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Appeals of Material Supervisory Determinations: Guidelines & Decisions

SARC-2005-02 (August 31, 2005)

Background
The FDIC’s Division of Supervision and Consumer Protection (“DSC”) conducted concurrent Compliance and Community Reinvestment Act (“CRA”) examinations of [Bank] (“Bank”), beginning on [*****]. The examination team assigned the Bank a Consumer Compliance Rating of 3. In addition, they assigned the Bank a "Satisfactory" composite (or overall) CRA rating although the Bank was assigned a "Low Satisfactory" rating for the Service Test component of the composite CRA rating.

The Bank disagreed with the assigned ratings and submitted a Request for Review to the DSC Director, Michael J. Zamorski, on January 27, 2005. Mr. Zamorski thereafter convened a panel of senior professional employees from DSC to evaluate the Bank’s Request. The panel determined that the assigned ratings were appropriate. Mr. Zamorski so advised the Bank by letter dated February 25, 2005 (the “Determination” letter). The Determination letter also advised, however, that DSC would amend the [*****] examination report to reflect the supplemental information that the Bank had provided in response to apparent violations of Federal Reserve Board Regulation CC (Expedited Funds Availability) and Department of Housing and Urban Development Regulation X (Real Estate Settlement Procedures).

The Bank then filed an appeal with the FDIC’s Supervision Appeals Review Committee (“Committee”) on March 24, 2005. The Bank advised that the sole issue presented on appeal is whether DSC erred in refusing to raise the Bank’s Consumer Compliance Rating to 2 and its CRA Service Test Rating to “High Satisfactory." The Bank indicated that its initial Request for Review set forth fully the basis for the Bank’s disagreement with the assigned ratings. The Bank also addressed in its Appeal new issues that the Bank believes were raised by the Determination letter.

Consumer Compliance Rating

Rating Criteria
The Consumer Compliance Rating System established by the Federal Financial Institutions Examination Council (“FFIEC”) is designed to help identify those institutions whose compliance with consumer protection and civil rights laws and regulations display weaknesses requiring special supervisory attention. Institutions are assigned a composite consumer compliance rating on a scale of 1 through 5 in ascending order of supervisory concern. Under this system, a 2 rated institution is in a generally strong compliance position and is described as follows:

Management is capable of administering an effective compliance program. Although a system of internal operating procedures and controls has been established to ensure compliance, violations have nonetheless occurred. These violations, however, involve technical aspects of the law or result from oversight on the part of operating personnel. Modifications in the institution’s compliance program and/or the establishment of additional review/audit procedures may eliminate many of the violations. Compliance training is satisfactory. There is no evidence of discriminatory acts or practices, reimbursable violations, or practices resulting in well-defined patterns of repeat violations.

In contrast, a 3-rated institution is in a less than satisfactory compliance position and is described as follows:

Institutions in this category are a cause for supervisory concern and require more than normal supervision to remedy deficiencies. Violations may be numerous. In addition, previously identified practices resulting in violations may remain uncorrected. Overcharges, if present, involve a few consumers and are minimal in amount. There is no evidence of discriminatory acts or practices. Although management may have the ability to effectuate compliance, increased efforts are necessary. The numerous violations discovered are an indication that management has not devoted sufficient time and attention to consumer compliance. Operating procedures and controls have not proven effective and require strengthening. This may be accomplished by, among other things, designating a compliance officer and developing and implementing a comprehensive and effective compliance program. By identifying an institution with marginal compliance early, additional supervisory measures may be employed to eliminate violations and prevent further deterioration in the institution’s less than satisfactory compliance position.

Discussion
The [*****] examination report concluded that the Bank’s overall compliance management system was weak and in need of improvement. In its Request for Review and in its Appeal, the Bank responded that management was proactive, sufficient controls were in place, and violations were technical and not “repeat” violations. The Bank argued, overall, that the examination team’s comments described a 2 rated bank.

It is true that the examination report acknowledged positive steps taken by the Bank to strengthen its compliance program. The report notes, for example, that management hired an outside consulting agency specializing in the training and auditing of consumer compliance regulations; the Bank’s board members receive regular updates regarding compliance and CRA issues; audits performed by the Bank’s internal audit department are presented to the Bank’s audit committee which is made up of board members. These positive steps were counterbalanced by deficiencies in the Bank’s compliance program, however. The Committee agrees that the assigned rating of 3 is appropriate.

Management and Allocation of Resources. The over-arching factor cited in the report is the concern that the resources allocated to the compliance function are not commensurate with the level and complexity of a $1.1 billion dollar institution. This concern was previously communicated to the Bank: the [****] report notes that management was criticized in the [****] report for not devoting sufficient resources to the Bank’s compliance program. Referring to the [****] report, the [****] report goes on to note that violations were cited in the [****] report and civil money penalties assessed for Home Mortgage Disclosure Act (“HMDA”) violations and that management promised to aggressively establish new controls to enhance the Bank’s compliance program. Since the [****] examination, the Bank’s loan portfolio has grown by 58.3 percent according to the DSC Determination letter. In spite of this dramatic growth, the [****] report indicates that since the [****] examination and through June 2004 the Bank’s compliance officer continued to be primarily responsible for maintaining the Bank’s compliance program.

The Bank suggests that it is inappropriate to evaluate the Bank based upon information contained in the [****] report and points out that ratings should reflect present compliance/operational adequacy. The Bank expresses concern that the examination team inappropriately lowered the Bank’s rating because the team believed past ratings were inflated. The Committee acknowledges that the [****] report contains a number of references to past examinations and internal audits, even referring to a 1996 examination at one point. When read in context, however, the Committee believes the references to past examinations and audits were intended to frame the discussion. The point of the reference to the [****] examination and prior HMDA violations is to underscore the Bank’s vulnerability.

Banks operate within a body of statutes and regulations, both federal and state. While the underlying rationale of such laws is the protection of the public, there can be more direct, immediate and personal reasons why directors and officers will want to assure that their institution’s activities conform with the law. Violations of laws and regulations may give rise to possible civil liability for damages and administrative adjustments for understated finance charges or annual percentage rates. A number of Federal statutes and regulations include provisions for assessing civil money penalties against banks and/or individuals for certain infractions. Successful legal actions by consumers could harm the institution if settlements were large. To the extent effective examination and supervision helps to identify violations, and preclude or minimize their recurrence, such problems can be avoided.

In this instance the FDIC expressed concerns regarding the resources dedicated to the compliance program in the [****] report. By framing the discussion in the [****] report in the context of past warnings and supervisory actions (i.e., a civil money penalty action), the examination team is highlighting the adverse consequences that can result if this area of the law is not carefully attended to by management.

The Bank’s compliance officer resigned in June 2004. Management contracted with an outside consulting agency to provide assistance and planned to have a compliance officer on staff at the beginning of 2005. The Bank expresses concern that the examination team gave inordinate weight to the lack of a compliance officer during the examination period. The focus of the examination comments is on the systemic weaknesses in the Bank's compliance effort more than the absence of a compliance officer during the examination. The lack of a compliance officer upon the departure of the incumbent continuing through December 2004 does, however, underscore the lack of institutional resources dedicated to the compliance program.

The Determination letter stated: "During the period examined, the Compliance Officer's time was diverted to Bank Secrecy Act [“BSA”] matters, leaving little time to devote to the consumer compliance area.” The Bank asserts in its appeal that the FDIC had never before expressed concern about the challenges associated with requiring a compliance officer to take responsibility for both BSA and consumer compliance matters. However, the Committee understands these comments as highlighting the fact that the Bank must comply with both BSA and consumer compliance requirements but that the Bank lacked the resources necessary to cover both areas in an effective manner. The Committee does not, as the Bank seems to do, interpret DSC’s comments to stand for the proposition that assigning one officer to both BSA and compliance issues is intrinsically deficient management justifying a downgrade.

During a November 16, 2004, meeting with Bank management in the [*****] Regional Office, DSC representatives acknowledged that the Bank received high marks from the FDIC for its performance in the BSA/USA Patriot Act area. The Committee applauds the Bank’s efforts to implement a strong BSA/USA Patriot Act compliance program. The Committee appreciates the challenges of complying with multiple, complex mandates. Success in one area does not justify neglect of another, however, but simply underscores the FDIC’s concern that the Bank is not allocating sufficient resources to assure compliance with all of its obligations under these comprehensive laws.

Violations and Program Sufficiency: Aside from commenting on the objective number of staff assigned to compliance, the [****] report cites specific program deficiencies as further evidence that the Bank’s compliance management system was weak. The deficiencies cited include the thoroughness of internal Bank audits, the sufficiency of written policies, and the adequacy of training. The report refers to apparent violations and suggests they could have been minimized had stronger internal audits, written policies, and training been in place.

As noted above, the Bank argues that the commentary describes a “2” rated bank. Certain aspects of the commentary are disconcerting in that the discussion combines criticism with praise. For example, the report refers to the Bank’s internal audits of 2002, 2003, and 2004 and states: “While the audits did not encompass a review of all compliance related regulations, the audits performed detected most of the areas that were found to have deficiencies at the current examination ...” Elsewhere the report refers to audits performed by the compliance officer in 2002 and 2003 and states: “[W]hile some deficiencies were noted during these reviews and brought to the attention of senior management, many of the items noted during the current examination were not detected, thus leading to the question as to the thoroughness of these reviews (which was not detectable as work papers were not maintained).” The report concludes that, on balance, the Bank’s internal audits and monitoring system were inadequate as evidenced by the fact that the Bank did not review compliance with all of the consumer compliance regulations and problems identified during the examination had not been detected by the Compliance Officer.

The banking agencies endeavor to ensure that financial institutions are evaluated in a comprehensive and uniform manner. While it may be disconcerting to read both praise and criticism in the commentary, we believe it is appropriate to acknowledge the positive aspects of the Bank’s program. Thus, the report credits the Bank for having written policies, regularly training its employees, and conducting internal audits but concludes that additional corrective action is needed. The Committee agrees that, overall, the corrective actions taken by the Bank were insufficient to prevent apparent violations of consumer compliance regulations.

The Bank stresses that the apparent violations cited in the report were technical and not “repeat” violations. In its Request for Review, the Bank stated:

A “3” rating generally requires: (1) numerous violations; (2) uncorrected, repeat violations; (3) overcharges; (4) weak compliance efforts; (5) weak management oversight of compliance; and (6) ineffective operating procedures and controls.... [A] “3” rated institution, by definition, cannot rectify errors itself and needs extra supervision to remedy deficiencies.

Request for Review, pg. 4.

The Committee differs with the Bank’s characterization of a 3 rated institution. It is not essential that a bank exhibit numerous or repeat violations or violations resulting in overcharges in order to be accorded a 3 rating. The Consumer Compliance Rating System established by the FFIEC does not refer to “repeat” violations; there is no requirement in the FFIEC rating system that repeat violations must exist before a 3 rating can be assigned. Nor do we agree that a 3 rated bank is incapable of rectifying its errors.

The Committee agrees with DSC that all of the attributes in a particular rating category will not necessarily apply to each bank that receives that rating. Each rating is based on a qualitative analysis of the factors comprising that rating. Some factors may be given more weight than others depending on the situation at the institution. In this case it appears that management has the ability to effectuate compliance but increased efforts are necessary.

The Bank’s Efforts to Strengthen its Compliance Program: In its Request for Review the Bank outlined a number of steps it has taken since 2001 through 2004 to strengthen its compliance program. We also note that the Bank's board of directors executed a Board Resolution on December 21, 2004, directing management to devote additional resources to ensure the Bank's compliance with applicable consumer protection laws and regulations. Further, the [****] report indicates that the Bank hopes to hire two individuals to assist the new compliance officer (one in lending and one in the deposit operations area) and is considering adding an individual with experience in compliance-related regulations to the Bank’s audit department.

The Committee is gratified that the Bank, even though it disagrees with the report findings, has committed to strengthening its program. As required by the Guidelines governing the appeal process, the scope of the Committee’s review was limited to the facts and circumstances as they existed at the time of the examination. Corrective actions subsequent to the examination were not considered as part of the Committee’s review. Such actions will, however, be considered during future supervisory activities.

Service Test Component Of CRA Rating

Rating Criteria
The Service Test evaluates a bank's record of helping to meet the credit needs of its assessment area by analyzing both the availability and effectiveness of a bank's systems for delivering retail banking services and the extent and innovativeness of its community development services. 12 C.F.R. § 345.24(a). The performance criteria prescribed by the regulation thus encompasses both retail banking services and community development services.

The retail banking services component includes the current distribution of the bank's branches among low-, moderate-, middle-, and upper-income geographies; its record of opening and closing branches, particularly branches located in low- or moderate-income geographies or primarily serving low- or moderate-income individuals; the availability and effectiveness of alternative systems for delivering retail banking services in low- or moderate-income geographies and to low- and moderate-income individuals; and the range of services provided in low-, moderate-, middle-, and upper-income geographies and the degree to which the services are tailored to meet the needs of those geographies. 12 C.F.R. § 345.24(d). The community development services component encompasses the extent to which the bank provides community development services and the innovativeness and responsiveness of community development services. 12 C.F.R. § 345.24(e).

Pursuant to 12 C.F.R. Part 345, Appendix A, a bank's service performance is rated High Satisfactory if

(A) Its service delivery systems are accessible to geographies and individuals of different income levels in its assessment area(s);

(B) To the extent changes have been made, its record of opening and closing branches has not adversely affected the accessibility of its delivery systems, particularly in low- and moderate-income geographies and to low- and moderate-income individuals;

(C) Its services (including, where appropriate, business hours) do not vary in a way that inconveniences its assessment area(s), particularly low- and moderate-income geographies and low- and moderate-income individuals; and

(D) It provides a relatively high level of community development services.

A bank's service performance is rated Low Satisfactory if

(A) Its service delivery systems are reasonably accessible to geographies and individuals of different income levels in its assessment area(s);

(B) To the extent changes have been made, its record of opening and closing branches has generally not adversely affected the accessibility of its delivery systems, particularly in low- and moderate-income geographies and to low- and moderate-income individuals;

(C) Its services (including, where appropriate, business hours) do not vary in a way that inconveniences its assessment area(s), particularly low- and moderate-income geographies and low- and moderate-income individuals; and

(D) It provides an adequate level of community development services.

Discussion
The [****] CRA Evaluation (“Evaluation”) prepared by the FDIC rated the Bank Satisfactory. The Evaluation notes that an institution in that group has a satisfactory record of helping to meet the credit needs of its assessment area, including low and moderate-income neighborhoods, in a manner consistent with its resources and capabilities.

With regard to the Lending Test, Investment Test, and Service Test components making up the Satisfactory rating, the Bank earned High Satisfactory, Outstanding, and Low Satisfactory, respectively. In support of the Low Satisfactory Service Test, the Evaluation stated that delivery systems are accessible to limited portions of the Bank’s assessment area; changes in the Bank’s branch network had reduced the number of branches within a low- and moderate-income census tract from one to none; services and hours of operation are tailored to the convenience and needs of the assessment area; the Bank provides an adequate level of community development services.

As indicated above, the Bank contends that DSC erred in not raising its CRA Service Test Rating from Low Satisfactory to High Satisfactory. The Bank states in its appeal that the Service Test rating was based almost entirely on the Bank’s reduction of the number of branches within low- and moderate-income census tracts from one to none. The Bank asserts “DSC completely disregards the arguments made by the Bank in its Request for Review and reality.” The Bank advises that the closed branch was located in an inconvenient high-rise office building in a relatively prosperous business district and was used very little by retail customers; that almost 95 percent of the branch’s deposits were business accounts; and a single business deposit represented 26 percent of all deposits. The Bank concludes that the branch closure had no material impact on the Bank’s service to customers within low- to moderate-income tracts.

The Committee believes that the assigned rating of Low Satisfactory is appropriate. The Committee considers both the examiners’ findings and methodology appropriate and the resultant rating well supported. It appears the Bank closed the branch for apparently legitimate business reasons. The totality of the Bank’s actions were insufficient to support an upgrade to a rating of High Satisfactory, however.

Retail Banking Services: Pursuant to Appendix A, Part 345-Ratings (b)(3), if a bank's retail service delivery systems are accessible to geographies and individuals of different income-levels it would be consistent with a High Satisfactory rating; or a Low Satisfactory rating if just "reasonably accessible". And, to the extent changes have been made, if its record of opening and closing branches has "not adversely affected" the accessibility of its delivery systems in low- and moderate-income geographies and to low-and moderate-income individuals, then performance would be consistent with a High Satisfactory rating; or a Low Satisfactory rating if such a record has "generally" not affected such accessibility.

In the Bank's prior Evaluation, dated [*****], the Bank was criticized for "inadequate" penetration of delivery systems within the assessment area's low- and moderate-income census tracts, noting that only one branch was located in a moderate income tract. The [****] Evaluation notes that with the branch closing, the bank does not maintain any branches in low- and moderate-income areas. While the Bank closed the branch for apparently legitimate business reasons, the next closest branch, in a middle income tract, is several miles away. It appears the Bank has not provided information on any alternative ways that it provides retail banking services to low- and moderate-income areas.

Therefore, a rating of Low Satisfactory is consistent with the Bank's provision of retail banking services in that the Bank's accessibility from low- and moderate-income areas is no more than "reasonable", and its record of opening branches (none in low- and moderate-income areas) or closing branches (one in a moderate-income area) only "generally" has not affected the Bank's already marginal accessibility of its retail banking delivery systems in low- and moderate income areas and to low- and moderate-income individuals.

Community Development Services: Under the regulation, Appendix A to Part 345-Ratings (b)(3), a bank's community development services would be rated as High Satisfactory if the bank provides "a relatively high level of community development services”, or as Low Satisfactory if it provides "an adequate level". While the Bank received a High Satisfactory CRA rating in the prior Evaluation in large part due to its high level of community development services, and although it is credited with participating in a variety of financial education and homeownership counseling programs in the [****] Evaluation, its overall level of participation in community development services appears to be less. The Bank’s performance is considered adequate and consistent with a Low Satisfactory Rating.

Conclusion

For the reasons set forth above, the Bank’s appeal is denied.

This decision is considered a final supervisory decision by the FDIC.

By direction of the Supervision Appeals Review Committee of the FDIC dated August 31, 2005.

_______________________________

Valerie J. Best

Assistant Executive Secretary


 


Last Updated 10/12/2005 Legal@fdic.gov