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A bank supervised by the Office of the Comptroller of the Currency (OCC) appealed to the Ombudsman the supervisory office’s (SO) conclusions in the most recent report of examination (ROE). Specifically, the bank appealed the component rating for asset quality and composite rating.
The appeal contends that the asset quality component rating more closely aligns with the definition of a 2 rather than a 3. The appeal states that the board and management have shown the ability to implement sustainable corrective actions regarding asset quality and lending, credit administration personnel have the necessary expertise to oversee the credit administration function, and the bank remains fundamentally sound.
The appeal contends that the bank’s overall condition more closely aligns with the rating of a 2 rather than a 3 for the composite rating. The appeal states that no component is more severely rated than 3, weaknesses identified in the examination are within the board and management’s capabilities and willingness to correct, the bank is financially stable, the bank is in substantial compliance with laws and regulations, and the overall condition of the bank has improved since the prior examination.
The Ombudsman conducted a comprehensive review of the appeal using the following supervisory standards in effect at the time of the examination:
The Ombudsman concurred with the rating of 3 for asset quality. According to the Uniform Financial Institutions Rating System (UFIRS), a rating of 3 is assigned when asset quality or credit administration practices are less than satisfactory. Trends may be stable or indicate deterioration in asset quality or an increase in risk exposure. The level and severity of classified assets, other weaknesses, and risks require an elevated level of supervisory concern. There is generally a need to improve credit administration and risk management practices. Refer to page 73 of the BSP booklet.
The bank’s failure to correct previously identified credit administration weaknesses and identification of new weaknesses led to an increase in credit risk exposure that requires an elevated level of supervisory concern. The ROE cited a new commercial credit risk management matter requiring attention (MRA) and assessed the two credit-related articles of the EA as not in compliance-past due.
Asset quality trends have shown some deterioration and an increase in risk exposure. The overall risk to the bank from the lending portfolio is moderate. While the overall level of classified and special mention assets is low, the greater concern is the unknown credit risk exposure in the loan portfolio. The sample of loans examiners reviewed showed inaccurate risk identification of problem loans by both the bank and external loan review as well as liberal underwriting that pose a moderate to high level of risk to earnings and capital. The loan portfolios also have a high level of policy exceptions.
Credit administration practices are less than satisfactory. Significant turnover in the credit department and the bank’s failure to implement effective training for staff in a timely manner have contributed to weak quality of credit risk management and increasing credit risk. The supervisory record supports that management has been ineffective at correcting the risk management concerns identified in asset quality over multiple examination cycles. Management also did not apply recommended downgrades from loan review or strengthen the underlying credits. This resulted in SO-identified loan downgrades during the examination.
Management and the board had sufficient time to implement corrective actions after the EA date. The actions they took in response to examiners’ conclusions of past-due MRAs and noncompliance with articles of the EA do not demonstrate ability and willingness to implement corrective actions.
The Ombudsman concurred with the composite rating of 3. According to the UFIRS, a composite rated a 3 is for financial institutions that show some degree of supervisory concern in one or more of the component areas. These financial institutions show a combination of weaknesses that may range from moderate to severe; however, the magnitude of the deficiencies generally will not cause a component to be rated more severely than 4. Management may lack the ability or willingness to address weaknesses within appropriate time frames. Financial institutions in this group generally are less capable of withstanding business fluctuations and are more vulnerable to outside influences than those rated a 1 or 2. Additionally, these financial institutions may be in significant noncompliance with laws and regulations. Risk management practices may be less than satisfactory relative to the institution’s size, complexity, and risk profile. These financial institutions require more than normal supervision, which may include formal or informal enforcement actions. Failure appears unlikely, however, given the overall strength and financial capacity of these institutions. Refer to page 71 of the BSP booklet.
The SO appropriately placed significant reliance on the supervisory concerns related to the management and asset quality component ratings of 3 when determining the composite rating. Composite ratings are generally closely related to the component areas assigned, but are not merely arithmetic averages of the component ratings, and some components often carry more weight than others. The management component rating is given special consideration when determining the composite rating. Management’s ability to respond to changing circumstances and address the risks that may arise from changing business conditions is an important factor in evaluating a financial institution’s overall risk profile and the level of supervisory attention warranted. Refer to page 70 of the BSP booklet.
Management and board performance has been rated 3 or needs to improve for multiple reports of examinations. All articles of the EA are past due, which indicates that management’s actions to correct the identified issues are often ineffective. The SO has identified risk management weaknesses in various areas of the bank’s operations during the past several supervisory cycles. The supervisory concerns have historically been identified by the SO. The board and management have not self-identified and self-corrected internal control and risk management weaknesses. In addition, informal enforcement actions needed to be issued to drive the board and management to implement effective, timely corrective actions.
