In summary, we believe that the Bank is at a crossroads in its history. As we have pointed out, the Bank cannot now demonstrate that it will be capable of developing the size and quality portfolio needed to allow it to mature into a viable organization. However, this situation should be tempered by the fact that the Bank has only been operational for a little over 3 years and may not have had the time needed to demonstrate an ability to develop the cooperative community as envisioned by its enabling legislation. Also, the Bank has had to adjust to the loss of financial support from the Federal Government, and has had to contend with much turmoil resulting from changes made within its organization. In addition, the Bank is in the process of establishing the separate corporation provided for by the 1981 amendments to carry out Title II activities and only time will tell how effective this organization will be in carrying out its responsibilities and in obtaining the necessary funds to do so.

Mr. Chairman this concludes my statement. We will be pleased to respond to your questions.

Chairman ST GERMAIN. At this point we will hear from the second panel, the Farm Credit Administration. Then we will go to the question-and-answer period.

Representing the Farm Credit Administration we have Mr. Eldon Stoehr, Deputy Governor, Chief Examiner; Ted Rabun, Associate Chief Examiner; Robert Hanley, Project Manager of NCCB examination; and Fred Medero, General Counsel.

STATEMENT OF ELDON STOEHR, DEPUTY GOVERNOR AND CHIEF EXAMINER, ACCOMPANIED BY TED RABUN, ASSOCIATE CHIEF EXAMINER, ROBERT HANLEY, PROJECT MANAGER, NCCB EXAMINATION, AND FRED MEDERO, GENERAL COUNSEL, ALL OF THE FARM CREDIT ADMINISTRATION

Mr. STOEHR. Good morning, Mr. Chairman. We appear to report on our examination on the National Consumer Cooperative Bank. At the request of this committee, FCA previously conducted a special review of the credit quality of the banks' portfolio as of May 21, 1982. In the course of that first examination, we reviewed all loans with outstanding balances.

As an adjunct evaluation of parallel importance, we assessed the effectiveness of bank staff in administering the loan portfolio; in doing so, we recognized that credit administration is ongoing in that it deals with the Bank's ability to analyze loan risks on origination, to make prudent lending decisions, to service loans, to administer loans where forbearance is appropriate and, as necessary, to take collection and foreclosure actions.

The report of our May examination was presented to the board of directors of the bank on October 20, 1982, and copies of the

report were furnished to both this committee and to the Senate Committee on Banking, Housing and Urban Affairs.

At the May examination date, we concluded that the quality of credit was quite low by Farm Credit system standards. Loss reserves, however, were adequate to cover our estimate of losses. Additionally, organizational problems and staff performance weaknesses in the administration of credit gave little assurance, if those deficiencies were not corrected, that the bank could appropriately carry out its mission as defined in the act.

The mission, of course, is to provide funding and technical assistance to user-owned cooperatives and to other types of self-help cooperatives which "have been hampered in their formation and growth by lack of access to adequate cooperative credit facilities and lack of technical assistance.'

Beyond the low quality of the loan portfolio, we concluded that the bank's organizational structure did not provide clearly defined responsibilities to permit effective supervision and administration of the credit function. Moreover, credit analyses, credit recommendations, and loan servicing actions clearly demonstrated a lack of experienced and seasoned credit judgment among a majority of the bank's credit personnel.

These deficiencies were further compounded by excessive involvement by the board of directors in the loan approval process, and the policy and practice of financing cooperatives which had little or no equity, including the financing of borrowers which were already in financially distressed situations. The latter types of financing require a high degree of lending expertise and collateral monitoring controls. Yet such expertise and controls on the part of the bank were not in evidence.

During the examination process we met with the bank president and her senior staff on numerous occasions-usually weekly, sometimes more often than that--to keep them apprised of our progress and tentative conclusions.

In October 1982, the president was given other responsibilities under an agreement with the bank, and the board is currently in the process of selecting a new chief executive officer. This interaction with bank management was substantially greater than normally occurs in our routine examinations but we felt it was appropriate for such a unique first-time engagement. Additionally, we verbally discussed findings and conclusions with the board in July 1982 and formally presented our examination report to them at their October 1982 meeting.

In January 1983 the Farm Credit Administration began an examination of the bank covering calendar year 1982, pursuant to section 115 of the act. This examination focused again on credit quality and the bank's administration of credit, primarily for the period following July 1, 1982.

Our objective was to determine the extent to which credit quality had improved or deteriorated, and to evaluate the adequacy and effectiveness of bank management's response to the deficiencies which we identified in the previous examination report. Because the bank had engaged consulting firms to make certain studies and evaluations-the General Accounting Office was also making studies-we deferred segments of the examination plan pending com

pletion of these studies to consider these studies and their impact on the bank.

For example, we had identified in our May examination the need to review the bank's regional office division because of its heavy involvement in the credit administration process. In early February 1983, we elected not to examine the regional office division, because we concluded that the consultant's scope of review was appropriate and progress reports provided constructive recommendations for change, including changes for the administration of credit. We reasoned that the study was part of the management response and little could be achieved until management took appropriate action, which we could then subsequently evaluate.

We concluded that the NCCB board and management responses to deficiencies identified in the previous report were generally appropriate. Examples of these responses, in the order of occurrence, included: Engaged a credit consultant to address weaknesses in the credit area; hired an experienced loan officer to assume managerial responsibility for the commercial loan division; engaged a consulting firm to evaluate the bank's regional operations and to make recommendations for organizational improvement; engaged a consulting firm to evaluate bank credit policies and procedures and to make recommendations for improvement; evaluated the credit quality of the bank's loan portfolio in conjunction with the determination of adequacy of the loan loss reserve; hired an experienced real estate person to manage the bank's real estate division; established goals for improving credit quality; and undertook a major restructure of the bank's organization in response to the consultant's report.

Nearly all of these changes require time and additional development before conclusions can be drawn about their ultimate effectiveness in resolving the bank's problems. We believe the bank still has a long way to go to achieve the level of operating effectiveness necessary to fulfill its responsibility under the act. Continuing areas of concern, identified again during the most recent examination, include: Further deterioration of credit quality as evidenced by the amount of loans in high-risk classification categories. It should be noted this is largely the result of continued deterioration of loans already booked at May 21, 1982; significant escalation of loan losses; lack of improvement in the administration of real estate loans and only limited assurance that improvements observed in the administration of commercial loans will be sustained; weaknesses in credit policies and procedures which have contributed to credit administration problems; and continued excessive involvement of the board of directors in the loan approval process. In summary, we see the bank doing what appears to be the right things in a number of areas. However, not only is it too early to know for sure, but these responses have been made in a fragmented way and it remains to be seen whether these individual parts will be brought together in a way which complements the whole. With regard to the Consumer Cooperative Development Corporation, established as of December 31, 1982, pursuant to section 211 of the act, to administer title II loans in the Office of Self-Help, we did make a separate examination of this entity primarily to determine the quality of loans previously examined in the bank as of

May 21, 1982. These loans had been transferred as partial capitalization of the newly formed corporation.

We found that credit quality of the title II capital advances had deteriorated since the last examination and we considered it unsatisfactory because of an excessive volume classified as high risk, categories which raise serious doubts about ultimate repayment. Most of the risk exposure is in the real estate area. Some modest improvement in nonperforming loans was observed.

Our conclusion concerning credit quality is predicated on our understanding of the act which we believe requires repayment of the advances, albeit over an extended period of time.

If the committee has questions about our report, we will be pleased to respond.

Chairman ST GERMAIN. Thank you, Mr. Stoehr.

I would ask of GAO, in your section on contracting, what was the period covered as far as contracts awarded by the bank looked at by your audit?

Mr. ALLEN. It was through March 1982. From the beginning of the bank through March of 1982.

Chairman ST GERMAIN. Do you know what the total dollar amount of those contracts were for that period?

Mr. ALLEN. Right off-yes; $3,872,108.

Chairman ST GERMAIN. You also mentioned the lack of adherence to contracting procedures. That is an important factor. However, just as important is knowing whether the bank received value for the contracts. In your audits, did you evaluate the work product and how it related to the purposes of the bank? In fact, was there a work product in all cases reviewed by GAO?

Mr. PEACH. What we did, Mr. Chairman, is we did not as such, let's say, look at work products in terms of the specific quality of the product, but we did look to see whether or not the bank got the product for which they contracted.

Out of the test contracts we examined, which was about 50 contracts, in 16 cases or about 33 percent of the contracts, we could not find, and the bank did not have available to give us, the product they should have received for that particular contract.

We have been subsequently advised within just the last few days that the bank has located the work product on 7 of those 16 contracts which they feel is the product they should have been delivered. We have not examined that yet.

Chairman ST GERMAIN. They are having trouble finding the work product for those contracts that they paid for?

Mr. PEACH. Right. We had trouble finding the work products for 33 percent of the contracts.

Chairman ST GERMAIN. Do you know of the cable television stud

ies?

Mr. PEACH. Let me confer with my staff.

Chairman ST GERMAIN. That's fine.

Mr. PEACH. That was not one in our sample, the cable television. Mr. MCKINNEY. Would the chairman yield?

Chairman ST GERMAIN. Briefly.

Mr. MCKINNEY. Mr. Chairman, there was a McKinney amendment, as I remember it, that required bidding for all contracts. I

would like the chairman to pursue this a little further to find out what policies they actually did use.

Chairman ST GERMAIN. I hoped the gentleman might pursue it. I have so many pursuings here myself, I will let you do it on your time.

I would ask of GAO, a lot of this, a lot of contracting out, evaluation of a particular co-op or to determine if it could be foreclosed and how, that sort of boggles the mind. I know a co-op bank is supposed to be different from other banks, but I didn't think it had to contract all duties out. In your opinion, couldn't some of this work contracted out have been done in-house for a whole lot less money? Look at some of these fees. Wow! I should go back to the practice of law.

Mr. PEACH. We did not do any comparative cost analysis in this area. Certain of the things are in the area of judgments the bank would routinely have to make with respect to the creditworthiness of cooperatives and actions they needed to make. I think that is certainly a reasonable point.

Chairman ST GERMAIN. Let me ask you this. In all the testimony we heard when we were having hearings about the co-op bank, never once did we hear about cable television. Yet when I reviewed many of these contracts, I note that a great deal of time was spent in this area. We have looked-you have looked at selected contracts, but obviously you have not looked at the cable TV study contracts; is that correct?

Mr. PEACH. That is right. That was not one in the sample we looked at.

Chairman ST GERMAIN. Well, let me ask you this: Isn't this cable TV an area of very rapidly changing, developing technology? I know for a fact you pick up the paper, the Wall Street Journal, other papers like that, and you find a lot of limited partnerships are being offered in this area, and the reason for that is a lot of competition, rapid change. Isn't it an area that is still developing and it's experimental and very chancy?

Mr. PEACH. It is a rapidly developing area which is highly competitive with a number of firms involved in it. There is no doubt about that.

Chairman ST GERMAIN. Let me ask you this. Are you aware of the number of cable TV contracts-contract studies performed? are you familiar with that at all? Mr. Elmore?

Mr. PEACH. There are two we are aware of that were from our work at the bank.

Chairman ST GERMAIN. Well, I am looking here, 1980, a $50,000 contract to develop a cable TV manual, a model project; 1980, a $15,000 contract to provide assistance to St. Paul Cable Co-op. 1981, $11,900 addition to St. Paul Cable Co-op; 1981, again, $50,000 feasibility study for Davis Cable Co-op; 1982, $7,500 legal contract to a Washington, D.C., law firm for IRS code work amendments amended by $40,205 to include legal work on the Davis Cable Co-op. So Davis Cable Co-op, just to study the thing now, is up to $50,000, $90,000, $100,000-$100,000 to study the Davis Cable Co-op. Doesn't that seem like an inordinate-I ask FCA, did they ever get a loan, Davis Cable Co-op?