FED BANKING AGENCIES REPORT "SERIOUS DEFICIENCIES IN UNDERWRITING STANDARDS AND RISK MANAGEMENT OF LEVERAGED LOANS"

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 

For Immediate Release November 7, 2014 

Credit Risk in the Shared National Credit Portfolio is High; Leveraged Lending Remains a Concern

The credit quality of large loan commitments owned by U.S. banking organizations, foreign banking organizations (FBOs), and nonbanks is generally unchanged in 2014 from the prior year, federal banking agencies said Friday. In a supplemental report, the agencies highlighted findings specific to leveraged lending, including serious deficiencies in underwriting standards and risk management of leveraged loans.

The annual Shared National Credits (SNC) review found that the volume of criticized assets remained elevated at $340.8 billion, or 10.1 percent of total commitments, which approximately is double pre-crisis levels. The stagnation in credit quality follows three consecutive years of improvements. A criticized asset is rated special mention, substandard, doubtful, or loss as defined by the agencies' uniform loan classification standards. The SNC review was completed by the Federal Reserve Board, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency.

Leveraged loans as reported by agent banks totaled $767 billion, or 22.6 percent of the 2014 SNC portfolio and accounted for $254.7 billion, or 74.7 percent, of criticized SNC assets. Material weaknesses in the underwriting and risk management of leveraged loans were observed, and 33.2 percent of leveraged loans were criticized by the agencies.

The leveraged loan supplement also identifies several areas where institutions need to strengthen compliance with the March 2013 guidance, including provisions addressing borrower repayment capacity, leverage, underwriting, and enterprise valuation. In addition, examiners noted risk-management weaknesses at several institutions engaged in leveraged lending including lack of adequate support for enterprise valuations and reliance on dated valuations, weaknesses in credit analysis, and overreliance on sponsor's projections.

Federal banking regulations require institutions to employ safe and sound practices when engaging in commercial lending activities, including leveraged lending. As a result of the SNC exam, the agencies will increase the frequency of leveraged lending reviews to ensure the level of risk is identified and managed.

In response to questions, the agencies also are releasing answers to FAQs on the guidance. The questions cover expectations when defining leveraged loans, supervisory expectations on the origination of non-pass leveraged loans, and other topics. The FAQ document is intended to advance industry and examiner understanding of the guidance, and promote consistent application in policy formulation, implementation, and regulatory supervisory assessments.

Other highlights of the 2014 SNC review:

Total SNC commitments increased by $379 billion to $3.39 trillion, or 12.6 percent from the 2013 review. Total SNC outstanding increased $206 billion to $1.57trillion, an increase of 15.2 percent.

Criticized assets increased from $302 billion to $341 billion, representing 10.1 percent of the SNC portfolio, compared with 10.0 percent in 2013. Criticized dollar volume increased 12.9 percent from the 2013 level.

Leveraged loans comprised 72.9 percent of SNC loans rated special mention, 75.3 percent of all substandard loans, 81.6 percent of all doubtful loans, and 83.9 percent of all nonaccrual loans.

Classified assets increased from $187 billion to $191 billion, representing 5.6 percent of the portfolio, compared with 6.2 percent in 2013. Classified dollar volume increased 2.1 percent from 2013.

Credits rated special mention, which exhibit potential weakness and could result in further deterioration if uncorrected, increased from $115 billion to $149 billion, representing 4.4 percent of the portfolio, compared with 3.8 percent in 2013. Special mention dollar volume increased 29.6 percent from the 2013 level.
The overall severity of classifications declined, with credits rated as doubtful decreasing from $14.5 billion to $11.8 billion and assets rated as loss decreasing slightly from $8 billion to $7.8 billion. Loans that were rated either doubtful or loss account for 0.6 percent of the portfolio, compared with 0.7 percent in the prior review. Adjusted for losses, nonaccrual loans declined from $61 billion to $43billion, a 27.8percent reduction.

The distribution of credits across entity types—U.S. bank organizations, FBOs, and nonbanks—remained relatively unchanged. U.S. bank organizations owned 44.1 percent of total SNC loan commitments, FBOs owned 33.5 percent, and nonbanks owned 22.4 percent. Nonbanks continued to own a larger share of classified (73.6 percent) and nonaccrual (76.7 percent) assets than their total share of the SNC portfolio (22.4 percent). Institutions insured by the FDIC owned 10.1percent of classified assets and 6.7 percent of nonaccrual loans.
The SNC program was established in 1977 to provide an efficient and consistent review and analysis of SNCs. A SNC is any loan or formal loan commitment, and asset such as real estate, stocks, notes, bonds, and debentures taken as debts previously contracted, extended to borrowers by a federally supervised institution, its subsidiaries, and affiliates that aggregates $20 million or more and is shared by three or more unaffiliated supervised institutions. Many of these loan commitments also are participated with FBOs and nonbanks, including securitization pools, hedge funds, insurance companies, and pension funds.

In conducting the 2014 SNC Review, the agencies reviewed $975 billion of the $3.39 trillion credit commitments in the portfolio. The sample was weighted toward noninvestment grade and criticized credits. In preparing the leveraged loan supplement, the agencies reviewed $623 billion in commitments or 63.9 percent of leveraged borrowers, representing 81 percent of all leveraged loans by dollar commitments. The results of the review and supplement are based on analyses prepared in the second quarter of 2014 using credit-related data provided by federally supervised institutions as of December 31, 2013, and March 31, 2014.

SEC ACCUSES BUSINESSMAN AND COMPANY OF MAKING FALSE STATEMENTS TO INVESTORS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission announced securities fraud charges accusing a New York businessman and his software company of making false statements to investors while raising more than $3 million to fund operations.

The SEC’s Enforcement Division alleges that Gregory Rorke falsely told investors that he possessed millions of dollars in liquid assets to personally guarantee their purchase of promissory notes issued by Navagate Inc., which claimed to create and sell computer software to help companies automate certain processes in sales and customer relations.  Rorke emphasized that he was an experienced businessman and former professor at Columbia Business School, and he signed and distributed a personal financial statement to investors.  However, virtually all of the liquid assets and real estate he claimed as his own in the financial statement actually belonged solely to Rorke’s wife, who did not pledge any of her assets in connection with the securities offering and had no obligation to make good on Rorke’s personal guarantee.  Ultimately, Navagate defaulted on the notes and Rorke did not adhere to his promise to pay investors under his personal guarantee.

The SEC’s Enforcement Division further alleges that when asked for proof that he owned one of the main pledged assets, Rorke covered up his lie by tampering with an account statement to hide the fact that the account belonged solely to his wife.  Rorke also initially failed to disclose and later materially understated the extent of corporate tax problems at Navagate, which owed at least $1 million in payroll taxes to the IRS for which Rorke was personally liable.  As Rorke faced pressure from investors to pay down this liability, he lied in a sworn affidavit that he had sent the IRS a check for $350,000.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Rorke, who lives in Bronxville, N.Y.

“Rorke comforted investors with a personal guarantee to back their investments in Navagate with his own pledged assets,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office.  “Yet he repeatedly made false statements about his ownership of the pledged assets, even tampering with documents to cover his tracks.”

In a separate administrative proceeding, the SEC’s Enforcement Division filed charges against Gregory Osborn and his New Jersey-based broker-dealer Middlebury Securities LLC, which served as the placement agent in selling Navagate securities.  The SEC’s order states that Osborn and Middlebury Securities repeatedly assured investors that Rorke’s personal guarantee was a good reason to enter into the deal despite knowing or recklessly disregarding that Rorke’s claim was false and he did not solely possess the assets listed in the personal financial statement.  Osborn and Middlebury Securities also orchestrated payments to some earlier Navagate investors by fraudulently using proceeds from additional investors despite knowing or recklessly disregarding that such payments are not permitted.
Osborn and Middlebury Securities agreed to partially settle the case against them with disgorgement and penalties to be determined at a later date.  Osborn agreed to be permanently barred from the securities industry and Middlebury Securities agreed to be censured.  They each consent to the entry of injunctions barring them from violating or causing violations of the federal securities laws.

“Osborn and Middlebury Securities collected significant placement agent fees while boldly highlighting Rorke’s personal guarantee and assuring investors it was a sound investment opportunity,” said Amelia A. Cottrell, Associate Director of the SEC’s New York Regional Office.

The SEC’s orders allege that Rorke, Navagate, Osborn, and Middlebury Securities violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  Rorke also is charged with causing Navagate’s violations of those provisions, and Osborn and Middlebury Securities are charged with willfully aiding and abetting and causing Navagate’s violations.

The SEC’s investigation was conducted by Lara Shalov Mehraban, Jorge Tenreiro, Alexander Janghorbani, and Michael Birnbaum in the New York office, and supervised by Ms. Cottrell.  The SEC’s litigation will be led by Mr. Janghorbani and Mr. Tenreiro.  The examination of Middlebury Securities that led to the investigation was conducted by Steve Vitulano, Michael J. McAuliffe, Simone Celio Jr., and Sean M. O’Brien.  The SEC appreciates the assistance of the Financial Industry Regulatory Authority, the Federal Bureau of Investigation, and the U.S. Attorney’s Office for the Southern District of New York.

SEC CHARGES MICHIGAN CITY, FORMER LEADERS WITH FRAUD INVOLVING MUNI BOND OFFERING

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission announced fraud charges today against the City of Allen Park, Mich., and two former city leaders in connection with a municipal bond offering to support a movie studio project within the city.

An SEC investigation found that offering documents provided to investors during the Detroit suburb’s sale of $31 million in general obligation bonds contained false and misleading statements about the scope and viability of the movie studio project as well as Allen Park’s overall financial condition and its ability to service the bond debt.

The city and the two officials – former mayor Gary Burtka and former city administrator Eric Waidelich – have agreed to settle the SEC’s charges.

“Municipal bond disclosures must provide investors with an accurate portrayal of a project’s prospects and the municipality’s ability to repay those who invest,” said Andrew J. Ceresney, Director of the SEC Enforcement Division.  “Allen Park solicited investors with an unrealistic and untruthful pitch, and used outdated budget information in offering documents to avoid revealing its budget deficit.”

The SEC alleges that Burtka was an active champion of the project and in a position to control the actions of the city and Waidelich with respect to the fraudulent bond issuances.  Based on this control, the SEC charged Burtka with liability for violations committed by the city and Waidelich.  This is the first time the SEC has charged a municipal official under a federal statute that provides for “control person” liability.  Burtka has agreed to pay a $10,000 penalty.

“When a municipal official like Burtka controls the activities of others who engage in fraud, we won’t hesitate to use every legal avenue available to us in order to hold those officials accountable,” said LeeAnn Ghazil Gaunt, Chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit.

According to the SEC’s administrative order against Allen Park and its complaints against Burtka and Waidelich filed in federal court in Detroit, the city began planning the studio project in late 2008 with the belief it would bring much-needed economic development.  The state of Michigan had just enacted legislation that provided significant tax credits to film studios conducting business in Michigan.  The original plan detailed a $146 million facility with eight sound stages led by a Hollywood executive director, and the city initially planned to repay investors with $1.6 million in revenue from leases at the site.  Allen Park issued bonds on Nov. 12, 2009, and June 16, 2010, to raise funds to help develop the site.

The SEC’s order finds, however, that by the time the bonds were issued, Allen Park’s plans to implement and pay for the studio project had deteriorated into merely building and operating a vocational school on the site.  Yet none of these plan changes were reflected in the bond offering documents or other public statements, which continued to repeat the original plans for the movie studio project.  Investors were left uninformed not only about the deterioration of the project itself, but also the substantial impact it would have on the city’s ability to service the bond debt.  Without the planned revenues from the studio project, the expected annual debt payments on the bonds represented approximately 10 percent of the city’s total budget.  Furthermore, Allen Park used outdated budget information in the bond offering documents that did not reflect the city’s budget deficit of at least $2 million for fiscal year 2010.  The studio project completely collapsed within months after the second set of bonds were issued, and Michigan appointed an emergency manager for Allen Park in October 2010 while citing the failed project as a primary factor in the city’s deteriorating economic condition.

The SEC’s complaints allege that Waidelich as city administrator reviewed and approved the offering documents for the bonds.  Waidelich’s actions violated Section 17(a)(2) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(b).  Without admitting or denying the allegations, Waidelich has consented to a final judgment barring him from participating in any municipal bond offerings and enjoining him from future violations.  The SEC alleges that Burtka is liable as a control person under Section 20(a) of the Exchange Act, based on his control of Waidelich and the city.  Without admitting or denying the allegations, Burtka consented to a final judgment requiring him to pay the $10,000 penalty, barring him from participating in any municipal bond offerings, and enjoining him from future violations.

The SEC’s order against Allen Park finds it violated Section 17(a)(2) of the Securities Act and Section 10 (b) of the Securities Exchange Act and Rule 10b-5(b).  The city agreed to cease and desist from future violations of those provisions.  The SEC considered certain remedial measures taken by the city, which settled the enforcement action without admitting or denying the findings.

The SEC’s investigation was conducted by Sally J. Hewitt of the Municipal Securities and Public Pensions Unit with assistance from John E. Birkenheier, John E. Kustusch, and Jean M. Javorski in the SEC’s Chicago Regional Office and Mark R. Zehner, Deputy Chief of the Municipal Securities and Public Pensions Unit.

CFTC ANNOUNCES COURT PERMANENT BAN FROM TRADING AND REGISTRATION ON N.C. MAN

FROM:  COMMODITY FUTURES TRADING COMMISSION 

Federal Court Permanently Bans North Carolina Resident Neal Hall from Trading and Registration and Imposes a $210,000 Penalty for Violating the CFTC’s Registration and Consumer Notice Provisions

Washington, DC - The U.S. Commodity Futures Trading Commission (CFTC) today announced that the Honorable James A. Beaty, Jr. of the U.S. District Court for the Middle District of North Carolina entered an Order imposing permanent trading and registration bans and a $210,000 civil monetary penalty against Defendant Neal E. Hall of Reidsville, North Carolina for registration violations and failure to include certain required disclosures on his website.

The Order entered on October 6, 2014, follows a Memorandum Opinion entered by the court on November 21, 2013, both of which stem from a civil enforcement action filed by the CFTC against Hall on May 31, 2011 (see CFTC Press Release 6049-11).  The CFTC Complaint charged that, starting no later than June 2010 and continuing to June 2011, Hall used the mails and other avenues of interstate commerce while offering his services as a Commodity Trading Advisor (CTA) in exchange for payment in the form of either flat charges or a percentage of profits from customers.

The court found that Hall used his website to solicit clients both to subscribe to his e-mini S&P 500 futures trading program and to have him manage their trading accounts, and, as a result, Hall violated the Commodity Exchange Act, by failing to register with the CFTC as a CTA.

Additionally, the court found that Hall violated CFTC Regulations 4.41(a)(3) and (b).  Those Regulations require cautionary statements to accompany the use of client testimonials and the presentation of the performance of a simulated or hypothetical commodities account.  Regulation 4.41(b) further dictates that the cautionary statement accompanying the presentation of the performance of simulated or hypothetical trading results contain specific language and be prominently displayed in immediate proximity to the hypothetical results.

The court found that Hall violated Regulation 4.41(a)(3) because his website lacked a cautionary statement despite featuring testimonials from unnamed clients.  Similarly, the court found that Hall violated Regulation 4.41(b) because his website did not contain a disclaimer with the specific language required by the Regulation that is prominently displayed in immediate proximity to the hypothetical trading results.

The CFTC appreciates the assistance of the North Carolina Securities Division and the Office of the U.S. Attorney for the Middle District of North Carolina.

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SEC SANCTIONS 13 FIRMS FOR VIOLATING RULE THAT PROTECTS SMALL INVESTORS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today sanctioned 13 firms for violating a rule primarily designed to protect retail investors in the municipal securities market.

All municipal bond offerings include a “minimum denomination” that establishes the smallest amount of the bonds that a dealer firm is allowed to sell an investor in a single transaction.  Municipal issuers often set high minimum denomination amounts for so-called “junk bonds” that have a higher default risk that may make the investments inappropriate for retail investors.  Because retail investors tend to purchase securities in smaller amounts, this minimum denomination standard helps ensure that dealer firms sell high-risk securities only to investors who are capable of making sizeable investments and more prepared to bear the higher risk.

In its surveillance of trading in the municipal bond market, the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit detected improper sales below a $100,000 minimum denomination set in a $3.5 billion offering of junk bonds by the Commonwealth of Puerto Rico earlier this year.  The SEC’s subsequent investigation identified a total of 66 occasions when dealer firms sold the Puerto Rico bonds to investors in amounts below $100,000.  The agency instituted administrative proceedings against the firms behind those improper sales: Charles Schwab & Co., Hapoalim Securities USA, Interactive Brokers LLC, Investment Professionals Inc., J.P. Morgan Securities, Lebenthal & Co., National Securities Corporation, Oppenheimer & Co., Riedl First Securities Co. of Kansas, Stifel Nicolaus & Co., TD Ameritrade, UBS Financial Services, and Wedbush Securities.

The enforcement actions are the SEC’s first under Municipal Securities Rulemaking Board (MSRB) Rule G-15(f), which establishes the minimum denomination requirement.  Each firm agreed to settle the SEC’s charges and pay penalties ranging from $54,000 to $130,000.

“These actions demonstrate our commitment to rigorous enforcement of all types of violations in the municipal bond market,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.  “We will act quickly and use all available tools to protect investors in municipal securities.”

LeeAnn G. Gaunt, Chief of the SEC’s Municipal Securities and Public Pensions Unit added, “These firms violated a straightforward investor protection rule that prohibits the sale of muni bonds in increments below a specified minimum.  We conduct frequent surveillance of trading in the municipal bond market and will penalize abuses that threaten retail investors.”  

The SEC’s orders against the 13 dealers find that in addition to violating MSRB Rule G-15(f) by executing sales below the minimum denomination, they violated Section 15B(c)(1) of the Securities Exchange Act of 1934, which prohibits violations of any MSRB rule.  Without admitting or denying the findings, each of the firms agreed to be censured.  They also agreed to review their policies and procedures and make any changes that are necessary to ensure proper compliance with MSRB Rule G-15(f).

The SEC’s investigation, which is continuing, is being conducted by Joseph Chimienti, Sue Curtin, Heidi M. Mitza, and Jonathon Wilcox with assistance from Kathleen B. Shields.  The case is supervised by Kevin B. Currid and Mark R. Zehner.  The SEC appreciates the assistance of the MSRB.