Mr. GREENEBAUM. The loss contingency. Mr. WORTHY. Of course, the resulting association will incur the losses which will be offset by our contribution.

Senator ALLOTT. Well, it does not mean anything if this is going to continue as a liability.

You put the cash in, but the cash is not a liability, so it does not mean anything.

Mr. WORTHY. Senator, what it amounts to in this particular case is that they got assets worth $44 million, we will say, and they got liabilities of about $51 million. So, had we not made a contribution, they would have actually been out $7 million.

As it worked out, we agreed to cover $6 million of those losses. They agreed themselves, out of the net worth of the stock association, to cover $1 million of the losses. So we are that $1 million better off because of their putting money into it and we are also better off from the standpoint that they will be able to dispose of these assets, we believe, at a more advantageous price than we would have had we set up a liguidation unit out there. You remove the stigma of liquidation, and you have disposal by a going concern.

Mr. HORNE. We are also better off in that, by settling it this way we avoid creating an additional bad image on the part of the public so far as the safety of associations is concerned.

I appreciate your concern, Senator Allott, but I want to emphasize that before we agree to a contribution, we carefully study and make certain at least in our own minds, insofar as we can, that this is the least expensive way we could possibly come out of the situation.

Senator ALLOTT. Well, I am sure that you do, Mr. Horne. I just think it is a situation that would probably have to be considered very carefully

Mr. HORNE. It is.

Senator ALLOTT (continuing). Before you get into this area, because it departs from the basic purpose of the Federal Savings and Loan Insurance Corporation.

TYPE OF INSTITUTION INVOLVED IN CONTRIBUTIONS

Mr. HORNE. Then there are two other things I am sure you keep in mind, because you know so much about this yourself: We are dealing here with two types of institutions. We are dealing with a mutual institution, which may be either a Federal or a State, and then we are dealing with a stock. Now, the only way you would help the stockholder when we are dealing with a stock owned association would be to make a contribution that would redound to the advantage of the stockholder himself.

This is something we try to avoid. We don't feel that under our contribution we are obligated at all to protect or to preserve him. This is a part of private enterprise, private industry, in which he himself has to take the risk.

Senator ELLENDER. What you are really doing is selling the assets of the corporation that is in trouble, more or less, at a discount, compared to what it might cost if you sold them at public auction or whatever procedure you followed to dispose of them.

Mr. HORNE. Yes.

Senator ELLENDER. You are selling the whole of it at a certain price, rather than selling it at bargain prices?

Mr. HORNE. It works out this way to a great degree, Senator, because by the remaining associations taking over what otherwise we would have to sell-what we would have to take over and liquidate on the market and set up our own operation to do so-by their taking the whole thing and then we make up the difference, say between an erroneous appraisal of $50 million that actually was worth $40 or so million, the corporation is much better off.

Somehow we have to make up this difference. So we enter into a standby agreement that if losses actually do occur, we make up the difference in the form of a contribution.

Senator ELLENDER. But you limit that loss to a certain amount? Mr. HORNE. Yes, sir.

Mr. WORTHY. Understand, we don't write them out a check. We say, "You dispose of the property and let us look over your shoulder while you are doing it, so we will know you get a good price for it, and whatever loss you incur, whatever is below the book value, we will pay a certain percentage of that loss. You will have to absorb a certain part of it yourself."

Senator ELLENDER. Is this done mostly in mergers?

Mr. HORNE. Yes.

Senator ELLENDER. In other words, you wouldn't furnish any money to a concern that was in trouble, merely to keep it afloat?

Mr. HORNE. Well, under the law we could do that, and here again, in taking that route, we would again have to weigh as to which was the less expensive to the Insurance Corporation.

Senator ELLENDER. Well, if you pursue that course, do you change the management?

Mr. HORNE. We may.

Senator ELLENDER. You have a better control?

Mr. HORNE. In the case of a stock association, before we could do that, we would make certain that we were repaid before the stockholders had any value passed to them for the stock they owned. Senator ELLENDER. That is fine. I just wanted to get that.

FACTORS AFFECTING MERGER CONSIDERATION

Senator ALLOTT. Then in the specific case that we were discussing, one of the determinative factors would be perhaps that you could not get a merger or arrange a merger without the contribution?

Mr. WORTHY. That is right.

Senator ALLOTT. It just would not exist?

Mr. HORNE. That is right.

Senator ALLOTT. As a purchaser, I would not be interested in it with this $6 million loss.

Mr. HORNE. No.

Senator ALLOTT. And by doing this then, you make it possible for a merger, or you make it possible to get new management, or you make it possible to perhaps get better management and to avoid the losses.

How about recouping against management? Does this factor ever come into it?

Mr. SCOTT. There are situations in which the Corporation has paid out on a liquidation or what have you, in which there are causes of action against the prior management which you can successfully pursue. We do so if it does not appear that the people involved are judgment proof.

Mr. TREVAS. We also had a situation several years ago where there was a loss involved in Virginia where our legal department was able to trace the funds that had been improperly removed from the association, and this reduced the ultimate loss to the Insurance Corporation considerably. In other words, we always have the obligation, if we sustain any loss, to do whatever we can to recoup.

In fact, in any particular case, determination is always made as to which would be the most effective way of handling it, at the lowest cost to the Insurance Corporation, to put it in the best liquid position.

And any one of these methods, loans, contributions, purchase of assets, or paying out insurance, is always determined by a choice that this is the best method we can arrange under the circumstances.

We are always obligated by law to pay up to $10,000 on each savings account. That is something we don't seek to avoid, nor could we avoid. The question is, what is the best course to accomplish the desired result to protect the saver at the least cost to the Insurance Corporation? Any one of these techniques may be applicable in one case, or some other in another case.

Senator ALLOTT. I was not aware of the contribution factor in this savings and loan insurance and I appreciate this explanation.

Senator ELLENDER. Let me ask you this: When you say you go against the management, usually there has been a little rascality. Mr. TREVAS. In the kind of a case, where there has been some rascality, and we can establish it as a legal matter, we would follow the appropriate route.

Senator ELLENDER. Fine. Proceed.

PURCHASE OF ASSETS BY CORPORATION

Mr. HORNE. There were as of June 30, 1965, 10 active cases, in which the Corporation had taken action to prevent default by purchasing all or a part of the assets of the problem institution involved. Two of these resulted in continuation under the same management; six involved either mergers with or bulk sales of assets to other insured institutions; two resulted in voluntary liquidation. At the end of fiscal 1964, the Corporation was handling six such cases, and during fiscal 1965, four new cases resulted in additional purchase of assets equaling approximately $15 million.

In addition to these 10 purchases of assets cases, an additional purchase of $38 million of assets was made in fiscal 1966. We now have approximately $151 million of assets based on book value, which we carry on our balance sheet at approximately $109 million. The difference of $42 million represents allowance for estimated losses. These assets principally consist of mortgages, mortgages in foreclosure, real estate contracts, real estate in judgment and real estate owned. We are endeavoring to dispose of these assets as quickly as possible but in an orderly manner. In the first half of fiscal year 1966 we converted approximately $12 million of such assets into cash.

63-054-66-pt. 2-11

We expect this conversion to liquid form to accelerate in the future. We place real estate on the market just as quickly as the market can absorb these properties, and we have instituted a guarantee plan for the sale of mortgages. We have disposed of approximately $8.5 million in mortgages under this plan.

MERGERS OF ASSOCIATIONS

Another technique to prevent an insured institution from going into default is to facilitate a merger by having the Insurance Corporation agree to make contributions to cover losses suffered by the merged association in disposing of assets acquired from the disappearing association. We have done this in the current fiscal year with two institutions having $75 million of assets.

While these two contribution agreements pose a maximum liability of $16.5 million, our estimate of actual losses to the Corporation is under $6 million. This type of settlement is preferred by the Board where possible because it involves no immediate disbursements, and we do not have to employ personnel in the field for asset management and disposal.

PAYMENT OF INSURANCE

We have also paid insurance of approximately $85 million upon the appointment of a receiver by the Illinois savings and loan commissioner for a $109 million, State-chartered stock savings and loan association. This payment represents 98 percent of the share capital. A loss of approximately $19.6 million is estimated as a result of this default. This was the first receivership we have had in 24 years.

CAUSES OF DIFFICULTIES

The question may properly be asked, What causes some associations to get into difficulties of a nature that cause the FSLIC to make disbursements? There is no pat answer that covers all situations, but there are some common factors or prevailing characteristics which seem to be present in most of these cases. One common factor is the practice of making loans in excess of the market value of the security property or without a proper evaluation of the risk factors inherent in speculative situations.

This gets back, Mr. Chairman, to a question you were asking a moment ago, when sometimes they pay a high amount for savings, then they have got to require a high rate of interest on loans.

Another characteristic in many of the problem cases is the rapid growth in savings capital solicited at dividend rates in excess of the rates in the area, or solicited by brokers for a fee paid by the association or by builders to whom loans are granted. Savings received in that manner must be invested promptly and at high interest rates and loan fees, or may be invested intentionally in loans of dubious merit because of the benefit they bring to insiders whose primary interest is their own enrichment and not the welfare of the association.

DETECTION OF UNSAFE PRACTICES

Early detection of deviations from safe and sound lending is difficult to achieve, because we learn of such lending after the transaction has

been completed and the loan proceeds have been disbursed. Monitoring of the growth of savings capital through monthly reports, and of radio and press advertising, may furnish a clue to incipient problem

cases.

An examination of the institution's affairs with independent test appraisals, if deemed necessary, also provides the means for detecting failure of the association to adhere to principles of accepted operating standards and financial soundness, and establishes the factual basis for requesting appropriate corrective action in policies and practices.

The examiner's review of the institution's operating policies and an evaluation of its assets require him to check designated circumstances and facts which on the basis of past experience can point to danger signals.

Persuasion based on facts, and education based on a background of nationwide experience of what constitutes acceptable standards in the industry are among the Board's principal supervisory tools. These are effective when dealing with a responsible group of directors and officers, amenable to suggestion. These tools are not effective for a group whose prime consideration is personal enrichment.

CHANGES IN SUPERVISORY PROCEDURES

Recent changes in examination and supervisory procedures would be helpful. For example, the examiner now custom fits his examination according to the situation he encounters and confines his attention to matters of fundamental importance. Under the Board's policy of decentralization the supervisory agent has primary responsibility in his district for prompt and effective supervision. The Board has also established procedures to provide more assistance to the supervisory agent through consultation and guidance, to minimize delays. More than this, though, is needed. And thus the Board is supporting legislation which could give it more effective tools.

TESTIMONY BEFORE SENATE BANKING AND CURRENCY COMMITTEE

On April 4, 1966, I testified in support of S. 3158, a bill which would permit the Board to issue cease-and-desist orders for violations of law and regulations or for unsafe and unsound practices and, in appropriate cases, to order the suspension or removal of officers or directors. This authority would furnish the Board with an alternative to the more drastic remedy presently available, the takeover of a Federal institution or the termination of insurance.

Senator ALLOTT. Now, at this point, I have not seen this particular bill. Where is it, do you know?

Mr. HORNE. It is still before the Senate Banking and Currency Committee, and I think the hearings on it will be completed this week. Senator ALLOTT. Suppose you have a situation in which an officer or officers of an institution disagree with the Board as to the efficiency of the action they are taking in a given situation. This would, in effect, give you the authority to suspend such officers or directors pending the ascertainment or the curing of the situation which you think is not right. It seems to me that such authority is a rather dangerous one, in that, by the time the matter is determined, you could