On July 13, 2012, the FDIC filed its 31st professional liability lawsuit since the advent of the current economic downturn.  This suit was filed against seven former directors and officers of Community Bank of Arizona (“CBOA” or the “Bank”), all of whom served on the Bank’s Board Loan Committee.  CBOA had four branches in metropolitan Phoenix before it was closed and placed into receivership on August 14, 2009.  For a copy of the FDIC’s complaint, click here.

As it has in prior D&O lawsuits, the FDIC generally alleges here that the defendants: (i) took unreasonable risks with the Bank’s asset portfolio; (ii) violated the Bank’s own loan policies and procedures when approving the acquisition of loans; (iii) ignored warnings regarding risky real-estate and constructions loans, and (iv) knowingly permitted poor underwriting in contravention of the Bank’s policies and reasonable industry standards.

The FDIC’s sharpest criticisms of the defendants relate to CBOA’s acquisition of loan participations without conducting any of its own underwriting.  Most of these loans were acquired from CBOA’s larger “sister bank,” Community Bank of Nevada (“CBON”).  The CBON loans were principally made to real estate developers in Nevada, and seventy-five percent (75%) of the participations that CBOA purchased from CBON ultimately became problem loans.  According to the FDIC’s complaint, the defendants “rubber stamped” the purchase of the loan participations, all without having CBOA: (i) conduct independent financial analysis of the loans; (ii) obtain updated appraisals of the collateral; (iii) obtaining or analyzing financial statements of the guarantors; or (iv) conducting independent site inspections as required by the CBOA loan policy.

The FDIC’s criticisms are not limited to the approval of loan participations.  It also alleges that the defendants negligently approved a “bulk purchase” of a large portfolio of residential-construction loans from First National Bank of Arizona (“FNBA”), also without any independent underwriting, and in many cases based on nothing more than a one-line summary of the loan.  The approval of this “bulk purchase” occurred less than two months after public reports that FNBA was in financial distress and was terminating its retail mortgage-lending activities.

This is not the first FDIC lawsuit to focus on a failed institution’s purchase of participation loans.  It should serve as a pointed reminder to healthy institutions that the FDIC expects the acquisition of participations to be based on the same degree of underwriting (and loan policy compliance) that supports the credit decisions for self-originated loans.