Q 1Q 1
• Read extracts from the SEC Complaint filed on September 25, 2012, against TierOne Bank.
• Examine extracts from TierOne?s Financial Statements (10-Ks) for 2005-2008. According to the December 31, 2007, 10-K, "TierOne Corporation ('Company') is a Wisconsin corporation headquartered in Lincoln, Nebraska. TierOne Corporation is the holding company for TierOne Bank ('Bank')" (p. 5).
• Respond to the following Case Study Questions.
a. Underestimation of allowance for loan losses: In the text, Signal #2 is "Allowance for Loan Losses Not Growing in Proportion to the Increase in Troubled Loans." Read the extracts from TierOne's financial statements and notes to its financial statements for the years 2005-2008. Explain whether you can identify the signal that TierOne's allowance for loan losses may allegedly have been understated. Show supporting calculations for your answer.
b. Underestimation of allowance for loan losses: In the text, Signal #3 is "Allowance for Loan Losses Not Increasing Significantly as House Prices Fall." Reread the discussion of Signal #3 in the text, as well as extracts from the SEC Complaint against TierOne. Search online for articles published in late 2008 about falling house prices. Explain how Signal #3 could have alerted users of TierOne?s financial statements that its allowance for loan losses at December 2008 may allegedly have been understated.
Extracts from Complaint against TierOne Bank*
Civil Action No. 12-cv-00343 Filed September 25, 2012 10
IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF NEBRASKA
SECURITIES AND EXCHANGE
PARAGRAPHS 3 and 7:
3. TierOne was a century-old thrift bank that had historically focused on residential and agricultural loans in the Nebraska/Iowa/Kansas region. Beginning in about 2004, TierOne expanded into riskier types of lending in high-growth geographic regions such as Las Vegas, Florida, and Arizona. By the second half of 2008, as a result of the financial crisis and accompanying crash in real estate markets, TierOne was experiencing a significant rise in high-risk problem loans.
7. The full extent of TierOne's loan-related losses did not become publicly known until late 2009, after OTS required TierOne to obtain new appraisals for its impaired loans. TierOne ultimately disclosed over $130 million of additional loan losses. Had TierOne recorded these additional loss provisions in the proper quarters, it would have missed the OTS-required capital ratios as of the end of December 31, 2008, and for each quarter thereafter. Following the announcements of the additional loss provisions, TierOne's stock price dropped more than 70 percent. TierOne eventually filed for bankruptcy shortly after the bank was shut down by OTS in June 2010.
24. Generally Accepted Accounting Principles, or "GAAP," provides that a loan becomes "impaired" when it is probable that the bank will be unable to collect all amounts due under the original loan agreement. In addition, TierOne?s written lending policy stated that a loan greater than 90 days past due should be considered impaired. 25. Under GAAP, TierOne was required to assess probable losses associated with its impaired loans and record those losses in its allowance for loan and lease losses ("ALLL"). GAAP permits the impairment to be measured using the fair value of the underlying collateral if the loan is collateral dependent, which is the method that was typically utilized by TierOne.
26. Any increase in ALLL (a balance sheet item) must be accompanied by the recording of a provision for loan losses (an income statement item), thereby increasing reported loss and further eroding the bank?s capital, which, in turn, negatively impacted the bank's ability to meet the OTS-required elevated capital ratios.
27. Some of TierOne's real estate loans were eventually foreclosed upon and the underlying collateral became the property of the bank, or OREO. GAAP required TierOne to carry OREO on its books at the lower of the property?s book value or fair value, less costs to sell the property.
28. Thus, a key consideration under GAAP regarding the existence and magnitude of losses for impaired loans or OREO is the fair value of the collateral or OREO property. A recent appraisal performed by an independent and certified real estate appraiser is normally the best evidence of a property?s fair value. In the absence of a current appraisal, all relevant and current information known at the time must be used. This information includes: the most recent evidence of market declines, broker price opinions ("BPO"), recent comparable sales, internal determinations of value, current project status and offers to purchase or sell.
29. In this case, TierOne intentionally delayed the process of obtaining current appraisals for properties that had declined in value, relying instead on inaccurate data and assumptions.
60. In August 2009, OTS directed TierOne to obtain updated appraisals. The new appraisals revealed the actual values of TierOne's collateral for impaired loans and OREO. On October 14, 2009, TierOne filed a Form 8-K reporting an additional $13.9 million in loan loss provisions for the second quarter of 2009. TierOne also announced that it intended to restate its second quarter 2009 financial statements, and that the bank?s capital ratios would fall below the levels required by OTS. In the days following this news, TierOne's stock price fell over 17 percent, from approximately $3.27 per share to $2.69 per share.
61. The situation worsened as more OTS-mandated appraisals came in. On November 10, 2009, TierOne filed another Form 8-K reporting an additional loan loss provision of $120.2 million for the third quarter of 2009. TierOne?s stock price dropped a further 54 percent over the next three trading days, from approximately $1.71 per share to $0.78 per share.
62. TierOne was shut down by OTS on June 4, 2010, and filed for bankruptcy later that month.