Risk Management Manual of Examination Policies - FDIC

Examination Conclusions and Comments (Continued) 99999
Lincoln is ultimately responsible for most of the day-to-day operations reviewed by the internal auditor, this
situation compromises the independence of the internal audit program. The internal auditor should report directly
to the Board of Directors or the Audit Committee of the Board to ensure the independence and effectiveness of
the audit function. President Lincoln is also a member of the Audit Committee, which oversees the external audit
function. His presence on the committee further limits audit independence. Several outside directors are
qualified to serve on the Audit Committee, and it is recommended that committee membership consist entirely of
outside directors.
Several internal control deficiencies are detailed under Item 5 of the Risk Management Assessment page of this
Report. While these deficiencies are relatively minor, management reported that two of these items were
corrected in the response to the last external audit. This error underscores the need for more independence in the
audit function.
Chairman of the Board Ratzlaff stated that the Board would consider these recommendations at its next
meeting. He also stated the internal control deficiencies would be addressed.
Reports of Condition and Income
Material errors were noted in the last three quarterly Reports of Condition and Income. In numerous cases,
examiners were unable to reconcile bank records and workpapers with reported figures. The most significant
errors relate to the inaccurate reporting of loans and ORE, and the inappropriate inclusion of gains on the sale of
repossessed assets in interest income. These errors have served to overstate net interest income somewhat,
although as stated previously, the primary reason for the improvement has been management’s ability to maintain
loan portfolio rates while decreasing cost of funds.
Executive Vice President/Cashier John M. Gutierrez filed amended Reports of Condition and Income during
the examination.
CAPITAL - 3
Capital is less than satisfactory in relation to the bank's risk profile. The Adversely Classified Items Coverage
Ratio remains high at slightly more than 84 percent. In addition, after making the needed ALLL provision, the
bank has had net operating losses over the past two and a half years, and future profitability is questionable. The
existing concentration in fishing industry loans, considering the industry’s current depressed condition and
anticipated continuing decline, adds to capital concerns. The Tier 1 Leverage Capital ratio of 7.44 percent
reflects current examination adjustments for assets classified Loss and the provision expense needed to replenish
the inadequate ALLL.
President Lincoln pointed out that dividends have not been paid for five years. He further stated that no
dividends would be paid until the Tier 1 Leverage Capital ratio exceeds 8 percent and bank earnings become
positive and stable.
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