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Appeal of Composite and Component Ratings (Second Quarter 2013)


A community bank supervised by the Office of the Comptroller of the Currency (OCC) appealed to the Ombudsman the supervisory office’s decision to lower certain ratings at a recent examination. The supervisory office lowered ratings from the prior examination as follows: capital from 3 to 4; liquidity from 2 to 3; and composite from 3 to 4.


Capital – The appeal stated the bank has been deeply affected by the recession and will be slower than most banks to bounce back. The bank experienced substantial losses over the last 24 months primarily due to nonperforming asset write-downs and repricing of the investment portfolio at historically low interest rates. It may take a year or two before the bank has positive earnings. The appeal said that asset quality has been deficient and that it will be a very long and difficult process to improve it. While the bank recognized that capital levels also need improvement, the appeal stated that the bank’s viability has not been threatened. The bank said that its capital is sufficient to meet the bank’s needs and its capital ratios are far above the “well-capitalized” requirements for Prompt Corrective Action purposes. Emerging capital needs could be addressed by prepaying Federal Home Loan Bank advances, issuing and selling capital certificates, or merging with another institution.

Liquidity – The OCC’s report of examination found the bank’s liquidity to be adequate for current and projected funding needs. The appeal said that funds management practices were described as adequate in many previous reports. The appeal also said that the bank has a comprehensive contingency funding plan, utilizes a number of different reports to monitor liquidity position, and conducts stress testing using a variety of different methodologies.

Composite – The appeal strongly disagreed with the downgrade to 4. While the bank recognized serious financial difficulties, the appeal stated, the difficulties were not the result of managerial problems. The difficulties resulted from economic devastation, which the bank argued should not be used to characterize the bank as engaging in unsafe or unsound practices. The appeal acknowledged that earnings and asset quality were weak but due only to poor economic conditions. The appeal stated the management team is strong and strives to comply with all recommendations voiced by the regulator.


The Ombudsman reviewed the information submitted by the bank and the OCC’s supervisory office. The Uniform Financial Institutions Rating System, as defined in the “Bank Supervision Process” booklet of the OCC’s Comptroller’s Handbook, was used as the standard for determining the appropriate composite rating and component ratings for capital and liquidity. The Ombudsman also relied on the following publications as standards for the analysis: “Liquidity” booklet of the Comptroller’s Handbook; OCC Bulletin 2010-13, “Interagency Policy Statement on Funding and Liquidity Risk Management”; and OCC Bulletin 2013-16, “Guidance for Evaluating Capital Planning and Adequacy.”

With respect to the capital rating of 4, the Ombudsman determined that the supervisory office appropriately supported this rating. The bank’s capital levels were deficient, did not fully support the bank’s moderate-to-high and increasing risk profile, and needed improvement. The bank suffered significant losses by year end, which continued through the examination date. These losses negatively impacted capital levels and ratios. Tier 1 leverage ratio declined because of increased provision expenses due to further credit losses. Furthermore, the bank’s budget showed additional projected losses for the next several years. If earnings do not improve, viability of the bank may be threatened. It appears the bank’s only significant source of capital is external sources, as retained earnings are not sufficient to accrete capital. Additional sources of capital are limited.

With respect to the liquidity rating of 3, the Ombudsman determined the supervisory office appropriately supported this rating. While liquidity levels were adequate, the bank was still moderately reliant on Federal Home Loan Bank borrowings. The bank’s net interest margin was compressed by the cost of these funds coupled with a high level of nonaccrual loans. In addition, the Ombudsman concurred with the supervisory office that funds management practices needed improvement. As of the examination date, bank management and the board did not have appropriate measures to identify, monitor, measure, or control liquidity risk commensurate with the bank’s increasing risk profile. Improved liquidity risk management is necessary, as the bank has suffered from significant deterioration in asset quality, in financial performance, and in its local economic conditions. These factors increased the bank’s liquidity risk profile and thus overall risk to the bank.

With respect to the composite rating of 4, the Ombudsman found that—based on the facts presented in this discussion—the supervisory office adequately supported this rating. The bank exhibited several unsafe or unsound practices, including financial and managerial deficiencies. The bank exhibited a moderate-to-high and increasing risk profile. The management rating was considered less than satisfactory because of noncompliance with the enforcement action, repeat Matters Requiring Attention, and the inability to generate sufficient earnings necessary to return the bank to a satisfactory condition. Large charge-offs in the last 18 months caused significant losses and capital erosion due to large provision expenses. Several risk management practices were less than satisfactory, including strategic, capital, liquidity, and profitability planning. The bank exhibited further weaknesses in its credit administration and allowance methodology. Therefore, the overall condition of the bank as of the appeal date was deficient. Management and the board were encouraged to work with their supervisory office to correct the identified deficiencies raised in the report of examination.