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Appeal of Component Ratings, Matters Requiring Attention, Troubled Condition Designation, and Compliance with an Informal Enforcement Action (Fourth Quarter 2012)


A federal savings association (FSA) appealed material supervisory determinations in the most recent Report of Examination (ROE) which was not issued until seven months after the examiners left the bank. Specifically, the FSA appealed:

  • Component rating downgrades for management from 2 to 3 and liquidity from 1 to 2;
  • Matters Requiring Attention (MRAs) for (1) management and board supervision, (2) business plan, (3) problem asset reduction plan, (4) capital management and planning, (5) independent loan review, (6) concentrations risk management, and (7) internal audit;
  • Compliance with the Memorandum of Understanding (MOU);
  • The “troubled condition” designation; and
  • The direction of credit risk and liquidity risk.


With respect to the component ratings for management and liquidity, the FSA argued the downgrades were unwarranted. The appeal stated the board and management had provided strong oversight of the organization. Despite the high level of problem assets and earnings deficiencies, the bank remained well capitalized and the institution was currently profitable with ample liquidity. Each member of the senior management team has over 30 years of banking experience and receives necessary training to understand changes in regulatory requirements. The appeal further stated the FSA had demonstrated improved performance in all areas and its risk profile was decreasing; therefore, the direction of credit risk was decreasing rather than increasing. In addition, the appeal stated liquidity was managed by a competent team and the return to profitability minimized liquidity risk, supporting a stable direction for liquidity risk.

With respect to the MRAs, the appeal argued the FSA submitted the required problem asset reduction plan, business plan, and capital plan with no feedback from the supervisory office. The FSA exceeded the concentration limit for church loans only because capital declined, not because of new loan originations. The bank obtained an external loan review which found no issues; therefore, the bank argued the external loan review MRA should be removed. The appeal further stated the board approved its risk assessment and additional internal audits were completed or were in process; therefore, the internal audit MRA was unsupported and did not rise to the level of a supervisory concern. Lastly, the appeal stated there was no justification to require the bank to perform a board and management study. At most, such a requirement should be postponed until conclusion of the next scheduled examination.

The FSA deemed itself in compliance with the informal enforcement action as all required actions were taken. The FSA disagreed with the “troubled condition” designation and requested the ombudsman reverse that designation.


The ombudsman thoroughly reviewed the information submitted by the FSA and the supervisory office.  The ombudsman conducted the review using the standards in effect at the time of the examination including Section 330 – Management Assessment and Section 530 – Liquidity of the Office of Thrift Supervision Examination Handbook.  The ombudsman also used the Comptroller’s Handbook – Bank Supervision Process regarding risk assessments and MRAs and the Uniform Financial Institutions Rating System for guidance on component ratings.  OCC Bulletin 2011-37 Bank and Federal Savings Association Supervision Operation Enforcement Action Policy provided guidance on informal enforcement actions and 12 C.F.R. § 163.555 provided guidance on the “troubled condition” designation.


Management rating

The ombudsman concurred with the supervisory office regarding the downgrade in management from 2 to 3. Management and board supervision need improvement. The high level of occupancy expense had plagued the bank since 2003; management did not take immediate actions to reduce its impact on earnings performance. Beginning in 2009, asset quality issues emerged and further diminished earnings performance. Since that time, the composite rating and component ratings for asset quality and earnings have been less than satisfactory. These persistent problems were reflected in declining capital levels. The corrective actions taken by the board and management have not resulted in substantial improvement through March 2012. The continuation of less than satisfactory operating performance and asset quality as well as risk management deficiencies related to external loan review, internal audit, and concentration management reflect negatively on the leadership provided by management and the board of directors.


The ombudsman concurred with the supervisory office regarding the downgrade in liquidity from 1 to 2. A rating of 1 indicates strong liquidity levels and reliable access to sufficient sources of funds on favorable terms to meet present and anticipated liquidity needs. The continuation of the composite 3 rating and the high level of classified assets may impair the bank’s ability to access funds on reasonable terms; therefore, a 2 rating was more appropriate. A 2 rating indicates satisfactory liquidity levels and funds management practices.

Matters Requiring Attention (MRAs)

  1. Ensure competent board and management supervision – The supervisory office provided adequate support for this MRA. The cause of the bank’s deterioration related to management’s decision to acquire and/or expand branch operations, lend in areas outside of management’s expertise, and failure to take timely and appropriate corrective actions. The examination also identified weaknesses in risk management; specifically, internal audit, loan review and loan concentration management. As such, it is in the best interest of the bank to perform an assessment of senior management capabilities.

    The appeal requested the ombudsman remove comments in the ROE regarding weak risk management practices, limit comments regarding weaknesses in board and management supervision to earnings and problem assets, and postpone the requirement to perform an assessment of the board. The ombudsman determined the ROE comments and required corrective actions were well supported.
  2. Business plan – The supervisory office provided adequate support for this MRA. This MRA was also cited during the 2010 OTS examination. The bank reported negative earnings each quarter from 2009 through 2011. Actual performance often varied from planned performance due to higher than expected loan loss provisions or higher losses on the sale of Real Estate Owned. The most recent business plan projected positive earnings by year-end 2012 and the FSA did report positive earnings for the first quarter of 2012. While recent performance to projections is positive, it would be premature to remove the requirement for the business plan until the bank’s strategy had proven effective in sustaining profitability. Therefore, the bank remained in noncompliance with the MOU.
  3. Reduction in problem assets – The supervisory office provided adequate support for this MRA. This MRA was also cited in the 2010 examination. Based on information submitted by the bank as part of the appeal, problem assets fluctuated between 90% and 63% from year-end 2009 through first quarter 2012. The 2011 examination reported problem assets of 66.8% and problem assets at the time of appeal were 63.3%. The FSA will be considered in compliance with this MRA when problem assets are reduced to an acceptable level.
  4. Capital management and planning – The supervisory office provided adequate support for this MRA. The level of Tier I Capital has declined each of the past three years and fell short of the FSA’s target. The Capital Plan submitted to the supervisory office provided insufficient specifics as to how the FSA would improve capital and acknowledged there were limited alternatives to raise capital other than earnings.
  5. Independent loan review program – The supervisory office provided adequate support for this MRA. The external loan review conducted as of March 31, 2012 and received by the bank on June 25, 2012 was not available to the examiners prior to issuing the ROE. The completion of an independent loan review, in and of itself, does not fulfill the need to develop a comprehensive, on-going program. Therefore, the FSA had not fulfilled the requirement of an effective program.
  6. Concentrations risk management – The supervisory office provided adequate support for this MRA. The ombudsman recognized that church loans exceeded the limit due to a reduction in capital, not because of new loan originations. Although the FSA was within limits at the time of the appeal, the board and management had not developed a plan to maintain compliance.
  7. Internal audit – The supervisory office provided adequate support for this MRA. With respect to improvements to the internal audit program undertaken or in process at the time of the appeal, there was insufficient information available to determine the effectiveness of the actions taken. Completion of additional audits, in and of itself, does not fulfill the requirement of a comprehensive, on-going internal audit program.

With respect to disagreement with the direction of credit risk as increasing, the ombudsman determined the quality of credit risk management is weak and the direction of credit risk is decreasing. The high level of problem assets, noncompliance with concentration limits, and lack of an independent loan review function were indicative of weak risk management. The FSA took steps to address these areas of weakness, which supported a decreasing direction of risk.

With respect to disagreement with the direction of liquidity risk as increasing, the ombudsman concurred with the increasing direction of risk. As stated above, the prolonged less than satisfactory composite rating as well as the downgrade in management may increase costs to access secondary liquidity sources.
With respect to the “troubled condition” designation, the ombudsman found the supervisory office complied with regulatory requirements. 12 C.F.R. § 163.555 defines “troubled condition” as a federal savings association:

  1. Having a composite rating of 4 or 5 as defined in §116.5(c):
  2. Subject to a capital directive, a cease and desist order, a consent order, or a formal written agreement, or a prompt corrective action directive relating to the safety and soundness or financial viability of the savings association unless otherwise informed in writing by the OCC; or
  3. Informed in writing by the OCC that it is in troubled condition based on information available to the OCC.

The supervisory office informed the FSA in writing of the “troubled condition” designation because of heightened concerns with earnings and the inability to accrete to capital. The “troubled condition” designation placed restrictions on changes in directors and senior management as well as severance agreements.

The ombudsman notified the supervisory office to change the supervisory record to show the quality of risk management as weak and the direction of credit risk as decreasing.