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Appeal of CAMELS Composite Rating and Component Ratings for Capital, Management, Earnings and Consumer Compliance (Fourth Quarter 2010)

Background

A community bank appealed the downgrade in composite rating from 2 to 3 and component ratings for capital from 2 to 3, management from 2 to 3, earnings from 1 to 3, and consumer compliance from 2 to 4. The bank also sought to vacate the violation of the Federal Trade Commission Act (FTC Act) related to the bank’s overdraft program.

Discussion

The appeal stated the downgrades were based principally on the basis of the alleged FTC Act violation. The appeal asserted the examination collected insufficient information to make a determination that a violation occurred. Additionally, the appeal stated the downgrades to capital and earnings were based on unproven theories of restitution obligations. Lastly, the appeal stated that without the violation of the FTC Act, there was no cause to downgrade management and the composite rating.

Conclusion

The ombudsman reviewed the information submitted by the bank and the supervisory office. The Uniform Financial Institutions Rating Systems (UFIRS) as defined in the Comptroller’s Bank Supervision Process Handbook was used as the standard for determining the appropriate composite rating and component ratings for asset quality, management, and liquidity. The OCC’s Overview Handbook for Consumer Compliance provided guidance for determining the appropriate consumer compliance rating.

The violation of the FTC Act cited in the report of examination was the basis for the OCC to issue a formal enforcement action against the bank and as such did not meet the definition of an appealable matter as defined in OCC Bulletin 2002-9 National Bank Appeals. However, because the appeal stated the violation of the Federal Trade Commission Act (FTC Act) was a primary contributor to the ratings downgrades, a limited review of the violation was performed. This review was limited to a determination that the standards for citing a violation of the FTC Act were appropriately applied by the supervisory office in assigning the appealed ratings.

With respect to the downgrade of the capital rating, the ombudsman found the downgrade was premature. The ROE cited the impending restitution resulting from the FTC Act violation as the primary cause for the ratings downgrade. The supervisory office provided insufficient support, as outlined in UFIRS, to warrant a downgrade of capital. Without commenting on the validity of the violation, the amount of restitution and the timeframe for assessing restitution were unknown at that time. The supervisory office has the ability to reassess the rating when the dollar amount of restitution is known and the impact to capital can be more precisely defined. Therefore, the ombudsman found the appropriate rating for capital as of the examination date to be 2.

With respect to the downgrade in the management rating, the ombudsman found the assigned rating appropriate. The management rating can be based on one factor or a culmination of many factors, depending on the severity of the issue. The ombudsman’s review of the bank’s overall condition found weaknesses in asset quality, credit risk management, and compliance management that, individually, could negatively impact the quality of board and management supervision. Therefore, the downgrade was appropriate and well-supported.

With respect to the downgrade in the earnings rating, the ombudsman found the downgrade to be premature. The ROE cited the impending restitution resulting from the FTC Act violation as the primary cause for the ratings downgrade. Without commenting on the validity of the violation, the amount of restitution and the timeframe for assessing restitution were unknown at that time. The supervisory office has the ability to reassess the rating when the dollar amount of restitution is known and the impact to earnings can be more precisely defined. Based on the ombudsman’s review of the bank’s earnings performance, the quantity of earnings was strong. However, consideration was given to the level of risk inherent in the bank’s revenue source and the sustainability of those earnings. Therefore, the ombudsman found the appropriate rating for earnings as of the examination date to be 2.

With respect to the consumer compliance rating downgrade, the ombudsman found the downgrade appropriate. Due to the impending formal enforcement action, the ombudsman’s review of the violation of law was limited to an assessment of the appropriate application of the standards of the FTC Act. The standards were appropriately applied to make a determination that the bank engaged in unfair and deceptive practices regarding its overdraft program. The gravity of the violation, the volume of consumers impacted, and the financial consequences to the bank would require close supervisory attention and monitoring to promptly correct the serious compliance problems disclosed.

Based on the above conclusions, the ombudsman found the composite rating downgrade was appropriate. The less than satisfactory rating for asset quality (which the bank did not appeal) coupled with a less than satisfactory rating for management was sufficient to support a less than satisfactory rating for the overall condition of the bank. The violation of the FTC Act was, in and of itself, sufficient to warrant a downgrade in the bank’s composite rating as well.