Section 17.1 - Bank of Anytown-Report of Examination

1. Are risk management processes adequate in relation to economic conditions and asset concentrations?
   
   No. The Board’s strategic plan is outdated and unrealistic. In addition, management makes no effort to monitor asset concentrations. A concentration of credit in the fishing industry, which is projected to remain depressed for the foreseeable future, is listed on the Concentrations page of this Report. Additional details regarding these deficiencies can be found on the ECC page.
   
   
2. Are risk management policies and practices for the credit function adequate?
   
   No. Internal credit review and grading are weak, and various credit administration practices are deficient. Refer to the comments under Asset Quality on the ECC page. In addition, although the bank’s loan policy is generally adequate, it fails to address the following matters:
• Participation Loans - The bank regularly purchases loans or portions of loans from other institutions. These specialized lending activities are not specifically covered in the policy.
• Construction Loans - The bank finances the construction of 1- to 4-family residences. The policy lacks specific guidelines pertaining to construction lending. President Lincoln was provided with a detailed list of issues that should be considered.
• Environmental Risk - An Environmental Risk Policy is nonexistent. Management was provided with FDIC guidelines with respect to an acceptable environmental risk program.
  

President Lincoln stated that guidelines concerning purchased loans and construction lending would be developed and the bank’s loan policy revised by December 31, 2004. He further stated that an environmental risk policy is currently under development.


3. Are risk management policies and practices for asset/liability management and the investment function adequate?
   
   Generally, yes. Management’s liquidity management practices are generally adequate; however, the bank has no written funds management policy. This deficiency is discussed more fully on the ECC page in the Liquidity comment.
   
   Investment policy guidelines are adequate; however, management’s adherence to its written investment policy is inconsistent. On at least three occasions since the previous examination, President Lincoln executed the purchase of securities over $250M without prior Board approval as required by the policy.
   
   President Lincoln stated that he was presented with the opportunity to purchase these securities at a good price and could not await Board approval.
   
   
4. Are risk management processes adequate in relation to and consistent with, the institution’s business plan, competitive conditions, and proposed new activities or products?
   
   No. Refer to comments under Management on the ECC page.
   
   
5. Are internal controls, audit procedures, and compliance with laws and regulations adequate (includes compliance with the Bank Secrecy Act [BSA] and related regulations)?
   
   No. As indicated under Management on the ECC page, apparent violations of Financial Recordkeeping regulations and Regulation O are cited during this examination. Full details of these citations can be found on the Violations of Laws and Regulations page. In addition, the audit and internal control function lacks independence.

Internal Controls
Examiners noted the following weaknesses in the bank’s system of internal controls:

• Dual Control of Negotiable Collateral – The bank does not maintain dual control over negotiable collateral. Several bearer bonds are maintained in a dual-lock drawer in the vault; however, both keys to the drawer are readily accessible to tellers. The bank's external certified public accountant also noted this deficiency in its December 2003 audit. An effective system of dual control should be implemented.
• Vacation Policy – The bank's vacation policy requires employees to be absent from their normal duties for an uninterrupted period of two weeks each calendar year. Executive Vice President Leslie S. Commander did not remain absent during her two-week vacation in 2003 as she returned daily to reconcile the Federal funds sold account. Management is strongly encouraged to enforce its policy, particularly for employees who are responsible for sensitive transactions.
• Reconcilement of Correspondent Bank Accounts – The bank has not reconciled its correspondent bank accounts for the past three months. While these accounts were reconciled during the examination, they should be reconciled at least monthly.


President Lincoln stated he would take action to address these deficiencies.


6. Is Board supervision adequate, and are controls over insider transactions, conflicts of interest, and parent/affiliate relationships acceptable?
   
   No. Board supervision is less than satisfactory. (Refer to comments under the Management heading on the ECC page.) Additionally, two loans are cited as apparent violations of Federal Reserve Regulation O regarding prior approval on loans to related interests of President Lincoln and Director Larry G. Killingbird. Refer to the Violations of Laws and Regulations page of this Report for details.