Federal Deposit Insurance Corp. examiners knew as early as 1997 of problems at Pacific Thrift and Loan and had requested that the bank fix them by mid-1998, more than a year before California regulators closed the bank, according to information obtained by American Banker.

State regulators closed the $118 million-asset bank on Nov. 19. FDIC liquidation experts blamed much of the projected $50 million cleanup cost on the bank's interest-only residuals, which are assets retained after the sale of securitized mortgages. Regulators contend these assets were overvalued and have little if any resale value.

One document shows, however, that FDIC examiners knew about the bank's asset problems far earlier than agency officials initially acknowledged - and missed key chances to rein it in early.

Initially, in an interview last week, FDIC supervision chief James L. Sexton said the agency first became concerned about Pacific's residuals during an April 1998 examination. Those concerns were translated into a December 1998 cease-and-desist order, which gave the subprime lender until June 30, 1999, to reduce its quantity of residuals and to obtain an independent analysis of its method for valuing them.

But a review of an annual report filed by the bank's holding company, PacificAmerica Money Centers Inc., shows the FDIC knew about the residuals problem in March 1997, when it performed a special exam to review the assets.

Moreover, the annual report reveals, the FDIC's December 1998 order was not the first time the bank had been given an ultimatum.

A confidential FDIC memorandum of understanding issued in February 1998 required the bank to reduce its residuals and obtain an independent analysis by June 7, 1998 - more than a year before the deadline first revealed by the FDIC.

When pressed to explain why they had not mentioned these earlier actions, FDIC officials in Washington said they had spoken before receiving a full report from regional examiners. But they continued to defend their examiners' actions.

"Regrettably, we responded to you too quickly. We just didn't have all our ducks lined up," Mr. Sexton said in a subsequent interview. "I think our regulatory record looks good." He said FDIC examiners were in almost constant contact with the bank's officials about the residuals after the March 1997 exam.

But the June 7, 1998, deadline passed without being satisfied. Pacific had failed to reduce its residuals to the required level, which would have been no more than 100% of total capital. The bank's independent analysis also fell short of expectations. Though the accounting firm it hired, Ernst & Young, did perform an analysis, the firm refused to turn over its model or work papers to the FDIC, citing proprietary rights.

In the ensuing months, Mr. Sexton said, the FDIC continued to work with the bank. But when it became clear that Pacific would not comply with the memorandum of understanding, which is not enforceable, the agency issued a cease-and-desist order.

The deadline given the bank for meeting the very same supervisory requirements was June 30, 1999.

By that time, the bank's ratio of residuals to capital had deteriorated. Meanwhile, Ernst & Young had finally turned over its work papers, but the FDIC concluded the firm's approach was unsatisfactory.

Not until October 1999 - two and a half years after first discovering the problem with Pacific's residuals - did the FDIC impose its own valuation method on the bank. Instantly, the bank was undercapitalized.

Mr. Sexton defended the agency's decision to wait and try to work things out with Pacific. He said the agency wanted to try to reach a mutual understanding with the bank before adopting the harsher tones of a cease-and-desist order. The FDIC had issued several to the bank in prior years.

He also defended the agency's decision to seek a third-party opinion, rather than impose the agency's own valuation formula on the bank.

Our formula "could be wrong," he said. "We don't do that for a living, and there are people that do."

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