MATERIAL LOSS REVIEW 

OF 

NEXTBANK, NA 

OIG-03-024 NOVEMBER 26, 2002 

Office of Inspector General

******* 

The Department of the Treasury 

Contents 

Audit Report....................................................................................................3 

 Results in Brief...............................................................................................4 

 Background .................................................................................................10 

Findings and Recommendations .....................................................................12 

 Finding 1 Causes of NextBank’s Failure ......................................................12 

 

 Finding 2 OCC’s Supervision of NextBank...................................................22 

 

 Finding 3 Other Regulatory Matters............................................................33 

 

 Recommendations....................................................................................36 

Appendices

 Appendix 1: Objectives, Scope, and Methodology .......................................40 

 Appendix 2: Chronology of Significant Events .............................................43 

 Appendix 3: Glossary of Terms ................................................................47 

 Appendix 4: Management Comments.........................................................49 

 Appendix 5: Major Contributors To This Report...........................................50 

 Appendix 6: Report Distribution.................................................................51 

Charts and Tables 

Chart No. 1: Total Managed Assets September 30, 1999 - December 31, 2001 .....13 

Table No. 1: NextBank and NextCard Total Operating Costs .................................18 

Table No. 2: Amount and Nature of Required Accounting Adjustments...................19 

Table No. 3: OCC Examination Issues and Enforcement Actions ............................23 

Chart No. 2: NextBank’s Operating Expenses Vs. Total Managed Assets ................27 

Table No. 4: NCI’s Board Resolution October 26, 2000 ........................................29 

Abbreviations

ALLL Allowance for Loan and Lease Losses 

 CEBA Competitive Equality Banking Act of 1987 

 DRR Division of Resolutions and Receiverships 

Material Loss Review of NextBank, NA (OIG-03-024) Page 1 
Contents 

Abbreviations (con’t) 

 EIC Examiner-in-Charge 

 FAS Financial Accounting Standards 

 FDIA Federal Deposit Insurance Act 

 FDIC Federal Deposit Insurance Corporation 

 NCI NextCard, Inc.

OCC Office of the Comptroller of the Currency 

 PCA Prompt Corrective Action 

 SEC Securities and Exchange Commission 

 

Material Loss Review of NextBank, NA (OIG-03-024) Page 2 
OIG Audit 

Report

The Department of the Treasury 

Office of Inspector General 

Material Loss Review of NextBank, NA (OIG-03-024) Page 3 

 November 26, 2002 

 John D. Hawke, Jr. 

 Comptroller 

 Office of The Comptroller of the Currency 

As mandated under section 38(k) of the Federal Deposit Insurance 

Act (FDIA), we reviewed the failure of NextBank, National 

Association, of Phoenix, Arizona (NextBank). On 

February 07, 2002, the Office of the Comptroller of the Currency 

(OCC) closed NextBank upon determining that unsafe and unsound 

practices had substantially dissipated assets and that insolvency 

was imminent without Federal assistance. NextBank’s failure is 

estimated to cost the Federal Deposit Insurance Corporation (FDIC) 

between $300 and $350 million, making it the most costly failure 

in 2002. 

The FDIA mandated review primarily requires us to (1) ascertain 

the cause(s) of NextBank’s failure; (2) assess OCC’s supervision of 

NextBank; and (3) where applicable, recommend how such failures 

might be avoided in the future. We conducted the detailed audit 

work at OCC Headquarters in Washington, D.C., and the OCC 

Western District office in San Francisco, California. We also met 

with FDIC’s Division of Supervision supervisory officials in 

Washington, D.C., and their regional office in San Francisco, 

California. We reviewed OCC and FDIC supervisory files and 

interviewed supervisory officials, attorneys, and examiners involved 

in the examination, enforcement, and or receivership processes. 

We also met with officials from FDIC’s Division of Resolutions and 

Receiverships (DRR) and the Division of Finance (DOF) personnel in 

Dallas, Texas; DOF personnel at NextCard, Inc. headquarters, the 

parent company of NextBank in San Francisco, California. A 

detailed discussion of the review objectives, scope, and 

methodology is provided in Appendix 1. 
 

Results in Brief

In less than two and a half years, NextBank opened as OCC’s first 

Internet-only credit card bank, grew six-fold from $300 million to 

over $2 billion in managed assets, never turned a profit, and failed. 

Based on an unproven technology-based business strategy, 

NextBank’s initial capitalization seemingly arose from the 

widespread dot-com optimism that prevailed at the time. 

NextBank’s principal owners had just previously operated a similar 

Internet-based business venture that had also lacked earnings. 

With a national bank charter, NextBank was able to pursue this

Internet-only business strategy, leveraging with Federally insured 

deposits. 

Chartered in September 1999, NextBank operated under the 

provisions of the Competitive Equality Banking Act of 1987 

(CEBA).1

 As such, NextBank’s product line was limited to credit 

cards and it could not diversify through commercial loans. 

NextBank’s funding was also restricted to $100,000 or greater

time deposits; it was prohibited from obtaining less costly and less 

volatile transaction demand accounts (e.g., checking), and deposits 

could only be accepted from a single office. NextBank effectively 

served as a shell bank gathering deposits and booking the credit 

card receivables which had actually been marketed, screened, 

originated, and securitized by its sole owner and parent company, 

NextCard, Inc (NCI), of San Francisco, California. 

Years prior to opening NextBank, the principals of NCI had 

developed propriety software that evaluated credit card applicants 

over the Internet. Rather than its own bank, NCI initially applied 

this technology through a nonaffiliated bank. Under that 

arrangement, NCI marketed and screened credit card applicants 

through the Internet, while the unaffiliated bank funded, originated, 

and booked the resulting credit card receivables with each sharing 

the associated proceeds. Although the strategy seemed to hold 

promise as an effective financial service technology application, 

NCI experienced consecutively increasing operating losses over 

2 years prior to opening NextBank, totaling more than $47 million. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 4 

1 12 U.S.C.§1841(c)(2)(F). 
Nevertheless, NCI raised over $299 million through two public 

offerings in 1999. Discontinuing the relationship with the 

unaffiliated bank, NCI channeled most of the proceeds from the 

public offerings to capitalize NextBank. 

NextBank commenced operations in September 19992

 and through 

its Internet-based platform quickly grew to over $900 million in 

assets in two years. The bank’s actual growth was far larger than 

that reflected by its balance sheet. NextBank securitized3

 about 

$1.4 billion in card receivables and retained the servicing (i.e., 

managed) for over $2 billion in credit cards. 

As with other technology-based companies at the time, NCI’s stock 

valuation reflected optimism rather than profitability. In what may 

have been an attempt to maintain those exuberant valuations, NCI 

deviated from its business plan as originally conveyed to OCC in 

1998. Asset growth more than tripled over plan, and NextBank’s 

targeted customer base shifted from prime to subprime borrowers.4

 

Rather than profitability, NextBank’s growth into subprime credits 

resulted in increasing annual losses. In just over 2 years of 

operation, NextBank incurred an operating loss exceeding 

$108 million on over $2 billion in managed assets, and fell three 

regulatory capital levels depleting capital by more than $96 million. 

FDIC estimates NextBank’s failure will cost between $300 and 

$350 million. 

Causes Of NextBank’s Failure

NextBank’s failure can be attributed primarily to improperly 

managed rapid growth that led to unacceptable high levels of credit 

risk, losses, and operational problems. Supervisory files repeatedly 

note that NextBank lacked the systems, controls, and expertise to 

properly support its excessive growth in a safe and sound manner. 

The challenges and risks associated with being an Internet-only 

bank were magnified by the shift from the initial plan of prime 

 2 Prior to NCI’s de novo application, there had been one other application with a business plan that entailed delivering banking 

products and services by electronic means. 3 Securitization essentially entailed selling the bank’s credit card receivables to investors through a third party which effectively 

removed the loans off the bank’s balance sheet. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 5 

4 Subprime borrowers are generally defined as exhibiting significantly higher default risk than traditional bank customers. Another 

common description is a borrower with a tarnished credit history.
lending to subprime borrowers ultimately accounting for more than 

40 percent of total managed assets by mid-year 2001. NextBank’s 

Internet-based technology also did not effectively control the 

associated credit risk. Indeed, some card applicants received initial 

approval within 30 seconds of submitting an online application. 

According to an OCC examiner, there was limited, if any, 

verification of the on-line submitted information. 

Even the credit risk reduction technique of securitization was 

partially negated. Although not required under the terms of the

securitization agreement, NextBank would replace previously sold 

credit cards that had defaulted with performing credit card 

receivables to maintain the market confidence needed to sustain a 

securitization program. 

The severity of NextBank’s lending problems was also partly 

obscured by deficient accounting practices. Contrary to standards, 

NextBank followed certain accounting treatments which effectively 

served to understate operating losses by deferring the recognition 

and reporting of (1) credit losses exceeding $12 million, (2) needed 

loan loss provisioning expenses of about $13 million, and (3) 

$35 million in expenses that had been improperly capitalized. 

NextBank’s restricted funding to high cost volatile deposits not 

only pressured interest margins, but also exposed the bank to a 

heightened liquidity squeeze to meet depositors’ demands. By the 

end of the second year of operation, NextBank failed to maintain or

augment regulatory capital commensurate with its increased risks, 

or with that needed to operate as a going concern. 

OCC’s Supervision of NextBank

OCC conducted two full scope examinations over the life of the 

bank. OCC was quick to close NextBank once examiners 

determined the severity of the bank’s credit risk problems in the 

latter part of 2001. In fact, OCC closed the bank before it became 

“critically undercapitalized,” doing so when it became apparent that 

there were unrealistic prospects of returning to an “adequately 

capitalized” level without Federal assistance. Nevertheless, we 

believe there were aspects of OCC’s examination and enforcement 

procedures that warrant closer review and assessment given the 

rapidity of NextBank’s uncontrolled growth and failure. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 6 
For the bank’s first full scope examination in 2000, the examinerin-charge (EIC) initially planned for what appeared to be a 

comprehensive examination based on OCC’s prior limited/targeted 

site visit shortly after NextBank had opened. However, the actual 

examination ended up less than planned, and the EIC was only able 

to focus on the lack of documented controls and risk management 

systems, and whether the bank had adhered to its original business 

plan. Little, if any, in depth portfolio analysis was completed; the 

actual impact of the absence of controls and management systems 

was not assessed; and the bank’s true financial condition as a 

result of its rapid growth into subprime lending was not 

determined. 

The less-than-desired examination coverage in 2000 was due to 

resource constraints in terms of budgeted examination hours, the 

number of examiners, and the needed specialized experience and 

knowledge of the credit card business and NextBank’s technology 

based platform. As a result, we believe the examination results 

understated the bank’s true risk profile and operating problems. 

Consequently, OCC’s enforcement response through a Board 

Resolution did not appear sufficiently forceful to reasonably effect 

corrective action. Further, the Board Resolution was based on a 

questionable presumption that NCI could provide needed capital 

support. 

A year later, the second full scope examination initially experienced 

similar resource constraints. Again, examination coverage was less 

than needed, but signs of portfolio deterioration had become 

pronounced. Asset growth accelerated even faster than before 

with only marginal management system improvements and doubts 

arose as to the accuracy of the bank’s financial records and 

supporting management information systems. Indeed, before the 

examination was completed, supervision of NextBank was turned 

over to OCC’s Special Supervision and Fraud Division in 

Washington, D.C. in July 2001. 

Shortly thereafter, the examination recommenced but this time 

with an expanded team including examiners with specialized skills 

in credit card lending. The expanded second phase of the 

examination in 2001 ultimately revealed NextBank’s deteriorating 

financial condition and portfolio, quantified the understated losses 

Material Loss Review of NextBank, NA (OIG-03-024) Page 7 
due to deficient accounting practices, and effected the restrictions 

and mandatory enforcement provisions of Prompt Corrective 

Action.5 OCC also issued a Temporary Cease & Desist order, but 

it’s unclear how effective these latter enforcement actions served 

to minimize FDIC’s losses in that NextBank was closed 3 months 

later in February 2002. 

Other Regulatory Matters 

 

Prior to any OCC supervisory examination or enforcement actions, 

we believe the circumstances and conditions under which 

NextBank obtained its operating charter point to a potential 

vulnerable regulatory area warranting management review. 

Initially, NCI filed an application with OCC for a new charter in 

December 1998. FDIC raised concerns over approving Federal 

Deposit Insurance for the new charter, which would have 

prevented final approval of the charter. FDIC’s concerns centered 

on the stock options accruing to NCI owners and whether the 

options would be in NextBank’s best interest or its long term

viability. In May 1999, OCC conditionally approved the application 

and included both pre-opening and on-going conditions intended to 

ensure NextBank would operate in a safe and sound manner. 

NCI then, however, pursued a different approach to chartering 

NextBank. Rather than operate under a new bank charter, NCI

instead filed a separate change-in-control application in August 

1999 to acquire a dormant existing national bank charter. The 

targeted charter would have existing FDIC deposit insurance 

coverage and OCC does not as a practice precondition change-incontrol decisions. We believe, however, preconditions could have 

possibly allowed OCC to more effectively control NextBank’s 

growth and operations early on rather than after its risk exposures 

had reached critical and costly proportions. For example, 

preconditions, in addition to those already set against the de novo 

application, as to how NextBank would control and support its

projected growth might have helped OCC examiners assess and 

prioritize NextBank’s risks in response to the resource constraints 

during the first full scope examination in 2000. 

 

Material Loss Review of NextBank, NA (OIG-03-024) Page 8 

5 12 U.S.C § 1831o (e),(f),(h).
Finally, as a CEBA charted bank, NextBank’s parent, NCI, was 

exempt from Federal oversight by the Federal Reserve as normally 

provided under the Bank Holding Company Act. NCI was licensed 

in California, but had never been subject to state examinations or 

oversight. While the OCC had examination authority over NCI as 

an affiliate and third party service provider of NextBank, OCC 

examination coverage of NCI was limited to the transactions and 

operations that directly related to the nationally chartered 

NextBank. Beyond the legal organizational distinctions between 

the two entities, NCI and NextBank were substantively the same 

organization with dual senior managers and managing directors, 

and NCI clearly controlled NextBank’s financial resources. 

However, OCC examinations did not cover the specific operations 

of NCI or its financial records. 

While possibly a unique situation, we believe this type of 

organizational structure points to a potential supervisory gap 

between OCC and a functional regulator. Of concern is when that 

supervisory gap exists over the non-supervised parent company 

whose financial condition and operations may adversely affect a 

national bank. For example, OCC examiners were not aware of a 

loan NCI made in 2000 to a senior manager who had held dual 

positions with NCI and NextBank. Months after NextBank failed in 

2002, the loan and interest had still not been repaid. Although the 

associated amount was not material (under $200,000), we are 

reminded that one of NCI’s primary source of funds was NextBank. 

Moreover, OCC had always viewed NCI as a source of capital 

support for NextBank. 

Recommendations

The report contains six recommendations aimed at enhancing 

certain regulatory matters dealing with credit card banks, 

refinements to certain examination and enforcement processes, a 

potential PCA violation, change-in-control applications, and 

oversight of unsupervised national bank parent companies. 

OCC Response and OIG Comments 

In its November 25, 2002 written response to the OIG’s draft 

report, OCC concurred with the reported findings and agreed that 

Material Loss Review of NextBank, NA (OIG-03-024) Page 9 
the recommendations, when implemented, may be helpful to 

avoiding similar situations in the future. Over the next few weeks, 

OCC plans to formulate action plans detailing the steps they will 

take to implement the recommendations. The actions will be 

formally reported and monitored through the Department’s Joint 

Audit Management Enterprise System. 

We believe OCC’s planned actions are responsive to the intent of 

the recommendations. The OIG will also continue to monitor 

OCC’s progress in addressing the reported findings and 

recommendations. The full text of OCC’s response is included in 

Appendix 4. 

Background

In 1996, NCI was incorporated in California and began offering 

Internet-based consumer financial services. NCI had developed 

proprietary Internet-based credit card application and underwriting 

technology. NCI sought new customers only through Internet

advertisements and e-mail solicitations rather than the mass 

mailings used by conventional credit card banks at the time. NCI’s 

Internet-based card system included accepting information 

submitted by an applicant and applying both credit bureau 

scorecards and discrete credit-specific criteria. The applicant could 

receive preliminary approval or disapproval within 30 seconds. 

NCI initially applied its Internet-based technology through a 

partnership with a nonaffiliated bank. NCI solicited and screened 

the credit card applications over the Internet, whereas the 

nonaffiliated bank funded and originated the credit card receivables 

from NCI’s website. In return, NCI collected origination and 

servicing fees plus a percent of the profits. However, NCI never 

achieved profitability with increasing operating losses totaling more 

than $47 million. Despite the lack of earnings, NCI was still able to 

complete two public stock offerings in 1999, raising over 

$299 million in gross proceeds. Like other technology-based 

companies at the time, NCI was viewed as an outstanding prospect 

by investors. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 10 
Rather than limiting itself to the technology applications, NCI 

acquired a dormant national bank charter in September 1999. The 

acquisition enabled NCI to fund its own credit card operations and 

retain the credit card receivables. NCI discontinued the business 

arrangement with the nonaffiliated bank, and channeled most of 

the proceeds from the 1999 public offerings to capitalize the 

acquired charter. The bank was named NextBank, National 

Association (NextBank), becoming OCC’s first charted Internet-only 

credit card bank. 

NextBank’s charter was also subject to the provisions of CEBA. 

Under CEBA, NextBank’s product line was limited to credit cards, 

and it could not diversify through commercial loans. Its funding 

was also limited to large deposits in amounts of no less than 

$100,000, and it could not gather less costly or volatile transaction 

deposits such as checking accounts. Although gathering deposits 

was also restricted to a single office, NextBank’s Internet platform 

allowed it to effectively market and obtain deposits on a nationwide basis. 

Aside from the legal organizational distinctions between the parent 

company and the banking subsidiary, NCI and NextBank were 

substantively the same entity. NCI employees staffed most of 

NextBank’s key operations and most of those operations were

covered under a fee based service agreement with NCI. NCI, in 

turn, contracted some of the functions with its subsidiary or 

another third party service provider. Key operations provided by 

NCI included deposit gathering, card solicitations, screening, and 

originations, most of which were performed in California. NCI also 

maintained NextBank’s financial records, support systems, and 

website. As a result, NCI’s sole source of income was NextBank 

and most of NCI’s operating cost was related to supporting 

NextBank’s operations. In terms of key management decisions, 

many of the senior managers and directors held dual positions at

both entities. From 1999 through 2001, NextBank paid NCI over 

$173 million under the service agreement. 

NextBank Grew Rapidly

Through its Internet-based platform, NextBank grew rapidly from 

about $300 million in assets in September 1999 to over 

Material Loss Review of NextBank, NA (OIG-03-024) Page 11 
$900 million in September 2001. Besides the Internet technology, 

other avenues facilitating rapid growth included balance transfers 

(assuming an applicant’s outstanding card debt balance(s)), 

accepting greater number of applicants with a higher risk of default 

(subprime borrowers), and increasing cardholders’ credit limit. 

NextBank’s rapid growth was far greater than reflected by its 

balance sheet. In addition to the booked assets, the bank had sold 

over $1.4 billion in credit card receivables for securitization. 

Besides reducing the credit risk, the proceeds from the 

securitizations also enabled NextBank to fund growth. Indeed, 

securitizations accounted for as much as 58 percent of total 

funding by January 2002. 

NextBank’s growth never reached the critical mass bank 

management believed was needed to achieve profitability. Instead, 

the rapid growth only resulted in operating losses totaling over

$108 million in just over two years. 

The recognition of losses was also delayed due to deficient 

accounting practices. However, by the fourth quarter of 2001, 

examiners identified NextBank’s true unsafe financial condition due

to its rapid growth, subprime loans, and the adverse effect of 

providing support on loans previously sold through securitizations. 

NextBank’s regulatory capital fell sharply in just a few months, 

from “well capitalized” to “significantly undercapitalized” by 

October 2001. As of October 31, 2002, NextBank’s failure is 

expected to cost the FDIC between $300 and $350 million, making 

it the largest failure of the year, and NextBank may well take on 

the distinction as one of the quickest bank failures in decades. 

Findings and Recommendations

Finding 1 Causes of NextBank’s Failure

NextBank’s failure can primarily be attributed to rapid growth that 

was not properly managed. The accompanying credit risks were 

magnified with much of that growth involving subprime credits. 

Operationally, NextBank faced not only the many challenges of 

Internet banking, but also the added risks of being an Internet-only 

Material Loss Review of NextBank, NA (OIG-03-024) Page 12 
bank. Under the operating restrictions of its CEBA charter, 

NextBank was not able to mitigate credit risks through product 

diversification or avoid the margin pressures given its high cost and 

volatile funding. Indeed, profitability through NextBank’s Internetbased business model was seemingly dependent on exceedingly 

high asset volume. NextBank pursued this strategy but did not 

have the systems and controls needed to support growth in a safe 

and sound manner. As assets grew so did the associated credit 

risks, losses and operational problems, followed by severe capital 

depletion and NextBank’s failure. 

Rapid Growth In Subprime Loans

NextBank’s business strategy depended on asset growth to achieve 

profitability. In 1999, management projected that more than 

$800 million in total assets would be needed to break even, and 

this growth was initially targeted at low risk prime borrowers. 

NextBank grew its managed assets by more than six-fold in just 

over 2 years as shown in Chart 1 below. 

 Chart 1 

Total Managed Assets 

September 30, 1999 – December 31, 2001 

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

9/99 3/00 9/00 3/01 9/01

(dollars in thousands)

On-Book Assets Trust Held Assets

 Source: Call Reports 

 

Material Loss Review of NextBank, NA (OIG-03-024) Page 13 
 

As previously shown, by March 2000 managed assets included 

both credit card receivables retained by NextBank (henceforth 

referred to as on-book loans) plus card receivables sold for 

securitization (henceforth referred to as trust-held loans)6

, where 

the bank retained the servicing. NextBank earned a fee by 

servicing the sold assets. Securitizing credit card receivables 

facilitated NextBank’s growth. Total managed assets peaked to

over $2.17 billion by September 2001. NextBank’s growth was 

rapid and greatly exceeded the initial growth projections conveyed 

to OCC. For example, planned growth was to reach $597 million, 

but actual was $1.5 billion in December 2000, and planned growth 

was to reach $1.2 billion, but actual exceeded $2 billion in 

December 2001. 

Besides asset securitizations, excessive growth was also achieved 

by increasing the origination of subprime loans. One industry and 

regulatory accepted measure used in defining subprime borrowers 

is the “FICO score.”7

 From September 1999 to December 2001, 

the average FICO score for the combined managed loan portfolio

fell from 704 to 655. The regulatory benchmark for subprime is

660. In July 2001, 72 percent of the Bank’s on-book loans, and 

38 percent of the trust held loans had FICO scores below 660. 

Not only had total credit risk increased, but NextBank had retained 

the brunt of the increased credit risk associated with subprime 

borrowers. NextBank’s credit risk exposure grew worse as the 

average FICO score for on-book loans continued to fall to 526 by 

December 2001. 

While FICO scores only reflect the risk of default, NextBank’s 

actual delinquency and default rates illustrate the adverse impact 

from the subprime loans. More than 19 percent of the on-book 

loans, and more than 9 percent of the trust-held loans were at least 

30 days past due as of July 2001. The annualized charge-off rate 

at the time was more than 22 percent and 8 percent, respectively. 

The examination files reflected a clear correlation between FICO 

scores and charge-off rates, with loans with the lowest FICO 

6

 Typically, when a bank securitizes loans, the assets are held by a trust on behalf of the investors.

Material Loss Review of NextBank, NA (OIG-03-024) Page 14 

7 FICO score refers to a test developed by Fair, Isaac, and Company, which is widely used to evaluate the credit worthiness of 

borrowers. Industry guidance published by the Federal Financial Institutions Examination Council in January 2001 defines a FICO 

score of less than 660 as subprime. 
scores having the highest charge-off rates. NextBank’s cumulative 

credit losses exceeded $41 million by December 31, 2001. 

Besides increased credit risk associated with growth, there were 

also signs of higher credit risk seemingly unique to the Internet 

platform. Examination files noted that Internet applicants were 

much more likely to be credit seekers who were beginning to 

experience financial problems that had not yet been reflected in 

their credit bureau reports. As a result of this informational lag, 

Internet applicants resulted in an observed phenomenon known as 

adverse selection. That is to say for any given FICO score, 

applicants obtained over the Internet tended to have higher default 

rates than applicants through traditional channels. 

Increased Liquidity Risk

Due to the operating limitations of CEBA, NextBank faced high 

liquidity risk.8

 NextBank funding was limited to deposits of 

$100,000 or more. Deposits at this high level generally command 

not only above market rates, but also attract “rate chasers” who 

are prone to moving their deposits to any bank offering higher 

rates. Under CEBA, NextBank could not accept lower cost 

demand deposits such as checking accounts or less volatile 

deposits of under $100,000. The liquidity risk associated with 

these large dollar deposits heightened due to regulatory restrictions 

imposed after NextBank’s regulatory capital levels had fallen in the 

third quarter of 2001. A severe liquidity crisis loomed based on 

projections of net deposit outflows for the subsequent quarters

with high prospects of not being able to meet depositors’ demands. 

 

Ineffective Risk Management

If properly managed, rapid growth and subprime lending does not 

necessarily subject a bank to undue risk. However, the supervisory 

files repeatedly indicated that NextBank had not established an 

effective risk management program needed to support these 

activities in a safe and sound manner. The bank lacked adequate 

management information systems, risk analysis procedures and 

 

Material Loss Review of NextBank, NA (OIG-03-024) Page 15 

8 Liquidity risk is the risk to earnings or capital arising from a bank’s inability to meet its obligations when they come due without

incurring unacceptable losses.
skills, and risk measurement capabilities. Even fundamental risk 

management planning was deficient. 

According to examiners, the bank’s management information 

systems could not produce the information needed to measure and 

monitor the bank’s activities. For example, in mid-2001 the bank 

increased the credit limits of existing customers by an aggregate of 

about $250 million, without adequate management information 

systems. The bank’s existing system could not provide 

management the information needed to determine the impact of 

the credit limit increases on delinquency and default rates. The

reports generated were generally done on an ad hoc basis, rather 

than regularly scheduled basis. As such the bank was less likely to 

identify developing problems on a timely periodic basis through 

regularly scheduled reports. 

NextBank’s management systems also did not produce accurate or 

complete information. Examiners found that certain risk 

management reports did not reconcile to the general ledger, and 

portfolio data did not differentiate between the trust-held and onbook loan performance. The latter prevented management from 

routinely tracking or analyzing the two portfolios separately. 

Consequently, the deteriorating condition of the on-booked loans 

were obscured by the generally better performing trust-held loans. 

This situation would eventually have significantly adverse effects 

on the bank. 

Examination records also revealed that bank management 

implemented new initiatives without adequate testing, 

measurement, and analysis. For example, in mid-2001 the bank

implemented a credit card repricing plan to increase interest rates 

for cardholders whose FICO score had fallen 75 points after the 

bank had originally approved the card applicant. It observed the 

performance of a test population of accounts for only 21 days 

before deciding to expand the repricing plan to the entire loan 

portfolio. Normal industry practice would be to base such 

decisions on a minimum test period of six months. The repricing 

plan affected $350 million in receivables. The initiative, however, 

adversely impacted NextBank. In response to the increased rates, 

the lower risk cardholders left the bank and the higher risk 

cardholders experienced higher delinquencies. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 16 
Relaxed Underwriting Standards

May 2000 loan portfolio data indicated that the bank experienced 

substantial levels of downward FICO drift as existing cardholders’ 

updated FICO scores fell after being approved for a credit card. For 

example, the average portfolio FICO score at September 1999 was 

704 and 675 for May. In May 2000, more than 18 percent of the 

managed loan portfolio had updated (added for emphasis) FICO 

scores below 650. However, only 3 percent of these same loans 

had FICO scores this low at origination.9

 FICO drift contributed to 

an overall decline of the managed portfolio. As of May 31, 2000, 

33 percent of the managed portfolio was below 660, which is 

below the regulatory definition of subprime. Rather than tightening 

underwriting in response to the increased credit risk, NextBank 

management relaxed the underwriting standards. From January

2001 to July 2001, the applicant approval rate remained constant 

but approvals comprised of an increasing number of applicants with 

even lower FICO scores from 620 to 659. 

Operational Problems

Compounding the risk of improperly managed growth and subprime 

lending, NextBank’s Internet-based platform suffered from two 

other problems that contributed to its failure: high operating cost

and deficient accounting practices. 

High Operating Costs

NextBank’s Call Reports reflected increasing operating costs 

averaging $14 million per quarter in 2000, growing to an average 

of $37 million in 2001. Operating costs consisted mostly of the 

fee service agreement with the parent NCI, and far exceeded what 

NextBank had projected in its original business plan. Moreover, 

there were indications that NextBank’s operating costs were 

actually higher than reported, which would have the effect of 

understating the bank’s losses. 

The bank’s reported operating costs consisted primarily of 

payments to NCI under a fee for service agreement. NCI provided 

 

Material Loss Review of NextBank, NA (OIG-03-024) Page 17 

9 Both percentages are based on the receivable balance owed.
most of the bank staffing, facilities, technology, and equipment. 

NCI also subcontracted portions of the functions to various third 

party service providers, such as collections and information 

technology. NextBank’s payments to NCI under the service 

agreement exceeded 75 percent of NextBank’s total operating 

expenses. Also, the bank’s actual operating expenses far 

exceeded the levels projected in NCI’s original charter application. 

For example, actual operating expenses exceeded planned for 2001 

by more than 2.3 times, i.e., $148 million vs. $62 million. 

As noted previously, bank operations were largely conducted by 

NCI and NCI’s operating costs relate mainly to services provided to 

NextBank. Based on NCI’s Securities and Exchange Commission 

(SEC) 10-K reports, there were indications that NextBank’s true 

operating expenses may have been understated. As Table 1 

shows, NCI operating expenses significantly exceeded that of the 

bank. 

Table 1 

NextCard and NextBank

Total Operating Costs 

($000) 

Year

NCI 

Consolidated NextBank Difference

2000 $146,249 $59,057 $87,192

2001 175,055 148,024 27,031

Total $321,304 $207,081 $114,223

 Source: Call Reports and SEC Forms 10-Q 

 

The difference column suggests that NextBank may have 

understated by more than double its operating expenses in 2000, 

in turn, understating its operating losses. In so doing, NextBank 

may have delayed regulatory attention from the magnitude of

actual losses, as well as NextBank’s longer-term prospects. 

Deficient Accounting Practices

In addition to the aforementioned operating costs, NextBank also 

followed certain accounting practices that further served to 

understate its losses, mask its true financial condition, and possibly 

Material Loss Review of NextBank, NA (OIG-03-024) Page 18 
delayed regulatory triggers that would have called for large capital 

augmentation. 

Table 2 shows the accounting adjustments that OCC required 

which totaled over $88 million. 

Table 2 

Amount and Nature of Required Accounting Adjustments

Description

Amount 

($000)

Write down of deferred loan acquisition costs $35,718 

Write down of seller’s interest from securitizations 21,899

Increase loan loss provision expense 13,197 

Reclassification of fraud losses 12,047 

Establish Reserve for Uncollectible Interest & Fees 5,598

 Total required adjustments $88,459 

 Source: OCC examination files 

Deferred Loan Acquisition Costs 

Fees paid for accounts opened by the parent NCI were incorrectly 

recorded as an asset (deferred loan acquisition costs), to be 

amortized over a 12-month period. According to Financial 

Accounting Standards (FAS) No. 91, loan acquisition costs may be 

capitalized only if paid to an independent third party. Since NCI 

was not an independent third party, these costs should have been 

expensed. OCC required the bank to write down capital by over 

$35 million for the associated fees paid to NCI through 

September 30, 2001. 

Incorrect Valuation Of Seller’s Interests

The terms of NextBank’s securitization trust agreement required 

the bank to retain a seller’s interest in the trust. NextBank 

accounted for this as a receivable and recorded it at par. Because 

the seller’s interest was “certificated,” the bank should have 

recorded the seller’s interest as a security rather than a receivable. 

OCC required the bank to reclassify the asset as a security as well 

Material Loss Review of NextBank, NA (OIG-03-024) Page 19 
as write down its recorded value by about $22 million to reflect 

current fair market value, in accordance with FAS 115. 

Inadequate Loan Loss Provisioning

NextBank’s basis for provisioning the Allowance for Loan and 

Lease Losses (ALLL) account provided for 9 months of losses. 

OCC determined that a more appropriate period would have been

12 months given the bank’s deficient underwriting, account 

management, and collections practices. The additional provision 

required by OCC amounted to $13.2 million. 

Establish Reserve for Accrued Interest and Fees

Given the subprime nature of the assets held by NextBank, the

collectibility of some portion of the associated accrued interest and 

fees were likely in doubt. Accordingly, OCC required the bank to 

establish a $5.6 million reserve for uncollectible interest and fees. 

Though required by FAS 5, the bank had not previously provisioned 

for this contingency.

Misclassification Of Fraud Losses

From the first quarter of 2000 through the second quarter of 2001, 

the bank accounted for certain types of losses as a fraud rather

than a credit loss. The basis for this accounting treatment did not 

conform to industry practice, and examiners also noted several 

operating inconsistencies that did not support this accounting 

treatment. These inconsistencies included: the lack of associated 

filing of Suspicious Activity Reports; charging off the losses after 

180 days instead of the 90 days to be in line with bank’s fraud 

policy; and the lack of involvement by the Bank’s Fraud 

Department. 

The required accounting reclassification totaled $12 million. The 

affect of this incorrect accounting was twofold. By understating 

the amount of credit losses, the ALLL was likely inaccurate (under 

provisioned), and regulatory capital was deficient given how 

NextBank responded to those “fraud losses” that were associated 

with the trust-held loans. The latter problem is discussed in further 

detail below “Implicit Recourse.” 

Material Loss Review of NextBank, NA (OIG-03-024) Page 20 
Implicit Recourse

As previously discussed, NextBank decreased its credit risk by 

selling its loans for securitization. However, OCC examiners 

determined that the bank would replace certain sold loans that had 

defaulted with its own performing loans10. In so doing NextBank 

effectively retained the credit risk. Although they were not 

obligated to provide this backup support, it appears NextBank did 

so to maintain market confidence in its assets for future 

securitizations. 

The terms of the securitization agreement provided for NextBank to 

give backup support for losses arising from fraud but not normal 

credit losses. As previously discussed NextBank had incorrectly 

accounted for over $12 million in fraud losses. Aside from the

accounting adjustments, there were even larger implications for 

regulatory capital purposes for providing backup support on losses 

improperly accounted as fraud losses. 

Regulatory guidance over assets sales with recourse requires the 

recognition of the retained credit risk for calculating capital 

adequacy.11 OCC’s Capital Steering Committee determined that 

NextBank’s had provided full implicit recourse on the securitized 

receivables in light of the practice of replacing loans misclassified 

as fraud losses. Accordingly, OCC required the bank to include

$1.2 billion in securitized assets in determining how much 

regulatory capital would be needed to support the additional risk. 

As a result, NextBank’s risk-based capital ratio fell from 

17.02 percent to 5.38 percent. In so doing, NextBank’s regulatory 

capital dropped three PCA capital levels to the “significantly 

undercapitalized” category. NextBank was unable to restore capital 

to sufficient levels, and many of the previously cited problems cast 

further doubt that the bank could continue as a going concern. 

 10 It was unclear from the supervisory files whether NextBank effected these replacements by reimbursing the trust or actually 

exchanging loans. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 21 

11 12 CFR Part 3. Risk-Based Capital Requirements--Low Level Recourse.
Finding 2 OCC’s Supervision Of NextBank 

The rapidity of NextBank’s growth and failure raises questions as 

to the adequacy of supervision in terms of detecting problems and 

responding with appropriate regulatory sanctions. We believe that 

supervisory performance was mixed. Sanctions taken in late 2001 

and early 2002 appeared timely and appropriate. But OCC early 

examinations were partly hampered by resource constraints, which 

appeared to have delayed the complete detection of NextBank’s 

actual risk profile, embedded asset problems, and unsafe banking 

practices. Left without an effective enforcement action, NextBank 

continued its uncontrolled growth to large and costly proportions. 

Given NextBank’s mere two and a half years of existence, it’s 

unclear how much of a difference earlier detection would have 

made. However, NextBank clearly illustrates how quickly an 

institution can accumulate large risk positions to the point that the 

supervisory response can do little to avert a costly failure. 

Examination History and Enforcement Actions

Table 3 summarizes the results of OCC’s examinations and 

enforcement actions. Also see Appendix 2 for a detailed 

chronology of significant events regarding NextBank. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 22 
 Table 3 

OCC Examination Issues and Enforcement Actions 

Date 

Started 

CAMELS 

Ratings12

Examination Type Significant Safety and Soundness 

Issues 

Supervisory Response/ 

Enforcement Actions 

12/6/99 2/222322 Limited scope, 

initial (60 day)

on-site 

• Establish a strategic marketing 

plan covering growth 

• Establish a formal and 

comprehensive capital plan 

• Enhance credit risk management 

in three areas 

• Strengthen Internal Audit

function 

• Establish a Vendor Management 

program 

• Establish a formal Strategic 

Planning process 

• Enhance liquidity risk 

management in four areas. 

• None 

5/8/00 2/222322 Full scope • Inadequate planning 

methodology and capital 

planning process 

• Inadequate Credit Risk 

Management 

• High risk areas not audited 

• Unfocused Vendor Management 

program 

• Problems retaining and recruiting 

management personnel 

• High credit risk and increasing 

due to significant growth and 

expansion in subprime lending. 

• Severe deterioration of asset

quality. 

• 10/00 Board Resolution 

issued 

5/21/01 Preliminary 

not rated 

Full scope 

Phase 1 

• Examiners could not conclude on 

the condition of the bank 

• 7/13/01 Supervision turned 

over to Washington, D.C.

Special Supervision Unit 

8/20/01 5/545554 Full Scope 

Expanded 

Phase 2 

• Insufficient risk, audit, and 

control systems 

• Inadequate independent 

assessment of bank practices 

and records 

• Improper accounting practices 

• Incomplete SARs filing 

• 11/01 PCA Directive issued 

• 2/02 Temp C&D issued 

• 2/02 Order of Investigation 

• 2/02 Bank Closed 

 

Source: OCC Reports of Examination & Supervisory files 

 

Material Loss Review of NextBank, NA (OIG-03-024) Page 23 

12 The CAMELS system grades institutions on 6 factors: capital, asset quality, management, earnings, liquidity, and sensitivity to

risk. Performance is rated on a scale of 1 to 5 with 5 being the worst.
Based on the supervisory record, we believe there were three major 

areas that reflect mixed supervisory effectiveness. One, the large 

dramatic drop of three CAMELS rating levels in a year’s time raises 

questions whether the earlier examination efforts had fully 

assessed the bank’s financial condition and the emerging problems. 

Two, the persistent reporting of certain examiner concerns raises 

questions as to the effectiveness of the enforcement response. 

Three, the bank’s continued phenomenal growth continued despite 

the lack of adequate controls and systems. 

NextBank’s Examinations

About 60 days after NextBank opened, OCC conducted a limited 

scope examination to: (1) assess the bank’s condition and risk

profile and (2) gain an understanding of how management intended 

to organize, manage, and grow the new bank. The scope was 

limited given the short time the bank had been operating, and the 

examination coverage reflected a review of policies and procedures 

but not detailed testing or analysis. Nevertheless, examiners 

pointed out several areas warranting management attention and 

corrective action. 

Five months later OCC commenced NextBank’s first full scope 

safety and soundness examination in May 2000. The examination 

scope memo reflects that the EIC had planned for comprehensive 

coverage, including Information Technology, consumer compliance, 

financial trends and credit risk management. However, the number 

of requested hours, examiners, and experience needed were not 

available due to higher priorities at other credit card banks at the 

time. As a result, examiners were able to touch upon most areas 

but available resources precluded in-depth analysis and testing. For 

example, about 100 staff days for six examiners had been 

requested to review asset quality. But only five examiners were 

provided, two of which had no prior asset quality or credit card 

experience. Roughly 60 days were spent on this aspect of the 

examination. 

Constraints aside, examiners found that the bank had done little to 

address their concerns raised in the prior December limited review. 

Moreover, signs of emerging problems were found, most notably 

increasing credit risk as reflected by increasing charge-off rates, 

Material Loss Review of NextBank, NA (OIG-03-024) Page 24 
and the bank’s planned expansion into subprime markets despite 

insufficient progress in addressing prior examiner concerns. The 

charge-off rates ranged from 9 to 12 percent on the loans that had 

been transferred from NCI when NextBank originally opened. 

Of note was that the loans had been underwritten and originated 

under NCI’s Internet-based platform for which current originations 

were growing. Moreover, actual growth was greatly exceeding 

original business plan projections. The bank had projected assets 

would reach $139 million by December, but actual growth had 

more than tripled at $468 million. As Table 3 previously showed, 

the CAMELS ratings went unchanged from the prior targeted 

examination with an overall composite rating of 2. 

The following year’s full scope safety and soundness examination 

experienced similar resource constraints. For the asset quality 

review portion, about 200 staff days for eight examiners had been 

requested. But only seven examiners were provided, five of which 

lacked asset quality or credit card experience. And instead of 200 

days, about 80 days were spent on this aspect of the examination. 

Again, examiners found that bank management had done little to 

address concerns raised in the 2000 examination even though the 

board had formally resolved to address them. Credit risk and 

losses were more pronounced with charge-offs now at 22 percent 

on the on-book loans and 8 percent on the trust-held loans. Also, 

the overall loan portfolio had clearly drifted from prime to subprime 

borrowers as reflected by the increase in cardholders with FICO 

scores under 660. However, examiners could not precisely assess 

the full impact of the observed problems and rapid growth, and 

greater uncertainty arose as to the bank’s true financial condition, 

given signs of questionable accounting practices. 

Supervision of NextBank was then moved from the Western 

District to the Special Supervision and Fraud Division in 

Washington, D.C. in July 2001. The second phase of the 2001 

examination recommenced in August but this time included issue 

area specialists from outside the district and no staff day 

constraints were imposed. By mid-September the gravity of the 

problems had been assessed, many of the needed accounting 

adjustments identified, and supervisory determinations (e.g., 

implicit recourse) that would result in the automatic triggering of

Material Loss Review of NextBank, NA (OIG-03-024) Page 25 
the operating restrictions under Prompt Corrective Action (PCA) 

implemented. 

Areas Warranting Further Examiner Review

As discussed in Finding 1, two contributing factors to NextBank’s 

failure were its high operating costs and deficient accounting 

practices. Aside from the possible resource constraints, we believe 

less than sufficient examiner attention and review had been given 

in the two areas. 

NextBank’s operating expenses were largely comprised of the fee 

service agreement with NCI. Payments to NCI accounted for over 

75 percent of the bank’s total operating expenses. Actual 

expenses far exceeded projected expenses under the business plan 

by more than 2 times in 2001. Expenses which totaled over 

$222 million likely absorbed the roughly $194 million in capital 

provided by NCI. From the first site visit in 1999, examiners 

pointed out the need for a Vendor Management program to oversee 

the performance of third party service providers. The same 

concern was raised again in the 2000 examination. 

Aside from pointing out the absence of a formal Vendor 

Management program, examiners did little to assure that the fees 

were accurate, reasonable, or appropriate, particularly in light of 

the parent company relationship. The fees were not only large but 

on a quarterly basis exhibited an unusual trend in that expenses did 

not parallel the bank’s growth as might be expected, and there was 

an unexplained spike in the third quarter of 2001 as illustrated in 

Chart 2. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 26 
 Chart 2 

NextBank’s Operating Expenses Vs. Total Managed Assets 

0

1

2

3

4

5

6

7

8

Sep-99Dec-99Mar-00Jun-00Sep-00Dec-00Mar-01Jun-01Sep-01Dec-01

(expenses $ 0,000,000)

0

5

10

15

20

25

(managed assets

$ 00,000,000)

Quarterly Operating Expenses Total Managed Assets

 Source: Call Reports 

Examiners could not recall conducting an extensive review of the 

operating charges under the service agreement but suggested the 

fees had been compared to industry standards, and reliance had 

been placed on the external auditors to surface any problems. 

We found no documentary evidence in the examination files 

evidencing that the operating charges had been reviewed as to 

compliance with the NCI’s service agreement, accuracy or 

reasonableness, or how the examiner had determined comparability 

to industry standards. There were indications that examiners were 

aware that NCI was in fact subsidizing NextBank’s charges, as 

previously discussed in Finding 1. We believe that by not fully 

assessing the accuracy and appropriateness of the fee charges, 

examiners in 2000 may not have been fully aware of the extent of 

NextBank’s actual operating losses, and thus true risk profile. 

As discussed in Finding 1, OCC examiners identified roughly 

$88 million in needed accounting adjustments, some of which 

materially affected NextBank’s capital. We found indications of 

examiners’ concerns in this area surfacing around January 2001. 

However, the concerns were presented as minor and dealing with 

Material Loss Review of NextBank, NA (OIG-03-024) Page 27 
only two of the five adjustments listed in Table 2. It was not until 

the second phase of the 2001 examination that the major 

accounting issues were fully developed. 

The 2000 examination scope memo provided for assessing 

accounting and affiliate transactions. But, it appears from the 

examination files and discussions with examiners that their focus 

may have been limited to a general review of policies and 

procedures, affiliate and intercompany transactions, and associated 

controls. As to the bank’s compliance with standard accounting 

practices, we found no documentary support of any coverage of 

the external auditors work as provided under OCC’s Internal and 

External Audits Comptroller’s Handbook of July 2000. For 

example, we did not find documentation that the Audit Function 

Questionnaire had been completed which would have provided the 

basis for assessing whether additional examination coverage would 

have been needed. 

Examiners acknowledge that some of the questionable accounting 

practices started in early 2000, but said the associated amounts 

were likely too small to have been of concern at the time. We 

suspect that some level of reliance may have also been placed on 

the external auditors’ work under NCI’s consolidated financial 

statements. We did not expand our work as to the reliability of the 

external auditors’ work given SEC’s on-going investigation of NCI 

at the time of this report. 

Although we believe examiners could have expanded their 

coverage over the service fee agreement and accounting practices 

in 2000, it’s unclear whether earlier detection by a year would 

have materially impacted the supervisory response, the bank’s 

failure, or its cost to the FDIC. Again we are reminded how quickly 

the bank grew and increased its overall risk profile. 

Enforcement Actions 

To address the concerns identified in the 2000 examination, OCC 

requested that the board officially commit through a resolution to 

address the identified weaknesses. The enforcement action is 

viewed as an informal action but of lesser severity than OCC 

issuing other informal enforcement documents such as a 

Material Loss Review of NextBank, NA (OIG-03-024) Page 28 
commitment letter or memorandum of understanding. Certain 

types of issued enforcement documents are subject to public 

disclosure as a regulatory enforcement sanction, whereas a Board 

Resolution is not. Table 4 shows the areas that OCC required the 

institution to address. 

Table 4 

NCI Board Resolution 

October 26, 2000 

NCI’s Board Resolution Commitments Established 

Timeframes

• Curtail growth of managed subprime receivables 

originated to 5 percent. 25 days 

• Maintain Total Risk Based Capital greater than 12 

percent of risk weighted assets, and equity capital 

plus ALLL of at least 6.5 percent of total 

managed assets. 25 days 

• Modify the 3-year strategic plan to provide for 

reasonable growth rates, adequate capital and 

adherence to the plan. 60 days 

• Develop a Credit Risk Management program 

including limits on the degree of risk incurred, 

systems to measure and control risks, and skilled 

employees managing the risks. 60 days 

• Develop monthly & quarterly risk management 

reports for management review. 60 days 

• Ensure the risk manager was independent of credit 

decision-making activities. 60 days 

• Develop a Marketing Plan to carry out the strategic 

plan. 60 days 

• Develop a 3-year Capital Plan, including a Capital 

Assurance Agreement between NextBank and 

NCI. 

60 days 

• Enhance the Internal Audit program. 30 days 

• Implement a Vendor Management program 

governing outsourcing of banking functions 30 days 

 Source: OCC Supervisory files

 

We believe that the 2000 examination had established sufficient 

basis for using a more forceful enforcement action than a Board 

Resolution to effect corrective action. NextBank had not

substantively addressed the concerns raised in the prior 1999 site 

Material Loss Review of NextBank, NA (OIG-03-024) Page 29 
visit, such as a establishing a plan covering growth and vendor 

management. Moreover, NextBank clearly exhibited a higher risk 

profile given its accelerated growth above the original business 

plan, its planned expansion into subprime credits, and the unproven 

Internet platform for controlling credit risk as evidenced by the 

9-12 percent charge-off rates of the older loans. In addition, 

operating losses were not stabilizing and the bank’s revised 

projections indicated that profitability could be achieved through 

higher than planned growth. Given the absence of fundamental 

bank risk management systems, we believe an appropriate 

response would have been an issued enforcement document rather 

than continually relying on bank management commitments. 

Besides the type of enforcement action, there were also certain 

aspects of the Board Resolution that seemingly could have been 

enhanced, specifically those aimed at growth and capital coverage. 

The Board Resolution only attempted to curb subprime growth with 

a set limit beyond a capital limitation even though the bank lacked 

systems and controls to support prime loan growth as evidenced 

by the increasing charge-off rates of prime credits. 

The requested capital support of 6.5 percent to total managed 

assets can be traced to the original charter application in 1998. 

However, that capital level was in support of projected volume and 

the type of business (i.e., prime creditors) at the time. As 

previously noted, those two basic assumptions materially changed 

with actual growth more than doubling planned, and the shift from 

prime to subprime credits. 

Another aspect of the Board Resolution was a required capital 

assurance agreement between the bank and NCI. The agreement 

called for an assurance from NCI to provide additional capital if the 

bank’s capital ratios fell below certain regulatory thresholds. 

Although it was reasonable to look to the parent and sole owner 

for needed future capital support, NCI had demonstrated that any 

capital support would not come from operations given its 

consecutive years of net operating losses, even prior to owning 

NextBank. NCI’s March 31, 2000, 10-Q reported cumulative 

operating losses continued to increase and now exceeded 

$112 million since it began in the Internet credit card business. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 30 
These increasing losses were dissipating NCI’s financial base and 

funds obtained from the 1999 public offerings. 

The Board Resolution proved to be ineffective in getting the bank 

to take corrective action. Most of the milestones were not met, 

and there was also uncertainty arising as to the interpretation of a 

key provision. Each month OCC was to monitor the bank’s 

progress towards meeting the 5 percent subprime loan restriction. 

However, the monthly reports filed by the bank were taken on face 

value; the examiner did not verify these reports. It was not until 

the second phase examination in 2001, some 9 months later, that 

examiners determined the reports had been inaccurate. Rather 

than control subprime growth to 5 percent, actual subprime loans 

were 34 percent for the quarter ending March 2001, and

27 percent for the following quarter. Bank management attributed 

this to a misunderstanding of the Board Resolution. OCC officials 

acknowledge that the Board Resolution had been ineffective, and 

pointed out that under the revised enforcement policy, PPM 5310-

3, July 2001, Board resolutions are no longer available as an 

informal action. 

Prompt Corrective Action

Prompt Corrective Action (PCA) provides Federal banking regulators 

an added enforcement tool to promptly address “undercapitalized” 

banks and thrifts. PCA consists of a system of progressively 

severe regulatory intervention that is triggered as an institution’s 

capital falls below prescribed levels. PCA does not replace or 

preclude the use of other available enforcement tools (e.g., cease 

and desist orders) that address unsafe and unsound banking 

practices before capital becomes impaired. PCA aims to minimize 

losses to the FDIC by providing for a quick regulatory response to 

troubled institutions. 

When OCC had determined in October 2001 that NextBank had 

provided implicit recourse on the trust-held loans, the resultant 

additional bank assets effectively dropped the bank’s regulatory

capital level from “well capitalized” to “significantly 

undercapitalized.” At that point, NextBank was automatically 

subject to the restrictions of PCA. Additional restrictions were 

imposed by OCC in November 2001 through a PCA Directive, 

Material Loss Review of NextBank, NA (OIG-03-024) Page 31 
containing 12 provisions. Some key provisions required NextBank 

to: develop a capital restoration plan due in 45 days; file amended 

Call Reports; restrict new credit card account originations to FICO 

scores above 680; prevent dividend payments; and restrict asset 

growth, management fees, and brokered deposits. 

By December 2001, NextBank advised OCC that it would not be 

able to address its capital deficiency. In January 2002, NCI and 

NextBank filed with the OCC an Asset Disposition Plan detailing 

plans to liquidate the bank. Notwithstanding the attempts made 

during numerous subsequent meetings to resolve the bank’s 

financial condition, OCC appointed FDIC as receiver on 

February 7, 2002. 

Brokered Deposit Restrictions

PCA restricts the use of brokered deposits and the rates paid on 

deposits when regulatory capital falls below the “well capitalized” 

category. These restrictions are intended to slow or reverse 

growth, and thus risk, by limiting a troubled institution’s funding 

sources. For NextBank these restrictions were automatically 

triggered on October 31, 2001. 

Call reports show a net outflow of about $56 million in deposits 

from September 30, to December 31, 2001. However, brokered 

deposits increased roughly $135 million from $55 million to 

$190 million during this timeframe. Because we were unable to 

determine the actual dollar amounts of brokered deposits and bank 

deposits on the day the PCA directive was issued, we spoke to an 

OCC analyst about the apparent increase in brokered deposits. 

The analyst opined that the apparent increase could have been due 

to the bank’s definitional interpretation as to what constituted a 

brokered deposit. Prior to the deposit restriction, the bank had not 

reported certain fiduciary deposits as brokered deposits. The 

analyst believed that NextBank might have reclassified a portion of 

their fiduciary deposits as brokered deposits for the 

December 2001 Call Report. We could not determine or estimate 

how much of the $135 million in additional brokered deposits could 

have been due to the reclassified fiduciary deposits versus how 

Material Loss Review of NextBank, NA (OIG-03-024) Page 32 
much may have actually been due to the use of brokered deposits 

contrary to the restriction. 

PCA Effectiveness

PCA’s effectiveness in NextBank’s situation is difficult to assess 

given the short time period of about 85 days from the time the 

PCA Directive was issued to the bank’s closure. The implicit 

notion that PCA provides prompt and progressively severe 

enforcement action based on a bank’s capital position appeared 

irrelevant in NextBank’s situation. By the time Nextbank’s true 

financial condition had been determined in the later part of 2001, it 

had already accumulated critically, if not irreversible, large 

proportions of risk. Coupled with the CEBA operating and funding 

restrictions, the bank had few, if any, realistic options to survive 

PCA. Rather than prompt enforcement action, NextBank’s 

situation points to a need to quantify uncontrolled growth so that 

risk and not just capital levels triggers supervisory action. 

Conventional enforcement actions had not been effective. 

 

Finding 3 Other Regulatory Matters 

 

One of the mandated review objectives of a material loss review is 

to bring to regulators’ attention any issues which might assist in 

avoiding bank failures in the future. Although not directly related 

to the examination of NextBank, we believe the circumstances and 

conditions under which NextBank obtained its operating charter 

point to potentially vulnerable regulatory and supervisory areas 

warranting OCC’s review. 

Potential Vulnerability in the Application Process

NCI initially applied to OCC for a new credit card bank charter in 

December 1998. NCI’s application clearly disclosed the planned 

Internet-based platform and delivery channel, its targeted prime 

customer base, planned funding, and basic organizational structure. 

In reviewing such applications, OCC considers (1) the organizers’ 

familiarity with national banking laws and regulations, (2) 

competencies of the managers and directors, (3) capital adequacy 

relative to projected volume and type of business activity, (4) 

profitability prospects, and (5) the safety and soundness issues. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 33 
 

OCC’s final approval of a bank charter also depends on the bank 

obtaining FDIC deposit insurance. Although FDIC had reached

favorable determinations for most of the insurance considerations, 

the FDIC March 1999 field investigation recommended that the 

Washington FDIC office deny deposit insurance. The denial was 

based on the factor “General Character of Management,” 

specifically over the planned compensation to insiders. The FDIC 

field investigative report concluded that the stock options accruing 

to NCI owners did not appear to be in the best interest of NextBank 

or its long-term viability. Aside from the FDIC concerns, OCC 

granted NCI “preliminary conditional approval” in May 1999. 

However, OCC’s approval included 12 conditions, which 

collectively were designed to better ensure that once opened, 

NextBank would operate in a safe and sound manner. 

NCI then, however, pursued a different approach to chartering 

NextBank. Rather than operate under a new bank charter, NCI

instead filed a separate change-in-control application to acquire a 

dormant existing national bank charter in August 1999. In so 

doing, the targeted charter would already have existing FDIC 

deposit insurance coverage, and OCC does not as a practice 

precondition change-in-control applications. NCI opened NextBank 

under the change-in-control application in September 1999. 

OCC’s authority to precondition a change-in-control application 

appears unclear and subject to interpretation. When we initially 

asked OCC why NextBank’s change-in-control decision had not 

been subject to the same conditions as its prior new bank charter 

application, we were told that OCC lacked clear legal authority to 

do so. We brought to their attention the OCC Corporate Manual13

for chartering an Internet Bank, which specifically states, in part: 

“...OCC may approve or conditionally approve any (emphasis 

added) filing after reviewing the application...” OCC officials 

indicated that the manual reference applied only to new charters 

and not a change-in-control application. Furthermore, OCC officials 

were not certain if such preconditions would be legally enforceable 

even though they were aware that the Federal Reserve 

preconditioned change-in-control applications and believed such 

preconditions were enforceable under 12 U.S.C §1818. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 34 

13 The Internet and the National Bank Charter, Comptroller’s Corporate Manual, January 2001
We believe NextBank was, in substance, a new bank given the 

dormant status of the acquired bank charter. Accordingly, we 

believe preconditions were not only prudent but also could have 

possibly allowed OCC to more effectively control NextBank’s 

growth and operations early on rather than after its risk exposures 

had reached critical proportions. For example, one precondition 

OCC had invoked under the new bank charter, which could have 

been expanded, was a minimum 6.5 percent capital to managed 

assets ratio. Such a precondition seemed appropriate given 

NextBank’s unproven Internet-based technology, and the unknown 

risks at the time of Internet banking, let alone being an Internetonly bank. NextBank was clearly not to be just another credit card 

bank. Besides the added capital cushion, preconditions may have 

also provided examiners an added basis to assess risk and prioritize 

examination tasks during the first full scope examination in 2000. 

 

Parent Company Lacked Sufficient Regulatory Oversight

Finally, as a CEBA charted bank, NextBank’s parent, NCI, was 

exempt from Federal oversight by the Federal Reserve under the 

Bank Holding Company Act. NCI was licensed in California but had 

not been subject to state examination or oversight. While the OCC 

had examination authority over NCI as an affiliate and third party 

service provider of NextBank, OCC examination coverage of NCI 

was limited to transactions and operations that directly related to 

NextBank. Distinguished only by legally separate organizational 

structures, NCI and NextBank were substantively the same 

organization with dual senior managers and managing directors. 

NCI also controlled NextBank’s financial resources and operations, 

the latter through a fee-based servicing agreement. In substance, 

NextBank was a shell bank that booked insured $100,000 time 

deposits and credit card receivables. But those assets, 

transactions, and liabilities were essentially created by NCI, a NCI 

operating subsidiary, or a third party service provider contracted by 

NCI. NCI’s financial condition and operations clearly could impact 

NextBank and its Federally insured depositors. 

OCC examinations of NextBank did not cover NCI’s specific 

operations as the parent company or its financial records. In 

effect, NCI was not subject to Federal oversight or sufficient 

Material Loss Review of NextBank, NA (OIG-03-024) Page 35 
 

oversight by the state functional regulator, certainly not to the level 

normally provided over an equivalent bank holding company. 

While possibly a unique situation, we believe this type of 

organizational structure points to a potential supervisory gap 

between OCC and a functional regulator.14 Of concern is when 

that supervisory gap falls over the parent company whose financial 

condition and operations may adversely impact a national bank. 

For example, OCC examiners were not aware of several personal 

loans NCI made in year 2000 to certain employees, including a 

senior manager that had held dual positions with NCI and 

NextBank. According to NCI’s 10-K filing, the manager’s loan 

included a stated interest rate and was secured by NCI stock and 

stock options. Eight months after NextBank failed, the manager’s 

loan and accrued interest had still not been repaid and is currently 

subject to a collections suit. 

The amount of the manager’s loan was not material (i.e., under 

$200,000). But it must be kept in mind that one of NCI’s primary 

source of funds was NextBank And from a supervisory 

perspective, NCI was also viewed as a source of capital support as 

reflected in the Board Resolution as requested by OCC after the 

2000 examination. OCC’s authority to proactively exam NCI, 

affiliates, and third party service providers is established under 

12 U.S.C.§ § 481 and 1867(c). We believe that examiners in 

2000 did not fully exercise this authority. 

Recommendations 

With respect to NextBank’s Internet-based credit card activities, 

the OIG has no recommendations in light of the Federal Financial 

Institutions Examination Council’s draft Credit Card-Account 

Management and Loss Allowance Guidance, July 22, 2002. While 

not applicable to NextBank’s entire situation, we believe the 

guidance provides sufficient regulatory expectations that would 

have mitigated some of the failed bank’s risky practices. 

14 A similar supervisory gap was reported by the FDIC OIG involving another bank failure that had resulted in a material loss to

the FDIC, Material Loss Review - The Failure of Pacific Thrift and Loan Company, Woodland Hills, California, June 7, 2000, Audit 

Report No. 00-022. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 36 
In Finding 2, we noted that examiner resource constraints appeared 

to have hindered OCC’s timely and full assessment of the bank’s 

risk profile and true financial condition until the last quarter in 

2001. We are aware that a similar situation had been identified in 

an OCC Lessons Learned Review for another recently failed bank. 

One recommendation from that internal review was for OCC to

establish a process to allocate specialized examination resources to 

banks that appear fundamentally sound but have a high or 

increasing risk profile. This process should be centralized to allow 

such specialized requests and assigning resources. 

1. Accordingly, we support the aforementioned 

recommendation from the Lessons Learned Review and 

further recommend that additional steps be taken to 

proactively expand the pool of examiners with 

specialized experience based on emerging trends and 

industry developments. 

Also in Finding 2, we noted additional and expanded examiner 

attention had been warranted in the areas of accounting practices 

and the service agreement with NCI. 

2. With respect to the accounting practice issue, we 

recommend that the July 2000 Internal and External 

Audits handbook be reassessed for clarity and whether 

NextBank’s situation calls for establishing or increasing 

mandatory procedures to review the external auditors 

work covering a bank’s accounting practices with 

respect to compliance with Generally Accepted 

Accounting Principles. 

 

3. With respect to the service agreement issue, we 

recommend that examiner guidance be reassessed for 

clarity or expanding the expected examiner coverage 

provided under OCC Bulletin 2001-47 Third-Party 

Relationships–Risk Management Principles. The bulletin 

establishes precise expectations of banks’ risk 

management processes. However, it’s unclear as to 

what examiners are expected to do when a bank’s

systems are insufficient or absent as in NextBank’s case. 

Specific consideration should be given to examiners 

Material Loss Review of NextBank, NA (OIG-03-024) Page 37 
gauging a third party service provider’s impact on the 

bank’s condition and operations. 

In Finding 2, we also pointed out the possible PCA violation of 

increased brokered deposits contrary to the associated 

restriction. 

4. We recommend that OCC assess how much of the 

increase in brokered deposits in the fourth quarter of 

2001 was actually due to the reclassification of fiduciary 

deposits, and assess the need for further sanctions if 

warranted. 

In Finding 3, we point out two potential vulnerable areas dealing 

with change-in-control applications, and oversight of national 

bank parent companies that are not subject to Federal 

supervision or sufficient supervision by the functional regulator. 

5. With respect to applications, we recommend that OCC 

seek legal clarity as to their authority to condition a 

change-in-control application. If needed, seek legislative 

authority in concert with the Federal Reserve as to the 

circumstances allowing OCC to invoke conditions when 

acting on this type of application. 

6. With respect to the second issue, the Comptroller of the 

Currency should reassess the adequacy of existing 

examination guidance on how examiners should assess 

the risks presented by the parent company. Added 

consideration should be given to the specific supervisory 

issues presented by entities operating under the 

Competitive Equality Banking Act of 1987. 

Management Response and OIG Comments

In its November 25, 2002 written response to the OIG’s draft 

report, OCC concurred with the reported findings and agreed that 

the recommendations, when implemented, may be helpful to 

avoiding similar situations in the future. Over the next few weeks, 

OCC plans to formulate action plans detailing the steps they will 

take to implement the recommendations. The actions will be 

Material Loss Review of NextBank, NA (OIG-03-024) Page 38 
formally reported and monitored through the Department’s Joint 

Audit Management Enterprise System. 

We believe OCC’s planned actions are responsive to the intent of 

the recommendations. The OIG will also continue to monitor 

OCC’s progress in addressing the reported findings and 

recommendations. The full text of OCC’s response is included in 

Appendix 4. 

******* 

We would like to extend our appreciation to OCC for the 

cooperation and courtesies extended to our staff during the audit. 

If you have questions please call me at (415) 977-8810 ext. 222. 

Major contributors to the report are listed in Appendix 5. 

Benny W. Lee /S/ 

Regional Inspector General for Audit 

Material Loss Review of NextBank, NA (OIG-03-024) Page 39 
Appendix 1 

Objectives, Scope, and Methodology 

We conducted this material loss review of NextBank in response to our 

mandate under Section 38(k) of the FDIA, 12 USC § 1831o(k). This 

section provides that if the deposit insurance fund incurs a material loss 

with respect to an insured depository institution on or after July 1, 1993, 

the inspector general for the appropriate Federal banking agency shall 

prepare a report to the agency, which shall: 

• Ascertain why the institution’s problems resulted in a material 

loss to the insurance fund; 

• Review the agency’s supervision of the institution; and 

• Make recommendations for preventing any such loss in the 

future. 

As defined by Section 38(k) of the FDIA, a loss occurring after 

June 30, 1997, is considered material if it exceeds $25 million or 

2 percent of the institution’s total assets. The FDIA also requires the 

inspector general to complete the report within 6 months after it becomes 

apparent a material loss has been incurred. We initiated a material loss 

review of NextBank based on the loss estimate by the FDIC. In 

October 2002, FDIC estimated that NextBank’s failure would cost the 

Bank Insurance Fund between $300 and $350 million. 

To accomplish our review, we conducted fieldwork at OCC Headquarters 

in Washington, D.C., and its Western District Headquarters in 

San Francisco, California. Additionally, we visited FDIC’s Division of

Supervision in Washington, D.C., the Division of Resolutions and 

Receiverships (DRR) in Dallas, Texas and Division of Finance (DOF) 

personnel operating out of NCI’s Headquarters in San Francisco, 

California. 

We also met with enforcement officials from the SEC in San Francisco, 

California to determine the nature and status of any planned or ongoing 

investigations relating to NCI. At the time of our inquiry, SEC had just 

filed notice of a formal investigation, and as such SEC was unable to 

comment. Given the potential breadth of SEC’s investigative subpoenas, 

we did not inquire or seek information surrounding NCI’s external auditors

with respect to any services provided to NCI or NextBank. Accordingly, 

our review did not assess what, if any, role the external auditors work 

may have contributed to NextBank’s failure. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 40 
Appendix 1 

Objectives, Scope, and Methodology 

Our review covered the period from December 1997 until NextBank’s 

failure on February 7, 2002. We conducted our fieldwork from 

April 2002 to November 2002. In November 2002, subsequent to 

issuance of our draft report, OCC issued their Lessons Learned Review of

NextBank. Consequently, we were unable to do an in-depth analysis of 

any information the review might have had with respect to the causes of 

NextBank’s failure or OCC’s supervision of the bank. However, reviewing 

the document shows it is consistent with our audit report. 

To assess the adequacy of OCC’s supervision of NextBank, we attempted 

to determine (1) when OCC first identified NextBank’s safety and 

soundness problems, (2) the gravity of the problems, and (3) the 

supervisory response OCC took to get the bank to correct the problems. 

Additionally, we attempted to determine whether OCC (4) might have 

discovered problems earlier, (5) identified and reported all the problems, 

and (6) issued comprehensive, timely, and effective enforcement actions 

that dealt with any unsafe or unsound activities. Specifically, we: 

• Assessed OCC actions based on its internal policies and 

guidance, and various guidance provided by the FFIEC. 

• Reviewed supervisory and enforcement files and records for 

NextBank and its parent from 1997 through 2002 that were 

maintained at OCC Headquarters, and its Western District 

Office. We analyzed all examination reports, supporting 

workpapers, and related supervisory and enforcement 

correspondence. We performed this analyses to gain an 

understanding of the problems identified, the approach and 

methodology OCC used to assess NextBank’s condition and 

the regulatory action used by OCC to compel bank

management to address the deficient conditions found. We 

did not conduct an independent or separate detailed review 

of the external auditor’s work or associated workpapers, 

other than those incidentally available through the 

supervisory files. 

• Interviewed and discussed various aspects of the supervision 

of NextBank with OCC officials, examiners, specialists, 

attorneys, and an analyst, to obtain their perspective on the 

bank’s condition and the scope of the examinations. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 41 
Appendix 1 

Objectives, Scope, and Methodology 

• Reviewed files, workpapers, and examination reports 

maintained by FDIC’s Dallas DRR staff to determine the 

nature, scope, and conclusions regarding the post closing of 

NextBank. 

• Interviewed the FDIC, DRR and DOF personnel who were 

involved in the receivership process and in the due diligence 

reviews, which were conducted prior to and after 

NextBank’s closure and appointment of the conservator. 

• Discussed the progress of FDIC’s investigative efforts with 

FDIC DRR investigators in Dallas, Texas. 

 

• We interviewed a FDIC Division of Supervision examiner who 

had participated with OCC on reviews and examinations at 

NextBank. 

We conducted our review in accordance with generally accepted 

government auditing standards. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 42 
Appendix 2 

Chronology of Significant Events

Chronology Of Events In NextBank’s History

06/96 Internet Access Financial Corporation, subsequently renamed 

NextCard, Inc. (NCI) in October 1998, is incorporated in the State of 

California to offer Internet-based consumer financial services. 

12/23/97 The NCI Visa is first offered to the public, with loans originating 

through the NCI website. Credit cards are issued solely through a 

strategic alliance with an unaffiliated bank. 

12/10/98 NCI files a charter application with OCC for a new national bank. 

01/12/99 NCI terminates its Consumer Credit Card Program Agreement with its 

strategic partner and begins purchasing credit card receivables from the 

partner using secured lending facilities extended to a subsidiary, NCI 

Funding Corporation. 

02/16/99 OCC and FDIC conduct charter field investigation. 

05/08/99 OCC grants NCI conditional approval to establish a new national, 

limited purpose credit card bank. Conditions include minimum capital 

greater than 6.5 percent of managed assets and limiting securitizations to 

not more than 73 percent of aggregate receivables for three years. 

 

05/19/99 NCI completes its Initial Public Offering (IPO) with gross proceeds 

of approximately $138 million. 

07/99 FDIC’s San Francisco Regional Office recommends denial of insurance, 

based on excessive stock-based compensation to insiders and 

noncompliance with its statement of policy on stock benefit plans. 

08/16/99 NCI files notice to acquire the charter of Textron National Bank (TNB) of 

Costa Mesa, California an almost dormant bank, insured by FDIC. 

09/15/99 NCI’s change in control becomes effective. TNB is renamed NextBank, 

National Association, a new limited purpose national credit card bank. 

Total Assets were about $313 million by September 30, 1999. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 43 
Appendix 2 

Chronology of Significant Events

12/06/99 OCC conducts a 60-day limited scope examination of NextBank as of 

September 30, 1999. CAMELS 2/222322. 

12/14/99 NCI completes a follow-on public offering with gross proceeds of 

approximately $161 million. 

03/00 Founder, Chairman and CEO of NCI steps down, retained 

as Chief Strategy Officer. 

05/08/00 OCC begins first full scope examination based on March 31, 2000 data. 

Total Assets as of March 31, 2000 were $696 million. 

05/00 NextBank submits a revised business plan for 2000. 

07/11/00 FDIC requests to attend exit meeting due to concerns about rapid growth, 

increasing risk profile and lack of controls. 

7/00 OCC requested NCI’s Board Of Directors to develop a Capital Assurance 

Agreement between the bank and NCI. 

09/06/00 OCC holds an exit meeting with NextBank on the May 2000 examination. 

OCC concludes that the bank’s condition is satisfactory and assigns 

CAMELS ratings of 2/222322. FDIC has reservations with OCC’s 

ratings, but concurs, lacking information that would substantiate a lower 

rating. Total managed assets were $951 million at June 30, 2000. 

10/26/00 Based on the May 2000 examination, NextBank’s Board of Directors 

adopts Board Resolution including a Capital Assurance Agreement. 

12/00 OCC on-site visit to review NextBank compliance with the Board 

Resolution. OCC finds that NextBank made minimal progress in 

addressing issues raised in the Board Resolution and asset quality issues. 

01/01 NextBank issues new Capital and Business Plans. 

01/02/01 OCC on-site review of NextBank securitizations and compliance with 

Board Resolution. OCC considers securitization activity satisfactory. 

However NextBank is not in full compliance with Board Resolution. OCC 

asks NextBank management to re-write the Capital and Business Plans. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 44 
Appendix 2 

Chronology of Significant Events

03/01 OCC on-site visit to evaluate NextBank’s compliance with Board 

Resolution. OCC finds only partial compliance. 

05/01 OCC begins a full scope examination, with FDIC participating. NextBank 

expanding subprime loan market, growing greater than planned, planning 

and control systems not keeping up with growth, and the bank deviates 

from original business plan. Total managed assets $1.9 billion as of 

March 31, 2001. 

07/13/01 OCC transfers NextBank supervision from the Western District to its 

Washington, D.C. Headquarters Special Supervision and Fraud Division. 

08/20/01 OCC begins Phase 2 of the full scope examination with an expanded 

team of specialized examiners. 

09/30/01 OCC examiners ascertain NextBank’s true financial condition, leading to a 

reduction of its capital position by $96 million. OCC deems that

NextBank is providing implicit recourse on securitized assets. Total Risk 

Based Capital is reduced to 5.38 percent, placing NextBank in the 

“significantly undercapitalized” PCA category. 

10/04/01 NCI retains outside investment bank to market the parent and bank for

sale, likely indicating that management is unwilling or unable to improve 

NextBank’s capital position. 

11/09/01 OCC asks NextBank’s Board of Directors to request in writing that NCI 

provide capital support as required under the Capital Assurance 

Agreement. 

11/16/01 OCC issues a PCA Directive requiring NextBank to file an acceptable 

Capital Restoration Plan with OCC by December 31, 2001, or a plan to

sell/merge/liquidate at no cost to the FDIC. 

12/31/01 NextBank files a Capital Restoration Plan with OCC proposing either 

the sale of NCI to a third party or a liquidation of NextBank’s assets and 

liabilities. 

01/12/02 NextBank files an Asset Disposition Plan with OCC since a Capital 

Restoration Plan is not feasible. The Asset Disposition Plan is 

unacceptable to OCC and FDIC because of its high cost, lack of 

Material Loss Review of NextBank, NA (OIG-03-024) Page 45 
Appendix 2 

Chronology of Significant Events

assurance that a buyer could be found, and inability to raise enough 

money to retire the bank’s liabilities. 

02/07/02 OCC issues a Temporary Cease and Desist Order requiring 

NextBank to take action to enforce the Capital Assurance Agreement 

between the bank and NCI. 

02/07/02 OCC issues an Order of Investigation requiring NextBank to 

provide documents needed to assess the financial condition and evaluate 

the affairs of NextBank and to determine whether any enforcement action 

is appropriate against directors, officers, or employees of the bank. 

2/07/02 OCC closes NextBank and names FDIC as Receiver. 

03/02 SEC opens an investigation of NCI. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 46 
Appendix 3 

Glossary of Terms 

Allowance for Loan and 

Lease Losses 

A valuation reserve established and maintained by

charges against a bank’s operating income. As a 

valuation reserve, it is an estimate of uncollectable 

amounts that is used to reduce the book value of loans 

and leases to the amount that is expected to be

collected. 

Brokered Deposits Funds, which a bank obtains, either directly or 

indirectly, by or through a broker, for deposit into a 

deposit account. Brokered deposits include both those 

in which a single depositor holds the entire beneficial 

interest and those in which the deposit broker sells 

participations to one or more investors. Under 12 Code 

of Federal Regulations § 337.6, only “well capitalized” 

banks may accept brokered deposits without FDIC 

approval. 

CAMELS The OCC and other bank regulators use the Uniform 

Financial Institution Rating System to evaluate a bank’s 

performance. CAMELS are an acronym for the 

performance rating components: Capital adequacy, 

Asset quality, Management administration, Earnings,

Liquidity, and Sensitivity. 

Implicit Recourse An implied obligation for the bank to make good all 

credit losses in accounts sold. 

Individual Minimum 

Capital Requirement

OCC may establish the minimum level of capital for an 

institution it supervises. This enforcement action is a 

special capital requirement set case-by-case for 

associations with unacceptably high-risk profiles. 

Informal and Formal 

Enforcement Actions 

Informal enforcement actions are documents that 

provide a bank with guidance in addition to that 

provided by the Report of Examination. Informal 

actions are those instances where it is desirable to have 

commitments from a bank’s management and board of 

directors. Formal enforcement actions are reserved for 

significant safety and soundness or compliance 

Material Loss Review of NextBank, NA (OIG-03-024) Page 47 
Appendix 3 

Glossary of Terms 

problems that, unless corrected, constitute a present or 

future threat to the survival of the bank or otherwise

pose a serious threat to the bank’s safety and 

soundness. 

Order of Investigation Orders approved by Washington Supervision Review

Committee and the Senior Deputy Comptroller for Bank 

Supervision Operations, which authorize formal 

investigations of certain national banks. Once issued 

the Comptroller’s representatives are authorized to 

subpoena documents and testimony from the entities 

within and outside the bank under investigation. 

Prompt Corrective Action A framework of supervisory actions for insured 

institutions, which are not adequately capitalized. 

These actions become increasingly severe as an 

institution falls into lower capital categories. The 

capital categories are: Well Capitalized, Adequately 

Capitalized, Undercapitalized, Significantly 

Undercapitalized, and Critically Undercapitalized 

(12 USC § 1831o). 

Subprime The term refers to the credit characteristics of the 

individual borrowers. Subprime borrowers typically 

have weakened credit histories that include payment

delinquencies, and possibly more severe problems such 

as charge-offs, judgments, and bankruptcies. They

may also display reduced repayment capacity as 

measured by credit scores, debt-to-income ratios, or

other criteria that may encompass borrowers with 

incomplete credit histories. 

Temporary Cease & 

Desist Order 

Interim order to impose immediate measures pending 

resolution of a final cease and desist order. May be

challenged in U.S. District Court within 10 days of 

issuance but effective on issuance. Pursuant to 

authority under 12 USC § 1818. 

Material Loss Review of NextBank, NA (OIG-03-024) Page 48 
Appendix 4 

Management Comments 

Appendix 4 

Management Comments 

Material Lo Material Loss Review ss Review of NextBan of NextBank, NA (OIG-03-024) Page 49 , NA (OIG-03-024) Page 49 
Appendix 5 

Major Contributors To This Report

Inspector General, Office of Audit

John A. Richards, Audit Manager 

John E. Carnahan, Auditor-in-Charge 

Jack Gilley, Auditor 

John Mansfield, Auditor 

Garrett W. Gee, Auditor 

Material Loss Review of NextBank, NA (OIG-03-024) Page 50 
Appendix 6 

Report Distribution 

U.S. Department of the Treasury

Office of the Under Secretary for Domestic Finance 

Office of the Assistant Secretary for Financial Institutions Policy 

Office of Strategic Planning and Evaluations, Departmental Offices 

Office of Accounting and Internal Control, Departmental Offices 

Office of the Assistant Secretary for Public Affairs 

Office of The Comptroller of the Currency 

Comptroller 

Deputy Comptroller Western District 

Senior Advisor-OIG/GAO Liaison 

Office of Management and Budget

OIG Budget Examiner 

U.S. General Accounting Office

Comptroller of the United States 

Federal Deposit Insurance Corporation

Chairman 

Material Loss Review of NextBank, NA (OIG-03-024) Page 51