Background
The ombudsman
received a formal appeal of examination conclusions involving the
sensitivity to market risk, earnings, and management component
ratings. The bank's
appeal stated that in the Report of Examination the OCC assigned the
bank a 3 rating for sensitivity to market risk, a 5 rating for
earnings, and a 5 for management. Bank management and the
board of directors' contention was that these CAMELS component
ratings did not accurately reflect the bank's condition at the time
of the examination.
Sensitivity to Market Risk-Rating
3
Background
Management and
the bank's board believed that:
"Neither the
condition of the bank's sensitivity to market risk as of the
examination date, as compared to the last examination, nor the
quality of the bank's Asset/Liability Management Policy warranted
the OCC downgrading the bank's Sensitivity to Market Risk rating
from a ''2'' to a ''3.''
Furthermore,
by commissioning reports with outside consulting firms, which also
reflects the positive state of the bank's interest rate risk
management, the bank has illustrated sound risk management policies
and procedures.
The
supervisory office concluded in the ROE that the bank's interest
rate risk was slightly elevated because of an imbalance resulting
from assets repricing faster than
liabilities. The ROE
also commented that the board and management's planning and risk
management processes were deficient. Additionally, the
supervisory office believed the Asset/Liability Management Committee
had not taken an active role in managing the balance sheet or
interest rate risk.
Discussion
and Conclusion
In accordance
with OCC Bulletin 97-1 (''Uniform Financial Institutions Rating
System'') the sensitivity to market risk rating is intended to
reflect the degree to which changes in interest rates can adversely
affect the earnings and capital of a financial institution. Considerations in
determining the sensitivity rating are management's ability to
identify, measure, monitor, and control market risk, and the
adequacy of the capital and earnings in relation to the bank's level
of interest rate risk exposure. The ombudsman's review did
not find adequate support that the board and management were
actively managing the bank's interest rate risk (IRR) position.
Review of the
information provided to the ombudsman's office
revealed:
- The input
and assumptions used in the modeling were not well supported and
hindered an accurate assessment of the risk, making it difficult
to quantify the bank's risk exposure.
- While the
bank had purchased a complete bank simulator model, allowing for
greater accuracy and more assumptions, the bank had never used
this model.
- The modeling
reports reflected gap positions outside of those limits
established in the Asset/Liability management policy of the
bank.
- The
Asset/Liability Committee (ALCO) minutes provided no insight on
management's and the board's efforts to manage IRR. The only discussion
reflected in the ALCO minutes was pricing of depository products,
which lacked detail.
Furthermore, the minutes did not reflect the board's
desired balance sheet composition or strategy to manage
IRR.
Based on the
risk management weaknesses described above, the ombudsman concluded
that the 3 rating assigned during the examination was
appropriate.
Earnings-Rating
5
Background
The bank's
submission commented that:
Although at
the time of the last ROE, the bank was experiencing losses, it was
taking steps to increase earnings. During the past year, the
bank commenced its SBA and Credit Card program, both of which
introduced a significant revenue stream to the bank. The bank's earnings trend is
not negative and does not represent a distinct threat to the bank's
capital. During this
time the bank also raised additional capital to compensate for
funding the increased provision for loan losses. The increase in revenue from
the last examination and the nature of the bank's expenses in no way
can justify the downgrading of the bank's earnings rating. The OCC's assignment was
wholly improper.
Comments in
the ROE concluded that earnings remain poor and were eroding the
bank's capital. The
supervisory office also stated that management and the board needed
to take immediate and ongoing action to alleviate large continuing
losses and address the other weaknesses. Examiners' primary concern
was that continuing losses of the magnitude experienced in the last
years would threaten the bank's viability.
Discussion
and Conclusion
Pursuant to
OCC Bulletin 97-1 (''Uniform Financial Institutions Rating System'')
earnings are intended to reflect not only the quality and trend, but
also factors that may affect the sustainability or quality of
earnings.
Considerations in determining the earnings rating are the
following:
- The level of
earnings, including trends and stability,
- The ability
to provide for adequate capital through retained
earnings,
- The quality
and sources of earnings,
- The level of
expenses in relation to operations,
- The adequacy
of provisions to maintain the allowance or loan and lease losses,
and,
- The adequacy
of the budgeting systems and forecasting
processes.
The
ombudsman's review revealed that over the last two years, the bank
had no traditional core earnings. The bank experienced
net-operating losses in the last two years of approximately $600,000
and $900,000, respectively.
These losses included provisions to the allowance for loan
and lease losses of $600,000 and $700,000, respectively.
Furthermore,
the net interest margin declined from 4.60 percent to 3.80 percent
in the same time period due to increasing funding costs and
declining loan yields.
Net losses had eroded capital, necessitating an injection of
capital. Additionally,
the earnings posture of the bank could be further affected by the
bank's risk profile and risk management practices. These
include:
- The bank's
high credit risk profile as evidenced by the level of classified
assets centered in the unguaranteed
portion of SBA loans, past dues, and
non-accruals.
- Measuring
and monitoring risk management systems. For instance, credit risk
identification, underwriting standards, loan grading, allowance
methodology, and collection efforts remain
deficient.
- A weak
budgeting process with overly optimistic assumptions based on past
performance.
- The bank's
earnings posture, the high risk profile of the bank, and the
questionable future prospects cause a significant supervisory
concern and represent a distinct threat to the bank's viability
through the erosion of capital.
Therefore, the
ombudsman concluded that the 5 rating assigned during the
examination was appropriate.
Management-Rating
5
Background
The bank's
appeal letter stated management and the board have made a concerted
and significant effort to improve the depth and stability of bank
management by making position-specific improvements. They believed that through
the creation of new officer positions and the hiring of new
officers, the bank management team was significantly stronger at the
time of this examination than at the time of the last
examination. For these
reasons, bank management believed a downgrade in the bank's
management rating was inconsistent with the actual condition of the
bank.
The ROE stated
management and the board's supervision was ineffective. The ROE comments also
asserted management actions were not substantive nor were they taken
in a timely manner to strengthen the bank's loans and risk
management systems. The
bank continued to experience turnover in management and the
board. Additional
examination findings revealed the bank did not have a legal number
of directors, the president/chief-lending officer was terminated,
and the chief financial officer resigned.
Discussion
and Conclusion
Pursuant to
OCC Bulletin 97-1 (''Uniform Financial Institutions Rating System'')
the management rating is intended to reflect the capability and
performance of the board and management. Some considerations in
determining the management rating are:
- The level
and quality of oversight and support of all activities in the
bank,
- The overall
performance of the bank and its risk profile,
- Management
depth and succession,
- The adequacy
and reliability of financial and regulatory
reporting,
- The
accuracy, timeliness, and effectiveness of management information
and the risk monitoring systems appropriate for the institution's
size, complexity, and risk profile,
- The adequacy
of, and conformance with, appropriate internal policies and
controls addressing the operations and risk of significant
activities, and
- The ability
of the board of directors and management in their respective
roles, to plan for, and respond to, risks that may arise from
changing business conditions or the initiation of new activities
or products.
The
ombudsman's review revealed that the position specific appointments
did not improve the depth, stability, and expertise needed in the
board and management.
This finding was based on the
following:
- The board
and management did not demonstrate the ability to reverse the
deteriorating trends and improve the poor financial condition of
the bank.
- The board
and senior management had not developed and maintained appropriate
risk management systems given the risk profile of the
bank.
- Both the
board and management were unstable with no strategic direction
given the continual turnover in executive
management.
- The bank had
operated without the legal number of directors for the last two
years.
Strong
leadership is essential in a financially troubled institution. The board's effort to
provide leadership had not been effective. Therefore, the ombudsman
concluded the 5 rating assigned during the examination was
appropriate.