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Appeal of Capital Rating and Adequately Capitalized Designation (Third Quarter 2008)

Background

A community bank appealed the capital rating of 3 assigned at the most recent examination.  Management agreed with the identified risks and committed to timely resolution but disagreed with the overall rating.  The bank also appealed the “adequately capitalized” designation contained in the draft formal enforcement action.

Discussion

The appeal stated that prior to the conclusion of the examination; the preliminary results led the bank to believe a capital rating of 2 was appropriate and the bank was “well capitalized” as defined in 12 C.F.R. Part 6 – Prompt Corrective Action.

The supervisory office stated the need for higher levels of capital were warranted because of increased credit risk in the commercial real estate portfolio and a high level of classified assets.  Historically, the bank maintained capital just above the well capitalized level in order to maximize shareholder equity.  The bank’s annualized return on average assets (ROAA) was .41 percent due to a large provision to the Allowance for Loan and Lease Losses (ALLL) directed during the current examination.  The supervisory office estimated additional provisions to the ALLL could total $1 million; wiping out earnings for the year.  The supervisory office projected a $3 million injection was needed to bring capital to a satisfactory level given the bank’s current risk profile.

Standards
The ombudsman thoroughly reviewed the information submitted by the bank and the supervisory office.  The ombudsman relied on standards established under 12 C.F.R.  Part 3 Minimum Capital Ratios and section 303 of the Comptroller’s Handbook to arrive at his opinion.

Conclusion
Based on the ombudsman’s review of the examination conclusions, the bank’s capital position met the quantitative capital requirements for a well-capitalized institution.  However, numerous factors distressed capital, including decreased income, high dividend payouts associated with holding company debt, increasing non-accrual and non-performing loans as well as increased losses and provisions to the ALLL.

Under the Uniform Financial Institutions Rating System, “a rating of 3 indicates a less than satisfactory level of capital that does not fully support the institution’s risk profile.  The rating indicates a need for improvement, even if the institution’s capital level exceeds minimum regulatory and statutory requirements.”  In contrast, “a rating of 2 indicates a satisfactory capital level relative to the financial institution’s risk profile.”

The ombudsman concluded the assigned capital component rating of 3 was appropriate based on the bank’s overall condition and risk profile.

The ombudsman declined to opine on the designation of “adequately capitalized” in the draft formal enforcement action because this is a preliminary designation until the bank receives written notice from the supervisory office.  The bank was designated as “well capitalized” in the Report of Examination.