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Appeal of Composite Rating and Component Ratings for Asset Quality and Management (Second Quarter 2009)


A bank appealed to the Ombudsman the component ratings for asset quality and management assigned as a result of its most recent examination. The bank also appealed the assigned composite rating. The appeal stated asset quality and management are more reflective of a 4 rather than a 5 rating. Further, the bank stated if the ratings for asset quality and management were increased, then increasing the composite rating to 4 from 5 would also be warranted.



The appeal agreed with comments in the report of examination (ROE) which cited past underwriting practices and the weakened economy as reasons for the escalating volume in problem assets. Additionally, the bank stated the OCC recognized management for implementing a satisfactory loan policy but insufficient time had passed to have the desired impact on new loan underwriting. Therefore, the appeal stated the asset quality rating should be 4 not 5.

The failure to comply with the formal agreement with respect to hiring of a senior lending officer (SLO) is based solely on the fact insufficient time has passed to determine the SLO's effectiveness. Therefore, the management rating should be 4 not 5. Finally, if the ratings for asset quality and management were raised to a 4, the appeal asserts a change in the composite rating to a 4 was warranted.

Supervisory Office

The supervisory office concluded weaknesses in underwriting and credit administration persist. The supervisory office determined management failed to estimate credit risk in the portfolio and was unwilling to recognize losses in a timely manner even when collateral values were readily available. Examiners directed charge-offs and provision expense. Inaccurate problem loan identification, liberal advance rates, inadequate collateral valuations, and excessive financial statement exceptions contributed to the determination of unsafe and unsound practices. These unsafe and unsound practices resulted in a directed provision expense totaling $1 million and a violation of law. The repeat criticisms relating to problem loan identification, inadequate allowance for loan and lease losses (ALLL), liberal underwriting, indefinite or liberal repayment terms, and ineffective corrective actions all reflected poorly on management and the board of directors.

Additionally, the ROE concluded the injection of capital did not come from external sources as had been indicated by the bank president. The capital injection came from a loan made by the bank to two directors. This transaction is inconsistent with accounting guidance and violates the law by overstating the bank's capital position. Accordingly, the 5 composite rating is based on critically deficient management, severe asset problems, negative earnings, and inadequate capital.


The Ombudsman reviewed the information submitted by the bank and by the supervisory office. The Ombudsman concludes the supervisory office's asset quality rating of 5, management rating of 5, and composite rating of 5 were all reasonable.

Asset quality is evaluated on the adequacy of underwriting, strength of credit administration, the level and severity of problem assets, and management's ability to identify and control risks within its portfolio. The underlying cause of the bank's deterioration was poor underwriting exacerbated by current economic conditions. Although a majority of classified assets were rated substandard, the lack of updated collateral values called into question the true value of the assets. Additionally, the ROE describes underwriting weaknesses in new credits indicating credit administration has not improved under a new SLO. The level of nonperforming assets remained high, the trend was not improving, and inadequate supervision of the portfolio persisted. The bank's level of problem assets and credit administration weaknesses had not declined with the addition of a new SLO. Therefore, the Ombudsman concluded the assigned rating of 5 was reasonable.

The Ombudsman noted the appeal did not address any of the management issues described in the ROE except those related to lending. Examiner directed charge-offs and ALLL provisions should have been recognized by management. Management violated the law and acted inconsistently with accounting guidance in its attempt to raise capital. Board members continued to receive payments in excess of those paid by other banks of similar size. The bank provided no evidence to refute the claims of the supervisory office regarding inadequate oversight by management and the board of directors. Accordingly, the 5 rating for management was reasonable.

The Ombudsman concluded the composite rating of 5 was well-supported and reasonable. The bank's appeal provided no rebuttal to the facts as they existed at the time of the examination. The volume and severity of problems were beyond management's ability or willingness to control or correct. Immediate outside financial or other assistance was needed in order for the financial institution to be viable and ongoing supervisory attention was necessary.