Experts eye insider loans, 1 to Conahan: Bank's lending practices in past three years, according to records, alarm two experts.

DUNMORE, Jun 22, 2008 (The Times Leader - McClatchy-Tribune Information Services via COMTEX) -- FDNM | Quote | Chart | News | PowerRating -- Loans totaling more than 60 percent of the net worth of a bank controlled by Louis DeNaples were issued to people or businesses related to the bank's board members, including the wife of Luzerne County Senior Judge Michael Conahan, court and regulatory agency records show.

In 2004, First National Community Bank of Dunmore loaned $848,000 to a corporation managed by Barbara Conahan for a condominium in Jupiter, Fla., -- $63,000 more than the reported $785,000 purchase price of the unit, court records show. Michael Conahan has been a member of the FNCB's board of directors since 2003.

The loan was among an increasingly large number of transactions -- known by federal regulators as "insider" loans -- that FNCB has issued in the past three years to persons directly affiliated with the bank -- an issue two banking experts say raises "red flags" regarding the bank's lending practices.

The bank, whose stock is publicly traded, filed documents with the Securities and Exchange Commission that show the amount of capital dedicated to insider loans jumped from $21.4 million in 2004, or 29 percent of the bank's net worth, to nearly $74.6 million, or 64 percent of its net worth, in 2007. As of March 2008, that figure increased to $75.6 million.

"That's a very high figure," said Stuart Greenberg of Baltimore, Md., a banking consultant with 36 years experience in the industry. "If you said it was 20 percent I wouldn't have a problem or maybe even 30 percent, but 64 percent is high. It raises a lot of questions."

FNCB, formed in 1997, is controlled by Louis DeNaples and his brother, Dominick, who are the largest shareholders.

Louis DeNaples, who also owns the Mount Airy Resort and Casino, has taken a leave of absence from the bank pending resolution of perjury charges filed against him alleging he lied to state gaming board officials who investigated his suitability to hold a gambling license.

Loans to banking industry insiders have been under the microscope since the savings and loan scandal of the late 1980s and early 1990s, during which hundreds of financial institutions failed, in part due to questionable lending practices of top officials.

That led to the adoption of stricter standards by the Federal Reserve System and Office of the Comptroller of U.S. Currency, the two agencies that govern banking operations.Those regulations prohibit financial institutions from providing loans to insiders at rates, terms or other conditions that are more favorable than what is available to the general public.

Banks are required to get approval from the bank's board of directors for any insider loan. They are also required to disclose information on who obtained loans, and the rates and terms of those loans, to federal regulators.

"It's OK to lend to directors, but there can be no favors. It has to be at standard market rates and fees," Greenberg said. "Directors should be treated no differently than any other customer of the bank."

Conahan is one of 12 members of the bank's board of directors -- a position that paid him $53,180 in 2007. He serves on several committees, including the audit committee and stock option committee, and is also part of a rotating group that sits on the bank's loan committee.

There is no indication that banking regulators found anything improper with the loan that was made to The Pinnacle Group, a corporation managed by Conahan's wife. Pinnacle Group is listed owner of the condo in Florida. A search of the OCC database shows there have been no enforcement actions against FNCB, its employees or directors since the bank was formed.

Greenberg said he found the Conahan loan to be unusual in some respects, however, because it appears to step outside standard lending parameters employed by most banks.

Documents filed in Palm Beach County Court show the Pinnacle Group purchased the condominium at the Mariner Yacht Club in Jupiter, Fla., on Feb. 13, 2004, for $785,000. Mortgage documents filed with the loan for $848,000 were signed on May 21, 2004. The mortgage says the Conahans planned to use the condominium as a second home.

Greenberg said it's unusual for a bank to loan more than the purchase price for real estate, noting banks normally lend only 70 to 80 percent of a property's value. Standards are usually even tighter for second homes.

"On the face of it, it's imprudent lending. It's dangerous to lend more than 100 percent of a property's value," Greenberg said.

Greenberg said it is also unusual for a small community bank such as FNCB to loan money to purchase property in geographic areas far outside their traditional lending area. Officials are reluctant do that because they are unfamiliar with market factors.

Greenberg stressed he is not saying either Conahan or the bank did anything improper. There are many extenuating circumstances that could have played a role in the bank's decision to go outside generally accepted lending practices.

For example, it's possible Conahan could have put up additional collateral above the value of the property purchased -- a move that would secure the larger loan.

It's also possible the market value of the property purchased was deemed to be significantly higher than the purchase price, he said.

"If they got a good deal and the property is worth two million, that may be acceptable," he said.

Conahan did not respond to phone messages or a detailed letter left at his office this week seeking information on the terms of the loan.

Greenberg and Steven Butler of ButlerBank Consulting of Avondale, a banking consultant with 37 years experience in the industry, said their primary area of concern is the percentage of FNCB's capital that is tied up in loans to insiders. The percentage increase from 2004 to 2007 is also significantly higher than would be expected.

"Every bank in the country is examined by federal regulators. One thing they look at are insider loans," Greenberg said. "If they saw the numbers you have, that a bank went from 29 percent to 64 percent, they would say what is going on here? They would start looking into it. If they didn't look into in, the regulators are negligent."

State and federal regulations limit the amount of money that can be loaned to any single borrower, but they do not limit the overall amount which a bank can loan to insiders.

"There is not a 'magic number,' but the higher the number, the more you question it," Greenberg said.

Greenberg and Butler said it's not considered good banking practice to have large amounts of money tied up in one area due to the risks involved should that particular sector experience financial problems.

"If you have a high percentage of loans to insiders it's an element of risk because you are putting so much capital behind the board of directors," Butler said. "One thing banks do is mitigate risk, and one way they do that is to diversify their portfolio. To have 64 percent of capital in any (one area) is not a good thing."

Butler said he also has concerns that the bank may not be fulfilling its obligation to serve the community if it is dedicating so much of its capital to insiders.

"If it's tying up so much of its capital in loans to insiders, it has limited capital to assist other community residents and businesses," Butler said.

J. David Lombardi, president and chief executive officer of FNCB, did not return several phone messages left at his office over several days or respond to a letter faxed to him with detailed questions.

Butler and Greenberg stressed they are not saying FNCB or its directors have done anything improper regarding the insider loans. The banking industry is extremely complex, they said, and it's difficult to gauge the level of risk associated with the insider loans without knowing more information.

For instance, Butler said if the loans are backed by solid collateral -- such as certificates of deposit or stock certificates -- there is relatively little risk. That's not information available to the general public, but it is to banking regulators who closely monitor insider loans, he said.

"It raises a red flag on the surface, but without knowing anything about the loans, the borrowers or the collateral, that's all it does," Butler said. "It's like seeing a car speeding down the road. You know it is speeding. You don't know how fast it's going or why it's speeding, but it's still speeding."

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