OCC’s lax oversight compounded costs of thrift failure, IG says
Supervisory lapses at the Office of the Comptroller of the Currency made a failed Chicago thrift’s hit to the Deposit Insurance Fund costlier than it should have been, according to a report by an internal government watchdog agency.
Regulators shuttered Washington Federal Bank for Savings on Dec. 15, and the resolution is now expected to cost the DIF about $82.6 million.
While the failure resulted from loan fraud by Washington Federal employees, including John Gembara, the bank's chairman, president and CEO, the Treasury Department’s Office of the Inspector General determined in a material-loss review that had examiners acted in a timelier manner, the fraud “may have been uncovered sooner and the loss to the DIF and individual account holders may have been reduced.”
The fraud depleted capital and led to the thrift’s insolvency, according to the Nov. 6 report. While there has been no criminal or civil judicial finding of fraud, the Treasury IG is still investigating the failure, the report said.
The report highlighted several weaknesses in the OCC’s exam process for Washington Federal.
First, the OCC’s supervisors did not provide enough oversight of inexperienced examination staff, according to the report.
Because Washington Federal was considered a noncomplex bank with a low risk profile, it was viewed as a “good place” to assign pre-commissioned examiners with limited exam experience, the report said. Five of the 11 examiners had one to three years of experience when they were assigned to the bank; some referred to Washington Federal as a “training” or “practice bank,” the report said.
Examiners missed red flags tied to the bank’s loan portfolio and, as a result, did not expand the core assessment minimum procedures quickly enough. Examiners also failed to identify and report unsafe or unsound practices that were contrary to the agency’s guidance and bank policy tied to appraisals, the report said.
Between 2011 and 2016, examiners did not review any of the external auditor’s work papers during their exams, the report said.
Under federal law, whenever a bank failure costs the DIF more than $50 million, the IG of the bank’s prudential regulator conducts an investigation. While an independent agency, the OCC technically is a bureau of the Treasury Department.
Toney Bland, the OCC’s senior deputy comptroller for midsize and community bank supervision, in an Oct. 22 letter to Jeffrey Dye, the IG’s director of banking audits, said the agency “generally performed examinations of Washington Federal in accordance with laws, regulations and guidance.”
Still, Bland said the OCC would reiterate guidance in several areas, including the supervision of non-commissioned examiners and the importance of thoroughly reviewing lower-risk activities at least once over a three-year period. The agency will reinforce guidance on the roles and responsibilities of supervisors and requirements tied to the importance of banks maintaining sufficient loan portfolio reporting for closed-end loans, Bland wrote.
The OCC will also reinforce its policy that examiners with limited experience use expanded procedures during exams, Bland wrote.
The IG’s postmortem revealed more details about what had seemed to be a mysterious failure. Before Washington Federal was closed, the $166 million-asset thrift had reported consistent profits, ample capital and a clean balance sheet.
Before 2017, the bank repeatedly reported past-due loans in call reports, only to claim during exams that the loans had been brought current, the report said. During a 2013 exam, the bank claimed that several loans selected by examiners for review had been paid off.
While the IG said that the bank was issued a “matter requiring attention” in 2016 tied to its management information system, no other problems appeared to have been flagged.
The bank’s collapse was sudden.
The report noted that the assistant deputy comptroller, who had recently assumed oversight of the bank, noticed several peculiarities at the beginning of the October 2017 examination. For instance, some loan-balance information provided by management came in a pdf format, which was not a customary practice.
When examiners requested information on nine loans during the exam, they were told that five of the loans had been paid off. Washington Federal then told the examiners that it was having difficulties obtaining information on the loans, leading the OCC to instruct Gembara that “examiners would not leave the bank until [it] provided the requested information.”
Also, several people were on vacation, including the chief financial officer and the designated loan officer, and Washington Federal’s compliance officer claimed that they lacked access to the loan compliance information.
Following a Nov. 28 meeting between OCC officials and board members, an unnamed member of Washington Federal’s management team, who was also a director, tipped the OCC off about “major fraud” at the bank.
While the report did not identify the employee, Gembara and Janice Weston, his sister and a senior vice president at Washington Federal, were the only bank employees serving on the board.
The manager disclosed that she had been informed by another employee that the employee and Gembara had been regularly falsifying loan payments for at least 29 loans totaling about $68 million — or nearly half of the bank's loans — and had falsified certain loan-balance information before giving it to examiners.
Specifically, the OCC learned that the bank had been reporting loans as being paid off when they were still outstanding. The report noted that the fraud may have been uncovered sooner if examiners had required validation to support claims of the payoffs.
That led examiners to immediately begin a review of those loans, confirming “fraud on a magnitude that jeopardized Washington Federal’s safety and soundness.” A day later, the OCC notified the bank in writing that it was in "troubled condition" due to the deficiencies.
On Dec. 3, Gembara was found dead at an associate's home. Becky Schlikerman, a spokeswoman with the Cook County Medical Examiner’s office, said at the time that it was suicide.
Two days later, the OCC again met with Washington Federal’s board, ordering the bank to recognize $39.4 million in loan losses, corresponding with the review of 13 loans. An interim report expressed a view that the losses had depleted capital, rendering the bank insolvent.
A deeper dive into the loans led the OCC to increase the estimated losses to at least $61.5 million, forcing the bank to recognize another $22.2 million in loan losses.
The bank was shut down about a week later, with certain assets and deposits sold to Royal Savings Bank in Chicago. At that time the failure was estimated to cost the DIF about $60.5 million.