Background
A formal appeal was received from a bank, which
disagreed with the composite CAMEL rating of "3" assigned to the
bank during its most recent safety and soundness examination.
The bank became involved in a retail loan
securitization program in 1993. The securitization program
began slowly with only one $35MM offering the first year. During 1994, the
securitization program grew to three offerings totaling
approximately $100MM.
The growth continued, and in 1995, the bank sponsored six
offerings totaling approximately 500MM. During the bank's 1993
examination, concerns were expressed about the lack of policies and
procedures to guide the bank's supervision of the securitization
program. During the
1994 examination, in addition to criticisms of the lack of policies
and procedures, questions were raised concerning the proper
accounting of the securitization program, which could have a major
impact on the bank's reported earnings, capital, and liquidity. The impact of these issues
on the bank escalated during 1995, when the program grew
rapidly.
An examination began in May 1995, including a
review of the securitization program. The report of examination
(ROE) was mailed to the bank on August 30, 1995. The bank was assigned a
composite CAMEL rating of "2".
The ROE stated that because of continuing questions regarding
the securitization program, that portion of the examination would be
forwarded under separate cover. The ROE also stated that the
outcome of the portion of the examination covering the
securitization program could affect the assessment of the overall
condition of the bank.
This ROE briefly discussed some aspects of the loan
securitization program including discrepancies in the accounting and
management information systems (MIS) and lack of internal audit
coverage. The ROE
acknowledged that the bank had forwarded records to explain the
deviations in accounting and MIS reports, and stated that the
examiners would follow up with senior bank management.
A second ROE, summarizing the results of the
examination of the bank's securitization program, was forwarded to
the bank on December 8, 1995 with a start date of June 5, 1995. Significant weaknesses in
the administration of the program were found, which the supervisory
office believed significantly increased the risk profile of the
bank. The composite
CAMEL rating of the bank was changed to a "3" in this ROE.
Discussion
The ROE received by the bank in December 1995
highlighted significant weaknesses in the administration of the
securitization program, including:
- Weak board supervision.
- Ineffective systems and controls,
- Significant accounting discrepancies that could
substantially reduce the bank's capital base,
- Questionable accounting treatment of loan
sales, which could also impact capital, and
- Overall deficiencies in management's
handling of loan sales to funding sources, which could potentially
limit the volume of funds available to finance expansion of the
program.
The ROE indicated that the above-referenced
weaknesses spawned serious concerns about the bank's ability to
maintain the program's current level of operating performance. Management was requested to
take immediate corrective action, with the board of directors
closely supervising their progress. The bank was requested to
take the following actions:
- Implement effective risk management
systems,
- Commission a comprehensive audit of the program
by a qualified team and
- Develop a comprehensive quality control
unit.
Although the items listed above were cited as the
major steps needed to correct operating weaknesses, numerous other
supporting actions the board needed to take were detailed in the
ROE.
In the appeal letter, management of the bank
contended that the June examination:
- Covered the
same basic examination topics as the May examination with respect
to the securitization program,
- Failed to
provide any conclusions to the technical accounting or legal
questions raised in the May examination,
- Covered
matters that were nothing more than guidelines,
- Misstated
bank procedures or failed to recognize efforts undertaken by the
bank and
- Failed to
identify specific shortcomings of the bank's program, and only set
forth general guidelines for any bank engaged in a similar
program.
Conclusion
The bank's program grew rapidly between the 1994
examination and the 1995 examination. The bank had begun to
institute controls and procedures in the program during the 1995
examination; however, these controls were not sufficient to fully
manage the risk that the program posed to capital, earnings, and
liquidity.
The bank obviously committed resources to the
program after the examination (but before receiving further
assurance of the program's proper administration through a
comprehensive external audit, formal accounting opinions, and
independent risk management processes).
Although the June 1995 ROE outlined several
significant weaknesses in the administration of the bank's
securitization program that increased the risk profile of the bank,
the frustration the bank felt with the protracted timing of the 1995
examinations, particularly the delayed receipt of the ROEs was
understandable. In
addition, management's dissatisfaction that many of the affirmative
actions taken to enhance the program were not evaluated and
acknowledged during the interim period is legitimate.
Executive bank management did not disagree with
the importance of maintaining appropriate systems and controls to
protect the bank's involvement in such a rapidly expanding
program. However,
because of the rapid growth, sufficient controls had not been
instituted at the time of the June 1995 examination. During the ombudsman's visit
to the bank, he recognized that many enhancements to the bank's
systems and controls had been implemented since the June 1995
examination. Because of
the addition of these enhanced systems and controls, as well as
other improvements in the program, the ombudsman recommended the
immediate re-examination of the bank by the supervisory office.
The composite CAMEL 3 rating, assigned as a
result of the June 1995 examination, was found to be an appropriate
rating considering the risks inherent in the program at that
time. The additional
efforts taken since the June 1995 examination, to enhance risk
monitoring and control of the program, will be reflected in the next
examination.
Material Subsequent Event: The bank was recently
re-examined by the supervisory office and the bank's composite CAMEL
rating was upgraded to a composite CAMEL 2.