21758 1 UNITED STATES OF AMERICA BEFORE THE 2 OFFICE OF THRIFT SUPERVISION DEPARTMENT OF THE TREASURY 3 In the Matter of: ) 4 ) UNITED SAVINGS ASSOCIATION OF ) 5 TEXAS, Houston, Texas, and ) ) 6 UNITED FINANCIAL GROUP, INC., ) Houston, Texas, a Savings ) 7 and Loan Holding Company ) ) OTS Order 8 MAXXAM, INC., Houston, Texas, ) No. AP 95-40 a Diversified Savings and ) Date: 9 Loan Holding Company ) Dec. 26, 1995 ) 10 FEDERATED DEVELOPMENT CO., ) a New York Business Trust, ) 11 ) CHARLES E. HURWITZ, ) 12 Institution-Affiliated Party ) and Present and Former Director ) 13 of United Savings Association ) of Texas, United Financial Group,) 14 and/or MAXXAM, Inc.; and ) ) 15 BARRY A. MUNITZ, JENARD M. GROSS,) ARTHUR S. BERNER, RONALD HUEBSCH,) 16 and MICHAEL CROW, Present and ) Former Directors and/or Officers ) 17 of United Savings Association of ) Texas, United Financial Group, ) 18 and/or MAXXAM, Inc., ) ) 19 Respondents. ) 20 21 TRIAL PROCEEDINGS FOR AUGUST 31, 1998 22 21759 1 A-P-P-E-A-R-A-N-C-E-S 2 ON BEHALF OF THE AGENCY: 3 KENNETH J. GUIDO, Esquire Special Enforcement Counsel 4 PAUL LEIMAN, Esquire SCOTT SCHWARTZ, Esquire 5 BRUCE RINALDI, Esquire RICHARD STEARNS, Esquire 6 and BRYAN VEIS, Esquire of: Office of Thrift Supervision 7 Department of the Treasury 1700 G Street, N.W. 8 Washington, D.C. 20552 (202) 906-7395 9 ON BEHALF OF RESPONDENT MAXXAM, INC.: 10 FRANK J. EISENHART, Esquire 11 of: Dechert, Price & Rhoads 1500 K Street, N.W. 12 Washington, D.C. 20005-1208 (202) 626-3306 13 DALE A. HEAD (in-house) 14 Managing Counsel MAXXAM, Inc. 15 5847 San Felipe, Suite 2600 Houston, Texas 77057 16 (713) 267-3668 17 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO. AND CHARLES HURWITZ: 18 RICHARD P. KEETON, Esquire 19 KATHLEEN KOPP, Esquire of: Mayor, Day, Caldwell & Keeton 20 1900 NationsBank Center, 700 Louisiana Houston, Texas 77002 21 (713) 225-7013 22 21760 1 ON BEHALF OF RESPONDENT FEDERATED DEVELOPMENT CO., CHARLES HURWITZ, AND MAXXAM, INC.: 2 JACKS C. NICKENS, Esquire 3 of: Clements, O'Neill, Pierce & Nickens 1000 Louisiana Street, Suite 1800 4 Houston, Texas 77002 (713) 654-7608 5 ON BEHALF OF JENARD M. GROSS: 6 PAUL BLANKENSTEIN, Esquire 7 MARK A. PERRY, Esquire of: Gibson, Dunn & Crutcher 8 1050 Connecticut Avenue, N.W. Washington, D.C. 20036-5303 9 (202) 955-8500 10 ON BEHALF OF BERNER, CROW, MUNITZ AND HUEBSCH: 11 JOHN K. VILLA, Esquire MARY CLARK, Esquire 12 PAUL DUEFFERT, Esquire of: Williams & Connolly 13 725 Twelfth Street, N.W. Washington, D.C. 20005 14 (202) 434-5000 15 OTS COURT: 16 HONORABLE ARTHUR L. SHIPE Administrative Law Judge 17 Office of Financial Institutions Adjudication 1700 G Street, N.W., 6th Floor 18 Washington, D.C. 20552 Jerry Langdon, Judge Shipe's Clerk 19 REPORTED BY: 20 Ms. Marcy Clark, CSR 21 Ms. Shauna Foreman, CSR 22 21761 1 2 INDEX OF PROCEEDINGS 3 Page 4 KEVIN O'CONNELL 5 Examination by Mr. Leiman...............21763 6 Voir Dire Examination by Mr. Dueffert...21807 7 Continued Examination by Mr. Leiman.....21807 8 Examination by Mr. Dueffert.............22017 9 Examination by Mr. Dueffert.............22018 10 11 12 13 14 15 16 17 18 19 20 21 22 21762 1 P-R-O-C-E-E-D-I-N-G-S 2 (9:00 a.m.) 3 THE COURT: Be seated, please. The 4 hearing will come to order. 5 Are there any procedural matters? If 6 not, we will proceed. 7 Mr. Leiman, you have a witness? 8 MR. LEIMAN: Yes, Your Honor. I call 9 Mr. Kevin O'Connell. 10 11 12 13 14 15 16 17 18 19 20 21 22 21763 1 KEVIN O'CONNELL, 2 was called as a witness and, having been first 3 duly sworn, testified as follows: 4 5 THE COURT: Be seated, please. 6 MR. LEIMAN: Your Honor, I might 7 mention first that I notice that in the courtroom 8 with us today is Mr. William Wallace, one of the 9 expert witnesses that's been listed by respondents 10 in their case regarding the real estate matters. 11 THE COURT: Okay. Thank you. 12 13 EXAMINATION 14 15 Q. (BY MR. LEIMAN) Good morning, 16 Mr. O'Connell. 17 A. Good morning. 18 Q. Would you please state your full name 19 and spell your last name? 20 A. Sure. Kevin Thomas O'Connell, 21 O'C-O-N-N-E-L-L. 22 Q. Where do you live, Mr. O'Connell? 21764 1 A. Washington D.C. 2 Q. Did you go to college? 3 A. Yes, I did. 4 Q. Where did you go? 5 A. I received a bachelor's and master's 6 degree from Northwestern University. 7 Q. And what was your bachelor's in? 8 A. Speech. 9 Q. And master's? 10 A. The same. Master's in speech. 11 Q. Mr. O'Connell, are you currently 12 employed? 13 A. That is correct. 14 Q. And who are you employed with? 15 A. I work for the Washington division of 16 the Office of Thrift Supervision. 17 Q. What's your present job title? 18 A. Senior regional coordinator for 19 supervision. 20 Q. And when did you begin your present 21 position? 22 A. When the regional coordinator positions 21765 1 were instituted in 1991. 2 Q. What are the principal responsibilities 3 of your job? 4 A. There are basically four core areas 5 that make up my time. First, we run through all 6 of the financial reports of all the thrifts that 7 file with the OTS. Every quarter, institutions 8 file what is known as thrift financial reports; 9 and we have computer modeling systems that take 10 the data, compute various averages, and rank them. 11 And from what we refer to as the thrift monitoring 12 system, we are able to rank those institutions by 13 asset size, by income, by balance sheet items. We 14 can rank them nationally, et cetera. We do that 15 on a national basis. 16 Because of that, I'm also what is 17 referred to as a program manager for the TMS 18 whereby all funds supervision to enhance -- to 19 improve the TMS go through me. 20 Secondly, I'm also the program manager 21 for the supervisory appeals process. That is an 22 informal process for institutions to appeal 21766 1 decisions made by the regions. Since the deputy 2 director for supervision in Washington has 3 authority over all the regions, including the 4 regional directors of supervision, institutions 5 can make an appeal to the deputy director of any 6 decisions. 7 In that capacity, from a minimal 8 standpoint, I just take the information, process 9 it, make sure the responses are done in a timely 10 manner. That I do for every appeal. 11 For appeals that have to do with loans, 12 loan accounting, classification of assets or 13 overall safety and soundness issues such as the 14 composite CAMELS ratings -- that's C-A-M-E-L-S, 15 all capitalized -- I actually do the core 16 analysis. I would look at the association's 17 submission, contact the region, look at the -- 18 look at the regional work papers of the particular 19 exam, and make a recommendation to the deputy 20 director. 21 On cases, however, where the knowledge 22 is so specialized that I need help such as very 21767 1 complex securities transactions, I would then just 2 serve essentially as a recordkeeper and assay the 3 capital markets division to do the core analysis. 4 My -- 5 Q. You mentioned the deputy director. The 6 deputy director of what? 7 A. Of supervision for OTS. 8 Q. What is his job? 9 A. He currently is the head of the entire 10 supervisory branch of the OTS, both in Washington 11 and all the regions. All the regional directors 12 of supervision answer to him. 13 Q. Proceed. 14 A. The third practical area I'm involved 15 in is helping out in policy. Essentially, we have 16 to participate with not only internal discussions 17 by various intraagency discussions in terms of 18 setting overall supervisory policy. The item 19 that's taking the most time right now is a holding 20 company task force, for instance, in which I've 21 been working with federal reserve policies and how 22 they handle holding companies and how different 21768 1 type holding companies may affect the way we 2 supervise or advise holding companies. The fourth 3 area is I've become somewhat of a supervisory 4 historian. I have participated, I believe, in 5 about two dozen panels with foreign delegations of 6 banking regulators from potential land which is 7 just really trying to set up a free market system 8 and starting from scratch on a regulatory system 9 to Japan that has a system that needs to adapt to 10 changing conditions. 11 Q. What do you talk about these panels? 12 A. Generally, they are asking about what 13 we refer to as the thrift crisis of the Eighties, 14 if you will, how the thrift crisis developed, how 15 it evolved, what the response of the Federal Home 16 Loan Bank Board was, how OTS was treated, how the 17 RTC was created, and the interplay between the 18 RTC, the Resolution Trust Corporation. They are 19 really just interested in what happened and how 20 did we respond to it and what was the end result. 21 In addition to these foreign panels which I 22 frankly have lost count over, I've also 21769 1 increasingly been used to the justice department 2 on various goodwill litigation. However, I 3 interpret various documents and obviously I'm here 4 today and will be -- am being called to testify in 5 another case in about two weeks regarding prior 6 cases that failed during the 1980s. 7 Q. What areas of special knowledge are 8 involved in the oversight and the tasks that you 9 just described? 10 A. One of the reasons I've been asked to 11 be on these panels is that I'm somewhat of a 12 oddity in Washington. I believe there are only 13 six people of roughly 300 employees we have in OTS 14 Washington that has been either a supervisory 15 agent or an assistant regional director out in the 16 field. So, at least what I have and several of 17 the other individuals who have that same 18 designation is that we're able to have a 19 perspective from the Washington standpoint, how 20 Washington views cases, how Washington views 21 supervision as well as a field aspect, how in the 22 field we actually enforce the regulations, review 21770 1 examination reports, review correspondence 2 documents that come to the supervisory agents. 3 Basically, it's just a knowledge of the overall 4 supervisory process of OTS from the top, if you 5 will, down to the field. 6 Q. What kinds of matters and issues are 7 involved in that supervisory process? What do you 8 look at? 9 A. The issues that I said that generally 10 come to us the most have to do with financial 11 monitoring, actually reviewing the correspondence 12 numbers filed by the institutions on the thrift 13 financial report, as well as basically work papers 14 and submissions regarding to loans. The primary 15 issue that continues to, say -- for instance, the 16 supervisory appeals that I've had to deal with 17 have to do with loan classifications and loan 18 accounting. In that situation, we're looking at 19 the loan understanding. We're looking at the way 20 fees and income are approved on various loan 21 transactions. So, principally, overall safety and 22 soundness issues as well as specifically real 21771 1 estate underwriting. 2 Q. With regard to real estate 3 underwriting, what are you looking at in 4 particular? What parts of underwriting are you 5 looking at? 6 A. Principally, we would be looking at the 7 manner in which the loan was underwritten; what 8 type of financial guarantees, if any, were given; 9 what value, if any, were the guarantees worth; 10 what is the underlying collateral of the real 11 estate. We would be looking carefully at the 12 appraisals to see if they had reasonable 13 assumptions and conclusions. Then we would be 14 looking at the terms of the loan to see whether 15 the loans was -- had terms that indicated it was 16 an arm's length transaction, if you will, or 17 whether or not it seemed to be some sort of 18 concessionary or insider transactions, if you 19 will, that indicated that the loan really wasn't 20 viewed as an arm's length transaction. 21 Q. You've described a number of skills and 22 special knowledge that you use in your position. 21772 1 How did you acquire that knowledge and your skills 2 overall? 3 A. That goes back a long ways. To some 4 extent, I suppose I grew up with them. My father 5 was at one point the president of the U.S. League 6 Savings Association. 7 Q. What's that? 8 A. It's a trade association of thrift 9 institutions. I kind of grew up with them. I 10 also started in a thrift institution in the late 11 Seventies as a teller, moved up to being a loan 12 officer, assistant to the senior lending officer, 13 eventually executive assistant to the president. 14 So, it's primarily experience by -- 15 clearly, over the 20 plus years, I've had a number 16 of courses and seminars, seminars on real estate 17 accounting, seminars on real estate underwriting, 18 several courses from Freddie Mac, the Federal Home 19 Loan Bank Corporation, and the Federal National 20 Association regarding, again, mortgage 21 underwriting and loan packaging. Later with the 22 Federal Home Loan Bank Board, some courses on 21773 1 problem loan workouts, commercial loans, interest 2 rate risk. And I'm sure I'm missing several 3 others; but generally, we have a regular system of 4 training at the Federal Home Loan Bank Board. 5 Q. Mr. O'Connell, you mentioned that you 6 had some special skill by virtue of the fact you 7 had been in the field. 8 Before we get to that, prior to your 9 present position, were you employed in Washington 10 in another job? 11 A. Yes. In two other positions as a 12 matter of fact. 13 Q. What are those? 14 A. Well, when I came from the field to 15 Washington in 1987, I was called the supervisory 16 analyst -- senior supervisory analyst for the 17 Office of Regulatory Activities. That was the 18 privatized arm of supervision of the Federal Home 19 Loan Bank Board. 20 In that capacity, I was basically given 21 two principal assignments. One was to coordinate 22 the overall supervision of an institution known as 21774 1 Lincoln Savings in California, and the second was 2 to oversee the supervision and help create policy 3 for what is referred to as the management 4 consignment program associations or MCPs. 5 Q. What is that? 6 A. Management consignment program 7 associations essentially were associations where 8 we had private -- privately-owned, privately-run 9 thrifts going in and managing institutions that 10 were put into conservatorship, some cases even 11 receivership because we were running out of 12 conservators. And that is what the -- we 13 consigned the management of the thrifts to other 14 thrifts to other private entities. So, all of the 15 cases I'm referring to would have been cases that 16 had already failed. 17 Q. I should have asked you this. When did 18 this other position in Washington start? 19 A. I believe I mentioned in the middle of 20 1987. 21 Q. Okay. 22 A. Those are the two principal areas. As 21775 1 I said, the job evolved a little bit as something 2 referred to as the Enforcement Review Committee 3 started in Washington. That was a committee that 4 looked at and made recommendations on all 5 enforcement actions that were being sent up from 6 the field. 7 At that time, with the exception of 8 supervisory agreements, I believe all cease and 9 desist orders, civil monitors, penalties and 10 removal of prohibition orders had to come through 11 Washington and get Federal Home Loan Bank Board 12 approval. With the Enforcement Review Committee, 13 I basically served as staff support to the then 14 director of supervision who was actually a holding 15 member of the committee. 16 Finally, I was named a supervisory 17 agent with another individual in our office to 18 help oversee a multi-district examination of 19 Lincoln Savings. I would say from June of '88 20 through May of '88, that responsibility started to 21 take up an increasing amount of my time; and MCPs 22 kind of fell off the wayside. 21776 1 Q. I think you just -- you may have 2 misspoken a moment ago. You said May of '88 3 through June of what year? 4 A. June of '89. 5 Q. Okay. The kinds of issues that those 6 tasks involved, what kind of analysis and 7 analytical responsibilities did you bring to bear 8 on those tasks? 9 A. With regards to MCP, it primarily had 10 to do with policies because the institutions were 11 already bust, as I said. With Lincoln, because we 12 were talking about individual assets, there again 13 we had to go into approvals, underwriting, proper 14 classifications, proper accounting. And again, 15 those were on individual assets, individual 16 appraisals, individual work papers. I think on 17 three occasions, I flew down to the Phoenix office 18 of Lincoln to see how the examination was going. 19 So, I would say basically it had to do 20 with overall real estate underwriting. And then 21 finally, Mr. Leiman, we broke off at June of '89. 22 In June of '89, I was then named deputy director 21777 1 of special cases. 2 Q. What's that? 3 A. Deputy director of special cases 4 basically had responsibility for processing all of 5 the failed institutions of the country. In that 6 capacity, from about June of '89 through December 7 of '90, I believe I signed off somewhere between 8 350 to 400 conservatorships or receiverships 9 throughout the country. All convervatorships and 10 receiverships had to be approved by Washington 11 before they could go through. My department was 12 responsible for reviewing the cases, agreeing that 13 the grounds existed for placing the institutions 14 in conservatorship or receivership, and then 15 signing concurrence memorandum from supervision to 16 approve the conservatorship receivership. 17 Q. Did you have the final say on approving 18 those? 19 A. No. Ultimately, the director of the 20 OTS or the chairman of the Federal Home Loan Bank 21 Board did. Just from a policy standpoint, before 22 they did that, they wanted concurrence memorandum; 21778 1 and I was on acting on their behalf and to someone 2 from the chief counsel's office, usually the 3 general counsel or his designee. 4 Q. Did the work ever involve balance sheet 5 analysis? 6 A. Very often, yes, because particularly 7 in the deputy director for special cases, as I 8 said, we had to make a final analysis of whether 9 or not this case was feasible or not. So, we 10 would try to spin off, if you will, special items 11 to see what was their core recurring earnings. 12 Did this institution have a viable chance of 13 surviving on its own. 14 So, yes, a balance sheet analysis was 15 very important. 16 Q. During your work in Washington D.C., 17 did you give me the range of institutions in terms 18 of asset size that you worked with? 19 A. Did you say my entirety in Washington? 20 Q. During your entire term in Washington. 21 A. All right. I have sat in on decision 22 meetings -- meetings with management on cases, I 21779 1 would say, ranging from 10 million in assets to 2 50 billion in assets. 3 Q. You're familiar with the major aspects 4 of thrift operations, I assume? 5 A. Overall, yes. 6 Q. What are they? What are the major 7 aspects of thrift operations? 8 A. Essentially, what a thrift institution 9 does is they take in liabilities, mostly in the 10 form of savings deposits, sometimes in the form of 11 loans. They invest those liabilities at a 12 profitable spread, primarily through loans, 13 sometimes through investment securities. And it 14 is that spread that basically funds the overall 15 operating expenses. Now, there are other 16 ancillary costs involved and income. For 17 instance, there's safety deposit income. But 18 primarily, what you've got is savings deposit and 19 borrowing cost versus income from assets. The 20 primary source of income is interest income and 21 loan fee income. 22 Q. Is that on any particular kind of loan, 21780 1 by and large? 2 A. Generally, only mortgage loans and some 3 commercial loans have some sort of fees involved; 4 but principally, it's real estate mortgage loans 5 that have the most amount of fees up front. 6 Q. Please continue. 7 A. That's the basic core of any thrift 8 institution is having a profitable spread between 9 assets and liabilities. Of course, then you have 10 ancillary issues of administration, of accounting, 11 of marketing. And, again, in that capacity, I 12 have a broad overview on it. But both as a matter 13 of a supervisory agent and old executive assistant 14 president, you touch on all these matters; but I 15 wouldn't want to say I'm an expert in, say, 16 marketing, for instance. 17 Q. When did you start working as a 18 financial institution regulator? 19 A. That was in June of 1984 at the Federal 20 Home Loan Bank of Chicago. 21 Q. What was your first position at the 22 Federal Home Loan Bank of Chicago? 21781 1 A. Supervisory analyst. 2 Q. And what did you do as the supervisory 3 analyst at the bank of Chicago? 4 A. Again, one of the principal things we 5 did is that I had a case load of, I believe, in 6 the low 40s, 40 to 45 institutions, to review -- 7 at that time, it was the monthly and semi-annually 8 thrift financial reports, to look for trends, to 9 look for changes in conditions, and to make a 10 determination from that whether or not more 11 supervisory action was needed. 12 In addition to that, we did review 13 correspondence back and forth from the thrift. 14 Obviously, the examination reports, responses to 15 the examination reports and, to the extent that 16 problems developed, we then would work with 17 Washington, either the -- at that time, the 18 Federal Savings and Loan Insurance Corporation, 19 FSLIC, or the Office of Enforcement. 20 Q. While you were at the Federal Home Loan 21 Bank of Chicago, you mentioned that you reviewed 22 reports of examination. 21782 1 Did you ever have an opportunity to get 2 into the field? 3 A. Yes. That was not my principal 4 responsibility, but yes. On about, I think, four 5 or five occasions, I actually did go out in the 6 field to look at specific work papers, to look at 7 specific loan documents to see what they were 8 finding. 9 Q. In that kind of hands-on review, what 10 were you looking for there? 11 A. Generally, that would be sparked 12 because -- again, that was not an ordinary course 13 of action for us. My going out to the field was 14 generally sparked by some sort of interim report 15 of examination that rose significant questions. 16 The reason I went out to the field was to try to 17 determine whether the issues and problems that the 18 examiners were finding were something isolated 19 because every institution in the country makes 20 some mistakes, makes some isolated miscalculation. 21 We have to make a decision and determination. 22 Were these isolated, or was it part of a pattern 21783 1 of behavior? Basically, when I went out to the 2 field, it was to try to make a determination in my 3 own mind of was there a pattern here. 4 Q. Tell me how you're using that term, 5 "pattern." 6 A. A systematic string of behavior that 7 was consistent among some major transactions, 8 whether it was poor appraisals, whether it was 9 very concessionary terms. We would be looking for 10 some sort of systematic behavior running across 11 several transactions. 12 Q. What would be an example of an isolated 13 problem? 14 A. An isolated problem would be if we went 15 out and saw, say, one bad appraisal on a project; 16 and then, after looking at several other loans, we 17 realized this is very much an aberration. So, 18 that would be the classification of an isolated 19 one. It would be just a simple screwup. 20 Q. When you started with the Federal Home 21 Loan Bank of Chicago, how many institutions did 22 you have in your caseload? 21784 1 A. As I recall, it was in the low 40s. 2 Between 40 to 45. 3 Q. Was there any point during your tenure 4 at the Federal Home Loan Bank of Chicago that that 5 caseload changed? 6 A. Yes. When I was promoted to 7 supervisory agent in March of '86, I was given all 8 the problem cases in the region. So, although the 9 amount of work per case increased, they did cut 10 the caseload back to, I think, around 22. 11 Q. You were made a supervisory agent. 12 What's that? 13 A. I believe the legal definition is that 14 we were agents of the Federal Home Loan Bank Board 15 and could make various supervisory decisions in 16 that capacity. It's actually a Federal Home Loan 17 Bank Board -- the board itself had to approve the 18 designation. 19 Q. Did that change -- when you became a 20 supervisory agent, did that correspond to any 21 point in the history of the savings and loan 22 industry? 21785 1 A. Not the exact date, no. I mean, it was 2 kind of -- in the core of the mid-1980s is, I 3 guess, what most thrift historians would say was 4 one of the peak areas of what is known as the 5 thrift crisis. I can't say it was a particularly 6 important date. 7 Q. Tell me what the effect of the thrift 8 crisis was on the regulatory system, from your 9 perspective. 10 A. Oh, well, from my personal perspective, 11 it was fairly easy. I probably was hired because 12 of that. In 1984, the chairman of the Federal 13 Home Loan Bank Board, Ed Gray, gave a speech in 14 which he announced that the supervisory staffs of 15 all of the Federal Home Loan Banks were being 16 increased by 50 percent in response to the failure 17 of Empire of Mesquite, Texas. There was a concern 18 on the Bank Board's part that supervisory 19 authorities were not taking quick enough action, 20 and he wanted an increase in staff. And myself 21 and, I believe, about six other individuals were 22 hired in supervision from mid-1984 to late 1984. 21786 1 In addition to that, along the same 2 line, in the middle of 1985, Chairman Gray 3 essentially privatized the examination core. The 4 actual field examiners of the Federal Home Loan 5 Bank Board were limited by civil service rules and 6 he was able to take those examiners out of civil 7 service and move them under the Federal Home Loan 8 Banks which are actually shareholder and 9 corporations of the thrifts that were part of the 10 Federal Home Loan Bank districts. 11 By doing that, he was able to get away 12 from the hiring instructions imposed by civil 13 service. So, in 1984, you had a huge increase in 14 supervisory staff. In 1985, you started to have 15 an increase in the examination staff. And 16 finally, in 1986, he then, I think I mentioned 17 earlier -- I referred to the Office of Regulatory 18 Activities as being the privatized arm of 19 supervision. He privatized the Office of 20 Regulatory Activities. What was used to be known 21 as the Office of Examinations and Supervision was 22 again transferred to the Federal Home Loan Bank 21787 1 system so, again, the individuals in that office 2 were cut away from civil service requirements. 3 Q. Was there a change in the nature of the 4 problems or issues at that particular point in 5 time that you're describing, from '84 through '86, 6 that stands out in your mind? 7 A. Yes. In fact, I think I mentioned 8 earlier as kind of a supervisory historian, one of 9 the questions that particularly the Japanese 10 regulators keep on asking is how the problems 11 evolved. When I was a supervisory analyst -- and 12 I think I had about, oh, half a dozen problem 13 cases. I believe three of them were referred to 14 as interest rate risk problems, cases where we had 15 institutions paying out more on liabilities than 16 they could earn on assets. And three of them were 17 from what were referred to as asset quality 18 problems, cases where institutions had gone into 19 very speculative lending and the loans were going 20 bad on them. By the time I became a supervisory 21 agent and I got the 22 problem cases, only one of 22 the cases was still an interest rate risk problem. 21788 1 There was a huge drop of interest rates from 2 roughly 1982 through 1986. 3 So, we had only 21 of them that were 4 asset quality problems. One of the reasons, of 5 course, the interest rates dropped so quickly is 6 the inflation rate had dropped quickly and since 7 so many loans were based on increasing rates of 8 interest and land values, a lot of the loans were 9 increasingly going bad. 10 So, the situation changed dramatically 11 just in the two years I was a supervisory analyst. 12 And that also accounts for the reason why the 13 regulations changed radically. 14 Starting in 1984, Chairman Gray started 15 to introduce -- and eventually, in 1985 and '86 16 actually implemented and had passed the -- and it 17 required full Bank Board approval -- a variety of 18 actions addressed at asset quality problems. 19 There was the direct investment 20 regulation that was first proposed, I think it 21 was, in December of '84. There was a 22 classification of assets regulation to give 21789 1 examiners more ability to classify assets that 2 were not yet delinquent. And there were some 3 growth restrictions placed into effect to keep 4 institutions from growing too fast by piling up a 5 lot of high-cost liabilities. 6 So, there were a series of regulatory 7 initiatives in the '84-'86 era primarily addressed 8 to the asset quality problems that were 9 developing. 10 Q. Mr. O'Connell, the way you're talking 11 about this makes me think that all the S&Ls that 12 were in the United States were having asset 13 quality problems. Is that true? 14 A. No, not at all. 15 Q. Was it 50 percent, 20 percent, as you 16 saw the issue? 17 A. Well, it depends. I will state that in 18 Chicago, I think we had about 370 institutions. 19 This is purely on memory. As I said, we only had 20 22 problem cases. So, that was 6 percent, 21 7 percent. But clearly, there were much more 22 problems in basically the California and the Texas 21790 1 districts, primarily because they had much more 2 liberal investment powers. In fact, I believe in 3 a couple of states, they had virtually unlimited 4 direct investment powers. In the State of Texas, 5 I believe they had the ability to make loans up to 6 100 percent of value or purchase price, whichever 7 was higher. So, if you had an appraised value 8 that was in excess of the purchase price, you 9 could actually lend more than what the purchase 10 price was. 11 So, Chicago was relatively healthy in 12 comparison. Nationwide, around 20 percent of the 13 industry was considered to be in trouble. 14 Q. You mentioned Texas and California. 15 Texas was the 9th District; is that 16 correct? 17 A. That's correct. 18 Q. Was there a particular problem in terms 19 of supervision or examinations there? 20 A. Yes. What was happening in Texas is 21 that, first of all, as I said, we were getting new 22 examiners, which itself is a problem. We have to 21791 1 train them, get them some experience. 2 In addition, as Texas real estate 3 prices were declining, exams that we thought were 4 going to take, say, three weeks, the 5 examiner-in-charge or the field manager would make 6 a call and say, "We've got problems we didn't know 7 existed. We're going to be here six or eight 8 weeks." That threw off the entire schedule of all 9 the examinations in the 9th District. 10 It got so bad that in 1986, I believe 11 about 40 institutions, at the direction of 12 Chairman Gray, were actually examined by 13 out-of-district examiners including, frankly, some 14 associations that were transferred to the 7th 15 District, as well. 16 Q. Did you ever have any of those in your 17 caseload? 18 A. Yes. I was -- you could call it a 19 co-supervisory agent for two 9th District 20 associations. 21 Q. "9th District associations" meaning? 22 A. There was one in Louisiana, and there 21792 1 was one in Texas. 2 Q. In terms of the overall transformation 3 that you're describing and the nature of the 4 problem, did financial institution or thrift 5 regulation change by virtue of the crisis that 6 you're mentioning? 7 A. Certainly. I recall back in the late 8 1970s -- this is when I was still in the thrift 9 industry actually -- there were speeches. There 10 was theorizing made that they could do away with 11 examiners altogether, that it was becoming such a 12 balance sheet issue, it was such an interest rate 13 risk issue, that we didn't need examiners. We 14 could do everything based on income from loan 15 expenses from liabilities. Clearly, by 1984 or 16 1985 with the realization that while interest rate 17 risk problems were starting to fade but now we had 18 asset quality problems, the idea had turned around 19 180 degrees. 20 We actually needed more examiners, more 21 supervisors to look hands-on at the actual loans 22 that institutions were making. And we really just 21793 1 had to get in there and do the best we could to 2 look at actual transactions. 3 In addition to that, the regulations 4 shifted from being primarily concerned with 5 interest rate risk to being primarily concerned 6 with high risk assets, the change in the capital 7 requirements, the change in direct investment 8 regulations, as I stated, and the change in the 9 classification of assets regulations. 10 Q. You mentioned December of 1984 or 11 thereabouts being the time frame when Chairman 12 Gray had a regulatory initiative to address the 13 new problems of asset quality that you're 14 mentioning. 15 With respect to the capital 16 requirements, asset classifications, and those 17 other new initiatives you mentioned, was it a 18 seamless transition? Was it absolutely smooth? 19 A. No, not at all. First of all, you had 20 the problem that anytime you have a new 21 regulation, you have to get the examiners and 22 supervisors conversant on it. Then once you get 21794 1 the examiners and supervisors conversant upon it, 2 then they have to get some experience in actually 3 using it. In fact, on the classification of 4 assets regulation, as I recall, there were policy 5 statements that we heard that associations would 6 have the ability to appeal any examiner's 7 classification of assets to the principal 8 supervisory agent which was then the president of 9 the Federal Home Loan Bank. 10 There clearly was a concern whenever a 11 new regulation is put into effect, how is it going 12 to be understood, how is it going to be 13 interpreted, and how is it going to be 14 implemented. So, it was certainly not a seamless 15 process. There were a lot of growth pains in the 16 process. 17 Q. Was it ever the -- concerning the 18 examiners that you had dealt with, did you ever 19 you understand their role to be one of ferreting 20 out all of the problems or problem loans at 21 institutions? 22 A. No, not at all. They couldn't do that. 21795 1 I mean, ultimately -- in fact, I believe if you 2 look at the classification of asset regulation, 3 that's ultimately management's job to 4 self-classify their assets. Examiners go in and 5 try to test the classifications. They do samples. 6 But no, they can't find all of them. In fact, 7 there are several examples I could give in which 8 we send examiners in. They give the best 9 assessment they can. We eventually find the 10 institution insolvent and transfer it to the 11 FSLIC. And suddenly, we find 30 or 40 percent of 12 the assets are gone. That's one of the reasons, 13 frankly, that both ourselves, the Federal Home 14 Loan Bank Board, and even the FDIC when Bill 15 Seidman was first being put under pressure to make 16 assessments of how much loss you're going to have. 17 The first few years, we were very light. We 18 radically underestimated the cost because all we 19 could do is base it on what the examiners could 20 find and extrapolate from that. A receivership 21 does have to do an inventory of every asset and 22 every liability of the association. They just 21796 1 can't do a test. They have to manage the whole 2 thing. It's only then that you really get a true 3 picture of the whole institution. Invariably, it 4 turns out to be much worse than what the examiners 5 were able to estimate. 6 Q. You mentioned a moment ago the word 7 "test." Are you applying that to what examiners 8 do by way of their examination? 9 A. Yes. 10 Q. Explain that for me. 11 A. In an examination scope, generally 12 there is a test process. First of all, on what is 13 referred to as homogenous assets, there is 14 basically a statistical sample. Based on the 15 portfolio, we will review 24 or 48 or 17 loans 16 depending on the size of the thrift. Then above 17 and beyond what we might call homogenous loans, 18 then you have large loans or special loans. 19 Special loans might be loans they have recently 20 gotten into. If an association has just recently 21 gotten into lease financing, even if it's a 22 relatively low amount of volume, the examiner will 21797 1 watch -- take a look at more percentage of those 2 loans to see how they are doing it. It's a new 3 process. Then they start looking at the larger 4 loans that the institution has; and, finally, they 5 will start doing a test of the problem loans an 6 institution has again to see if the 7 self-classification process is working. 8 For healthy, well-run institutions, 9 what we normally will find in an examination 10 report is an examiner has looked at 20 percent of 11 the classified assets, found that the association 12 has properly classified them, also found that the 13 overall policies and procedures of the institution 14 seem to be safe and sound and, therefore, decided 15 there was no need to go any further, that it 16 appeared the association was doing a proper job of 17 self-classifying. 18 If the test process -- if the 19 association fails the test, then they have to 20 expand their scope. Then they start looking at 21 more and more loans, and it then becomes a 22 management issue of how long and how many loans 21798 1 the examiners can look at before they are called 2 away to the next assignment. 3 Q. What do you mean by that, before the 4 examiners are called away on the next assignment? 5 That implies there's some kind of emergency care 6 or triage carried on by examiners. 7 What do you mean? 8 A. Actually, it's just a management issue. 9 The -- we have statutory responsibility to examine 10 every thrift that's over $200 million at least 11 once a year. Thrifts under $250 million we only 12 have to do once every 18 months. The fact of the 13 matter is we have currently statutory -- and back 14 in the mid-1980s, we had policy requirements to 15 examine thrifts every so often. We couldn't have 16 a team of examiners stay at an association for six 17 months. It just wasn't feasible. Even Lincoln 18 Savings, which was an extraordinarily complicated 19 case, I think the examiners were only in the field 20 three months. Eventually, you have to make a 21 management decision: "Okay. Cut off where you've 22 got it, go home, and we'll deal with what you've 21799 1 got. We will pick up from there next year." 2 Examiners simply cannot stay 3 indefinitely at institutions. At least, not a 4 whole field team cannot. I do know that the OCC 5 has occasionally had what is known as a resident 6 examiner at some major institutions. Again, 7 that's just one examiner; and that's usually in 8 the 40- or 50 billion-dollar-and-up range. 9 Q. You mentioned that it's management's 10 responsibility to oversee classification and 11 identify problems. 12 What do you mean? Who in management 13 are you referring to? 14 A. Ultimately, it's the board of 15 directors. I mean, that is their job is to direct 16 the affairs of the institution. In most cases, 17 the board of directors will themselves not be the 18 primary officers. I mean, there are going to 19 be -- usually the chief executive officer and the 20 chief operating officer are themselves directors. 21 Generally, most boards will have an outside 22 director; and they will actually hire management 21800 1 to run the day-to-day affairs of the institution. 2 Ultimately, it is the board of directors' 3 responsibility. They, in turn, make various 4 designations to management. 5 Q. Before you started your position at the 6 Federal Home Loan Bank of Chicago, you mentioned 7 that you were involved in another institution. 8 What was the name of that? 9 A. Skokie Federal Savings and Loan. 10 Skokie, S-K-O-K-I-E. 11 Q. What jobs did you do at Skokie? 12 A. As I said, I first started as a teller; 13 and that primarily was during summer vacations and 14 the like. I eventually became a single-family 15 loan officer, then eventually helped out and 16 eventually became the assistant to the senior 17 lending officer and eventually became executive 18 assistant to the president. I became somewhat of 19 a troubleshooter as the years went on. 20 Q. What skills and special knowledge did 21 you develop and use in the positions you've just 22 mentioned at Skokie? 21801 1 A. Oh, as I said, I became something of a 2 troubleshooter, particularly as an assistant to 3 the lending officers and executive assistant to 4 the president. It ranged from putting together 5 loan underwriting documents, making presentations 6 and -- for instance, we sold several multi-family 7 loans to the Federal Loan Mortgage Corporation, 8 made several presentation -- the Freddie Mac 9 staff. 10 In addition, as executive assistant to 11 the president, I helped draft speeches for the 12 president, prepared branch applications, made a 13 presentation at a Federal Home Loan Bank hearing 14 on a branch application. Helped draft responses 15 to examination reports, prepared the board of 16 directors minutes, prepared the -- I shouldn't say 17 prepared -- gathered the material for the board of 18 directors minutes, particularly for the outside 19 directors. Would even make sure they would get 20 the material well ahead of the board meeting. As 21 I said, it was kind of a troubleshooting role. 22 Q. Did you ever deal with any regulatory 21802 1 process issues? 2 A. Sure. In fact, I think I just said I 3 actually represented the thrift in a hearing on 4 the branch application and dealt with the 5 examiners on a day-to-day basis on various items 6 as well as helped draft a response to an 7 examination report. 8 Again, would you have included 9 Freddie Mac in that? 10 Q. (Witness nods head affirmatively.) 11 A. There I had quite a bit of dealings 12 with Freddie Mac. For instance, when 13 Freddie Mac's loan underwriter wanted to visit 14 some of the projects, I actually escorted him out 15 there, helped show him around some of the 16 multi-family projects that we had, and had several 17 meetings at their office to work through various 18 issues. 19 MR. LEIMAN: Your Honor, at this time I 20 would offer Mr. O'Connell as an expert witness in 21 the field of savings and loan supervision and 22 examinations with regard to real estate 21803 1 underwriting and transactions and overall 2 financial monitoring. 3 MR. DUEFFERT: Your Honor, one 4 clarification. He's designated with regard to the 5 12th claim for relief. With that clarification, 6 we have no objection. 7 THE COURT: All right. So designated. 8 Q. (BY MR. LEIMAN) Mr. O'Connell, have 9 you had read the claims regarding real estate and 10 the Notice of Charges? 11 A. Yes, I have. 12 Q. Are you familiar with the facts that 13 underlie those claims? 14 A. Yes. 15 Q. How did you become familiar with those 16 facts? 17 A. In late 1985, I believe it was -- 18 actually, you approached me with some portions of 19 a draft Notice of Charges and -- 20 THE COURT: Excuse me. You said '85. 21 THE WITNESS: I'm sorry. '95. We're 22 in a time warp here. 21804 1 A. -- in 1995 with some draft portions of 2 Notice of Charges and asked me if, frankly, the 3 Notice of Charges read logically from the 4 standpoint of real estate underwriting, from the 5 standpoint of what an examiner would look at and 6 find significant. 7 Q. (BY MR. LEIMAN) Do you remember what 8 you told me? 9 A. Yes. I thought that overall, the 10 charges seemed reasonable. However, I did state 11 that I thought the Norwood project as it was 12 described was even worse than you portrayed it. 13 Q. Were you asked to -- by me and the 14 other members of the Office of Enforcement and the 15 chief counsel's office at OTS to formulate an 16 opinion related to the real estate transactions in 17 the Notice? 18 A. Not at that time, no. But 19 approximately, I would say, 10 or 12 months later, 20 yes. 21 Q. Did you do that? 22 A. Yes, I did. 21805 1 Q. Did you prepare a written report 2 regarding your opinion? 3 A. Yes, I did. 4 Q. Let me hand you a copy of what's 5 previously been marked as T7452 and ask you to 6 identify this. 7 A. Okay. (Witness reviews the document.) 8 Yes. This is the opinion that I prepared in late 9 1996, early 1997 that I actually executed as of 10 January 13th, 1997. 11 Q. Did you write this report? 12 A. Yes, I did. 13 Q. Are the opinions and conclusions in the 14 report your own? 15 A. Yes, they are. 16 Q. Since you wrote the report, have you 17 had occasion to read any additional materials? 18 A. Yes. There was a substantial amount of 19 material that I believe the defendants submitted. 20 In particular, I recall reviewing the documents of 21 Mr. Fibert. 22 Q. Mister who? 21806 1 A. Fibert, who I believe is one of their 2 expert witnesses, sent to us. I know I've had a 3 chance to review all of the T exhibits, T7000 4 exhibits I guess they are called, as well as a 5 great deal of trial testimony. 6 In addition, I believe I have had 7 access to -- I can't say I've gone through all of 8 it -- various loan files, accounting work papers 9 and the like that the defendants had produced. 10 Q. Have you read anything that changed 11 your opinions or conclusions that are provided 12 here in your report? 13 A. No, not really. In fact, if anything, 14 on the whole, they have been reinforced. The 15 views have been reinforced. 16 MR. LEIMAN: Your Honor, I move the 17 admission of T7452, Mr. O'Connell's expert report. 18 MR. DUEFFERT: Your Honor, could I have 19 one question on voir dire? 20 THE COURT: Yes. 21 22 VOIR DIRE EXAMINATION 21807 1 2 Q. (BY MR. DUEFFERT) Do you know of any 3 statements in your report that you now believe to 4 be false or misleading? 5 A. I've since been advised, I think, there 6 are two typos in the report. But other than that, 7 no. 9.5 million is what I kept saying, but it was 8 actually 9.4 million. 9 Q. Nothing false or misleading? 10 A. No. 11 MR. DUEFFERT: No objections. 12 THE COURT: Received. 13 14 CONTINUED EXAMINATION 15 16 Q. (BY MR. LEIMAN) Mr. O'Connell, just 17 looking at Paragraph 11 in your report for just a 18 second, are those items that are listed there 19 documents and materials that you reviewed in 20 preparing your report? 21 A. Yes, they were. 22 Q. And the other materials you've reviewed 21808 1 since writing this are the materials you 2 mentioned? 3 A. That is correct, yes. 4 Q. Mr. O'Connell -- 5 MR. LEIMAN: Your Honor, let me at this 6 moment -- Mr. Schwartz points out that in the 7 Notice of Charges, although the bulk of the real 8 estate matters are contained in Paragraph 12, 9 there are matters relating to unsafe and unsound 10 lending practices in Section 11. I would add 11 those to the matters that Mr. O'Connell will be 12 talking about. 13 MR. DUEFFERT: I'm sorry. What 14 paragraphs are you referring to in the Notice? 15 MR. LEIMAN: If you look at Page 94, 16 that would be Section No. Roman XI, the 11th 17 claim, Mr. Dueffert. 18 MR. DUEFFERT: One moment, Your Honor. 19 20 (Discussion held off the record.) 21 22 MR. LEIMAN: We've just identified a 21809 1 typo in the Notice of Charges. It's Roman 2 Numeral XI starting at Paragraph 249 and preceding 3 through what has previously been identified as the 4 12th claim of relief, Your Honor. It's the real 5 estate claims. 6 THE COURT: All right. 7 Q. (BY MR. LEIMAN) Back to your report, 8 Mr. O'Connell. 9 A. Okay. 10 Q. Tell me what you concluded with regard 11 to -- if you would, just briefly summarize your 12 conclusions that are laid out here in Paragraph 12 13 of your report. 14 A. Oh, essentially, the -- in terms of the 15 two real estate transactions that I reviewed, the 16 institution engaged in unsafe and unsound 17 practices which overstated their income, 18 understated their capital requirements, violated 19 various regulations relating to books and records, 20 and overall resulted in substantial losses to the 21 thrift and ultimately the Deposit Insurance Fund. 22 Q. You used the word in Paragraph 13 that 21810 1 the regulatory violations and unsafe and unsound 2 were so clear-cut and egregious. 3 What do you mean by that? 4 A. In that the practices that were used 5 were such that any reasonable individual 6 conversant with savings and loan operations would 7 have known that they were in violation of 8 regulations and they were an unsafe and unsound 9 practice that would place the institution at an 10 unreasonable risk of harm. 11 Q. Is that the same as reckless disregard, 12 in your mind? 13 A. I would say yes. 14 Q. How did the -- these activities by the 15 thrift as you talk about in Paragraph 14, how did 16 those affect the financial condition of the 17 institution or its portrayal, I should say? 18 A. The loans in question were being 19 falsely reported in the case of Norwood as being a 20 performing loan when, in fact, it really was not. 21 That would have the implication of increasing the 22 amount of income that they had on their books, 21811 1 decreasing the amount of non-performing assets 2 they had on their books, and reducing their 3 overall capital requirements since, at the time of 4 these transactions, it would have been deemed a 5 scheduled item. And a scheduled item had a 6 20 percent additional capital requirement against 7 them. 8 In regards to the Park 410, actually I 9 did not see any problem with the Park 410 in the 10 1985 transaction because the original transaction 11 was, indeed, booked as a direct investment. But 12 in the 1986 transaction, the association still had 13 the entire economic risk of the transaction, that 14 it should have remained as a direct investment. 15 That again overstated income and understated their 16 capital requirements. 17 Q. You mentioned -- earlier, we talked a 18 little bit about Chairman Gray and new initiatives 19 by the Federal Home Loan Bank Board net 20 requirements, capitalization, and direct 21 investments. 22 Do you remember that? 21812 1 A. Yes. 2 Q. How does the level of capital affect a 3 thrift's ability to make loans or investments? 4 A. There are basically two ways of -- that 5 is addressed. Number one, the actual 6 loan-to-one-borrower regulation was with the 7 exception of very small thrifts. Very small 8 thrifts had a minimum 500,000-dollar 9 loan-to-one-borrower regulation. That doesn't 10 apply here. The loan-to-one-borrower regulation 11 was tied to the amount of the association's net 12 worth or later referred to as the association's 13 capital. 14 In addition, the direct investment 15 regulation that was first proposed in 1984, I 16 think adopted in 1985, used an association's net 17 worth again as a ceiling. If an institution had, 18 say, over 5 percent net worth, the amount of 19 provable direct investments would have been two 20 times their net worth. If the association's 21 capital net worth was less than 5 percent, then 22 the overall amount of approval for direct 21813 1 investments was less than 10 percent of assets. 2 Q. Can you give me an example of how those 3 new initiatives worked together? 4 A. The primary thing in terms of the 5 direct investment regulation -- presume you have a 6 100-million-dollar thrift and remember the 7 10 percent or twice net worth requirement for 8 direct investments. If that thrift had $4 million 9 of net worth and they had the state authority to 10 make direct investments in the first place, they 11 could make up to $10 million of direct investments 12 without getting prior approval from the Bank 13 Board. If, on the other hand, that same 14 institution had $6 million of net worth, they 15 could make up to $12 million, twice their net 16 worth, without going to the Federal Home Loan Bank 17 Board for prior approval. 18 Q. I would like to show Mr. O'Connell 19 B3969, please, which is Tab -- I believe it's 20 1541. 21 A. Okay. 22 MR. DUEFFERT: What was the B number, 21814 1 Mr. Leiman? 2 MR. LEIMAN: That would be 3969. 3 Q. (BY MR. LEIMAN) Mr. O'Connell, I gave 4 you a copy of the classification of assets 5 regulation that appeared in the Federal Register 6 December 31, 1985. 7 Have you seen this before? 8 A. Yes, I have. 9 Q. Is this the classification regulations 10 that you've been alluding to in your testimony? 11 A. Yes, it is. 12 Q. Look with me, please, at Page 53277. 13 It's the third -- should be the third page. 14 A. Okay. 15 Q. You had mentioned earlier when I asked 16 you about your report that there had been some 17 misreporting in connection with Norwood and 18 subsequently with regard to Park 410 on the part 19 of USAT. 20 A. That is correct. 21 Q. There is a reference in the middle 22 column on Page 53277. One of the issues that was 21815 1 identified by the Bank Board is many problem -- in 2 this first full paragraph in the middle column -- 3 "Many problem ADC loans were improperly reported 4 by thrifts to the board as loans when, under 5 proper accounting principles, they are, in 6 economic substance, direct investments." 7 Do you see that? 8 A. Yes. 9 Q. Then it goes on to talk about "Because 10 of the absence of any substantial borrower equity, 11 the lender must generally depend upon the success 12 of the underlying project to receive payment of 13 the principal and interest on the ADC loan"? 14 A. That is correct. 15 Q. What does that mean, Mr. O'Connell? 16 A. Again, it relates to some extent to 17 what I mentioned earlier in terms of the balance 18 sheet analysis. An acquisition and development 19 loan is listed on an association's thrift 20 financial reports as an earning asset. They are 21 able to book accrued interest on it, mostly funded 22 out of interest reserves. What the Bank Board was 21816 1 concerned about is that many of these ADC loans 2 were, in fact, direct investments. There really 3 was no borrower equity in the projects. The 4 thrift had all the economic risk. What they were 5 hoping to do is have institutions voluntarily and, 6 later, eventually have the examiners do the 7 classification for them if necessary to start 8 reporting these "at risk" ADC loans as direct 9 investments. 10 Q. Mr. O'Connell, is there any special 11 significance to the use of the term "ADC loan" as 12 opposed to "ADC direct investment"? 13 A. Only in the sense that they are 14 concerned about how the transactions were 15 currently listed on the association's books. What 16 they were clearly worried about were transactions 17 that were listed on the association's books as 18 loans when, in fact, they should have been direct 19 investments. 20 Q. You talk in Paragraph 16 of your report 21 about capital net worth and retained earnings. 22 And you go on to talk about "To the extent an 21817 1 institution can increase reported earnings or 2 reduce reported losses, it will report higher 3 retained earnings and, therefore, higher levels of 4 capital or net worth." 5 How does a thrift obtain earnings? 6 What does it have to do? 7 A. Primarily through retained earnings, 8 it's just a simple matter of does their income 9 exceed expenses. To the extent that income 10 exceeds expenses, they are reporting profits. As 11 long as they are not paying dividends in excess of 12 those profits, that amount of profits will go 13 immediately into retained earnings. 14 Q. Is there an advantage for a thrift to 15 report higher capital? 16 A. Sure. 17 Q. What is it? 18 A. As I said, it ranges from everything 19 from higher loan-to-one valuabilities but from the 20 standpoint of, say, external forces, institutions 21 with higher capital are generally viewed as being 22 stronger, more stable, less likely to invite 21818 1 supervisory attention from OTS, most likely to get 2 higher credit ratings, for instance, from Moody's 3 or Standard and Poors or any other agency if they 4 are interested in floating debt. More likely to 5 get approval from various underwriting houses. 6 There are a number of advantages to having higher 7 overall capital net worth. 8 Q. Can you tell me, how do capital 9 levels -- how are those affected by earnings or 10 losses. What's the relationship? 11 A. Again, forgetting dividends for the 12 moment because, obviously, dividends would make an 13 impact on the overall capital loans -- assuming no 14 dividends are paid, the capital net worth will be 15 directly affected by earnings. To the extent the 16 association is showing positive earnings, the 17 capital will increase. To the extent the 18 association is posting losses, the capital will 19 decrease by a like amount. 20 Q. Paragraph 17 -- well, first of all, let 21 me ask you this: Can you give me just a quick 22 mini example illustrating what you just said? 21819 1 A. Sure. Go back to that 2 100-million-dollar thrift again. Presuming they 3 had $6 million of net worth and in the year ending 4 1997, for instance, that institution made $500,000 5 in net income. Presuming no dividends were paid, 6 that $500,000 would go directly to capital net 7 worth; and their net worth would increase from 8 6 million to 6,500,000. If the institution lost 9 $500,000, the capital would drop from 6 million to 10 5,500,000. 11 Q. Could loan classification ever cause a 12 loan? 13 A. Yes. 14 Q. How does that work? 15 A. There actually is -- within the 16 classification of assets, there is, in fact, a 17 loss classification which would be a direct 18 chargeoff against earnings and, therefore, a 19 direct chargeoff against capital net worth. 20 Q. Do you remember whether or not in the 21 period of the thrift crisis that you were talking 22 about earlier, was there -- was there an 21820 1 initiative on the part of the Federal Home Loan 2 Bank Board to close large institutions -- 3 institutions over a billion? 4 A. I hate to give this answer, but it's 5 actually "yes" and "no." We did not liquidate 6 institutions in the sense of paying off the 7 savings deposits. I don't believe you would have 8 liquidated an institution in, I think, May of 1988 9 that had over a billion dollars of assets and 10 liabilities. Clearly, in terms of MCPs, we were 11 putting large institutions into convervatorships, 12 yes. 13 Q. Was there a reason why -- why 14 receiverships for large institutions were deferred 15 until '88? 16 A. Well, again, I won't say the 17 receiverships were deferred. I would say the 18 liquidation of them was certainly referred. It 19 had to do with the liquid assets of the FSLIC. 20 Q. What do you mean? 21 A. Well, the FSLIC had a fixed amount of 22 liquid assets that they could use to pay off 21821 1 depositors at any one time; and this was a matter 2 of long discussion for several years in terms of 3 how much the FSLIC needed to recapitalize to gain 4 other resources in order to close more 5 institutions. I believe in 1985 and '86, FSLIC 6 was showing to have roughly 5 to 6 billion in net 7 assets. So, by that virtue, a handful of 8 billion-dollar liquidations could wipe out the 9 Insurance Fund. 10 Q. Let's get back to your report. Let's 11 look at Paragraph 17. You say that real estate 12 loans provide higher immediate income than real 13 estate investments. Institutions can book 14 origination fees and interest income on loans as 15 opposed to investments. 16 From an S&L's perspective, 17 Mr. O'Connell, what's the difference between 18 direct investments and loans? 19 A. In a direct investment, presuming there 20 was a 10-million-dollar transaction, a 21 10-million-dollar direct investment is a direct 22 equity ownership of the thrift in the real estate. 21822 1 Therefore, there are no origination fees because 2 it would be kind of silly. It would be a 3 processing fee paid by itself to itself. So, 4 there are no origination fees involved with direct 5 investment. In addition, the amount of income 6 that can be booked on a direct investment is less 7 than that of a real estate loan. If it is 8 completely vacant land, they can book no interest 9 income at all. 10 Q. Why is that? 11 A. You would have to ask an accountant for 12 that. I can only relate what the overall FASB and 13 AICP rulings were at the time. 14 The only time you could start 15 capitalizing interest -- that was the phrase the 16 accountants used -- was if the land was starting 17 to undergo development, was actually in the 18 process of being developed with hard improvements. 19 Q. Let's turn now to Paragraph 20 and the 20 header above that, B. You state here that "USAT 21 operated under various regulations requiring 22 appropriate books and records." 21823 1 Are there regulations to assure 2 regulators that they are able to -- to assure that 3 they are able to maintain oversight? The books 4 and records -- 5 A. Excuse me? 6 Q. Let me rephrase this question. 7 Your reference to the books and records 8 regulation, what's the purpose of it? 9 A. Well, it's spelled out actually in the 10 regulation itself. It is basically to allow the 11 examiners -- the Federal Home Loan Bank Board to 12 ascertain the true condition of the association. 13 So, the association is supposed to maintain books 14 and records that give an accurate accounting of 15 the affairs of the institution. 16 Q. Why is that -- why is that important 17 from the regulators' point of view? 18 A. Well, for an examiner to be able to 19 examine, we actually have to have hard pieces of 20 evidence, hard data to be able to make assessments 21 as to the operations of the thrift. This ranges 22 from loan underwriting documents so the examiner 21824 1 can test the loan for regulatory compliance, for 2 safety and soundness, to such issues as expenses, 3 to issues of the way an association's securities 4 are on the books, whether or not, say, for 5 instance, repurchase agreements are actual loans 6 or whether they are securities transactions. 7 There are just a number of areas that for 8 examiners to be able to examine, we need to have 9 appropriate books and records from which to make 10 an assessment. 11 Q. What happens if those books and records 12 are not accurate? 13 A. Then it becomes somewhat of a game of 14 hide and seek unfortunately. Traditionally -- and 15 I believe there are a number of studies, including 16 from the general accounting office, that most 17 failed institutions tend to have terrible books 18 and records. It makes it very difficult, if not 19 impossible, for an examiner to make appropriate 20 assessments as to what the condition of the thrift 21 is. We're forced to rely on guess work. And 22 frankly, it became something of a vicious cycle in 21825 1 some of the problem cases. The books and records 2 would be so sloppy that examiners would make their 3 best assessment. The association would say, 4 "Well, you don't have any documents to support 5 these judgments." 6 "Well, that's partly true because we 7 couldn't find them." 8 In fact, there was a phrase that we 9 used on occasion. It was called deliberate 10 sloppiness, that institutions were deliberately 11 maintaining sloppy books and records. 12 Q. You mean inaccurate? 13 A. Inaccurate or missing. In many cases, 14 they were just plain missing. That's why, in many 15 cases, it evolved into a game of hide and seek. 16 Q. Is it your opinion that accuracy of 17 books and records would include the accurate 18 portrayal of loans and direct investments? 19 A. Certainly, yes. 20 Q. Would that also be true with regard to 21 ADC loans? 22 A. Yes. 21826 1 Q. Look at Paragraph 22. You say there 2 that it's the duty of the board of directors to 3 take all necessary steps that policies and 4 procedures are in place to ensure -- and you go on 5 to talk about that -- that policies and procedures 6 are being followed. 7 Whose responsibility is it to assure 8 that the books and records are maintained in a 9 proper and safe and sound accurate manner? 10 A. Ultimately, it's the duty of the board 11 of directors. 12 Q. Would you expect the board of directors 13 to -- to go down and look at loan files on a 14 weekly, daily, monthly, bi-monthly basis? 15 A. No. That ultimately would be the 16 responsibility of the management that they would 17 hire. The board of directors primarily has to set 18 overall policies and procedures and then has to 19 set into place some sort of process to ensure that 20 the policies and procedures are in effect. 21 Currently, I will say that the standard practice 22 would -- most institutions, at least of a 21827 1 particular size now have some sort of internal 2 audit departments to do that. That process was 3 only beginning in the 1980s. 4 Basically, there would have to be some 5 process involved that the board of directors could 6 tell that the policies and procedures were being 7 adhered to. 8 Q. You referred to the board of directors 9 setting policies and procedures. Is there some 10 mechanism by which that concept and view is 11 transmitted down to senior management of the 12 thrift? 13 A. Usually, as I said, the top two 14 officials of management are usually members of the 15 board. They should be advised of the direction of 16 the board of directors, and the board of directors 17 meetings are almost always memorialized in terms 18 of formal minutes which, again, senior management 19 should be advised of decisions being made that 20 affect those specific areas. 21 Q. Looking now to the paragraph labeled C 22 which is above 23, Paragraph 23 in your report, 21828 1 "USAT operated under regulations regarding safe 2 and sound loan underwriting." "The basic 3 principle," you say in Paragraph 23, "of loan 4 underwriting is to take all necessary steps to 5 ensure that the loan principal is repaid." 6 A. That is correct. 7 Q. How did this relate to the books and 8 records regulation? 9 A. The books and records regulation has, 10 as part of it, specific minimum requirements for 11 loan -- for loan documentation. Specifically for 12 real estate loans, they required an appraisal, 13 loan application, credit report. There are a 14 number of documents, as I said, minimum 15 requirements that the books and records regulation 16 has for real estate underwriting. 17 So, there is -- there's a direct 18 correlation in that. Overall, because there are a 19 lot of loans such as consumer loans where that 20 type of detail is not needed. It wouldn't be cost 21 efficient to have that much documentation for a 22 5,000-dollar consumer loan. 21829 1 But in recognizing that, it's just an 2 overall admonition of the requirements shall 3 maintain safe and sound management and accurate 4 books and records. But for the real estate 5 transaction in particular, there is a specific 6 detail of minimum requirements. 7 Q. Mr. O'Connell, you mentioned 8 appraisals. 9 Are appraisals a significant part of 10 loan documentation? 11 A. Yes. 12 Q. Why is that? 13 A. Well, particularly from an examiner's 14 standpoint because real estate loans by definition 15 are primarily supported by the real estate 16 themselves, the appraisals are often the first 17 thing an examiner will look at. He will look at 18 the raw data supporting the conclusion, the 19 assumptions supporting the conclusion, and make an 20 assessment whether or not the appraisal seems 21 reasonable or not. 22 Q. Are appraisals to be used merely to 21830 1 corroborate a value that management believes the 2 property is worth? 3 A. No. In fact, appraisals are supposed 4 to be independent of management because that's the 5 entire purpose of it, to provide an independent 6 arm's length view of the value of the property by 7 an expert who does not really have an interest in 8 whether or not a loan or transaction ever takes 9 place. 10 Q. What's the ultimate rationale for 11 knowing how much a piece of property is worth? 12 A. Again, that gets into the core use, the 13 appraisals for real estate loans. Since real 14 estate appraisals are supported by the value of 15 the loan, you want to have an independent 16 assessment of the value of the collateral before 17 the loan is ever made. 18 Q. You mention in Paragraph 24, 19 Mr. O'Connell, "The purpose of the books and 20 records reg and that association should have at 21 least the bare minimum of documents to provide 22 reasonable insurance loans are repaid." 21831 1 Tell me this: What is the principal 2 issue relating to loan underwriting? 3 A. Well, again, it basically -- as I've 4 tried to spell out, the principal basis of loan 5 underwriting is to take all reasonable and proper 6 steps to ensure that the loan principal is repaid. 7 It's not supposed to be about fees. It's not 8 supposed to be about income. Obviously, that gets 9 into the matter of pricing the loan. No matter 10 what the loan is, your primary concern is how do 11 you make sure the loan gets repaid. 12 Q. What do you mean by "pricing the loan"? 13 A. That gets into more operational issues 14 of how much do you have to charge for the loan to 15 make an operational profit, what type of fees are 16 appropriate and manageable. That gets in -- 17 pricing gets into the question of profitability 18 and operations. But regardless of the pricing, 19 the principal core of loan underwriting is to 20 ensure that the loan is getting repaid. 21 Q. Looking at Paragraph 25, the core of 22 loan underwriting regulations is the admonition 21832 1 that thrift executives ensure that, quote, "each 2 insured institution and service corporation 3 thereof shall maintain safe and sound management." 4 Who administers loan underwriting on a 5 day-to-day basis? 6 A. Again, that would be the association's 7 management overall who would be doing that. 8 Q. At what level would that be? 9 A. Again, that depends on the size of the 10 thrift. For certain thrifts that have only three 11 or four employees, the president will often do 12 everything. For multi-billion-dollar 13 institutions, management would be required to 14 oversee major transactions. As transactions get 15 lesser in scope, they would normally be delegated 16 to loan officers, senior loan officers, depending 17 on how large the overall association is. On a 18 day-to-day basis, overall management is 19 responsible for the operation of the thrift. 20 Q. In looking at an institution such as 21 United Savings and looking specifically at the 22 largest loan in its portfolio of $80 million, 21833 1 Park 410, whom would you expect to be involved in 2 the making of that loan and the underwriting of 3 that loan? 4 A. In that sort of situation, since we're 5 talking about the largest loan in the history of 6 the thrift, I would expect the president, the 7 senior lending officer, both of them at a minimum 8 to be involved in the day-to-day management and 9 day-to-day negotiations and the overall 10 administration of that loan. 11 Q. Why would you expect that? Why do you 12 think that's important? 13 A. Well, at this point, we're talking 14 about basic common sense. If the president and 15 senior lending officer are not involved in 16 granting the largest loan in the history of the 17 thrift, when are they going to get involved? If 18 the president is not going to be involved in that, 19 what is he going to get involved in, then? 20 Q. What when you say "involved," what do 21 you mean? 22 A. Being aware of the overall comparables 21834 1 of the area, being involved in knowing what 2 appraiser is being picked out, being aware of the 3 reasoning for why the appraiser was picked out, 4 the assumptions he's using, the loan pricing, the 5 loan term, any problems, any difficulties that the 6 project may be undergoing. He really needs to 7 be -- he needs to be involved in the core 8 decision-making processes of such a loan. 9 Q. Let's look at Paragraph 26. You 10 mention that "It's the duty of the board of 11 directors to take all necessary steps to ensure 12 safe and sound policies and procedures are in 13 place and that they are followed." 14 Who is charged with establishing and 15 seeing to the enforcement of safe and sound 16 policies and procedures? 17 A. Again, it's ultimately the board of 18 directors' responsibility to set out the overall 19 policies and procedures. And, again, it's 20 basically the duty of the overall board to have 21 some sort of a process established to ensure that 22 management they have hired are following those 21835 1 policies and procedures. 2 Q. Have you ever seen cases in the span of 3 your career where management -- where -- strike 4 that. 5 Have you ever seen cases in the span of 6 your career where the board of directors does not 7 take action to enforce its own policies and 8 procedures? 9 MR. DUEFFERT: Objection, Your Honor. 10 We've been here for an hour and a half now, and I 11 have no doubt there's value to background and 12 context and procedures. The expert is designated 13 with respect to two loans files, and we're not 14 hearing about those two loans. 15 THE COURT: If that's an objection, 16 I'll deny it. Let's move this along. 17 MR. LEIMAN: We're at the end of this 18 road, Your Honor. 19 A. Could you repeat the question? 20 Q. (BY MR. LEIMAN) Yeah. Have you had 21 occasion to see cases where the board of directors 22 does not enforce its policies and procedures? 21836 1 A. Yes. 2 Q. And would that be -- would it -- would 3 the case that we've been -- you've been asked to 4 report on and testify about in USAT be such an 5 example? 6 A. Yes. 7 MR. LEIMAN: All right. 8 Q. (BY MR. LEIMAN) Now, let's get into 9 the analysis of the transactions, Mr. O'Connell. 10 THE COURT: This might be a good time 11 for a recess. We'll take a short break. 12 13 (Whereupon, a short break was taken 14 from 10:30 a.m. to 10:50 a.m.) 15 16 THE COURT: Be seated, please. We'll 17 be back on the record. 18 19 20 21 THE COURT: Be seated, please. We'll 22 be back on the record. 21837 1 MR. LEIMAN: Mr. Nickens, do you have 2 something? 3 MR. NICKENS: Yes. Your Honor, on 4 Friday, we had a discussion about Mr. Lapidus and 5 I indicated to the court it was our intention to 6 file a motion. I'm handing Mr. Langdon the 7 original and one copy of that motion. It involves 8 Mr. Lapidus, who we've been told will be the next 9 witness. I told Mr. Guido on Friday that should 10 we reach Mr. Lapidus this week, that I will go 11 ahead and conduct my examination, should we get to 12 that, while the motion is pending. As a pragmatic 13 matter, I just think that's the way to handle it 14 and not delay things. And it's likely that should 15 we get to Mr. Lapidus, he will probably be a 16 holdover anyway. And during the recess, the Court 17 would have a chance to -- well, the OTS would have 18 a chance to reply to my motion and the Court would 19 have a chance to consider it so we'd know where we 20 are. 21 So, this should not cause any delay., 22 and you know, whatever schedule makes sense as far 21838 1 as their reply, even if it occurs during the 2 recess. 3 THE COURT: Have you served a copy of 4 this on our office in Washington? 5 MR. NICKENS: Your Honor, it will be in 6 the mail. I have served counsel here, and it's 7 being sent to Washington by the normal process. I 8 don't know. What is it -- sent by Federal 9 Express? 10 THE COURT: There should be a copy to 11 the secretary of whatever, OTS, and a copy to our 12 office. 13 MR. NICKENS: Right. There is an 14 indication of service there, but it was just 15 completed in the last 15 minutes. So, that 16 process is still -- it is our intention to serve 17 them today. 18 THE COURT: All right. Thank you. 19 Mr. Leiman? 20 MR. LEIMAN: Yes, Your Honor. Thank 21 you. I just want to make a point for the record 22 that Mr. Fribert, who is another of respondents' 21839 1 experts in real estate matters, is now in the 2 courtroom in addition to Mr. Wallace. 3 THE COURT: Okay. Now we're going to 4 get into the loans? 5 MR. LEIMAN: Yes, we are, Your Honor, 6 right now. 7 Q. (BY MR. LEIMAN) Would you give me, 8 Mr. O'Connell, a key point summary as you 9 understand the Park 410 transaction from your 10 perspective? 11 A. The association's first involvement in 12 Park 410, I believe, began in late 1984 when the 13 institution or an affiliate -- it may have been a 14 service corporation, United Financial Corp. -- 15 expressed an interest in actually buying the 16 property outright. I believe there was an actual 17 offer of approximately 37 and a half million for 18 the property that was presented to the then 19 owners, Alamo partnership. 20 However, a different party eventually 21 wound up bidding, I believe, $39 million for the 22 property; and so, the institution's involvement as 21840 1 being the owner of the whole property fell by the 2 wayside in late 1984, early 1985. 3 The acquiring party, Gulf Management 4 Resources, eventually entered into a joint venture 5 with a number of parties, including Stanley 6 Rosenberg who, in terms of the original 7 acquisition offer by USAT, actually served as 8 USAT's attorney. Once that offer fell through, 9 the joint venture, the venture that purchased the 10 Park, approached Rosenberg about whether or not he 11 would be interested in buying a partial ownership 12 in the property. 13 Enter Rosenberg did, indeed, purchase I 14 believe it was a 50 percent interest in the 15 property. Mr. Rosenberg then contacted the 16 institution, asking whether the institution would 17 like to have an interest in his overall property. 18 There was then a letter agreement, I 19 believe, executed in March or April of 1985 in 20 which the thrift effectively purchased 50 percent 21 of -- boy, I get confused -- 50 percent of 22 Mr. Rosenberg's 50 percent interest in the 21841 1 property or basically 25 percent overall equity 2 interest in the project. And at the same time 3 would take over the cash flow requirements of 4 Mr. Rosenberg, the entire cash flow requirements 5 of Mr. Rosenberg, for the immediate future. 6 So, in late 1984, they tried to buy the 7 whole thing. In March of 1985, they wound up 8 purchasing a portion of it and effectively picked 9 up 50 percent of the cash flow requirements of the 10 joint venture. 11 Later in 1985, the joint venture 12 decided to go for a full development and 13 construction loan. And in early 1986, started 14 negotiating with the thrift for the thrift to 15 actually give the overall acquisition and 16 development loan. And by the spring of 1986, the 17 institution became -- took a lender's position, 18 made an 80-million-dollar acquisition and 19 development loan to the joint venture that now 20 owned the property, and in so doing, paid off its 21 own joint venture interest that it acquired in 22 March of '85. 21842 1 So, by the spring of 1986, the 2 institution was in an 80-million-dollar lender 3 position. 4 Q. Thank you, Mr. O'Connell. I'd like to 5 show you a document which has previously been 6 marked as A2057. 7 MR. EISENHART: Is there a tab number? 8 MR. LEIMAN: 211. 9 Q. (BY MR. LEIMAN) If you would, 10 Mr. O'Connell, look at the last page of this 11 exhibit. 12 You've seen it before? 13 A. Yes, I have. 14 Q. Okay. Do you see a photograph in the 15 bottom -- second row of photographs, Stanley D. 16 Rosenberg? Do you see that? 17 A. Yes, sir, I do. 18 Q. Mr. Rosenberg was a member of the board 19 of directors of MCO Holdings. 20 Are you aware of that? 21 A. Yes. In fact, I believe this is a 22 financial statement of MCO Holdings. Yes. In 21843 1 fact, the -- I believe around ten pages into it, 2 we actually see it starts the Form 10K of MCO 3 Holdings, Incorporated which -- 10Ks normally 4 include the audited financial statements. 5 Q. Mr. O'Connell, of what significance is 6 it that USAT used Stanley Rosenberg as its lawyer 7 and later as its partner? 8 Is that significant in some way? 9 A. The thing that bothers me -- and it 10 really -- I don't want to say, by the way, that I 11 believe Mr. Rosenberg was an affiliated party. 12 Checking the regulations, I don't think it is, 13 indeed, clear that he would be a controlling 14 person. But there is an appearance of conflict 15 issue primarily from the standpoint of the USAT 16 individuals that were negotiating this transaction 17 with Mr. Rosenberg in March of '85. 18 The fact that Mr. Rosenberg was a 19 director of the leading shareholder of the thrift 20 puts the officers of the thrift in at least an 21 uncomfortable position of not really wanting to 22 offend Mr. Rosenberg or not particularly wanting 21844 1 to, say, take an overly negative position towards 2 him. So, it's more of an appearance of a conflict 3 of interest; but I did not site any specific 4 regulatory violation of it. 5 Q. Would you have expected some kind of 6 inquiry on the part of management or the board of 7 directors with regard to the status of Stanley 8 Rosenberg with respect to him as a co-venturer as 9 well as an attorney role? 10 A. Could you repeat that? I'm not quite 11 sure actually. 12 Q. Would you have expected some kind of 13 inquiry or question to have been raised by the 14 board of directors or senior management in the 15 file or on paper with regard to Mr. Rosenberg's 16 role? 17 A. I think what I would have expected from 18 the standpoint of overall comfort level would be 19 some sort of a letter from Mr. Rosenberg 20 explaining how he moved from being an attorney for 21 the association, representing the association on 22 the same transaction, going from the attorney to 21845 1 being actually a co-buyer of the project. 2 I saw testimony, I believe, of both 3 Mr. Rosenberg and Mr. Gindy laying out the time 4 frames. So, again, I'm not alleging there was 5 necessarily a violation. At the very least, there 6 should have been some sort of itinerary -- some 7 sort of chronology laid out by Mr. Rosenberg 8 stating how he got from one role to the other 9 role. 10 Q. You mentioned there was a letter 11 agreement with Mr. Rosenberg. 12 A. That is correct. 13 Q. Would you have expected that that 14 letter agreement would have been in some manner 15 formalized and/or recorded with some State of 16 Texas text governmental entity? 17 A. Yes. In fact, I believe the letter 18 agreement itself indicated that eventually there 19 would be some sort of a formal joint venture 20 agreement or cooperation agreement or some sort of 21 a formal agreement specifying the terms and 22 conditions of the agreement between Mr. Rosenberg 21846 1 and the association. 2 So, not only would I have expected 3 that, I believe the letter itself presumed that 4 such a document was going to be created. 5 Q. Would the failure to have such a 6 document, a formalized document, constitute in and 7 of itself a books and records violation? 8 A. In my view, yes. 9 Q. How come? Why? 10 A. Because we're talking about 11 multi-million dollars of exposure. We're talking 12 about a 2-million-dollar letter of credit that was 13 put up immediately. We're talking about the 14 funding of interest payments and other expenses, 15 at least 50 percent of the interest payments and 16 other expenses of the institution over a period of 17 time which would amount to -- I believe in the 18 real estate investment committee minutes, it's 19 even estimated to be about 7, 7 and a half million 20 over the next two years. 21 So, yes, I would expect something 22 beyond a two-Page letter agreement to justify such 21847 1 a multi-million-dollar exposure. 2 Q. Let's talk for a few minutes about the 3 paragraph -- you reference here in 4 Paragraph No. 34 the sell being financed by three 5 non-recourse loans totaling $38 million provided 6 by the Alamo partnership. 7 You're talking there about Alamo's 8 financing of the joint -- the first joint venture 9 of Park 410. Right? 10 A. That is correct, yes. 11 Q. Of what significance is it that the 12 notes that were financing that particular venture 13 were non-recourse? Why is that important? 14 A. It meant that at the -- I believe they 15 were two-year notes. At the end of the two-year 16 period or even during the course of the two-year 17 period, if the joint venture decided just to 18 default on the loans on the interim basis, that 19 the joint venture partners could just walk away 20 from the project and their losses would be capped 21 at whatever cash flow they had already put 22 forward, cash flow and other collateral. It would 21848 1 mean that the joint venture partners did not have 2 to pay off the entire principal of those loans, 3 that the principal of the loans essentially was 4 secured only by the property. 5 Q. So, does the fact that the notes are 6 non-recourse mean -- that you've mentioned here in 7 your report in Paragraph 34, does the fact that 8 the notes were non-recourse mean that there was no 9 interest due and owing on those notes? 10 A. No, that's not true. In fact, there 11 were periodic interest payments made over the next 12 several months, next few quarters before it 13 finally -- before the new loan closed in April of 14 '86. 15 Q. Look, please, at Paragraph 35 of your 16 expert report, T7452. You talk about the 17 potential outlay being $32.5 million. 18 How did you come up with that 19 particular figure? 20 A. Actually, it came from a GMR analysis 21 of the project which indicated an overall cost to 22 develop of -- I believe it was $64.8 million. And 21849 1 50 percent of that, which was Mr. Rosenberg's 2 overall exposure, would have been 32 and a half 3 million. 4 Q. Have you read Mister -- Mr. O'Connell, 5 have you read the board of directors minutes with 6 regard to the limitation on real estate 7 investments without board of directors approval? 8 A. Yes, I have. 9 Q. How much is the limitation with respect 10 to exposure in that regard? 11 A. I believe just the month prior to this 12 investment being made, in February of '85, I 13 believe the limitation was fixed at 2.5 million. 14 Q. Now, with respect to that, you 15 mentioned a few minutes ago that the real estate 16 investment committee minutes indicated that there 17 was a 7-million-dollar or 18 7-and-a-half-million-dollar possible outlay by 19 USAT? 20 A. Actually, I think -- well, we could 21 actually rely on the document by -- I believe it 22 said 7, $7 and a half million just for the first 21850 1 two years. That would not represent the actual 2 total exposure if they decided to develop the 3 project. 4 Q. If they decided to develop the project, 5 is that where the 32-and-a-half-million-dollar 6 exposure would come in? 7 A. Yes, that is correct. The problem with 8 a full development, at least from the documents 9 I've seen and actually the testimony I've seen, a 10 full development would have been gone well beyond 11 the two-year term of the Alamo note. So, they 12 would have had to find other sources of funds or 13 restructure the Alamo partnership note. But if 14 they were going to go for full development, yes, I 15 think the estimate at that time was about 16 $65 million for the whole thing. 17 Q. In Paragraph 37, Mr. O'Connell, you 18 state that the agreement to take on 19 Mr. Rosenberg's financial obligations was not 20 approved by USAT's board of directors contrary to 21 USAT's policies. 22 Do you see that? 21851 1 A. Yes, I do. 2 Q. Have you seen any reference to the 3 board of directors itself approving this 4 particular investment? 5 A. No, I have not. 6 Q. Was there a joint venture agreement 7 between Mr. Rosenberg and his co-venturers of GPR 8 and IPIC? 9 A. Yes, there were. 10 Q. All right. What would be the net 11 effect of that joint venture agreement? 12 A. Well, since the association was picking 13 up all the cash flow obligations of Mr. Rosenberg 14 when they entered into their agreement with 15 Mr. Rosenberg, essentially the association was 16 bound to supply the cash flow required by that 17 joint venture agreement. 18 Q. Are there any particular provisions in 19 there that would have required that? 20 A. There is a reference to the joint 21 venture partners, it would be assumed that they 22 would fund any and all funds included within a raw 21852 1 budget that was prepared by the joint venture. 2 Q. Let's look at Paragraph 38 of your 3 report. You talk about the agreement to take over 4 Mr. Rosenberg's obligations left a potential real 5 estate investment of $32 and a half million. 6 How does the prescribed risk or reward 7 split in the Rosenberg/USAT partnership affect the 8 allocation of risk? 9 A. Excuse me? Could you repeat that? 10 Q. Yeah. If you're balancing out how much 11 USAT had to gain versus how much its downside was, 12 how did that come out? 13 A. Oh, okay. The problem with the USAT 14 agreement is, as I said, they were taking over 15 twice the amount of the cash flow exposure for 16 only half of the upside. The -- 17 Q. What do you mean by "half of the 18 upside," Mr. O'Connell? 19 A. Mr. Rosenberg had a 50 percent overall 20 interest in the joint venture of which the 21 association would pick up all of the cash flow 22 obligations. Now, subsequently, presuming profits 21853 1 would be made, Mr. Rosenberg did have an 2 obligation to pay those back. 3 So, to the extent that Mr. Rosenberg 4 had -- I really do feel more comfortable -- can I 5 just use numbers, theoretical numbers. 6 Q. If it helps to illustrate your point. 7 MR. DUEFFERT: Your Honor, I would ask 8 if he could use real numbers, that would be better 9 than theoretical numbers. 10 A. Okay. At the time of the April -- I 11 think it was April 1986 closure, I believe the 12 joint venture of the association paid off the 13 joint venturers about $2.5 million. I think it 14 was in the closing statement. Of that, 15 Mr. Rosenberg's half of the expenses would have 16 been 1.4 million. That 1.4 million would have 17 been funded entirely by the thrift. 18 Now, in theory, Mr. Rosenberg -- and 19 again, we don't know if he had -- whatever they 20 had come up with; but in theory, if the money had 21 to come from Mr. Rosenberg, he would have had to 22 subsequently lend to the institution or give to 21854 1 the institution half of that 1.4 or $5 million. 2 We don't know if that ever would have happened. 3 But the problem with that is what we're saying is 4 actual cash flow exposure of 50 percent of the 5 operations against only 25 percent of the actual 6 profits. 7 So, that's what I mean by the -- in 8 terms of the imbalance between the risk of the 9 association versus the potential benefit. 10 Q. What about the letter of credit issue? 11 A. Well, the letter of credit, again, was 12 funded entirely by the institution. Again, 13 Mr. Rosenberg in theory would have had to have 14 refunded half of that cost if the letter of credit 15 was ever cashed in. But again, we don't know if 16 that ever would have happened because it was 17 cancelled at the time of the 1986 transaction. 18 Q. Let's look at Paragraph 40 of your 19 report, T7452. You mention here "USAT made this 20 investment without any evidence of obtaining 21 independent appraisals of the property." 22 Why would it be important to get an 21855 1 independent assessment of value? 2 A. Again, it's just a basic issue of 3 safety and soundness. And the requirement to have 4 an assessment of the overall property in any 5 investment you have, you need to be able to 6 support the valuation on your balance sheets. You 7 just cannot buy anything, whether it be a piece of 8 real estate, whether it be a car, whether it be a 9 table or something, without some sort of an 10 independent assessment of value. 11 In the case of a real estate investment 12 that had a potential outlay of 32 and a half 13 million, that the institution might be capitalized 14 multi-million dollars of expenses on their books, 15 they need to have some sort of an arm's length 16 assessment of the value of the property. 17 Q. Looking now at Paragraph 41, 18 Mr. O'Connell, you say "In 1985, a decision made 19 to convert the project to an active development." 20 Do you see that? 21 A. That is correct, yes. 22 Q. Why is it -- is it important that a 21856 1 decision -- to your mind, is it important that a 2 decision to convert the project to active 3 development was made? 4 A. Yes, it was. 5 Q. Why? 6 A. Well, for several reasons. First of 7 all, it meant that the joint venturers were going 8 to be forced to get a new loan. Again, the Alamo 9 partnership was only a two-year loan. And I think 10 the development budgets were projecting a five- or 11 six-year project. 12 In addition to that, we also saw an 13 increase in the overall costs of the project. 14 Budget items seen in the spring of 1985 or at 15 least the projection I had seen indicated the 16 costs of development to be approximately 17 65 million. Now, six or seven months later, they 18 are talking about a 75- to 80-million-dollar cost. 19 So, from the standpoint of -- they were 20 going to be forced to get some sort of financing 21 other than the Alamo partnership loan and the cost 22 to complete, this was a very significant 21857 1 development. 2 Q. Could USAT -- strike that. 3 Could the partnership, the joint 4 venture, have sold the property or flipped it? 5 A. Yes. 6 Q. Well, is it significant that they 7 didn't? 8 A. Obviously, it's significant in the 9 sense that if they had just sold the property, 10 then the acquisition and development loan would be 11 a non-issue. It would be somebody else's 12 responsibility. But other than that, no. I'm 13 hesitant to speculate on a theoretical 14 transactions. 15 Q. So, there is nothing you can tell about 16 what the condition of the markets were at the time 17 based upon the lack of sale of the property? 18 A. No, not just based on that, no. 19 Q. Okay. Let's look, please, at 20 Paragraph No. 44. 21 A. Okay. 22 Q. You mention here that USAT was not in a 21858 1 position of an un interested third party at the 2 point that it -- the financing was sought. 3 What do you mean by "uninterested third 4 party"? What is that? What are you referencing 5 there? 6 A. Meaning somebody who had no interest at 7 all in whether or not the transaction would ever 8 close. That is ideally what you would be looking 9 for, particularly from an appraiser. It is 10 somebody who would assess the value and has no 11 interest at all whether or not the loan closes, 12 the real estate sale closes. It's just to give 13 his best overall assessment of the value of the 14 property. 15 In this particular case, since USAT 16 already had millions of dollars of exposure on the 17 property, they were somewhat caught. If they 18 decided to walk away from this project, they would 19 suffer -- they would suffer at least the potential 20 of multi-million-dollar losses so they weren't an 21 uninterested third party. They had a very strong 22 interest in seeing some sort of financing take 21859 1 place. 2 Q. What kind of cost would they -- or 3 losses would they have incurred? 4 A. Well, again, the potential losses at 5 this point I think would have been about 3 to $3 6 and a half million based on the numbers I saw at 7 that time. 8 Q. And what would that affect in terms of 9 their balance sheet? What line item? 10 A. That would have been a reduction in 11 retained earnings. 12 Q. All right. And what would that relate 13 to? 14 A. That would be your reduction in their 15 capital, the net worth at the time. 16 Q. And would affect those -- how would 17 that affect things? 18 A. Well, again, it would show up as -- not 19 only would it be a reduced capital level, but it 20 also would have shown up as a loss on the books. 21 It would have shown up as an additional loss on 22 their thrift financial reports. That would have 21860 1 led to -- although given the size of the thrift, 2 I'm not sure if a 3-million-dollar loss in and of 3 itself would have led to more supervisory action. 4 Clearly, it would show somewhat of a more 5 distinct -- the overall operating earnings would 6 have been reduced by that whole amount. 7 Q. Are you aware of any other thrifts or 8 savings and loans or banks or other entities that 9 were interested in making a loan to the joint 10 venture partnership in connection with Park 410? 11 A. I'm aware of at least one institution. 12 I believe it was Gibraltar that -- I saw a letter 13 in the T7000 files indicating a very tentative -- 14 a very tentative offer. 15 Q. Do you know if that ever came to 16 fruition? 17 A. No, it did not. 18 Q. What advantage was there for USAT to 19 pay off the advanced funds and to make a new loan? 20 A. Well, there would be several factors 21 involved. First of all, the institution again 22 would -- they would be able to eliminate the 21861 1 possibility of a loss on their roughly 3 to $3 and 2 a half million of exposure. And that was -- I 3 believe we talked about earlier about a million 4 4 is what we could conclude from the loan and 5 closing statement, the actual cash outlays plus a 6 2-million-dollar letter of credit. 7 So, they could eliminate that 8 possibility. They could also free up -- since 9 they were going to book this as an ADC loan, they 10 could free up the 3 million plus of direct 11 investment authority. 12 By paying it off, the institution -- I 13 had seen records -- was always running up against 14 their direct investment limitations. In fact, I 15 believe they had already made a filing with the 16 Federal Home Loan Bank of Dallas for approval to 17 make more investments above and beyond the 18 10 percent, 10 percent of total assets. 19 So, you devoid a loss. You reduce your 20 direct investment levels. Plus, in the booking of 21 loan fees, they would be able to book -- I believe 22 they eventually booked $2.4 million in '86 on an 21862 1 80-million-dollar transaction. 2 So, eliminate the possibility of a 3 loss, reduce their direct investment levels, and 4 book origination fees. 5 MR. DUEFFERT: Your Honor, I'm just 6 having one problem with the witness' answers. I'm 7 hearing what I think was a subjunctive tense, like 8 what would happen. I'm hoping that if the witness 9 is actually talking about what did happen, that he 10 will clarify that. 11 MR. LEIMAN: I don't know what the 12 subjunctive tense is, Your Honor. His answers 13 sound fine to me. If there is -- 14 Q. (BY MR. LEIMAN) I guess what is being 15 asked is if something is possible, say it's 16 possible. If it's actual, then that's fine. Or 17 if it's appropriate to say it's possible, then do 18 that. 19 Paragraph 46. You talk about an 20 80-million-dollar loan and other costs incurred to 21 date, loan fees. We see on one of the closing 22 statements a 400,000-dollar fee payable to -- or 21863 1 paid to Stanley Rosenberg. 2 A. That is correct, yes. 3 Q. Were you able to -- have you ever been 4 able to figure out what that fee is for? 5 A. Frankly, no. 6 Q. Have you seen any explanation of it? 7 A. Oh, sure. Mr. Rosenberg's -- in 8 Mr. Rosenberg's testimony, he spent some time 9 discussing how he felt he was entitled to the fee, 10 the services he performed on behalf of the 11 institution. So, yes, I've seen Mr. Rosenberg's 12 explanation, yes. 13 Q. That wasn't Mr. Rosenberg's testimony 14 in this courtroom. It was in a deposition? 15 A. That was a deposition, correct, yes. 16 Q. Tab 711, T7143, please. T7143, 17 Tab 711. 18 Mr. O'Connell, have you seen T7143 19 previously? 20 A. Yes, I have. 21 Q. Just for the record, what is it? 22 A. This is an appraisal of the Park 410 21864 1 project as of -- I believe it was December 31st. 2 Yes. December 31st, 1985. The appraisal was 3 actually dated February 12th, 1986, by the 4 appraisal firm of Love & Dugger of San Antonio, 5 Texas. 6 Q. And the amount of the appraisal is how 7 much? 8 A. As I recall, it was around 47 -- yes. 9 I rounded up to 47 million. It's actually 10 46,560,000. 11 Q. Would this appraisal be of importance 12 in underwriting the Park 410 transaction? 13 A. Yes, certainly. 14 Q. Why? 15 A. What this appraisal does is actually 16 give an assessment of the value of the Park 410 17 project as it currently exists. So, it takes the 18 property in its current vacant unimproved status, 19 applies various appraisal tests to it, including 20 the income approach -- they do, in fact, assume 21 that the project is going to be developed and sold 22 out -- but then they present value the sales 21865 1 proceeds back to the present. 2 So, this is an actual current appraisal 3 of the project as it currently exists as vacant 4 land. 5 Q. I just -- one more time. Why is that 6 important to have that value? 7 A. Because that is ultimately the value of 8 the property that you're making the loan on, the 9 value of the property as it currently exists. 10 Q. Could I have T7084, please? That would 11 be Tab 709. 12 Let me hand you another appraisal, 13 Mr. O'Connell. This is T7084, Tab 709, and ask 14 you if you've seen this one before. 15 A. Yes, I have. 16 Q. Okay. Identify it for the record, 17 please, as to what it is. 18 A. This is an appraisal again of the 19 Park 410 project. The "as of" date is 20 February 17th, 1986. The appraisal itself is 21 dated March 19th, 1986. And it is perform by 22 Edward Schulz, Edward B. Schulz & Company of 21866 1 Houston, Texas. 2 Q. How much is it for? 3 A. $88 million. 4 Q. Would this particular appraisal be 5 important to management in underwriting the 6 Park 410 loan for $80 million? 7 A. I personally would say no. 8 Q. Why? 9 A. There are several factors, one of which 10 is that the comparables are not very comparable, 11 as I go later on in my opinion. 12 So, if the actual real estate 13 comparables are not comparable to the project 14 being assessed, then the overall conclusions have 15 to be questioned. 16 Secondly, this is not an appraisal as 17 the property currently exists. This is a 18 projected appraisal of what the property would 19 exist after all development is in and sales have 20 actually started. 21 Q. What do you mean? 22 A. To presume a developed state of the 21867 1 project is to presume, basically, a future value. 2 You would -- and the numbers that I have seen and 3 the projections I have seen is that it was going 4 to take anywhere from one to three years to fully 5 develop it with some sales occurring in, say, 6 Year 2. 7 So, for the sake of -- I'm going to use 8 a two-year average time to development if I could 9 use that. By using a presumed developed property, 10 you are presuming the property as it exists two 11 years from today. 12 Q. What's wrong with that? 13 A. It would be similar to a stock analyst 14 making a projection to buy General Electric -- I'm 15 using General Electric because I think it's the 16 largest stock in the world, about $280 billion 17 worth or something. 18 General Electric is selling, I believe, 19 at about $90 a share. If a stock analyst is 20 saying you should buy it because I think it's 21 going to be worth $150 a share in two years, this 22 appraisal effectively says it's worth $150. It's 21868 1 not worth $150. It's worth $90. It might be 2 worth $150 a share in two years if everything goes 3 right, if the economy goes according to plan, if 4 the profits go according to plan. 5 For this particular project, he is 6 presuming that the development is going to go on 7 per budget, that all other improvements are going 8 to be performed as budgeted, that the economy is 9 going to maintain stable or improve per budget. 10 All of these are just projections of 11 what might happen. And you can make such 12 projections, but you then have to discount them 13 back to the present, which is what Mister -- what 14 Love & Dugger did. They projected it back to its 15 current value. This is just a predicted future 16 value when it's fully developed. 17 Q. Would the use and reliance by USAT upon 18 this particular appraisal by -- upon the 19 88-million-dollar Schulz appraisal by USAT violate 20 any regulation you're aware of? 21 A. I personally would find it a violation 22 of the R-41B regulation, and also it's just an 21869 1 unsafe and unsound practice to base any type of 2 loan decision on an appraisal that has such very 3 poor methodology. 4 Q. Now, let's talk about R-41B just for a 5 second. I won't belabor the point. 6 Are you certain that R-41B is a 7 regulation? 8 A. It's actually a policy guidance; but as 9 I recall, the actual underwriting documents make 10 reference to the overall policy statement. So, we 11 could actually refer to the underwriting document 12 itself; but I believe the loan underwriting 13 documents make reference to appraisers -- 14 appraisals being done per Bank Board policy. 15 MR. DUEFFERT: Move to strike. He was 16 not asked not about what the loan underwriting 17 document said but his opinion. The answer was 18 nonresponsive, I believe. He just talked about 19 loan underwriting documents, and I believe he was 20 just asked is it a regulation or not. 21 THE COURT: Yeah. Let's have the 22 answer to that. 21870 1 THE WITNESS: Okay. It is not itself a 2 regulation, no. It's a policy statement by the 3 Bank Board. 4 THE COURT: Thank you. 5 Q. (BY MR. LEIMAN) In your experience as 6 a thrift regulator, in your experience working in 7 a savings and loan, are you familiar with -- did 8 you have or gain familiarity with R-41B? 9 A. Yes. 10 Q. Did savings and loan institutions 11 recognize generally that R-41B was the applicable 12 standard in the time frame of 1984 through the 13 period of this Park 410 loan in 1986 that R-41B 14 was the applicable standard to which appraisals 15 had to conform? 16 A. Yes. In fact, I believe both of these 17 appraisers -- appraisals even make reference to 18 them. 19 Q. What do you glean from the fact that 20 these appraisals make reference to R-41B? 21 A. That the industry and the appraisals -- 22 and the appraisers that worked for the industry 21871 1 knew that R-41B was the guiding policy. 2 Q. You mentioned comparables. 3 A. Yes. 4 Q. Do you have -- are you able to put your 5 finger on an illustration of what you meant by 6 "inappropriate comparables"? 7 A. Sure. Actually, I wish I had noted 8 page numbers. If you'll note in Section -- 9 Paragraph 50 to 52, there is a reference to the 10 differences in comparables. I believe 11 Love & Dugger actually gave a summary of, say, the 12 land comparables -- 13 Q. If you would, take a look at Page 71, 14 Mr. O'Connell. 15 A. Thank you. I'll accept any help at 16 this point. 17 Q. In T7143. 18 A. Okay. Thank you. Yes. (Witness 19 reviews the document.) All right. On Page -- 20 Q. This is the Love & Dugger appraisal. 21 A. Right. The summary of comparable land 22 sales. If you look at the size of the acreage 21872 1 that Love & Dugger chooses for their land 2 valuations, you'll notice that the smallest 3 acreage that they use -- I think it was Sale 4 No. 7 -- was 98 acres. And it goes up to, I 5 believe, 327 acres in Sale 2. 6 So, even for Love & Dugger, who was 7 actually based in San Antonio -- and thus probably 8 had more immediate access to land values, even he 9 wasn't able to find a 400-acre comparable. But at 10 least he -- at least was in the ballpark. He was 11 making an effort to find very large land tracts to 12 make a valuation estimate. 13 So, here you've got -- the smallest 14 land comparable was 98 acres, I believe, on Edward 15 Schulz'. 16 And, again, I'll try to find that 17 summary. I believe his largest comparable was 18 only 50 acres. 19 Q. If you'd turn to Page 32 in Mr. Schulz' 20 appraisal, I think that will help you locate that. 21 A. 32 is the beginning of it. I thought 22 he also had a chart. In fact, I'm pretty sure he 21873 1 did. 2 Q. Well, what's -- let me ask you this, 3 Mr. O'Connell. What's the relationship between 4 acreage or comparable acreage and the value that's 5 derived from it? 6 A. Real estate -- obviously, each 7 individual parcel has its own unique valuation 8 characteristics to it. But nevertheless, real 9 estate does operate under the same laws of supply 10 and demand. To the extent that there is a greater 11 supply of real estate outstanding as opposed to 12 the demand that's out there, the price is going to 13 decline. For real estate, as opposed to almost 14 any commodity, if you're trying to market a 15 400-acre lot, you're going to get less per acre of 16 land than if you're just selling a 2- or 3-acre 17 lot. Again, this is just a fairly elemental part 18 of supply and demand. And I believe, in fact, 19 that Mr. Bolin even makes reference to -- 20 Q. Mr. who? 21 A. Mr. Bolin even makes reference to that 22 fact in his appraisal. I'm sorry. Mr. Dugger. 21874 1 I'm getting confused. Mr. Dugger made reference 2 to that in his appraisal. But in terms of -- I do 3 want to find that chart for Mr. Schulz. 4 Mr. Schulz has a series of comparables 5 starting on Page 32, but I believe he had an 6 actual chart summarizing all of them. 7 Q. Well, maybe we can come back to that. 8 A. Whoops. Wait a minute. Page 41. 9 Q. Page 41 of -- 10 A. Yes. 11 Q. -- Exhibit 7084? 12 A. Yes. 13 Q. What are you talking about with regard 14 to that page? 15 A. If you compare Page 41 of the Schulz 16 appraisal with the page we looked at earlier for 17 the Love & Dugger appraisal, again, the 18 Love & Dugger appraisal actually had comparables 19 of, as I said, from 98 acres to 327 acres. 20 Schulz actually gave one comparable of 21 slightly less than an acre to only as high as 22 50 acres. The Schulz comparables simply are not 21875 1 comparable. 2 Q. Are you telling me that would skew the 3 results in terms of comparables? 4 A. Sure. Again, by trying to compare 5 smaller lots to a 400-acre project, you're 6 effectively increasing the overall per lot value 7 because, again, 400 acres being sold on a per-acre 8 or per-lot basis is going to come in less than if 9 you were selling just a handful of acres. 10 Q. And the fewer acres that are sold would 11 translate into a higher per square foot price? 12 A. That is correct, yes. 13 Q. Please turn with me to Page No. 18 in 14 T7143. And that would be Love & Dugger's 15 appraisal. 16 A. Okay. 17 Q. And look at the middle paragraph which 18 is the first full paragraph on the page. 19 A. Okay. 20 Q. You talked earlier in your testimony, 21 Mr. O'Connell, about the history of USAT with the 22 Park 410 property. 21876 1 A. Okay. 2 Q. In this middle paragraph, the 3 appraiser, Love & Dugger, talk about the total 4 amount of office space in San Antonio. 5 A. That is correct. 6 Q. Would that be an important factor in 7 terms of USAT's understanding how much it should 8 loan in connection -- in terms of its underwriting 9 of the Park 10 loan? 10 A. Oh, sure. This is -- a basic part of 11 loan underwriting is somewhat are the supply and 12 demand features going on in the market that the 13 loan is being made. 14 Q. Look at -- of your report, sir, 15 Paragraph No. 55. You talk about opinion 16 shopping. 17 My question to you is: To what are you 18 referring with respect to opinion shopping? 19 A. Essentially, opinion shopping is the 20 idea of trying to shop for a favorable opinion to 21 fit a pre-determined decision, that somebody is 22 not looking for an independent assessment, whether 21877 1 it be an appraisal, but somebody is looking for a 2 pre-determined decision and is going to shop 3 around until they get somebody who gives that 4 pre-determined decision. 5 Q. Why would they be looking for a 6 pre-determined figure? 7 A. Because it really cuts away at the 8 foundation of getting appraisals in the first 9 place. You're supposed to get appraisals to get 10 an independent assessment of value. If you're 11 just using appraisals as a document -- as a file 12 stuffer, just to say, "Well, we've got some sort 13 of an appraisal to fit the requirements," then 14 you've really gutted the entire purpose of it. 15 If you're not going to get an 16 independent assessment of value, then you really 17 are just saying, "I've been to the property. I 18 think it's worth this," and that's it. 19 And if you want to say that that is a 20 safe and sound practice, you can make the 21 argument. But I consider it very reckless. 22 Q. Mr. O'Connell, did you see any evidence 21878 1 that USAT had carefully considered and reviewed 2 Love & Dugger's appraisal that's in front of you 3 as Exhibit T7143 at Tab 711? Did you see any 4 evidence of that? 5 A. No, I did not. 6 Q. Could we have T7127, please? This is 7 Tab 710. 8 A. Before we go any further, can I put one 9 of these away or should I keep them open? 10 Q. You can set them aside. 11 A. Okay. Good. Thank you. 12 MR. EISENHART: Is there a tab number 13 on that? 14 MR. LEIMAN: Yeah. It would be 15 Tab 710. 16 Q. (BY MR. LEIMAN) Mr. O'Connell, have 17 you seen this feasibility study before? 18 A. Yes, I have. 19 Q. Would you identify T7127 for the 20 record? 21 A. This is -- it's -- I will state -- I 22 can't recall if they actually use the word 21879 1 "feasibility." They do use the word "market 2 potential." Be that as it may, it's an analysis 3 of market potential of Park 410 West Development 4 prepared by Tremar Real Estate Research, 5 Incorporated based in -- I believe it is Houston, 6 Texas. 7 Q. Have you reviewed this analysis of 8 market potential? 9 A. Yes, I have. 10 Q. Do you believe that it supports the 11 making of an 80-million-dollar loan in connection 12 with Park 410? 13 A. In my own personal belief, no. 14 Q. Why not? 15 A. What Tremar basically -- 16 MR. DUEFFERT: Your Honor, I just want 17 to clarify. Is he speaking now not as an expert 18 but as a person? I understand his expertise in 19 rules and regulations and safety and soundness; 20 but when he says "in my own personal opinion," I 21 just don't know what that means. 22 THE COURT: Are you offering it as an 21880 1 expert opinion? 2 THE WITNESS: Only insofar as "can this 3 be used to justify the loan?" That's the only 4 thing. I'm not an expert in certainly analyzing 5 the San Antonio real estate market or something 6 like that, no. 7 THE COURT: What you're saying as an 8 expert is that this does not support the loan, or 9 what are you saying? 10 THE WITNESS: Not in terms of 11 fulfilling the regulatory requirements, no, it 12 does not. 13 MR. LEIMAN: Let me ask a different 14 question if I could, Your Honor. 15 Q. (BY MR. LEIMAN) Have you read the 16 Tremar study? 17 A. Yes, I have. 18 Q. Okay. In looking through and reviewing 19 and reading the Tremar study, did you see any 20 indication in the Tremar study that making a loan 21 in the amount of $80 million would not be 22 supported by this study? 21881 1 MR. DUEFFERT: Objection. I don't 2 understand the question. Could he restate it? 3 THE COURT: I don't understand it 4 either. 5 Q. (BY MR. LEIMAN) What were the 6 negative -- were there any negative factors that 7 you saw in the Tremar study? 8 A. Well, certainly, yes. But I think from 9 the standpoint of being able to make reference to 10 this document as supportive of an 11 80-million-dollar loan, it was clearly inadequate. 12 Q. Why would it be inadequate? And you're 13 speaking now as an expert? 14 A. Right. 15 Q. And why would it be inadequate? 16 MR. DUEFFERT: Your Honor, just to 17 clarify, inadequate for purposes of a regulatory 18 requirement? I just don't understand the standard 19 that he's using, and that's all I'm asking for. 20 Q. (BY MR. LEIMAN) For purposes of 21 underwriting, safety and soundness, Mr. O'Connell, 22 why would it be inadequate? 21882 1 A. Because this is not an assessment of 2 the collectibility of a loan that would be made on 3 the project. This is as it is. It is a market 4 potential. It is not a formal appraisal. 5 Q. Would reliance solely upon the Tremar 6 study and its conclusions, in your opinion as an 7 expert, constitute an unsafe and unsound practice? 8 A. Let me have that question back. 9 MR. LEIMAN: Would you read it back for 10 the witness, please? 11 12 (The record was read by the court 13 reporter, as requested.) 14 15 MR. DUEFFERT: I'll object to the 16 extent that the question assumes that this is the 17 only document they looked at. The word "solely" 18 is in there. If it's expressly a hypothetical, I 19 don't think it's of any value. 20 MR. LEIMAN: Well -- 21 THE COURT: Are you contending that the 22 loan was made solely on this document? 21883 1 MR. LEIMAN: Let me ask a preliminary 2 question, Your Honor. 3 Q. (BY MR. LEIMAN) Do you have an 4 indication that USAT reviewed the Tremar study? 5 A. Yes, they did. At least, there is 6 indication in the correspondence that they did 7 review it. 8 Q. All right. And do you have any basis 9 for your conclusion that the Tremar study would 10 not have -- would have violated the safety and 11 soundness principles if it were relied on solely 12 for purposes of making this loan? 13 MR. DUEFFERT: Your Honor, that's the 14 same objection. I still don't understand what 15 we're doing here. 16 THE COURT: Are you going to restate 17 your question? 18 Q. (BY MR. LEIMAN) Let me see if I can 19 restate this question, Mr. O'Connell. 20 Would it have been a violation of 21 safety and soundness principles, hypothetically, 22 for USAT to have relied solely upon the Tremar 21884 1 study in making this 80-million-dollar loan. 2 MR. EISENHART: Your Honor, I don't 3 think making it a hypothetical question changes 4 anything. He's asking him to assume that this 5 document was relied on solely, and there is no 6 evidence in the record to support that contention. 7 MR. DUEFFERT: I think the point is 8 it's just a worthless question. I just don't see 9 the point of this. 10 THE COURT: I'll sustain the objection. 11 MR. LEIMAN: Let me move on, Your 12 Honor. 13 Q. (BY MR. LEIMAN) Looking at 14 Paragraph 59 of your report, you state that an 15 indication of no serious independent underwriting 16 was done on the loan or minutes of a loan 17 committee meeting of February 10, 1986, which 18 indicated the closing of the Park 410 loan was 19 likely the following month. You indicated, "This 20 indicated closing comes before any informal 21 approval process had been under taken." 22 What's significant about that fact? 21885 1 A. The fact that the members of the senior 2 loan committee had been presented with what was 3 effectively a fait accompli, that this loan was, 4 in fact, going to be funded around the end of 5 March, the senior loan committee had not yet had a 6 formal underwriting document sent to it by the 7 chief lending office of the thrift. In fact, I'm 8 not even sure if the Edward Schulz appraisal, 9 which they eventually used to justify the loan, 10 was even ordered by that time. 11 Essentially, that was an indication to 12 me that the senior loan committee had already made 13 the pre-determination that this loan was going to 14 be funded no matter what. 15 Q. Were there any other examples as to 16 whether there were pre-decisions made regarding 17 the Park 410 loan? 18 A. Actually, could you have that read back 19 again? 20 Q. Let me ask the question again. 21 A. Okay. 22 Q. Are there other examples that you came 21886 1 across in your review as to the decision being 2 made prior to the SLC meeting approving this loan 3 that suggested to you that a decision to fund 4 Park 410 had already been made? 5 A. Yes. 6 Q. What are those? 7 A. Well, among the factors -- and I think 8 I made reference to a letter -- I think it was 9 between Messrs. Gindy and Graham -- indicating the 10 requirements for an appraisal, of the numbers that 11 needed to be done in order to get the loan to 12 close which is an indication to me that, again, 13 the loan was going to close no matter what and 14 they were going to get whatever number from the 15 appraisal was required to get the loan to fund. 16 I've also seen testimony from Mr. White 17 regarding how projections were massaged, if you 18 will, in order for various sales projections to 19 meet the overall ultimate evaluations. 20 So, yes, I've seen a fair amount of 21 evidence to suggest that somewhere along the line, 22 even before the senior loan committee met on this 21887 1 loan, that the decision to close it had already 2 been made. 3 Q. Would it be significant that members of 4 the real estate department, as well as the 5 chairman of USAT and the CEO of USAT had 6 conversations about this loan in the hall or 7 during office hours in informal meetings? 8 A. It would be significant. It would also 9 be presumed, yes. 10 Q. What do you mean it would be presumed? 11 A. I mean, that's one of the jobs of a -- 12 of senior management from -- you know, line 13 management has to advise senior management, not 14 always in formal documents but in conversations 15 and phone calls, basically of what's going on. 16 Q. Mr. O'Connell, have you seen any 17 documentation to support the fact that there were 18 conversations in the halls or in the offices of 19 the CEO or between the CEO and the real estate 20 department? 21 A. I have seen testimony to the effect 22 that both Mr. Graham and Mr. Gross have made 21888 1 reference to they thought it was just part of the 2 regular business. But I don't believe I've seen 3 any actual formal documents. 4 Q. All right. What would be the formal 5 documents that examiners would rely upon in 6 connection with the underwriting of this loan? 7 MR. DUEFFERT: Your Honor, just a 8 clarification again. Is this pattern and 9 practice, or is he asking exactly what was done 10 here? 11 MR. LEIMAN: I'm going to ask both 12 questions, Your Honor. 13 A. Okay. In general, for a loan of -- put 14 it this way. For very straightforward 15 single-family loans, we would not expect formal 16 discussions by senior loan officers. The examiner 17 would almost always go directly to the loan 18 document. The loan application, the appraisal of 19 single-family loans is generally one single-sized 20 sheet double-sized and not much more than that. 21 As the loan gets more complex, again 22 you would go to the core loan documents: Note, 21889 1 mortgage, appraisal, application, credit reports, 2 et cetera. But then you would also start looking 3 for minutes of various meetings, senior loan 4 committee meetings, executive committee meetings 5 if they had it, board of directors meetings if it 6 was discussed, and any other memorandum that would 7 be in the file regarding the process by which the 8 loan was actually made. Disputes with the other 9 side over terms, disputes over -- if not the 10 actual book terms, over the legal documents, how 11 the terms were being interpreted. 12 So, depending on the complexity of the 13 loan, you would either go for the straight core 14 minimum documents or, for a more complex loan, you 15 would be looking for some memorandum and minutes 16 discussing the reasoning of how the transaction 17 came about. 18 Q. Mr. O'Connell, I know you're working 19 from memory. 20 Tell me what you recall as being the 21 documentation for the Park 410 loan that you saw 22 in the file in nineteen -- for 1986, for the 1986 21890 1 loan. 2 MR. DUEFFERT: Just again, a 3 clarification. "In the file," does that mean in 4 the entire loan file or in the examination work 5 papers or -- 6 MR. LEIMAN: Thank you, Mr. Dueffert. 7 Q. (BY MR. LEIMAN) In the files that you 8 reviewed. 9 A. Okay. That is a good clarification. 10 The only document that I saw in terms of, say, the 11 examiners' work papers, I believe I saw a 12 reference to the senior loan committee minutes and 13 to the board of directors minutes. Some of the 14 other correspondence that I made reference to, 15 such as this letter which I believe was between 16 Mr. Graham and Mr. Gindy, I did not see any 17 reference in terms of the -- I don't believe I saw 18 a reference to that in the work papers. 19 So, those are the types of documents I 20 saw. As I said, I think the only one that I'm 21 fairly confident that the examiners saw would have 22 been the senior loan committee minutes. 21891 1 Q. Would you have expected to see a letter 2 such as the one you described from Mr. Graham to 3 Mr. Gindy regarding the appraisal in the loan 4 files? 5 A. Yes. 6 Q. Do you know why it wouldn't be there? 7 A. Again, Counselor, I can only state 8 what -- I can't testify what the loan files looked 9 like 12 years ago. But if you're asking me if 10 they were not there, should they have been there, 11 yes, they should have. But I cannot testify what 12 the loan files looked like 12 years ago. 13 THE COURT: Excuse me. Did you examine 14 the examiner's files, or did you examine the 15 files, the loan files that were in USAT's -- 16 THE WITNESS: Actually, both. 17 THE COURT: So, you did look at the 18 loan documents that were in USAT's files? 19 THE WITNESS: Well, I looked at the 20 files that the defendants have produced. Again, 21 how those files existed 12 years prior, I do not 22 know. 21892 1 MR. DUEFFERT: Your Honor, I believe 2 you mean -- you looked at exhibits provided to you 3 by OTS, and then eventually you got some of the 4 stuff we introduced? 5 THE WITNESS: That's correct, yes. 6 MR. DUEFFERT: It wasn't just what we 7 produced? 8 MR. LEIMAN: No. I don't think that's 9 all that he's talking about. 10 THE COURT: All right. Let's develop 11 that. 12 MR. LEIMAN: Yeah. 13 Q. (BY MR. LEIMAN) Let's talk about that 14 for a minute, Mr. O'Connell. 15 Do you remember visiting a document 16 room in the -- what was the training facility of 17 OTS and reviewing documents on shelves that were 18 similar to this? 19 A. Yes. 20 Q. All right. Do you remember how 21 those -- what those were identified as? 22 A. My -- my recollection is that they were 21893 1 identified as documents produced by the defendants 2 in terms of the -- in terms of the loan files. 3 But now that I think about it, I could very well 4 be wrong. Perhaps they were produced by the RTC 5 because they actually were the receiver and they 6 produced the loan files. So, actually, that's a 7 good point. 8 I did see loan files, but you're right. 9 I can't swear right now -- I presume you're right, 10 that they were produced by the defendants. They 11 may very well have been produced by the RTC. But 12 I did, in fact, review the loan files as they were 13 sent up to the OTS office. 14 Q. Did you look at Mr. Fribert's 15 materials? 16 A. Yes, I did. 17 Q. All right. Did you look at materials 18 that were produced by Federal Home Loan Bank Board 19 examiners? 20 A. The work papers? Yes, I did. 21 Q. Okay. By the way, they are not 22 defendants. They are respondents, Mr. O'Connell. 21894 1 A. Oh, sorry. 2 Q. Were there any other documents that you 3 looked at? 4 A. As I said, I've seen a fair amount of 5 core testimony regarding the real estate 6 transactions. I know that within Mr. Fribert's 7 material, there was a great amount of auditors' 8 work papers on some transactions. 9 Q. Auditors' work papers? Who would those 10 have been? 11 A. I believe it was Peat Marwick were the 12 independent auditors at the time. I believe 13 that's it. 14 Q. Were you ever denied access to any 15 document that you had asked for by OTS staff? 16 A. No, I did not. I do recall asking for 17 a copy -- because the examination report made 18 reference to an Arthur Andersen study and 19 documentation that I never received a copy of, and 20 nobody in OTS either said that the document didn't 21 exist anymore or they didn't have a copy of it. 22 But that's the only document that I can think of 21895 1 that I was ever curious about and I never got a 2 copy of. 3 Q. Do you believe that your opinions are 4 based on an adequate universe of documents and 5 materials and testimony such as to reflect your 6 opinions and conclusions accurately? 7 A. Yes, I do. 8 MR. LEIMAN: I'd like to proceed, Your 9 Honor, to Paragraph 61. 10 Q. (BY MR. LEIMAN) You state here, 11 Mr. O'Connell, in a March 17, 1986 memorandum to 12 USAT's loan committee seeking approval of the 13 80-million-dollar loan that there is no mention of 14 USAT's interest in the joint venture or of the 15 47-million-dollar Love & Dugger appraisal. Okay? 16 A. Correct. 17 Q. Why do you think it's important to have 18 disclosed those two factors in the loan files? 19 A. If the senior loan committee or if this 20 had been an executive committee meeting or if this 21 had been a board of directors presentation, 22 whatever, if the committee that is meeting to make 21896 1 this decision is a real, independent 2 decision-making body and is going to come up with 3 their best judgments as to how to proceed in a 4 transaction, they need all the pertinent facts in 5 front of them. 6 Particularly, the issue of the 7 Love & Dugger appraisal and the fact that they 8 already had some money outstanding on this project 9 were clearly factors that if I were a member of 10 the senior loan committee, I certainly would want 11 to know that because that would affect my 12 judgment. 13 Q. Do you happen to know or have you read 14 any testimony to the effect as to the 15 qualifications of the senior loan committee 16 members? That is to say, whether they were all at 17 the same real estate skill level. 18 A. Yes, I have read a fair amount of 19 testimony about that. 20 Q. And what did you -- what did you 21 conclude? 22 A. Mr. Gross clearly indicated that he 21897 1 felt he was -- he was qualified in real estate. 2 Mr. Graham obviously was the principal real estate 3 lending officer. I did recall Mr. Grow (sic) 4 indicating that he didn't really know much 5 about -- 6 Q. Mr. Grow. 7 A. Crow. Sorry. I didn't mean to 8 mispronounce that. Mr. Crow indicating he really 9 did not know real estate that well and essentially 10 relied on other people's representations. 11 Q. How about Mr. Williams? 12 A. I don't recall anything memorable from 13 what Mr. Williams said offhand. I'm drawing a 14 blank on that. 15 Q. With the skill level that's of 16 different -- that's disparate, does that make it 17 more or less important to have thorough 18 documentation in a proposal before voting on it? 19 A. It would require more thorough 20 documentation because you would want to give the 21 people who are not as familiar with real estate 22 more background information for which they could 21898 1 make a judgment. 2 Q. Mr. O'Connell, let me go back a second 3 just to wrap up a loose end, if I could. 4 Were there any documents that you came 5 across or were aware of that would have suggested 6 to you that were produced by any source whatsoever 7 that suggested to you that any of your opinions or 8 conclusions was inaccurate? 9 A. I would say no. 10 Q. You say that affirmatively? 11 A. You're right. Probably yes. 12 Q. Affirmative no? 13 A. No, I did not. Now I understand that 14 situation. Okay. You threw a good negative 15 there. 16 No, I saw nothing that would persuade 17 me that the conclusions I made were inaccurate. 18 Q. Okay. Let's look at 62. 19 A. Okay. 20 Q. Paragraph 62 of your report. T7452. 21 You say "In breach of USAT's policies, the loan 22 committee approved the 80-million-dollar loan." 21899 1 Okay? 2 A. Correct. 3 Q. What policies were breached by the loan 4 committee, vis-a-vis any other entity in USAT, in 5 approving the Park 410 80-million-dollar loan? 6 A. The board of directors, I believe, 7 passed a 70-million-dollar limit on what the 8 senior loan committee could make. I believe this 9 was the same board meeting of February '85 that 10 they passed the 2-and-a-half-million-dollar limit 11 on direct real estate investments. So, that would 12 be the policy that I was referring to. 13 Q. You've seen testimony and there's been 14 reference in the loan proposal itself that funding 15 would be limited to $70 million if the board of 16 directors didn't approve the 80-million-dollar 17 loan. 18 What's wrong with that? 19 A. The problem is it doesn't make any 20 economic sense. If, as the joint venture has 21 proposed, that it's going to cost $77 million to 22 develop the property, once you agree to make this 21900 1 loan, to cap it at $70 million is effectively 2 saying "we're going to cap it before it's viable." 3 Once they made this loan, they were stuck with 4 funding the full amount of the loan or stopping 5 development before it's complete. 6 I may also add that for all the 7 cosmetic effect of that statement, the institution 8 at the time of closing booked the fees for 9 80 million. Not for 70 million, but for 10 80 million. 11 Q. Well, there is some reference in the 12 loan documentation that some of those fees, a 13 third of them, were deferred. 14 Do you remember seeing that? 15 A. Yes, I did. 16 Q. Does that comport with what you saw as 17 actually happening? 18 A. No. Actually, what we saw in the 19 Peat Marwick work papers actually was a notation 20 from Peat Marwick that the deferred income was 21 booked into immediate income during 1986, that 22 there was some sort of a representation made by 21901 1 USAT to Peat Marwick that the cost of making the 2 loan exceeded the $1.6 million and, thus, they 3 could book the full amount of the fees into 4 income. 5 Q. The significance of booking those fees 6 into income would be that they would go to what 7 bottom line? How would they be accounted for? 8 A. It would be -- it would be an increase 9 in net worth. It would be an increase in net 10 income that would be reported on the thrift's 11 books. 12 Q. And if you were at USAT, that would be 13 a good thing. Right? 14 A. Yes, that's correct. But again, the 15 deferral issue is not the important issue in terms 16 of the 80 million. If this was actually, quote, a 17 70-million-dollar loan with a 10-million-dollar 18 option, they would only have booked 2.1 million. 19 They didn't. They loaned -- see, the loan closing 20 statement, they took out the full 2.4. This loan 21 was in, in substance, an 80-million-dollar loan 22 throughout. We could -- you know, I'm sure we 21902 1 have the loan closing statements to show that; but 2 they booked the 2.4 million directly out of the 3 loan proceeds on day one. 4 Q. You write in Paragraph No. 64, "The 5 failure to record USAT's interest in the joint 6 venture and the failure to reveal that the joint 7 venture interest demonstrates a gross neglect for 8 the books and records regulations by senior USAT 9 officials." 10 Do you see that? 11 A. Yes. 12 Q. Why would it be important, again, to 13 record that joint venture interest? 14 A. The issue about recording, the issue 15 about finalizing the joint venture agreement, 16 again gets into the question of should a two-page 17 document be responsible for potential of exposure 18 of up to $32 million? My personal assessment, it 19 is not. 20 In addition, you've got the situation 21 of when you're making presentations to the senior 22 loan committee, when we're using this document to 21903 1 make presentations to the board of directors, 2 eventually one -- the federal examiners or the 3 state examiners take a look at these minutes. 4 They are entitled to see all the pertinent facts 5 that went into making the decision on the project 6 of this size. 7 So, for all of those reasons, I 8 consider that to be a failure of the books and 9 records regulation. 10 Q. Paragraph No. 65 in your report, 11 Mr. O'Connell, you use the descriptive phrase "by 12 merely, quote, 'rubber stamping,' end quote, the 13 loan committee's decision to approve the 14 80-million-dollar loan that was in excess of their 15 authority, the board of directors not only failed 16 to take steps to ensure its policies and 17 procedures were being followed, it actually 18 ratified a violation ever its own policies and 19 procedures." 20 A. Correct. 21 Q. Do you believe that the board of 22 directors was signalling something in connection 21904 1 with that decision? 2 A. Yes. To the extent -- in fact, I think 3 even Mr. Gross' testimony, he made reference, 4 "Well, they could have always fired us." But the 5 fact of the matter is I saw no evidence that the 6 board ever took any action against any individual 7 or any officer for closing and funding this 8 80-million-dollar loan before the board of 9 directors had a chance to act on it. 10 That, to me, is an indication that they 11 were just rubber stamping it, that the policies 12 and procedures that the board had implemented were 13 just for show and that they really were not going 14 to take any actions to actually enforce those 15 policies and procedures. 16 THE COURT: Mr. Leiman, we'll take a 17 recess until 1:30. 18 19 (Whereupon, a lunch break was taken 20 from 12:06 p.m. to 1:35 p.m.) 21 22 THE COURT: Be seated, please. We'll 21905 1 be back on the record. 2 Mr. Leiman, you may continue. 3 MR. LEIMAN: Thank you, Your Honor. 4 Q. (BY MR. LEIMAN) Before our lunch 5 break, Mr. O'Connell, we were talking about the 6 Park 410 loan. And specifically, I was going to 7 ask you about Paragraph No. 66 in your report. 8 A. Okay. 9 Q. 66 states, "As a consequence of these 10 clearly unsafe and unsound practices related to 11 granting of the 80-million-dollar loan, the 12 deposit insurance fund suffered a gross loss of 13 $55 million on the eventual disposition of the 14 Park 410 property." 15 Do you see that? 16 A. Yes. 17 Q. Okay. Tell me what you mean by the 18 term "gross loss." 19 A. At the time of the receivership, it's 20 my understanding that the RTC capped the loan 21 amount at the amount then outstanding. So, they 22 advanced no further funds to the actual loan 21906 1 amount. They just wrote off any additional cash 2 flow losses such as real estate taxes, et cetera, 3 as operating expenses. 4 So, using the gross amount of, I 5 believe it was around 73 million, I then used that 6 as the basis for the loss figure and then 7 subtracted the amount of proceeds that the RTC got 8 from the actual sale of the property and the 9 liquidation of all the collateral, CDs and the 10 letter of credit, which I believe totaled 11 something over $17 million. 12 So, rounding it, the figure -- the 13 gross loss was $55 million again based on the loan 14 amount at the time of the receivership. 15 Q. Did you see any indication in any of 16 the files that you reviewed that suggested that 17 either the RTC or the FDIC or any other 18 governmental entity delayed the sale by any period 19 of time of the Park 410 property? 20 A. Delayed? Certainly. I think it was, 21 what? Three years, four years after the 22 receivership date. But yes, it occurred some days 21907 1 after the receivership. 2 Q. Did you see anything that indicated 3 they intentionally delayed the sale? 4 A. No, not at all. 5 Q. Let's talk about the Norwood 6 transaction which you will find at Paragraph -- 7 starting at Paragraph 67. 8 A. Okay. 9 Q. As you did with Park 410, please give 10 us a key element outline as you understand the 11 transactions. 12 A. In late 1984, the institution lent a 13 joint venture led by Stephen Block and Thomas 14 Gordon $18 million to acquire 95 acres of vacant 15 land in Austin, Texas. The loan was for a very 16 brief period of time, only six months. And 17 subsequently, six months later, when the loan came 18 due, a new loan was restructured in the amount of 19 $21 million. Again, the same property. Again, 20 the same borrowers. But in addition to 21 Messrs. Block and Gordon, there was -- there were 22 two more partners involved: Messrs. Krasovec, 21908 1 K-R-A-S-O-V-E-C, and Minch, M-I-N-C-H. 2 At this point in -- this would have 3 been in the middle of 1985 -- the association with 4 a 2.8-million-dollar additional advance now had 5 $21 million in total invested in the property. 6 The loan was restructured again when 7 the loan term -- the new loan term came due in 8 December of 1985. At that time, no additional 9 funds were advanced; but they did extend the loan 10 term again. 11 There was another restructuring early 12 in 1986 when the 21-million-dollar loan limit was 13 reached and they had to advance additional funds 14 for basic operating expenses. I believe maybe 15 even real estate taxes and the like to make sure 16 the loan wasn't forfeited or the property wasn't 17 forfeited until finally in the middle of 1986 the 18 association actually entered into a transaction 19 with only Messrs. Krasovec and Minch. 20 And this was to actually develop the 21 vacant land, and this transaction totaled, I 22 believe, 39.4 million. The 39 million consisted 21909 1 of $9.4 million from an association affiliate -- I 2 believe it was United Financial Corporation -- as 3 well as a 30-million-dollar loan from the 4 association. 5 In return for this, the association was 6 to receive -- I believe it was five-eighths. I 7 believe it was 65 percent. It was in the -- 8 approximately 60 percent of the equity of the 9 joint venture. 10 And so, at the time of the middle of 11 1986, the total commitment outstanding to the 12 property would have been $39.4 million and the 13 association had a majority interest in the joint 14 venture that now owned the property. 15 Q. What ultimately happened? 16 A. Ultimately, sales projections that were 17 set at the time of the 1986 transaction were not 18 met. In 1988 -- I don't believe any sales of the 19 lots ever occurred before the time of the 20 receivership, and the RTC ultimately liquidated 21 the property after the receivership. 22 Q. Could we have T7029 at Tab 698, please? 21910 1 MR. LEIMAN: I may have pulled the 2 wrong tab, Your Honor. I think I meant 3 Exhibit B3828 at Tab 777, although we will be 4 using that one, as well. 5 I apologize to the Court for the error. 6 Q. (BY MR. LEIMAN) Now, having this in 7 front of you, Mr. O'Connell, what is the 8 appraisal -- the appraised value that the 9 appraiser in this case comes up with? 10 First of all, tell me what -- identify 11 the document for me. 12 A. Okay. This is an appraisal of the 13 95 acres of land in Austin which we've been 14 referring to as Norwood. It is made by the firm 15 of Rex E. Bolin Associates out of Houston, Texas. 16 The date of the appraisal is June 10th, 1985. And 17 the appraised value is $28.9 million. However, 18 the "as is" date of the appraisal was 19 December 17th, 1984. 20 Q. Mr. O'Connell, from an underwriting 21 perspective, is there anything that -- and a books 22 and records perspective and a safety and soundness 21911 1 perspective, is there anything unusual about the 2 dating -- the dates on this appraisal? 3 A. To the extent that this was supposed to 4 justify a loan amount that was made in December, 5 the fact that it was not issued until June of 1985 6 is an indication that the association violated the 7 books and records charge. The nearly six-month 8 difference between the as-is date and the 9 appraised date is unusual. I have seen it happen, 10 but it is not used for the purposes of loan 11 underwriting because for loan underwriting, you 12 want a more current appraisal. I've seen this 13 more, frankly, when we've been doing, say, 14 receivership audits and we are looking for as-is 15 dates as of a specific time. But for loan 16 underwriting, this is not very helpful to get an 17 appraisal six months after the as-is date. 18 MR. DUEFFERT: Your Honor, I want 19 some -- I believe there is a misimpression being 20 created on the record that's rather important. 21 I asked Mr. Leiman last May when we 22 were involved in this case for the complete loan 21912 1 files on the original Block loan, 1984 Block loan. 2 At that point, he represented to me 3 that there were no files on that loan and they had 4 never been produced in this case. 5 So, we don't know exactly what 6 appraisal they were looking at in 1984. And I 7 think the record should reflect that. 8 MR. LEIMAN: I think what I represented 9 to Mr. Dueffert at the time and what I'll stand by 10 today is that we did look for any documentation 11 other than this appraisal and this is all we found 12 in the loan files that related to this particular 13 loan as well as the approval by the real estate -- 14 real estate committee in this case of the original 15 amount, the 18-million-dollar loan. 16 MR. DUEFFERT: I believe what he's 17 saying is there were no loan files for the '84 18 loan. This may have been historical documentation 19 that got passed along. This appraisal may have 20 been resent. But we simply don't know what the 21 complete loan file was in 1984. At any rate, I 22 don't believe the 1988 loan is fairly raised in 21913 1 the Notice of Charges. 2 MR. LEIMAN: Your Honor, this deals 3 specifically with the practice done by United 4 Savings. They have dealt with -- continually with 5 appraisals in a manner that essentially disregards 6 them or they never got them or there's no 7 indication that they have gotten them. 8 I merely want to ask Mr. O'Connell -- 9 actually, I only have two questions for him. 10 MR. DUEFFERT: For the record, my 11 objection is there is an implication that they 12 didn't have an appraisal in '84, and that's the 13 objection I'm making and that's the implication he 14 seems to be driving at. 15 MR. LEIMAN: Well, if I could ask the 16 witness if he's ever seen one. 17 MR. DUEFFERT: Again, he's asking a 18 witness for a negative inference regarding a loan 19 file that doesn't exist. 20 MR. LEIMAN: There is documentation in 21 the record, Your Honor, that, first of all, this 22 loan did occur. We know that for a fact because 21914 1 we know it was restructured, as Mr. O'Connell has 2 said in his testimony already. We know that there 3 was some kind of an appraisal in the files of the 4 institution. 5 THE COURT: How do we know that? 6 MR. LEIMAN: Because we have it by way 7 of this particular exhibit, Your Honor. 8 MR. DUEFFERT: That's my point, Your 9 Honor. 10 MR. LEIMAN: Sorry? 11 MR. DUEFFERT: I apologize. 12 MR. LEIMAN: I didn't hear what you 13 said. 14 THE COURT: Well, do we know this was 15 in the loan file? 16 MR. LEIMAN: We know that it was in the 17 receiver's files, Your Honor. That and -- 18 Mr. Dueffert specifically asked me for any files 19 we had that related to the loan to Block and 20 Gordon loan that at the time it was known as the 21 Deauville loan, and we provided it. We provided 22 him with a copy of this, as well as a copy of the 21915 1 original proposal for $18 million. 2 MR. DUEFFERT: I believe the "it" he's 3 referring to is not the complete loan file of the 4 1984 Block loan. 5 THE COURT: You believe -- 6 MR. DUEFFERT: The "it" that he just 7 referred to is not the complete loan file. That 8 has been lost apparently through the years. It 9 just doesn't exist. 10 MR. LEIMAN: To the extent that -- Your 11 Honor, to the extent that any of these files are 12 complete and available, we believe we have 13 everything that was in them. That's the case with 14 regard to Park 410 as well as all of the Norwood 15 transactions. And Mr. Dueffert is correct. We 16 did not specifically charge this as a violation in 17 our Notice of Charges, and we are not expanding it 18 at this time either. But I think it's important 19 and significant background because it specifically 20 deals with appraisal practices which, as 21 Mr. O'Connell has pointed out, were egregious and 22 unsafe and unsound and in reckless disregard of 21916 1 safe and sound banking practices. 2 THE COURT: Well, is this witness going 3 to be able to tie this document to that loan? 4 MR. LEIMAN: I believe he will, Your 5 Honor. I think so. 6 THE COURT: All right. Ask him. 7 Q. (BY MR. LEIMAN) Who is this appraisal 8 made to, Mr. O'Connell? 9 A. It was sent to Mr. Tom Gordon, who was 10 one of the borrowers on the Norwood project. 11 Q. Okay. In terms of the amount of this 12 particular appraisal and comparing this amount to 13 the original loan amount in the Block and Gordon 14 loan, the original Norwood loan, is there anything 15 significant that you notice? 16 A. The primary thing that I noticed was 17 that the December 17th, 1984 valuation of nearly 18 $29 million was far in excess of what the actual 19 purchase price was. The Block and Gordon joint 20 venture actually purchased it for, I believe it 21 was 16.9 million. And for such a wide variance 22 between an appraised value and what a willing 21917 1 buyer and a willing seller are willing to transact 2 it for frankly raises all sorts of red flags as to 3 "What's going on here? Why didn't this person 4 just assume that the purchase price was an 5 accurate reflection of the value?" 6 So, that was the principal red flag 7 that hit me when I first saw this appraisal. 8 Q. You talk about red flags. What should 9 have occurred at this point in time to the 10 institution or to a lender? 11 A. Well -- 12 MR. EISENHART: Your Honor, at what 13 point in time are we talking about now? Are we 14 now going back to the time when the loan was made, 15 or is he now going to speculate about what should 16 have been in this loan file that nobody seems to 17 have? Are we talking about June of '85? I'm not 18 sure what time we're talking about. 19 MR. LEIMAN: Let me address that with a 20 question, Your Honor. 21 Q. (BY MR. LEIMAN) Do you have any 22 reason to doubt that this appraisal was used in 21918 1 connection with -- do you have any reason to think 2 this appraisal was not used in connection with 3 USAT's 18-million-dollar loan to Block and Gordon? 4 MR. DUEFFERT: Objection as to 5 foundation. 6 THE COURT: Well, I'll sustain the 7 objection. I think the proper question is does he 8 have any reason to think that it was. 9 MR. LEIMAN: Let me ask that question, 10 Your Honor. 11 Q. (BY MR. LEIMAN) Do you? 12 A. There is a reference to a Bolin 13 appraisal in the senior loan committee minutes. 14 This is the earliest appraisal we can find, and 15 the valuation noted in the minutes reflects this 16 approximate value. But you're right. There is 17 not a specific -- the senior loan committee 18 minutes don't specifically state it was a 19 December 17th, 1984 loan. But there was a 20 reference to a Bolin appraisal of this approximate 21 value. 22 THE COURT: Approximate value? 21919 1 THE WITNESS: About 28 to 29 million. 2 Do we actually show this in the loan 3 committee minutes instead of my relying on my 4 recollection? 5 MR. LEIMAN: It will take a few minutes 6 to pull it out, Your Honor, but we can do that. 7 While we're doing that, Your Honor, let me 8 proceed. I don't want to slow this down any more 9 than we need to. 10 Q. (BY MR. LEIMAN) Mr. O'Connell, we'll 11 come back to the original Block and Gordon 12 transaction. Let's go to Paragraph 74 in your 13 report. 14 A. Okay. 15 Q. You point out in Paragraph No. 74 of 16 your report that after the initial loan was made 17 of 18 -- some $18 million, that USAT -- there was 18 another loan request? 19 A. Yes, there was. 20 Q. And a second amount of $2.8 million -- 21 another amount, in this case, $2.8 million, was 22 lent; is that right? 21920 1 A. That is correct. 2 Q. The $2.8 million was for what purpose? 3 A. Principally, it was for interest 4 payments on the prior loan that was coming due. 5 There was also additional soft costs. 6 Essentially, the association was funding all of 7 the expenses of the joint venture. 8 Q. Did it include loan fees, too? 9 A. Yes. A fairly modest amount. I think 10 it was only a loan fee on the 2.8 million itself; 11 so, it was only about $28,000. 12 Q. Okay. Mr. O'Connell, here we have a 13 loan that, as you put it earlier, is being 14 restructured. But in addition to the 15 restructuring, there is a 2.8-million-dollar 16 addition. Is that right? 17 A. That is correct. 18 Q. What's significant about the 19 2.8-million-dollar addition? 20 A. The problem with it is that by funding 21 the soft costs, there has yet to be any actual 22 improvements to the property. All they are doing 21921 1 is adding their overall basis to the property, 2 their overall investment to the property, their 3 overall risk to the property, and no real 4 enhancement to value has yet occurred. 5 So, all they are doing is creating a 6 new loan to -- is creating a brand-new loan to 7 keep the old loan from going into default. 8 Q. Why do you point out that this 9 particular loan did not add value? Why is that? 10 A. If you look at the actual loan 11 projections and the actual loan requests, you'll 12 find that there is no hard cost development in 13 terms of streets, utilities, roads. I think I 14 said roads. There were no actual hard costs that 15 would be funded by this $2.8 million. 16 Q. So, did it add anything to the value of 17 the collateral property? 18 A. No, it did not. 19 Q. All right. 20 MR. LEIMAN: Your Honor, I'd like to 21 address the question that has previously been 22 raised by Mr. Dueffert and by Mr. Eisenhart. We 21922 1 have pulled Exhibit 7008, which is Tab 663. I'll 2 wait a moment for the Court to get its copy of 3 this. 4 Q. (BY MR. LEIMAN) Mr. O'Connell, is 5 this document the one that you were thinking of 6 when you mentioned that there had been an 7 appraisal of approximately $28 million or 8 $29 million in connection with the initial block 9 and Gordon loan? 10 A. Yes. 11 Q. All right. Would you point us to where 12 that is in the document that's in front of you? 13 A. Sure. It's on the second page, and 14 it's under "appraisal," a section for the 15 appraisal. And it sites, quote, "We have received 16 a verbal from Bolin & Associates, appraisers, 17 which indicates the as-is value of this tract to 18 be $28,500,000 ($6.91/square foot), which makes 19 United's loan 63.9 percent of appraised value," 20 unquote. 21 Q. Mr. O'Connell, is that what you relied 22 on in connection with your analysis in your 21923 1 report? 2 A. Yes, it is. 3 MR. LEIMAN: Your Honor, may I proceed 4 to question the witness? 5 THE COURT: Yes, you may. 6 MR. LEIMAN: Thank you. 7 Q. (BY MR. LEIMAN) Let's take a half 8 step backward, if I might, if we could, 9 Mr. O'Connell. Let's look at Paragraph -- 10 A. Actually, Mr. Leiman, I'm glad you 11 brought this up. If I may make a correction. I 12 made a mistake. I believe I said it was 13 16.9 million was the purchase price. It was 14 actually 15.9 million. I stand corrected. It's 15 in the same document. 16 Q. Okay. Again, is the reference there -- 17 is the discrepancy between the, quote, verbal 18 appraisal or the appraised value and the amount of 19 the purchase price significant? 20 A. Yes. 21 Q. Why? 22 A. As I said, any reasonable lender 21924 1 looking at this would wonder "why is there such a 2 huge discrepancy between what the appraiser said 3 is the value and what a willing buyer and a 4 willing seller are actually willing to transact on 5 it." So, yes, that is a huge red flag. 6 Q. All right. Paragraph No. 71. You talk 7 about one possible explanation concerning the wide 8 discrepancy. Okay? 9 A. Okay. 10 Q. You state that the 1984 sale was, 11 according to the appraisal, was a, quote, 12 "distressed sale," unquote, due to problems with 13 the partnership that owned the land in 1984. 14 Where did you -- how did you conclude 15 it was a, quote, "distressed sale"? 16 A. Actually, I didn't make that 17 conclusion. I say just quoting the appraisal. 18 Q. You mean the written appraisal that -- 19 A. That's correct. 20 Q. Mr. Bolin's appraisal that USAT might 21 not have gotten? 22 A. Oh, no. This is an appraisal that -- I 21925 1 believe this is the first appraisal you brought, 2 the 698. This is the 698 appraisal. 3 Q. So, for the record, to clarify it, what 4 is the "T" number on that? 5 A. T7029. 6 Q. All right. What's the tab number? It 7 should appear on the jacket. 8 A. Is that trial number? 9 Q. Should be 777. 10 A. 698. (Witness reviews the document.) 11 And the question was? 12 Q. Where did you get the information that 13 it was a, quote, unquote, "distressed sale"? 14 A. There was -- what they did in this 15 appraisal is, as often the case, in terms of the 16 comparable land transactions, they actually used 17 the 1984 transaction. And it is cited in here. 18 And if you have it noted, that would save us some 19 time. This is not a marked copy so -- 20 Q. The reference to "distressed sale" had 21 to do with the 1984 purchase by whom? 22 A. By the Block and Gordon joint venture. 21926 1 Q. Is it appropriate to -- for an 2 appraiser to refer back to -- in the appraisal to 3 the sale to the previous -- 4 A. I'm lost. Did you want me to find that 5 cite or not? That specific cite, did you want me 6 to find that or not? 7 Q. Why don't you find it? 8 A. Okay. (Witness reviews the document.) 9 Q. Mr. O'Connell, to speed this up just a 10 tad bit, look at Page 18, please. 11 A. 18? 12 Q. Yeah. Look at the third full sentence 13 on that page. 14 A. Oh, okay. 15 MR. DUEFFERT: Just so the record's 16 clear, I thought that the witness was looking for 17 a comparable in the land comparables and now 18 Mr. Leiman's asking him about the market history 19 of the subject property. I'm just a little 20 confused as to whether Mr. Leiman and the witness 21 are on the same track at this point. 22 MR. LEIMAN: I think we are on the same 21927 1 track, Your Honor. We're looking for -- what I'd 2 like to ask him about is how he arrived at the 3 conclusion that it was a -- where he found the 4 reference to distressed property. 5 A. Actually, there are two separate 6 references under both categories. We'll start on 7 Page 18. 8 Q. (BY MR. LEIMAN) Yes, sir. 9 A. Which you've noted. And you're right. 10 The -- and I'll -- under the history of the 11 subject property and the -- actually, the fourth 12 full sentence states, quote, "This transaction is 13 considered to be a distressed sales due to 14 partnership complications within Ivanhoe, Inc." 15 In addition, on Page 68 of the same 16 appraisal under "Land Sale No. 3," quote, "this 17 94.713-acre tract, is a portion of the subject 18 property, that sold for $178,160/acre. It is felt 19 that the sale of this tract was under duress due 20 to the internal partnership problems of the 21 guarantor (sic)," unquote. 22 Q. I think it says grantor, does it not? 21928 1 A. Yes. I'm sorry if I mispronounced 2 that. 3 Q. Mr. O'Connell, what's the significance 4 of the fact that it was -- that it might have been 5 a distressed sale? 6 A. From the standpoint of a lender, they 7 would want to know, "Well, what was the reason for 8 it being distressed? Was it a problem with the 9 property itself? What was the factor of such a 10 sale that would justify such a huge discrepancy 11 between what the appraiser estimated the market 12 value to be and what the final sales transaction 13 was?" 14 In addition, a lender would want to 15 know specifically what was the problem with the 16 partnership that could justify such -- I believe 17 the implication is kind of a liquidation sale. 18 Q. Now, with respect to the quote on 19 Page No. 68 of the appraisal you've just read 20 from, there is a reference here to the Land Sale 21 No. 3 as a comparable. 22 A. Right. 21929 1 Q. Is it significant that the appraiser is 2 using the sale to Block and Gordon as one of the 3 comparables? 4 A. Yes. 5 Q. Why is that? 6 A. It's significant in the sense that they 7 are now trying to use a comparable at 8 approximately a 178,000-dollar purchase price as a 9 comparable for a valuation of the same tract for 10 almost three times the value of the actual sale. 11 Remember, the sale was approximately for 12 $16 million. And although we haven't gotten into 13 the '86 appraisal that much, the 1986 appraisal is 14 for almost three times that amount less than two 15 years later. 16 Q. The fact that it's such a high multiple 17 more in terms of the appraised value, what is the 18 significance of that? 19 A. What is the justification for the huge 20 increase in valuation between December of 1984 and 21 June of 1986? 22 Q. What about appreciation? 21930 1 A. Again, that is perfectly feasible if, 2 in fact, it can be documented. If they can show 3 there is a hot real estate market, that land 4 prices have been skyrocketing at -- that would 5 have been roughly almost 100 percent a year. That 6 would be a factor. 7 Q. Let's look at -- jump ahead to 8 Paragraph No. 77. 9 A. Oh, my opinion again. Okay. 10 Q. Now, in your opinion, you state that 11 the practice of restructuring and refinancing 12 problem assets. 13 Do you see that? 14 A. Yes. 15 Q. With additional funds does not improve 16 the viability of the asset and defers recognition 17 of loss and makes that loss even greater when it 18 must be recognized. 19 I paraphrased, but did I do it 20 accurately? 21 A. That is correct, yes. 22 Q. Would you explain what indications 21931 1 there were that this was a problem asset? 2 A. Well, as I said, the first thing that 3 strikes you is that within six months of the 4 original loan being done, it was restructured. 5 They had to add another $2 million. And within 6 six months after that, the loan term had to be 7 restructured again. 8 Basically, Mr. Leiman, what I've 9 described there is one of the issues that 10 examiners, the Federal Home Loan Bank Board, OTS, 11 and the RTC have been struggling with for years. 12 We have in this transaction an 18-million-dollar 13 loan which ultimately cost the insurance fund over 14 $30 million. The reason that occurred is that 15 we -- and I myself have used the phrase "these are 16 100 percent losses." They managed to lose more 17 than the original loan amount. And the reason for 18 that is -- and certainly not just to USAT but lots 19 of problem institutions refused to recognize a 20 problem. They just kept lending more money and 21 more money and more money, trying to keep the loan 22 from going into default, trying to ignore economic 21932 1 reality. And so, when the house of cards finally 2 comes down, the deposit insurance fund winds up 3 losing more than the original loan amount. 4 Q. From an economic or financial point of 5 view, why does the house of cards come down? 6 What's your basis for saying that? 7 A. Economic reality cannot be defeated. 8 You may be able to put it off a bit, but I have 9 never seen a situation where bad loans are just 10 being refinanced, refinanced, refinanced and it 11 doesn't just eventually collapse. 12 Q. Is the economy a consideration -- 13 A. Oh, sure. 14 Q. All right. The economy is a 15 consideration, am I right, Mr. O'Connell, in 16 connection with these kinds of restructurings? 17 A. Oh, sure. 18 Q. What role does the economy play? 19 A. To the extent that the economy is in a 20 downturn, it then fortunately has the tendency of 21 encouraging institutions to engage in these 22 constant restructurings. And the reason being 21933 1 that if the economy is in a downturn, the 2 institutions realize if they take back in property 3 now, recognize the economic reality, they are 4 going to lose money. So, the hope is that they 5 can buy time and maybe the market will come back. 6 MR. DUEFFERT: Your Honor, I just want 7 to -- again, I urge the witness to talk about the 8 two loan files and what happened. To the extent 9 he wants to tie that in, it's helpful. I don't 10 know if a general background is terribly useful at 11 this point. 12 MR. LEIMAN: Your Honor, we're moving 13 as quickly as we can into the -- 14 THE COURT: Next question. 15 MR. LEIMAN: I'm sorry? 16 THE COURT: I said let's have the next 17 question. 18 Q. (BY MR. LEIMAN) Are you aware of a 19 specific regulation, Mr. O'Connell, that would 20 have been targeted at prohibiting a transaction 21 such as the Norwood transaction we've been 22 reviewing? 21934 1 A. Could you repeat that? 2 Q. Is there some regulation that covers -- 3 that would have stopped or prevented or prohibited 4 USAT from making the loan to Block and Gordon? 5 A. Not a flat prohibition, no. 6 Q. Regulations are designed to do what, 7 then, as you see them? 8 A. There are several regulations in the 9 '84-'86 area that certainly would have discouraged 10 it, but I certainly don't want to say -- I don't 11 know of a regulation that, in fact, prohibited 12 this. 13 Q. Are you saying that regulations can't 14 cover every contingency? 15 A. No, of course not. 16 Q. Look at Paragraph No. 80. You talk 17 about -- well, why don't you read it for us -- 18 A. Okay. 19 Q. -- from your report. 20 A. Quote, "Jenard Gross, who was a member 21 of USAT's loan committee in 1985, wrote the 22 following on October 23rd, 1984, quote, 'United is 21935 1 making 100 percent loans and funding interest 2 payments on risky deals. That is, real estate 3 deals where the developer has no equity in it at 4 all,'" end quote. 5 Q. All right. I'm going to show you three 6 memoranda that Mr. Gross wrote. T7571, T7572, and 7 T7573, please. These are at Tabs 1035, 36, and 8 37. 9 A. (Witness reviews the documents.) Okay. 10 Q. Mr. O'Connell, can you please identify 11 these three documents? 12 A. Okay. These are three memorandum 13 prepared by Mr. Gross when he was a consultant 14 with the institution. They are dated -- one is 15 dated October 23rd, 1984. And two are dated 16 October 24th, 1984. 17 Q. With respect to these memorandum -- 18 first of all, did you use these in your analysis? 19 A. Yes. 20 Q. How did you use them? 21 A. They were useful in the sense of 22 determining what the institution knew, what the 21936 1 institution was made aware of before these 2 transactions came into being. 3 Q. Have you had an opportunity to read 4 Mr. Jenard Gross' testimony in this hearing? 5 A. Only the real estate section, which I 6 think is about the first day and a half or so of 7 the testimony, yes. 8 Q. Did you read his explanation with 9 respect to T7571, notes regarding United Savings? 10 A. Yes, I did. 11 Q. Do you remember reading that Mr. Gross 12 stated that -- 13 MR. BLANKENSTEIN: Can you give us the 14 page number before you quote the deposition -- the 15 transcript testimony, sir? 16 MR. LEIMAN: I don't have that. I 17 don't have that immediately available, 18 Mr. Blankenstein. I'm asking him for his 19 recollection. 20 MR. DUEFFERT: Of what value, sir? I'm 21 sorry. Objection. It's not relevant. 22 MR. LEIMAN: No. It is particularly 21937 1 relevant because I'd like to -- I have a question 2 for -- let me ask a different question, if I 3 might, Your Honor, of this witness which is not 4 objectionable. Well, anything will be 5 objectionable, I'm sure. But I don't think it's 6 objectionable. 7 THE COURT: What's your question? 8 Q. (BY MR. LEIMAN) My question is: Is 9 the advice that Mr. Gross purports to give in this 10 memorandum, "Notes Regarding United Savings," 11 would that be limited to information that only 12 examiners would be interested in; or would it also 13 cover thrift executives? 14 MR. BLANKENSTEIN: Objection. 15 MR. EISENHART: Your Honor, I think we 16 all can remember Mr. Gross' testimony about this, 17 which was that he was not giving advice. Rather, 18 he was setting out in this memorandum observations 19 that he thought examiners would make. 20 MR. BLANKENSTEIN: I join in that. 21 That was the testimony, Your Honor. 22 MR. DUEFFERT: And it's also unclear 21938 1 what information, if any, Mr. Leiman is referring 2 to in his question. 3 MR. LEIMAN: My question is, Your 4 Honor, whether or not the admonitions that are 5 contained in this memorandum would apply with 6 equal weight to thrift executives and senior 7 management at a thrift. 8 MR. BLANKENSTEIN: I'm not sure I 9 understand the question, what testimony it's 10 designed to elicit that's within the competence of 11 what this witness testified to. 12 MR. LEIMAN: Your Honor, it's clearly 13 within his competence to testify about whether 14 100 percent loans and funding the interest 15 payments on risky deals without any equity are 16 safe and sound. 17 THE COURT: Is that your question? 18 MR. DUEFFERT: That's a different 19 question. 20 MR. BLANKENSTEIN: Essentially it is, 21 Your Honor. 22 THE COURT: Why don't you ask him that 21939 1 one? 2 Q. (BY MR. LEIMAN) All right. Let's go 3 through the memo. 4 A. All right. 5 Q. Let's look at No. 2. 6 A. Okay. 7 Q. In T7571. It states, "United is making 8 100 percent loans and funding the interest 9 payments on risky deals. That is, real estate 10 deals where the developer has no equity in it at 11 all." 12 Do you see that? 13 A. Yes, I do. 14 Q. Do you believe that that's the kind of 15 admonition that should be followed that is 16 important to thrift executives? 17 MR. DUEFFERT: Objection. Beyond that 18 question. 19 Q. (BY MR. LEIMAN) Has there been 20 identified in that statement information that 21 would serve as an admonishment or warning to 22 thrift executives? 21940 1 MR. DUEFFERT: Objection, Your Honor. 2 I just cannot understand any of these questions. 3 MR. BLANKENSTEIN: Is he asking outside 4 the context in which Mr. Gross wrote this 5 memorandum? He can ask that question directly. 6 THE COURT: All right. I'll deny the 7 objection. 8 Do you understand the question? 9 THE WITNESS: Actually, let me have it 10 reread. What was it? 11 Q. (BY MR. LEIMAN) Is the statement 12 "United is making 100 percent loans and funding 13 the interest payments on risky deals, that is real 14 estate deals where the developer has no equity in 15 it at all," the kind of admonition that would be 16 important to senior management and thrift 17 executives? 18 MR. DUEFFERT: Objection. Incomplete 19 hypothetical. Vague and ambiguous. 20 THE COURT: Denied. Let's have the 21 answer. 22 A. My reading of this is that Mr. Gross is 21941 1 warning senior management that these are risky 2 deals and that these are the type of deals that 3 have higher risk for loss. 4 MR. BLANKENSTEIN: Your Honor, I'm 5 going to object to the answer. Mr. Gross 6 testified as to what his meaning was here. He can 7 interpret -- he can testify as to whether these 8 type of loans are or are not risky, but I don't 9 think he can testify as to what Mr. Gross meant 10 when he wrote this memorandum. Mr. Gross was 11 here. He testified. He explained what those -- 12 what his -- what he meant in that comment in this 13 exhibit. 14 THE COURT: All right. We have both 15 witnesses' testimony. Let's move on. 16 Q. (BY MR. LEIMAN) Mr. O'Connell, how 17 does this document, "Notes Regarding United 18 Savings," lend itself to supporting your opinions 19 in your report? 20 A. As I think I said earlier, the primary 21 use of this document was to ascertain what senior 22 management already knew or should have known. 21942 1 Regardless of how -- what Mr. Gross actually 2 stated his intent was, I thought that the clear 3 language in the document spoke for itself in terms 4 of what it should advise senior management. 5 Q. Are there any other specific sentences 6 or numbered bullet points that you used in 7 reaching your conclusion? 8 A. I believe -- I believe that was the 9 only one I directly quoted, that one sentence that 10 we've already gone through. But clearly, the 11 following sentence regarding the risky real estate 12 ventures also was a factor in terms of what the 13 institution knew or should have known. 14 Q. Now, this memo in Paragraphs 5, 6, 7, 15 and 8 and 9 refers to parts of the portfolio of 16 United Savings. 17 Do you see that? 18 A. Yes. 19 Q. Would it be significant or is it -- 20 let's take No. 5. 21 A. Okay. 22 Q. "As of the past moment, 25 -- 21943 1 27 percent of all construction loans were 2 delinquent." 3 Is that the kind of observation that 4 would be of concern or interest to management? 5 A. Yes. 6 Q. Why? 7 A. It would be -- hopefully, it would be 8 something that management was already aware of 9 because most thrift institutions would have a 10 breakdown not only of their overall delinquencies 11 but how the delinquencies break down by various 12 asset type. 13 If the association is having a high 14 level of delinquencies, setting aside this -- even 15 this association, if an institution had a high 16 level of delinquency in, say, the consumer debt, 17 the board of directors would want to take a look 18 at the policies and procedures. "What's going on 19 here? Why are we having such high delinquencies?" 20 Or if they are having high delinquencies in 21 apartments or commercial, again, they would want 22 to look at their policies and procedures, what's 21944 1 going on with real estate. 2 So, this level of delinquency is 3 something I would expect all thrift managers to 4 already be aware of. 5 Q. Would that -- would your analysis that 6 you just testified to apply with equal measure to 7 Paragraph 6, 7, and 7? 8 A. I can't say the same about No. 7. I'm 9 not entirely sure what he means by "installment 10 loans." Installment loans could be just auto 11 loans. It's somewhat unclear what he's referring 12 to there. But certainly No. 6 and 8, yes. 13 Q. All right. Look at Paragraph No. 13. 14 A. Okay. 15 Q. It states, "With a portfolio of 16 approximately 900 commercial loans from United, 17 fully one-third of the files had the original 18 documents missing." 19 A. Correct. 20 Q. Is that the kind of observation that 21 would be of concern or interest to management? 22 MR. EISENHART: Your Honor, I'm going 21945 1 to object to this line of questioning. We have a 2 witness here who, as I understand it, is being 3 offered as an expert witness on two real estate 4 loans. And I don't understand what all this other 5 stuff has to do with his testimony. I mean, is he 6 going to get up here and just offer his criticisms 7 willy-nilly of every aspect of the institution? 8 It seems to me we're going well beyond what he's 9 being offered for. 10 MR. LEIMAN: I hardly think, Your 11 Honor, that these are willy-nilly criticisms. 12 What I believe these are directed to are the books 13 and records violations and the awareness on the 14 part of Mr. Gross and senior management officials 15 that the books and records of United Savings were 16 in shambles in 1984, '85, and '86 at the time that 17 these loans were made. I mean, I think it's 18 germane and relevant, Your Honor. 19 MR. EISENHART: I think we've already 20 been through this, Your Honor, that this is not a 21 books and records case. This is a case about 22 specific loans. 21946 1 THE COURT: What is the connection to 2 the books and records and these loans? Is the 3 witness testifying that these loans went bad 4 because of bad books and records, or what is -- 5 MR. LEIMAN: Your Honor, what this goes 6 to is their knowledge and their -- the awareness 7 of -- on the part of senior management that this 8 institution had an historical problem as 9 identified by Mr. Gross in these memoranda. And 10 what this directly goes to is our claim that this 11 is -- that what occurred in this case with respect 12 to these real estate transactions was in reckless 13 disregard of maintaining adequate books and 14 records as well as appraisal violations, 15 accounting violations, as well as being unsafe and 16 unsound. That is really what is going on with 17 respect to the identification by Mr. O'Connell of 18 what it was that Mr. Gross knew about at the time. 19 MR. DUEFFERT: Your Honor, if I might 20 add just a couple points. First, the memos we're 21 looking at took place before either of these loans 22 were booked in whatever form or made. 21947 1 No. 2, obviously we're not talking 2 about the books and records which pertain to these 3 two loan files. 4 No. 3, the witness is not being asked 5 to say things like "They did X in the Norwood loan 6 and that was a violation of this regulation and 7 here it is." Or even "They did X in the Norwood 8 loan, and that's a safety and soundness 9 violation." 10 What we're getting is testimony that's 11 just kind of like what in some world would one 12 want and I think all of this is improper and there 13 is no foundation and it's of no use to the Court 14 or to us. 15 MR. EISENHART: Your Honor, my 16 objection is even a little more fundamental than 17 that. I mean, we have somebody here who, if I 18 hear his testimony right, has been a part of the 19 OTS prosecution team in this case since before 20 even the Notice of Charges was written. He's 21 coming in here to testify about two loans. He's 22 being pointed to specific documents. He's being 21948 1 asked to say, "Oh, yes, this was bad, this was 2 bad, this was bad." 3 He hasn't sat here and he hasn't heard 4 the evidence that we have. He hasn't heard about 5 the reason for the books and records problems, the 6 merger of the two institutions. He hasn't heard 7 about the agreement with the examiners to go out 8 and have Grant Thornton audit the books and 9 records, the fact that they audited them and came 10 back in and said, "The problems have been 11 corrected. They are fine." He's just being 12 called in to take potshots. 13 THE COURT: I don't see how this 14 witness can testify as to any connection between 15 what's written here and the loans that he is 16 criticizing. I mean, there were bad books and 17 records in '84 before the loans were made, and 18 these loans went bad. But I'm not sure this 19 witness can connect the two. 20 MR. LEIMAN: Your Honor, what I 21 believe -- what I believe the connection is has to 22 do with knowledge and awareness on the part of 21949 1 senior management which goes directly to -- if 2 senior management knew, for example, that the 3 books and records were in shambles in 1984 and 4 that the books and records were a critical element 5 in maintaining a safe and sound thrift and 6 practicing banking in a safe and sound manner and 7 was aware a year before -- months and months 8 before the Park 410 loan was ever granted and then 9 did nothing about it, did nothing to solve the 10 problem and make sure and be certain that the same 11 kinds of books and records violations did not 12 occur with the biggest loan that this institution 13 made, Your Honor, it seems to me that that was in 14 reckless disregard. And I think that's what this 15 witness is testifying to. I think that's what 16 he's saying. He's saying that this -- this 17 institution was run by people who were well aware 18 that what they were doing was inappropriate and 19 wrong. And I think that's what -- and I believe 20 that's what Mr. O'Connell will state on the 21 record. 22 MR. DUEFFERT: Your Honor, if I could 21950 1 have one last go at this, I think it's -- this 2 witness has looked at two loan files, and I think 3 he's perfectly qualified and there is foundation 4 for him to talk about what was in or not in those 5 two loan files. There is no foundation for 6 testimony as to anything beyond those two loan 7 files. 8 THE COURT: I'm going to sustain the 9 objection. I just don't see that he can testify 10 as to what happened as a result of these memos or 11 whatever unless he has some knowledge that these 12 loans went bad because of bad books and records or 13 something and that, therefore, these people should 14 have known what was going on before. 15 I sustain the objection. 16 Q. (BY MR. LEIMAN) Let's turn to 17 Paragraph No. 81. 18 A. Okay. 19 Q. You state, "In 1986, Norwood/United 20 Park Joint Venture was formed to acquire the 21 property. The partners were UFC, United Financial 22 Corp., a subsidiary of USAT, and Frank Krasovec 21951 1 and Jeffrey Minch." 2 Do you see that? 3 A. Yes. 4 Q. Was this transaction that's referred to 5 here in Paragraph No. 81 a new loan as 6 distinguished from the loans to Block and Gordon 7 that you testified about earlier? 8 A. In my view, in substance, no, it was 9 not. And I believe the examiners made the same 10 conclusion. It was basically a restructuring of 11 the prior loan. 12 Q. What is the significance, if any, to 13 Block and Gordon being dropped as guarantors from 14 the loan in 1986? 15 A. The principal area of significance is 16 why? Why would Block and Gordon walk away from 17 the transaction without any consideration that I 18 could see if the property was really worth what 19 the appraisal was saying? If we have supposedly a 20 29-million-dollar appraisal on a 21-million-dollar 21 loan, why would any joint venture partner walk 22 away. That would be an indication to the 21952 1 examiners that the appraisal simply has no value 2 whatsoever. 3 Q. Does the failure to get any 4 consideration for releasing the guaranty 5 demonstrate anything about United Savings' intent 6 to enforce the guaranty? 7 A. I think it shows that they really had 8 no intention of enforcing the guaranty. 9 Q. Why do you say that? 10 A. They didn't take any action. 11 Q. To hold Messrs. Block and Gordon 12 accountable for the guarantees that they had 13 posted back in 1984. 14 T7701. It's Tab 734. 15 Mr. O'Connell, have you seen or 16 reviewed T7701? 17 A. Yes, I have, subsequent to doing my 18 opinion. But yes, I have. 19 MR. EISENHART: Your Honor, I'm not 20 sure we're on the right track on exhibits here. 21 Mr. Leiman I, thought, said Tab 773. And at that 22 tab, I find Exhibit B9 -- 21953 1 MR. SCHWARTZ: Exhibit T7701, Tab 734. 2 MR. EISENHART: Thank you. 3 Q. (BY MR. LEIMAN) As you were saying, 4 Mr. O'Connell, you saw this particular appraisal 5 after you wrote your opinion? 6 A. Yes. 7 Q. All right. And what is it that is 8 significant about this appraisal, if anything? 9 A. There are basically two things that 10 caught my attention. First of all, that the 11 valuation -- first of all, there is no valuation 12 of the pure 95 acres, the original 95 acres. This 13 assumed that the adjacent 4 acres was, in fact, 14 going to be added to it. So, we have a valuation 15 of the 99-acre lot of approximately 24.9 -- 16 $24,900,000 at the same time that the Bolin 17 appraisal was coming in with an appraisal of, I 18 believe it was around $47 million. 19 The other thing that struck my 20 attention, frankly, was the address. And I think 21 I even mentioned to you, Mr. Leiman, that I 22 probably would have noted that in my opinion had I 21954 1 known about this before. 2 In both cases, in both the 410 and the 3 Norwood transaction, there were appraisals made by 4 home appraisers, if you will. Love & Dugger was 5 based in San Antonio and came in with $47 million. 6 Appraisal Associates of Austin was based in Austin 7 and came in with a lower appraisal. And in 8 neither case did United actually use a 9 locally-based appraisal. They went to a 10 Houston-based appraiser. 11 Q. Why is it -- why is that significant to 12 you? 13 A. All other things being equal, you would 14 prefer an appraisal firm that is actually familiar 15 with the marketplace. Obviously, there can be bad 16 appraisers in San Antonio and bad appraisers in 17 Austin and superb appraisers in Houston; but the 18 benefit of the doubt will actually go to the 19 appraiser who's got the most experience in the 20 market. 21 Q. Do you have any reason to think that 22 this appraisal -- as to whom paid for this 21955 1 appraisal? 2 A. The association was paying all expenses 3 of the joint venture. So, they would have -- the 4 association would have -- through its loan 5 proceeds, would have paid for this appraisal. 6 Q. At the risk of getting this number 7 wrong yet a third time, Mr. O'Connell, if we look 8 at the page marked KM000067, do you see on the 9 bottom of the page there is a number? 10 A. Yes. 11 Q. What is that number? 12 A. Keeping in mind that this would be for 13 124 acres, the number is $37,500,000. 14 Q. Now, with regard -- in comparing this 15 appraisal with subsequent -- with other appraisals 16 for the same property, did you reach any 17 conclusions? 18 A. Again, counselor, it's not exactly the 19 same piece of property. If I may turn your 20 attention back to T7029, and just the cover page 21 of the Rex Bolin appraisal, you'll see in capital 22 letters "99.43 acres." The Austin appraisal is of 21956 1 124 acres. So, it's not exactly the same 2 property. 3 Q. So, let me see if I can get this right. 4 Would the actual appraised value be 5 less for a comparable 99-acre lot? 6 A. Yes. 7 Q. What would the appraised value for a 8 99-acre lot be? 9 A. That's impossible to say from this 10 particular summation. I will state in the second 11 line item from the top, they separately appraise 12 the 24-acre lot at approximately $7.6 million. 13 So, a best estimate would be approximately 14 $37 million for the 99 acres. 15 Q. Okay. 16 A. $30 million for the 99 acres. 17 Q. For the sake of argument, 18 Mr. O'Connell, assume that what's being appraised 19 here is 125 acres as shown for $37 million at the 20 bottom of the page. 21 A. Okay. 22 Q. All right? 21957 1 A. Okay. 2 Q. How much money did USAT have in this 3 transaction as of the date -- as of 1986, in July 4 of '86? 5 A. USAT committed to $39.4 million total 6 exposure to the property. 7 Q. Which would be some $2 million more 8 than this appraisal would show for what you said 9 is 125 acres or -- is that right? 10 A. That is correct, yes. 11 Q. What is the significance of that? 12 A. Well, just from an examiner's 13 standpoint, if an examiner had seen this appraisal 14 in the document, they probably would have 15 immediately told the institution to set up a loss 16 reserve of at least 2 million, quite probably 17 closer to 9 and a half million dollars because of 18 the discrepancy of the land being appraised. 19 Q. In your review of the files that were 20 provided to you -- the receivership files, the 21 production by respondents, as well as the T 22 exhibits, all of the other documents that were 21958 1 made available to you, had you seen this Appraisal 2 Associates of Austin appraisal? 3 A. No. It was not in the receivership 4 loan files, no. 5 Q. All right. Let's look at 6 Paragraph No. 84. 7 A. Okay. 8 Q. It states here, "The stated value in 9 the as-developed appraisal by Rex E. Bolin 10 associates was $46 million." And I believe you 11 can find that in T7029. 12 Do you have that in front of you? 13 A. That is correct, yes. 14 Q. Okay. It should be at Tab 698. I 15 think you've already pointed out that Mr. Bolin 16 was a Houston appraiser? 17 A. Yes. That is what it states here. 18 Q. All right. Did you find any -- in your 19 review of this document, did you find any 20 statements or information that you believed would 21 not -- were in any way misleading or unsupportable 22 of the conclusion of the appraisal? 21959 1 A. Yes. The principal one that I cite 2 here in No. 85 was the fact that the -- in order 3 to justify the final conclusion, the appraisal 4 actually used an improved property. 5 Q. What's wrong with using an improved 6 property? 7 A. The problem is that it was vacant land 8 at the time, and you cannot -- 9 Q. What was vacant land, Mr. O'Connell? 10 A. The 95 acres was vacant land at the 11 time. It had not even had basic utilities, roads, 12 et cetera, put in, much less an operating 13 property. If I could -- let's see if I can find 14 that again. Actually, it was fairly easy. Same 15 page. 16 Q. What page would that be? 17 A. The same page where we found the 18 statement that was posed -- the "under duress" 19 statement. Page 68, the bottom of Page 68. 20 Q. And what are you referring to here? 21 THE COURT: Would you give the exhibit 22 number? 21960 1 THE WITNESS: Oh, sure. T7029. 2 A. And under Land Sale No. 5, the very 3 last paragraph, sold in August, 1985, quote, "This 4 30.8-acre tract sold for $426,888/acre. This 5 tract had a 30,375 square foot retail store on 6 1.99 acres of the property; the contributory value 7 is unavailable." 8 Q. (BY MR. LEIMAN) That's only one 9 comparable sale that you're looking at here, 10 Mr. O'Connell. 11 Does that indicate that the entire -- 12 that wouldn't suggest the entire appraisal is bad 13 if one comparable is bad; is that right? 14 A. The problem with that, Counselor, is if 15 you look at all of the -- yes. All of the seven 16 land values, land sale comparables, that was the 17 only comparable that could justify the actual 18 appraised value that Bolin came up with. 19 Q. Explain that for me, please. 20 A. All of the -- essentially, Mr. Bolin 21 came up with a valuation on the 99 acres on 22 Page 70. The 99 acres he came up with vacant land 21961 1 value of $32 million or approximately $320,000 an 2 acre. 3 If you check the other six, six of the 4 seven comparables that are used -- in fact, we can 5 go through it. 6 Land Sale No. 1 on Page 68 was for 7 $19,000 an acre. Land Sale 2 was for $20,000 an 8 acre. Land Sale 3 was $178,000 an acre, and that 9 was actually the sale of the Norwood property in 10 1984. Land Sale 4 is for $261,000 an acre. Land 11 Sale 6 on the next page was for $30,000 an acre. 12 And Land Sale No. 7 is $2.09 per square foot. And 13 now to do some quick math, I believe that goes out 14 to be approximately $100,000 an acre. I believe 15 there's about 45,000 square feet in an acre, if 16 memory serves me correct. 17 So, none of the properties that he used 18 as comparables to show the value could come up to 19 the 320,000-dollar valuation except the property 20 that has an operating restaurant on it. And what 21 was particularly striking is the phrase, quote, 22 "the contributory value is unavailable," unquote. 21962 1 If one is desperate and you really 2 can't find other raw land sales to use as 3 comparables, you can start to use other types of 4 property. But then you have to discount it. You 5 have to discount the value of the property back to 6 its current -- to a raw land value. This remark 7 that the contributory value was unavailable is an 8 indication that he did not do that. He just -- he 9 just took it, and there is no evidence that he 10 actually discounted the purchase price back to 11 what it should be for raw land value. 12 Q. What would that -- using your analysis 13 on the comparables, how would that affect the 14 utility or usefulness of this appraisal, the Bolin 15 appraisal? 16 A. If I was an examiner looking at this, 17 well -- since I was somebody in supervision 18 looking at this several years later, it would 19 frankly void the credibility of the appraisal, 20 that this appraiser is stretching to get valuation 21 and will use any comparable he can find to do so. 22 Q. Look at page -- if you would of this 21963 1 appraisal, would you look at Page No. 24, please? 2 Looking at the middle of the page, "As evidenced 3 by predevelopment" -- 4 A. Haven't got there yet. Okay. Now I've 5 got it. 6 Q. Here the appraiser states, "As 7 evidenced by predevelopment contracts, 8 approximately 38 percent of the project has been 9 committed." 10 Do you see that? 11 A. Yes. 12 Q. Wouldn't that enhance the value of the 13 project or make it more credible -- make the 14 appraisal more credible? 15 MR. DUEFFERT: Objection. I don't 16 understand the question. "Enhance the value of 17 the project or make it more credible"? 18 MR. LEIMAN: I'll strike the question, 19 Your Honor. 20 Q. (BY MR. LEIMAN) Would the statement 21 made by Mr. Bolin. "as evidenced by 22 predevelopment contracts, approximately 38 percent 21964 1 of the project has been committed," what do you 2 understand Mr. Bolin to be saying in that regard? 3 A. Well, actually, he spells it out, I 4 believe, later in the appraisal when he starts to 5 take into account the supposed sales as 6 represented by these predevelopment contracts. 7 But my reading of this -- and again, we can go 8 back and look at the appraisal and look at it -- 9 is that there were already committed sales of 10 portions of the property. Approximately 38 acres 11 had already been committed and were going to close 12 in the very near future. 13 Q. And is something wrong with that? 14 A. There were a couple of things wrong 15 with it. Obviously -- and this is somewhat by 16 hindsight when I'm looking at it now. Obviously, 17 the sales never occurred, that the contracts 18 really weren't binding. 19 So, in that sense, using this as -- 20 this is obviously -- this is obviously not a 21 supportive factor. But even if the sales were 22 real, you would find later in the appraisal that 21965 1 the sales were at valuations less than Mr. Bolin 2 was noting in the appraisal. 3 Q. Explain that for me. 4 A. Well, we could actually look at the 5 numbers again, if you wish. It was in his -- when 6 he was doing the income approach to value, when he 7 was breaking down the valuations. And that would 8 have been -- should be around Page 49, I think. 9 Here we go. Page 48. 10 Q. And what does this tell us at Page 48, 11 Mr. O'Connell? 12 A. Now, this is somewhat -- this is 13 basically a summation of his valuation of the 14 overall property. Here he has got lot sales -- I 15 believe this is for the -- this is for the hotel 16 sites. These specific -- Lots 2, 3, and 5 are the 17 hotel -- proposed hotel sites totaling 18 approximately 28 acres. 19 If you go to the second full paragraph, 20 quote, "We have been furnished with contracts on 21 Lot Nos. 1 and 7 and we have used the contract 22 prices in our income approach. Lot No. 1 is under 21966 1 contract for $7.25 a square foot, a discount of 2 27.5 percent from our value estimate. Lot No. 7 3 is under contract for $18 a square foot, a 4 discount of 10 percent from our value estimate," 5 unquote. 6 Again, looking at this from an 7 independent third party standpoint with no 8 interest in making this loan, they would wonder 9 particularly about the 27.5 percent. Again, why 10 is this appraiser coming up with appraised value 11 well in excess of what supposedly a willing buyer 12 and willing seller have agreed upon? 13 Q. Would you have expected senior 14 management officials that voted in favor of this 15 transaction to have reviewed this material in this 16 appraisal? 17 A. They certainly should have known about 18 the proposed land sales. If the proposed land 19 sales were, in fact, a factor in terms of the 20 overall viability of the project, yes, they should 21 have been -- they should have known about it, and 22 they certainly should have been aware of what the 21967 1 actual prices were versus what the appraised value 2 were and, in fact, what they were loaning on. 3 Q. Look at Page 55, if you would, please. 4 A. Okay. 5 Q. Mr. Bolin states that -- I think it's 6 the third full sentence on this page, Page 55. 7 "During the construction period and two-year 8 projection period, we have estimated an annual 9 increase of 10 percent for the raw land." 10 Is there something significant about 11 that annual increase? 12 A. The use of projected increases in land 13 value was a common way for institutions to 14 essentially get around the discounting mechanism, 15 that institutions had to discount future sales to 16 present value. 17 And in this case, if the association 18 was using, say, a 10 percent discount factor, a 19 way to get around that and a way to basically 20 neutralize that discount was to just assume that 21 the price of the land would increase at the same 22 amount. 21968 1 So, this is a fairly common strategy. 2 It is again something an examiner would not have 3 looked fondly upon. 4 Q. Let me ask you -- rather than go 5 through this appraisal anymore, would this 6 appraisal, Mr. O'Connell, have supported the 7 transaction as made for Norwood of 39.5 million -- 8 $39.4 million? 9 MR. DUEFFERT: Objection as to clarity. 10 I just want the witness to say -- I apologize. 11 I'm just unclear if the question is asking does 12 this appraisal report conform with R -- Memorandum 13 R-41B or is it the witness' understanding from 14 other sense? I'm trying to figure out if this 15 witness is testifying as to R-41B requirements or 16 just what he would like to see as an examiner, and 17 the questions and answers are unclear on that. 18 THE COURT: Well, I think he can answer 19 the question as posed. 20 A. And the question was again? 21 Q. (BY MR. LEIMAN) The question was 22 would this have been a useful tool in deciding 21969 1 whether or not -- for USAT to be involved in a 2 39.4-million-dollar transaction on this -- on the 3 Norwood project? 4 A. No, it would not. 5 Q. And is that because -- well, tell me 6 why that is, in summary. 7 A. An analysis of this appraisal would 8 show that it had improper comparables. It had 9 valuations in excess of what the appraiser assumed 10 to be bona fide sales. It had a discount factor 11 that essentially -- it had a depreciation factor 12 that eliminated discounts and I'm aware of other 13 documentation and testimony that there were 14 instructions, I believe, by Mr. Graham that the 15 appraisal had to come out to a set number before 16 the -- before the appraisal could be accepted. 17 Q. What you're referring to, a set number 18 before the appraisal was completed, is that a 19 common event in the 1985-'86 time frame? 20 MR. DUEFFERT: Objection to the extent 21 the witness has mischaracterized it and that 22 Mr. Leiman has based that as a predicate for his 21970 1 question. His question has a vague reference of 2 "that," which I don't know where it comes from. 3 I'm just trying to get a clean record. 4 MR. LEIMAN: Your Honor, Mr. O'Connell 5 has probably seen -- 6 Q. (BY MR. LEIMAN) How many appraisals 7 have you seen, Mr. O'Connell -- 8 A. Well, let's see what the question -- 9 THE COURT: The question was, was there 10 here a requested valuation? Is that what you're 11 saying? 12 Q. (BY MR. LEIMAN) Was it a common event 13 for there to be made-as-instructed appraisals in 14 the 1985-'86 time frame? 15 MR. DUEFFERT: Your Honor, I don't know 16 what a made-as-instructed appraisal is. 17 THE COURT: Well, maybe the witness 18 does. 19 A. "Made-as-instructed" was a phrase that 20 came out of -- I believe it was the Federal Home 21 Loan Bank Board. It may have even been -- it may 22 have been the Professional Appraisers Association. 21971 1 I don't know. But it was a phrase picked up 2 from -- and it was a play on words from the Master 3 of Appraisal Institute, that appraisers were 4 supposed to be certified MAI appraisals. And as 5 excessive appraisals, as bloated appraisals were 6 becoming more and more common and being found, the 7 words became made-as-instructed appraisal. 8 That the appraisal was just created and 9 made as instructed by whoever, the chief executive 10 officer, whoever, but it was made for the express 11 purpose of supporting an already pre-determined 12 loan amount. So, it wasn't an independent 13 assessment. It was just created as they were 14 instructed to create it. 15 THE COURT: So, to answer Mr. Leiman's 16 question, this was not unusual at that time? 17 A. For problem institutions, no, it was 18 not unusual. For safe and sound institutions, 19 it's extremely rare. But for problem 20 institutions, yes, it was fairly common. 21 Q. (BY MR. LEIMAN) What do you mean by 22 "problem institutions"? 21972 1 A. Institutions that engaged in very high 2 risk, very speculative activities, institutions 3 that very much were trying to cover up their 4 problems. I believe earlier in the testimony I 5 made the phrase referred to deliberate sloppiness. 6 These types of made-as-instructed appraisals were 7 fairly common for these type of institutions. 8 Generally, what we could find in the 9 loan files is only what the association wanted us 10 to find. And oftentimes, it was a 11 made-as-instructed appraisal. Any documents that 12 lent down as to the credibility of the loan were 13 missing or didn't exist or whatever, but this was 14 fairly common. 15 Q. I take it made-as-instructed appraisals 16 were pre-decided appraisal amounts and would 17 constitute an unsafe or unsound practice; is that 18 right? 19 A. Yes, that would be true. 20 Q. Let's look at Paragraph 87. 21 A. Okay. 22 Q. It says, "In addition to the clearly 21973 1 inadequate appraisal, the association also 2 received loan, quote, unquote, 'guarantees' from 3 Messrs. Minch and Krasovec." 4 Why do you put the word "guarantees" in 5 quotes? 6 A. From everything that I saw, there was 7 no economic substance to the guarantees, that 8 neither Messrs. Minch nor Krasovec ever expected 9 their guarantees to be called, and that 10 essentially the guarantees were basically cosmetic 11 documents. 12 Q. What makes you say that? Is it 13 something about the terms of the guarantees? 14 A. The terms of the guarantees plus, of 15 course, what actually happened. You have a 16 situation where the terms of the guarantees would 17 be void if they were released from the joint 18 venture and they would be released from the joint 19 venture if they didn't meet certain sales 20 projections. That is a self-contradictory theory; 21 that if a project didn't meet sales projections, 22 we're going to release guarantees because if they 21974 1 didn't meet sales projections, that means the 2 property's in trouble and you would need some 3 guarantees. 4 So, the entire concept was peculiar. 5 And frankly, as I said, I thought they were 6 basically cosmetic documents. 7 Q. Let's turn to Paragraph No. 88. 8 A. Okay. 9 Q. You say here that in the second -- 10 well, first of all, I think this is one of the 11 typos that you referred to at the beginning of 12 your testimony in the second full sentence. You 13 say the guarantees would be voided -- I think you 14 say -- is that word "if"? 15 A. Oh, you're right. That's "if." I 16 apologize. 17 Q. Okay. So, that should be corrected to 18 read "if"? 19 A. Yes. 20 Q. "...if the project did not make 21 specified sales projections. In other words, if 22 the project failed, the guarantees would not go 21975 1 into effect defeating the entire purpose of the 2 guarantees." 3 Mr. O'Connell, what then becomes 4 significant by way of collateral for this project 5 if the guarantees are, as you put it, 6 substantively worthless? 7 A. Basically, the only substance to the 8 loan would be the collateral itself, would be the 9 real estate. 10 Q. Paragraph No. 89. You state that all 11 and all, Norwood was, in substance, a direct 12 investment disguised as a loan. 13 Could we have T7591, please? 14 MR. BLANKENSTEIN: Mr. Leiman, is this 15 a new document? 16 MR. LEIMAN: It is. 17 Q. (BY MR. LEIMAN) Now, this was one of 18 the documents that was on the list provided to 19 counsel prior -- well, actually several weeks ago. 20 First of all, Mr. O'Connell, take a 21 look through the document. And after you've had a 22 moment to refamiliarize yourself with it, tell me 21976 1 what it is and identify it. 2 A. This is an internal memorandum from a 3 Mr. Ron Carlson of United Savings of Texas 4 summarizing what he felt was the pertinent 5 findings from a seminar sponsored by the National 6 Council of Savings Institutions. It is dated 7 June 11th, 1986, and the distribution was noted on 8 Page 3 to Jenard Gross, Gerry Williams, Mike Crow, 9 Art Berner, Jim Wolfe, Bruce Williams, Chuck 10 Doolittle, and Keith Johnson. 11 Q. Do you know those names to be names of 12 senior management officials at USAT? 13 A. I frankly don't recall seeing 14 Mr. Johnson's name before. I may have. But the 15 other names, yes, I have seen on various 16 correspondence or memorandum. 17 MR. LEIMAN: Your Honor, I move the 18 admission of T7591. 19 MR. DUEFFERT: No objection. 20 THE COURT: Received. 21 Q. (BY MR. LEIMAN) Mr. O'Connell, my 22 first question to you is: Was this document 21977 1 useful or significant -- let me change that. 2 Was it significant in your analysis of 3 the Norwood transaction? 4 A. Actually, no. I don't believe I saw 5 this until after my opinion was issued. 6 Q. Okay. What's the significance, then, 7 of T7591? 8 MR. DUEFFERT: Objection, Your Honor. 9 He just said it wasn't significant to his 10 analysis. 11 MR. LEIMAN: I'd like to know whether 12 it related to his opinion today, Your Honor, 13 because his opinion is continuing and it was 14 formed not only at that time but it's been -- has 15 since involved having read the testimony of 16 virtually every single one of the respondents in 17 this matter related to the real estate case. 18 THE COURT: All right. If he's saying 19 this document is used in formulating his opinion, 20 maybe he should tell us how. 21 A. Okay. The pertinent issue here 22 regarding the real estate transactions is on the 21978 1 second page under "other items," Point 3. 2 Q. (BY MR. LEIMAN) And what in that 3 regard? 4 A. Essentially, Mr. Carlson is advising 5 what the final notice on acquisition and ADC 6 loans -- acquisition, development, and 7 construction loans -- was released on February the 8 10th, 1986. And essentially goes into advising 9 individuals -- actually all -- not only savings 10 and loans, but basically all financial 11 institutions regarding that under certain 12 circumstances, what the types of terms are and 13 what the types of conditions are in terms of 14 determining the ADC loan as opposed to being an 15 investment. 16 Q. And why is that important to your 17 analysis and opinion today? 18 A. It essentially supports the idea that 19 the institution should have been advised and 20 should have been aware of the fact that the 21 transactions that they were entering into had the 22 economic substance of being direct investments. 21979 1 MR. EISENHART: Your Honor, I object 2 and move to strike. He's now being asked to offer 3 his interpretation of accounting standards. The 4 witness, by my recollection, has no training in 5 accounting and is not an accountant. As we know 6 from prior situations where we've had go rounds on 7 this, OTS has not designated in this case any 8 accounting witness. It seems to me they are 9 simply trying a back door method of getting in 10 accounting testimony from a witness who's already 11 said that this wasn't important enough to him to 12 even note in his report or take into account in 13 formulating his opinions. 14 THE COURT: I'll deny the objection. 15 We'll take a short recess. 16 17 (Whereupon, a short break was taken 18 from 3:04 p.m. to 3:28 p.m.) 19 20 THE COURT: Be seated, please. We'll 21 be back on the record. 22 Mr. Leiman, you may continue. 21980 1 MR. LEIMAN: Thank you, Your Honor. 2 Q. (BY MR. LEIMAN) If you remember where 3 we were, Mr. O'Connell, we were talking about 4 T7591. 5 Do you remember that? 6 A. Yes. 7 Q. Okay. Paragraph 90 states that 8 reporting direct investments as real estate loans 9 is a clear violation of regulations and shows 10 willful neglect of regulatory requirements. 11 Right? 12 A. Yes. Now you're going back to my 13 opinion. Right. Okay. 14 Q. Do you know how the Norwood project was 15 reported in terms of its -- how it was carried on 16 the balance sheet of USAT? 17 A. In nineteen -- the original 1984 and 18 1985 loans, the 18.2 and then the 21 million, were 19 both reported as loans. The 39.4-million-dollar 20 transaction in July of '86 I believe was reported 21 $9.4 million equity investment and then 22 30-million-dollar loan. That's based on the 21981 1 examination report, I believe. 2 Q. Do you believe that it was improper for 3 the 30-million-dollar portion of that Norwood 4 transaction to be reported as a loan? 5 A. Yes. 6 Q. Why? 7 A. The borrower had no real equity -- 8 MR. DUEFFERT: Your Honor, just one 9 point of clarification. Mr. Leiman's using the 10 word "report," and there is a difference between 11 accounting reporting and I don't know what the use 12 of the word "report" is. If I could just have the 13 witness' clarification as to what he means when 14 he's using the word. I'd like a clear record. 15 THE WITNESS: I'm referring to, I 16 believe it was the 1987 examination report which 17 had the classification. And I believe at that 18 time it was, as I said, the 9.4-million-dollar 19 investment and then the 30-million-dollar loan. 20 So, it was as reported to the federal examiners. 21 Q. (BY MR. LEIMAN) Back to my question, 22 Mr. O'Connell. 21982 1 Why would it be a violation of 2 regulation to carry it as a loan versus a direct 3 investment? 4 A. Pursuant to the direct investment 5 policy and pursuant to the ADC statement that 6 was -- that we discussed earlier, projects where 7 the borrower did not have any equity in it, where 8 the institution had residual interest in the 9 overall profits were supposed to be reported as 10 direct investments. And the reason for that is 11 that the institution de facto had all of the 12 economic risk for the transaction. 13 Therefore, it really wasn't a loan as 14 much as it was a pure direct investment reliant on 15 the property to appreciate in value for the 16 association to recover its funds. 17 Q. A6022, please. 18 MR. DUEFFERT: Do you have a tab 19 number, Mr. Leiman? 20 MR. LEIMAN: Yeah. It's Tab 468. 21 MR. DUEFFERT: 468? 22 MR. LEIMAN: I believe so, yes. 21983 1 Q. (BY MR. LEIMAN) Now, Mr. O'Connell, 2 would you tell us, first of all, what is this 3 document, A6022? 4 A. Okay. This is a July 28th, 1988 letter 5 from the Federal Home Loan Bank of Dallas acting 6 as the supervisory agent of the thrift. And it is 7 transmitting a copy of the report of examination 8 of November 16th, 1987, of United Savings of 9 Texas. 10 Q. Was this document instrumental in 11 formulating your opinion for your testimony here 12 today? 13 A. Yes, it was. 14 Q. In what way? 15 A. It gave me some background information 16 in terms of how the particular loans were being -- 17 were being reported, how the loan classifications 18 were being contested, and it did give me some 19 overall background information in terms of the 20 overall operation of the thrift. 21 Q. Did management at United Savings agree 22 with the examiner's classification of the Norwood 21984 1 project? 2 A. No, they did not. 3 Q. What's your understanding of what 4 senior management's position was? 5 A. My understanding of the position is 6 that senior management contested the idea that 7 this was a distressed property and that the 8 valuation of the property was sufficient to avoid 9 it being classified. 10 Q. Did they take issue with the notion 11 that the Norwood transaction was a direct 12 investment? 13 A. I don't believe they took issue with 14 the $9.4 million. And I don't believe the 15 examiners actually raised the issue of the 16 $30 million being a direct investment. 17 Q. Looking back today, was the direct 18 investment regulation in place in 1986? 19 A. Yes, it was. 20 Q. All right. Was that one of the 21 regulations you talked about earlier as being a 22 significant change in the '84 -- the '85-'86 time 21985 1 frame? 2 A. That is correct, yes. 3 Q. You indicated that there was a 4 memorandum at that had been circulated among 5 senior management at USAT. Right? 6 A. Yes. 7 Q. And that particular document dealt with 8 what? 9 A. It actually didn't deal with the direct 10 investment regulation itself. It actually dealt 11 with the accounting treatment of ADC loans, as to 12 when ADC loans should be treated as equity 13 investments. 14 Q. And how does the ADC loan -- tell me 15 about the -- explain to me what the relationship 16 is between ADC loans and direct investments. 17 A. In theory, there shouldn't be. They 18 should be entirely separate types of transactions. 19 But what the Bank Board did with the direct 20 investment regulation is that it -- a good portion 21 of the preamble of the document dealt with the 22 fact that there were so many ADC loans being made, 21986 1 they, in substance, were equity investments. 2 And the regulation then goes into 3 certain examples of, again, lack of borrower 4 equity, lack of any payments by the borrower to 5 keep the loan current, that the loan is being kept 6 current only by the loan proceeds itself, residual 7 interest in the overall profits of the project 8 being retained by the thrift. 9 It was clear that the direct investment 10 regulation wanted to catch really in substance 11 direct investments, not only those that were 12 admitted poor direct investments. They didn't 13 want institutions to structure direct investments 14 as ADC loans to try to get around the regulation. 15 Q. If I understand your testimony, the 16 Norwood transaction, all $39 and a half million of 17 it, should have been a direct investment? 18 A. That's the way I saw it, yes. That was 19 my opinion, yes. 20 Q. Okay. What significance is there to 21 the fact that the examiners in 1987 did not set 22 that out as a violation of regulation? 21987 1 A. Significance to me? 2 Q. Yeah. Tell me what that means. 3 A. That the examiners came to a different 4 conclusion or that they were just interested in 5 the classification issue from the standpoint of 6 whether it was substandard or not and really 7 didn't take into account the question of whether 8 it was a direct investment or not. 9 Q. Going back -- I know that we're going 10 to jump back just for a moment -- to Park 410. 11 A. Okay. 12 Q. Looking at the 1986 examination -- are 13 you familiar with that? 14 A. Yes. 15 Q. Can you tell me whether or not there is 16 any significance to the fact that the examiners 17 did not classify Park 410 as substandard, for 18 example? 19 A. Primarily, the significance to me is 20 that it was deemed to be a brand-new loan and the 21 examiners did not see any immediate prospect of a 22 loss. That is how I would normally interpret 21988 1 that. But no, it did not affect my overall 2 assessment of the case. 3 Obviously, my assessment -- I have the 4 advantage of knowing what actually happened to the 5 loan and I have access to various documents that I 6 don't believe the examiners had access to. 7 Q. You mentioned the newness of this -- of 8 the classification regulation as well as capital 9 regulations at the time. 10 Do you have an opinion as to whether or 11 not that would have affected the use of those new 12 regulations on an examination that started as of 13 May 1986? 14 A. Well, certainly, yes. The -- I think I 15 mentioned earlier that there was an understanding 16 that institutions could appeal any classifications 17 to the principal supervisory agent. 18 So, from the standpoint of when the 19 examiners were going on site, they generally -- 20 unless the case was overwhelming, they tended not 21 to classify because they realized that they would 22 have -- not only would they have to argue with the 21989 1 institution, but they would have to make a 2 presentation to the principal supervisory agent. 3 And the principal supervisory agent in Dallas at 4 that time would have had, I think, well over 100 5 problem institutions he would have had to deal 6 with. 7 So, from the standpoint of being able 8 to get the PSA's attention, to be able to assure 9 him that the classification was proper, my 10 understanding is they -- and this is partly due to 11 the fact that obviously, as I mentioned, I had 12 some tangential dealings with it by being the 13 supervisory agent for two 9th District 14 associations, that generally they wanted 15 overwhelming evidence before they would actually 16 classify an asset. 17 Q. What would be overwhelming evidence? 18 A. Well, I think the key document that the 19 examiners would have wanted to see and what I 20 think would have -- I grant this is indeed 21 hypothetical. I think the key document the 22 examiners would have wanted to see would have been 21990 1 the Love & Dugger appraisal. If there had been 2 evidence that the association was opinion 3 shopping, I think that probably would have been 4 the evidence they needed to classify at the time. 5 Q. Looking at Paragraph No. 91, you talk 6 about -- 7 A. Oh, the opinion. Okay. 8 Q. You talk there about restructurings and 9 refinancings and that USAT continued to report the 10 Norwood financings as current loans. Okay? 11 A. Yes. 12 Q. If the loan is current, why is it a 13 problem to restructure it? 14 A. Well, again, I think I discussed that 15 earlier, that you get into this process of 16 increasing the ultimate loss once economic reality 17 finally sets in. And this is a situation, again, 18 that I've seen many times before where losses to 19 the thrift exceed the original investment because 20 of the continued restructurings, continued 21 refinancing all for the purpose of trying to keep 22 a loan current. 21991 1 I believe this is even addressed in our 2 classification of assets regulation that continued 3 modifications and restructuring should not stop an 4 asset from being classified, that you have to go 5 back to what the economic substance is and go from 6 there. 7 But clearly, the classification of 8 assets regulation in part was to address these 9 type of situations where constant restructurings 10 are meant to try to keep a loan from actually 11 becoming a, quote, "scheduled item," a loan that 12 was actually in default. 13 Q. Turning to Paragraph 92, you state that 14 "as a result of these clearly" -- referencing back 15 in your report -- "...result of these clearly 16 unsafe and unsound practices that led to the 17 making of this 39.5-million-dollar investment, the 18 deposit insurance fund suffered a gross loss of 19 $31 million on the disposition of this asset." 20 How did you calculate the 21 31-million-dollar loss? 22 A. Again, the same method that I used for 21992 1 the Park 410. I used the investment balance that 2 existed at the time of the receivership. And 3 again, I believe the receivership capped the 4 amount -- and I believe it was around $34 million. 5 And holding that $34 million constant then, again 6 I believe the receivership just expensed all other 7 items subsequent to the receivership. 8 I then subtracted from that the amount 9 that the receivership finally got for the 10 distribution for the -- for the disposition of the 11 asset, which I think was just about $3 million. 12 Q. Tab 1794, T7584. 13 Mr. O'Connell, do you have the document 14 in front of you now? 15 A. Yes, I do. 16 Q. All right. Have you seen this document 17 before? 18 A. Yes, I have. 19 Q. Identify the document, please. 20 A. It is a memorandum from Jenard Gross to 21 the members of the executive committee dated 22 March 26, 1986, entitled, quote, "It was the best 21993 1 of times. It was the worst of times," unquote. I 2 do not see an actual distribution list identifying 3 who the executive committee members were. 4 Q. Have you read this before? 5 A. Yes, I have. 6 Q. When did you read this? 7 A. Again, this would have been subsequent 8 to my preparing the -- my actual opinion. So, it 9 would have been sometime -- I think it was last 10 fall that I first saw this document. 11 Q. Was this document instrumental in 12 formulating -- in you formulating your opinion for 13 testifying here today? 14 A. For testifying today, yes, it has. 15 Q. All right. In what way? 16 A. Again, it's an indication of what the 17 executive committee members, what senior 18 management should have known -- in fact, did know 19 about the condition of the real estate markets in 20 the period of time 1986. I believe this -- in 21 fact, this was before the closing of both the 22 Park 410 80-million-dollar transaction and the 21994 1 39.4-million-dollar transaction for Norwood. 2 Q. Why is it important to know what senior 3 management may have been aware of? 4 A. Well, it gets into the question of did 5 they have reason to understand that they were 6 increasing their involvement in real estate 7 markets that at that time were experiencing -- and 8 I'll use the phrase the appraiser used -- that 9 experienced duress. And I believe this memorandum 10 actually lays that out pretty well. 11 Q. What is the significance to you of the 12 following: "During 1985 in the real estate 13 market, there was no progress made in office 14 occupancy anywhere in the state, including 15 Houston"? 16 MR. EISENHART: Your Honor, may we know 17 where Mr. Leiman is reading from? 18 MR. BLANKENSTEIN: First page. 19 MR. EISENHART: Oh. 20 A. First page, four lines from the top or 21 from the bottom? 22 Q. (BY MR. LEIMAN) Yes. 21995 1 A. Given the fact that the institution was 2 about to approve two mixed-use projects, two of 3 the largest -- in one case, the largest loan the 4 institution had ever made and the second one, I 5 think, was the third largest loan ever made by the 6 institution that included office -- office 7 buildings in their mixed-use projections, that's 8 an indication that the institution's senior 9 management realized they were heading into 10 declining markets and increasing their exposure to 11 declining markets. 12 In fact, I believe specifically they 13 even mention San Antonio and Austin in another 14 page. The next page, as a matter of fact. 15 Q. Where are you looking at, 16 Mr. O'Connell? 17 A. The last paragraph of the second page 18 of the document. 19 Q. Would you read the portion of the 20 document that you're referring to? 21 A. Certainly. It is the third from the 22 last sentence. Quote, "And, imposed upon this, 21996 1 the overexpansion of office facilities and other 2 real estate in Dallas, Austin, and to a much 3 lesser degree, San Antonio," end quote. 4 Q. Was that instrumental in formulating 5 your opinion for testimony today? 6 A. In conjunction with other data that 7 supported that, yes. There was, in fact, 8 reference to the increase in office vacancies in 9 San Antonio, for instance, in the Bolin appraisal. 10 I think the -- I really shouldn't guess on that. 11 Where was that? Do you remember the -- the 12 Love & Dugger appraisal. I'm sorry. T7143. 13 Q. All right. 14 A. And it was in the general economic 15 discussion -- whoops. Okay. Page 18. 16 Q. Yes, sir. 17 A. The first -- I guess first full 18 paragraph. 19 Q. And what are you reading -- what are 20 you -- 21 A. Well, actually, that entire paragraph 22 indicates just how much that the -- that the 21997 1 amount of office space in the San Antonio area had 2 more than doubled from the period of 1980 to '84. 3 And I believe it's the third sentence that states, 4 quote, "As a result of this development activity, 5 occupancy levels have dropped from 93 percent in 6 1980 to the current rate of 78 percent overall," 7 unquote. 8 And I believe a similar drop in 9 vacancies -- I'm sorry -- drop in occupancies was 10 cited in a -- I believe it was the Burke, O'Hara 11 study regarding the Norwood project in 1986 that 12 showed almost exactly the same figures as I recall 13 from the mid-Nineties to the mid-Seventies in 14 terms of occupancy in the City of Austin. 15 So, Mr. Gross is not an economist in 16 and of itself; but the fact that he makes 17 reference to this in conjunction with other hard 18 documents that indicate the trends he's 19 referencing did, indeed, occur, that did have a 20 factor in my current opinion, yes. 21 Q. This document states on Page 3 in the 22 second full paragraph -- 21998 1 MR. SCHWARTZ: Which document? 2 MR. LEIMAN: T7584. 3 Q. (BY MR. LEIMAN) Mr. Gross' 4 memorandum, "best of times, worst of times," 5 states as follows. The second full paragraph -- 6 "Along that same line, I guess part of the 7 mentality is the same thing we faced in Houston 8 ten years ago in real estate in that a lot of the 9 things that are being built today are not worth 10 economically what they cost physically the day 11 they are furnished because you can't rent them out 12 at the price that gives you a return on your real 13 cost." 14 Going back to your earlier testimony, 15 Mr. O'Connell, about 100 percent -- I think you 16 said -- and I'm not 100 percent sure about this -- 17 100 percent plus loan to value. 18 Is that what you said? 19 A. No. Well, yes. There is that. But it 20 was basically the 100 percent plus losses of 21 ultimate disposition of assets resulting in the 22 original investment. But in this particular case, 21999 1 that remark by Mr. Gross was supported by some of 2 the other issues that we talked about. For 3 instance, the remark, quote, "costs are rising at 4 a time when rents are falling," unquote. 5 We saw in the Love & Dugger appraisal 6 that occupancy rates were dropping in the 7 San Antonio area, that -- you'll also recall that 8 we saw budgets from the GMR or the Park 410 Joint 9 Venture showing an increase in costs to develop 10 from roughly 65 million to a cost of 77 million. 11 That's a classic mismatch of a rise in 12 costs with, at the same time, a reduction in 13 future revenues because of lower occupancy. 14 The comment that he made also about 15 things being built today are not worth 16 economically what they cost physically the day 17 they are furnished, looking at the appraisal of 18 the -- the triple A appraisal, the Appraisal 19 Associates of Austin, what that appraisal 20 indicates is that the 39.4-million-dollar project 21 was not feasible because the value returned to 22 investors was less than the actual investment 22000 1 amount. 2 And again, if you have a mismatch 3 between the ultimate valuation and what you're 4 putting into it, you don't do it. It's not a 5 feasible project. That's one of the reasons why 6 we always require the cost approach to be involved 7 in -- to be included in appraisals of ADC and 8 commercial properties. If at any time the market 9 value of a project comes in less than the cost 10 approach, you don't do it because it would be 11 stupid to spend $80 million building a project if 12 some day it will be worth $70 million at the end. 13 Q. Mr. O'Connell, isn't that why lenders 14 are encouraged to obtain feasibility studies? 15 A. Yes, it is. 16 Q. Let's -- 17 A. To clarify, because there was a 18 reference, Mr. Leiman, to -- it's important -- 19 there was a reference in a senior loan committee 20 minutes, as I recall, to getting a feasibility 21 study some time later. This would have been after 22 the senior loan committee approved it. You get a 22001 1 feasibility study and you review appraisals before 2 the loan is closed. That's the time to get it. 3 You don't get feasibility studies just to stuff in 4 a file. 5 Q. Again, why do you want to do that? 6 A. Because you'd want to have information 7 about whether or not you're lending on a feasible 8 project before you make any such commitment. 9 Q. Let's just take a very quick look, and 10 I'm not going to belabor this point with you at 11 all. But let's look at Tab 710, T7127, which is 12 the Tremar Real Estate Research report that you 13 identified earlier. 14 A. Okay. That's trial number what again? 15 Q. That would be T7127, Tab 710. 16 A. Okay. Okay. 17 Q. With respect to the financial economic 18 feasibility of making a loan and getting involved 19 in a real estate transaction, would it be 20 important to the S&L to know -- if, in fact, it's 21 making a loan regarding multi-family projects -- 22 to know what the occupancy rates are? 22002 1 A. Certainly. Within the general market 2 area of the property, sure. 3 Q. All right. Look at Page 46 of this 4 Tremar study. 5 A. Okay. 6 Q. The information on this page regarding 7 in Table Roman V-IV about occupancy and absorption 8 rates of comparable apartment properties in the 9 Park 410 West study area, would those approximate 10 occupancy rates be relevant to determining whether 11 or not to go forward with the project? 12 A. Oh, sure. In particular, the -- it's 13 not so much the occupancy rates because, in 14 general, the occupancy rates will be less -- the 15 newer the project, since they need time to fill 16 up. But particularly the monthly unit absorption 17 becomes important when you assess this project as 18 well as other projects that the joint venture has 19 to -- has to compete against. 20 Q. Looking at Page No. 88, Table Roman 21 V-VIII, under proposed construction and business 22 space analysis in the Park 410 West study area, 22003 1 would the information there be significant? 2 A. Yes. Again, in terms of the -- in 3 terms of showing the competition that the project 4 is going to face as well as the overall estimated 5 absorption rates. 6 Q. Looking at Page 100 -- in this case, 7 131 -- should be the last page of the exhibit -- 8 would the summary paragraph, especially that 9 relating to "Development opportunities were 10 plentiful; however, there is an abundance of raw 11 land currently available for development of the 12 aforementioned types of facilities," be 13 information that would be useful to a lender? 14 A. Again, yes, sure. 15 Q. Why? 16 A. Essentially, what this market potential 17 says is that the project does have great 18 potential, but it also has high risk. That, in 19 fact, as it states -- I mean, the very last 20 sentence makes -- does make the comment that the 21 project can provide the basic -- I should do this 22 in quotation marks. Quotation marks, "can provide 22004 1 the basis for successful absorption of the site 2 into this competitive marketplace," unquote. 3 So, they are saying this can be a 4 marketable project. But it also is noted in what 5 you've said, it is also a high-risk venture, that 6 there are many risk factors that need to be 7 considered. 8 MR. DUEFFERT: Your Honor, again, just 9 for clarity of the record, he's using a 10 comparative called "higher." Higher risk. I'm 11 just wondering "higher than what" so we have a 12 clear record. 13 THE COURT: Can you respond to that? 14 THE WITNESS: In the sense that this is 15 a speculative venture, that this is not a venture 16 that has a guaranteed return of either principal 17 or interest. 18 Q. (BY MR. LEIMAN) Turning back to your 19 report, Mr. O'Connell -- before we do that, let me 20 just ask you a couple of quick questions about 21 what the Court mentioned a moment ago. 22 What is the relationship between safe 22005 1 and sound banking practices and risk? 2 A. Hum. Boy, that's a very broad 3 question. 4 Q. Let me change the question. Let me 5 change the question to be this. 6 Does a -- are you suggesting that only 7 risk-free ventures are safe and sound? 8 A. No, I'm not. 9 Q. What are you saying when you talk about 10 ventures that have guaranteed return and such? 11 A. Essentially, what you're looking for in 12 items of underwriting the loan or investment is 13 you're looking for reasonable assurance of 14 particularly the return of principal. 15 So, in loans, you're looking for equity 16 to be put up by the borrowers so that there is a 17 buffer in terms of any market decline between -- 18 in terms of value of the collateral versus the 19 loan. That itself is not a risk-free investment. 20 Let us presume you get a 20 percent 21 downpayment on a single-family mortgage. Clearly, 22 that is a buffer. That gives you reasonable 22006 1 assurance, but it's no guarantee. The market may 2 really collapse and you're going to lose money on 3 it anyway. But there is a difference between 4 reasonable assurance and basically speculating 5 that the market value has to increase in order for 6 the principal to be repaid. 7 With a 100 percent loan, when you're 8 giving all of the payments -- in fact, even 9 more -- you're funding all of the cost of the 10 loan, on day one, that loan is going to be in 11 excess of the original loan amount because you've 12 got accrued interest to it. You're funding the 13 entire loan. You're funding all interest. That 14 is a purely speculative investment. You are 15 speculating that the value of the property is 16 going to increase. 17 So, you're not just taking an asset as 18 it currently exists and underwriting it as it -- 19 in its current condition. You're speculating that 20 the price is going to increase. 21 So, no, I'm not -- every loan amount 22 other than you're purchasing treasury bonds or 22007 1 mortgage-backed securities or something where 2 you've got an explicit government guarantee, any 3 other type of a loan does have some element of 4 risk. But you take some -- you've got to take 5 some reasonable steps of assurance to protect the 6 association and to make sure that your principal 7 is repaid. 8 Q. Is that what underwriting is supposed 9 to do? 10 A. Yes. 11 Q. The type of speculation you mentioned a 12 few moments ago, would that be unsafe and unsound? 13 A. Very much so, yes. The -- in this 14 particular project, you have -- again, the 15 association -- 16 Q. Which project are we talking about? 17 A. Both of them. On both Norwood and on 18 Park 410, you have all of the expenses being paid 19 for by the thrift. You even have -- in the case 20 of these two loans, not only the borrower is not 21 making any payments. They are actually getting 22 paid. Krasovec and Minch, I believe, were making 22008 1 $20 odd thousand a month in management fees. 2 Block and Gordon got a cut of the original sales 3 commission in 1984. Rosenberg got a 4 400,000-dollar fee. The borrowers not only 5 weren't making any payments, they were actually 6 getting paid. They weren't really borrowers in 7 that sense. They were just managers of a project 8 that the association bore all the economic risk 9 on. 10 So, in that sort of a situation, yes, I 11 believe that is unsafe and unsound, particularly 12 by portraying to use its actual loans as opposed 13 to being what they were, which is the thrift owned 14 all the economic risk of the transaction. 15 Q. Looking at Paragraph 93 in your 16 conclusion, Section Roman V, what conclusions did 17 you reach regarding United Savings' structuring of 18 equity investments in real estate? 19 A. My conclusion on both of the 20 transactions, not just limited to 93 which dealt 21 with Park 410, but on both of the transactions, is 22 that USAT engaged in a number of activities to 22009 1 structure equity investments in real estate to be 2 reported as real estate loans. 3 And by doing this, the institution 4 showed higher income and reduced its overall 5 capital requirements because, as I said, direct 6 investments had higher capital requirements than 7 ADC loans had. 8 Q. Are your conclusions set out in 9 Paragraphs 93 through 97 inclusive? 10 A. Yes, they are. 11 Q. Now let's talk about Subsection B. 12 A. Okay. 13 Q. Did you reach any conclusions about the 14 manner in which United Savings maintained its 15 books and records? 16 A. Yes, I did. 17 Q. And what are those conclusions? 18 A. That USAT failed to maintain adequate 19 books and records in terms of these two projects 20 and that the failure to maintain the adequate 21 books and records frankly showed a willful neglect 22 for regulatory practices and for safe and sound 22010 1 practices. 2 Q. Are your conclusions set out in 3 Paragraphs 98 through 103 inclusive? 4 A. Yes, they are. 5 Q. Turning now to Subsection C, you state 6 that "USAT failed to utilized" -- I guess it's 7 another typo. 8 Is that right? Should we eliminate the 9 "D"? 10 A. What paragraph was that again? 11 Q. In the -- 12 A. Oh, you're right. 13 Q. Should we eliminate the "D" in 14 utilized? 15 A. Actually, I just noticed that. 16 Q. Read it for me as it should be. 17 A. "USAT failed to utilize safe and sound 18 real estate investment practices." 19 Q. And what were your conclusions with 20 respect to that? 21 A. Basically as it states, that USAT 22 failed to utilize safe and sound real estate 22011 1 underwriting practices to underwrite these two 2 transactions. The association received no 3 guarantees that had no substance. They used 4 appraisals that had comparables that simply were 5 not comparable. And essentially, they acted as if 6 these were pre-determined transactions and that 7 they were not going to be deterred from making the 8 transactions no matter what the economic realities 9 of the transaction were. 10 In addition, specifically with regard 11 to the Norwood transaction, you have a situation 12 that, as I said, the guaranty was superfluous and 13 was basically being put in purely as a cosmetic 14 reason. 15 Q. Now, are your conclusions set out in 16 Paragraphs 106 through 116 -- 17 A. Yes. 18 Q. -- inclusive? 19 A. Yes, they are. 20 Q. Okay. What was the last conclusion you 21 reached in D, Mr. O'Connell? 22 A. Essentially, that the unsafe and 22012 1 unsound practices by USAT resulted in significant 2 losses to the thrift and, ultimately, since the 3 institution went into receivership, the deposit 4 insurance fund. 5 Q. Are your conclusions set out in your 6 report? 7 A. Yes, they are. 8 Q. And would those conclusions be in 117 9 and 118? 10 A. Yes, they would be. 11 Q. Do you have an opinion as to the 12 category -- the group of persons that would be 13 responsible for the reckless disregard and unsafe 14 and unsound conduct and regulatory violations that 15 are the subject of your report? 16 MR. DUEFFERT: Objection, Your Honor. I 17 believe his report refers to different loans at 18 different times, different alleged conduct. We're 19 talking about booking issues. I think he can't 20 tie a group to all of it. I don't think the 21 question is appropriate. 22 MR. LEIMAN: I think if we allow the 22013 1 witness to answer the question, maybe he can give 2 us some insight as to the group. 3 MR. DUEFFERT: My objection is to the 4 form of the question. 5 THE COURT: All right. I'll deny the 6 objection. 7 A. My report continued to make reference 8 to the senior management and to the board of 9 directors of the institution as they are 10 ultimately responsible for the operations of the 11 thrift. I did not state out in the opinion any 12 specific individuals. 13 Q. (BY MR. LEIMAN) All right. Now, 14 Mr. O'Connell, you testified earlier that -- and 15 obviously, you cannot know since you were not in 16 the institution in 1984, '85, or '86 yourself what 17 the loan files looked like some 12 years ago. 18 Am I right? 19 A. Yes, that's true. 20 Q. Obviously, you can't know precisely 21 what information the senior loan committee or the 22 real estate investment committee had in front of 22014 1 it at the time that these loans were approved, can 2 you? 3 A. I think that is also true. But let me 4 have that question reread. 5 MR. LEIMAN: Please reread it. 6 7 (The record was read by the court 8 reporter, as requested.) 9 10 A. That is correct. No, I cannot -- I 11 cannot know for certain what they had in front of 12 them, no. 13 Q. (BY MR. LEIMAN) Let me ask you this 14 question, Mr. O'Connell. 15 Have you seen any information that was 16 available at the time the senior loan committee or 17 the real estate investment committee voted that 18 supports making the Norwood loan and investment or 19 the Park 410 investment and loan? 20 A. Oh, God. Could you ask -- at the 21 time -- let me ask you a question. The senior 22 loan committee or the board of directors? 22015 1 Q. Senior loan committee. Have you seen 2 any supporting documentation to make those loans? 3 MR. DUEFFERT: If that last question is 4 just the question, I have no objection. 5 A. No. I have not seen any documents that 6 existed at that time, no. 7 Q. (BY MR. LEIMAN) And finally, let 8 me -- in this connection, have you seen any 9 information that would have supported not making 10 these loans? 11 MR. DUEFFERT: Your Honor, I don't 12 think I can follow that question. Objection. 13 THE COURT: I gather you're asking 14 whether he saw any information that would suggest 15 the loans should not have been made? 16 MR. LEIMAN: That's exactly what I'm 17 asking, Your Honor. 18 A. Yes. I've seen quite a bit of 19 documentation suggesting the loans should not have 20 been made, yes. 21 Q. (BY MR. LEIMAN) All right. And was 22 that the information we were talking about today 22016 1 with respect to -- why don't you tell us -- give 2 me an example. 3 A. The Love & Dugger appraisal was clearly 4 the most important document in that regard in 5 terms of the Park 410. 6 In terms of the Norwood, frankly, 7 the -- just the loan history of the transaction 8 was an indication that something was wrong. I 9 don't think -- and I've been racking my brain on 10 this. In all my years of supervision, I don't 11 think I've ever seen a loan restructured three 12 times in 12 months. Something is terribly wrong 13 there, and they should have just bit the bullet 14 and realized they had a problem. 15 Q. Mr. O'Connell, I want to clear up one 16 final matter for the record. 17 We talked about documentation that was 18 made available to you, where it was made available 19 to you, what you've seen. 20 Do you understand that you have seen 21 the real estate files with respect to the Park 410 22 transaction and the Norwood transaction that were 22017 1 turned over by the FDIC and the receiver in this 2 matter? 3 A. That's my understanding, yes. 4 MR. LEIMAN: I have no further 5 questions at this time, Your Honor, of this 6 witness. 7 MR. DUEFFERT: Your Honor, if we have 8 three minutes off the record, we are prepared to 9 proceed. 10 THE COURT: All right. We'll be off 11 the record. 12 13 (Discussion held off the record.) 14 15 THE COURT: We'll be on the record. 16 Mr. Dueffert, you may cross. 17 MR. DUEFFERT: Thank you, Your Honor. 18 19 20 21 22 22018 1 2 EXAMINATION 3 4 Q. Good afternoon, Mr. O'Connell. 5 A. Hello. 6 Q. For the record, my name is Paul 7 Dueffert and I represent respondents Arthur 8 Berner, Michael Crow, Ron Heubsch, and Barry 9 Munitz. You may remember me from your deposition 10 last summer. 11 A. Yes, I do. 12 Q. I'd like to -- Mr. Leiman was asking 13 you some questions about what you looked at in the 14 loan files. And he asked you where you looked at 15 it. I'm curious to know when you looked at it. 16 First off, in getting the chronology correct, do I 17 understand it that you first learned the basic 18 facts of this case from reviewing a draft of the 19 notice of charges? 20 A. Yes. In late 1985, yes, that would be 21 correct. 22 Q. And you advised -- 1995. 22019 1 A. '95. Thank you, Counsel. 2 Q. You advised Mr. Leiman with respect to 3 certain paragraphs of the Notice of Charges? 4 A. Yes, I did. 5 Q. And then when were you contacted by OTS 6 to given drafting your report that you now present 7 to the Court? 8 A. I believe it was sometime in the fall 9 of 1996. I want to say October, November. I 10 don't precisely remember when, though. 11 Q. Was it roughly a month before you 12 actually submitted the report? 13 A. No. It was a bit more than that. As I 14 said, it was either October or November. 15 Q. So, how long did you spend drafting 16 your report? 17 A. I would estimate about six or seven 18 weeks. 19 Q. And -- 20 A. Obviously, in terms of drafting a 21 report, I presume you also mean actually going 22 through the documents as opposed to actually 22020 1 writing it? 2 Q. I am interested in what you did before 3 you arrived at your conclusions that you expressed 4 in your report. 5 A. Yes. That would be about right, about 6 two months or so, yes. 7 Q. And your report is dated January 17th, 8 1996? 9 A. '97, yes, that would be correct. 10 Q. Before you arrived at those conclusions 11 and signed the report on January 13, 1997, did you 12 look at all of those boxes that you told 13 Mr. Leiman about on the wall? 14 A. No. I basically -- I think the 15 documents I laid out were the documents I had laid 16 out in Paragraph 11 of my opinion. No, I did not 17 see all the T -- all of the T documents or all of 18 the loan receivership documents, no. 19 Q. You did not review the entire loan 20 files, correct? 21 A. No. I didn't even know that we had 22 them. 22021 1 Q. And is it -- do I understand correctly 2 that you relied almost exclusively on documents 3 that were provided to you by Mr. Leiman? 4 A. Ultimately, yes. The Office of 5 Enforcement provided me with the documents I 6 requested, and they also provided me with some 7 core documents beforehand, yes. 8 Q. I'm getting lost in the time line. 9 We're talking only about in the time before you 10 signed your report. 11 A. That is correct, yes. 12 Q. And so, before that date, January 13th, 13 1997, you relied on documents given to you by 14 Mr. Leiman? 15 A. Right. That is correct. 16 Q. Did you ask to look at anything else? 17 A. Well, yes. In fact, I think I 18 mentioned there were some documents I did ask 19 Mr. Leiman to get me a copy of, yes. 20 Q. Before January 13th? 21 A. That is correct, yes. 22 Q. And they related to the letters of 22022 1 credit for the Park 410 loan. Right? 2 A. That was one of them, yes. Also, 3 there -- I wanted to look at some thrift financial 4 reports. I don't recall if he originally gave me 5 those. There -- I can't think of anything offhand 6 now other than those. 7 Q. That you requested? 8 A. That I requested, yes. 9 Q. Before arriving at your conclusions and 10 signing your report, did you review the auditor's 11 work papers? 12 A. No, I did not. 13 Q. Why not? 14 A. The auditor wasn't a party in this was 15 my understanding. I believe -- at least, I have 16 been told that Peat Marwick signed off on this as 17 part of their -- as part of their global 18 settlement with the RTC and the FDIC that they 19 specifically cited USAT as one of them that they 20 basically -- wanted immunity from. So, no, I 21 didn't think Peat Marwick was a party to this. 22 Q. Did you think there might be any useful 22023 1 information to your analysis in the auditor's work 2 papers? 3 A. Not particularly, no. That was not a 4 party in the loan documents. 5 Q. Even though you're accusing United of 6 books and records violations? 7 A. That is correct, yes. 8 Q. In fact, your opinion was that the 9 auditor's work papers were superfluous. Right? 10 A. To the basic core analysis, that is 11 correct, yes. 12 Q. Do you see -- would you please turn to 13 Pages 19 and 20 of your deposition? 14 A. Okay. Which depositions? 17th? 18th? 15 Q. We're talking the first day. The 16 pagination is consecutive. Looking at Pages 19 17 and 20. 18 A. One more question. The pages in 19 parentheses or the pages that say Pages 16 to 22, 20 et cetera? 21 Q. The small pages that say 19 and 20. 22 A. Okay. That would be -- okay. Got you. 22024 1 That I've got on the page. All right. 2 Q. Turn to Line 9, please. 3 A. Okay. 4 Q. "As of 1986, who was the outside 5 auditor to USAT?" 6 Answer, "Offhand, I do not recall." 7 Question, "Did you review the work 8 papers of that entity, whatever it was?" 9 Answer, "No, I did not." 10 Line 16, "Any particular reason why 11 not?" 12 Answer, "Again, basically, the same 13 answer I would state. Unless there was a specific 14 factual dispute, reviewing the work papers would 15 be superfluous." 16 Question, "Would it be irrelevant to 17 your conclusions?" Mr. Leiman makes an objection. 18 "Asked and answered." 19 You answer at Line 22, "Superfluous? 20 Yeah, it would. Simply not be" -- I'm sorry. 21 Strike that. 22 "Superfluous? Yeah. Would simply not 22025 1 be -- well, it would not be -- not be relevant. 2 Unless there was a specific fact dispute here, it 3 would be irrelevant." 4 MR. LEIMAN: Your Honor, correct me if 5 I'm wrong; but I don't know that there is a 6 question pending. And I don't know that the 7 witness has answered anything inconsistent with 8 what Mr. Dueffert has just read. 9 THE COURT: I'm not sure why we're 10 getting into the deposition from his prior 11 questions. 12 MR. LEIMAN: I object, and I move to 13 strike the -- whatever that was. 14 Q. (BY MR. DUEFFERT) Two questions for 15 you. 16 One, when I asked you that question in 17 your deposition, your answer was it wasn't 18 irrelevant to my basic conclusions? 19 A. That is correct. 20 Q. And it still is irrelevant to your 21 basic conclusions; is that correct? 22 A. That is correct, yes. 22026 1 Q. You continue to think that the exam 2 work papers are irrelevant? 3 A. Oh, sure. 4 Q. I'm sorry. The auditor's work papers? 5 A. Thank you. Again, unless they have 6 some specific facts that are central to the issue, 7 no, I really haven't seen -- I have seen work 8 papers after the deposition because you raised 9 certain questions. But that had to do 10 specifically with the accrual to fee income. But 11 in terms of the actual specific loan underwriting, 12 no, I did not see anything particularly relevant. 13 Q. The other reason I used the transcript 14 was because at Line 16 -- or I'm sorry -- at Line 15 9, I asked you, "Who do you recall the auditor to 16 be?" And at your deposition, you could not tell 17 me the name of the auditor. 18 My understanding from your recent 19 testimony is you did not want to review the audit 20 work papers because of a prior settlement 21 involving Peat Marwick. Those appear to be 22 inconsistent to me. 22027 1 A. I was told before I was doing this 2 opinion that the -- that the auditors were not at 3 issue here because of a global settlement. It's 4 quite true at the time of the deposition, I had 5 forgotten who it was; but I knew the auditors were 6 not a party to this. 7 Q. Before you signed your report, did you 8 review the work papers of the federal or state 9 examiners? 10 A. I believe there were some -- yes, there 11 were some federal examination work papers, as I 12 recall, as part of -- I'm pretty sure there was 13 some examination work papers in the stack of 14 materials. I believe we even copied the material 15 and gave it to you before the -- either at or 16 before the deposition. 17 Q. Sir, is it correct that what you 18 reviewed from the examination work papers was two 19 examination reports that would have been available 20 to supervisory agents? 21 A. No. I think there were actually some 22 work papers, as well. I seem to recall actually 22028 1 handwritten notes from -- I believe it was Brenda 2 Krause, K-R-A-U-S-E, that were also part of the 3 process. 4 Q. Before you signed your report -- 5 A. That's correct. 6 Q. -- did you ever review the complete 7 set of examination work papers with regard to 8 these two loans? 9 A. That is -- no, that would be correct. 10 I don't believe I saw the -- all of the 11 examination work papers, no. 12 Q. And you did not think it would be 13 relevant to your analysis, correct? 14 A. That would be correct, yes. 15 Q. Because they would have a lot of 16 clutter in them? 17 A. No. Because the examiners wouldn't be 18 able to know what I already knew. And I think I 19 already made comment of that in my testimony, that 20 I had access to a great deal more information than 21 the examiners had. 22 Q. I'll ask you to turn again to your 22029 1 deposition at Page 15. 2 A. Oh, okay. 3 Q. Line 4, question, "Did you review the 4 supervisory work papers?" 5 A. Whoops. What line number? 6 Q. Page 15, Line 4. 7 A. Line 4. Okay. 8 Q. "Did you review the supervisory work 9 papers?" 10 Answer, "From the 1986 exam, no, I did 11 not." 12 Question, "Did you review the 13 examination work papers from that exam?" 14 Answer, "I believe that would be the 15 same thing but no, I did not." 16 Question, "Why not?" 17 Answer, "The examination report itself 18 is the culmination of findings of the Office of 19 Thrift Supervision. The work papers clearly gave 20 some backup information but there is a lot of 21 clutter also in the work papers as the examiners 22 are trying to determine just what the basic facts 22030 1 are." 2 Does that refresh your recollection 3 that at your deposition, you told me you didn't 4 look at the examination work papers because there 5 was a lot of clutter? 6 MR. LEIMAN: Your Honor, he's testified 7 completely consistently with what he's testified 8 to in his deposition. He stated that he saw some 9 work papers from Brenda Krause. Brenda Krause's 10 examination was not the 1986 examination report, 11 which is exactly what's being asked in this 12 question that Mr. Dueffert just quoted. 13 THE COURT: Well, we're dealing now, I 14 think, with the word "clutter." 15 Can you answer it? 16 THE WITNESS: Oh, sure. The 17 examination work papers have a great deal of 18 summation of raw data that doesn't finally work -- 19 does not come into the final examination report. 20 Some of it has to do with discussions with other 21 examiners. Sometimes it has to do with 22 discussions about other cases. But there is a 22031 1 great deal of basically raw data in the work 2 papers that is not really relevant to the basic 3 underlying core facts of the transaction. 4 Q. (BY MR. DUEFFERT) Is it your 5 testimony that contemporaneous review of a loan 6 file -- in this case, the Park 410 and Norwood 7 loan file -- by a trained examiner and their 8 conclusions is irrelevant to your review? 9 A. Again, Counselor, I think I've already 10 answered that question. That to the extent that I 11 have a great deal of information that the 12 examiners did not have, that no, it would not be 13 relevant. The examiners did not have the 14 information that I had regarding the Love & Dugger 15 appraisal and certainly not with regards to the 16 subsequent 1987, 1988 memorandum regarding the 17 status of the projects. 18 Q. When you signed your report, did you 19 know if the examiners had the Love & Dugger 20 appraisal? 21 A. I did not know for certain, no. In 22 fact, to this day, I still do not know for 22032 1 certain. 2 Q. With regard to the accounting treatment 3 of these loans, would not the contemporaneous 4 review by a trained auditor, assuming that auditor 5 sees all of the salient facts that you rely on, be 6 of any relevance to your analysis? 7 A. Frankly, Counselor, no. As I think 8 you've known from my prior testimony, I have 9 testified against the opinions of independent 10 auditors several times regarding loan accounting. 11 And no, I make my own independent assessments. 12 Q. Is it your testimony that you wouldn't 13 want to look at the exam work papers to see if 14 they made a good faith analysis of the 15 transactions? 16 A. No. What I'm saying is that what I was 17 asked to look at is the loan underwriting of these 18 particular loans. I was not asked to review the 19 examination process. The loan underwriting of 20 these loans -- something repetitive here. The 21 loan underwriting is set out by the core 22 documents, by the appraisals, by the underwriting 22033 1 summaries, by the credit reports, financial 2 reports, loan applications, et cetera. I was not 3 asked to affirm or deny the examination findings. 4 I was not asked to affirm or deny the independent 5 auditor's findings. I was asked to come to my own 6 independent conclusions based on the documents as 7 is evidenced, I think, by the fact that the 8 opinion mentioned here is that the Notice of 9 Charges did not. I don't believe the Notice of 10 Charges ever mentioned direct investments. But I 11 was asked to give an independent assessment, and I 12 gave it. 13 Q. Mr. O'Connell, you're familiar with the 14 Federal Home Loan Bank Board policy 1986 15 designated 12 CFR 571.17? 16 A. I believe so. Does that have to do 17 with appraisals? Is my recollection of 571.17? 18 Q. Let's take a look at it. 19 A. Okay. 20 MR. LEIMAN: Could I have the cite 21 again, please? 22 MR. DUEFFERT: 12 CFR Section 571.17. 22034 1 I believe it is Exhibit A11058. 2 Mr. Langdon -- I apologize, Your Honor. 3 Exhibit B4171. Tab 1048A. 4 A. ADC loans. Okay. 5 Q. (BY MR. DUEFFERT) Is this regulation, 6 12 CFR Section 571.17, something you just referred 7 to in your testimony to Mr. Leiman? 8 A. Yes, it is. 9 Q. Is it of any significance to your 10 analysis? 11 A. Yes, it is. 12 Q. Could you explain? 13 A. Again, this is an indication of when -- 14 in terms of how ADC -- well, this essentially has 15 to do with when ADC loans should be accounted for 16 as equity investments. And it lays out various 17 issues. In fact, should I just quote it instead 18 of trying to summarize it? 19 Q. Actually, I'd like you to tell me why 20 it's significant. 21 A. Well, as I said, it basically lays out 22 the types of conditions which exist which require 22035 1 the classification of ADC loans as real estate 2 investments. In fact, I believe the final -- the 3 final sentence of Paragraph B basically states 4 what the purpose of the policy is. It sets forth 5 the general criteria for determining whether 6 transactions are real estate investments, joint 7 ventures, or loans, and specifies the accounting 8 principles and procedures that shall be used to 9 account for such transactions. 10 Q. Okay. Mr. O'Connell, did you -- do I 11 understand that this is, as of 1986, the governing 12 Federal Home Loan Bank Board policy regarding the 13 booking of ADC loans? 14 A. I believe -- I believe so, yes. It 15 appears that this took effect as of April 30th, 16 1985. 17 Q. Okay. And did you review that 18 regulation in the course of preparing your 19 opinions or conclusions prior to your deposition? 20 A. Oh, sure. This is also a regulation 21 that I've become very familiar with in other 22 cases. In fact, I may have even -- I'm not sure 22036 1 if I specifically quoted this regulation before. 2 But I'm -- this type of issue came up, I believe, 3 in the Lincoln trial, as well. 4 Q. One more time. Did you review that 5 regulation in the course of preparation your 6 opinions or conclusions in this case? 7 A. Again, I think I did answer that. Yes. 8 MR. LEIMAN: Your Honor, that's a 9 different question. 10 Q. (BY MR. DUEFFERT) Turn to Page 515 of 11 your deposition, please. 12 A. Okay. 13 THE COURT: Would you state that page 14 again, please? 15 MR. DUEFFERT: Page 515, Your Honor. 16 THE COURT: Okay. 17 A. 515? 18 Q. (BY MR. DUEFFERT) 515. 19 A. Okay. Thank you. 20 Q. Let's begin actually a couple lines 21 above that on Page 514. Just let me know when 22 you're ready. 22037 1 A. Okay. (Witness reviews the document.) 2 Okay. 3 Q. Page 514. 4 A. Okay. 5 Q. Line 20. "Is this Section 571.17 a 6 section with which you are familiar?" 7 Answer, "Yes. I was familiar more in 8 the mid-1980s; but yes, I am familiar with it." 9 Question, "Did you review this 10 regulation in the course of preparing your 11 opinions or conclusions in this case?" 12 Answer, "No, I have not." 13 MR. LEIMAN: Your Honor, that's 14 entirely consistent with his testimony. 15 MR. DUEFFERT: I believe I asked him 16 the question twice, and he said -- 17 MR. LEIMAN: No. You asked two 18 different questions, Mr. Dueffert. If necessary, 19 we can have them read back. 20 MR. DUEFFERT: You just objected that I 21 asked and answered the second time around. 22 THE COURT: All right. Mr. Leiman, I'm 22038 1 going to hear you. 2 MR. LEIMAN: All right. Your Honor, 3 what he asked the witness was had he reviewed this 4 regulation before his deposition. That was the 5 question. The witness said, "Yes, I did. In 6 fact, I reviewed it in connection with the Lincoln 7 case." "It came up in connection with the Lincoln 8 trial." I believe that was closer to his exact 9 words. 10 The question is not whether or not he 11 ever reviewed this, but did he review it in 12 connection with preparing his opinions for this -- 13 for this case or for his deposition? To the 14 extent that this impeachment is going anywhere, I 15 would submit that the question should be at least 16 a consistent question that's clear and not be two 17 different questions. 18 THE COURT: I thought he asked him 19 first whether he had reviewed this prior to the 20 preparation of the report, and then he asked him 21 whether he had read it in preparation for his 22 deposition. 22039 1 MR. DUEFFERT: The second time around, 2 I read the question word for word. 3 MR. LEIMAN: No. 4 THE COURT: And I thought the answer 5 was no or -- 6 MR. DUEFFERT: The answer was "yes" 7 that he gave me here, and then the answer in his 8 deposition is "no." 9 Q. (BY MR. DUEFFERT) Mr. O'Connell, 10 let's go beyond this because I don't want to 11 belabor this. 12 THE COURT: Restate the question. 13 Q. (BY MR. DUEFFERT) Have you agreed 14 with me that that policy statement, 571.17, was 15 the governing policy statement as of 1986 for the 16 booking of ADC transactions? 17 A. That's my understanding, yes. I don't 18 have a 1986 regulatory book in front of me, but 19 the statement does read "as of April 30th, 1985." 20 And I'm not aware of a 1986 update. So, as far as 21 I know, yes. 22 Q. You're an expert here coming to testify 22040 1 about the booking of these transactions, correct? 2 A. That is correct. 3 Q. So, I would expect that you would be 4 prepared to answer whether this was the actual 5 regulation that you relied on or policy statement, 6 correct? 7 A. I'm not sure if I can answer to your 8 expectations, but... 9 Q. You didn't prepare for your testimony 10 here today by reading this policy statement, did 11 you? 12 A. Now we'd better get the time frame. 13 Within the last year? Within this morning? Or 14 what -- what exactly -- when is the last time I 15 read this policy statement? Is that what you're 16 asking me? 17 Q. Let me try it a different way. I'd 18 like you to turn to your expert report. 19 A. Okay. 20 Q. T7452. 21 A. Okay. 22 Q. And I note that you cite -- 22041 1 A. What paragraph? Okay. 2 Q. I note on Page 5 of the exhibit which 3 includes Paragraphs 21 and 25, you cite to 4 Section 563.17-1(c). 5 A. That is correct. 6 Q. And that is the general books and 7 records requirement in the Code of Federal 8 Regulations, correct? 9 A. Yes, that is correct. 10 Q. Will you agree with me that it does not 11 contain any subjective or objective criteria 12 regarding the booking of ADC transactions? 13 MR. LEIMAN: Your Honor, could the 14 witness be shown the regulation if he's going to 15 be asked about it? 16 MR. DUEFFERT: I think he remembers. 17 A. I don't believe so, no. But yes, I'd 18 prefer to look at the actual document. 19 Q. (BY MR. DUEFFERT) Well, here is my 20 actual question. Anywhere in your report do you 21 cite the contemporaneous Federal Home Loan Bank 22 Board standard 571.17 that did provide objective 22042 1 and subjective standards for the booking of ADC 2 loans? 3 A. The answer to that is no. But frankly, 4 Mr. Dueffert, you're being much too specialized. 5 The general books and records had to deal with 6 overall accounting, and that would obviously 7 include direct investments. 8 So, no, I don't believe I cited 571.17. 9 But 563.17 (sic) would encompass the direct 10 investment reporting since it has to do with the 11 overall reporting of the thrift institution. We 12 could look at the regulation itself, and I could 13 show you what I'm referring to. 14 Q. So, the answer is you didn't cite 15 571.17, correct? 16 A. That is correct. I did not. 17 Q. And you agree with me now that you did 18 not review or rely on it for purposes of preparing 19 for your deposition or in preparing your report? 20 A. Wait a minute. Time out again. This 21 is -- as I said, Mr. Dueffert, if the issue is did 22 I specifically read 571.17 before the deposition 22043 1 or immediately before drafting the opinion, no. 2 But as I've said before, I've been familiar with 3 that regulation for quite some time. 4 So, what -- what exactly -- 5 Mr. Dueffert, if you've read my overall testimony 6 in front of Judge Belvy and Judge Orkin, you know 7 I talked at length about basically sham 8 transactions that were being treated as real 9 estate loans. So, you know I'm familiar with 10 this. 11 Q. I guess -- here is the question. Where 12 in your report do I look for the objective 13 criteria by which thrift management would look to 14 determine whether a transaction was properly 15 reported, in your word, as a loan versus a direct 16 investment? 17 A. For that specific -- for that very 18 specific category, you're right. 571.17 would 19 have been the appropriate authority. 20 Q. Okay. Apart for the distinction 21 between categorizing these transactions as loans 22 versus direct investments, what other books and 22044 1 records violations do you cite for which there are 2 objective standards? 3 A. Let me have that reread again. 4 5 (The record was read by the court 6 reporter, as requested.) 7 8 A. I'm not sure what you referred to as 9 objective standards. But you -- as we discussed 10 earlier today, the classification of ADC loans as 11 direct investments also relates to the overall 12 booking of earnings, the booking of net worth -- 13 Q. (BY MR. DUEFFERT) We're talking about 14 these two loans, sir. 15 A. Okay. That's fine. Well, they would 16 affect these two loans. 17 Q. I understand. You're talking about the 18 booking -- I'm asking apart from the booking of 19 the loans as loans versus direct investments, are 20 there any other books and records violations? 21 A. Yes. I believe my criticisms of the 22 two appraisals -- the Bolin appraisal and the 22045 1 Schulz appraisal, the violations of R-41B. I 2 believe also I made mention of the fact that 3 clearly, the loan underwriting documents that 4 were -- that I cited in these -- in the opinion 5 failed to have all pertinent information which is 6 clearly, again, a violation of 563.17(c) in terms 7 of having accurate and complete books and records. 8 Q. But the standard -- I'm sorry. But the 9 standard in that regulation is just they have to 10 maintain accurate books and records, correct? 11 A. It's actually more than that. It's 12 actually a complete record. We can again check 13 the regulation, if you'd like. 14 Q. Let's -- we'll do that tomorrow 15 morning. We don't have it in front of us. 16 A. Actually, we do have it in front of us. 17 It's in my opinion. Paragraph 21. 18 Q. Does anything in the regulation -- 19 A. May I -- 20 Q. Sure. I'm sorry. I apologize. 21 A. It states very clearly -- and I believe 22 this is a direct quote -- "Shall establish and 22046 1 maintain such accounting and other records as will 2 provide an accurate and complete record of all 3 business transactions," end quote. 4 Q. Does that reference what information 5 has to be in a senior loan committee proposal? 6 A. Well, I think just reading the plain 7 language of it, it would be a complete record of 8 all material aspects that went into underwriting 9 the loan. 10 Q. Could we turn, please, to 11 Exhibit T7143, which is at Tab 711? 12 A. Okay. That is the Love & Dugger? 13 Q. Correct. 14 A. Okay. 15 THE COURT: Mr. Dueffert, let's adjourn 16 until 9:00 o'clock tomorrow. 17 18 (Whereupon at 4:45 p.m. 19 the proceedings were recessed.) 20 21 22 22047 1 STATE OF TEXAS COUNTY OF HARRIS 2 REPORTER'S CERTIFICATION 3 TO THE TRIAL PROCEEDINGS 4 I, Marcy Clark, the undersigned Certified 5 Shorthand Reporter in and for the State of Texas, 6 certify that the facts stated in the foregoing 7 pages are true and correct to the best of my ability. 8 I further certify that I am neither 9 attorney nor counsel for, related to nor employed 10 by, any of the parties to the action in which this 11 testimony was taken and, further, I am not a 12 relative or employee of any counsel employed by 13 the parties hereto, or financially interested in 14 the action. 15 SUBSCRIBED AND SWORN TO under my hand 16 and seal of office on this the 31st day of August, 17 1998. 18 ____________________________ MARCY CLARK, CSR 19 Certified Shorthand Reporter In and for the State of Texas 20 Certification No. 4935 Expiration Date: 12-31-99 21 22 22048 1 STATE OF TEXAS COUNTY OF HARRIS 2 REPORTER'S CERTIFICATION 3 TO THE TRIAL PROCEEDINGS 4 I, Shauna Foreman, the undersigned 5 Certified Shorthand Reporter in and for the 6 State of Texas, certify that the facts stated 7 in the foregoing pages are true and correct 8 to the best of my ability. 9 I further certify that I am neither 10 attorney nor counsel for, related to nor employed 11 by, any of the parties to the action in which this 12 testimony was taken and, further, I am not a 13 relative or employee of any counsel employed by 14 the parties hereto, or financially interested in 15 the action. 16 SUBSCRIBED AND SWORN TO under my hand 17 and seal of office on this the 31st day of August, 18 1998. 19 _____________________________ SHAUNA FOREMAN, CSR 20 Certified Shorthand Reporter In and for the State of Texas 21 Certification No. 3786 Expiration Date: 12-31-98 22