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Appeal of Composite Rating and Component Ratings for Management, Liquidity and Sensitivity to Market Risks (Fourth Quarter 2010)


A community bank appealed the downgrade in composite rating from 2 to 4 and component ratings for management from 2 to 4, liquidity from 2 to 3, and sensitivity to market risks from 2 to 3.


The bank's appeal stems from a two level downgrade in all the above CAMELS ratings when compared to the prior examination which was less than one year ago. The appeal states that earnings and asset quality had declined due to unpredictable economic factors and conditions beyond management's control and the decline was not a reflection of deficient board and management oversight. The appeal further stated the bank had an abundance of liquid assets which indicated that the bank could withstand any liquidity crisis. The appeal stated that although the bank was asset sensitive, management of interest rate risk was effectively controlled and monitored; therefore, the downgrade was unwarranted. Lastly, the appeal disagreed with the downgrade in the composite rating because there were no serious financial or managerial deficiencies; the bank's unsatisfactory performance was primarily a result of economic conditions that could not reasonably have been foreseen and were totally outside the bank's control.


The ombudsman conducted a comprehensive review of the information submitted by the bank as well as documentation supplied by the Supervisory Office (SO). The Uniform Financial Institutions Rating Systems (UFIRS) as defined in the Comptroller's Bank Supervision Process Handbook was used as the standard for determining the appropriate composite rating and component ratings for management, liquidity, and sensitivity to market risk. The bank was informed of the OCC's intent to issue a formal enforcement action; therefore, this review was limited to a determination that the standards were appropriately applied by the supervisory office in assigning the appealed ratings.

With regards to the downgrade in liquidity, the ombudsman found the ratings guidance was appropriately applied. The ROE acknowledged that sufficient liquid assets were currently on hand. However, consideration was given to the bank's ability to access secondary sources of liquidity at reasonable costs and the validity of contingency funding plans. The high volume of classified assets (loans and investments) could impact the bank's borrowing costs and borrowing capacity from collateralized lines of credit at the Federal Reserve or Federal Home Loan Bank. At the time of the examination, the ROE stated the bank had not stress-tested its contingency funding plan (CFP) during the past 12 months. Unless the CFP is tested using current operating conditions, its validity is questionable. The likelihood that the bank's current financial condition will impact liquidity levels in the near term made the downgrade appropriate.

With respect to the downgrade in sensitivity to market risk, the ombudsman found the ratings guidance was appropriately applied. Market risk management was ineffective in balancing the high cost of funds with low interest earning assets. As such, the net interest margin and earnings were negatively impacted. Based on the bank's balance sheet composition, there was high potential that market risk exposure could further impact earnings performance and capital.

With regards to the downgrade in the management rating, the ombudsman found the ratings guidance was appropriately applied. The management rating can be based on one factor or a culmination of many factors, depending on the severity of the issue. Each ROE since 2005 had cited, with increasing intensity, the need to measure, monitor, and control the commercial real estate (CRE) loan portfolio. Ineffective oversight of this portfolio by management and the board had contributed to the volume of classified loans and loan losses. This strategy, coupled with inadequate funds management systems, resulted in deficient earnings and capital to support the bank's risk profile. Management and board performance was deficient when considering the nature of the bank's activities. Therefore, the ombudsman concurred with the supervisory office rating.

Based on the factors noted above, the downgrade in the composite rating was appropriate. The bank operated under unsafe and unsound conditions that posed significant risks to its viability. Immediate correction of the deficiencies noted above, as well as others identified in the ROE, was necessary to return the bank to a healthy position.