Currency contributed to a $36.6 million Bank Insurance Fund loss, according to a recent Treasury report. Mechanics National Bank, Paramount, Calif., which failed in 1994, was plagued by poor management and a lack of effective internal controls as early as 1988, according to Treasury's inspector general. However, examiners with the Comptroller's office did not pick up on the bank's problems until 1991, when its portfolio was awash with bad real estate and Small Business Administration loans, said the report, obtained by American Banker under the Freedom of Information Act. "OCC did not fully identify or address the bank's management and lending problems until the bank had already established a base of problem loans," said Treasury Inspector General Valerie Lau, in a Sept. 29 memo to Comptroller Eugene A. Ludwig. "Had OCC identified these management and lending problems earlier, OCC may have initiated enforcement actions sooner," she added. Swift enforcement actions could have lessened the estimated $36.6 million in losses to the Bank Insurance Fund resulting from Mechanics' failure, the report said. Bank records and Comptroller's documents showed that examiners could have recognized as early as 1989 that Mechanics' management "aggressively pursued asset growth" without managing the risks involved, the report said. The bank's assets nearly doubled from $138 million in 1988 to $261 million in 1991. Forty percent of the bank's loan portfolio in 1991 consisted of real estate construction loans, many of which went into default when the California economy turned sour in 1990. "The 1989 and 1990 examinations ... were not in sufficient depth to detect and correct the bank's unsafe management and lending practices," the report said. The Comptroller's office did take an enforcement action against the bank in the early '80s, but the report said it didn't change Mechanic's unsafe practices. In 1983, the agency slapped a cease and desist order on the bank, insisting that it correct its loan approval methods. During a limited-scope exam in June 1988, the Comptroller's office found that Mechanics was in substantial compliance, and dropped the order. However, in 1991 - when the agency conducted its first full-scope examination of the bank since 1988 - examiners found that its poor underwriting standards continued after the 1983 cease and desist order was lifted. Indeed, more than $9 million of the bank's $27.7 million in problem loans were originated in 1988, the Treasury said. "These deficiencies would have been evident before 1991 had full-scope examinations been conducted earlier," the report said. Karen Shaw Petrou, president of ISD/Shaw Inc., said the issues raised by the report are still relevant now, especially in light of Daiwa Bank's recent $1.1 billion trading loss, which was hidden from regulators for 11 years. "While Daiwa is a far more significant event, the questions still exist: What ought bank supervision be expected to catch, and are enforcement actions sufficient?" Ms. Petrou said. The report did not go so far as to recommend any changes in the way the Comptroller's office supervises banks. Instead, it said that bank laws enacted in 1989 and 1991, as well as changes in the agency's policies, have "done much to address the ... weaknesses in OCC's supervisory practices." "Since the onset of the Mechanics problem, regulators have gotten a lot more authority, which has had a deterrent effect," said Susan Krause, senior deputy comptroller for bank supervision policy. "There is a lot more incentive for a bank to stay clear of enforcement problems."

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