Audit finds OTS helped banks cook their books

An audit report by the US Treasury's Office of the Inspector General, released on May 21, cited six examples of lenders receiving capital after the end of a reporting period, and then backdating the capital injection to make it appear they were adequately capitalised.

The only firm named was IndyMac, the Californian mortgage lender taken over by regulators in July last year. While it was preparing its quarterly report for the first quarter ending on March 31, 2008 - a report that would have shown it to be under the OTS's minimum 10% risk-based capital ratio - it received a $50 million capital infusion from its holding company, intended for the second quarter.

On May 9, 2008, IndyMac's chief executive Michael Perry asked the OTS's western region director, Darrel Dochow, whether $18 million of the capital could be backdated - reported as though it had been received before the end of March - to make the bank appear well-capitalised for the first quarter.

Both Dochow and a representative of IndyMac's auditor, Ernst & Young, agreed to allow the backdating, which breaks US generally accepted accounting principles. Ernst & Young officials told the inspector-general they were unfamiliar with the rules on capital backdating, and based their approval solely on the OTS's say-so.

The OTS's deputy director of examinations and supervision, Timothy Hill, told the investigators he was informed backdating was legal, as the capital had arrived in the form of a capital note before the end of March, even though the cash had not been infused until May. This, however, was not the case - the capital had only arrived in May, and no such note ever existed, Hill found after checking records in October.

The backdating did not help IndyMac for long - it received an OTS 'Camels' (capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk) financial strength rating of 5 (the worst rating) after a comprehensive examination in June, and was in receivership by July 11.

At least five other institutions in the US have backdated capital in the same way - the report did not name them, as all are still trading.

In one case, OTS senior deputy director Scott Polakoff agreed to accept a south-eastern lender's backdating in August 2008 on the grounds capital had been received - again, in note form - before quarter-end on June 30, even though he was told no capital note or other evidence existed. The lender in question had already been warned privately by the OTS in a memorandum, described as an "informal enforcement action to correct unsafe and unsound practices or compliance issues", to raise its capital ratio above 15% rather than the normal 10%. It is now on the Federal Deposit Insurance Corporation's Problem Banks List, and also has a Camels rating of 5.

Polakoff, also the acting director of the OTS, is now on administrative leave.

In another case, the institution told the OTS in advance it planned to create a note in July 2008 and backdate it to June, to make it appear that it was well-capitalised at the end of June. The OTS agreed after the institution's chief financial officer warned that, without OTS approval of its capital levels, it would lose access to the broker deposit market and could collapse.

The OTS argued the institutions in question had all ultimately received the cash before filing their reports with the SEC, albeit after the end of the period to which the reports supposedly referred. The inspector-general replied this was irrelevant.

See also: Merge SEC and CFTC, says former SEC commissioner
FDIC: 252 US banks now at risk
Regulators shut down IndyMac
US mortgage lender closes doors after capital warning
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