Background
The
bank's board of directors appealed the downgrade of its overall
composite rating and the component ratings for consumer compliance,
asset quality, and management.
The bank had an overall composite rating of 1 for the last
five examinations until the most recent examination when a 2
composite rating was assigned.
The board was of the opinion that had the three
component ratings been properly rated, a 1 composite rating
would have been assigned.
The
appeal states that management disagreed with the downgrade in the
consumer compliance rating, because they believed the compliance
program was sound and there had been no change from the previous
examination. The Report
of Examination (ROE) noted that the compliance program was
satisfactory and stated a bank with a 2 rating is generally in a
strong compliance position.
It further stated that risk management systems were
satisfactory and management responds promptly to audit and
regulatory concerns.
The ROE notes management plans to implement enhancements
to internal controls in response to the OCC's 2004 Fair Lending
examination and Bank Secrecy Act weaknesses. These issues were identified
internally and confirmed by OCC examiners.
Management
disagreed with the asset quality rating of 2 as they believed that
asset quality remains strong as evidenced by the low level of
classified assets, historical losses, past dues, and nonaccruals.
The supervisory office stated that the downgrade in the asset
quality rating was attributed to identified
weaknesses in risk management practices in the commercial real
estate (CRE) portfolio. Specifically, the weaknesses included
portfolio and concentration management and reporting, market
analysis, appraisal processes, policy exception reporting, and the
allowance for loan and lease losses (ALLL). The overall level of
risk had increased significantly from the prior examination without
a commensurate improvement in risk management practices. Several of these weaknesses
were noted at the previous examination.
Management
disagreed with the management rating of 2 since they believed the
downgrade was the result of the lack of credit risk management
processes and weaknesses noted in their trust area. Management believed that the
due diligence it performed on the group of trust accounts was
adequate. Furthermore,
they believed that the supervisory office was overly critical of
management's slower-than-expected development of loan
concentration reports, analyses, and policies. The supervisory office
stated the downgrade was because of risk management practices
lagging behind the bank's substantial growth and change in the loan
mix and the lack of due diligence over a group of new trust
accounts. Violations of
law were noted related to the oversight of these trust
accounts.
Management
disagreed with the downgrade of the composite rating to 2, because
they believed that, if the compliance, asset quality, and management
ratings had been appropriately assigned a 1 rating, then this would
have resulted in a 1 composite rating. The supervisory office
stated that the downgrade was reflective of a higher risk profile,
increased leverage, higher concentrations in the loan portfolio, and
the need to strengthen credit risk management
practices.
Discussion
and Conclusion
The
ombudsman conducted a review of the information submitted by the
bank and supporting documentation from the supervisory office. The review included meetings
with the bank's senior management team as well as with members of
the supervisory office.
The
ombudsman ruled that the conclusion reached by the supervisory
office regarding asset quality was appropriate and well
supported by the facts at the time of the examination. The ROE and other OCC
communications with the bank outlined concerns with the bank's
approach to managing and monitoring real estate-related
concentrations in the loan portfolio. While the ombudsman agreed
with management's quantitative assessment on asset quality, the
overall level of risk had increased from the previous examination
without a commensurate improvement in risk management
practices. The
ombudsman was particularly concerned with the board's and
management's approach to managing and monitoring concentrations in
the lending portfolio.
The
ombudsman ruled that the conclusions reached by the supervisory
office regarding consumer compliance and management were more
reflective of a 1 rating.
The ombudsman noted the existence of a strong compliance
management program including an efficient system of internal
controls. Bank
management demonstrated that it understands and is committed to all
aspects of compliance risk management. While the ROE did identify
areas needing improvement in the compliance area, these can be
addressed in the normal course of business and do not materially
detract from the overall quality of the compliance program. Furthermore, the bank has a
history of substantial compliance with laws and
regulations.
The
ombudsman noted that the board and management have demonstrated the
ability to effectively administer the bank's affairs. This is evident in the
strong audit and compliance culture, strong internal control
structure, good historical financial performance, and management's
depth and knowledge to plan and respond to risks as changes in
business conditions occur.
While the bank needs to strengthen the credit risk management
processes recommended by the OCC supervisory office, the ombudsman
believes management has demonstrated over multiple business cycles
the ability to implement the needed controls during the normal
course of business.
Based on these factors, the ombudsman concluded that a 1
rating is more reflective of the management
component.
Finally,
the ombudsman agreed with the concerns raised by the supervisory
office, that the higher risk profile, increased leverage, higher
concentrations in the loan portfolio, and the need to strengthen
credit risk management practices support the assigned 2 composite
rating.
Additionally, the bank's low risk-based capital level at
the time of the examination and the low ALLL provides little
flexibility to handle unforeseen losses of
substance.
Appeal of Composite and
Component Ratings - (First Quarter 2006)
Background
The
bank's board of directors appealed the overall composite, capital,
and management ratings.
A downgrade to a 3 rating was assigned to the composite and
capital components.
There was no change to the management rating of 3; however,
the board believed that based on projected strategic growth and
profitability goals, an upgrade to a 2 was warranted. Additionally, the informal
Memorandum of Understanding (MOU) issued as a result of the Report
of Examination was appealed.
The
board disagreed with the assigned capital rating of 3, because the
bank had maintained capital above the regulatory minimum level. According to management, the
bank's capital level either improved or stayed the same since the
previous examination and contended that it was in full compliance
with a strategic plan previously submitted to the OCC. Furthermore, management
stated that the bank's principal shareholder had demonstrated the
capacity to support the bank's capital needs. The supervisory office
stated that the downgrade was because of declining capital ratios
and the lack of a formal capital plan. Additionally, the
supervisory office was concerned with the overall weak earnings
trend and that the bank would need a capital injection by year-end
2005.
The
board disagreed with the assigned management rating of 3 based on
the implementation of their strategic plan. Management stated that the
strategic plan was not fully implemented and that the bank had a
demonstrated capacity for future growth. Additionally, core earnings
were improving rapidly with potential improvement in
profitability as the strategic plan continued to be
implemented. The supervisory office stated that the key factor
in rating management a 3 was the failure of the board and management
to ensure that appropriate risk management processes were
maintained over the lending area. The supervisory office
believed that the bank's rapid loan growth, coupled with weak credit
risk management, low capital, and weak earnings posed a high
potential for future problems. Subsequent to the examination, the
board replaced the president and senior credit administrator in an
effort to improve credit administration and overall bank
management.
The
board disagreed with the composite rating, but provided little
support as to why the rating was in error. Management stated that the
condition of the bank had not deteriorated from the previous
year, but instead had improved dramatically in all key areas. The supervisory office
stated that the composite 3 rating was assigned because of a
combination of weaknesses in management, capital, and
earnings.
The
board appealed the MOU, but did not provide support as to what
provisions of the MOU it believed were inappropriate. The supervisory office
stated that it believed the MOU was appropriate to aid the bank
in addressing its long history of weak management, poor financial
performance, and weak credit risk management processes. Consideration was given to
the fact that the present level of problem assets was not severe and
the bank's principal shareholder had a history of providing
financial support.
Discussion
The
ombudsman conducted a review of the information submitted by the
bank and supporting documentation from the supervisory office. The review included
discussions with the bank's senior management team as well as with
members of the supervisory office.
The
ombudsman concurred with the supervisory office's conclusions of the
bank's weak financial and managerial deficiencies existing at the
time of the examination.
While certain aspects of the bank's operations appear to have
stabilized, overall financial performance was less than
satisfactory. The
bank's total asset growth had been erratic and earnings performance
had been weak to nonexistent.
Tier 1 leverage capital declined from a high of 10.09 percent
at year-end 2000 to 6.85 percent at year-end 2004. While asset
quality remained satisfactory, credit risk management practices
warranted improvement.
Although
the earnings rating was upgraded from a 4 to a 3, the ombudsman
concluded that earnings from core operations were insufficient
to support planned asset growth and augment capital. While nonrecurring items had
affected the quantity of earnings, the quality of earnings as the
primary source to support future operations was impaired by the
bank's below-average net interest margin. Capital levels were
insufficient without the capital injections by the principal
shareholder.
Conclusion
In
conclusion, the ombudsman concluded that the composite rating of 3
assigned at the examination was appropriate and complies with
the factors provided in the Uniform Financial Institutions Rating
System (UFIRS), (OCC Bulletin 97-1, "Uniform Financial Institutions
Rating System and Disclosure of Component Ratings,"
January 3,
1997). The
ombudsman also concluded that the ratings for capital, earnings, and
management were appropriate as assigned. Additionally, the ombudsman
ruled that the MOU entered into between the board of directors and
the OCC was reasonable and in the best interest of the
bank.