Skip navigation
Ensuring a Safe and Sound Federal Banking System for All Americans Site Map | Text Size: S M L


Resources for bankers

Appeal of Composite and Component Ratings and Matters Requiring Attention (Second Quarter 2017)


A federal savings association (bank) supervised by the Office of the Comptroller of the Currency (OCC) appealed the supervisory office’s (SO) determinations in the most recent report of examination (ROE). Specifically, the bank appealed the following:

  • Matter requiring attention (MRA) status denoted in the ROE
  • Component ratings of “5” for capital, asset quality, earnings, and management
  • Composite rating of “5”


The appeal argued that the SO did not accurately characterize the status of the MRAs in the ROE in stating that a few of the MRAs were addressed and 10 of the 16 MRAs remained open and required further action. The appeal contended that of the 16 MRAs, six were closed, seven were pending validation, one was not yet due, and at most, two were past due.

The appeal stated that, according to the Uniform Financial Institutions Rating System (UFIRS), a rating of “5” for the capital component is intended to indicate a critically deficient level of capital, such that the institution’s viability is threatened. The appeal contended a rating of “4” was more appropriate because the bank was not critically undercapitalized, capital levels were not a threat to viability, capital ratios were increasing, and the bank was pursuing a recapitalization.

The appeal stated the asset quality rating of “5” was unsupported. The appeal contended that asset quality was not critically deficient and the level of classified assets did not pose an imminent threat to the bank’s viability as problem assets continued to decline. The appeal argued that the level of classified assets as a percentage of capital should not have been the sole justification for the asset quality rating and contended that the SO inappropriately linked the asset quality rating to the capital rating. The appeal asserted that the ROE is solely based on historical asset quality deterioration without regard to current trends and overall improvement. Finally, the appeal stated that the asset quality section should address the quality of the underlying assets. It further stated that the allowance for loan and lease loss (ALLL) calculation and related MRAs do not affect the quality of the underlying assets so they should not be a consideration for the asset quality rating.

The appeal stated that while earnings needed to improve, the rating of “5” was unsupported. The appeal argued that earnings were not critically deficient as the bank was profitable in most months in the past year, the bank projected profitability for the current year, and earnings did not erode capital.

The appeal argued that the outstanding MRAs, the accounting irregularities, and the bank’s overall condition do not support the rating of “5” for management. The bank contended that management and the board have always demonstrated the ability to correct problems identified during the examination process, corrected a majority of the outstanding MRAs, and implemented initiatives to improve the bank’s condition. The appeal stated the management rating should be no worse than a “4.”

The appeal contended the composite rating was unsupported because the bank’s condition was improving and the problems identified were within management’s capability to correct. The appeal asserted that, according to the UFIRS, financial institutions with a composite rating of “5” exhibit extremely unsafe and unsound practices or conditions, but the ROE did not document unsafe and unsound conditions or practices as support for the bank’s composite rating. The appeal further argued that management addressed many of the MRAs, indicating a willingness and ability to correct deficiencies.

Supervisory Standards

The Ombudsman conducted a comprehensive review and primarily relied on the “Bank Supervision Process” booklet of the Comptroller’s Handbook, dated September 2007. The Ombudsman also relied on the “Community Bank Supervision” (dated January 2010) and “Rating Credit Risk” (dated April 2001) booklets of the Comptroller’s Handbook; OCC Bulletin 2014-52, “Matters Requiring Attention”; and the Federal Financial Institutions Examination Council’s “Instructions for Preparation of Consolidated Reports of Condition and Income.”


The Ombudsman concurred with the bank that the SO must adjust the characterization of some MRAs to reflect the implementation of corrective action by management and the board.

The Ombudsman concurred with the SO’s assessment of a “5” rating for capital. The capital rating is not solely dependent on the prompt corrective action designation, and requires evaluation of various factors, including management’s ability to address emerging needs for capital, level of problem assets and ALLL, risk profile, quality and level of earnings, and access to capital markets and other sources of capital. Capital is critically deficient, the viability of the institution is threatened due to its high-risk profile, significant losses have led to capital erosion, and management has been unable to restore capital or develop an acceptable capital restoration plan. Capital ratios are decreasing, not increasing as noted in the appeal. The ALLL is flawed, and the SO was unable to determine if the reserve is adequate. In addition, the bank’s policies, procedures, training, and internal control environment are inadequate.

The Ombudsman concurred with the SO that asset quality was critically deficient and warranted a “5” rating. The Ombudsman determined that the SO appropriately credited the board and management’s attempts to change the composition of the loan portfolio to reduce credit risk when assessing the direction of credit risk. The ROE also acknowledges reduction in problem assets. While problem loans and net loan losses have declined, the overall levels remain high relative to the bank’s critically deficient capital and earnings and pose an imminent threat to the bank’s viability. The Ombudsman also determined that the SO appropriately linked the asset quality rating to the bank’s capital rating. As outlined in the “Bank Supervision Process” booklet, “Each component rating is based on a qualitative analysis of the factors comprising that component and its interrelationship with the other components.” Due to the interrelationships between component ratings, it is prudent to consider the bank’s capital when assessing the asset quality component rating. In addition, it is OCC and industry practice to assess problem assets as a percentage of capital. Finally, the Ombudsman concluded that it is appropriate for the SO to consider the quantity of credit risk as well as the quality of credit risk management when evaluating the asset quality component. The asset quality of a financial institution is rated based on an assessment of multiple evaluation factors, both qualitative and quantitative.

The Ombudsman concurred with the SO that earnings are critically deficient and rated “5.” The bank did not produce positive earnings as stated in the appeal and has not achieved sustained profitability. Within the past two years, the bank posted a quarterly loss in each quarter except one. Net losses have depleted already critically deficient capital levels. The bank’s projections of profitability for the current year are not reliable, and the bank is not operating under an approved strategic plan.

The Ombudsman determined that the SO appropriately assessed a rating of “5” for management reflecting critically deficient board supervision or risk management practices. Management and the board did not demonstrate the ability to correct problems and implement appropriate risk management practices as evidenced by failure to comply with multiple enforcement actions issued over several years, develop or submit acceptable capital restoration or strategic plans, raise capital, and ensure timely and effective corrective actions through past due or continuing MRAs. The accounting errors identified during the examination further supported the critically deficient risk management practices and represented additional significant risks that were inadequately identified, measured, monitored, or controlled.

The Ombudsman concurred with the SO rating of “5” for the composite. The ROE noted the bank’s overall condition is critically deficient, the viability of the bank remains a serious concern, and the bank needs immediate outside financial or other assistance to achieve long-term viability. These are all factors in the definition of a 5-rated bank. Past due MRAs, noncompliance with the enforcement actions, failure to recapitalize the bank, and identification of new supervisory concerns at each supervisory cycle do not demonstrate management’s ability or willingness to control or correct problems. Board and management supervision, earnings, capital, and asset quality were critically deficient or rated “5,” and were the key drivers for an overall “5” composite rating. According to UFIRS, “Financial institutions in this group exhibit extremely unsafe and unsound practices or conditions; exhibit a critically deficient performance; often demonstrate inadequate risk management practices relative to the institution’s size, complexity, and risk profile; and are of the greatest supervisory concern.”