As Community Bank Crumbled, Bank Regulator Snored

(MoneyWatch)  Ever enter a building and notice the security guard, feet propped up on his desk, having a snooze? That's the image you get reading this report on the collapse of Ocala National Bank by the Treasury Department's Inspector General.

Ocala National's failure is a case study in how lax financial regulation allowed a small bank to run itself into the ground. The Office of the Comptroller of the Currency shut the Florida community bank in January, and the FDIC helped arrange its sale to another local institution.

Ocala National was a disaster. As chronicled in Treasury's postmortem, over a couple years the company greatly increased its lending for residential real estate construction and land development projects. It also used a risky strategy known as "wholesale funding" to finance this growth. Underwriting standards were a joke, as was the bank's corporate governance. One family controlled Ocala National, which is what enabled the owner in 2004 to appoint his son, who had never run a bank, as CEO.

By 2007, with the value of Floridian real estate vaporizing, the company was in big trouble. That didn't stop Ocala National from paying dividends, even as it was losing money. It generously even shelled out roughly $1 million to a company partly owned by the bank owner's son and several boardmembers to repurchase some of the business's bad loans, while the bank's financial condition deteriorated.

Thing is, bank regulators had long known that Ocala National was a dud. From 2005 through 2008, OCC examiners repeatedly expressed their concerns to Ocala National execs about its poor credit underwriting and flaccid risk management. The OCC knew the bank's concentration of construction and land development loans had reached nearly 700 percent of total capital, when 100 percent is considered high. They knew most of these loans were for properties in parts of Florida where real estate prices were plunging. They knew that the bank didn't bother with trivialities such as verifying a borrower's income. And examiners knew that the company's bookkeepers failed to recognize most of its problem commercial real estate loans.

These warning signs were nothing new to the OCC. In 1997 and 1998, the agency took enforcement action against Ocala National over its poor management, uncontrolled loan growth and poor credit administration practices. For a decade, then, the OCC had known that Ocala National's management was dangerously out of control and that they treated risk like a pesky fly -- as something to be ignored.

The obvious question is why the OCC didn't do something. Part of the answer relates to an overarching weakness in financial regulation, which is that it tends to equate profitability with security: Ocala National made money. At least until it didn't, and by then it was too late. Despite the company's many problems, the OCC "took no forceful action" until 2008, said Donald Benson, audit director in the Treasury IG office, in the report.

Perversely, the OCC thinks its oversight of Ocala National was just fine. According to the report, an internal OCC review of its 2007 examination of the bank concluded that the agency's supervision was "satisfactory and effective." It's belaboring the obvious to note that had regulators had done their job, Ocala National might still be in business. Or at least if wouldn't have cost the FDIC nearly $100 million in taking the company into receivership.

On its own, the case of Ocala National is a minor episode. But it is part of a major narrative of regulatory neglect and ineptitude enabling what amounts to gross corporate recklessness. As we are learning, as banks plunge off a cliff, the costs of that neglect are exceedingly high.

Earlier this month, OCC head John Dugan testified before the Senate Banking Committee on the subject of financial reform. Dugan said he opposes the formation of a proposed Consumer Federal Protection Agency, which would assume responsibility for regulating banks.

"Our experience at the OCC," he said, "has been that effective, integrated safety and soundness and compliance supervision grows from the detailed, core knowledge that our examiners develop and maintain about each bank's organizational structure, culture, business lines, products, services, customer base, and level of risk. . . . An agency with a narrower focus, like that envisioned for the CFPA, would be less effective than a supervisor with a comprehensive grasp of the broader banking business."

Photo of sleeping guard courtesy of Flickr user Mrjoro.