that such management
practices are effectively addressed before they become safety and
soundness problems?
(8)

What role did the OCC have in the development of the CIC/CINB
Assistance Program? Review the chronology of the Assistance
Program's development.

(9)

Were all public statements made by you or your agency regarding the
soundness of CINB consistent with the information you or your agency
had at the time the statement was made?

(10) The cost of funds in open financial markets is closely related to the risk
of nonpayment. Other things being equal, the cost of funds for those
financial institutions the public views as being so large the government
cannot allow them to fail will decline relative to the cost of funds for
institutions not so viewed. In this respect, what are the long term
implications of the Assistance Program for the competitive relationship
between large and small banks and between bank holding company
affiliated and non-affiliated businesses?
In accordance with Committee rules, please deliver 175 copies of each
prepared statement to Room B303 Rayburn before 12:00 p.m. on September 17,
1984. Your prepared statement will be distributed to all Members of the
Subcommittee in advance of the hearing and will be included in its entirety in the
hearing record.
Sincerely,

Fernand 3. St Germain
Chairman

F3StG:jDc




INQUIRY INTO CONTINENTAL ILLINOIS CORP.
AND CONTINENTAL ILLINOIS NATIONAL BANK
THURSDAY, OCTOBER 4, 1984
HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON F I N A N CIAL INSTITUTIONS SUPERVISION, REGULATION AND INSURANCE, COMMITTEE ON BANKING, FINANCE AND
URBAN AFFAIRS,

Washington, DC.
The subcommittee met, pursuant to call, at 10:25 a.m., in room
2128, Rayburn House Office Building, Hon. Fernand J. St Germain
(chairman of the subcommittee) presiding.
Present: Representatives St Germain, Annunzio, Hubbard, Barnard, Vento, Patman, Lehman, Carper, Wylie, Hansen, Leach,
McKinney, McCollum, and Wortley.
Also present: Representative Thomas J. Ridge of the full committee.
Chairman S T GERMAIN. The subcommittee will come to order.
We resume hearings this morning on Continental Illinois National Bank with testimony from its largest single stockholder, the Federal Deposit Insurance Corporation.
It may not have filtered through the ranks of the bureaucracy
yet, but the Continental Illinois failure will have a lasting and
heavy impact on the entire Federal financial regulatory system—
and the public's acceptance of its role.
It raises fundamental questions about the fairness, cost and,
most of all, the efficacy of a regulatory system built on the quicksand of secrecy, procrastination and expediency.
The Federal Deposit Insurance Corporation is revealed not as the
solid cornerstone of confidence, but as the linchpin in the Federal
Government's most costly and grandiose corporate welfare program. The FDIC finds itself not in its traditional role as champion
of the small independent banks, but as the cashier in a fail-safe
program for the biggest of our big banks—direct Government intervention t h a t is certain to distort the marketplace in favor of the
big and against the small.
Perhaps FDIC looks on itself as an unwilling partner forced to
accept and pay the bills of its profligate fellow regulators. If t h a t is
the case, this hearing provides an excellent opportunity to set the
record straight.
FDIC did have its moments of glory as the regulators sat around
in those long agonizing, hand wringing sessions about their problem in Chicago.




(395)

396
Reading the examination reports, FDIC's supervisory personnel
did spot the severity of the problems. In May 1983, ignoring the
Comptroller of the Currency's lukewarm rating of a " 3 , " (risks
above normal) the FDIC declared the bank a full scale " 4 " (serious
financial weakness) and threw the illustrious name of Continental
on the agency's infamous list of problem banks.
At this point, FDIC looked like the star performer among the
regulators. But, what did FDIC do with the information? Our investigators cannot find any alarms, red flags, or other signals t h a t
warned anyone t h a t FDIC had found a rotten apple—a large rotten
apple. Apparently, even the State banks—for which FDIC has a
primary regulatory role—didn't get any signals, and the examiners
appeared to have stood silently while they continued to move deposits into Continental—increasing FDIC liability in an institution
they knew was a problem bank. In the final analysis, the supervisory personnel who insisted on the " 4 " rating might as well have
stayed in bed for all the good their findings did.
A bailout of this magnitude raises monumental questions of
public policy. Many of these questions, unfortunately, have been
shrouded in the secrecy of the regulatory agencies and the seeming
willingness of so many to accept at face value the ex post facto rationalizations t h a t pour so freely in the background briefings and
mimeographed handouts.
Even if one believes—and this takes some believing—that the
regulators performed brilliantly, one surely must still question the
power, the inordinate power, t h a t is assumed by these agencies.
Billions of dollars are committed, banking policy is changed, the
marketplace redefined, without public hearings, without votes,
without any of the checks and balances t h a t we accept in our
system. Perhaps all these gentlemen are the wisest of the wise and
above reproach, but even such personal credentials would be a frail
peg on which to hang such massive governmental power in a democracy.
The only thing t h a t appears to top the magnitude of the outlays
to save Continental is the mountain of misinformation, distortions,
and half-truths t h a t seem to surround every aspect of this case.
At times, the multibillion dollar bailout has been described as
virtually cost-free. Even more frequently, the domino theory has
been floated, suggesting t h a t 75 or more banks would have failed
had the regulators not staffed the bucket brigade. In fact, the regulators briefed Members of both the House and Senate in July and
used the domino theory as the centerpiece of their contention t h a t
"we had no choice." Variations on the theme have been repeated
time and again in major publications.
Unless one assumes t h a t all the assets of Continental—and they
were considerable—would have been vaporized overnight and t h a t
the entire support mechanisms of the regulatory system would
have disappeared, the numbers are nothing less t h a n absurd.
Unless they are more incompetent t h a n we suspect, the agencies
knew full well t h a t the domino theory was concocted. At most—
and this stretches a pessimistic scenario pretty far—may be a half
dozen institutions would have been on the edge of a failure line. A
more reasonable analysis suggests t h a t these troubles could have
been handled by the emergency mechanisms of the Federal regula


397
tory system—incidentally at a fraction of the bailout costs of Continental. The number of dominoes is probably close to zero. At least
one publication, I am happy to note, did question the domino
theory. Associate Editor Sanford Rose wrote in Tuesday's edition of
the American Banker: "It now appears t h a t top bank regulators
were something less t h a n candid when they said t h a t a significant
number of small U.S. banks would fail unless Continental Illinois
was bailed out." And Mr. Rose concludes: * * * the American
public has the right to a little more honesty from its public officials
than it apparently got in this sordid episode."
We have been analyzing the regulators' domino theory and will
be developing these facts fully during the hearing. We can assure
the American Banker that there is plenty of evidence to support
Sanford Rose's conclusion.
The idea t h a t the bailout is a painless cost-free exercise should
be thrown in the same pile with other unsupported rationalizations. Yes, Continental could have a substantial budget impact—
conceivably amounting to as much as $3.8 billion according to the
Congressional Budget Office.
Unfortunately, FDIC's liquidation and bailout estimates often
have a way of growing after the initial optimistic projections.
When United American Bank and the other Butcher banks failed
in Tennessee in 1983, the forecasts were t h a t the FDIC would get
out of t h a t mess with costs of $400 million or less. Just last week,
banking publications carried reports of estimates t h a t FDIC's
actual cost could probably top $1 billion—more t h a n 100 percent
above those well publicized and rosy predictions of 1983. The same
people who came up with the United American projections programmed the same computer in calculating the costs of the Continental collapse.
In hopes of dampening the public's concerns over cost, the regulators have suggested t h a t all this was being paid for with "play"
money out of someone's Monopoly game. The insurance premiums
which support, in part, the Government's guarantees to banks are
paid ultimately by the customers of those institutions in the form
of higher fees and interest rates. More important, it is absurd to
think t h a t the premiums begin to pay the value of the full faith
and credit of the Federal Government which stands behind—and
provides the real strength for the insurance funds.
The FDIC has a direct draw on the Treasury of $3 billion and
when t h a t is exhausted additional sums will have to be appropriated out of tax moneys.
This idea t h a t somehow the FDIC's funds are bankers' money is
disturbing. Taking some of these statements literally, there is a
clear suggestion t h a t the FDIC and the bankers have a perfect
right to go off in the corner and d i w y up the insurance fund in
any manner t h a t appears expedient. Such a mind-set, I fear, pervades the Federal bank regulatory system—a feeling t h a t everything operates on an agency-constituency relationship—the rest of
the Federal Government and the public notwithstanding.
Uncalculated in the cost figures of Continental is the liability incurred by the Federal Government in a fail-safe program for big
banks as described by the Comptroller before this committee 2
weeks ago. Uncalculated also are the costs to smaller- and medium39-133 0 - 8 4


26

398
sized banks and their communities which must face the distinct
competitive disadvantages of a federally inspired fail-safe program
for the big banks. That famous level playing field was stood on its
end by the Continental bailout.
Support for Government programs depend in large part on the
public's perception of how equitably those outlays are made in the
economy. Clearly, fail-safe bailout policy for one class of banks and
a hit and miss policy for the remainder of the industry is the very
epitomy of unfairness and unequal treatment.
But, the double standard does not apply simply to small banks.
From 1981 through 1983 we had between 70,000 and 80,000 business failures, the highest rate in 50 years. Where were the Continental-style Government bailouts for all the small business people
who saw their doors padlocked for the last time?
All of us, I believe, would feel better if there was any strong evidence t h a t the regulators approached the Continental problems in
a concerted, businesslike manner and based their decision on hardnosed data.
In t r u t h and in fact, it appears that the three regulators made
their initial decision to assist Continental with little in hand but
the broad concept t h a t the bank was "essential" in a global sense.
At this point, not even a contrived list of dominoes was in hand
and apparently no cost analysis which would have given the regulators a clue as to what route might save the Federal Government
money. It appears that the decision to bailout was made on high in
the early hours without any hard facts or empirical evidence. After
t h a t apparently the word went out to the bureaucracy to come up
with numbers to rationalize the action for public consumption.
Again, this entire process calls for greater openness. It cries out
for a greater degree of truthfulness. It does not enhance the confidence of the American people in the Federal regulatory structure
to have one of its officials issue misleading statements about the
condition of the bank as the Comptroller did during the early
stages of the rescue effort. It does not enhance the credibility of the
agencies to float distorted or manufactured numbers suggesting
t h a t the banking system would collapse like so many dominoes
unless the money gates were opened wide.
The Continental failure doesn't have many bright spots, but it
does explode some myths. It certainly disabuses any thought that
the regulators—faced with the debris of Penn Square—got their act
together. It's the same timid, uncoordinated, secretive regulatory
system. It certainly suggests t h a t one must take great care in accepting—on face value—stock tips coming out of the banking agencies or buying the sky-is-falling approach to public policy and outlays of Federal moneys. It ends the myth that there is a solid wall
between the holding companies and their subsidiary banks. When
the rescue squad raced into Chicago, it headed straight for the
holding company and installed the life lines to the bank through
t h a t structure. Ever since, the poor fellows at Treasury have been
shredding old copies of speeches and testimony which assured the
world t h a t there was a full and definitive separability between the
holding company and the bank subsidiary.



399
Let's hope that a few other banking myths disappear before we
end these hearings so that we can move the regulators back to the
real world in which the American people reside.
At this point, I would ask unanimous consent to place the report
from the Congressional Budget Office at the conclusion of my statement, without objection.
[The Congressional Budget Office report follows:]




400

CONGRESSIONAL BUDGET OFFICE
U.S. CONGRESS
W A S H I N G T O N , D.C. 2 0 5 1 5

Rudolph G. Penner
Director

October 3, 1984

Honorable Fernand 3. St Germain
Chairman
Committee on Banking, Finance and
Urban Affairs
U.S. House of Representatives
2129 Rayburn House Office Building
Washington, D.C. 20515
Dear Mr. Chairman:
As you requested, the Congressional Budget Office has prepared an analysis
of the estimated federal budget impact of the financial assistance provided
to Continental Illinois National Bank and Trust Company.
There is much uncertainty about key factors in the analysis—especially the
value of loans transferred to the FDIC and the future value of CI stock.
Consequently, a single point estimate of the budgetary effects of the
assistance plan is not feasible. Based on an assessment of various possible
outcomes, CBO estimates that net federal outlays over the 1984-1990 period
are likely to fall between -$0.2 billion and $3.8 billion. The outlays will be
incurred by the FDIC and will appear on the unified budget.
If you wish further details on this estimate, we will be pleased to provide
them.




Sincerely,

^vRudolph G. Penner

401
October 3, 1984
CONGRESSIONAL BUDGET OFFICE
ANALYSIS OF THE FEDERAL BUDGET IMPACT
OF ASSISTANCE TO THE CONTINENTAL ILLINOIS
NATIONAL BANK AND TRUST COMPANY
INTRODUCTION
Over the past several months, agencies of the federal government have
participated in efforts to maintain the viability of the Continental Illinois
National Bank and Trust Company (CI). The assistance began with Federal
Reserve loans to maintain the bank's liquidity and culminated in a long-term
assistance plan announced on July 26, 1984 by the Federal Deposit Insurance
Corporation (FDIC), the Comptroller of the Currency, and the Federal
Reserve. CI stockholders approved that plan on September 26. At the
request of Chairman St Germain of the House Committee on Banking,
Finance and Urban Affairs, the Congressional Budget Office (CBO) has
analyzed the rescue plan and has assessed its budget impact.
There is much uncertainty about key factors in the analysis—especially the
value of loans transferred to the FDIC and the future value of CI stock.
Consequently, a single point estimate of the budgetary effects of the
assistance plan is not feasible. Based on an assessment of various possible
outcomes, CBO estimates that net federal outlays over the 1984-1990 period
are likely to fall between -$0.2 billion and $3.8 billion. The outlays will be
incurred by the FDIC and will appear on the unified budget.
FDIC expenditures are not funded from general tax revenues, however.
They are derived from a trust fund financed by insurance assessments paid
by member banks. As a result, the cost of FDIC assistance will ultimately
be borne by the banking system's depositors, borrowers, and/or stockholders.
The loan activity of the Federal Reserve and the administrative expenses of
both the Fed and the Comptroller of the Currency will not have any
significant budgetary effects. The Fed loans are at rates approximating its
normal earnings, while the administrative activities are estimated to cost
less than $1 million in 1984 and to fall within the normal scope of agency
activities thereafter. There are no off-budget expenses associated with the
assistance plan.
THE ASSISTANCE PLAN
The financial portion of the permanent assistance program for Continental
Illinois (CI) consists of a purchase of CI loans and equity by the FDIC, for a
total of $4.5 billion. In addition, the Federal Reserve is continuing its
lending to Continental to help maintain the bank's liquidity.




402
Loan Purchases
The FDIC will purchase, for $3.5 billion, loans from CI with a face value of
$5.7 billion. The loans will be transferred in two parts: the first group, with
a face value of about $4.2 billion, was sold to the FDIC for $2.0 billion. The
second group, with a face value of $1.5 billion, will be sold to the FDIC over
the next three years for $1.5 billion. \J CI's selection of loans to be
transferred is restricted in that: (a) loans must have been originated or
committed prior to May 31, 1984, and (b) no loan to or guaranteed by a
foreign government shall be transferred, except as agreed by the FDIC.
The FDIC will pay the $3.5 billion purchase price by assuming $3.5 billion of
CI debt to the Federal Reserve. The FDIC will pay interest to the Fed
quarterly, and will also pass through as principal payments to the Fed any
collections, over and above interest and other expenses, on the $3.5 billion
portfolio of troubled loans, until the Fed loan is repaid. Five years after the
agreement is implemented, the FDIC will be required to pay off any
remaining principal on the $3.5 billion in Fed loans. At that time, the FDIC
will be compensated for any losses incurred on the loans by receiving an
option to acquire, at $.00001 per share, a portion of the 40 million shares of
CI currently outstanding. If the losses are $800 million or more, the FDIC
will acquire all 40 million shares.
Equity Purchase
The FDIC purchased $1.0 billion in preferred stock in CI, divided into two
non-voting issues. One issue, of $720 million, is convertible (upon sale to a
third party) into 160 million shares of newly authorized common stock. This
preferred stock will be entitled to dividends equivalent to those paid on
common stock (though none are anticipated for at least a year). The second
issue, of $280 million, will pay dividends at an adjustable rate based on
current rates for certain U.S. Treasury securities. This issue is callable at
the option of CI and, for the first three years, the dividend is payable in
cash or in additional adjustable rate preferred stock.
THE BUDGET IMPACT
While a number of federal agencies have played a role in developing the
assistance plan, the direct budget impact derives from the actions of the
FDIC. The Federal Reserve Board and the Comptroller of the Currency are
also involved in the plan, but their activities will not have any significant
budget effects.
The rescue plan may also affect the American and
international financial systems and the U.S. economy, which could, in turn,
affect the federal budget.
The direct budgetary effects are highly
uncertain, and there is no reliable way to predict the nature or magnitude of
possible secondary effects.
J/

Instead of transferring loans, the bank has the option of paying all or
part of the $1.5 billion in cash, but it is unlikely that this option will
be exercised. This analysis assumes that the maximum amount of
loans is sold.




2

403
The FDIC
All of the significant budgetary consequences of the plan are related to the
activities of the FDIC. Assistance to banks and administrative expenses
paid from the FDIC trust fund appear as outlays in the federal budget when
they are disbursed. On the other hand, earnings on the trust fund portfolio,
recoveries on previous investments, and insurance assessments paid by
insured banks reduce budget outlays when they are received. Each of the
FDIC transactions in this plan has a direct impact on the unified budget.
Fiscal Year 1984 Budget Impact. In May 1984, the FDIC provided $1.5
billion of a $2.0 billion loan to CI as part of a temporary assistance
plan. 2/ This loan resulted in an initial $1.5 billion federal budget outlay.
FDIC interest receipts were not significantly affected by this interim loan,
because the interest payment by CI to the FDIC is approximately equivalent
to the earnings the FDIC would have received on Treasury investments.
The permanent assistance plan became effective after approval by the CI
stockholders on September 26, 1984. Under that plan, the interim loan was
repaid, and the FDIC completed the $1.0 billion equity purchase, resulting in
net federal outlays of $1.0 billion in fiscal year 1984. 3/
Loan Purchases. By acquiring the CI loans (having a face value of $5.7
billion), the FDIC will receive any principal and interest payments made by
the borrowers, and these receipts will reduce net outlays. On the other
hand, the FDICs payments to the Fed to cover interest and principal on the
$3.5 billion loan assumed from CI will increase FDIC outlays over the 19851989 period. It is likely that the receipts from the transferred loans will be
less than the payments due to the Fed, and the difference between the two
will be net additional outlays to the FDIC.
The plan also requires the FDIC to pay CI the amount by which interest the
bank paid to the Fed on $2.0 billion of its borrowings exceeds collections on
the initial $2.0 billion in transferred loans from July 26, 1984 to the
implementation date of the plan. 4/ This amount is expected to be about
$24 million, and will be paid in fiscal year 1985.
2/

Another $0.5 billion was provided by a group of U.S. banks.

3/

This analysis is consistent with the budgetary treatment projected by
the FDIC and used in the Administration's mid-session budget
estimates released in August. Alternatively, it is possible to view the
assistance plan as a $3.5 billion loan from the Fed to the FDIC, and
$4.5 billion in direct assistance from the FDIC to CI. Under such an
interpretation, the entire $4.5 billion would be recorded as an outlay in
1984, rather than being spread out over a five-year period, and the
FDICs subsequent principal payments to the Fed would not be
regarded as budget outlays. Total FDIC outlays over the 1984-1990
period would be the same with either treatment.

kj

This provision has an effect similar to that of transferring the first
$2.0 billion in loans to the FDIC as of July 26, with the FDIC assuming
$2.0 billion in CI loans to the Fed at the same time.




3

404
The value of the troubled loans acquired by the F D I C is the major
uncertainty in the cost of the plan to the F D I C . CI has indicated that many
of the loans will be for energy exploration and development activities, which
have little prospect of success unless energy prices increase sharply. The
transferred loans will also include real estate, shipping, and foreign private
sector loans. All of the loans will be of poor quality on the date on which
they are sold. According to the CI proxy statement, the loans will be
administered to maximize recoveries to the F D I C over the five years prior
to the valuation date.
To reflect the uncertainty as to the amount of likely loan collections, the
CBO analysis is based on three alternative scenarios:
o

an optimistic assumption--that the F D I C will collect $4.0 billion of
principal and interest on the $3.5 billion in transferred loans.

o

a pessimistic assumption—that collections of principal and interest
will total about $2.0 billion on the $3.5 billion in transferred loans.

o

a midpoint assumption--that collections of principal and interest will
be about $3.0 billion on the $3.5 billion in transferred loans.

The estimated range of $2 billion to $4 billion in collections is based on
FDIC's historical rate of recovery on assets obtained from failed institutions
and on information from knowledgeable individuals in government agencies
and in the financial community. Because a significant portion of the loans
are related to energy development activities, the collections are very
sensitive to oil prices. This analysis assumes relatively stable oil prices over
the next five years (consistent with CBO's baseline projections).
Loan
recoveries could be greater or less than projected if oil prices were to
dramatically increase or decrease.
A number of other factors affect the estimate of loan collections. On the
pessimistic side, the loans are being specifically selected because of their
expected poor performance; they include loans obtained from the Penn
Square Bank and some foreign loans, which may be particularly difficult to
collect. In addition, only the collections obtained in the first five years are
applicable to the valuation date transactions. On the other hand, the F D I C
is assuming these loans at a discount of close to 40 percent from the $5.7
billion face value. I t is possible, therefore, that the rate of collections on
the $3.5 billion could exceed the 70-75 percent of book value the F D I C
estimates to be its average historical rate.
The analysis also assumes a relatively steady stream of F D I C loan
collections and F D I C repayments to the Fed over the five-year period. I t is
possible that these flows could be uneven. For example, the F D I C could sell
some of the transferred loans and/or pay off the Fed loan early, resulting in
large cash flows in a particular year.
Table 1 shows the budget effects of the loan purchase transaction under
each of the above assumptions. I t is displayed in two components, with
outlays occurring at the end of the five-year period (the "valuation date")
shown separately from those occurring at other times during the 1985-1989
period. Under the optimistic assumption, the F D I C would be able to pay




4

405
back about $2.7 billion in principal of the $3.5 billion Fed loan from its loan
collections before the valuation date, and net FDIC outlays over the fiveyear period would be about $0.6 billion. Under the pessimistic assumption,
$3.2 billion in principal would remain unpaid until the valuation date, and
net outlays associated with the loan purchase transactions over the fiveyear period would be $3.1 billion. Under the midpoint assumption, the FDIC
would repay $1.5 billion in principal from its loan collections before the
valuation date, and net FDIC outlays from the loan transactions would be
$1.9 billion from 1985 through 19S9. In all cases, some additional loan
collections may occur after 1989, but the amounts are not likely to be
substantial.
TABLE 1. EFFECT OF LOAN PURCHASES ON FDIC OUTLAYS
(By fiscal year, in billions of dollars)
1985-1989
Excluding
Valuation
Date
Transactions

Valuation
Date
Transactions

Total
1985-1989

Optimistic:
FDIC payments to Fed:
Principal
Interest
FDIC loan receipts
(net of expenses)

2.7
1.1

0.8

*

3.5
1.1

-fr.O

—

-fr.O

Net FDIC outlays

-0.3

0.9

0.6

0.3
1.5

3.2
0.1

3.5
1.6

-2.0

—

-2.0

-0.2

3.3

3.1

1.5
1.3

2.0

*

3.5
IA

-3.0

—

-3.0

-0.2

2.1

1.9

Pessimistic:
FDIC payments to Fed:
Principal
Interest
FDIC loan receipts
(net of expenses)
Net FDIC outlays
Midpoint:
FDIC payments to Fed:
Principal
Interest
FDIC loan receipts
(net of expenses)
Net FDIC outlays
*

Less than $50 million.

NOTE: Details may not add to totals because of rounding.




.5

406
Equity Purchases. The F D I C paid $1 billion for preferred stock--$720
million for preferred convertible into 160 million shares of common, and
$280 million for floating rate preferred. Under the pessimistic and midpoint
assumptions used in this analysis, the FDIC would acquire an additional 40
million shares of common stock at a total cost of $400, as a result of losses
incurred on the acquired loans. (There could be a maximum of 240 million
shares of common stock outstanding, which would occur if present
shareholders exercise their right to acquire up to 40 million additional
shares of CI.) In the optimistic case, the F D I C would acquire about 28
million shares.
For the purpose of this analysis, CBO has assumed that the floating rate
preferred stock would be sold in about three years, after accumulating
dividends over that period in the form of additional stock. I t is likely that
such stock could be sold at a negligible discount, because it will be earning
rates equivalent to those of Treasury securities.
On this basis, F D I C
receipts from the sale are projected to be about $0.4 billion.
The value of the remaining stock—the preferred stock convertible into 160
million shares of common, plus up to 40 million additional shares of
common—will depend on the market price of CI common stock, which in
turn depends on the success of the "new" CI and the market's assessment of
its prospects. For the purpose of this analysis, CBO has assumed that the
F D I C would sell its rights to 160 million shares in 2-3 years. 5/
(The
additional shares would be obtained on the valuation date, and would
probably be sold shortly thereafter.) The budget impact is estimated using
optimistic, pessimistic, and midpoint assumptions, with prices of $7.00,
$1.00, and $4.00, respectively, per share of common stock.
Each stock price assumption represents a number of different possible
combinations of the key factors that determine prices. As an example, the
$4.00 price could be considered to represent a return on total assets of 0.6
percent, about what CI earned in 1979-1981 and typical for large banks over
the past several years, applied to a projected asset base of about $27 billion
and valued at six times earnings, currently typical for a large bank. The
$7.00 price would represent assumptions on the high end of the industry's
recent experience—for example, a return on assets of 0.7 percent and a
price-earnings ratio of 8:1—applied to a larger asset base of $30 billion.
The $1.00 price would represent assumptions on the low end of recent
industry experience—for example, a return of 0.2 percent of assets and
valuation at four times earnings—applied to $25 billion in assets.
On this basis, the FDIC's receipts from the sale of the convertible preferred
and common stock would range from $0.2 billion (pessimistic) to $1.3 billion
(optimistic), with a midpoint of $0.8 billion--in addition to the $0.4 billion
from the floating rate preferred stock. The budget impact of all the equity
transactions, net of the $1.0 billion purchase price, is projected to range
from a net outlay of $0.4 billion to a net receipt of $0.7 billion, excluding
interest costs. These estimates are summarized in Table 2.

5/

The F D I C has indicated that it would sell the stock "as soon as
practicable." I t is likely to wait, however, until CI's financial situation
is stabilized in the hope of obtaining a high sale price.




407
TABLE 2. EFFECT OF EQUITY PURCHASES ON FDIC OUTLAYS
Assumed
market price
per share of
common stock
(in dollars)

Receipts from
stock sales
(in billions
of dollars)

Net gain (+) or
loss (-) on
equity purchases
(in billions
of dollars)

Optimistic

7.00

1.7

0.7

Pessimistic

1.00

0.6

-CM

Midpoint

b.00

1.2

0.2

Net Effect _on FDIC Outlays. The overall budget im pact on the FDIC is
summarized in Table 3. It includes the results of the loan and equity
purchases, as well as dividend income 6/ and the loss of interest on the FDIC
portfolio as a result of the outlays for CI assistance. Net outlays over the
1985-1990 period are projected to range from -$0.2 billion (using optimistic
stock price and loan collection assumptions) to $3.8 billion (using pessimistic
assumptions), with a midpoint estimate of $1.8 billion.
These estimates do not include any change in the insurance assessments paid
by member banks and retained by the FDIC. The assessment rate is set by
statute, at 1/12 of 1 percent of total domestic deposits (after adjustment
for deposits in transit), and it cannot be changed by the FDIC. If assessment
income exceeds the amounts required to meet the FDIC's expenses and
insurance losses and to maintain the trust fund at an appropriate level,
banks generally receive a credit against their next year's assessments.
While historically the rebate has been about 50 percent, the record number
of recent bank failures has been reducing this percentage annually, so that a
rebate toward the 1985 assessments is not expected, even without the CI
transactions. Thus, FDIC expenses related to bank failures reduce potential
credits toward FDIC's insurance assessments and lead to higher bank costs.
These costs are passed on to depositors, borrowers, and/or stockholders.
If the FDIC incurs losses in future years as a result of CI, as in the
pessimistic and midpoint cases, it would reduce or eliminate insurance
rebates that might otherwise be made. If losses exceed FDIC income,
equity in the trust fund would be reduced. Over time, the FDIC recovers a
majority of its losses through the bank assessments. There is no reliable
basis for projecting when the FDIC would be able to replenish its trust fund
from such assessments.
6/

Dividends are assumed to be paid starting in fiscal year 1986, at an
annual rate of about 40 cents per share in the optimistic case and 20
cents per share in the midpoint case. No dividends are assumed in the
pessimistic case.




7

408
TABLE 3. NET BUDGET IMPACT OF FDIC TRANSACTIONS
(Outlays, by fiscal year, in billions of dollars)

198*
Optimistic:
Equity purchases (+)
and sales (-)
Net collections on
transferred loans
Interest and principal
paid to Fed and CI
Loss of interest on
portfolio less cash
dividends received
NET OUTLAYS
Pessimistic:
Equity purchases (+)
and sales (-)
Net collections on
transferred loans
Interest and principal
paid to Fed and CI
Loss of interest on
portfolio less cash
dividends received
NET OUTLAYS
Midpoint:
Equity purchases (+)
and sales (-)
Net collections on
transferred loans
Interest and principal
paid to Fed and CI
Loss of interest on
portfolio less cash
dividends received
NET OUTLAYS

*

1985- 19S9 Transactions
Excluding on Valuation
Valuation
Date or
Date
Shortly
Transactions Thereafter

1.0

-1.5

-0.2

-0.7

—

-4.0

—

-4.0

—-

3.7

0.9

4.6

—

-0.1

—

-0.1

1.0

-1.9

0.7

-0.2

1.0

-0.5

0.4

—

-2.0

-2.0

—-

1.8

3.3

5.1
0.3

—

0.3

1.0

-0.4

3.2

3.8

1.0

-1.0

-0.2

-0.2

—

-3.0

—

-3.0

---

2.8

2.1

4.9

—

0.1

—

0.1

1.0

-1.1

1.9

1.8

Less than $50 million.

NOTE: Details may not add to totals because of rounding.




Total
1984-1990

8

409
What is even harder to assess is the potential budget impact of the
alternatives that were available to the FDIC. For example, in many similar
situations involving smaller banks, the FDIC has closed the bank and merged
it with an existing institution or created a new bank. The FDIC sought to
make similar arrangements for Continental Illinois, but the bank size, the
volatility of its funding sources, and the composition of its assets made
finding a suitor difficult. The FDIC received one tentative offer to take
ownership of the bank, but rejected it as too costly.
Alternatively, the bank could have been closed and depositors paid off to the
statutory limit. The FDIC would have been named receiver of the bank's
assets, would have paid off depositors and creditors as necessary, and would
have recovered as much of such payments as possible by liquidating the
bank's assets. Insured deposits at that time were only $3 billion to $4
billion, and creditors (including the Federal Reserve) were owed in excess of
$3 billion. The FDIC, along with financial institutions and other depositors
with holdings in excess of $100,000, would have shared in any losses, which
might have threatened the financial viability of some of the affected
institutions. Once the FDIC had agreed to guarantee all deposits and
general creditors, its direct liability in the event of a CI failure would have
been about $38 billion, though its net liability after recoveries would have
been considerably less. In either case, the failure of a bank of CI's
magnitude might have caused a general loss of confidence in American
banking institutions, and the long-term budgetary and economic impact,
although impossible to measure, could have been enormous.
The Federal Reserve Board
While the Federal Reserve System is off-budget, the bulk of Federal
Reserve earnings are returned to the Treasury and counted as miscellaneous
receipts in the unified budget. Therefore, any activity which changes
Federal Reserve earnings can be considered to have a revenue effect. The
Federal Reserve's loans to Continental Illinois totaled about $7 billion in
late August, and more may be made in the future. These loans do not
appear to have affected the size of the Fed's portfolio. Federal Reserve
earnings could be affected by any difference between the interest rate the
Federal Reserve receives on the Continental loans and what it would have
earned on alternative instruments. The rate paid by CI and the rate
assumed by the FDIC (the three-month Treasury bill rate plus 25 basis
points) are close to the rate the Fed might be expected to have earned on
the mix of short-term Treasury securities it presumably gave up for the CI
loans. Administrative costs associated with the rescue effort cannot be
determined precisely, but they have been less than $1 million in 1984 and
are not likely to be substantial in the future. Therefore, any revenue effect
is expected to be negligible.
Comptroller of the Currency
The Comptroller of the Currency is the primary supervising agency of
national banks, including CI. In order to monitor the financial condition of
CI and assist in developing the rescue plan, the Comptroller has shifted
some resources, primarily staff time, to assist with the CI effort, but does
not expect total agency obligations to increase in 1984 or subsequent years
because of activities related to CI. As a result, no significant budget
impact is expected to result from the Comptroller's activities.




9

410
Chairman S T GERMAIN. Mr. Wylie.
Mr. WYLIE. Thank you very much, Mr. Chairman.
I have a much shorter statement with a slightly different view.
I am pleased to have the opportunity to say to Chairman Isaac
publicly what I have already said to him privately: t h a t I think his
handling of the Continental situation was highly commendable
given the choices t h a t were available to you and the amount of
time you had to react. It has become a cliche to say t h a t the regulators had no choice but to act as they did in the case of Continental, and Chairman Isaac presents this argument forcefully in his
statement today.
What this subcommittee and the full Banking Committee must
realize is t h a t if we want the regulators to have more choices, if we
want large and small banks to be treated alike, and if we want to
avoid bailouts of failed managers, it is up to us to make those options possible, and in general to enlarge the range of options available to meet unforeseeable circumstances.
Chairman Isaac makes the point very well in his statement when
he says, "While a great many people in and out of government deplore the necessity of Continental-type rescue efforts, few appear to
be willing to make fundamental changes in the system t h a t gave
rise to it."
The task ahead is to reform the deposit insurance system and to
improve the supervision of depository institutions with special attention to internal controls and capital adequacy. Chairman Isaac
has submitted a thought-provoking proposal—the Federal Deposit
Insurance Improvements Act of 1984, H.R. 5738—which I have introduced at his request. Tuesday's Wall Street Journal carried an
article about an FDIC proposal to raise insured banks' capital to 9
percent by allowing subordinated debt securities to be converted.
Additional proposals for long overdue regulatory reforms will be
forthcoming, in particular from Vice President Bush's task force
group on the regulation of financial services. Our task will be complicated by the need to implement any changes gradually, so t h a t
the system can make an orderly adjustment. Ideally, the market
should be on notice as to how the regulators will handle these situations which are foreseeable so that the damage done by rumors
and reckless speculation can be contained.
We have an opportunity to make a significant contribution to the
safety and soundness of the banking industry on which the health
of the entire economy depends. Although, Mr. Chairman, I personally was disappointed by your announcement of September 21
about enacting banking legislation this year, I respect your decision as being realistic and I do find comfort in your statement t h a t
the House Banking Committee will consider these important issues
in the next session.
I want to assure you t h a t I offer you my full assistance and t h a t
of my staff to get on with early hearings, not just on the subjects of
loopholes and asset deregulation, but also on reforming our deposit
insurance system and our Federal examination and supervisory
system to assure the kind of financial system which can meet the
challenges ahead and support a growing and vibrant American
economy. Thank you very, very much for this opportunity.
[The opening statement of Congressman Wylie follows:]




411
STATEMENT OF

REP. CHALMERS P. WYLIE, OHIO
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
HEARINGS ON CONTINENTAL ILLINOIS

OCTOBER h, 1 8 +
9*
MR. CHAIRMAN:

I AM PLEASED TO HAVE THE OPPORTUNITY TO SAY TO CHAIRMAN ISAAC
PUBLICLY WHAT I'VE ALREADY SAID TO HIM PRIVATELY, THAT HIS HANDLING OF THE
CONTINENTAL SITUATION WAS HIGHLY COMMENDABLE, GIVEN THE CHOICES THAT WERE
AVAILABLE TO YOU AND THE AMOUNT OF TIME YOU HAD TO REACT.

IT HAS BECOME A CLICHE TO SAY THAT THE REGULATORS HAD NO CHOICE BUT
TO ACT AS THEY DID IN THE CASE OF CONTINENTAL, AND CHAIRMAN ISAAC PRESENTS
THIS ARGUMENT FORCEFULLY IN HIS STATEMENT TODAY.

WHAT THIS SUBCOMMITTEE

AND THE FULL BANKING COMMITTEE MUST REALIZE IS THAT IF WE WANT THE
REGULATORS TO HAVE MORE CHOICES THAN THEY HAD IN THIS INSTANCE, IF WE WANT
LARGE AND SMALL BANKS TO BE TREATED ALIKE, AND IF WE WANT TO AVOID
UNSEEMLY BAILOUTS OF FAILED MANAGERS, IT IS UP TO US TO MAKE THOSE OPTIONS
POSSIBLE, AND IN GENERAL TO ENLARGE THE RANGE OF OPTIONS AVAILABLE TO MEET
UNFORESEEABLE CIRCUMSTANCES.

CHAIRMAN ISAAC MAKES THE POINT VERY WELL IN HIS STATEMENT WHEN HE
SAYS, "WHILE A GREAT MANY PEOPLE IN AND OUT OF GOVERNMENT DEPLORE THE
NECESSITY OF CONTINENTAL-TYPE RESCUE EFFORTS, FEWER APPEAR TO BE WILLING
TO MAKE FUNDAMENTAL CHANGES IN THE SYSTEM THAT GAVE RISE TO IT."

THE TASK AHEAD IS TO REFORM THE DEPOSIT INSURANCE SYSTEM AND TO
IMPROVE THE SUPERVISION OF DEPOSITORY INSTITUTIONS, WITH SPECIAL ATTENTION
TO INTERNAL CONTROLS AND CAPITAL ADEQUACY.

CHAIRMAN ISAAC HAS SUBMITTED

A THOUGHT PROVOKING PROPOSAL^ TJ^FEDERAL DEPOSIT INSURANCE IMPROVEMENTS




412
ACT OF 198^ (H.R. 5738) WHICH I INTRODUCED AT HIS REQUEST ON MAY 2k, 1984.
TUESDAY'S WALL STREET JOURNAL CARRIED AN ARTICLE ABOUT AN FDIC PROPOSAL TO
RAISE INSURED BANKS CAPITAL TO 9% BY ALLOWING SUBORDINATED. DEBT SECURITIES
TO BE CONVERTED.

ADDITIONAL PROPOSALS FOR LONG OVERDUE REGULATORY REFORMS

WILL BE FORTHCOMING, IN PARTICULAR FROM VICE PRESIDENT BUSH'S TASK GROUP
ON THE REGULATION OF FINANCIAL SERVICES.

OUR TASK WILL BE COMPLICATED BY

THE NEED TO IMPLEMENT ANY CHANGES GRADUALLY, SO THAT THE SYSTEM CAN MAKE
AN ORDERLY ADJUSTMENT.

IDEALLY, THE MARKET SHOULD BE ON NOTICE AS TO HOW

THE REGULATORS WILL HANDLE THOSE SITUATIONS WHICH ARE FORESEEABLE, SO THAT
THE DAMAGE DONE BY RUMORS AND RECKLESS SPECULATION CAN BE CONTAINED.

MR. CHAIRMAN, WE HAVE AN OPPORTUNITY TO MAKE A SIGNIFICANT
CONTRIBUTION TO THE SAFETY AND SOUNDNESS OF THE BANKING INDUSTRY, ON WHICH
THE HEALTH OF THE ENTIRE ECONOMY DEPENDS.

ALTHOUGH I PERSONALLY WAS

DISAPPOINTED BY YOUR ANNOUNCEMENT OF SEPTEMBER 21ST ABOUT ENACTING BANKING
LEGISLATION THIS YEAR, I RESPECT YOUR DECISION AS BEING REALISTIC, AND I
DO FIND COMFORT IN YOUR STATEMENT THAT THE HOUSE BANKING COMMITTEE WILL
CONSIDER THESE IMPORTANT ISSUES.

I TRUST YOU WILL MAKE THESE HEARINGS ON

THE FINANCIAL SERVICES INDUSTRY YOUR FIRST PRIORITY NEXT CONGRESS.

I WANT

TO ASSURE YOU THAT I OFFER YOU MY FULL ASSISTANCE, AND THAT OF MY STAFF,
TO GET ON WITH EARLY HEARINGS, NOT JUST ON THE SUBJECTS OF LOOPHOLES AND
ASSET DEREGULATION, BUT ALSO ON REFORMING OUR DEPOSIT INSURANCE SYSTEM AND
OUR FEDERAL EXAMINATION AND SUPERVISORY SYSTEM TO ENSURE THE KIND OF
FINANCIAL SYSTEM WHICH CAN MEET THE CHALLENGES AHEAD AND SUPPORT A GROWING
AND VIBRANT AMERICAN ECONOMY.




413
Chairman S T GERMAIN. Thank you, Mr. Wylie.
I would announce to the members of the subcommittee t h a t at
this time we are going to ask one of our staff members, Mr.
Dugger, accompanied by a gentleman who has been assigned to the
committee by the GAO—along with others, GAO has provided facts
and computer data, and so forth, to the committee staff t h a t has
compiled and produced the drafts t h a t will be explained to us by
Mr. Dugger.
So, prior to Mr. Isaac's testimony we wish to get this into the
record so Mr. Isaac could then comment on these numbers when he
testifies subsequent to our discussion with Mr. Dugger and Mr.
Bowser.
I would ask the two gentlemen, Mr. Dugger and Mr. Bowser, to
rise at this point.
Do you swear t h a t the testimony you are about to give will be
the truth, the whole t r u t h and nothing but the truth?
Mr. DUGGER. I do.
Mr. BOWSER. I do.
Chairman S T GERMAIN. YOU

may proceed, Mr. Dugger.

TESTIMONY OF ROBERT H. DUGGER, SUBCOMMITTEE DEPUTY
STAFF DIRECTOR: ACCOMPANIED BY GARY BOWSER, SENIOR
AUDITOR, GENERAL ACCOUNTING OFFICE
Mr. DUGGER. Mr. Chairman, and members of the subcommittee,
you each have before you a copy of a committee staff report on the
potential impact of a Continental bank failure on banks which had
exposure in the form of deposits or Federal funds investments in
that bank. This report, which I shall refer to as the staff report,
attempts simply to clarify certain findings obtained last J u n e by
the FDIC staff concerning the exposure of certain banks to a Continental bank failure.
This report was prepared by the committee staff, but particular
credit must go to the individual on my right, Gary Bowser, and his
colleagues. Gary is a senior GAO auditor on assignment to the committee to assist us in carrying out the Continental inquiry.
He and I together will attempt to answer any questions you may
have at the conclusion of my brief presentation.
Last May, Continental Bank's situation reached a point that the
FDIC, Comptroller of the Currency and Federal Reserve concluded
t h a t a $2 billion temporary assistance program had to be implemented on an emergency basis. The temporary assistance program
went into effect on May 17. About 20 days later, as best we can determine, FDIC Chairman Isaac asked his staff to obtain information on the deposit and investment exposure of other banks in Continental. His staff produced two memoranda which appear in the
appendix of the staff report, dated J u n e 20 and J u n e 22, about 34
days after implementation of the temporary assistance plan.
Chairman S T GERMAIN. IS t h a t the assistance plan of May 10 or
15?
Mr. DUGGER. May

17.

These two memoranda have been referred to in official statements on a number of occasions. This may be because the memoranda contain the only extended discussion of any of the aspects of

39-133 0 - 8 4

27




414
Continental Bank on which the FDIC's essentiality finding was
based.
The information contained in the memoranda was referred to,
for example, in the conference call made by Chairmen Volcker and
Isaac and Comptroller Conover to the chairmen and ranking minority members of the House and Senate Banking Committees, the
evening before the permanent assistance package was approved on
July 26.
The information in the memoranda was referred to again most
recently by Comptroller Conover when he testified before this subcommittee 2 weeks ago.
On t h a t occasion, Mr. Conover said "If Continental Bank had
failed and had been treated as a payoff, certainly those 66 banks
would have failed and probably a goodly number of the other 113
would have failed; if not immediately thereafter, certainly within
some timeframe afterwards. So let us say t h a t we could have seen
another 100 banking failures."
This statement and others like it which attempt to justify the
Continental assistance program failed to give appropriate weight to
three important limitations in the analysis contained in the two
FDIC memoranda prepared last June. The limitations appear to be
the result of the FDIC staff providing Mr. Isaac only what he asked
for and the brief amount of time available to them to perform t h a t
very difficult task.
The limitations are, first, the benefit of $100,000 in deposit insurance coverage is not incorporated in the analysis.
Two, the benefit of the proceeds from a sale of Continental
Bank's assets is also not incorporated in the analysis.
Three, the deposit and investment data used in the analysis is as
of April 30, a date prior to the enormous deposit outflows and
public concerns about Continental Bank.
To properly assess the impact of a Continental Bank failure on
those banks with deposits in it or on the banking system generally,
far more information t h a n is contained in the two FDIC memoranda would be needed. At a minimum, the effect of deposit insurance,
asset sales, and deposit shifts after Continental's troubles became
well known, should be included.
To assist the subcommittee in its inquiry, the committee staff
has recomputed the information in the two FDIC staff memoranda,
this time to include the benefits of deposit insurance and asset
sales.
We have also requested the FDIC to provide information on the
level of deposits as of J u n e 30 for those banks with significant exposures in Continental.
The analysis, incorporating deposit insurance and asset sales, is
in the report in front of you and reflected in the charts along the
far wall.
The J u n e 30 deposit information will have to await an opportuity
to discuss it at a later date. It is simply not available this morning.
The FDIC staff memoranda focused on the amount of demand deposits, time deposits and Federal funds invested by individual
banks in Continental. The sum of these items is referred to as a
bank's exposure.



415
The FDIC staff found that there were 113 banks with exposures
in Continental amounting to between 50 and 100 percent of their
equity capital. They found that 66 banks had over 100 percent of
their equity capital exposed.
From these facts, it has been concluded by various agency officials, as Mr. Conover did 2 weeks ago, that if Continental had
failed, 66 banks would have had 100 percent of their capital wiped
out and another 113 would have had their equity capital significantly impaired. That is, if Continental Bank had failed, it would
have resulted in the failure of 179 banks with total assets of $17
billion.
For this conclusion to be true, one must assume that the banks
would not receive an insurance payment from the FDIC covering
the first $100,000 of their deposits in Continental, and that in the
subsequent liquidation of Continental Bank, there would be no recovery from the sale of Continental's assets.
Chairman ST GERMAIN. Excuse me, are you saying that according to the FDIC's data, the assumption was apparently made that
Continential's loans were valueless?
Mr. DUGGER. That is correct.
Chairman ST GERMAIN. SO you have to assume that out of all
those assets, there would be nothing coming from them?
Mr. DUGGER. Correct. Neither of these assumptions are true. And
what considerations are included in an impact analysis, the
number of banks that apparently would be seriously affected by
Continental failure decreases significantly.
Chris, could you bring the chart up, please? This chart and the
analysis in the staff report reflect an initial subtraction of $100,000
from the insured deposits to account for FDIC deposit insurance.
With this done, the number of banks with deposits exceeding 100
percent of capital drops to 65. The number of banks with deposits
between 50 and 100 percent drops to 101. The number of banks in
each of these categories, for various levels of recovery assumptions,
is portrayed in this chart and in the report.
You may find table 4 in the report particularly useful at this
point. The top line of numbers in table 4 in the report corresponding to a recovery assumption of zero is what the FDIC staff would
have obtained had they been asked to net out deposit insurance.
On this chart, this is reflected as the number of banks at the
zero recovery level, that is, at this point here, assumed percent of
recovery, zero, the number of banks is about 65 with greater than
100 percent of assets at risk; and between 50 and 100 percent of
assets, a number of 101 with deposit
Mr. VENTO. Mr. Chairman, did you research what the cost of
that would be? What would be the price to the FDIC insurance
fund for that particular insurance? Do we have that information?
Mr. DUGGER. I believe we will touch on that point in a moment.
Mr. VENTO. Thank you.
Mr. PATMAN. Could I ask a question at this point?
Chairman ST GERMAIN. Could we allow him to finish. Then we
will have questions and answers.
Mr. DUGGER. With deposit insurance taken care of, the question
becomes how much would the banks have received from the general liquidation of Continental Bank? This is a very difficult question



416
to answer. The only guide is the FDIC historical recovery rate from
liquidating institutions much smaller than Continental.
We have been told t h a t the FDIC historically has been able to
recover from 72 to 74 cents on the dollar. You should be aware t h a t
there are strong arguments justifying both higher and lower recovery levels in the case of Continental. Therefore, in the absence of
any other indicator, the subcommittee may wish to consider accepting a level of 70 percent, a level somewhat below this FDIC historical performance for the purpose of discussion today.
If this is done, the number of banks that would be seriously affected by a Continental failure is indicated in table 4 on the line
corresponding to the 70-percent recovery level, and in this chart, as
the point above the 70-percent recovery level, that would be right
about here, at this level.
In this context, assuming the banks in both groups, t h a t is
groups between 50 and 100 and those above 100 percent of capital
at risk, the number of banks with over 50 percent of capital at risk
would be 28; the volume of banking assets would be $1.47 billion, or
$1.5 billion. The amount of losses to those 28 banks would be $58
million.
This is a very different assessment of the impact of a Continental
Bank failure from the 179 banks with $17 billion in assets, and $1
billion in losses referred to by some agency officials.
Chairman S T GERMAIN. Does that answer your question, Bruce?
Mr. DUGGER. Before concluding, I would like to direct your attention to the two other aspects of the information staff developed
which bear directly on the seriousness of the impact on the depositing banks and on the time sensitivity of the information.
As you discussed on page 16 of the committee staff report, of the
179 banks with significant exposures in Continental, 58 had no uninsured deposits at all in Continental. This means that the exposure t h a t jeopardized the solvency of these banks was due entirely
to their Federal funds investment in Continental Bank.
Federal funds investments are uninsured overnight investments
made by banks in other banks. They are generally made only on
the basis of which bank is offering the highest overnight interest
rate and are not indicative of what is generally understood as a
correspondent banking relationship. Correspondent relationships
involve provision of check clearing, cash handling, loan funding,
and other banking services generally by a larger bank to smaller
banks.
A precipitous cutoff in a correspondent relationship could cause
a hardship on a smaller bank. Ending a Federal funds investing relationship would cause no such hardship to the investing bank. It
would simply invest its funds elsewhere. The amount of interest
sensitive deposit and Federal funds investments in Continental are
likely to have been sensitive to public concerns about t h a t bank
and, therefore, the level of these exposures may have declined in
May and June.
It was for this reason t h a t the FDIC was asked to gather information concerning the J u n e 30 level of exposure.
That completes our presentation of the staff report, Mr. Chairman. Gary and I will do our best to answer any questions you or
the other members of the subcommittee may have.



417
[The staff report entitled "Continental Illinois National Bank
Failure and Its Potential Impact on Correspondent Banks" follows:]




418

CONTINENTAL ILLINOIS N A T I O N A L BANK
F A I L U R E AND ITS
POTENTIAL IMPACT ON
CORRESPONDENT BANKS

STAFF REPORT
TO
SUBCOMMITTEE ON F I N A N C I A L INSTITUIONS SUPERVISION, REGULATION AND INSURANCE
COMMITTEE ON B A N K I N G , FINANCE AND URBAN AFFAIRS

October 4, 1984

This report is the result of staff findings to date and does not
necessarily r e f l e c t the views of the Members of the Subcommittee.




419
CONTENTS

Page
Executive Summary

1

Section
Statistical data on the number of banks,
total assets, and amount of loss for those
banks with an uninsured loss in excess of 50%
of capital and those banks with exposure to
CINB greater than $10 million with an
uninsured loss less than 50% of capital.

Recalculation of the effect of Continental
Illinois National Bank's failure on
correspondent banks.

Cost analysis used by FDIC to determine the
least costly method of assistance.
Appendix




14

19

Memoranda: Robert V. Shumway, Director
Division of Bank Supervision

420
Executive Summary

This report discusses the potential impact of the liquidation of Continental
Illinois National Bank on banks w i t h deposits and federal funds in Continental Bank.
The report is divided into three sections.
In the f i r s t section, we present (1) three charts which provide information on
the number of banks, t o t a l assets, and the amount of loss as related to various
percentages of recoveries f r o m that would have resulted from a possible
Continental Illinois National Bank liquidation for those banks with an uninsured loss
in excess of 50% of their equity c a p i t a l , (2) a table summarizing the data values
used to produce the 3 charts, (3) a series of tables providing information on banks
that had at least $10 million of funds invested in Continental Illinois Bank and a
percent of exposure to capital less than 50%.
The second section presents the Federal Deposit Insurance Corporation's
calculation and the Committee's recalculation of the potential impact that the
failure of Continental Illinois National Bank would have had on its "correspondent
banks."
The third section discusses the cost analysis that is normally used by the
Federal Deposit Insurance Corporation to determine the least costly method of
assistance.




421
Section 1

Statistical data on the number of banks, total assets, and amount of loss
for those banks with an uninsured loss in excess of 50% of capital

Statistical data on the number of banks with exposure to CINB greater
than $10 million with an uninsured loss less than 50% of capital.




2

422
TABLE 1
NUMBER OF BANKS WITH AN UNINSURED LOSS
IN EXCESS OF 53 PERCENT.OF CAPITAL
185180-

95-J
98 -1
85-j
88 H
75 H

49.5* TO 99. 4X

65 4,
60-j

55 A
50-J
40-4
35-J
30-1
25 H
20H
15

I

10H
5

GREATER THAN 99.4X

%

**v-m

I

3-4- T — i — \ — i — i — i — i — i — i — i — i — i — i — i — i — i
8

(0

20

30

40

50

60

78

88

y

T

98

. PERCENT OF RECOVERY

Note:

Ranges for points on the two lines were chosen to
prevent overlap. Banks with ratios between 49.5
percent and 49.9 percent were included in the 50
percent category. Also, banks with ratios between
99.5 percent and 99.9 percent were included in the
100 percent category.




3

188

423
TABLE 2

TOTAL ASSETS OF BANKS WITH AN UNINSURED LOSS
I N EXCESS OF 50 PERCENT OF CAPITAL
DOLLARS

1 <> CM O-m

MILLIONS 1 1 , 4 4 8 13,86818.2969.7249.1528.588T
0
T
A
L
A
S
S
E
T
S

8.8887.4366,864-

\

49.S% TO 99.4%

6.2925,7235,148-

V

\

4,576J

*

4,884-

^
k%

3,432-

\

V

2,868-

%K

*

2,288-

\
\
V

****

V

1,7161,144-

GREATER THAN 9 9 . 4 X V

X

5723-

—i—i—i—i—i—rr—i—i—i—i—i—i—i ^-irr^w '
i i " v 1Tr
J
< 18 2 8 3 8 4 3 5 0 6 0 7 0 8 0 9 0 1$*8
PERCENT OF RECOVERY

Note:




Ranges for points on the two lines were chosen to
prevent overlap. Banks with ratios between 49.5
percent and 49.9 percent were included in the 50
percent category. Also, banks with ratios between
99.5 percent and 99.9 percent were included in the
100 percent category.

4

424
TABLE 3
THE AMOUNT OF LOSS FOR BANKS WITH AN
UNINSURED LOSS IN EXCESS OF 53 PERCENT OF CAPIT;
567-

49.5* TO 99.4X

188
PERCENT OF RECOVERY

Note:




Ranges for points on the two lines were chosen to
prevent overlap. Banks with ratios between 49.5
percent and 49.9 percent were included in the 50
percent category. Also, banks with ratios between
99.5 percent and 99.9 percent were included in the
100 percent category.

5




TABLE 4

NUMBER OF BANKS. AMOUNT OF ASSETS. AND UNINSURED LOSS UNDER VARIOUS RECOVERY ASSUMPTIONS

NUMBER OF BANKS
PERCENT
GREATER
OF RECOVERY THAN 99.4%
0
5
10
15
20
25
30
35
40
45
50
55
60
65
70
75
80
85
90
95
100

65
60
54
49
45
40
38
30
27
19
14
11
9
9
6
3
2
0
0
0
0

BETWEEN
49.5% & 99.4%
101
99
90
85
83
78
68
61
56
55
51
45
36
29
22
11
7
6
2
0
0

AMOUNT OF ASSETS
(dollars in millions)
GREATER
THAN 99.4%
$4,792
4,170
3,546
3,046
2,716
2,281
2,021
1,612
1,460
1,024
796
513
465
465
385
240
119
0
0
0
0

BETWEEN
49.5% & 99.4%
$11,857
11,875
11,051
10,460
10,050
9,335
8,411
6,105
4,846
4,419
3,997
3,465
2,251
1,556
1,085
555
346
385
119
0
0

AMOUNT OF LOSS
(dollars in millions)
GREATER
BETWEEN
THAN 99.5% 49.5% & 99.4%
$473
401
343
293
254
204
178
137
116
82
63
38
31
27
18
10
2
0
0
0
0

$554
555
509
473
441
408
349
273
227
203
174
146
96
61
40
21
13
9
1
0
0

to

426
TABLE 5

LISTING OF CORRESPONDENT BANKS
WITH EXPOSURE TO CINB OF
GREATER THAN 50 MILLION AND
P ERCENT OF EXPOSURE TO CAPITAL LESS~THAN 50%
(In Thousands: of Dollars)
Bank
No.
1
2
3

*

5
6
7
8
9
10
11
12
13
14
15
16
17
IS
19
20
21

Assets

Demand
Deposit
Accounts

Time
Deposits

Federal
Funds
Sold

Exposure

Capital

S, 096,390
23,001,540
109,668,351
23,855,154
20,848,829
5,954,922
6,973,980
35,539,783
936,822
17,440,544
9,138,864
16,897,106
40,129,581
22,634,707
12,645,530
49,345,727
58,059,865
56,204,251
113,474,000
5,799,603
8,353,574

2,759
408
17,916
97,767
55,976
0
41
0
3,533
52
69
923
355
5,841
9,297
10,639
27,364
972
55Z
6,541
1,471

146
138,975
213,817
0
5,650
86,579
53,322
224,569
14,000
74,000
12,100
127,416
226,815
85,000
50,000
135,938
6,797
206,250
72,000
20,000
50,000

50,000
0
300,000
0
0
40,000
30,000
0
44,500
0
50,000
0
0
0
0
0
150,000
0
0
50,000
0

52,906
139,383
531,733
97,767
61,626
126,579
83,364
224,569
62,033
74,052
62,169
128,339
227,171
90,841
59,297
146,577
184,161
207,222
72,551
76,541
51,471

412,957
1,008,532
4,200,083
1,051,730
925,552
322,891
358,620
1,425,664
0
763,226
438,313
776,475
1,636,597
878,802
632,737
1,954,240
2,502,005
2,906,265
5,924,000
528,144
422,500

644,999,123

242,482

1,803.374

714,500

2,760,359

29,069,333




7

%of
Exp. to
Capital
13
14
13
9
7
39
23
16
0
10
14
17
14
10
9
8
7
7
1
14
12

427
TABLE 6

LISTING OF CORRESPONDENT BANKS
1
WITH EXPOSURE TO CINB OF
20 MILLION TO 49.9 MILLION AND
PERCENT OF EXPOSURE TO CAPITAL LESS THAN 50%
(In Thousands of Dollars;
Bank
No.
1
2
3
4
5
6
7
S
9
10
11
12
13
1*
15
16
17
13
19
20
21
22
23

Demand
Deposit
Accounts

Time
Deposits

Federal
Funds
Sold

Exposure

2,755,764
3,697,908
4,757,591
8,477,650
3,066,290
2,004,140
1,072,501
1,983,223
1,699,321
7,485,877
9,681,201
79,546,624
109,927
954,074
3,236,369
4,736,423
5,128,125
21,809,868
4,866,675
2,553,669
11,034,025
12,581,531
3,800.762

12,351
19
201
1
5,187
16,233
4,523
201
5
0
86
6,383
0
0
5,784
900
1,266
6,001
51
200
806
904
26

10,000
31,000
0
7,300
26,195
11,000
0
35,000
0
25,000
43,000
16,812
20,000
20,000
0
33,043
3,000
20,000
30,000
20,000
0
35,000
13,209

0
0
20,000
25,000
0
10,000
25,000
0
25,000
0
0
0
0
0
20,000
0
25,000
.0
0
0
25,000
0
10,000

22,351
31,019
20,201
32,301
31,382
37,233
29,523
35,201
25,005
25,000
43,086
23,195
20,000
20,000
25,784
33,943
29,266
26,001
30,051
20,200
25,806
35,904
25,235

105,318
217,050
207,275
438,220
174,839
112,882
72,770
117,031
102,740
498,067
904,847
3,662,570
0
53,615
125,080
218,338
331,543
930,407
220,810
132,316
331,902
529,659
193,728

197.039.548

61,128

_401,559

185,000

647,687

9,681,007

Assets




Capital

%of
Exp. to
Capital
21
14
10
7
IS
33
41
30
24
5
5
1

-

37
21
16
9
3
14
15
8
7
13




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