MICHAEL PATRIARCA : Fraud Called a ‘Significant’ Factor in S&L; Failures

For much of the last three years, executives at savings institutions have complained--both publicly and privately--about the federal regulatory agency that examines their books and sometimes restricts their activities.

Demonstrating that the bureaucracy is not immune to change, the Federal Home Loan Bank Board and its 12 district banks have streamlined operations and changed the way they review the nation’s savings and loans.

A number of S&L; executives have said they like the new changes.

Executives and regulators alike said the bank board and the district banks have instilled a greater sense of professionalism in their staffs. One major reason for the new attitude has been the emergence of former banking regulators--primarily from the Office of the Comptroller of the Currency--as top S&L; regulators.

Michael Patriarca, 37, is one of those former banking regulators who controls regulatory functions for the Federal Home Loan Bank in San Francisco, the district bank that supervises savings institutions in California, Arizona and Hawaii.

Patriarca joined the comptroller’s office in 1976, shortly after graduating magna cum laude from the University of Santa Clara College of Law. He rose through the ranks to become deputy comptroller for multinational banking, a job that put him in charge of supervising the country’s largest national banks, such as Bank of America and Citibank.

He switched to the district bank in San Francisco in August, 1986, and soon began planning the restructuring of the district bank’s regulatory functions, aligning them more like an S&L; than a regulatory agency.

He merged two key divisions--supervisors and examiners--into one because they often had ignored each other’s concerns in telling S&Ls; what problems they found on the books. And he divided S&Ls; into three categories for review purposes--about 20 of the largest and more innovative ones are in one group. About 160 of the smaller, non-problem S&Ls; are in another group. The third group is composed of some 50 troubled S&Ls;, including those that have failed but are being operated by the Federal Savings and Loan Insurance Corp., an arm of the bank board. About 45 California savings institutions, including 10 failed Orange County S&Ls;, are in the third group.

Q. So far this year, 10 savings and loans in California, half of them in Orange County, have been seized by regulators. Why are so many still failing?

A. Well, an institution doesn’t do a bad deal and then have the effects show up immediately on its income and its capital. Depending on the nature of the activities, it can take years for deals that would be uneconomic or fraudulent or just plain stupid to result in damage, especially in damage that prompts the regulators to close the institution and take it over. So there are still a number of institutions this year that have failed, for the most part, for reasons that date back to inappropriate activities in previous times.

Q. Has there been an evolution in the causes of S&L; failures since 1982, when financial institutions were deregulated?

A. We looked earlier this year at the institutions that have failed and concluded that the causes of the failures were nothing particularly surprising--poor management decisions, management entering into areas beyond its expertise, inadequate supervision by directors, inadequate policies and procedures for doing the lines of business that they were doing, and inadequate capital to absorb losses when they were encountered. It’s a pretty common way most institutions have gone down the tubes.

Unfortunately, there’s another common element that’s in there as well, and that’s fraud. There are any number of grand juries investigating activities that went on in S&Ls;, and regulators have initiated lawsuits in many of the cases.

Q. In the last three years, regulators have seized 10 Orange County-based S&Ls; and publicly imposed orders on two more. FSLIC has sued former directors and officers at seven of 12 S&Ls;, and the FBI has opened bank fraud and embezzlement investigations on 10 of them. Has civil or criminal fraud become more prevalent in S&L; failures?

A. In the last several years, fraud has been a significant factor in more than a few failures. As a matter of fact, we’ve been doing what we can to assist the FBI and the U.S. Attorney’s office in the prosecution of some of the frauds that have been discovered and that have led to the eventual demise of some of these institutions. The principal problem is that those agencies don’t have enough resources to bring all the prosecutions that are warranted.

Q. Has the cooperation between the regulators and criminal authorities improved since a House subcommittee hearing in Los Angeles last spring first revealed the lack of communication and cooperation between the two groups?

A. I think things have improved significantly in terms of the attention being devoted by both sides, both the regulators and the prosecutors. But the results will depend in large part, I think, on the ability of the prosecutors to get more resources.

Q. A number of former executives at failed savings and loans--such as those who ran American Diversified, Consolidated or Butterfield--have claimed that regulators involved themselves so much in the day-to-day operations that they became the businessmen running the shops. If that’s true, is that a proper role for a regulatory agency?

A. Well, let me say that I think it’s not true, and it’s not a proper role for a regulatory agency. It is not our desire to make management decisions for institutions. That’s what boards of directors are responsible for--for hiring management that’s competent to do it. I don’t want regulators to put themselves in, either de facto or otherwise, as management. It’s not our role. Our role is to see that the institution is adequately managed and, if not, to see that corrective measures are taken. But the regulators are never the management.

Q. But typical supervisory orders sent to troubled institutions often limit the ability of those S&Ls; to engage in some activities--such as making loans over certain amounts without approval from regulators. Does that approval process--which is often criticized as so slow that it kills money-making deals--put you in charge of day-to-day business decisions?

A. We issue orders and directives, which limit operations, only on an interim and temporary basis--until a problem that we’ve discovered is fixed. If we find an institution that is making major construction loans and it doesn’t have the management, policies or controls necessary to run that business competently, we say, “Wait a minute. Hold everything. Don’t do any more of this until you get these areas fixed. When you get them fixed, then we lift the restriction.� The fact that we put those restrictions in our directives is simply a safety valve.

It’s not intended that the institution will continue to operate by sending in requests for us to approve deal after deal in the normal course of business. We’re not going to approve any deals except those extraordinary ones where the institution absolutely has to do it or else suffer serious consequences. We don’t want to be in the deal-approval business. We want them to clean up their act and get back in the business of approving their own deals. But they have to be in a position to do that prudently.

Q. Former executives uniformly say that they were the objects of unfair reappraisals by regulators and that the reduced value of their real estate assets wiped out whatever net worth their institutions had and put them deeper in the hole. Have regulators relied as heavily on reappraisals as they may once have?

A. It’s hard for me to give the historical perspective that the question calls for in view of my fairly short tenure. I can tell you that in the real estate business, appraisals have an appropriate role. But we don’t look at the appraisal as the only factor that needs to be taken into account. You also need to look at the ability of the borrower to service the debt. That requires some credit analysis of the borrower. If the collateral is the only source of repayment for the loan, however, then the appraisal becomes a very, very important means--if not the exclusive thing--to look at in valuing the loan.

Q. Some examiners and supervisors have earned derogatory nicknames in the industry because of their rude and arrogant behavior in dealing with troubled institutions. What is being done to alleviate the problem?

A. Whenever there are complaints about the appropriateness of behavior on the part of examiners or others, those complaints are taken seriously. We do not simply adopt the mind-set that if they’re in our employ, they’re always right. One of the things that’s we did when we reorganized--something novel for the regulation business--is we created an internal auditor for the agency side. He reports directly to me. When a complaint arises about behavior, I ask the internal auditor to do an investigation. The auditor has visited institutions and people who are making complaints publicly, as well as privately, to ascertain whether there is any basis for the complaint. I am very interested in those reports. And when there is a legitimate complaint of inappropriate behavior, I can promise that it’ll be dealt with by me.

Q. Have any examiners or supervisors been removed or transferred to other positions because of their possible clashes with those they examine?

A. Oh, let me not answer that. The answer just puts me in a very awkward position.

Q: How has the bank board changed its approach to regulating S&Ls;?

A: What we’re doing is assessing each individual institution’s strengths and weaknesses to form our supervisory judgment on the basis of the circumstances present in each case. We’ve developed a supervisory profile--a risk profile, if you will--for each institution in the district. We identify on paper what our areas of supervisory concern are, and then create an action plan for what we’re going to do to try to address those concerns. And an action plan can include a whole variety of things. Whether it be an examination into whatever it is that is the cause of concern, whether it includes having a meeting with the board of directors, requiring an outside audit by a CPA firm or anything else in the regulatory arsenal.

But our activities are prompted by what we perceive as the risks. Instead of approaching each institution and doing the same thing, we’re identifying where we ought to put our resources by where we perceive the risk.

Q. Do you normally let the institutions know what you think their particular risks are?

A. That’s another kind of overused concept that we’re trying to get employed. That is, we expect that our supervisory agents will have effective and ongoing communications with the institutions and their caseload. And I don’t mean by that simply that we write a supervisory letter to them when we finish an examination. I want the institutions to know what our concerns are and to know that if we’re wrong, they should convince us that we’re wrong. I’d like to be convinced by institutions that where we thought there were risks really aren’t.

But, while we won’t give out the supervisory strategy or risk profile to an institution--simply because they’re written in a very candid fashion and I don’t want the staff constrained in writing these things--I do want communicated to the institution what our concerns are. And if we don’t do that, then we can’t really expect the institutions to be fixing what the problem is. So, effective communications to the institution does include telling them what we see as problems and either having them convince us that they’re not or tell us how they’re going about fixing it.

Q. Bank board officials have predicted the sale or closings next year of at least 52 of the failed S&Ls; that the bank board has kept open and operating with hired managers. What can those institutions being run by regulators in California and Orange County expect?

A. My guess is that in next year, we’ll probably see six to eight resolutions--through sales or disposals--of institutions that already have failed in California. It will depend more than anything else on what the most cost-effective solution is. It will be decided by which institutions are costing the most to keep open, coupled with what what proposals we have for the disposal of them.

Q. Is there an end in sight to the rash of failed and troubled S&Ls;?

A. I think the answer is yes. We still have a number of institutions that have problems. We have probably 25 institutions that we’re working with intensely to try to help them get back on their feet. You know we may not be successful, and they may not be successful and some of those may fail. I hope that the vast majority of them return to health.

I think the difference is that, around here, there is a much greater feeling that we’ve identified the problems, and we’re working with them than was the case a couple of years ago. I also think that the number of problems is probably less than it was a couple of years ago. That has to do more with working through the problems and the continued benign economy than it does with any change in the regulators.