Appeal of CAMEL Rating (Fourth Quarter 1996)

Background

A formal appeal was received from a bank that disagreed with the composite CAMEL rating of "3" assigned during their most recent safety and sound­ness examination. The bank's chairman provided a summary of the bank's view of the more significant misstatements and omissions of fact included in the Report of Examination (ROE):

1. The decline in the Tier I capital to assets ratio was the result of significant asset growth. During 1995, the bank acquired a portfolio of approxi­mately 20 international deposit-backed loans to­taling over $4OMM. The loans were transferred directly from another bank, no international currency transactions or wire transfers took place from banks outside the United States . The bank had more than 5 years experience in handling international deposit-backed loans. The loans have been reviewed at two special OCC exams and the underwriting was never criticized by the OCC.
2. The bank always has the option to not renew the short-term, international deposit backed loans, which would significantly increase the bank's Tier 1 capital ratio. The bank recently initiated this control and raised the Tier 1 capital ratio to approximately 7 percent by the nonrenewal of those loans.
3. Although the bank's Tier 1 leverage capital ratio did decline in 1995, the actual dollar amount of Tier 1 capital grew by over $1MM, a 40 percent increase. The growth was primarily attributed to an increase in interest income, which was generated by (a) the deposit-backed loans, (b) the increase in value of the bank's mutual fund portfolio, and (c) a capital injection by the bank's owner.
4. The bank's mutual fund investments were also subject to OCC reviews and have been re-examined numerous times over the five years the bank has managed this portfolio. The interest rate risk was never mentioned as a major concern of the OCC prior to this exam.
5. Although this is the first time the OCC has recommended that the bank's capital plan include the impact of fluctuations in interest rates and that the bank's written policies set forth procedures to control and inform the board of directors of interest rate risk, the board has regularly been apprised of the degree of interest rate risk and its impact on capital and earnings and has always accepted those levels as manageable.

In the appeal letter the chairman also stated that while the bank does not agree with the conclusions drawn by the OCC or the degree of severity afforded many of their concerns, the board and management have already taken the following action to resolve the major concerns as follows:

1. The ROE indicates that Tier 1 capital is inadequate at 4.24 percent as of year end. Since the bank's request for an exception to operate the bank below the minimum ratio was not granted, the board of directors passed a resolution to increase Tier 1 capital to 6 percent within 9O days by controlling the renewal of the deposit-backed international loans.
2. The bank has disposed of all of its mutual fund investments to reduce their impact on capital and earnings from interest rate risk.

The chairman also noted that at the time of appeal the bank's Tier 1 leverage ratio was already approximately 7 percent.

Discussion

During the third quarter of 1995, the bank acquired a portfolio of loans made to foreign corporations and individuals secured by third party certificates of deposit (offshore shell corporations). On September 30, 1995, the bank reported a Tier 1 leverage ratio of 4.05 percent due to the funding of the $40MM in deposit-backed international loans during the third quarter. A month later the bank requested authority to operate with less than the minimum Tier I leverage ratio required under 12 CFR 3.6. The bank's request for an exemption was not granted. As of December 31, 1995, the bank's Tier 1 leverage ratio was 4.24 percent.

The bank's ROE describes the Office of the Comptroller of the Currency's (OCC's) primary concern as the drop in the bank's Tier 1 capital as a percent of adjusted total assets (leverage ratio) to an unacceptable level. The drop in the leverage ratio was a result of the bank significantly increasing their holdings of loans to foreign corporations and individuals secured by third party certificates of deposit. Because of the drop in capital ratios, the banks supervisory office also became very concerned about the levels of interest rate risk, the banks earnings, and the supervision by management and the board of directors.

Subsequent to the examination the board of directors passed the following resolution:

BE IT RESOLVED, that steps will be taken to reduce the number and amount of international loans so that a capital-to-assets ratio of no less than 6 percent is attained within ninety days and, that future international business would not cause the bank to fall below 6 percent.

BE IT RESOLVED, that the banks mutual fund holdings will be disposed of within the next 30 days.

BE IT RESOLVED, that at this time, mutual funds will not be considered an appropriate investment for the bank.

Through runoff of a portion of the banks deposit backed loans, the banks Tier 1 capital ratio was ap­proximately 7 percent at the time of the appeal and the bank had disposed of all of its mutual fund investments.

Conclusion

The significant growth in the deposit backed loans during 1995 materially changed the banks risk profile. The ombudsman concluded that at the time of the examination the "3" rating assigned in the bank's most recent ROE was appropriate. However, the subsequent actions taken by the board to resolve the OCC's major concerns changed the risk profile of the bank to the point of justifying a new examination: The ombudsman requested the supervisory office to schedule an examination to reassess the bank's current condition.

Material Subsequent Event: The bank was recently re-examined by the supervisory office and the bank's composite CAMEL rating was upgraded to a composite CAMEL "2."