Disaster On A Watchdog's Doorstep

On the surface, the collapse of Madison National Bank wasn't much different from the 49 bank failures already recorded this year. Like many others, the Washington (D. C.) bank was done in by bad real estate loans and the recession.

Still, in the days since the institution was seized on May 10, it has become apparent that Madison's failure was anything but routine. Financial statements have revealed that loans to the bank's directors, executives, and their associates--legal under strict guidelines--accounted for a startling 80% of Madison's troubled credits.

Worse, the episode has raised serious questions about regulators' ability to keep a wary eye on their charges. For several years, the U. S. Office of the Comptroller of the Currency had been aware of the bank's questionable lending practices and loans to Madison insiders. Yet, even though the OCC's headquarters is only a 10-minute ride away from Madison's headquarters, regulators acted far too late to prevent the bank from hurtling to its demise.

METROPOLIS. Madison's failure, which will cost the government $160 million, will be the focus of hearings by the House Banking Committee on May 31. As lawmakers work on legislation to shore up the depleted bank deposit-insurance fund, says Chairman Henry B. Gonzalez (D-Tex.), "it is essential that this committee determine how well the regulatory system protects the insurance funds."

What the committee will find in combing through Madison's rubble is an institution with its roots in the "other" Washington. This isn't the stomping ground of politicians and bureaucrats but the habitat of the local businesspeople who transformed the city from a sleepy town into a metropolis of gleaming office buildings. Many were real estate developers who prospered from the building boom that has swept Washington over the past 30 years. Construction was so explosive that new office space totaled 15 million square feet in 1986, up 64% in the space of four years.

It was in the midst of this building spree that Madison was born. In the 1960s, Washington's struggling entrepreneurs had few connections to the financial elite. Many were Jewish or of Italian descent and were routinely discriminated against by the capital's white-shoe bankers, industry veterans say. Typical of the group was restaurateur Ulysses ("Blackie") G. Augur, who started with a sandwich stand and eventually built the Blackie's House of Beef chain. Dominic F. Antonelli Jr., a now bankrupt developer, was another. He parked cars as a boy, then bought parking lots and later built office complexes on them.

To improve their access to loans, Augur, Antonelli, and several others banded together in 1963 to found Madison for the purpose of financing real estate ventures. They installed veteran Florida banker Louis C. Paladini as chairman. But directors, including many real estate developers, ran the bank. Under the bank's bylaws, the board's executive committee passed final judgment on all real estate loans regardless of size, says a former senior lending officer. Directors were also substantial shareholders. As of May, directors and executive officers held 15.6% of Madison's common stock.

BACK-SCRATCHING? For years, no one objected to Madison's heavy portfolio of loans to insiders. Under federal rules, insider loans are perfectly legal as long as the bank offers market terms and the loans don't exceed 15% of capital. What's more, directors must recuse themselves from votes on their own loans and on loans to their business associates. Former Madison General Counsel Robert L. Davis insists that directors adhered to the law.

Other D. C. bankers, however, have wondered if there was some boardroom back-scratching. The directors were a close-knit group and often discussed business at social gatherings. A popular hangout was the elegant Mayflower Hotel, a block away from Madison's headquarters, according to a former senior loan officer.

Whatever the case, Madison seemed to thrive. Reported profits doubled to $4.7 million in 1985 from $2.4 million in 1980. Acquisitions of other banks almost doubled Madison's assets, to $840 million in 1990 from $463 million in 1985.

The booming real estate market proved a rich source of business. According to the OCC, the bank often gave 100% financing based on the borrower's reputation, without requiring collateral. Commercial property loans and leases climbed steadily from about 30% to 45% of Madison's total portfolio. That's almost quadruple the average at other Washington-area banks.

By 1987, however, Washington's heated real estate market was showing signs of fatigue. And it wasn't long before problems became apparent at Madison. During a 1988 examination, regulators questioned Madison executives about the insider loans and other troubling lending practices. Examiners were also alarmed by the bank's inadequate loan-loss reserves. Madison's reserves covered less than 1% of $558 million in outstanding loans and leases. The OCC downgraded Madison's rating to a troubling 3 from a good 2, and forced Madison's management to agree to changes in their loan policies.

In November, 1989, another team of examiners visited Madison. The group had barely started its review when it was called away to bolster the understaffed examination force at troubled Northeastern banks. A hiring freeze and Reagan-era budget cuts had left only 2,300 examiners, down 100 from 1987, at a time when the banking industry was entering a crisis. OCC spokeswoman Leonora S. Cross admits: "With significant real estate deterioration up and down the East Coast, Madison was not high up on the scale."

By the time examiners returned in early 1990, Madison was listing badly. Sour real estate loans were piling up. The regulators became noticeably tougher. To appease the OCC, the board finally relinquished much of its loan approval authority to Madison's loan officers.

Madison's deterioration, however, continued. By September, its correspondent banks were refusing to do business with it. To keep the bank afloat, directors added to their own deposit balances. In December, Madison's holding company signed an agreement with the Federal Reserve to improve operations.

At yearend, Madison had an operating loss of $73.9 million, compared with profits of $1.5 million in 1989. The red ink reflected a hefty provision for possible loan losses. Reserves shot up to $70.2 million from $5.7 million in 1989. And its capital-to-assets ratio was just under 1%, far below the required 7.25%.

Yet even during this crisis and the intensified regulatory oversight, the bank continued making loans to insiders. Real estate records show that on Jan. 28, 1991, Madison lent $220,000 to Halifax Square Associates to develop land at 21st and P Streets in downtown Washington. Halifax' general partner was Angelo A. Puglisi, chairman of Madison's Maryland bank. Developer Antonelli, who by then had resigned from Madison, owns 47% of Halifax, according to his bankruptcy filing. The bank had made the loan even though it was widely known at the time that Antonelli was having trouble meeting obligations to creditors. Antonelli declined comment on the loan, and Puglisi didn't return phone calls.

TOO LATE. In Madison's final days, regulators pressured Madison Chairman K. Donald Menefee and President Norman F. Hecht Sr. to resign. Michael F. Ryan, a veteran Washington banker, took over the management. The Federal Reserve Board pumped in $100 million to try to keep the bank alive. It was too late, however. Regulators seized the bank and sold its franchise to Signet Banking Corp., based in Richmond, Va.

Reflecting on the Madison episode, an official from the OCC admits it paid insufficient attention to the bank. She blames scarce resources. Maybe so. But it doesn't inspire much confidence when regulators can't prevent such horror stories on their own doorsteps. As one local banker puts it: "It's not like the regulators had to travel 2,000 miles to get to the bank."

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