Such relationships were flagged as troublesome as far back as 2004. An FDIC examination warned that the bank's "over-line loans" posed a credit risk (over-line loans are loans made by bank affiliates because the borrower does not meet the credit standards and/or goes above the legal lending limit of the bank). The FDIC concluded that because of over-line lending, the parent company was not a source a strength to the bank. Examiners rated the bank a "3" for management controls (on a scale from 1 to 5, "1" = safe and sound, "5" = imminent failure).
Regulators raised the management controls rating to a "2" in their 2006 examination in part because management confirmed that the bank had stopped making over-line loans, and limited loans to individual borrowers to 35% of capital.
By March 2009, however, 12 borrowers represented 243% of capital (54% of the non-performing loans), and over-line lending appeared to be alive and well. The memo cites an example of a loan approved in 2007 for a condominium project that exceeded the bank's legal lending limit. To cover funds, Washington First Capital (the bank's venture capital affiliate) advanced the amount required.
Unfortunately, WFC ran out of cash before the project was completed. The condo project's failure alone was $13 million. By May 2010, examiners downgrade the management control rating a "5," and the bank failed in June 2010. Assets of the bank were acquired by Pasadena-based East West Bank.
The OIG memo concludes:
"The sharp decline in the bank's ratings that paralleled the deterioration in the institution's financial condition underscores the risks associated with the affiliate relationships in the years preceding the economic downturn. At a minimum, consistent with forward-looking supervision, greater emphasis in the examination reports on those risks and the adequacy of mitigating controls may have been warranted."
Article in the Puget Sound Business Journal regarding a failed Washington-First-funded project in Auburn, WA (Dec 2011) written by Kelly Gilblom