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Appeal of Sensitivity to Market Risk, Earnings, and Management Component Ratings – (Fourth Quarter 2001)


The ombudsman received a formal appeal of examination conclusions involving the sensitivity to market risk, earnings, and management component ratings.  The bank's appeal stated that in the Report of Examination the OCC assigned the bank a 3 rating for sensitivity to market risk, a 5 rating for earnings, and a 5 for management.  Bank management and the board of directors' contention was that these CAMELS component ratings did not accurately reflect the bank's condition at the time of the examination.

Sensitivity to Market Risk-Rating 3


Management and the bank's board believed that:

"Neither the condition of the bank's sensitivity to market risk as of the examination date, as compared to the last examination, nor the quality of the bank's Asset/Liability Management Policy warranted the OCC downgrading the bank's Sensitivity to Market Risk rating from a ''2'' to a ''3.''

Furthermore, by commissioning reports with outside consulting firms, which also reflects the positive state of the bank's interest rate risk management, the bank has illustrated sound risk management policies and procedures.

The supervisory office concluded in the ROE that the bank's interest rate risk was slightly elevated because of an imbalance resulting from assets repricing faster than liabilities.  The ROE also commented that the board and management's planning and risk management processes were deficient.  Additionally, the supervisory office believed the Asset/Liability Management Committee had not taken an active role in managing the balance sheet or interest rate risk.

Discussion and Conclusion

In accordance with OCC Bulletin 97-1 (''Uniform Financial Institutions Rating System'') the sensitivity to market risk rating is intended to reflect the degree to which changes in interest rates can adversely affect the earnings and capital of a financial institution.  Considerations in determining the sensitivity rating are management's ability to identify, measure, monitor, and control market risk, and the adequacy of the capital and earnings in relation to the bank's level of interest rate risk exposure.  The ombudsman's review did not find adequate support that the board and management were actively managing the bank's interest rate risk (IRR) position. 

Review of the information provided to the ombudsman's office revealed:

  • The input and assumptions used in the modeling were not well supported and hindered an accurate assessment of the risk, making it difficult to quantify the bank's risk exposure.
  • While the bank had purchased a complete bank simulator model, allowing for greater accuracy and more assumptions, the bank had never used this model.
  • The modeling reports reflected gap positions outside of those limits established in the Asset/Liability management policy of the bank.
  • The Asset/Liability Committee (ALCO) minutes provided no insight on management's and the board's efforts to manage IRR.  The only discussion reflected in the ALCO minutes was pricing of depository products, which lacked detail.  Furthermore, the minutes did not reflect the board's desired balance sheet composition or strategy to manage IRR.

Based on the risk management weaknesses described above, the ombudsman concluded that the 3 rating assigned during the examination was appropriate.

Earnings-Rating 5


The bank's submission commented that:

Although at the time of the last ROE, the bank was experiencing losses, it was taking steps to increase earnings.  During the past year, the bank commenced its SBA and Credit Card program, both of which introduced a significant revenue stream to the bank.  The bank's earnings trend is not negative and does not represent a distinct threat to the bank's capital.  During this time the bank also raised additional capital to compensate for funding the increased provision for loan losses.  The increase in revenue from the last examination and the nature of the bank's expenses in no way can justify the downgrading of the bank's earnings rating.  The OCC's assignment was wholly improper.

Comments in the ROE concluded that earnings remain poor and were eroding the bank's capital.  The supervisory office also stated that management and the board needed to take immediate and ongoing action to alleviate large continuing losses and address the other weaknesses.  Examiners' primary concern was that continuing losses of the magnitude experienced in the last years would threaten the bank's viability.

Discussion and Conclusion

Pursuant to OCC Bulletin 97-1 (''Uniform Financial Institutions Rating System'') earnings are intended to reflect not only the quality and trend, but also factors that may affect the sustainability or quality of earnings.  Considerations in determining the earnings rating are the following:

  • The level of earnings, including trends and stability,
  • The ability to provide for adequate capital through retained earnings,
  • The quality and sources of earnings,
  • The level of expenses in relation to operations,
  • The adequacy of provisions to maintain the allowance or loan and lease losses, and,
  • The adequacy of the budgeting systems and forecasting processes.

The ombudsman's review revealed that over the last two years, the bank had no traditional core earnings.  The bank experienced net-operating losses in the last two years of approximately $600,000 and $900,000, respectively.  These losses included provisions to the allowance for loan and lease losses of $600,000 and $700,000, respectively.

Furthermore, the net interest margin declined from 4.60 percent to 3.80 percent in the same time period due to increasing funding costs and declining loan yields.  Net losses had eroded capital, necessitating an injection of capital.  Additionally, the earnings posture of the bank could be further affected by the bank's risk profile and risk management practices.  These include:

  • The bank's high credit risk profile as evidenced by the level of classified assets centered in the unguaranteed portion of SBA loans, past dues, and non-accruals.
  • Measuring and monitoring risk management systems.  For instance, credit risk identification, underwriting standards, loan grading, allowance methodology, and collection efforts remain deficient.
  • A weak budgeting process with overly optimistic assumptions based on past performance.
  • The bank's earnings posture, the high risk profile of the bank, and the questionable future prospects cause a significant supervisory concern and represent a distinct threat to the bank's viability through the erosion of capital.

Therefore, the ombudsman concluded that the 5 rating assigned during the examination was appropriate.

Management-Rating 5


The bank's appeal letter stated management and the board have made a concerted and significant effort to improve the depth and stability of bank management by making position-specific improvements.  They believed that through the creation of new officer positions and the hiring of new officers, the bank management team was significantly stronger at the time of this examination than at the time of the last examination.  For these reasons, bank management believed a downgrade in the bank's management rating was inconsistent with the actual condition of the bank.

The ROE stated management and the board's supervision was ineffective.  The ROE comments also asserted management actions were not substantive nor were they taken in a timely manner to strengthen the bank's loans and risk management systems.  The bank continued to experience turnover in management and the board.  Additional examination findings revealed the bank did not have a legal number of directors, the president/chief-lending officer was terminated, and the chief financial officer resigned.

Discussion and Conclusion

Pursuant to OCC Bulletin 97-1 (''Uniform Financial Institutions Rating System'') the management rating is intended to reflect the capability and performance of the board and management.  Some considerations in determining the management rating are:

  • The level and quality of oversight and support of all activities in the bank,
  • The overall performance of the bank and its risk profile,
  • Management depth and succession,
  • The adequacy and reliability of financial and regulatory reporting,
  • The accuracy, timeliness, and effectiveness of management information and the risk monitoring systems appropriate for the institution's size, complexity, and risk profile,
  • The adequacy of, and conformance with, appropriate internal policies and controls addressing the operations and risk of significant activities, and
  • The ability of the board of directors and management in their respective roles, to plan for, and respond to, risks that may arise from changing business conditions or the initiation of new activities or products.

The ombudsman's review revealed that the position specific appointments did not improve the depth, stability, and expertise needed in the board and management.  This finding was based on the following:

  • The board and management did not demonstrate the ability to reverse the deteriorating trends and improve the poor financial condition of the bank.
  • The board and senior management had not developed and maintained appropriate risk management systems given the risk profile of the bank.
  • Both the board and management were unstable with no strategic direction given the continual turnover in executive management.
  • The bank had operated without the legal number of directors for the last two years. 

Strong leadership is essential in a financially troubled institution.  The board's effort to provide leadership had not been effective. Therefore, the ombudsman concluded the 5 rating assigned during the examination was appropriate.