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Appeals of Material Supervisory Determinations: Guidelines & Decisions
SARC-97-03 (September 19, 1997)
Your appeal of material supervisory determinations has been decided. Rulings not in your favor were made by the Supervision Appeals Review Committee (“Committee”) of the Federal Deposit Insurance Corporation (“FDIC”) on September 16, 1997, and are conveyed in this letter.
The Committee decided against [Bank] (“Bank”) in every appealed matter. The Committee’s reasoning is set forth below.1. Loan Classifications
The Substandard classification on the six loans listed in the appeal are deemed appropriate. As of the examination, the examiner’s judgement that each loan was inadequately protected by the sound worth and paying capacity of the obligor or of the collateral pledged was correct. Weaknesses that jeopardize liquidation of the debt were supported, and the distinct possibility of some loss was present if the deficiencies are not corrected. Factors leading to this determination regarding each loan are listed below.
2. Provision for Loan Losses/Adequacy of the Allowance for
3. CAMELS Rating
a. Asset Quality Component
According to the CAMELS guidelines, an asset quality rating of “3” is assigned “when asset quality or credit administration practices are less than satisfactory. Trends may be stable or indicate deterioration in asset quality or an increase in risk exposure. The level and severity of classified assets, other weaknesses, and risks require and elevated level of supervisory concern. There is generally a need to improve credit administration and risk management practices.” Factors to be considered by the examiner include adequacy of underwriting standards, soundness of credit administration practices, and appropriateness of risk identification practices; adequacy of the loan valuation reserve; adequacy of loan and investment policies, procedures and practices; volume and nature of credit documentation exceptions; and level, distribution, severity, and trend of problem, classified, nonaccrual, restructured, delinquent, and nonperforming assets.
The examination report reflects weak underwriting standards, with loans made largely predicated on the perceived collateral support and character of the borrower. Technical exceptions were noted in 78 percent of loans reviewed (with just 28 percent of the portfolio included in the loan sample). Classifications have increased substantially since the prior examination and are a matter of elevated supervisory concern at 77 percent of capital and reserves. If the disputed adverse classifications were omitted, the level would be 54 percent of capital and reserves. Although improved, the level would remain a matter of supervisory concern. Loan policy deficiencies cited in past examination reports remain uncorrected.
Based upon the foregoing, a “3” rating for asset quality is considered appropriate.b. Management Component Rating
According to the CAMELS guidelines, a rating of “3” is assigned when management and board performance need improvement or risk management practices are less than satisfactory given the nature of the institution’s activities. The capabilities of management or the board of directors may be insufficient for the type, size or condition of the institution. Problems and significant risks may be inadequately identified, measured, monitored or controlled.
Factors to be considered by the examiner include: adequacy of, and conformance with, appropriate internal policies and controls addressing the operations and risks of significant activities; compliance with laws and regulations; responsiveness to recommendations from auditors and supervisory authorities; depth and succession of management; the extent that the board of directors and management is affected by, or susceptible to, dominant influence or concentration of authority; and, adequacy of audits and internal controls to promote effective operations and reliable financial and regulatory reporting, safeguard assets, and ensure compliance with laws, regulations and internal policies.
Given loan quality problems and inadequate loan administration, the failure of the bank to initiate corrective measures for previously identified weakness in the lending function, and the failure to comply with a variety of policy statements, a “3” rating is deemed appropriate.
c. Uniform Financial Institution Composite Rating
The overall composite rating of “3” is supported based upon management’s failure to implement previously recommended corrective actions coupled with the increase risk profile presented by the increasing level of classified assets. The failure to implement loan administration improvements recommended at past examinations, the lack of attention to loan documentation details, and the failure to properly structure loan payments are indicative of a less than satisfactory situation. Such failure does not appear to be due to a lack of ability, as evidenced by the success of the Bank in the past, but rather a failure to recognize the need for such changes in the Bank’s operations. Compliance with the Memorandum of Understanding signed following receipt of the examination should result in effecting needed changes and return of the Bank to a satisfactory condition.
The determinations constitute the final decision of the FDIC.
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