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A bank supervised by the Office of the Comptroller of the Currency (OCC) filed a formal appeal with the Ombudsman regarding the supervisory office’s (SO) conclusions in the most recent report of examination (ROE). Specifically, the bank disputed the following:
The appeal asserted that the ACL methodology MRA was unwarranted. The appeal stated that the bank complied with regulations and its practices, to use peer data when internal data is insufficient or lacks statistical relevance, are consistent with supervisory standards and provide a more accurate loss estimate.
The appeal asserted that the liquidity risk management MRA was not warranted. The appeal contended that the board and management fully and accurately identify, measure, monitor, control, and report liquidity risk. The appeal contends that the bank had effective processes and procedures given its low organizational complexity and seasoned and knowledgeable board and management.
The appeal asserted that the strategic and capital planning MRA was not warranted. The appeal contends the SO had not previously communicated concerns with the bank’s existing strategic or capital planning. The appeal asserts the SO did not fully comprehend the bank’s strategic planning process, which includes discussions documented in board minutes, pro forma projections, and employee-specific goals.
The appeal asserted that the sensitivity to market risk component should be rated 2 instead of 3 and disagreed with the assessment of IRR. The appeal contended that the bank used the same IRR tools and methodology from prior examinations that resulted in a reduction in short-term IRR and a positive effect on earnings performance. The appeal asserted that the board meeting discussions illustrated that the board and management understand financial interrelationships and managed the bank’s risk comprehensively rather than focusing on a single risk component. The appeal stated that the SO mischaracterized the bank’s non-maturity deposit runoff as something “simply allowed to happen” rather than a strategic decision to manage funding costs.
The appeal contended that the capital component rating should be a 2 instead of 3. The appeal asserted that the bank systematically increased tier 1 capital due to market conditions. The appeal disagreed that management and the board made strategic decisions that led to deteriorating earnings and balance sheet growth, resulting in volatility in the tier 1 leverage ratio. The appeal stated that total assets were stable and changes to the balance sheet were the result of reducing asset duration, thus mitigating balance sheet risk. The appeal noted that the SO must consider all capital sources, including the capacity of the holding company or shareholders when evaluating capital.
The appeal contended that the management component should be rated 2 instead of 3. The appeal asserted that the board and management were qualified, engaged, and largely unchanged since the prior examination, and market conditions during the supervisory cycle that were out of the bank’s control created unprecedented challenges for the banking industry. The appeal stated that the bank had withstood market forces over the supervisory cycle and still grew, generated earnings, and improved its interest rate position. The appeal asserted that the bank remained well capitalized, managed retail deposit outflow, controlled fundings costs, improved balance sheet duration, employed hedging strategies, maintained low classifieds, and complied with laws and regulations. The appeal questioned whether the OCC has an informal convention that the management component must be 3 rated if the earnings component is 3 rated.
The appeal contended that the composite rating should be 2 instead of 3. The appeal asserted that preliminary conversations indicated the bank would maintain a 2 composite rating with no notable concerns. The appeal noted that the SO concluded satisfactory ratings for the bank’s specialty components and questioned what weight the SO gave to those ratings when concluding the composite rating. The appeal highlighted that per guidance, the SO typically cites violations of laws or regulations or MRAs to address deficiencies but could achieve supervisory objectives by informal means without the undue burden on the bank of a formal, public enforcement action.
The Ombudsman conducted a comprehensive review of the appeal using the following supervisory standards in effect at the time of the examination:
The Ombudsman issued a split decision on the appeal. The Ombudsman concurred with the bank that the SO did not sufficiently support the ACL methodology MRA and that the direction of IRR was stable. For all remaining appealable matters, the Ombudsman concurred with the SO. The Ombudsman directed the SO to revise and reissue the ROE to capture the Ombudsman’s appeal decisions.
The Ombudsman concurred with the bank that the ACL methodology MRA is not warranted and directed the SO to remove the MRA from the ROE. While it is prudent for the bank to maintain documentation of how it reconciles external benchmark data to the bank’s loan portfolio, the lack of complete documentation did not rise to the level of an MRA. The process was not a deficient practice that may affect the bank’s condition and was not an unsafe or an unsound practice that would result in risk or damage to the bank. The Ombudsman noted satisfactory asset quality and risk management practices, adequate ACL balance, and satisfactory current expected credit loss policies and ACL model validation practices. The appeal documented a valid reason to rely on external data from a third party and the documentation weaknesses noted by the SO were within the board and management’s capabilities to correct. It is permissible for the bank to use information and data from third-party vendors. This is consistent with supervisory standards, including ASC 326-20-30, “Developing an Estimate of Expected Credit Losses,” the “Allowances for Credit Losses” booklet of the Comptroller’s Handbook, and OCC Bulletin 2023-11, “Interagency Policy Statement on Allowances for Credit Losses.”
The Ombudsman concurred with the SO’s decision to issue the liquidity risk management MRA that included concerns for risk limits, the contingency funding plan (CFP), and stress testing. The bank’s liquidity risk was high and increasing due to a high reliance on high-cost wholesale and non-core funding as well as limited access to low-cost deposits. These risk exposures adversely impacted earnings. Liquidity risk management practices were insufficient as the variety of liquidity reports management used to identify, measure, monitor, and control liquidity risk were ineffective in managing and controlling liquidity risk. The liquidity risk management deficiencies could reasonably be expected to cause material risk of harm to the financial condition by having to realize securities losses, being unprepared to handle a liquidity event, or experiencing continued deterioration in earnings due to inability to manage the cost of funds.
Risk limits for liquidity and funding risk were insufficient as they did not align with the bank’s liquidity risk profile. Liquidity ratios lacked consideration of wholesale funding sources and inaccurately depicted the bank’s liquidity risk. The primary measurement ratios for liquidity were flawed and ineffective for controlling risk as they did not consider situations where the bank may not be able to access wholesale funds due to regulatory or market restrictions and failed to consider cost of funds. While the board monitored compliance with various established liquidity risk limits, the board’s tolerance for wholesale funds was high and did not enable management to effectively control liquidity risk and its impact on earnings and capital.
The CFP needed improvement as it was not commensurate with the high liquidity risk. The CFP lacked effective early warning triggers to alert management of a potential liquidity event, did not outline specific action plans management would take during a liquidity event, and did not discuss whether management had tested the access and availability of potential funding sources. Finally, the liquidity stress testing needs improvement. Stress scenarios were not sufficiently severe given the bank’s reliance on wholesale and noncore funding and financial condition. Stress testing did not align with scenarios in the CFP, and management did not measure the impact of stress testing to board-approved liquidity ratios.
The Ombudsman concurred with the decision to issue the strategic and capital planning MRA. The strategic planning process was insufficient given the bank’s financial condition and risk profile. Strategic planning did not include an evaluation of the bank’s internal or external environment and its strengths, weaknesses, opportunities, and threats to allow the board and management to effectively assess the impact on the bank’s risk profile and financial condition. The strategic priorities document did not include measurable objectives, address priorities for non-earnings-related goals, or sufficiently measure progress with goals or objectives. Capital planning needed improvement as documentation showed conflicting capital minimums that are not sufficient or are directionally inconsistent with the bank’s increasing risk profile. Capital planning did not sufficiently identify strategies to ensure capital adequacy and contingency planning, was not well-defined, lacked triggers for developing and implementing action plans, and did not sufficiently incorporate stress testing results. While the SO had not previously criticized the strategic and capital planning processes, the bank’s financial condition deteriorated, and its risk profile increased compared to prior examinations, warranting the SO to reassess the effectiveness of these processes.
The Ombudsman concurred with the SO’s decisions to rate the sensitivity to market risk component a 3, high quantity of IRR, insufficient quality of IRR management, and high aggregate level of IRR. However, the Ombudsman determined a stable direction of IRR rather than increasing, as noted in the ROE. The board and management’s actions since the prior examination, while not yet fully successful in improving the net interest margin or reducing the economic value of equity at risk, reduced short-term IRR metrics to within the board and management’s risk tolerance. However, there remained a significant potential that earnings performance and capital would be adversely affected by changes in interest rates given the bank’s low and declining earnings and capital position in relation to risk. Risk management practices needed improvement given the level of market risk accepted by the board. While the board and management used the same IRR tools and methodology from prior examinations, the SO’s rating and risk assessment decisions were based on board and management decisions during the high-rate environment that materially harmed the bank’s financial condition. Bank decision makers did not anticipate or respond effectively to rate changes, and actions to address high IRR exposures were reactive. Management subsequently took actions to mitigate IRR, but the impact of these actions had not yet been effective in reversing net interest margin compression or reducing long-term IRR exposures to comply with board-established limits. Contrary to the appeal assertion, the ROE did not state that the bank’s deposit runoff was “simply allowed to happen.”
The Ombudsman concurred with the SO’s decision to rate the capital component a 3. Capital was less than satisfactory and did not fully support the bank’s high and increasing risk profile. Interest rate, liquidity, and strategic risks posed the greatest risk to capital and stemmed from the bank’s funding structure, increasing interest rate environment, and ineffective strategic planning. These risks negatively impacted earnings and resulted in a less than satisfactory tier 1 leverage ratio to support the bank’s high-risk profile. As noted previously, capital planning needs improvement. Ineffective minimum capital limits impaired the board’s ability to recognize the need to strengthen capital levels and thus, the board and management had not taken such actions. The lack of consideration for shareholder capacity is the result of the board and management not planning for and the capital planning documents lacking sufficient details of this capital source.
The Ombudsman concurred with the SO’s decision to rate the management component a 3. Board and management performance needed improvement as risk management practices were less than satisfactory. The board and management ineffectively positioned the bank’s balance sheet for an elevated interest rate environment, negatively impacting earnings and impairing capital. Internal policies, plans, and limits needed improvement and were not commensurate with the related risk exposures. Satisfactory component ratings for the specialty areas do not negate the mismanagement of the financial areas. There are no requirements or conventions that the management component be 3 rated if the earnings component is 3 rated. The overall performance of the bank is an evaluation factor for assessing the capability of the board and management, according to the “Bank Supervision Process” booklet of the Comptroller’s Handbook.
The Ombudsman concurred with the SO’s decision to rate the composite a 3. The bank’s overall condition deteriorated and exhibited supervisory concern. During the supervisory cycle, the bank’s financial performance weakened, and its risk profile increased. Capital, management, earnings, liquidity, and sensitivity to market risk were less than satisfactory. Interest rate, liquidity, and strategic risks were high, and risk management practices were insufficient. Board and management performance needed improvement. Management’s ineffective planning and balance sheet management led to high interest rate and liquidity exposures that caused earnings deterioration. Strategic and capital planning were less than satisfactory. The aforementioned factors make the bank less capable of withstanding business fluctuations and more vulnerable to outside influences. The appeal assertion that the formal enforcement document was not necessary is not an appealable matter under OCC Bulletin 2013-15, “Bank Appeals Process: Guidance for Bankers.”
