10558 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 12-15-97 22 10559 1 A-P-P-E-A-R-A-N-C-E-S 2 ON BEHALF OF THE AGENCY: 3 KENNETH J. GUIDO, Esquire (Not present) Special Enforcement Counsel 4 PAUL LEIMAN, Esquire SCOTT SCHWARTZ, Esquire 5 BRUCE RINALDI, Esquire RICHARD STEARNS, Esquire (Not present) 6 and BRYAN VEIS, Esquire (Not Present) 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 16 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 10560 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 (Not present) 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 (Not present) 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 10561 1 2 EXAMINATION INDEX 3 Page 4 JOHN STONE 5 Examination by Mr. Leiman...............10562 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 10562 1 P-R-O-C-E-E-D-I-N-G-S 2 (10:00 a.m.) 3 THE COURT: Be seated, please. The 4 hearing will come to order. 5 Mr. Leiman, you have a witness? 6 MR. LEIMAN: Yes, I do, Your Honor. 7 I'd like to call Mr. John Stone. 8 9 JOHN STONE, 10 11 called as a witness and having been first duly 12 sworn, testified as follows: 13 14 THE COURT: Be seated, please. 15 16 EXAMINATION 17 18 19 Q. (BY MR. LEIMAN) Good morning, 20 Mr. Stone. 21 A. Good morning, Mr. Leiman. 22 Q. For the record, would you state your 10563 1 full name? 2 A. John W. Stone. 3 A. I live 230 North Royal Street, 4 Alexandria, Virginia. 5 Q. Are you currently employed? 6 A. I am mostly retired. 7 Q. Okay. When did you retire? 8 A. December 2nd, 1995. 9 Q. And prior to your retirement, where 10 were you employed? 11 A. I was employed by the Federal Deposit 12 Insurance Corporation. 13 Q. Is that also know as the FDIC? 14 A. Yes. 15 Q. And in what capacity were you employed 16 with the FDIC? 17 A. At the time I retired, I was executive 18 director of the divisions of supervision, 19 resolutions, and compliance. 20 Q. What were your duties and 21 responsibilities as the executive director of the 22 divisions of supervision, resolutions, and 10564 1 compliance? 2 A. Well, as the senior-most career person 3 at the FDIC, I oversaw the activities of three 4 divisions -- it was a unique position 5 unprecedented up until 1991 -- all functions 6 regarding those three divisions and primarily to 7 see they operated together in a cohesive fashion. 8 Q. Before I ask you about each of those 9 divisions, I'd like to ask counsel -- 10 MR. LEIMAN: Mr. Villa, is Mr. Freibert 11 in the courtroom today? 12 MR. VILLA: Yes, that's correct. 13 MR. LEIMAN: All right. Mr. Freibert 14 would be who, for the record? Would you identify 15 him, please? 16 MR. VILLA: Mr. Freibert is our expert 17 witness, Your Honor, in response to Mr. Stone's 18 expert testimony. 19 THE COURT: Thank you. 20 Q. (BY MR. LEIMAN) Getting back, 21 Mr. Stone, to your job at the FDIC as executive 22 director, you said there were three divisions: 10565 1 Supervision, resolutions, and compliance. 2 What did you do as -- when you had your 3 supervision hat on? 4 A. I considered the most major decisions 5 made by that division of supervision of the -- I 6 could give examples -- whether it be termination 7 of insurance, enforcement actions, major mergers. 8 I reserved that those decisions be run past me for 9 my signature prior to going to our board of 10 directors or acted on under delegated authority by 11 the director of that division, that it was 12 concerning all major matters of bank supervision 13 for all insured institutions, thrift and banks, 14 that came within the purview of the FDIC. 15 Q. Can you give me an example of the kind 16 of matter that might come to you without breaching 17 any confidences? 18 A. Termination of insurance is a very 19 important and far-reaching decision for the FDIC 20 to make. Any termination of insurance, I would 21 want to have been apprised of and may have wanted 22 to be signatory to. 10566 1 Other matters that I think were 2 sensitive and I did require my consideration and 3 approval would be actions against institutions 4 that were not -- where the FDIC was not the 5 primary regulator but had the authority to take 6 actions against those institutions, whether they 7 be thrifts, national banks, federal reserve member 8 banks, or institution-related parties I reserved 9 for my consideration. 10 Q. You mentioned thrifts. When did the 11 FDIC acquire authority over thrifts? 12 A. Well, to answer your question totally 13 correctly, the FDIC has always had that authority 14 to the extent that when created and it became 15 operational in 1934, the FDIC examined mutual 16 savings banks across the country, primarily in the 17 northeast. These institutions were the 18 forerunners of what later became in our history 19 savings and loans in other states. We first got 20 the authority, however, to examine the 21 FSLIC-insured institutions, if my memory is right, 22 late 1988 and going forward from that time. 10567 1 Q. Now, you also mentioned resolutions. 2 What did you do in that capacity? 3 A. Resolutions entailed the disposing of 4 failing banks. And there's a cumbersome lengthy 5 process, but each failure finding a non-disruptive 6 and cost efficient solution in our insurance 7 function to the failure of the particular 8 institution. 9 Q. Did you ever have occasion to explore 10 the reasons why a particular bank might have 11 failed? 12 A. In every case we explored the reasons 13 why a particular bank failed. 14 Q. And were you able to reach any general 15 conclusions about bank failures that you had seen? 16 A. General, yes. 17 Q. We'll get to those later. What about 18 your compliance hat? Tell me about what you did 19 in the area of compliance. 20 A. Well, subsequent to 1992 -- it was 21 either 1992 or 1993 -- the agency decided to split 22 off from supervision the job of compliance 10568 1 examinations, meaning consumer laws and 2 regulations as they applied to insured 3 institutions, believing it should be a dedicated 4 effort. There was a lot of concern primarily from 5 me with that decision that we not have two sets of 6 examiners talking with two voices to the 7 institutions that we examined. My role was to see 8 in these early days of the split-off that the 9 division of supervision and division of 10 compliance, consumer regulations, did, in fact, 11 coordinate their activities and did, in fact, 12 speak with one voice. 13 Q. Now, tell me when you took over the 14 position of executive director of the supervision, 15 resolutions, and compliance divisions at the FDIC. 16 A. I assumed that position in September of 17 1993 or, pardon me, correct myself. I was 18 appointed to that position in September of 1993. 19 Q. Who was your supervisor? 20 A. I reported directly to the board of 21 directors. 22 Q. And in terms of the FDIC hierarchy, 10569 1 where would that have put you? 2 A. I was the senior-most career person at 3 the FDIC in title and compensation. 4 Q. Did that -- being the senior-most 5 person in title -- mean that you were the -- you 6 weren't the number one. 7 That would have been Ricki Helfer. 8 Right? 9 A. I said "career person" as opposed to 10 appointive. 11 Q. Okay. And hierarcally, would you have 12 been the number two person in terms of authority? 13 Three? 14 A. I would qualify by saying number two 15 because of my prior role as deputy to the 16 chairman, which had various levels of authority. 17 Q. In terms of the kinds of institutions, 18 financial institutions that you dealt with, what 19 size were they? 20 A. Ran the full gamut from the smallest 21 institution in the country to the very absolute 22 largest. 10570 1 Q. Okay. Can you give me the range as to 2 what those were in millions or billions? 3 A. The smallest would be day one of a new 4 bank. Could be a dollar and a half. The 5 largest -- and it would range in time to time, 6 whether it was CitiBank or whether it would be 7 Bank of America. That was changing as we went 8 through mergers and acquisitions, but those would 9 be institutions with assets in excess of 10 $200 billion. 11 Q. In terms of your decision -- and you 12 talked a little bit about the kinds of things that 13 you considered in terms of enforcement actions, 14 termination of insurance. 15 What factors were involved in your 16 decision making in the position that you held as 17 executive director? 18 A. Well, of the two you mentioned, the 19 termination of insurance was predicated largely on 20 the condition of the particular institution, that 21 being an unsafe and unsound condition to such 22 degree that its charter would be withdrawn by the 10571 1 chartering authority or we would take termination 2 of insurance proceedings to discontinue the 3 insurance. On the removal actions or enforcement 4 actions would be a totally different matter. That 5 would be largely a result of culpability of an 6 individual or a group of individuals and their 7 administration of the affairs of the particular 8 institution. 9 Q. What kinds of criteria would be 10 involved in determining culpability in connection 11 with an institution -- I'm sorry -- in connection 12 with individuals that you just referred to? 13 A. An established evidence trail, if I may 14 use that term, of actions or inactions that the 15 particular individual or individuals took or 16 didn't take that either caused harm to the 17 institution or had the potential to cause harm to 18 the institution, threaten its viability. 19 Q. When you talk about viability, what are 20 you talking about? 21 A. Its ability to continue operations. 22 Q. Financially? 10572 1 A. Financially, yes. 2 Q. What about -- you mentioned "unsafe and 3 unsound." How did that apply to your -- how was 4 that applied in the criteria? 5 A. Unsafe and unsound is a fairly wide 6 range, encompasses a wide range of activities. 7 For example, continued violations of laws or 8 regulations is an unsafe and unsound activity. 9 However, some cases may not involve or result in 10 an unsafe and unsound condition of the institution 11 financially; but a disregard for laws and 12 regulations is nonetheless an unsafe and unsound 13 condition and one that is opposite of absolutely 14 not tolerated. 15 However, on the other side, you can 16 have an institution that has minimal violations of 17 laws and regulations but, nonetheless, is an 18 unsafe and unsound condition financially. 19 Q. What about unsafe and unsound conduct? 20 Did you deal with that in your role? 21 A. Yes. Yes, we did. 22 Q. How does that differ from an unsafe and 10573 1 unsound condition? 2 A. Oh, an example would be fraud on the 3 part of an insider. Insider abuse. Not 4 necessarily criminal, but abusive in using the 5 institution for their own personal gain 6 inappropriately. 7 Q. Now, in your role as executive 8 director, did you also have authority -- in 9 addition to the authority you've mentioned, did 10 you control examinations or were you -- was that a 11 separate function? 12 A. I would rely on the director of 13 supervision and the associate director of 14 supervision, both positions that I had previously 15 held, largely for that activity. However, I 16 nonetheless would monitor the progress of the 17 examination effort through regularly-required 18 reporting. 19 Q. When -- for purposes of continuity, 20 let's go back in time for a few minutes. 21 Tell me where you went to college. 22 A. I went to Southern Illinois University, 10574 1 Carbondale, Illinois. I graduated from that 2 university. 3 Q. And what was your degree in? 4 A. Financial management with a minor in 5 economics. 6 Q. What did you do after college? 7 A. Immediately upon graduation, I joined 8 the FDIC as an assistant bank examiner trainee. 9 Q. Where were you employed then? 10 A. At that point, in the then St. Louis 11 region. 12 Q. Has that since merged? 13 A. The regions have realigned. It has not 14 been a regional office site since 1967. 15 Q. You say that you started out as a 16 trainee. Were you ever commissioned as a bank 17 examiner? 18 A. Yes. 19 Q. When was that? 20 A. December of 1967. 21 Q. Is there a difference at the FDIC 22 between a commissioned and a non-commissioned bank 10575 1 examiner in terms of the kinds of tasks that they 2 are allowed to do? 3 A. Yes, definitely. 4 Q. And there was back then at that time? 5 A. Yes. 6 Q. What is the difference? 7 A. The primary distinction is one of 8 authority, and that is only a commissioned bank 9 examiner can sign an examination report that goes 10 back to the particular institution, sign on behalf 11 of the FDIC. In practical terms, the work 12 performed by commissioned examiner is 13 predominantly in a review of the asset side of the 14 balance sheet as to quality and risk. The 15 assistant examiner, just as the name would imply, 16 is a lower level that prepares various schedules 17 and does various routines to help the examiner to 18 that end. 19 Q. How many institutions did you examine 20 as a commissioned examiner? 21 A. Actually, as the examiner in charge -- 22 it's been a long time -- I would have to say 200. 10576 1 Q. And of those 200, do you have a vague 2 recollection of the size? Was it in millions or 3 billions again? 4 A. At that time, serving as the examiner 5 in charge, they were mostly smaller institutions 6 in the mid-west part of the country. 7 Q. Tell me briefly what the approach was. 8 You mentioned that there was an assistant examiner 9 and you went in -- you would be the examiner in 10 charge on some -- you think about 200 11 examinations. 12 Was it a team approach, or were there 13 just two people that went in? 14 A. It would be very rare that you would 15 have only two people. We -- that would be the 16 absolute smallest of institutions. I have been in 17 two people bank examinations but very, very rare. 18 No. It's a team effort, and the size of the team 19 would be commensurate with the size of the bank. 20 For example, in those days, in the Sixties, it 21 would not be uncommon to have as many as 15 or 20 22 examiners on behalf of the FDIC in a 10577 1 50-million-dollar bank. And even at that point in 2 time, there more than likely would have been a 3 team of state bank examiners, the charting 4 authority along with. 5 Q. Mr. Stone, jumping forward for a 6 moment, when the FDIC acquired examination 7 authority directly, I think you said, in late 8 1988, whatever the time period, '88, '89, did you 9 ever personally participate in a bank -- in a 10 thrift examination? 11 A. No. I could not afford to do that with 12 the duties I had before me, but I did have an 13 oversight role. 14 Q. And what was that oversight role? Was 15 it one of direct supervision or a supervision 16 through others? 17 A. It would be the latter, supervision 18 through others, a contact point for our regional 19 directors on major issues. The review of all 20 problem memos in any instance, bank or thrift, in 21 which an institution was rated a MACRO rating of 4 22 or 5, the two lowest ratings. In each and every 10578 1 case, those memos would cross my desk for my input 2 and, quite frankly, my discretion. If I decided 3 to change the management rating or to change a 4 particular recommendation for enforcement action. 5 Q. Did you change ratings in both 6 directions on occasion or -- 7 A. Yes. Yes, I did. 8 Q. Some got better? 9 A. Some I raised as well as lowered. 10 Q. The MACRO rating -- what are MACRO 11 ratings, just briefly? 12 A. MACRO ratings are now -- I say now -- a 13 rating system used by all the federal regulatory 14 authorities and many of the state authorities -- 15 or most of the state authorities, to correct 16 myself -- and a uniform rating system as a result 17 of an examination or a rating system that can even 18 be changed in the interim for consistency purposes 19 rating the major components of an institution's 20 operations. 21 Q. Looking at the -- 22 A. Mr. Leiman, pardon me. May I correct 10579 1 myself? I have used the term MACRO because I'm 2 thinking the old thrift ratings. It's the CAMEL 3 rating system. It's another acronym used by the 4 federal bank regulatory authorities. 5 Q. With that in mind, Mr. Stone, looking 6 at your days as an examiner in the field and 7 looking at the way in which examinations had been 8 conducted when you had supervision over that 9 function, examination function, was there a 10 significant difference in the approach that 11 examiners took at that time versus in 1988 or 12 thereafter when you were looking over the shoulder 13 of examinations? 14 A. Mr. Leiman, if you'd re-ask the 15 question. I'm not totally clear I understood you. 16 Q. Okay. I'll try and be more clear. 17 Was there a big difference between the 18 way examinations were run when you were an 19 examiner in the field back in the Sixties versus 20 the way in which examinations were run, for 21 example, at thrifts in '88 and thereafter? Did 22 they look at different things? 10580 1 A. Not -- the same standards were 2 employed. The only difference I think of 3 immediately between the Sixties and the Eighties 4 was really a shortage of personnel. We didn't 5 have quite the luxury we did of the Sixties to 6 adequately staff all of our examinations, but the 7 job of the examiner did not change from the 8 Sixties or even until today. There are new 9 products and new instruments being used in the 10 industry that obviously the examiner has to be 11 aware of, but safety and soundness principles have 12 not changed from the Sixties through the present 13 day. 14 Q. Is it fair to say the examiner still 15 needs to be a financial gum shoe? Is that -- 16 A. Could be said, yes. 17 Q. After working as a commissioned bank 18 examiner in the Sixties, what did you do then? 19 A. I transferred to the Washington office 20 of the FDIC in 1972 and -- with the title of 21 review examiner. 22 Q. What's a review examiner? 10581 1 A. A review examiner had -- was used to 2 cover various functions. Predominantly, it was to 3 do just as the name implies, review examination 4 reports or investigation reports of institutions. 5 My job, however, while carrying that title, was 6 more aligned to serving as a liaison to then 14 7 regional offices on all matters of policy and 8 direction, as well as some personnel and 9 administrative duties again concerning the 10 regional offices. 11 Q. While you were in Washington, did you 12 have an opportunity to take any courses at any 13 graduate schools or banking schools? 14 A. I did finish the requirements, 15 including the thesis, at the Graduate School of 16 Banking, then at Rutgers University, and I believe 17 I completed that in 1973. And there were other 18 training courses, internal-type courses, and 19 perhaps external of lesser commitment that I was 20 involved in; but memory is vague on that. 21 Q. What year did you graduate? 22 A. From? 10582 1 Q. Did you say Rutgers? 2 A. Well, it was held on Rutgers campus. 3 It's the Stonier Graduate School of Banking; and 4 best of memory, that was 1973. 5 Q. What kinds of things does that involve, 6 the graduate school, in a nutshell? 7 A. The basics of banking in depth, if you 8 will, of the loan function, the investment 9 function, the asset/liability management function, 10 the full gamut of the more important functions of 11 a banking organization. 12 Q. After serving as a review examiner in 13 the FDIC's Washington office, what was next for 14 you? 15 A. In 1977, I was appointed assistant 16 regional director of the San Francisco region. 17 Q. What did that job involve? 18 A. Involved -- let me explain. We had 19 two -- there were two, at that point in time, two 20 assistant regional directors in every regional 21 office reporting to a regional director. That job 22 involved both the safety and soundness issues, the 10583 1 examination reports conducted in the field, the 2 scheduling of those examinations, the review of 3 those examination reports, recommendations as 4 appropriate to the Washington office, as well 5 as -- I don't know if I mentioned investigations, 6 merger applications, et cetera. It was the second 7 tier of management level at the regional office. 8 Q. And to whom would you make 9 recommendations? 10 A. As assistant regional director, I would 11 prepare them, if under delegated authority to the 12 region, to the regional director. If 13 non-delegated, I would prepare for either his 14 signature or mine, if I was given that authority 15 by him, which I was, to our Washington office. 16 Q. Who appointed you to the position of 17 assistant regional administrator in San Francisco? 18 A. It was either the chairman or the full 19 board. I was advised of it by the chairman; but 20 memory serves me right, I believe the entire board 21 had to approve it. 22 Q. Who was the chairman in 1977? 10584 1 A. I was appointed by Bob Barnett, to the 2 best of my memory. 3 Q. What kinds of -- what size institutions 4 were you dealing with in the San Francisco region? 5 A. Direct supervisory authority over state 6 non-member banks would range from very, very small 7 banks -- again, a newly-chartered institution 8 would have very little in the way of assets early 9 on -- up through the largest institution which, if 10 I recall, was between 5 and $10 billion. But then 11 also, we were charged with the review of the 12 reports from the controller of the currency and 13 from the federal reserve. And obviously that 14 would include institutions such as Bank of America 15 which, back at that time, was probably somewhere 16 between 70 and 100 billion, Wells Fargo, and other 17 larger west coast institutions. 18 Q. You used the term "non-member banks." 19 What are you referring to? 20 A. "Non-member" means not a member of the 21 federal reserve system. By law, a national bank 22 has to be a member of the federal reserve system. 10585 1 So, consequently, it means a state-chartered 2 institution that has not opted to -- for federal 3 reserve membership. Consequently, it's the 4 non-member banks that -- for which the FDIC serves 5 as the primary federal regulator. 6 Q. In terms of the issues and problems you 7 dealt with at the regional level, what were those? 8 A. I'm sorry. 9 Q. What kinds of issues and problems did 10 you deal with at the regional level? 11 A. Well, exactly as mentioned before, 12 enforcement actions, investigations, mergers, new 13 bank applications, criminal referrals. There 14 would be a laundry list of more, but any action to 15 be taken with the institution that's being 16 examined. 17 Q. How long did you stay in that position? 18 A. I was there three years. 19 Q. Till 1980 roughly? 20 A. Yes. 21 Q. And what did you do then? 22 A. I was transferred in the same capacity, 10586 1 assistant regional director, to the New York 2 regional office. 3 Q. Was there a difference in the kind of 4 work you did in the New York regional office 5 versus the San Francisco regional office? 6 A. The base job was identical, but the 7 reason for me being transferred was that we -- the 8 FDIC was beginning to experience fairly severe 9 problems with the large mutual savings banks in 10 the New York region. And I assumed more 11 authority, safety and soundness wise, in the New 12 York region than I had had in the San Francisco 13 region. 14 Q. What kinds of problems were the large 15 mutuals -- mutual S&Ls having? 16 A. The mutual savings banks? 17 Q. Yes, sir. 18 A. The primary problem -- not the sole 19 problem, but the primary problem of the mutual 20 savings banks in the New York region was merely 21 interest rate imbalance. By that, I mean typical 22 of thrifts, S&Ls as well, they borrowed short and 10587 1 loaned long and had worked for many, many years 2 successful. But with the change in the federal 3 reserve policy of 1979 and a rapid run-up in the 4 cost of funds, deposits, they were caught in a 5 horrible squeeze and were losing money at a rapid, 6 rapid rate. 7 Q. Did that lead to legislation or some 8 solution? 9 A. Yes, it did. 10 Q. What was that? 11 A. The Garn-St. Germain Act of 1982. 12 Q. And in a nutshell, can you describe 13 what effect that had on the interest rate 14 imbalance? 15 A. It didn't affect interest rate 16 imbalance so much as address the problem. And the 17 problem primarily with the savings and loans and 18 with the mutual savings banks, as well, in some 19 states was limitations of authority, that many 20 were limited and had confined themselves only in 21 the residential real estate market and were, in 22 effect, handcuffed from entering other legitimate 10588 1 banking functions that their competitors had. 2 So, the thought process as I understand 3 it and as I recall, was to allow those 4 institutions new avenues to pursue that would 5 diversify their portfolios and give them other 6 opportunities to earn money in the banking 7 environment. 8 Q. How long did you serve as the assistant 9 regional director in New York? 10 A. Until the spring of 1982. 11 Q. Then where did you go? 12 A. I left the FDIC and went with a 13 small -- a consulting firm in New York City off 14 Wall Street. 15 Q. What did you do there? 16 A. I went for the sole purpose of working 17 with the thrift industry and dealing and 18 consulting with them on the problems they were 19 having. 20 Q. What was the name of the firm? 21 A. It was Lyons, Zomback & Ostrowski, Inc. 22 Q. And what was your title there? 10589 1 A. Vice president, if I recall. 2 Q. How did your work at Lyons, Zomback 3 differ from your work at the FDIC? 4 A. Primarily, the difference was I was on 5 the other side of the table working directly with 6 the institutions, attending meetings with their 7 senior management, attending board meetings. But 8 primarily it ran the gamut from developing 9 strategic plans for those institutions to 10 hopefully improve their financial situation. In 11 the worst cases, attempt to find merger partners 12 to -- and receive assistance from the FDIC. In 13 some cases, to convert the institution from a 14 mutual institution to a stock held institution 15 through a community offering, what have you. 16 There was a wide range of activities dependent on 17 the particular client's problems. 18 Q. You mentioned working -- some of the 19 work you did as a consultant dealt with dealing 20 with boards of directors; is that right? 21 A. Yes. Savings banks, they are referred 22 to as boards of trustees. 10590 1 Q. How important is a board of trustees in 2 a savings bank or a board of directors in a 3 savings and loan? 4 A. There is no difference of the duties 5 and responsibilities of a director of a savings 6 bank or a savings and loan is no different than 7 that of a banking institution. 8 Q. Do they serve important functions? 9 A. The most important function. 10 Q. What do you mean? 11 A. Well, they are the ultimate authority, 12 the senior-most authority, for the institution. 13 And their job is to guide and direct and monitor 14 the activities of that institution. 15 Q. Since you worked -- how many did you 16 work with when you were at Lyons, Zomback? 17 Boards, that is. 18 A. In all cases, I worked with the boards. 19 I would insist on that. The three years I was 20 there, I likely worked with 12, 15 institutions, 21 perhaps more. 22 Q. What was the composition of the boards? 10591 1 Were they all primarily senior officials at the 2 financial institution, or were they from outside? 3 How was the board comprised generally? 4 A. I didn't see a difference between 5 boards of trustees or boards of directors of 6 savings banks and banks. By that, I mean the 7 primary composition would be outside directors 8 successful in their own rights, and hopefully 9 representing a wide range of activities to bring 10 the maximum knowledge to the board in serving in a 11 lending function in their community. 12 Q. You said you were there for three 13 years. So, you would have left in 1985? Is that 14 about right? 15 A. That's correct. 16 Q. What did you do then? 17 A. The FDIC approached me while I was 18 under contract teaching at the FDIC's training 19 center and asked me to return to the FDIC to head 20 up what they saw was going to be increasing 21 activity of failing banks that would be coming 22 before the FDIC. And that's the position I took 10592 1 in 1985. I accepted the invitation back, and I 2 became the assistant director for failing banks in 3 assistance transactions. 4 Q. That sort of sounds like being 5 appointed captain of the Titanic. 6 What was that job about? 7 A. That was first and foremost 8 anticipating the upcoming failures that the FDIC 9 would have to handle. As institutions progressed 10 from the problem bank list to potential failure, 11 and keeping the board apprised of what would be 12 coming down -- likely to be coming down the pike. 13 The last thing anyone wanted was for our board to 14 be surprised. By that, I mean we would project 15 failures and the volume of failures over a 16 two-year period going forward. 17 We handled the small bank failures 18 under -- eventually under delegated authority. 19 Primarily we would still report to the boards, but 20 the ultimate decision would be left with staff 21 under certain parameters and guidelines which we 22 would assure them we followed. But the big job 10593 1 after 1985 for me was the large bank failures, the 2 multi-billion-dollar failures across the country. 3 Q. Did you see a number of causes related 4 to the bank failures, or was there one overriding 5 cause? What did you attribute the failure 6 situation to be? 7 A. There was more than one cause. More 8 often than not, the cause would be unsafe and 9 unsound practices on the part of the individual 10 bank, undue concentrations in certain areas of 11 loans or certain types of loans. But I will say 12 there were any number of failures and I think, 13 quite frankly, in this section of the country 14 first, but then even New England following because 15 that was the two big areas of failures in the 16 1980s. After the savings bank crisis of the early 17 Eighties, we had an agricultural crisis in the 18 mid-west. Then it moved to the southwest where we 19 had the largest number of failures in the history 20 of the FDIC. And then as we exited the Eighties, 21 the problems moved to the northeast. But we did 22 see another side of the failures, and that is 10594 1 where you had banks that were generally well 2 operated and well run but the economy overtook 3 them. Their loans were well underwritten; but 4 with a drastic decline in underlying property 5 values, it was just more than they could handle, 6 which is the same as we mentioned earlier on the 7 interest rate imbalance. We had a lot of good 8 savings and loans that served their communities 9 and, in many cases, couldn't make variable rate 10 loans and failed not because of any impropriety or 11 malfeasance on their part but just overcome by the 12 economy. 13 Q. You said that you didn't want the board 14 to be surprised. You mean the FDIC board of 15 governors? 16 A. Well -- 17 Q. Tell me who -- 18 A. It was -- we didn't want the FDIC board 19 to be surprised, but we didn't want banks' 20 directors to be surprised either. So, I have a 21 little difficulty answering your question. First 22 of all, our own board was our responsibility but 10595 1 we also felt the responsibility to the boards of 2 the banks we supervised, that they never be 3 surprised with any action that we would take. 4 Q. And you saw this as part of your 5 mission? 6 A. Yes. Not only did I preach it, but our 7 own board preached it to me. 8 Q. What do you mean you preached it? 9 A. Well, first of all, that if I had had 10 any recommendation coming to me from our regional 11 office, that -- for an enforcement action -- by 12 that, I mean removal of insurance, cease and 13 desist act, removal of an individual, any serious 14 action -- I would want to know that the board of 15 directors had been apprised and what their 16 reaction was to that particular -- to that 17 particular advice that that action would be 18 pursued. And there were various reasons you'd 19 want to do that, not just fairness to the 20 individual board. Primarily that, but hopefully 21 they would take corrective action on that on their 22 own and we wouldn't have to result to using our 10596 1 enforcement. 2 Q. You'd give them a chance to fix it? 3 A. Yes. 4 Q. One of the things you mentioned had to 5 do with -- I think you said concentration of 6 lending. 7 Was that just one of the problems? 8 What were some of the other issues that you were 9 being faced with at that point? 10 A. Concentration of lending was a very 11 large part of the problem. Also, a relaxation of 12 underwriting standards became very apparent. 13 Q. Did you have -- were you able to 14 discern what that -- what would cause that? 15 A. There was no valid cause; but often, 16 the excuse would be given that competitors would 17 lower lending standards to gather more volume 18 activity and an institution would either have to 19 meet those standards, lowered standards, or not be 20 able to get new loans. 21 Q. Besides concentration of lending and 22 lowered underwriting standards, what other kinds 10597 1 of issues were there? 2 A. Well, again, we have the -- I'd say the 3 isolated cases of insider abuse either to members 4 of the board or senior officers. But I will say, 5 in all fairness, those were a minority of the 6 cases, even though they grabbed much of the 7 headlines of the Eighties. That was in a minority 8 of cases. 9 I would have to say that concentrations 10 and underwriting standards were the two 11 predominant causes of failure. 12 Q. Where were you based when you were 13 serving in the position of associate director? 14 A. In Washington, D.C. 15 Q. Did you have nationwide jurisdiction? 16 A. Yes. 17 Q. How long did you stay in that position? 18 A. As associate director, from 1988 till 19 1991. 20 Q. Then what did you do? 21 A. I became -- I was appointed the 22 director of supervision. 10598 1 Q. What was involved with being director 2 of supervision? 3 A. The -- as the title would imply, the 4 stewardship, if you will, of the entire division 5 of supervision which involved all examiners, FDIC 6 examiners across the country, and responsibility 7 for the functions they performed. 8 Q. You mentioned earlier that you did some 9 liaison work with field offices. 10 Did you ever do liaison work with any 11 other groups internationally, nationally? 12 A. Both nationally and internationally. 13 From the time I came back with the FD -- well, 14 even before. Let me back up. 15 From the time I was appointed assistant 16 regional director in San Francisco going forward 17 to increasing degrees as I went up the ladder of 18 the FDIC involved good liaison, coordination, and 19 exchange of information with the other federal 20 regulators. By that, I mean the controller of the 21 currency and the federal reserve, as well as each 22 of the state banking departments that I was 10599 1 involved in in San Francisco and New York. You 2 had to maintain good relations, assure you were 3 getting good information from them, and likewise 4 providing them with all information that we had 5 concerning institutions they chartered. 6 Well, as I came up through the ranks 7 and I would say assistant -- pardon me -- 8 assistant director level handling failing banks, 9 obviously I had tremendous contact because it was 10 the controller of the currency that was revoking a 11 national charter that -- or a state authority 12 revoking a state charter that predicated us having 13 to act. But then as director of the division, 14 obviously, I had very, very close contact with all 15 the federal regulators, OTS as well, and 16 maintained through various associations and direct 17 contact with state authorities across the country. 18 Internationally, in 1991 -- pardon 19 me -- 1993, I was appointed as the FDIC's sole 20 representative to the international committee on 21 supervision in Basle, Switzerland, under the 22 auspices of the Bank for International 10600 1 Settlements. And that is a body comprised of the 2 G-10 countries, G-10 plus two or three other 3 countries that met quarterly and discussed and 4 exchanged information of importance not only to 5 our respective countries but as well to -- 6 globally to individual countries or all of those 7 countries. The composition of that committee was 8 restricted under the terms of the Basle agreement 9 to the senior-most career supervisory person. 10 Appointed positions, such as chairman or board 11 members, were not allowed as members. 12 Q. After you served in the -- as the 13 director of the division of supervision, did you 14 have another position at the FDIC? 15 A. Yes. 16 Q. What was that? 17 A. In 1992, I was appointed deputy to the 18 chairman of the FDIC. 19 Q. What did that job involve? 20 A. Deputy to the chairman was -- largely 21 involved the constant provision of advice and 22 council to the chairman that was, if you will, the 10601 1 senior-most authority over all of the operations 2 of the FDIC, personnel matters, budgets. The 3 budgets would come through and be controlled by me 4 as deputy, as well as important -- all important 5 board decisions. Anything going before the board 6 would be cleared through that office and put onto 7 the agenda. For a period of time while serving as 8 deputy, I was the sole person at the FDIC with 9 authority to take a professional liability suit 10 against any director or officer across the 11 country. During my tenure, as things started to 12 return to a bit of normalcy from the failures we 13 had seen, the board reassumed that role of using 14 the group judgment of the board on professional 15 liability suits. 16 Q. We've already talked about your final 17 position at the FDIC before you retired, which 18 would have been as executive director of the 19 supervision, resolutions, and compliance 20 divisions. 21 Why did you leave the FDIC? 22 A. Things slowed down considerably. In 10602 1 fact -- it was two years ago. I think they have 2 had one failure this year as opposed to eight or 3 10 failures a week that we peaked at in the 4 Eighties. And quite frankly, I found that the 5 executive director position became redundant, that 6 the division of resolutions I recommended be 7 disbanded. In fact, it since has. And the 8 divisions of compliance and supervision seem to be 9 working cohesively and in harmony and I just saw 10 the position as largely being redundant. And, in 11 fact, the press release that went out indicated 12 that I had, in fact, recommended the abolishment 13 of my own job. 14 Q. During your career both with the FDIC 15 and as a consultant in private industry, did you 16 have occasion to deal with the gamut of both 17 healthy and non-troubled financial institutions? 18 A. Particularly so. I say that because 19 while supervisors are always -- a supervisory 20 official, whether it be at the state or federal 21 level, always sees the gamut from healthy to 22 strong, there were particular responsibilities 10603 1 placed on me when I was the assistant director of 2 failing banks and as I carried that job with 3 promotions that I received as director and later 4 executive director in that one of the functions 5 when you have a failing bank is to prepare what is 6 called a potential bidders list. And obviously, 7 you want strong, healthy institutions buying 8 failing banks. You do not want to put or add to a 9 bank's already existing problems. And many 10 troubled banks do, in fact, want to be bidders 11 because there is an implied blessing that they 12 would receive, having been asked. 13 So, as a part of my responsibilities to 14 the board in handling failing banks was to assure 15 them that we used and had good information on the 16 criteria for selecting potential bidders. 17 Q. Tell me what the FDIC's mission was in 18 a nutshell, please. 19 A. In a nutshell, the mission of the FDIC 20 when created in 1933 was to restore and maintain 21 public confidence in the banking system. 22 Q. Do you see that mission as different -- 10604 1 strike that. 2 Do you have an understanding as to what 3 the mission is of the other banking regulatory 4 agencies, including at the time the Federal Home 5 Loan Bank Board -- now OTS -- and OCC? 6 A. Yes. It's roughly the same mission. 7 The distinction being, as insurer, that the FDIC 8 would want to avoid runs on institutions and 9 pictures you have seen from the Thirties and the 10 Depression of lines of customers around the bank 11 unable to get to their life savings. Well, the 12 missions of the chartering authorities, whether 13 they be state or federal or whether they be the 14 federal reserve, is not that much different. 15 It -- obviously, they are not insurers; but their 16 role is to maintain safety and soundness and to 17 see that safety and soundness practices are, in 18 fact, adhered to and followed. 19 Q. The Federal Home Loan Bank Board's 20 counterpart, the FSLIC, what did that do? 21 A. Well, while they still had the 22 responsibilities I just mentioned, their role was 10605 1 also to promote the housing industry. And if my 2 memory serves me right for their creation, to 3 make, in effect, an intermediary that would 4 provide the nation's housing needs and to 5 individuals of all levels of income, if you will. 6 Q. They served as an insurer? 7 A. FSLIC did, yes. FSLIC. 8 MR. LEIMAN: Your Honor, I would -- at 9 this time, I would offer Mr. Stone as an expert in 10 the supervision of financial institutions, 11 including safety and soundness and underwriting 12 policies and practices. 13 MR. VILLA: No objection, Your Honor. 14 THE COURT: All right. So certified. 15 We'll take a short recess. 16 17 (A short break was taken 18 at 11:03 a.m.) 19 20 THE COURT: Be seated, please. We'll 21 be back on the record. 22 Mr. Leiman, you may continue. 10606 1 MR. LEIMAN: Thank you, Your Honor. 2 (11:24 a.m.) 3 Q. (BY MR. LEIMAN) Mr. Stone, when I 4 asked you if -- about your retirement, you said -- 5 you hedged a little bit. I guess you were 6 referring to this engagement in which -- 7 A. Yes. 8 Q. -- you've been hired. 9 A. There were a couple of other small 10 engagements. 11 Q. Who hired you for your consulting and 12 expert witness position here today? 13 A. The individual? 14 Q. No. The agency. 15 A. Oh, Office of Thrift Supervision. 16 Q. Did you -- in connection with your 17 undertaking, what was the nature of the engagement 18 as you understand it? 19 A. I understood that I was being retained 20 as expert witness to give my opinion on the safety 21 and soundness implications involving two loans: 22 Park 410 and Norwood. 10607 1 Q. In that regard, with respect to safety 2 and soundness, were you also -- does that include 3 opining on the nature of underwriting? 4 A. Yes. 5 Q. Tell me what underwriting is. 6 A. Underwriting is the process of the 7 decision-making procedure and documentation that's 8 involved in making a loan or an investment. I use 9 that definition as it applies to financial 10 institutions, not investment bankers. 11 Q. In connection with your engagement, did 12 you prepare a report? 13 A. Yes, I did. 14 Q. May I have 7451? 15 Mr. Stone, take a moment to look 16 through Exhibit 7451 and tell me if that's a copy 17 of your report that you prepared in connection 18 with your engagement with the OTS. 19 A. (Witness reviews the document.) Yes, 20 it is. 21 Q. Have you had a chance to go over your 22 report since you've written it? 10608 1 A. Yes, I have. 2 Q. Is the report correct in all respects, 3 or are there any changes you'd like to make? 4 A. There are some changes I'd be allowed 5 to make, some small, some more substantive. 6 Q. Why don't you do that now. 7 A. I have a copy of mine. It is easier 8 for me to refer to it. On Page 3 of my report, 9 under Roman Numeral IV, analysis, the second 10 paragraph, second-to-last line where it reads 11 "Regulatory net worth of 56.4 million" -- 12 Q. Yes. 13 A. 56.4 should be 31.3 million. 14 Subsequently in that same sentence where it says 15 "Net worth of 190.2 million," 190.2 should be 16 corrected to show 215.3 million. The reason for 17 that change we can explain later when we get to it 18 or now, whichever your preference. 19 Q. Why don't you keep making the changes? 20 Let's finish that up. 21 A. On Page 4, second sentence from the 22 top -- second line from the top -- pardon me -- a 10609 1 word was left out. Instead of "did indicate," it 2 should say "did not indicate." 3 Page 5, second paragraph, that 4 paragraph as stated is correct. But, however, to 5 make the date appropriate to the two loans, it 6 should be worded -- instead of August 14th, 1986, 7 it should be February the 14th, 1985. The 8 delegation referred to is the same in both cases. 9 Page 6, Item 3 near the bottom, second 10 paragraph starting with "the principles involved," 11 my interpretation of that guaranty is not correct 12 for reasons we can go into later. I subsequently 13 determined that that was incorrect. 14 Q. Anything else? 15 A. Page 7. At the top of Page 7, the very 16 first line, it should be worded something to the 17 effect that the guarantors could be withdrawn from 18 the projects and their guaranties be extinguished. 19 Those are the changes that come to 20 mind. 21 MR. LEIMAN: Your Honor, I offer T7451. 22 MR. VILLA: Your Honor, it's not clear 10610 1 to me what the testimony is on Page 6. He says 2 that his interpretation is not correct, the 3 guaranty is not correct. I'm glad he's figured 4 that out, but the question is: How is he going to 5 change the text of the report? What are the line 6 changes in this report because this report's going 7 into evidence? 8 So, if he could tell us what the line 9 changes are in the report that will reflect his 10 current understanding of the guaranty, I'd have no 11 objection to it. 12 THE COURT: All right. Can you do 13 that, Mr. Stone? How should it read? 14 THE WITNESS: Well, the way I would -- 15 since it's my report, the way I would word it, 16 Your Honor, is I'd keep the first sentence as it 17 is. "The principles involved in the Park 410 gave 18 limited guarantees to USAT." And I would -- as 19 well as the second sentence would stay intact. 20 All I would do is eliminate the sentence beginning 21 with "hypothetically." 22 THE COURT: So, you would eliminate 10611 1 that sentence and the rest of it stands? Is that 2 what you're saying? 3 THE WITNESS: Yes. 4 MR. LEIMAN: Your Honor, I re-offer the 5 exhibit. 6 MR. VILLA: No objection, Your Honor. 7 THE COURT: Received. 8 Q. (BY MR. LEIMAN) Are you still 9 pondering, Mr. Stone? 10 A. If I may. (Witness reviews the 11 document.) I'll let it stand as I stated, if I 12 may. No further changes. 13 THE COURT: I thought you had some 14 changes on the top of 7, didn't you say? 15 THE WITNESS: Oh, I'm sorry. I meant 16 to that paragraph. 17 THE COURT: Okay. 18 THE WITNESS: On the top of 7, Your 19 Honor, I changed that top line, that the 20 guaranties could -- insert the word "be" -- 21 withdrawn rather than could withdraw -- "could be 22 withdrawn." 10612 1 MR. VILLA: Excuse me, sir. You mean 2 the guarantors could be withdrawn? 3 THE WITNESS: Did I say something 4 different? 5 MR. VILLA: You said "guaranties." 6 A. I'm sorry. "The guarantors could be 7 withdrawn from the project," and I'd leave the 8 rest of the sentence as it is. 9 THE COURT: You may continue, 10 Mr. Leiman. 11 MR. LEIMAN: Thank you, Your Honor. 12 Q. (BY MR. LEIMAN) Mr. Stone, if you 13 would, summarize for the Court what the gravamen 14 of your report is. 15 A. In preparing this report, I reviewed 16 the following materials: Exhibits that were 17 marked on my copies as RE1 through, I believe, 18 101; thrift financial reports quarterly from 19 March '84, I believe, through June of 1986; 20 examination reports of the Texas State Banking 21 Department, 1984 -- and I don't recall the exact 22 dates. Maybe if I can -- I can refer to notes and 10613 1 give you exact -- as well as the Federal Home Loan 2 Bank during that same relative time period, '84 to 3 '86; depositions of certain individuals in this 4 proceeding: Mr. Graham, Mr. Rosenberg. Let me 5 refer to notes. 6 Q. Why don't you finish with what you do 7 remember, and then we'll see what we need to 8 refresh your memory with. 9 A. SEC filings, regulatory filings with 10 the Securities and Exchange Commission during that 11 same time frame, '84, '86; the entire loan 12 files -- 13 Q. Of what loans? 14 A. Of -- housed at OTS in Washington for 15 Park 410 and Norwood, other files maintained at 16 the same location. I remember specifically -- 17 it's called the Gindy files. The -- I think the 18 terminology you used, the admitted exhibits. 19 Q. That were admitted in this proceeding? 20 A. As I understand it, yes. Testimonies 21 before this proceeding: Mr. Graham, Mr. Minch, 22 Mr. White, Mr. Lovell, Mr. Winters, Mr. Cool. I'm 10614 1 certain there may be other things. That's just 2 from the top of my head what I'm recalling. 3 Q. Did you look through documents that had 4 been designated by OTS as potential exhibits? 5 A. Yes, I did. 6 Q. When you're talking about the SEC 7 filings, are you referring to 10Qs, annual 8 reports? Did you look through those? 9 A. I looked at some 10Qs, yes. 10 Q. Let me ask you this, Mr. Stone: Did 11 you do the reading? Did you actually go look at 12 loan files? Did you actually read all these 13 exhibits, or did somebody give you summaries of 14 them? 15 A. I personally looked at the exhibits. I 16 will qualify it only to the extent there were 17 voluminous files covering many lateral file 18 drawers. To say that I looked at every page of 19 every document would be a mistake. There were 20 some documents, such as lengthy appraisals, that I 21 did not review. But to the -- it's safe to say I 22 did go through the files to determine what I 10615 1 believed was relevant; and, if relevant, I did 2 review it. 3 Q. Before you prepared your written 4 report, which we've now -- which has now been 5 admitted as T7451, had you looked through all of 6 the materials that you've just mentioned? 7 A. When I prepared this report? 8 Q. Yes. 9 A. No. 10 Q. Since you prepared the report, have you 11 gone through -- you went through the loan files? 12 A. Yes. 13 Q. All right. You went through potential 14 exhibits? 15 A. Yes. 16 Q. You read the -- you couldn't have read 17 the testimony -- 18 A. Testimonies. 19 Q. Right. Is there anything in -- is 20 there anything in your review, apart from the 21 changes or the one change -- I guess it was on 22 Page 6 to your report -- that altered your mind 10616 1 about anything in your report, changed your mind? 2 A. No. 3 Q. What was the net effect of having gone 4 through all of this material and all of this 5 testimony and all of these depositions? 6 A. I'd have to say more comfort, if you 7 will, that I had necessary information in front of 8 me to consider in reaching this report and gave me 9 more comfort -- not that I didn't have comfort in 10 my report, but I had more comfort having had 11 additional information made available to me. 12 Q. Tell me what your conclusions were in 13 your report in a nutshell, if you will. 14 A. Probably because I authored the report, 15 it's largely going to follow the order of the 16 report. So, I may refer to it from time to time. 17 The first conclusion reached was that 18 the 80-million-dollar line to Park 410 was 19 excessive for USAT to make, given the condition of 20 the institution at that time. 21 Secondly, likewise, the loan/investment 22 of $39.4 million to Norwood was excessive, given 10617 1 the financial condition of USAT at the time the 2 loan/investment was made. 3 In both cases, Park 410 and Norwood, 4 the lines were excessive, given the known 5 prospects for augmenting capital at USAT to a more 6 commensurate level to those two particular loans. 7 I concluded that the board of directors 8 of USAT abdicated their responsibilities in their 9 delegation of a totally inappropriate level to a 10 body below that of the board of directors outside 11 of their consideration, their personal 12 consideration as a body. 13 The senior lending officials of USAT 14 did not employ sound -- safe and sound practices 15 in the granting of loans within their authority 16 and that the board did not establish or did not 17 enforce sound loan policies and underwriting 18 standards. 19 As far as the Park 410 loan, the board 20 of directors did not have, nor did the -- did not 21 have a policy, nor did the senior lending 22 officials exercise due care in a loan involving an 10618 1 insider of the institution. 2 Those were the primary conclusions and 3 overall conclusion as a result of those. 4 Q. What was your overall conclusion with 5 regard to all of these conclusions that you've 6 just mentioned? 7 A. That based upon the very conclusions 8 I've just listed, that the board of directors and 9 the senior lending officials acted -- by omission 10 or co-omission -- with reckless disregard for the 11 safety and soundness of USAT. 12 Q. Mr. Stone, what do you mean when you 13 say they acted with reckless disregard? Define 14 the term for me as you would define it: Reckless 15 disregard. 16 A. Again, I'd use my own phraseology. I'm 17 sure there are references in case law. In this 18 case, USAT's board of directors, knowing what they 19 did about the condition of USAT, its financial 20 condition and its earnings, knew and should have 21 known that the acts -- again, whether omission or 22 co-omission -- placed the institution at undue 10619 1 risk as a result of their acts. 2 Q. You talked a few minutes ago about 3 underwriting, and you defined -- I believe you 4 defined the term "underwriting." 5 Is underwriting, as you've used it and 6 you've observed it in your 25, 30 years in banking 7 as a banking regulator -- is there a sliding scale 8 of underwriting standards? For example, do you 9 underwrite a thousand-dollar loan differently than 10 you would underwrite an 80-million-dollar loan? 11 A. While the same credit judgment goes 12 into -- same basic credit judgment, the same 13 thinking process goes into the extension of any 14 credit, obviously, the documentation required of a 15 1,000-dollar loan would be much less because of 16 the risk involved than it would be for the largest 17 loans made by any institution solely for -- for 18 two purposes, quite frankly. One, the risk of the 19 smaller loans, that it would take a large group of 20 smaller loans to hurt an institution. And 21 secondly, just because of economics. If you 22 applied the same underwriting standards to a 10620 1 1,000-dollar loan that you would to 2 a-million-dollar loan, you've already got an 3 uneconomic loan, your overhead expenses exceeded, 4 your return. 5 Q. Well, when you've talked about 6 underwriting, are you including documentation -- 7 who, what, where, when, how, why kind of 8 documentation that goes into a loan? 9 A. Documentation, in my opinion, is a part 10 of the underwriting process, yes. 11 Q. Should that appear in every loan? 12 A. In some cases, regulations may require, 13 regardless of the size of the loan, that it have 14 certain documentation. I've see that with state 15 laws; and it may well apply for Federal Home Loan 16 Bank, FSLIC. I mean, title policy or hazard 17 insurance or appraisal. 18 But beyond that, in a board granting 19 authorities and lending limits to -- down the line 20 to their lending officials, you would expect less 21 documentation on a lending officer that's 22 extending a thousand-dollar credit as to the 10621 1 rationale that was used as you would a larger 2 loan. 3 Q. So, it's fair to say, then, that the 4 level of complexity of documentation would 5 increase with the size of the loan; is that right? 6 A. The level of complexity or the volume 7 of documentation, yes, would increase with the 8 size of the loan. 9 Q. Apart from the basics, the sort of 10 reporter's questions, the who, what, where, when, 11 how, why questions documenting a thousand-dollar 12 loan, what else would you expect to see in a more 13 complex or more -- or a larger loan of 50, 14 $80 million? 15 A. I would expect, as you get into 16 specialized areas of lending and a board of 17 directors employing qualified people in those 18 specialized areas, you can't expect individual 19 board members to have the same level of expertise 20 as those specialized lending area officers. That 21 doesn't mean, however, that they just turn over 22 the fate of their institution to the specialized 10622 1 lending officials. They would ask and demand that 2 executive summaries be written in these 3 specialized areas concerning some of the levels of 4 documentation as to support that safe and sound 5 considerations were employed, generally accepted, 6 approaches to the credit were employed and, to the 7 extent necessary, to satisfy the board that the 8 larger credits of the institution are being 9 soundly underwritten and they have sufficient 10 documentation to validate that decision. 11 Q. What kind of analysis would be required 12 in connection with the documentation you're 13 talking about? 14 A. A specialized analysis by someone 15 qualified to conduct just such analysis. In other 16 words, very relevant to this proceeding is the 17 issue of appraisals. I don't profess to be an 18 expert in appraisals, but -- and I don't expect 19 lending officials or boards -- pardon me. I don't 20 expect boards of directors necessarily, 21 individually, to be experts. But they would have 22 the knowledge of what is required by law or 10623 1 regulation for them to meet. And as importantly 2 as that -- more importantly as to what is prudent 3 and what is safe and sound, and that for any major 4 credit coming to their attention -- and all major 5 credits should -- that their specialized lending 6 official has gone through every major 7 consideration of that appraisal, which may be that 8 thick (indicating), and synopsized to the board's 9 satisfaction that it was done accurately, that the 10 appraisal in that particular lending official's 11 independent judgment -- not just the view of the 12 appraiser -- but in his judgment or her judgment, 13 it was a soundly analyzed appraisal that meets all 14 requisite standards. 15 Q. Now, you're not talking about the 16 lending officer doing that kind of synopsis and 17 analysis for every home loan that comes down the 18 pike, are you? 19 A. Absolutely not. 20 Q. What kinds of loans are you talking 21 about? 22 A. Maybe I omitted it. I meant to say 10624 1 major -- the largest, most important loans made by 2 an institution. 3 Q. In connection with your engagement, did 4 you spend a great deal of time looking over 5 Federal Home Loan Bank Board or FSLIC regulations? 6 A. No, I did not. 7 Q. Why didn't you do that? 8 A. My understanding of the engagement was 9 just as I stated earlier, to look at the safety 10 and soundness implications involved in the two 11 loans. As an independent expert witness, I 12 assumed that OTS -- very familiar with their own 13 regulations, their own rules, their own laws, what 14 have you as to -- as those -- the two particular 15 loans that I think had my -- if I had been asked 16 to review laws and regulations, I would have 17 likely said I would have thought that would have 18 been more appropriately done by someone in the 19 legal profession, even though you do that 20 constantly as an examiner. 21 Q. I think you talked about the kinds of 22 investment policies -- strike that. 10625 1 You talked about loan policies and that 2 board of directors have their authority and what 3 it extended to. 4 When you talk about board of director 5 policies and the interaction between the board of 6 directors and the lending committees, can you 7 describe for me what you mean when you talk about 8 the policies? 9 A. There are several necessary ingredients 10 to loan policies and delegations. Loan policies 11 would, first of all, involve a statement to 12 lending officials of an institution from the 13 board. First of all, "Here are the following 14 loans the institution should be making." And it 15 may be negative, as well. "Here are the loans it 16 shouldn't be making." Again, the staff can only 17 follow the direction of their superiors with the 18 ultimate authority. Absent that, there would be 19 chaos. 20 In addition to that, for those loans 21 that are indicated as to be pursued by the 22 institution is a statement of what are the 10626 1 policies that are to be followed, not just what 2 laws and regulations -- obviously, all laws and 3 regulations are to be adhered to -- but back in 4 the Eighties, what loan-to-value ratios, what 5 income verification, what types of procedures 6 should be followed on loans of certain sizes, of 7 certain types. There should be a manual -- an 8 institution over a billion dollars, I would say, 9 at a minimum would have a manual of loan policies 10 for their lending officials to use. 11 But then separate and apart from that, 12 once that is all described, is the level of 13 delegations. At what level does the board reserve 14 for itself solely on its authority to approve 15 loans and/or investments? It would then delegate 16 to a secondary level, a loan committee -- a senior 17 loan committee is an appropriate title you see 18 frequently as used in USAT -- to be the next step. 19 Loans up to a certain amount less than what the 20 board has reserved for its own judgment could be 21 approved by a senior loan committee and, in turn, 22 down the chain of command through the lending 10627 1 officials down to a branch manager, if you will. 2 That entails the loan delegation process as well 3 absent any rule or regulation which, again, is 4 expected to be followed. You would expect an 5 institution to take particular precautions at the 6 board of directors level and disseminate it 7 through the organization for loans to insiders, 8 broadly interpreted, of the institution. 9 Q. Do these strictures that you're talking 10 about also have applicability to investment 11 policies as well as loan policies? 12 A. Definitely. 13 Q. Why? 14 A. Because investments, again, pose 15 potential risk to an institution. And as such, 16 the board of directors has to determine what level 17 can be delegated to less than their body, below 18 their authority, what they reserve for their own 19 authority, and what precautions, what policies, 20 and what underwriting standards are to be followed 21 if, in fact, delegated. 22 Q. Now, a few minutes ago, you told us 10628 1 what the first conclusion was with regard to your 2 report, that you felt that the Park 410 and the 3 Norwood loans were for excessive amounts given the 4 financial condition of USAT as it was at the time 5 they made the loan as well as in connection with 6 future prospects. 7 How did you figure that out? What was 8 your analysis? 9 A. My analysis was predicated on the 10 then-existing condition on the capital position of 11 USAT at or near the time those loans were made. 12 Q. What was the first thing that you 13 looked at? 14 A. The thrift financial report of 15 March 31st, 1986. 16 Q. Let's see if we have a copy. It's 17 A4012. Do you have the exhibit in front of you, 18 Mr. Stone: A4012? 19 A. Yes, I do. 20 Q. What is it? 21 A. The exhibit provided me is the 22 quarterly financial report ending March 31st, 10629 1 1986, filed by USAT to the Federal Home Loan Bank. 2 I should say it's more than one report. It's the 3 report of March 31st, 1986; but it's been revised 4 as of April 28th and subsequently as of August the 5 8th, which is another issue in and of itself. 6 Q. Why is that an issue? 7 A. Well, I won't use it as an excuse. But 8 if you'll recall, earlier today I changed my 9 report on Page 3 regarding the negative tangible 10 net worth of USAT and its regulatory reported net 11 worth. Their report that was initially filed in a 12 required filing was amended, and that was the 13 report that I had picked up for my information. 14 Only subsequently, in going through the documents 15 again, did I find attached behind some other 16 schedules yet another amendment of August the 8th 17 which, again, I found somewhat unusual in my 18 experience, amending a report on two different 19 occasions. 20 Q. You didn't have thrift financial 21 reports at the FDIC, did you? 22 A. Well, yes, we did, after -- 10630 1 Q. Was that what they were called? 2 A. -- '88; but before that, we didn't. 3 Q. What were they called before '88? 4 A. I think they were called thrift 5 financial reports; but at the FDIC, we had a 6 corollary or a counterpart, if you will, that 7 banks, as well, file similar reports with the 8 FDIC, again on a quarterly basis. They were 9 called call reports, but essentially the same type 10 of information. In fact, in some cases, with not 11 as much detail as TFRs. 12 Q. All right. Now, you mentioned that you 13 felt that the loans were of an excessive amount 14 given the financial condition of the institution. 15 What did you look at and what tipped 16 you off in this Exhibit A4012 to that conclusion? 17 A. What I looked at primarily -- and for 18 anyone that has a copy, I'm looking at the third 19 page back from the very back of that report. The 20 top right-hand section or midway, the right-hand 21 section, there is a line. I believe it's Line 900 22 titled "total regulatory net worth" as filed by 10631 1 the institution which, in this case, lists a net 2 worth of 215 million 330 something thousand -- I 3 can't get the last digit -- and relating the size 4 of the Park 410 loan and the Norwood 5 loan/investment to both that number, which is the 6 regulatory net worth, and to the institution's 7 tangible net worth. I'll explain the latter if 8 you -- 9 Q. I'd like you to explain them both, but 10 tell me what the -- what calculation you went 11 through. It sounds like you're going towards a 12 calculation here. 13 A. It's a very simple calculation. What 14 percent of 215.3 million rounded is an 15 80-million-dollar loan which, I think, if my math 16 is right, is roughly 37 percent of that capital to 17 Park 410. And in Norwood, approximately 18 18 percent, both which I considered considerably 19 excessive both to that capital and the tangible 20 capital or lack of tangible capital of the entity 21 at the time that they were made. 22 Q. Now, let's deal first with the 10632 1 regulatory net worth, that calculation that you 2 made. 3 You said you feel that a single loan of 4 37 million -- of $80 million, which amounts to 5 37 percent, I think you said -- is that right? 6 A. Yes. 7 Q. -- is excessive. Why? 8 A. Because a loan of $80 million when an 9 institution only has $215 million of regulatory 10 net worth is -- defies the basic principle of 11 diversification. 12 Q. What's that? 13 A. Diversification is expected in 14 regulatory -- pardon me -- in financial 15 institutions because financial institutions, by 16 their nature, are highly leveraged compared to any 17 other corporation and dependent largely on 18 depositories as their creditors, their funding. 19 So, they have, first of all, a 20 relatively low capital base to begin with compared 21 to any other institution: Finance company, any 22 other type of major corporation. Consequently, 10633 1 even though the principles the same regardless of 2 the size of your capital account, consequently, 3 risk is the prime determinant in extending any 4 credit or making an investment. It's expected 5 that any loan has risk. Any investment has risk. 6 The attempt is to minimize the risk. 7 Consequently, you diversify that risk 8 across a broad spectrum. In this particular case, 9 $80 million in what in my opinion is a 10 highly-speculative investment of $215 million is 11 an excessive concentration. Had the loan been 12 secured by government bonds, I would have said it 13 was a concentration. 14 Q. What do you mean, "a concentration"? 15 What does that mean? 16 A. Again, concentration is the opposite of 17 diversification. Diversification means risk 18 spread over a multitude of investments that have 19 different sources of repayment and different risks 20 involved. That one catastrophe in one will not 21 affect the capital of the particular institution 22 beyond its own loss as opposed to having one large 10634 1 investment or one large loan that can affect a 2 large part of your capital account and dissipate 3 that buffer that exists, that capital as a buffer 4 against losses to depositors. And you should not 5 put that at risk with an undue concentration 6 either by class or type. 7 Q. Would these two loans be, as you 8 understand it, in the same class or type? 9 A. Yes. Even though Norwood involves both 10 equity as a joint venture and a loan, both loans 11 are predicated on the future value of real estate 12 where the institution has all the money at risk 13 and has little protection outside of the 14 underlying real estate. 15 Q. Now, you calculated these separately -- 16 37 percent of regulatory net worth for Park 410 17 and 18 percent for the Norwood loan/investment 18 joint venture. 19 Did you calculate a total figure as to 20 what these two transactions would amount to 21 relative -- as a relative percentage of regulatory 22 net worth? 10635 1 A. Yes. Obviously, it's the sum of the 2 two. These two loans, both predicated on real 3 estate, speculative real estate, these two loans 4 amount to over 50 percent of the institution's 5 regulatory capital. 6 Q. You've been in the banking business a 7 long time. Have you seen this kind of 8 concentration previously in connection with 9 institutions that you've been involved with? 10 A. Not in individual loans like Park 10 11 and Norwood. 12 Q. 410. 13 A. I'm sorry. Park 410. 14 Q. Okay. That's another one. 15 A. Yes, it is. It shows up in the files 16 sometimes by mistake. The answer is I have never 17 seen it in two individual loans comprising 18 55 percent at the time made -- now, obviously, if 19 that ratio can be that high of capital 20 subsequently deteriorates. But at the time made, 21 I have never seen two loans made -- 22 Q. What do you mean "at the time made"? 10636 1 When these loans were made? 2 A. When these loans were made, they 3 comprised more than 50 percent of the regulatory 4 reporting capital of USAT. I have never seen two 5 loans -- now, I have seen concentrations of 6 credit, a grouping of various loans of similar 7 characteristics, that together would exceed 8 50 percent. 9 Q. Would you tell us what you mean by 10 tangible net worth and how that relates to the 11 concentration issue? 12 A. It was of consideration to me. The 13 concentrations to regulatory net worth are just as 14 I have stated. But in USAT, while they have a 15 reported net worth of 215,300,000, they have on 16 their asset side of their balance sheet -- pardon 17 me. I'll have to go through the various of the 18 three filings to get the right report. I believe 19 it's the fourth page back, from the back of the 20 document. Pardon me. It isn't. 21 (Witness reviews the document.) Yes. 22 I stand corrected. It is the fourth page back. 10637 1 On the right-hand side below mid-page, there is a 2 line, "goodwill and other intangible assets." 3 Q. Would that be Line 540? 4 A. It's not that clear, but I believe it 5 would be -- it is Line 540. 246,550,000, I think. 6 I can't really read the thousands. That -- 7 MR. VILLA: Could you give me the Bates 8 stamp number of the page? Does it have a Bates 9 stamp number in the lower right-hand corner? 10 THE WITNESS: Maybe. Hardly legible. 11 It ends in 332. 12 MR. VILLA: Okay. I'm sorry. The 13 fourth page from the back of the exhibit? 14 THE WITNESS: Yes. 15 MR. VILLA: Okay. Thank you very much. 16 MR. LEIMAN: It's the third amended 17 TFR. 18 MR. VILLA: Right. 19 THE WITNESS: Second amended. 20 Q. (BY MR. LEIMAN) Oh, the second 21 amended. I'm sorry. 22 A. Perhaps we'd better pick up where we 10638 1 were. 2 Q. All right, Mr. Stone. My question to 3 you is: Tell me about how the concentration issue 4 relates to tangible net worth as opposed to 5 regulatory net worth. 6 A. There was a very considered process 7 that I went through. This 246 million on the 8 asset side of the balance sheet relative to the 9 reported net worth of 215 million, this asset 10 exceeds what the capital of USAT is. This asset, 11 246 million, has no economic justification. It 12 has no economic worth to speak of. 13 Q. You mean goodwill? 14 A. Yes. Goodwill. 15 Q. What is it? 16 A. From a purely analytical standpoint -- 17 I'll answer that question, but I haven't finished 18 this one. 19 From a purely economic standpoint, this 20 institution has no tangible net worth. If they 21 had to liquidate today or March 31st, they would 22 have no capital because they couldn't realize 10639 1 anything on capital. 2 Goodwill, to answer your question, was 3 a convention of the 1980s that resulted as a 4 result of the horrible situation that savings and 5 loans across the country faced and FSLIC faced and 6 the U.S. government faced. And that is, having a 7 tremendous number of institutions that were either 8 insolvent or very close -- very soon to be 9 insolvent. And a decision was made by the 10 government to allow many of these institutions to 11 be acquired by another party -- frequently another 12 institution, but not necessarily. Maybe 13 individuals -- and allowed them to be marked to 14 market. Marked to market means take the assets of 15 the institution and mark them at their current 16 market value. And, as well, mark the liabilities 17 to market. 18 Well, what happened when that would be 19 done is there wouldn't be sufficient assets to 20 cover liabilities. In other words, insolvency. 21 Net worth or solvency is the excess of assets over 22 liabilities. When you have the opposite, fewer 10640 1 assets than liabilities, you have insolvency. 2 So, in these institutions where they 3 would be marked to market and assets were 4 insufficient to cover liabilities, the difference 5 was allowed to be booked as goodwill. 6 Q. And thus the accounting condition that 7 you're referring to? 8 A. Right. It's air. There is nothing 9 there to report it except a debit ticket, and a 10 debit ticket wouldn't, in this case, be worth 11 $246 million. It wouldn't be worth the piece of 12 paper it's written on. 13 Q. So, what -- when we talk about 14 concentration relative to the tangible net worth 15 of the institution, what then would your 16 calculation show? 17 A. It would be a futile exercise. The 18 institution has no net worth. What I did, 19 notwithstanding that, is my mission or my 20 engagement was to look at Park 410 and Norwood at 21 the time they were made. And again, that's what I 22 had to keep in mind. At the time they were made, 10641 1 accounting convention allowed this type of 2 accounting. It was permitted. And quite frankly, 3 in many cases, I agreed with why this initially 4 was allowed and thought it was in the best 5 interest of the government. Consequently, the 6 idea was to buy time, let these institutions 7 recover. 8 Well, because of that -- and the 9 institution was permitted to continue 10 operations -- I tried to put myself in the shoes 11 of directors or as an examiner looking at these 12 loans myself and saying, "What would be an 13 acceptable level for a loan in this institution?" 14 And I went from there, if you will. 15 Q. Did you put yourself in the shoes of a 16 director in the board of directors? 17 A. Yes. 18 Q. And what did you conclude? 19 A. I think I was liberal in my conclusion. 20 I felt that given the conditions when the loans 21 were made and the attitude as expressed by the 22 government and FSLIC at the time, that it would 10642 1 not have been inordinate for this institution, 2 given its size -- if I recall, the largest 3 institution in Houston at the time, savings and 4 loan in Houston -- that maybe an acceptable loan 5 could be justified as high as $20 million, even 6 though it had no tangible capital behind it. 7 Q. What are you basing that on? 8 A. Not on sound analysis. Sound analysis 9 would be -- even in 1986 -- this bank shouldn't be 10 making any loans because it had no capital to 11 support the loans. But on the conditions that 12 existed in 1986, what was tolerated in the 13 industry -- and you might even say blessed by the 14 government -- I couldn't separate that from my 15 thinking and what the intent of it was. And it 16 would have been ludicrous, in my opinion, to say 17 "I'm looking at the negative tangible net worth. 18 So, I think every loan over a million dollars 19 ought to come to the board." That would be 20 totally impractical. The board of directors just, 21 quite frankly, could not have handled it. 22 Particularly since they are only meeting 10643 1 quarterly. That's an entirely separate issue. 2 So, I think I was liberal in my 3 arriving at a 20-million-dollar figure; but that 4 was my opinion. 5 Q. How would that have affected -- in 6 terms of concentration, you talk about a 7 20-million-dollar loan. In this instance, we've 8 seen two transactions that total up to 9 $129 million. 10 Is there any justification for doing 11 that from the perspective of the board of 12 directors? 13 A. Pardon me. Could I have that question 14 again, please? 15 Q. Could that be justified, from the board 16 of directors' perspective, making $129 million 17 collectively investing in these two transactions? 18 A. It must be me or my hearing. I'm 19 sorry. One more time so I know I understand the 20 question you're asking. 21 Q. Sure. Could the board of directors, 22 given the level of concentration that you've 10644 1 discussed and the capital level, have concluded 2 that making a 100 -- making a collective 3 investment, loan investment of 120 -- I'm sorry. 4 I said -- $120 million would have been safe and 5 sound? 6 A. Was the question could the board have 7 reached a judgment -- 8 Q. In your opinion? 9 A. -- that two loans comprising 10 $120 million could be safe and sound? 11 Q. Yeah. 12 A. Absolutely not. They could. Should 13 they have is another issue. 14 Q. We've gone through your analysis 15 regarding the situation as it existed in March of 16 1986. 17 What about future prospects and looking 18 in that direction? You stated -- 19 A. Perhaps I'd better explain why I looked 20 at future prospects, because that in itself is not 21 that common or ordinary in the loan decision 22 process for most institutions. It's really a 10645 1 function of why -- the same factors I used in 2 looking back in time in '86 at that time made and 3 the same concept of regulatory capital versus 4 tangible capital. 5 For example, had USAT made those loans 6 as they did and there had been a sustained track 7 record of quarterly reports showing improving 8 earnings, their core businesses taking up and they 9 are trending up in a progressive state, perhaps -- 10 I don't even think that could have justified the 11 80 and the 39.4. But perhaps for some large 12 but -- smaller amount than those, could have been 13 justified. 14 Okay. We don't have the capital 15 perhaps to support these loans now, but we've got 16 a good track record of where our capital is 17 trending upward on a consistent basis with good 18 quality earnings, not phony earnings. 19 So, while it looks high now, you've got 20 every reason to believe as that capital grows, 21 these loans will come down in significance. 22 That's why I looked at future prospects. 10646 1 Q. All right. In looking at the future 2 prospects of the institution, did you also look at 3 TFRs? 4 A. Yes. That's where I got the source of 5 my information. 6 Q. Could we have A4003, please? 7 MR. LEIMAN: Your Honor, I move A4012 8 into evidence. 9 MR. VILLA: No objection. 10 THE COURT: Received. 11 Q. (BY MR. LEIMAN) I've handed you 12 A4003. What is this document? 13 A. This is the thrift financial report, 14 March 31st, 1984. 15 Q. Have you seen it before? 16 A. Yes, I have. 17 Q. And when did you see it? 18 A. Early this year, late last year. 19 Q. And what was your purpose in looking at 20 it? 21 A. Looking -- going back beyond the time 22 the loans were -- Park 410 and Norwood were made 10647 1 to look at the financial position trend of USAT. 2 Q. And that was part of your analysis in 3 connection with your report? 4 A. Yes, it was. 5 Q. Okay. Where would we look on A4003 to 6 follow along with your analysis? 7 A. Several places. I don't know how you 8 want to proceed with this. There are two 9 different things I'm looking at in these reports. 10 If we're going to go through more than one, it may 11 save time or it may be better to discuss just one 12 facet at a time. 13 Q. Let's try one at a time. 14 A. All right. One thing that I looked at 15 was the level of foreclosed real estate assets, 16 and that is on the front page of the document that 17 was just entered, Line 310, upper right, 18 "repossessed assets, foreclosed real estate, and 19 real estate in judgment." 20 In this particular case, even though 21 it's hardly legible -- the document I had before I 22 believe was legible to read -- 17,200,000. 10648 1 Q. And what's the significance of that 2 number? 3 A. It's just one number, but one I've used 4 as an analyst of saying "What was the trend of" -- 5 starting here, "What's going to be the trend? If 6 I see this trend going down, it might be an 7 indication things are getting better. I'll have 8 to look at other things. But if I see it going 9 up, might be a trend things are getting worse." 10 So, it means that the loans that were 11 previously -- these were previously loans that 12 didn't pay as agreed and the institution had to 13 realize on the underlying collateral to get 14 repayment. The borrower did not effect repayment. 15 Q. This would have been as of March 31, 16 '84? 17 A. According to their report, yes. 18 Q. All right. Is there anything else on 19 this particular document that would be of 20 significance? 21 A. The second consideration, yes. 22 Q. What would that be? 10649 1 A. You'd look at the third page of the 2 document at the top saying Section D income, 3 Section E expense. The bottom of that page, near 4 the bottom on the right, current net income. In 5 this case, 6,828,000. That represents the 6 difference between, again, the two columns "income 7 and expense" for the three months ended. I looked 8 at that number for each quarter in relation to the 9 non-operating income that is on the left-hand side 10 of the document right below mid-page, 11 non-operating income. In this case -- 12 Q. What's the line number on that? 13 A. The main line number -- the 14 non-operating income encompasses Lines 200 through 15 280, I believe. Again -- 16 Q. I apologize for the poor copies. 17 A. Well, I would look at the profit on the 18 sale of foreclosed real estate and other items, 19 primarily loans and investment securities, which 20 are shown below, No. 230 and 240, to see if there 21 were any what I would consider non-recurring items 22 that inflated the income shown on the right of 6.8 10650 1 million. 2 In this case, I noticed -- observed 3 that they had sold 3.8 million of investment 4 securities as shown on Line 240, indicating to me 5 that their operating earnings would be current net 6 income, Line 810 on the right lower side, less 3 7 million 856, since it's included in that number 8 that was a profit on the sale of loans, meaning 9 they really earned on a quarter basis, operating 10 basis, $3 million. 11 MR. LEIMAN: Your Honor, I move A4003 12 into evidence. 13 MR. VILLA: No objection. 14 THE COURT: Received. 15 Q. (BY MR. LEIMAN) A4004. 16 THE COURT: Mr. Leiman, we'll adjourn 17 until 2:00 o'clock. 18 19 (Luncheon recess taken at 12:36 p.m.) 20 21 THE COURT: Be seated, please. 22 Mr. Leiman. 10651 1 MR. LEIMAN: Thank you, Your Honor. 2 (2:01 p.m.) 3 Q. (BY MR. LEIMAN) Good afternoon, 4 Mr. Stone. 5 A. Good afternoon. 6 Q. When we left off before the lunch 7 break, we were about to have a look at 8 Exhibit A4004. 9 Have you seen Exhibit A4004 before 10 today? 11 A. Yes, I have. 12 Q. Okay. And was that in connection with 13 your analysis and your report for OTS? 14 A. Yes, it was. 15 Q. And specifically, would you tell us 16 what lines we should be looking at here in 17 connection with the point that you were explaining 18 regarding the excessive transaction amounts 19 relative to the future prospects of USAT? 20 A. Yes. Let's take first the front page 21 of 4004. Again, to the top right-hand section 22 under the top caption "repossessed assets, 10652 1 foreclosed real estate, and real estate in 2 judgment" which is shown on that Line 310 as being 3 20,562,000. And that same number is reflected in 4 my report. On Page 4 on the schedule near the top 5 of the page, I rounded to 20,500,000. 6 Turning back in the report three 7 pages -- 8 Q. You mean the TFR? 9 A. Pardon me. Correct. The TFR. Three 10 pages back, similar as we did with the preceding 11 report, looking down at the bottom right, 12 quarterly income is reflected on Line 810. 13 Current net income, 8,521,000. On the left-hand 14 side of the document right below mid-page under 15 non-operating income, Line 220 is "other real 16 estate held." Profit on sale, 2,965,00. Loans, 17 583,000, two lines down on 240. Again, analysis 18 being that net operating income as I'm using it 19 would be the current net income of 8 million 521 20 less 240, which would bring that figure down to 21 just over $5 million representing earnings on 22 operation. 10653 1 MR. LEIMAN: Your Honor, I move A4004 2 into evidence. 3 MR. VILLA: No objection. 4 THE COURT: Received. 5 Q. (BY MR. LEIMAN) Mr. Stone, looking at 6 the TFRs regarding the numbers that you've told us 7 about regarding foreclosed assets, rather 8 foreclosed real estate -- I'm sorry -- is there 9 some -- is it enough to have two quarters to 10 determine whether a trend exists, or do you need 11 additional information? 12 A. No. I would not say that two quarters 13 would be evidence of a trend. 14 Q. You used additional information? 15 A. Yes, I did. 16 Q. Let's look at A4005. What is A4005? 17 A. It is the thrift financial report for 18 United Savings of Texas for the quarter ending 19 September 30th, 1984. 20 Q. And where would you direct our 21 attention? To the same lines? 22 A. Exactly the same lines on the front 10654 1 page of the TFR, upper right, Line 310 under 2 "repossessed assets," where the number is shown to 3 be 36 million 366, which I carried forward to Page 4 4 of my report, rounded at 36,400,000. Third page 5 back, TFR, current net income on Line 810, bottom 6 right, is shown as 3,587,000. Looking back to the 7 left side of the balance sheet or -- pardon me -- 8 the income statement, Lines 220, particularly, and 9 Line 240, "profit on sale of other real estate," 10 "profit on sale of loans" respectively. 11 Those items totaled would be 12 approximately $8,500,000 represented by sale of 13 assets and profits thereon, which would mean that 14 the current net income figure of 3 million 587 15 less those two numbers would indicate that the 16 institution lost $5 million on a net operating 17 basis for the period of September 30th, 1984. 18 Q. You looked at additional TFRs, 19 quarterly reports? 20 A. Yes. I should add it's going to 21 consistently follow what I have shown on Page 4 22 through March of 1986, this same analysis in each 10655 1 case. 2 MR. LEIMAN: All right. Your Honor, I 3 move 4005 into evidence. 4 MR. VILLA: No objection. 5 THE COURT: Received. 6 Q. (BY MR. LEIMAN) 4006. Did you use 7 4006 in your analysis? 8 A. Yes, I did. 9 Q. And what is it? 10 A. It is the thrift financial report for 11 United Savings as of December 31st, 1984. 12 Q. Looking at Line 310? 13 A. Yes. 30 million -- pardon me -- 14 30,700,000, also reflected on my Page 4 of my 15 report. Three pages back, looking at "current net 16 income," bottom right, Line 810, not very legible 17 but I believe it shows a negative 6,400,000. 18 Again on the left-hand side, below mid-page, we 19 have a loss -- net operating income figures on 20 loans, 2,300,000. Profit on sale and other 21 assets, 76,800,000. The -- which means that the 22 current net income listed as a negative 6 million 10656 1 less the profit on the sale of assets of 2 79 million would leave a current net income of a 3 negative $85 million. But I should add in this 4 particular case that there is a partial offset. 5 Bear with me, and I'll point it out. The copy I 6 have is not illegible. I think I had a more 7 legible copy when I reviewed this. In fact, I 8 know that I did. 9 Yes. And I believe we need to go back 10 to the previous report for a bit of explanation. 11 Q. To A4005? 12 A. Yes. On that same third page of A4005, 13 the upper right-hand side of that third page back, 14 there is a Line Item 110, amortization of 15 goodwill, shown at $6,770,000. That figure 16 normally in these statements ranges around 17 $2 million. 18 What happened in 4006 for 19 December 31st, 1984, as shown on the income 20 statement, sale of other assets was largely 21 comprised of selling branch offices of United 22 Savings. When branch offices are sold -- in this 10657 1 case, at a 76-million-dollar profit -- the related 2 portion of the goodwill that is carried on the 3 books that we discussed earlier this morning had 4 to be adjusted because some portion of that 5 goodwill was attributable to the franchise and, 6 consequently, $4 million of what I said was a 7 negative operating income for December 31st of '84 8 would reduce that number, that negative number, by 9 that same $4 million. 10 Q. And so, the net would be what, instead 11 of negative 85 million? 12 A. Approximately 81 million. And there 13 are -- I will say for the Court, there are some 14 lesser adjustments but not of materiality of the 15 numbers that I am discussing here. There are 16 other minor adjustments an analyst would take into 17 account, but not in the magnitude of the dollars I 18 am talking here. 19 MR. LEIMAN: Your Honor, I move 4006 20 into evidence. 21 MR. VILLA: No objection. 22 THE COURT: Received. 10658 1 Q. (BY MR. LEIMAN) Mr. Stone, I'm going 2 to hand you 4008. Would you tell us what that is? 3 A. It is the thrift financial report for 4 United Savings, quarterly report ended March 31st, 5 1985. 6 MR. LEIMAN: I should say -- correct 7 for the record that it's A4008. 8 Q. (BY MR. LEIMAN) Go ahead. In terms 9 of your analysis? 10 A. Exactly the same as previously -- 11 reports looking at repossessed assets, Line 310, 12 listed at 48 million 360, listed on the top of 13 Page 4 of my report in the schedule as the same 14 amount rounded off, 48,400,000. 15 Three pages back under "net income," 16 the bottom right, is shown as negative current 17 negative income, a negative. I believe it's -- I 18 believe it's either 4 million or 6 million. I 19 cannot -- I believe it's 4,289,000. 20 Looking again to the left side of the 21 income statement, Line 240, profit on sale of 22 loans 5,400,000, which would mean net operating 10659 1 income is approximately a loss of $10 million. 2 MR. LEIMAN: Your Honor, I move A4008 3 into evidence. 4 MR. VILLA: No objection. 5 THE COURT: Received. 6 Q. (BY MR. LEIMAN) A4009. Mr. Stone, 7 I've handed you A4009. Can you describe this, 8 please? 9 A. It is a thrift financial report. 10 Pardon me. 11 Q. I notice that the front page of this is 12 somewhat different -- 13 A. Well, it's not the quarterly report. 14 The front page is the monthly report. If the 15 Court will permit me, let me look through the 16 entire document. (Witness reviews the document.) 17 I think, if all copies are the same as 18 mine, there are two documents that are stapled. 19 The first with the exhibit number on it is not a 20 report that I spent any time with. The second is. 21 The first is a monthly report. The attached 22 stapled copy is the quarterly report similar to 10660 1 the others that we have been reviewing, and that 2 is the document that I used for my report. 3 Q. And this is for the quarter ended -- 4 A. June 30th, 1985. Again, attention is 5 drawn to the same parts of the report. No. 310 on 6 the front sheet, "foreclosed assets," 63 million 7 952, shown on Page 4 of my report rounded at 8 63,900,000. 9 Three pages back, in the income 10 statement, current net income listed at 4,648,000. 11 On the left side, lower mid-page, Line Items 230 12 and 240 -- I'd have to look at the copy of this. 13 230 is other real estate and 240, profit on sale 14 of loans of 3 million 9, 6 million 8. Added 15 together, it would indicate that the institution, 16 while on a net income basis, is showing a profit 17 of approximately $5 million. On an operating 18 basis, lost $5 million. 19 MR. LEIMAN: Your Honor, I move A4009 20 in. 21 MR. VILLA: No objection. 22 THE COURT: Received. 10661 1 MR. LEIMAN: We just have a couple more 2 of these, I believe, Your Honor. 3 Q. (BY MR. LEIMAN) A4010. Would you 4 identify this, Mr. Stone? 5 A. Yes. A4010 is the thrift financial 6 report for United Savings as of September 30th, 7 1985, quarterly statement. 8 Q. Did you use this in your report? 9 A. Yes, I did. 10 Q. And what did you use it for? 11 A. The -- primarily for the review of the 12 net worth of the institution as reported in 13 relation to the Park 410 and Norwood loans and the 14 future prospects of that capital based on the 15 trend lines as evidenced in these reports. 16 Q. And would it be the same lines that you 17 looked at previously? 18 A. Yes. 19 Q. Line 310 for foreclosed real estate? 20 A. Yes, it would. 21 Q. Three pages back? 22 A. Yes. 10662 1 Q. And what would the net income there be? 2 A. In this case, a net -- net income is 3 shown as 4 million 790; but on the left-hand side 4 of the income statement, a profit is shown on the 5 sale of investment securities and a smaller amount 6 for loans of approximately 8 million 3 in total, 7 indicating that while net income is shown as a 8 positive of 4,790,000, that the institution on an 9 operating basis lost approximately 3,600,000. 10 MR. LEIMAN: Your Honor, I move A4010 11 into evidence. 12 MR. VILLA: No objection. 13 THE COURT: Received. 14 Q. (BY MR. LEIMAN) Mr. Stone, my 15 colleague has gone down. We seem to have 16 misplaced A4011, which would be the December 17 quarterly report. 18 Did your report contain, however -- 19 we'll bring that up in a moment. Does your report 20 contain the foreclosed real estate in connection 21 with the December quarter? 22 A. Yes, it does. 10663 1 Q. What does your report show that to be? 2 A. $90,900,000 and the source of that was, 3 in fact, that December '85 quarterly statement. 4 Q. All right. Let's look, once again, 5 please, at A4012, which has been previously 6 admitted. Turning to Exhibit A4012, did you use 7 this for determining future prospects? Was this 8 included in the analysis you've been talking 9 about? The quarterly report A4012. 10 A. Oh, for March? 11 Q. Yes. 12 A. Correct. 13 Q. And do you have that in front of you? 14 A. Oh, pardon me. 15 THE COURT: Which exhibit are we 16 talking about? 17 MR. LEIMAN: A4012, Your Honor. It's 18 the first one we talked about. This is the one 19 that had two revisions. 20 A. Yes, I have it. 21 Q. (BY MR. LEIMAN) Okay. Mr. Stone, 22 would I be right in turning to the final revision 10664 1 which is dated 8-8-86? 2 A. Yes. It would be the fourth page from 3 the back. 4 Q. Okay. And what do the repossessed 5 assets show here? 6 A. On Line 310, the income statement, 7 fourth page from the back, it is shown as 8 122 million 160 some odd thousand. And also on 9 Page 4 of my report. 10 Q. And looking then at the third page, 11 what about the net income? 12 A. It's the second page from the back. 13 Legibility is a little difficult, but I believe 14 it's -- current net income on Line 810 is 15 28,500,000. Looking on the left side under 16 "non-operating income," Lines 230 and 240, sale of 17 investment securities, profit on sale of 18 investment securities, profit on sale of loans, 19 26,383,000 which, together, would be approximately 20 49,700,000. 21 So, current net income of 28 million 5 22 less $49 million of profit on sale of assets would 10665 1 leave approximately a 21-million-dollar negative 2 net operating income. 3 Q. Mr. Stone, what did you glean from the 4 numbers that you focused on regarding foreclosed 5 real estate? 6 A. First, as shown in the last sentence on 7 Page 3 of my report, that absent gains on sale of 8 branches and loans which are non-recurring events, 9 not core operations, the institution operated at a 10 loss over the time period we have just reviewed. 11 Secondly, as shown on top of Page 4, as 12 far as future prospects, the institution had a 13 consistently increasing volume of foreclosed real 14 estate, the trend line obviously indicating to the 15 negative. 16 Q. What would that suggest to the board of 17 directors in connection with making an 18 80-million-dollar and a loan to Park 410, the 19 39.4-million-dollar transaction investment/loan 20 with Norwood? 21 A. That even if they felt in their 22 judgment, their collective judgment that a loan as 10666 1 large as $80 million or a loan/investment as large 2 as 39.4 million was appropriate at the time the 3 institution made the investments, that 4 notwithstanding that, they had ample information 5 from their own reports generated from their own 6 records and submitted by them to their regulators 7 to indicate the likelihood that capital protection 8 in USAT was on the decline, offering less 9 protection and a higher concentration to the 10 institution in the Park 410 and Norwood 11 transactions. 12 Q. You used the word "capital protection 13 on the decline." 14 What do you mean by that? 15 A. I had asked during the break for a flip 16 chart. I best can explain it if I could have the 17 use of that. 18 The question being -- do you want to 19 rephrase it or restate it? 20 Q. You need the question read back? 21 A. Please. 22 10667 1 (Whereupon the requested portion 2 was read back by the reporter.) 3 A. Capital protection, the reason I used 4 the word "protection" -- and not to insult anyone 5 in the Court, but being simplistic, is a bank or a 6 thrift's balance sheet is comprised of total 7 assets, total liabilities, and net worth. An 8 institution's balance sheet -- let's call total 9 assets, A; total liabilities, B; total net worth, 10 C; and total of liabilities and net worth, D. 11 In other words, the computation is 12 simple. Assets equals the total of liabilities 13 plus net worth. As said earlier this morning, net 14 worth is the protection afforded to the bulk of 15 the liabilities comprised of depositors. This is 16 the only thing that stands in their way of loss. 17 As losses are incurred on assets, whether they be 18 Park 410 or Norwood, this declines, net worth 19 declines, raising their exposure to loss. 20 There are several ways to supplement 21 this net worth, whether it be new injections of 22 capital by present owners, sale of the institution 10668 1 to new owners, but the usual buildup of net worth 2 comes from earnings from the institution. As they 3 make profits, as we have reviewed these 4 statements, thrift financial reports to look at 5 current income and net operating income, to the 6 extent that is positive, net income -- this net 7 worth -- grows, giving them a bigger cushion 8 against loss. 9 However, what I am saying, in reviewing 10 the TFRs, I'm observing two things: One, within 11 the total assets, there is an up trend, as shown 12 on Page 4 of my report, in foreclosed real estate. 13 These are loans that didn't go to fruition. 14 Borrowers were not able to meet their terms and 15 repay the loans. The bank had to resort to 16 foreclosing on the real estate and holding it as 17 an asset until they could dispose of it. 18 Foreclosed real estate is generally, with some 19 exceptions, generally non-income producing. It 20 doesn't throw off income. Occasionally, you can 21 rent a property, and institutions do. But by and 22 far, far and away, there are over 2,000 properties 10669 1 involved. 2 So, the trend -- we know at least in 3 1986 they had $122 million of largely non-earning 4 assets and it was growing, as shown in my report. 5 That didn't portend well for net worth. 6 Also in reviewing the income 7 statements, we saw that what occasionally would 8 be -- or mostly shown as profit net income was 9 more than offset by sale of assets, which are 10 non-recurring. A bank normally isn't in the 11 business, nor a thrift, of selling assets, 12 investment securities. Now, on the plus side, I 13 will concede when we looked at the profit on sale, 14 we saw some profits on sale of foreclosed assets. 15 So, that's to the institution's favor for the 16 assets they could, in fact, foreclose and sell at 17 a profit. But that's -- those profits were very 18 small compared to the volume of the foreclosed 19 assets we see and by their own reports, which 20 we'll cover later, of where they were actually 21 incurring losses on most of that -- on most of 22 those foreclosed properties. 10670 1 So, my point being at the time the 2 Park 410 and Norwood loans/investments were put on 3 the bank's books, the investment decisions made, 4 this net worth, which was small to start with -- 5 was non-existent on a tangible basis but small to 6 begin with in relation to those size loans -- the 7 trend was down and looked as if it was not going 8 to grow to offer any more protection to 9 depositors. In fact, the trend was depositors 10 were at more risk based on the trend line. 11 Q. You also mentioned -- you mentioned, 12 Mr. Stone, that this would result in a higher 13 concentration. Do you remember saying that? 14 A. One more -- if I may have the question, 15 please. 16 Q. Sure. You mentioned two items: 17 Capital protection and that with these two 18 transactions, they would result in a higher -- the 19 concentration would be higher in terms of 20 percentage. 21 Why does that happen as -- 22 A. If net worth declines after the loans 10671 1 are made for reasons of not generating income, 2 recurring income, sustainable income, the 3 percentage of those two loans, if they don't 4 decline through sales of the properties being 5 developed, if they stay in the neighborhood of 73 6 to 80 million in Park 410 or 39 -- 30 to 7 $39 million in the situation with Norwood, if 8 those loans aren't reducing, the capital is 9 reducing, they become even more significant to net 10 worth, further placing depositors at risk. 11 By way of clarification, in total 12 fairness, I looked at this from both sides. When 13 we went through these thrift financial reports and 14 indicated my analysis of looking at net income, 15 taking away net operating -- or taking away 16 non-operating income, there may have been certain 17 quarters -- for example, the end of 1985 showed a 18 large loss with the sale of branches. There may 19 have been some other entries in that particular 20 quarter that I didn't go into. They may have had 21 increased loan/loss provision. They may have -- I 22 didn't want to -- that quarter stuck out 10672 1 tremendously as a large loss period. I'm looking 2 at the trend line and not looking at every item in 3 it, and I'm doing it with a degree of comfort. 4 It's the same type of analysis I've used for 30 5 years. I didn't want to indicate that some of 6 those may be aberrations, couldn't be partially 7 explained. But they couldn't be partially 8 explained to put the institution back in a 9 profitable net operating mode. 10 Q. Would that be true regarding what we 11 see here on A4012, which is the March 31, '86 TFR 12 which shows, for example, $26 million -- 13 $26.4 million in profit on loans and investment 14 securities bringing in $23.4 million. 15 How can you tell that these aren't 16 going to be the upward trend, this won't be the 17 turnaround? 18 A. Well, that's exactly back to that same 19 page which is, again, the third page -- second 20 page back. Sheer logic would tell you that on 21 Line Item 230, a profit on sale of investment 22 securities at 23,400,000, that an institution is 10673 1 no different than any other investor. An 2 institution can't sustain on a quarterly, 3 semi-annual, or annual basis outguessing the 4 market, if you will. 5 Normally, investment securities, with 6 other exceptions, are bought for income purposes. 7 They buy U.S. Treasury securities, U.S. government 8 bonds notes, other types of investments that throw 9 off a coupon income. And that's the normal part 10 of doing a financial institution business. But 11 occasionally, markets will turn and you will have 12 some of those investments that you bought for 13 income purposes that now are at above-market rate. 14 Consequently, they have a premium in the market; 15 and you can sell and realize a profit. Now, when 16 you do that, you're giving up above-market income 17 because someone else is buying that from you. But 18 banks are not in the business of speculating in 19 the markets, and no bank could be expected -- 20 reasonably be expected to sustain, nor any 21 investor, on a continuing basis profits on the 22 sale of investment securities or, for that matter, 10674 1 on the origination and sale of loans. 2 Q. Do I understand you to be saying that 3 it wouldn't be reasonable for the board of 4 directors to assume that the income -- that that 5 profit would continue from quarter to quarter in 6 the future? 7 A. No. Well, that as well as being able 8 to sell branches at a 76-million-dollar profit. 9 Eventually you run out of branches, yes. 10 MR. LEIMAN: For the sake of cleaning 11 up the record, Your Honor, A4011 I didn't have a 12 moment ago. 13 MR. VILLA: Your Honor, may I ask that 14 the document that Mr. Stone has just written on be 15 marked as an exhibit in the case for 16 identification? 17 MR. LEIMAN: I have no objection. 18 THE COURT: Well, do you have a number 19 for it? 20 MR. SCHWARTZ: Your Honor, the next 21 number in order, I'm told by our paralegal, is 22 T7804. 10675 1 MR. VILLA: T7804. Thank you, Your 2 Honor. 3 THE COURT: All right. Received. 4 Q. (BY MR. LEIMAN) Just briefly back to 5 A4011, Mr. Stone, this document is the 6 December 31, 1985 TFR? 7 A. Yes, it is. 8 Q. And -- 9 A. Amended 2-7-86. 10 Q. Okay. And looking at the amended 11 version at Line 310; is that correct? 12 A. Yes. 13 Q. What does it show? 14 A. 90 million -- it's illegible, but I 15 have it on my report on Page 4 as 90,900,000. 16 Q. And in terms of net income? 17 A. Again, illegibility issue; but current 18 net income, third page back, is listed as 19 5 million, and I cannot read beyond that into the 20 thousands. 21 Q. I think it's 815,000. 22 A. On the left side, same page, 10676 1 "non-operating income," "Profit on sale of 2 investment securities, 15 million 9. Profit on 3 sale of loans, a million 3. Profit on sale of 4 other assets, 7 million 4, which would approximate 5 $24 million against a current net income of 5, 6 indicating a net operating loss of approximately 7 $19 million. 8 Q. And you used this in your report in 9 your analysis; is that right? 10 A. Yes, I did. 11 MR. LEIMAN: Your Honor, I move A4011 12 into evidence. 13 MR. VILLA: No objection. 14 THE COURT: Received. 15 Q. (BY MR. LEIMAN) Earlier, you told us 16 that you had looked, Mr. Stone, at a number of -- 17 quite a few documents and included were some 18 filings that were made with the Securities and 19 Exchange Commission; is that right? 20 A. Yes, I did. 21 Q. Let me have T7569, please. This is Tab 22 721. 10677 1 MR. VILLA: Your Honor, before we move 2 to the next subject, I'd like to make sure that we 3 get a copy of the document that the witness used 4 for purposes of testifying there. May I have a 5 copy of that when he's completed his -- 6 MR. LEIMAN: Sure. 7 MR. VILLA: Thank you. 8 Q. (BY MR. LEIMAN) Mr. Stone, I've 9 handed you Exhibit T7569, which is a Form 10Q for 10 the quarter ended March 31, 1985 for a registered 11 entity, United Financial Group Inc. 12 Do you see that? 13 A. Yes, I do. 14 Q. Did you use this in your analysis in 15 preparing your report? 16 A. Yes, I did. 17 Q. In what way? 18 A. Primarily looking at the income 19 statement four pages back of United Financial 20 Group, Incorporated, which I understood to be the 21 parent holding company of United Savings. Just a 22 note that it reflects on that page for the three 10678 1 months ending March 31st, 1985, a negative income 2 of $7,663,000. It's the consolidated statement. 3 And further back, notably -- I think it's Bates 4 No. 1201. Under mid-page, "results of operation," 5 indicating the loss for the quarter and stating, 6 if I may read from this document, "The unfavorable 7 change reflects an increase in the provision for 8 loan and real estate losses and a decrease in the 9 net interest margin of 4.2 million and 2.3 million 10 respectively. These changes are primarily 11 attributable to the continuing adverse economic 12 and real estate conditions primarily in the 13 Houston and Brownsville areas which have resulted 14 in significant increases in foreclosures and 15 net-occurring loans. In addition, the net 16 interest margin was hampered by the cost of carry 17 on investments in real estate" -- investments 18 plural -- "which are currently in the development 19 stage." Primarily those statements. 20 Q. How do these statements enter into your 21 analysis? 22 A. One, this report was for the quarter 10679 1 ending March of 1985, approximately a year before 2 Park 410 was granted by the institution and some 3 approximate 15 months before the Norwood 4 transactions were consummated. Both of them 5 being, said earlier, concentrations of credit 6 speculatively made on real estate where the 7 institution's holding company, its parent, 8 indicating losses for the quarter one year earlier 9 have attributed losses to adverse economic 10 conditions citing real estate, citing 11 foreclosures, citing cost of carry on investments 12 in real estate which are currently in the 13 development stage which most certainly both 14 Park 410 and Norwood were at the time the loans 15 were made. And that obviously -- I won't say 16 obviously -- obvious to me was that the 17 institution and its board, through their own 18 filings, knew that the conditions one year before 19 making these loans were trending negative and were 20 predominantly due to real estate and real estate 21 underdevelopment. 22 Q. What is cost of carry? 10680 1 A. Cost of carry is the average cost of 2 funds. When we refer to the balance sheet, all 3 the liabilities, the deposits -- in this instance, 4 they had repurchase agreements -- any type of 5 borrowings they may have had, whatever their 6 liability composition was, what is the average 7 cost of funds, weighted average cost of funds of 8 those liabilities as opposed to what are the 9 earning assets of the institution throwing off. 10 What they are saying and they have said 11 in other reports within the institution is that 12 they were having a decreasing net interest margin. 13 That interest margin is total interest income, 14 total interest expense, the difference being that 15 interest margin. They were having problems on 16 operations of earning money on a recurring and 17 sustained basis. 18 Q. Let's look at T7568. It's at Tab 721A. 19 Mr. Stone, Exhibit T7568 is a 10Q similar to the 20 last one we saw. However, this one is for the 21 quarter ended June 30, 1985. Again, the 22 registered company is United Financial Group, Inc. 10681 1 Have you seen this before? 2 A. Yes, I have. 3 Q. And how did you come to see it? 4 A. I requested it from OTS. 5 Q. And did you use it? 6 A. Yes, I did. 7 Q. What did you use it for? 8 A. In arriving at my conclusion as a 9 result of my engagement to review the Park 410 and 10 Norwood loan transactions. 11 Q. If you would, look at Page Bates 12 OW013004. 13 A. All right. 14 Q. Looking under "results of operations," 15 did you find -- did you use this section in your 16 report? 17 A. Yes, I did. It's the identical section 18 from the previous report we discussed. 19 Q. Well, is it entirely identical or is 20 it -- 21 A. No. Identical in its heading, "results 22 of operation," and its description of the net loss 10682 1 reported for the sixth-month period of 1985. The 2 description is essentially the same in different 3 words. 4 Q. Let's turn just to the middle of this 5 document, the middle of the paragraph. In 6 describing the real estate market in this 7 subsequent filing, it talks about the real estate 8 markets in Houston and most of Texas and is no 9 longer related primarily, as it's stated in 10 Exhibit T7569, which indicated Houston and 11 Brownsville areas. 12 A. Yes. It does make it more expensive in 13 this report which was filed three months later. 14 Q. Should the board of directors of United 15 Savings Association of Texas have taken these 16 reports into account? 17 A. To the extent made available to them, 18 and they should have been made available to them 19 in as much as its part of their holding company or 20 owner; but had they not had them available to 21 them, the same information should be more 22 recognized by them as they are, if you will, the 10683 1 ones on the firing line. This is the owner, the 2 holding company, reporting this. They would have 3 to use the institution as a source. Even if they 4 didn't use them as a source, I can't imagine any 5 situation where this being the case, that the 6 boards of directors of the institution, which this 7 holding company owned, would be unaware of those 8 conditions. 9 Q. Let's turn to your second conclusion, 10 Mr. Stone, in which you indicated that the board 11 of directors failed to exercise responsibility and 12 due care in lending and investment functions, in 13 particular regarding Park 410 and Norwood. 14 Did I say that right? 15 A. I believe you did. 16 Q. T7486. Mr. Stone, did you have 17 occasion to read these minutes of the meeting of 18 the board of directors of United Savings 19 Association of Texas dated February 14th, 1985? 20 A. Yes, I did. 21 Q. And what was your purpose in reading 22 them? 10684 1 A. As mentioned on Page 5 of my report 2 near the top, I looked at these minutes -- I 3 reviewed all minutes during the time frame. These 4 minutes particularly set out the delegations of 5 authority in many areas but, of my concern, the 6 lending authorities for the institution that were 7 applicable at the time Park 410 and Norwood 8 Properties were -- Norwood transactions were 9 entered into. 10 Q. And what did you find out? 11 A. That within these minutes -- bear with 12 me until I find it. It's a lengthy document. 13 (Witness reviews the document.) I'm looking for 14 the 70-million-dollar delegation. I just must 15 have missed it on the first pass. 16 Yes. On Page 9 of 26, if you'll look 17 at the upper right-hand page of the document, 18 Page 9 of 26, Item C, "Any loan to one borrower or 19 guarantor in excess of $70 million shall be 20 presented to the board of directors for 21 consideration after receiving a favorable 22 recommendation from the senior loan committee." 10685 1 That had very significant import to me. 2 Q. What are the implications of the 3 70-million-dollar delegation of authority? 4 A. Quite frankly, incomprehensible. The 5 information, I think, that -- covered later in my 6 report, not only was the $70 million to me a 7 totally improper delegation but a horribly 8 excessive amount, the institution -- and this is, 9 by the way, a carry-over from 1984, if I recall -- 10 the institution had never made a loan of this size 11 ever in its history. And I couldn't imagine the 12 board of directors delegating a loan not only that 13 large in capital but a loan significantly in 14 excess -- if my memory is right -- more than 15 double the size of any loan that they had ever 16 made. But to abdicate their responsibility and 17 say that such a loan could be made by a senior 18 loan committee without the board of directors 19 passing on it formally themselves was just 20 unbelievable. 21 Q. In your experience, what is the -- I 22 want to say the average delegation to a senior 10686 1 loan committee, but perhaps there is no -- what's 2 the highest amount you've ever seen delegated to a 3 senior loan committee? 4 A. The best way to answer, I have worked 5 in numerous states and been in a senior capacity 6 of the FDIC regional offices and regions that 7 covered numerous states. And the various lending 8 limits -- because the FDIC at this point in time 9 had no lending limits of its own. It relied on 10 the state authorities, the chartering authorities. 11 Those varied from state to state. And I'm 12 speaking off the top of my head now; but to the 13 best of memory, maximum loan limits ranging on 14 both sides from state to state might be 20 percent 15 of a bank's capital and surplus -- unimpaired 16 surplus positions as being a maximum loan limit to 17 any one borrower. Delegations for that amount -- 18 there were many banks that never, ever made their 19 maximum loan limit for the very reasons I've 20 discussed earlier: Undue risk because of the 21 concentration of risk in one borrower. 22 I'm sure there is an average, but it 10687 1 would be so difficult to compute. I'll make, if 2 it can be accepted as that, my best memory that an 3 institution would delegate maybe somewhere between 4 35 and 50 percent of its maximum loan limit to a 5 senior officer committee. 6 Q. What does a delegation of this 7 magnitude, of $70 million -- how does that affect 8 the board of directors' ability to take action? 9 A. I'm sorry. I don't understand the 10 question. 11 Q. Does a delegation of this size affect 12 the board of directors and its ability to make a 13 decision on loans? 14 A. Well, in this case, as I mentioned, 15 information available to me in preparing this 16 report indicated that the institution had never 17 made a loan of this size. Well, I guess it 18 affects the board. They don't have to think. 19 They don't have to take responsibility. They have 20 let someone else take the responsibility for a 21 large loan. 22 Q. What's wrong with that -- with 10688 1 eliminating that discretion from the board of 2 directors? 3 A. Because a loan of this size -- and 4 USAT's an example, based on their capital, based 5 on their future prospects -- should not have been 6 allowed even with board of director approval in my 7 estimation but, at the very least, if they were to 8 choose such an amount as their maximum loan, 9 period, by any authority within USAT -- and they 10 are the highest authority -- it should have been 11 only with their consideration and analysis and 12 in-depth review. 13 So, to me, it was absolutely derelict 14 to give this much authority to staff. 15 Q. Look with me, please, at Page 17 of 26 16 in this exhibit. Look at the first full paragraph 17 on that page. 18 A. 17 of 26? 19 Q. Yes. OW012743 is the Bates number. 20 A. On mine, that's a carry-over of a 21 paragraph on the previous page. 22 Q. The first full paragraph. 10689 1 A. Oh, pardon me. "Any real estate or 2 joint venture" -- oh, yes. As I pointed out in my 3 report -- in fact, I quoted that exact section. 4 Q. Well, why don't you quote it for us? 5 A. Page 5 of my report, "Any real estate 6 or joint venture project which involves a total 7 equity and/or debt exposure to the association of 8 2 and a half million or more shall require prior 9 board ratification." 10 I read that particular paragraph with 11 some interest, yes. 12 Q. Why did you read it with interest? 13 A. Well, again, as I said on Page 5, 14 without trying to interpret the meaning of "prior 15 board ratification," I found it most 16 incomprehensible that the board wanted some 17 involvement -- which, again, I'm not sure what 18 prior board ratification is -- on a decision that 19 might be 2.6 million, yet delegate a 20 70-million-dollar decision. I just couldn't 21 equate the two. The delegation, depending again 22 on what "prior board ratification" means, isn't 10690 1 necessarily inappropriate at 2 and a half million, 2 in my mind. 3 Q. What would be the maximum delegation 4 that you feel would have been appropriate if it 5 wasn't 70 million? 6 A. I believe I said earlier this morning 7 in coming to my conclusions, given full 8 consideration to conditions at the time, 9 accounting convention at the time, the 10 government's reasons for doing what they did, et 11 cetera, giving a liberal consideration of that, I 12 felt that $20 million for an institution the size 13 of USAT would have been the outermost limit. For 14 some reason, in my deposition there is one 15 reference to it where I said 26 million, but it 16 was 20 million. 17 Q. What about the -- in connection with 18 the senior loan committee, what would an 19 appropriate delegation have been by the board of 20 directors? Would it still be that 21 20-million-dollar figure? 22 A. No, no, no. My reference to the 10691 1 20-million-dollar figure would have been the upper 2 most limit for the board of directors. 3 Q. Oh, I see. 4 A. The -- it's difficult to answer, 5 reviewing only the materials involving these two 6 loans without the entire financial position of 7 USAT, but -- and that wouldn't enlarge -- that 8 would have a large determining factor. But a 9 delegation to a senior loan committee of 10 $5 million, maybe, would be appropriate depending 11 on the composition of that committee. Such a 12 committee, I would expect to see outside directors 13 involved in, as well. 14 Q. We've talked about the Park 410 loan 15 and the size of that loan. 16 Do you believe that the delegation of 17 the $70 million that you've seen was done solely 18 for purposes of the Park 410 loan or in 19 anticipation of it? 20 A. No. I have no reason to believe that 21 because I think I mentioned the delegation, as far 22 as I could tell, went back at least till August of 10692 1 1984. So -- but again, I have no basis for that. 2 It just doesn't seem -- there is no evidence to 3 suggest the delegation was to accommodate the 4 loan, no. 5 MR. LEIMAN: Your Honor, I move T7586 6 into evidence. 7 MR. VILLA: One moment, Your Honor. No 8 objection. 9 THE COURT: It's in evidence as A1102. 10 MR. VILLA: I believe Mr. Winters. 11 MR. LEIMAN: Thank you, Your Honor. 12 Let's take a look at T7662, please. 13 Q. (BY MR. LEIMAN) You referred a minute 14 ago, Mr. Stone, to -- in fact, you didn't think 15 that the board of directors had made this 16 delegation in particular looking at the Park 410 17 loan, and you referred to the August 1984 minutes 18 of the board of directors as being a prior 19 delegation of the 70-million-dollar loan -- a 20 70-million-dollar loan delegation to the senior 21 loan committee. I've handed you T7662 which are 22 the August 29th, 1984 minutes. 10693 1 A. Yes. 2 Q. Is there a delegation in here of 3 $70 million? 4 A. Yes. That is the third page back. 5 Bottom of the page, Item C, any loan to one 6 borrower or guarantor in excess of $70 million. 7 (Witness reviews the document.) 8 May I -- having seen these board 9 minutes, may I make -- there was one observation 10 that I did not include in my report that I think, 11 because we're on this very subject, needs to be 12 pointed out and I think explain why it wasn't in 13 my report. 14 If you'll notice on these minutes and 15 on the prior, the cover page of the minutes says 16 that the meeting was held on August 29th, 1984. 17 And if you'll read down to the second paragraph, 18 "On motion by Dr. LeMaistre, seconded by 19 Dr. Munitz, the minutes of the board meeting of 20 June 2nd, 1984 were unanimously approved as read." 21 I found over the time period I reviewed 22 the board minutes, '84 through some period in '86, 10694 1 that this was rather consistent, that the board, 2 as in this case, only met on a quarterly basis 3 which, to me, again, is absolutely 4 incomprehensible. 5 MR. VILLA: Objection, Your Honor. 6 This goes beyond his expert report. It goes 7 beyond the issues in the case. While I'm sure 8 we're all interested in Mr. Stone's views, we're 9 not litigating the number of times the board met 10 and we have no notice that this issue was going to 11 be raised. So, we object to testimony on this 12 point. 13 THE COURT: I'll deny the objection. 14 Q. (BY MR. LEIMAN) Mr. Stone, let me ask 15 you a question about your observation, if I could. 16 In your experience, how often should a 17 board of directors meet in order to exercise due 18 care and properly perform its obligations and 19 duties as directors? 20 MR. VILLA: Your Honor, may I have a 21 standing objection to this line? I won't 22 interrupt him again. 10695 1 THE COURT: All right. You may. 2 MR. VILLA: Thank you, Your Honor. 3 Q. (BY MR. LEIMAN) Do you know -- how 4 often should a board meet? 5 A. My experience has been, regardless of 6 the size of bank, a minimum of monthly meetings. 7 I recall no instances of meetings being held on a 8 regular basis less than monthly. Now, I have 9 taken exception as a supervisor in some problem 10 institutions where meetings were skipped for some 11 reason or another and the board went two months 12 without a meeting. But how a board of directors 13 can believe that they are properly administering 14 the affairs of the institution that they are 15 charged with administering by meeting only 16 quarterly, even in a well-run institution with no 17 evident problems, is -- again, I don't see how a 18 director could feel comfortable, even in the 19 best-run institution in the company, be it thrift, 20 be it bank, credit union, whatever. 21 Even more so, in an institution that 22 we've spent a lot of time today on talking about 10696 1 negative tangible net worth, not making money on 2 an operating basis, it's amazing to me. I won't 3 say I've never seen it, but I am fairly confident 4 that I have never seen quarterly minutes. And 5 like I say, I've been in institutions of 6 $1 million and I have read examination reports and 7 reviewed reports of the largest institutions in 8 the country and I have never observed this. 9 MR. LEIMAN: Your Honor, I would move 10 T7662 into evidence if it hasn't previously been 11 admitted, which it might well have. 12 MR. VILLA: It's in evidence, Your 13 Honor. 14 THE COURT: It's in evidence as A10545. 15 MR. LEIMAN: Thank you, Your Honor. 16 Q. (BY MR. LEIMAN) Let's turn to your 17 third conclusion, if we could. Mr. Stone, you 18 said that in approving the Park 410 -- I'm 19 paraphrasing. 20 In approving the transactions, the 21 institution did not employ and the board of 22 directors didn't establish or enforce sound loan 10697 1 and investment policies or underwriting standards. 2 Do you remember -- 3 A. Yes. 4 Q. -- saying that? What is that based on? 5 A. Various documents. 6 Q. Could we have T7667 and 7670, please? 7 T7670 is in evidence at Tab 654, and 7667 is at 8 Tab 653 or I guess it was put in as A1649. 9 Mr. Stone, I handed you two previously 10 admitted exhibits. Do you have those in front of 11 you? 12 A. Yes, I do. 13 Q. Did you consider these documents in 14 connection with your report? 15 A. Yes, I did. 16 Q. If you would, please, turn with me on 17 Exhibit T7670, which is Tab 654, to the third page 18 of the exhibit. 19 A. Yes. 20 THE COURT: Go ahead, Mr. Leiman. 21 Q. (BY MR. LEIMAN) Looking at this 22 senior loan committee approval of March 17th, 10698 1 1986, and specifically directing your attention to 2 the section dealing with the appraisal. Here, the 3 borrowers projected sales through 1990 and cash 4 payoffs through 1992. And in this regard, there 5 was pending a completion of an R-41B appraisal, 6 according to the document, by Edward B. Schulz. 7 Do you see that? 8 A. Yes, I do. 9 Q. How did that enter into your analysis 10 and report? 11 A. In several ways. One, this appears to 12 be the -- maybe even the presentation document or 13 at least the document that was used to record, in 14 this case, an approval as shown on the 15 next-to-last page. And I found it jump out at me 16 that -- again, we're dealing with the largest loan 17 made by this institution -- that the reference is 18 to, quote, "borrowers project sales." It goes to 19 the semi-colon at '92. "Their projected sales and 20 the bank's share of the profits projected to be." 21 I don't see in this document any loan 22 officer citing the reasonableness of those 10699 1 projections, the projected sales, the projected 2 share of profits. Again, these are the borrowers, 3 the people that are applying to the bank for 4 funds. Not exactly without a conflict of 5 interest. I'm not saying there was anything 6 untoward about it at this point in time or known 7 to be untoward, but the point being there is no 8 reference to a test of reasonableness, the bank's 9 own internal staff, some of which have extensive 10 experience, making -- giving any opinion in this, 11 the approval document. It may have been 12 discussed. It may have been discussed in depth. 13 But there is some indications I'll get to in just 14 a minute that that wasn't the case. 15 But in any event -- and then that the 16 time of this approval was indicated as March 17th 17 and signed as of March 17th saying that an 18 appraiser is presently completing a detailed R-41B 19 which will indicate a present discounted economic 20 value -- and gives a range. The group that is 21 making the decision doesn't have the appraisal in 22 front of them or even an executive summary of that 10700 1 appraisal, how it was approached. Did it -- in 2 fact, someone attesting at the bank level, not the 3 appraiser -- that it did, in fact, comply with 4 R-41B; that it did, in fact, use reasonable 5 assumptions; it did, in fact, use reasonable 6 comparables of a recent date in the economic area 7 being affected; and give the bank's opinion as to 8 whether the appraisal for which they are basing 9 the largest loan ever made by the institution. 10 They are instead relying on the borrower's 11 projection and appraisals numbers they haven't 12 even seen. It's just amazing. 13 Q. Did you see any evidence in the files 14 that you reviewed or in any of the testimony of 15 any of the individuals that you read -- including 16 Mr. Graham, Charles White, Mr. Gindy -- that would 17 have indicated that there had been such an 18 analysis done, that there was time taken to verify 19 the projections and separately to do an analysis 20 of the appraisal? 21 MR. VILLA: Objection, Your Honor. 22 It's a compound question. I'd ask if he could 10701 1 just ask one part of it at a time. 2 THE COURT: All right. Restate it. 3 Q. (BY MR. LEIMAN) Did you see any 4 indication in anything you read that would have 5 suggested that the appraisal had been -- 6 Mr. Schulz' appraisal would have been analyzed or 7 any appraisal had been separately analyzed by USAT 8 staff? 9 A. Well, this document dated as of 10 March 17th when the loan was approved indicates in 11 its body that such an appraisal isn't complete. 12 So -- which will indicate -- tells me that nothing 13 indicates it at this point in time -- present 14 discounted economic value between 86 and 15 $90 million. 16 But more specific to your question, I 17 saw evidence to the contrary that an analysis was 18 done of the appraisal. 19 Q. What do you mean? 20 A. Well, quite frankly, that Mr. Schulz 21 was given a number to get to and he got to it. 22 And that being the case kind of negates or does 10702 1 negate the value of analyzing a manufactured 2 appraisal. 3 Q. Do you know what the appraisal would 4 have been used for in this kind of a credit? 5 A. The appraisal should have been used 6 for -- should have, first of all, been an 7 independent appraiser getting back, dealing with 8 the institution, the lender, analyzed in depth for 9 its reasonableness and its adherence to R-41B 10 prior to this decision being made at all. It's 11 not an after-the-fact, fill-the-file type of 12 document. It's meant to safeguard the 13 institution, to get an independent appraisal of 14 the value of the collateral that it is to take on 15 a loan. 16 Q. Did you see any evidence in any of the 17 documents that you reviewed or files that you 18 looked at that indicated there was an analysis 19 done regarding the projections that were made by 20 the borrower? 21 A. I saw no evidence of that. I'm not 22 saying it doesn't exist. But in the extensive 10703 1 loan files I reviewed, I saw no evidence. Are we 2 talking -- pardon me, but are we talking both 3 documents or -- 4 Q. No. We'll get to the second one in a 5 moment. We're just talking about 7670, Mr. Stone. 6 Let's look at 7667, which is the other 7 document. In particular, I'd like you to focus on 8 the time the meeting started, the senior loan 9 committee, on the second page of this document. 10 Meeting opening at 9:04 a.m. 11 A. Yes. 12 Q. And then the time of the meeting 13 adjourning at 10:13 a.m. 14 A. Yes. 15 Q. Would an hour and nine minutes be 16 adequate to have -- well, I see there are other 17 credits or other discussions that went on. 18 Would that have been adequate to have 19 discussed this Park 410 transaction? 20 A. Not in my opinion, no. 21 Q. What kind of discussion would the 22 senior loan committee have had to have had and 10704 1 about what topics? 2 A. Again, as stated earlier, that -- 3 pardon me for interjecting, but it does say there 4 was an approval of an 80-million-dollar loan to 5 Park 410 West Joint Venture. I am fairly certain 6 that is a typographical error, that the official 7 record does say 80 (sic) because if there was, in 8 fact, according to this document an 9 80-million-dollar approval, they exceeded their 10 loan limit approval of $70 million. I believe 11 other documents may show it was a 12 70-million-dollar approval. 13 Q. Putting that issue aside for a 14 moment -- 15 A. But the fact, again -- I feel like I'm 16 repeating myself -- for a 70-million-dollar loan, 17 a 70-million-dollar speculative loan, a 18 70-million-dollar speculative loan predicated 19 predominantly only on the underlying collateral 20 with limited guaranties of the obligors with no 21 cash equity on the part of the obligors, with no 22 interest service obligation on the part of the 10705 1 obligors and interest reserve, with fees going 2 directly to the obligors, and to say that the 3 official body, notwithstanding the fact that some 4 staff members and some members of the committee 5 may have had discussions prior in an official 6 senior loan committee meeting comprising slightly 7 over an hour, discussing four other items 8 including Deauville, which we'll discuss later 9 and, reviewing the minutes of the last board 10 meeting or senior loan committee meeting is -- 11 again, I hate to use the same terms -- rather 12 unbelievable. 13 Q. T7077. 14 THE COURT: We'll take a short recess. 15 16 (A short break was taken 17 at 3:30 p.m.) 18 19 THE COURT: Be seated, please. 20 MR. NICKENS: Your Honor, before we -- 21 THE COURT: Do you want this on the 22 record? 10706 1 MR. NICKENS: Yes, sir, please. 2 THE COURT: Mr. Nickens. 3 MR. NICKENS: Your Honor, before we 4 resume Mr. Stone's testimony, I've been having 5 some discussions with Mr. Guido about some 6 scheduling difficulties we have at the end of the 7 week and I'd like to apprise you of that if I 8 might at this time. The -- and I also have been 9 authorized to say that this matter has been 10 discussed with Mr. Stearns, as well. 11 We're facing this difficulty. We have 12 Mr. Stones testimony and then we have 13 Mr. Seidman's testimony scheduled. We had 14 scheduled Mr. Williams' testimony for Thursday, 15 which is the only day that he is available. The 16 OTS is having stand by three out-of-town witnesses 17 for Friday -- one from North Carolina, one from 18 New York, and one from California -- all of whom 19 are asking that they be advised as to their status 20 for this season. 21 It is our impression that both the 22 direct and the cross-examination of Mr. Stone and 10707 1 Mr. Seidman is likely to go into Thursday. That 2 is the only day, as I indicated, that Mr. Williams 3 is available so that we wouldn't finish 4 Mr. Williams. And with the result that we could 5 not inform any of these people as to when they 6 might start or that they could reasonably finish 7 on time with further the result that, as would 8 happen with Mr. Claiborne, that he might fly here 9 from out of town, find that he can't be reached 10 and then have to be sent back or, at best, come 11 testify and then have to come back again. 12 The bottom line, Your Honor, is that we 13 are suggesting the possibility that we finish with 14 Mr. Stone, finish with Mr. Seidman which, given 15 our best estimate at this time, would put us into 16 Thursday but possibly into Friday but probably 17 not, but that we otherwise be able to release 18 these people that have been put on hold for 19 Thursday and Friday. 20 Now, that's just the problem that we're 21 facing and, of course, you know, whatever your 22 wishes are is exactly what we'll do. 10708 1 THE COURT: If we don't finish with 2 Mr. Williams on Thursday, can he be held over till 3 Friday? 4 MR. NICKENS: No, Your Honor. And 5 what -- we cannot do that because he is only 6 available on Thursday. So, we are suggesting to 7 release him as well as the three people because 8 if -- if things go the long way -- that is, 9 Mr. Stone's testimony goes into Wednesday or well 10 into Wednesday, then Mr. Seidman man may be into 11 Thursday and we'd find that we are not even 12 finishing him; that is, Mr. Williams. 13 So, we're -- the suggestion is that we 14 finish Mr. Stone, Mr. Seidman. And whatever that 15 may be, whether that's the end of the day on 16 Wednesday, if it's the end of the day on Thursday, 17 or even into Friday, then that -- then we take our 18 recess. 19 MR. LEIMAN: Your Honor, I have spoken 20 with Mr. Guido, as well. I know these matters are 21 under consideration. I think Mr. Nickens has more 22 current information than I do. The only thing I 10709 1 could actually add to this is to say that Bruce 2 Rinaldi will be in the courtroom tomorrow morning 3 and probably will have more current information. 4 Perhaps Mr. Nickens can telephone Mr. Guido yet 5 again and find out if anything has changed. 6 Mr. Nickens has more recent information than I. 7 MR. NICKENS: I just got off the phone 8 with Mr. Guido. He asked me to raise it at this 9 time in order that he be able to inform these 10 witnesses for Friday, some of whom have to make 11 arrangements as early as possible. 12 MR. SCHWARTZ: Your Honor, if I may, I 13 also spoke with Mr. Guido during the break and the 14 representation -- my understanding is that the 15 representations made by Mr. Nickens are accurate 16 with regard to the timing of the testimony and his 17 conversation with Mr. Guido is consistent with 18 mine. That's all that I can add. 19 THE COURT: So, we're going to have 20 Mr. Williams at a later date? Is that what you're 21 saying? 22 MR. NICKENS: Yes, Your Honor. We'd 10710 1 have him come back after the recess, whatever it 2 may be, and that's a larger issue that we are not 3 addressing at this point and would need Mr. Guido 4 and Mr. Rinaldi to address that issue. 5 THE COURT: All right. Well, I think 6 that's what we'll have to do. I think you can 7 inform those witnesses that we won't -- will not 8 be hearing them this week. 9 MR. SCHWARTZ: Thank you, Your Honor. 10 MR. NICKENS: Thank you, Your Honor. 11 MR. SCHWARTZ: And being a week before 12 the holidays, I'm sure they will appreciate it as 13 well. 14 THE COURT: Mr. Leiman, you may 15 continue. 16 MR. LEIMAN: Yes, sir. 17 Q. (BY MR. LEIMAN) Just before we had 18 our break, Mr. Stone, I was going to direct your 19 attention to Exhibit T7077, which is at Tab 706, 20 Your Honor. 21 Mr. Stone, you made a reference in your 22 testimony a few minutes ago to the projections 10711 1 that related to the Park 410 project and sales. 2 In addition, you mentioned that the appraisal by 3 Mr. Schulz was not entirely without some influence 4 by others. 5 Turn your attention, please, to the 6 first full paragraph on T7077. It's a 7 February 6th, 1986 letter from David Graham to 8 Mr. Noel Simpson of Gulf Management Resources. 9 Do you have that in front of you? 10 A. Yes, I do. 11 Q. Mr. Graham says "We will need and, 12 quite frankly, you should not have a major problem 13 obtaining, based on your sales projections of 14 $120,289,938, an appraisal indicating a 41-B 15 regulatory value of $98 million which would 16 indicate the loan to be 80 percent of appraised 17 value, which is typical." 18 First of all, have you seen this 19 document before? 20 A. Yes, I have. 21 Q. Did you use this in your report? 22 A. I used it in forming my opinions. I 10712 1 may not have quoted directly from this document. 2 Q. What did you understand this letter to 3 be saying and, specifically, the information I 4 just quoted? 5 A. Primarily two things. One, that the 6 phraseology "based on your sales projections of 7 $120,289,938," again, the reliance on the borrower 8 for such projections without an analysis on the 9 part -- on the behalf of the lender, there is an 10 acceptance that is implied in this letter. Even 11 further down the page, even though they indicate a 12 concern, they are still referring to the 13 numbers -- not challenging the numbers so much as 14 some other potential problems. 15 So, again, it's -- that first paragraph 16 is saying "We will need and, quite frankly, you 17 should not have a major problem obtaining, based 18 on your sales projections, an appraisal." 19 And then going on to say -- first of 20 all, it's saying "You shouldn't have a problem 21 obtaining an appraisal" -- which is the tail 22 wagging the dog. The lender should get an 10713 1 appraisal. Again, the borrower is not an unbiased 2 party. The party primarily at risk, the lender, 3 should have the independent view of an appraisal, 4 not one that is dealing with the borrower. And 5 this implies a direct communication between 6 borrower or lender. He predicts that "I really do 7 not believe Ed Schulz," the appraiser as it turns 8 out, "should have a problem achieving this figure 9 or at least something close to it" which, absent 10 an analysis of the author of this letter I think 11 would be a difficult prognostication and one not 12 plausible. 13 So, two problems. One, reliance on the 14 borrower's projections and reliance on the 15 borrower to obtain an appraisal, as indicated by 16 the lender: "You should not have a problem 17 getting one from a particular individual to 18 support it." 19 Q. I notice going further in this letter, 20 though, Mr. Stone, that there is some -- 21 Mr. Graham expresses some -- he says that he's 22 somewhat confused by the recent calculations, if 10714 1 you look with me at the second full paragraph. 2 I'll give you an opportunity to read that over. 3 A. (Witness reviews the document.) I 4 would have to spend some time with that paragraph. 5 I'm sure I read it at the time in reaching my 6 analysis, but -- 7 Q. Well, let me ask you this question, 8 having read the paragraph over now. Here 9 Mr. Graham expresses some analysis regarding the 10 per square foot sales price and does seem to have 11 done some kind of a study, at least at some level, 12 with regard to the property. 13 Do you agree with that? 14 A. As I read it, I see no question of the 15 numbers that have been provided nor the 16 projections but using those same numbers, 17 explaining that the given numbers demonstrate why 18 they want collateral to be proportionately larger 19 as the loan is repaid and the following reasons. 20 Q. Then I take it this is not the kind of 21 analysis you were talking about that should have 22 been sent to the board; is that right? 10715 1 A. Not by far. It's only raising one 2 small point in doing so, accepting the numbers, at 3 least as far as this letter and at this point in 4 time as they were provided. 5 Q. T7084, please. It's been admitted at 6 Tab 704. Mr. Stone, I handed you -- 7 MR. BLANKENSTEIN: Mr. Leiman, can you 8 give us that exhibit number again, please? 9 MR. LEIMAN: Sure. It's T7084, which 10 is Tab 704. 11 MR. BLANKENSTEIN: We don't have that 12 as 7084. We are trying to find it. 13 THE COURT: It also seems to be in as 14 10331. A10331. 15 Q. (BY MR. LEIMAN) Mr. Stone, did you 16 have a chance to look at the Ed Schulz appraisal 17 prior to today? 18 A. Yes. I did look at parts of it. 19 Q. I'd like to point your attention, if I 20 could, to the date on the appraisal, which is 21 March 19th, 1986. 22 Do you see that? 10716 1 A. That's correct. It is. 2 Q. Okay. And if you would, look back with 3 me at the senior loan committee approval of the 4 Park 410 credit, which would have been 5 March 17th -- 6 A. Correct. 7 Q. -- 1986. Is there any significance to 8 the fact, in your mind, that the appraisal by 9 Mr. Schulz was not received until after the senior 10 loan committee had approved this particular 11 credit? 12 A. Yes. It's consistent with the 13 March 17th approval document stating that 14 Mr. Schulz was then presently completing an 15 appraisal that was not available to the committee 16 at the time the loan was approved. 17 Q. And there, you would have been looking 18 at T7670. Right? 19 A. What number did you give me? 20 Q. 7670, which would have been the 21 committee approval; is that correct? 22 A. Yes, that's correct. But when I 10717 1 reviewed this, I failed to point something out. 2 May I review this? 3 Q. It's fine with me. 4 A. Well, what I failed to point out 5 relevant to -- I think the question was -- we were 6 discussing the fact that the committee made this 7 decision without the appraisal in hand. And I 8 meant to mention that it didn't go unobserved to 9 me that I saw no condition placed on anyone, any 10 member of the official family, of saying "All 11 right. You've stated it in our approval document 12 here. Someone is presently conducting an 13 appraisal. Prior to that loan being disbursed, 14 someone analyze it as a condition to this loan and 15 if it's not proper, get back to us. We might want 16 to reconsider this decision." Because in that 17 document, 7670, there are only two conditions: 18 One, that the board has to approve the additional 19 10 million because this is a 70-million-dollar 20 limit on this committee and it's an 21 80-million-dollar request. There is no -- my 22 point being there is no condition for the 10718 1 appraisal. 2 There is a condition, however, in 3 addition to the board having to approve the 4 additional 10, for an additional security that the 5 approving authority wanted, the committee, being 6 Item No. 1, on securing United Savings' interest 7 and other projects on which they have loans with 8 these same people. I never saw that that -- I 9 know fairly confidently they never did get that 10 collateral. I don't know to what extent it would 11 have been valuable. But I saw no evidence that 12 anyone came back to this committee and said "Your 13 condition that you put on us that we get this 14 additional collateral, we didn't get. Do you want 15 to reconsider before we disburse?" It may have 16 happened, but I did not see it in any of the 17 bank's formal records. 18 Q. You refer, Mr. Stone, to the "official 19 family." Who do you mean is the -- who is the 20 official family? 21 A. If you'd help me on when I referred to 22 it and what context. I'm sorry. 10719 1 Q. Just a few minutes ago, you said that 2 no one in the official family had gotten back to a 3 loan committee. 4 A. I'm sorry. Terminology I use too often 5 in my occupation. What I'm saying is that at that 6 senior loan committee meeting were various senior 7 officials, including lending officials such as 8 Mr. Graham. I would have expected that in -- 9 again, for all the reasons I said before on the 10 sizable loan and its character, that the approving 11 body having been told "we don't have an appraisal 12 in hand," much less having one to see themselves, 13 absolute minimum would have said, "All right. We 14 are approving this credit but we are putting a 15 condition on it that someone" -- Mr. Graham or if 16 he's not qualified, someone they had confidence 17 in -- "review the appraisal. Make sure it adheres 18 to 41B and make sure that it uses reasonable 19 assumptions before this loan is disbursed." It is 20 devoid of that condition. And like I say, it 21 imposes another condition that, best I can tell, 22 was never met. 10720 1 Q. Let's look at T7130, Tab 1. In this -- 2 in Exhibit T7130, Tab 1, you see the borrower's -- 3 the closing statement that was prepared by First 4 American Title. This is the borrower's statement 5 noting at the very top of the statement the date 6 of April 17th, 1986. 7 A. Yes, I see it. 8 Q. In preparing your report and in 9 preparing for your testimony, did you have 10 occasion to review this document? 11 A. Yes, I did. 12 Q. What's the significance of the fact 13 that the date on this closing statement, with 14 disbursements of some $45.6 million, is dated 15 April 17th and the -- 16 A. The primary -- 17 Q. Let me finish the question. And this 18 is no -- as of this moment in time, would not have 19 been any -- did you see any approval as of this 20 point in time by the board of directors of this 21 credit? 22 A. No. The board of directors did not 10721 1 approve the 10 million portion of this particular 2 loan until subsequent to this April 17th date when 3 loan proceeds of $45 million were disbursed by the 4 institution. 5 Q. Okay. Look at Tab 4196, please. I'm 6 sorry. It's Exhibit 4196. 7 MR. SCHWARTZ: It's T4196, the May 8th 8 minutes. 9 Q. (BY MR. LEIMAN) Mr. Stone, looking at 10 T4196, have you seen this before? 11 A. Yes, I have. 12 Q. This is the May 8th, 1986 minutes of 13 the board of directors of USAT? 14 A. Yes. I believe it is. I thought I saw 15 a signed copy, but this appears to be the May 8th 16 board minutes of USAT. 17 Q. Look at Bates Page K004892. 18 A. Yes. 19 Q. Do you understand the board of 20 directors here to be taking action with regard to 21 Park 410? 22 A. Yes, I do. 10722 1 Q. How can you tell that? 2 A. That -- from the top of the page -- on 3 a motion and seconded with a dissenting opinion, 4 the board recognizes the delegation of authority 5 we previously discussed of 70 million. The senior 6 loan committee approval on March 17th is noted as 7 a 70-million-dollar approval. And then lastly, 8 that the loan in the amount of $80 million was 9 being approved on terms and conditions, some of 10 which we discussed, on the senior loan committee 11 of March 17th, 1986. 12 Q. Now, this particular motion to approve 13 the loan for Park 410 was, according to these 14 minutes, made by Dr. Munitz. 15 Do you know who Dr. Munitz is? 16 A. Yes. I have seen his name throughout 17 the documents that I have reviewed. 18 Q. Do you happen to know if he was a 19 member of the board of directors of USAT at the 20 time? 21 A. I believe he was. 22 Q. Look with me at the front page of this 10723 1 document, please, indicating that in the third 2 full sentence, present at meeting were Messrs. 3 Charles Hurwitz, Burton Borman, Michael Crow, 4 Arthur Berner, and James Pledger. 5 Do you see that? 6 A. Yes. 7 Q. Do you know if Charles Hurwitz was a 8 member of the USAT board? 9 A. Again, I had information -- pardon me. 10 Would you restate the question? 11 Q. Was he -- was Mr. Hurwitz -- 12 A. Who? 13 Q. Mr. Charles Hurwitz, do you know if he 14 was a member of the USAT -- 15 A. I'm sorry. I thought we were talking 16 about Mr. Munitz. 17 Q. No. 18 A. I thought you asked me earlier; so, I 19 may have asked you incorrectly. 20 Did you ask me on the -- on the last 21 page where we were talking about the board 22 action -- I thought you had asked me if Dr. Munitz 10724 1 was a board member. I'm sorry. I may have 2 answered you incorrectly because I didn't hear you 3 correctly. 4 Q. Okay. Do you know if Mister -- 5 Dr. Munitz was a board member? 6 A. I thought -- it was my understanding 7 that he was, yes. 8 Q. Okay. Now, looking at the front page, 9 do you happen to know if Charles Hurwitz was a 10 United Savings Association of Texas board member? 11 A. No. I never understood him to be a 12 board member at the institution level. 13 Q. Do you know what he was doing at this 14 meeting? 15 A. I had observed that he had attended 16 other board minutes -- or board meetings -- pardon 17 me -- and committee meetings. And I was somewhat 18 puzzled with his attendance. In fact, in this 19 very case, May 8th, '86, he's indicated in the 20 first paragraph "also present," presumably a 21 non-member; but yet in the fourth paragraph, he 22 seconds a motion. I've never known a non-member 10725 1 at a board of directors meeting to second a motion 2 as if he were a director. But be that as it may, 3 I didn't know why non-directors were allowed to 4 participate -- pardon me -- non-directors and 5 non-officers. I don't believe he had any official 6 title at the institution, as well. 7 Q. In your experience, is there something 8 that you know about whereby the board of directors 9 could have somehow made efforts to gain the return 10 of the some 45-million-dollar disbursement that we 11 saw in connection with T7130, Tab 1 in that 12 closing statement, as of the date of this -- the 13 approval on May 8th? Park 410? 14 A. As indicated on Page 4, the bottom of 15 my report, I found this most unusual, that -- in 16 fact, I think the board was put -- if I didn't use 17 the phraseology -- in somewhat of an untenable 18 position because one director did dissent. Had 19 others started -- or if others did have equal 20 problems or did discuss it, you may come to the 21 realization that it's too late. $45 million of 22 the institution's money had already exited the 10726 1 institution, as we showed on a previous document, 2 April 17th. Some almost three weeks prior to this 3 meeting. Likewise, even to deny the additional 4 10 million, if the loan -- and I'm saying "if," 5 emphasis -- had logic at 80 million, "Here's the 6 development. Here's what it's going to cost to 7 build it out. Here's what's needed in 8 expenditures," what have you, to tell the borrower 9 we've approved 70 of it but we cut off the top 10 10 because our board said no to the additional 10 11 could destroy the economics of the particular 12 loan. 13 But again, for the sake of repetition, 14 the most amazing thing about it was the tail 15 wagging the dog. A committee below the board 16 approves $70 million in a loan, disburses 45. A 17 loan the size the institution has never come close 18 to making, ever, then comes to the board and says 19 to the senior-most authority at the bank, "We made 20 70. Would you folks like to make 10?" It's just, 21 again, incomprehensible. 22 Q. Okay. When you say "incomprehensible" 10727 1 or "amazing," do you mean -- 2 A. For a board to be put in this position, 3 for a board to have made the delegation to begin 4 with, and then it actually occur and then be in 5 the position of it approving, as the senior-most 6 authority in the institution, only $10 million of 7 an 80-million-dollar loan with really not much of 8 a choice to make. 9 Q. Let's look at Tab 822, please. T7187. 10 MR. LEIMAN: Your Honor, I would move 11 T4196 into evidence. 12 MR. BLANKENSTEIN: Your Honor, I 13 believe if that's the May 6th, '86 minutes, it's 14 already in evidence as T7586 at Tab 655, I 15 believe. 16 MR. LEIMAN: Mr. Blankenstein, did you 17 say May 6th? 18 MR. BLANKENSTEIN: May 8th. I'm sorry. 19 THE COURT: Well, we have it marked and 20 received as T7587. And it seems to also have been 21 marked as A1113. Now we have it as T4196. 22 MR. LEIMAN: Well, I'd like to 10728 1 substitute T7587, which is, I believe, a signed 2 copy of these minutes, Your Honor. I would go 3 ahead and withdraw T4196. 4 THE COURT: Which one do you say is 5 signed? 6 MR. LEIMAN: I'll accept 7 Mr. Blankenstein's representation that it's T7587. 8 MR. BLANKENSTEIN: The document we had, 9 Your Honor, was 7586; and it is not a signed copy. 10 Now, it may have been that the signed copy was 11 later substituted for the copy that appears at 12 7586. 13 THE COURT: Well, T7587 doesn't seem to 14 be signed either. 15 MR. LEIMAN: Maybe I should ask -- 16 THE COURT: Neither does T4196. 17 MR. LEIMAN: Your Honor, I think we 18 need to get to the bottom of this. Perhaps we 19 need to look at A1113, which you suggested was 20 another alternative of this because if we don't 21 have a signed copy of the board of directors 22 minutes, I would like to inquire of the witness as 10729 1 to what the significance of that would be. 2 MR. VILLA: Your Honor, whether or not 3 the lawyers in this room have a signed copy of the 4 board of directors minutes does not seem to be 5 probative as to whether or not the minutes were, 6 in fact, signed. So, I would suggest that that 7 inquiry would probably not be appropriate. 8 MR. LEIMAN: My only point, Your Honor, 9 would be that perhaps this was -- I do not believe 10 that they could have delegated that function of 11 signing the minutes. 12 THE COURT: Well, it's a little hard 13 for me to make a ruling whether they were signed 14 or not. I don't have a document before me with 15 signatures on it or even a secretary's signature. 16 That's the state of the record as I see it, but be 17 that as it may. 18 MR. LEIMAN: If I might just ask the 19 witness. 20 Q. (BY MR. LEIMAN) Is there any 21 significance to the fact that the board of 22 directors minutes would not be signed? 10730 1 MR. VILLA: Objection. 2 THE COURT: Denied. 3 A. I, as a regulator, as a supervisor, if 4 I were reviewing documents first of all, the first 5 question would be "Are then these the real minutes 6 of that meeting or is this a draft that was in 7 error and not signed because the people said this 8 wasn't indicative of the meeting?" That would be 9 my first concern. 10 If I were then -- had been advised and 11 comfortable with the fact that "Yes, these, in 12 fact, were the minutes. We just failed to sign 13 them," I would regard it as a technical exception. 14 If it was an isolated case and the 15 bank's formal records were not being signed where 16 they had shown a good track history before, I 17 probably wouldn't make much of it. If it was 18 just -- if it was a repeat situation, I would give 19 more concern as just sloppy recordkeeping or 20 inattention to details. 21 MR. LEIMAN: Under the circumstances, 22 Your Honor, I'd like to strike my withdrawal of 10731 1 T4196 and leave it as it stands with the witness' 2 testimony on that. 3 MR. BLANKENSTEIN: Your Honor, we're 4 endeavoring to see if we can find a signed copy of 5 the minutes of May 8th, 1986. 6 Q. (BY MR. LEIMAN) Let's move on, 7 Mr. Stone, to T7187. Let me draw your attention, 8 please, to the second full paragraph referring to 9 R-41B appraisal. 10 A. Yes. 11 Q. Did you see this February 6th, 1986 12 letter from GMR? 13 A. Yes, I did. 14 Q. And did you consider it in connection 15 with your testimony and report? 16 A. Yes, I did. 17 Q. What did you understand -- what did you 18 focus on? 19 A. The purpose of an appraisal of real 20 estate being, in a particular case, collateral to 21 a lending institution, that the institution needs 22 to have the appraisal independent, direct 10732 1 involvement with the lending institution, not one 2 arranged for or contacted and directed by the 3 borrower. This document does say "United wants 4 us" -- meaning the borrower -- "to use Ed Schulz," 5 dropping another appraisal which, obviously, as a 6 former examiner, the latter part would raise 7 questions, as well, why one appraiser is being 8 dropped and another being used. But this document 9 does say "If it achieves the desired result, we 10 had better do it" and goes on to say that the 11 author, Mr. Simpson, who is addressing this letter 12 to Mr. Rosenberg and Mr. Gindy, will meet with the 13 appraiser as quickly as possible. 14 It's inappropriate for the borrower to 15 be contacting the appraiser to work with them and 16 raises the question of why another appraiser was, 17 quote, "dropped" or "dropping." 18 Q. T7589 and T7590. 19 A. Mr. Leiman, I haven't completed my 20 answer. I'm sorry. I'm trying to look at one 21 document. I'm still back on the previous. 22 Q. Your answer in connection with T71 -- 10733 1 A. Yes. What we were just talking about 2 on the Schulz appraisal. 3 Q. Yes, sir. 4 A. And what -- how it figured into my 5 analysis. 6 Q. Yes, sir. 7 A. At the time I wrote this report, I did 8 see this document and raised the question on 9 dropping one appraiser and directing the borrower 10 to contact another. I subsequently have seen 11 information that shed more light on that very 12 matter. 13 Q. In what way? 14 A. That according to testimony, Mr. Schulz 15 pretty much made a "made as instructed" appraisal. 16 Q. Whose testimony did you review? 17 A. It was Charles White. In Mr. White's 18 testimony, he does mention Love & Dugger as the 19 appraiser but states, "The appraised value that 20 Love & Dugger was indicating they would be able to 21 achieve did not come near the figure that we 22 needed on an R-41B appraisal in order to make the 10734 1 loan, which might explain" -- and I emphasize -- 2 "might explain why they were dropped." But it 3 raises the question why wasn't the underlying 4 information that Love & Dugger came up with, they 5 couldn't come up with that high a value, why 6 wasn't that sought? Why wasn't that analyzed for 7 the institution's protection if it wasn't high 8 enough for them to make the loan? The perfect 9 opportunity to see should they make the loan. 10 In Mr. White's deposition, he goes on 11 to say, referring again back to this document, 12 "Was that why Mr. Graham told you to go see Ed 13 Schulz in Houston?" 14 Q. What are you referring to there 15 specifically, Mr. Stone? Is that the testimony of 16 Charles White? What's the page number and the 17 date? 18 A. I want to make sure I'm saying 19 testimony instead of deposition. I see it's page 20 number -- various page numbers. 7627, 7629, 7631, 21 Page 7632. 22 Q. Did you read his whole transcript, all 10735 1 of Mr. White's testimony? 2 A. Yes, I did. But in those pages, there 3 are references that Mr. Schulz knows the number we 4 need to see, that Mr. Graham had said that he had 5 talked with Mr. Schulz and Mr. Schulz knew the 6 number that they needed and that he would provide 7 it. 8 Again, this was obtained after 9 preparation of this -- of my initial report but 10 verified my concern, if you will, for that type of 11 a relationship between a borrower and an appraiser 12 and by an institution. 13 Q. Specifically, you say it verified your 14 concern. Your concern regarding underwriting or 15 safe and sound policies that were imposed by the 16 board of directors or -- exactly what are you 17 talking about? 18 A. I can't say for a fact that USAT didn't 19 have sound loan policies. There may be some loan 20 policy book or manual that was back before the 21 time of the records I reviewed. I did say they 22 either didn't have them or they didn't enforce 10736 1 sound policies. But insofar as the appraisal is 2 concerned and the independence of the appraisal, 3 the fact that the borrower shouldn't be contacting 4 the appraiser, telling them what number to come up 5 with, that is both an unsafe and unsound practice 6 as well as an underwriting flaw and I guess 7 possibly a loan policy that is dictated by the 8 board, even though it's common sense, that says 9 "Don't do that." 10 Q. What do you understand the principal 11 source of repayment to be in connection with a 12 credit based upon real estate? 13 A. Well, it depends on the purpose of the 14 credit. In this particular point with Park 410, 15 it was a development loan building the 16 infrastructure to a point that lots could be sold 17 off to prospective buyers. Repayment would come 18 from the sale of those various parcels. And much 19 the same with Norwood as the, quote, "Deauville 20 property" was being developed for the same, 21 perhaps different uses in mind. 22 So, the primary source of repayment in 10737 1 these particular loans were looked to be the 2 development and sale of the properties as opposed 3 to the wherewithal of the individual borrowers. 4 Q. Does that make the appraisal more 5 important or less important than if it was looking 6 at the wherewithal of the borrowers? 7 A. Obviously much more important. 8 Q. Let's look at T7589 -- do you have that 9 in front of you -- as well as T7590? 10 A. I have 90. Pardon me. 89 was on the 11 bottom. Yes, I do. 12 Q. A moment ago, you mentioned the Norwood 13 transaction. Take a look at T7590 and tell me if 14 you reviewed T7590, this June 2, 1996 loan 15 committee approval in connection with -- '86. I 16 may have misspoken -- in connection with your 17 opinion. 18 A. Yes, I did. 19 Q. Look with me, please, at the third page 20 of T7590 and specifically turn your attention to 21 the portion dealing with the appraisal. 22 A. Yes. I'm looking at it. 10738 1 Q. What did you understand the author of 2 this document to be saying in connection with the 3 appraisal and Mr. Bolin? 4 A. I understand that to be telling the 5 approval authorized committee that while they are 6 being asked to approve a loan June 2nd, that an 7 appraisal has not been prepared but is being 8 prepared which should indicate a value of raw land 9 around 30 million and the value of the tract fully 10 developed at 45 million plus. The point being, 11 again, much less -- much like the previous 12 document. The approval is being sought for a loan 13 without an appraisal, indicating what an appraisal 14 should possibly indicate when it comes in and, 15 obviously, the approving officials not only not -- 16 not only don't have the document to review, they 17 don't even know if it conforms with R-41B which is 18 a requirement of a thrift financial institution at 19 that period of time. 20 Q. Let's look at T7027. 21 A. Incidentally, the same objection -- 22 problem is raised on the condition in the 10739 1 approval. Pardon me, Mr. Leiman, again. 2 Q. I don't know if I cut you off 3 previously in your answer. I'm not sure if you 4 were completely done, Mr. Stone. Were you? 5 A. Well, I don't know -- I thought at 6 first you had asked me to look at T7589 -- is that 7 correct -- and then T7590 where -- I was looking 8 at both documents that were brought up. 9 Q. I did ask you to look at that. 10 A. The point I wanted to make on T7589 is 11 minutes of the senior loan committee meeting. 12 And, again, to note it indicates the approval of 13 the 30-million-dollar development loan to Frank 14 Krasovec, Jeffrey Minch who we were referring to 15 synonymously with Norwood. And again, five other 16 items were discussed at that meeting, including 17 approving the previous minutes. Yet again, the 18 meeting opened up at 9:04 a.m., adjourned at 19 10:19, a period of an hour and 15 minutes. The 20 approval of the second largest loan ever made by 21 the institution was approved within that time 22 frame with other matters discussed, which is 10740 1 something that was not lost on me when this was 2 reviewed in preparing the report. 3 Q. What effect does that have in 4 connection with your opinion regarding the 5 underwriting of that credit? 6 A. That at a minute, the formal records of 7 the bank do not indicate that sufficient time, 8 attention, and analysis was devoted by the 9 approving officials in their formal action that 10 they took on that date. 11 Q. Look, if you will, at T7027. 12 A. Yes. 13 Q. This is a July 21st, 1986 letter to 14 David Graham from Rex E. Bolin Associates in which 15 Mr. Bolin says, "We are currently completing a 16 full narrative R-41B appraisal of Norwood Park." 17 And he goes on to indicate values in a preliminary 18 draft. 19 Did you see this in connection with 20 your opinion? 21 A. Yes, I did. 22 Q. What did you understand it to mean? 10741 1 A. Well, primarily, the previous document 2 where we discussed the approval of that loan, 3 where we said on June 2nd, an appraisal is being 4 prepared. On July 21st, some six weeks following, 5 an appraisal is still being prepared to support -- 6 but not yet prepared -- to support the value of 7 the underlying property. 8 MR. LEIMAN: Your Honor, I've -- 9 Ms. Allen, the paralegal, has just informed me 10 that we do not have in evidence T7590, nor do we 11 have T7589 in evidence. 12 MR. BLANKENSTEIN: Your Honor, with 13 regard to 7590, I believe Mr. Leiman attempted to 14 introduce this in connection with Mr. Graham's 15 examination. We objected at the time because of 16 the attachment to the minutes, and I believe Your 17 Honor did not accept it at the time. Mr. Leiman's 18 reoffering the same document with no better 19 explanation of foundation for the two-page 20 attachment at the end. 21 THE COURT: The exhibit without the 22 attachment is in as T7020. 10742 1 MR. LEIMAN: And T7589, Your Honor? 2 We'll move that. 3 MR. BLANKENSTEIN: No objection to 4 7589. 5 THE COURT: All right. Received. 6 Q. (BY MR. LEIMAN) T7801. 7 MR. BLANKENSTEIN: Is this a new 8 document, Mr. Leiman? 9 MR. LEIMAN: Yes. 10 Q. (BY MR. LEIMAN) Mr. Stone, I've 11 handed you what's been marked T7801, which is a 12 June 27th, 1986 letter from David Graham to 13 Mr. Rex Bolin. 14 Have you seen this letter before? 15 A. Yes, I have. 16 Q. Where did you see it? 17 A. I believe I saw it in my review of the 18 loan files at OTS. I'm not absolutely certain, 19 but I don't think I saw this document when I was 20 preparing my initial report. 21 Q. When you read this document, what did 22 you understand it to mean? 10743 1 A. Well, bottom line, it is telling the 2 appraiser exactly what the institution plans to 3 put into the property, which in my opinion 4 jeopardizes the intended independence of the 5 appraiser. He should not be told what target 6 level the bank is seeking. He does not need to 7 know the details of the financing necessary to 8 reach an opinion on the property value. 9 Q. Do you happen to know if it was a 10 common practice in the mid-Eighties for loan 11 underwriters to provide the details of a loan to 12 appraisers? 13 A. "Common" may be too broad. "Frequent" 14 may be appropriate. 15 Q. Is there a danger in that? 16 A. I think it's since been proven; but 17 yes, there is an inherent danger. 18 Q. And why is that? 19 A. Because there is an inherent conflict 20 of interest on the part of an appraisal. That's 21 with every appraisal. And that's why ethics 22 governs. An appraiser wants -- lifeblood is 10744 1 continuing to make appraisals. And to, if you 2 will, disappoint an institution that obviously 3 wants to make the loan that seems to be saying "we 4 need to have a conforming appraisal that will 5 support our decision" compromises the appraiser. 6 He cannot make them happy and will probably not 7 get their business in the future. 8 United Savings, if I am correct, at 9 this point in time was the largest savings and 10 loan in the Houston and MSA area. And obviously, 11 a lot of appraisers would have loved to have done 12 business with them. An ethical appraiser -- and 13 I'm not saying Mr. Bolin isn't. An ethical 14 appraiser would say, "I don't want to know the 15 value" or if he even found out inadvertently, 16 would not be swayed by what number was expected. 17 They would not compromise their integrity, their 18 reputation, and their credentials in what 19 colloquially became known as "made as instructed" 20 rather than what the initials were intended for. 21 Q. T7701. 22 MR. LEIMAN: Your Honor, I would move 10745 1 7801 into evidence. 2 MR. BLANKENSTEIN: No objection, Your 3 Honor. 4 THE COURT: T7801 is received. 5 MR. LEIMAN: This is Tab 734. 6 Mr. Leiman, how much are you going to have on this 7 exhibit? 8 MR. LEIMAN: Maybe ten minutes, Your 9 Honor. 10 THE COURT: We'll adjourn until 11 9:00 o'clock tomorrow. 12 13 (Whereupon at 5:01 p.m. 14 the proceedings were recessed.) 15 16 17 18 19 20 21 22 10746 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 15th day of 17 December, 1997. 18 ____________________________ MARCY CLARK, CSR 19 Certified Shorthand Reporter In and for the State of Texas 20 Certification No. 4935 Expiration Date: 12-31-97 21 22 10747 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 15th day of 18 December, 1997. 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