Questionable lending practices have come to light as the collapse of Penn Square Bank NA here continues to reverberate throughout the banking industry.
Penn Square appears to have played a kind of musical loans or "shell game" with its loan participations, exchanging questionable credits for others that were supposedly better, informed sources confirmed for American Banker.
Larger correspondents, which included Seafirst, Continental Illinois, Chase Manhattan, and Northern Trust, would at various points become nervous with certain shaky credits, sometimes following a quarterly default, and ask to be bought out, sources here say. Upstream correspondent banks bought more than $2 billion in these participations.
The sources contend that Penn Square, sometimes pleading that its loan-to-deposit ratio was too high and that it was experiencing liquidity problems, would then implore an upstream bank to hold the loan with the promise of getting the bank into another "blue chip" deal. Or, say sources, Penn Square would assure the other bank that Penn Square would buy the credit back at some point in the future, or in fact purchase the participation of yet another upstream bank.
These sources add that they did not know the extent of this practice, only that it in fact took place.
The involved upstream banks declined to comment about these alleged practices.
These sources further assert that the upstream correspondents would sometimes become so swamped with Penn Square credits, they would ask the bank's lending officers, and even secretaries, to fly to their institutions and help them do their loan writeups in their own formats.
Loans were extended by Penn Square and the larger banks, these sources say, often before adequate documentation and current financial statements became available.
Sometimes these trips would involve stopovers in Las Vegas.
How Hanover Avoided Involvement
One money-center institution, Manufacturers Hanover Trust Co., was spared involvement with Penn Square because of an incident that took place at a gathering of bankers and oil men at the Cowboy's, a local country and western club. This story was confirmed by several eyewitnesses.
A senior calling officer at Manufacturers Hanover observed Bill G. Patterson, Penn Square's 35-year old senior executive vice president in charge of the oil and gas division, drinking what appeared to be liquor out of his shoes. The MHT officer turned to another guest and remarked, "There's no way we'll ever do business with this guy." Mr. Patterson could not be reached for comment.
Mr. Patterson was suspended last week before the failure.
The $460 million-deposit bank was closed Monday because of losses on its energy-related loans and funding difficulties.
Oklahoma state bank commissioner Robert Y. Empie said yesterday in an interview that as much as $250 million of Penn Square deposits were brokered certificates of deposit in denominations of $100,000, $500,000, and $1 million sold for a fee to Penn Square Bank by a Hillsdale, Calif., funds broker on behalf of California thrift institutions and credit unions.
Penn Square typically paid a higher-than-market rate on these funds, he said.
Mr. Empie called the shift of such deposits from California institutions to Penn Square an "unnatural event." He envisioned the possibility that federal legislation might be enacted from this episode to block the sale of deposits for a fee.
Mr. Empie also said that a large number of Oklahoma thrifts and credit unions held an indeterminate amount of funds in deposits at Penn Square. Some of these funds are uninsured.
Fed to Lend Certificate Holders
These institutions would be treated like any other individuals or entities in that they will receive from the FDIC a receiver's certificate for 80% of the face value. He pointed out that the Federal Reserve has agreed to lend to any holder of a receiver's certificate — be they individuals, businesses, institutions, or otherwise — 90% of this discounted value or 72% of the full value.
Five state-chartered Oklahoma country banks, Mr. Empie said, are now known to be "in difficulty" as a result of buying downstream loan participations from Penn Square or because of other dealings with the defunct bank.
He confirmed that one of those was the Bank of Healdton, Okla., whose chairman is the 85-year old mother of Penn Square chairman Bill P. Jennings. Mr. Empie said that state examiners have been there for almost two weeks.
In April, Mr. Jennings told American Banker that about 30 Oklahoma country banks held some $125 million in downstream participations. At that time, he said total outstanding participations was more than $2 billion.
Mr. Empie noted that he had learned that national bank examiners had only reviewed one-quarter to one-half of Penn Square's portfolio when they threw up their hands and determined last weekend that the institution was no longer viable.
By that point, chargeoffs had reached $40 million to $50 million, wiping out the bank's capital. Mr. Empie also said that negligence on the part of the bank's directors and the lack of communication between federal banking agencies and between the Comptroller and state agencies allowed a bad situtation to linger longer than it should have.
SEC Probe
In another development, the Securities and Exchange Commission has launched a probe of alleged securities fraud involving Longhorn Oil & Gas Co. drilling funds, backed by Penn Square standby letters of credit, according to Ray N. Erlach, an attorney with the San Francisco law firm of Hunt, Gram & Epstein.
Mr. Erlach's firm is representing three groups of 19 investors who, days before the collapse of the Oklahoma City institution, obtained preliminary injunctions blocking Penn Square from demanding payment on letters of credit issued by the investors' local institutions.
"The SEC has asked me to cooperate with the investigation of the individuals involved, and I have agreed," Mr. Erlach said.
The suit, filed in California court, named Penn Square and Longhorn Oil & Gas, whose principal owner is Carl Swan, a major Penn Square customer, stockholder, and director. Courts in at least six states have enjoined issuing banks from paying on letters of credit about to be called by Penn Square, according to briefs filed in May in California Superior Court by Mr. Erlach.
There are unconfirmed reports now circulating in New York, Washington, and Oklahoma City that certain parties close to Penn Square may have pulled large deposits from the bank, one account as large as $30 million, last Friday when they learned that FDIC examiners had been dispatched to Oklahoma City. Attempts to contact the individuals mentioned in connection with these transactions have been unsuccessful.
A significant number of credit unions had deposits with Penn Square Bank, and regulators of credit unions have already begun to act deal with the situation.
The National Credit Union Administration board at an open meeting this week in Chicago approved an additional share insurance premium of one-eighteenth of 1% to increase the size of its fund.
The board noted that the increase was due, in part, to the failure of Penn Square. It has been estimated that credit unions had more than $100 million — perhaps as much as $121 million — in uninsured deposits with the failed bank.
The Federal Deposit Insurance Corp. has said it will not guarantee a 100% payback to uninsured depositors of Penn Square.
Sources said the NCUA board originally had planned just to discuss the possibility of an increase, but they added that the exposure of credit unions prompted quick action.
There have been conflicting reports about the number of credit unions with deposits at Penn Square Bank.
Edgar Callahan, chairman of the NCUA, said in a statement in Chicago that as many as 150 credit unions were involved, but other industry sources estimated that the number was closer to 120.
Some sources have said that the credit unions, although hard hit, will be able to withstand the losses. Others, however, have noted that it is too early to make such a statement.
Mr. Callahan in his statement said that although a number of credit unions have been seriously affected, Penn Square's closing has not resulted in a single credit union insolvency.
However, there are some reports that not only individual credit unions but some corporate central credit unions may be affected by the Oklahoma bank failure.
A corporate central is, in effect, a credit union's credit union where a credit union may borrow money or invest its excess funds. There are 43 corporate centrals in the United States.
One source said that a few corporate centrals — less than six — had uninsured deposits with Penn Square and that perhaps two of them "are going to get hurt."
He said that "chasing" the highest rate is as common with credit unions as it is with other financial institutions. The practice can be dangerous, he added, if an institution devotes too much money to it.
The two corporate centrals may have gotten too heavily involved in "chasing the rate."
An industry representative said Wednesday that it is going to be some time before the total impact of the Penn Square failure on credit unions is known.
"No one seems to know at this point how these uninsured deposits were spread out among the credit unions involved or what kind of reserves they had," he said. "No one seems to know what the numbers are."
Credit union sources have said that Professional Asset Management of Delmar, Calif., arranged many of the credit union investments with Penn Square.
William Goldsmith, executive vice president of that company, said in an interview Thursday that he could not confirm those reports but acknowledged that the company invested on behalf of some of the credit unions.
"I am not aware of the names of the credit unions referred to by the NCUA," he said. "If I could see that list, I would be able to say how many we worked with."
He added that Professional Assets has worked with about 1,000 credit unions.
"We see the role we play as one of an information system for potential investors that have not the time or perhaps expertise to do an in-depth analysis of its own to make an investment," Mr. Goldsmith said.
In the case of Penn Square investments, Mr. Goldsmith said he relied, in part, on the certified accounting report by Peat Marwick & Mitchell which, he said, gave Penn Square a "complete bill of health."
Another source close to the issue said the same thing about a financial statement certified by Peat Marwick.
Mr. Goldsmith said his company also, as standard practice, does a five-year trend analysis based on annual reports before recommending investments, and that such an analysis was done concerning Penn Square.
He said information that the bank had been on the Comptroller's supervisory list for two years was not available to him.
"If you can't depend on information from a certified audit, who can you rely on?" Mr. Goldsmith said.
There have also been reports that 20 savings and loan associations had uninsured deposits with Penn Square.
The Federal Home Loan Bank Board refused to comment on the issue. The Comptroller of the Currency also refused to disclose how many institutions had invested in jumbo certificates.
In another development, Michigan National Corp., which is holding $190 million in Penn Square energy loan participations, said it was less pessimistic about the quality of the loans than it was earlier in the week. The change in attitude followed discussions with approximately one-third of the debtors involved.
Of the borrowers contacted, a spokesman for Michigan National said that all of them "were paying and intended to pay" on the loans. Some had been "slow" in repaying, the spokesman said, but noted that this was not unusual in light of the general slowdown in the energy business.
Michigan National has been unwilling to make any predictions on potential losses due to the Penn Square portfolio, saying it has insufficient information. "We certainly will add to our reserve," for any possible losses that are detected, the spokesman said.
According to sources close to the bank, Michigan National had its own geologists review the engineering reports that accompanied the Penn Square deals, and the amounts lent were "less than 50% of the reserves as represented."
According to a knowledgeable source, another potential problem that could arise in the Penn Square workout generally involves the $190 million in uninsured deposits at the failed bank. Some portion of this total apparently represents compensating balances that had been placed with the bank by energy borrowers, and some of it may have been slated for loan repayment.
These balances have been, in effect, frozen by the FDIC, a situation that could exacerbate any liquidity problems the borrowers are already experiencing. The uninsured deposits have been given "general unsecured creditor status," which would appear to make any setoff of the deposits against the loans difficult.
In a further development, some money market analysts suggested the Federal Reserve may be responding to the Penn Square failure by its offering last Thursday of overnight repurchase agreements for its own account. This action fueled market talk of a more accommodative monetary policy.
Chengiz Israfil, an analyst with Morgan Guaranty Trust Co., said the Fed's recent open-market activity may be aimed at calming market psychology because of the Penn Square failure. When the Fed offered system account repos last Thursday, it probably knew of the impending failure, he said.
