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A bank supervised by the Office of the Comptroller of the Currency (OCC) appealed to the Ombudsman a notice of decision to establish individual minimum capital ratios (IMCR decision notification).
The appeal disagrees with the two considerations in 12 CFR 3.402 that the supervisory office (SO) identified as supporting the decision to establish the IMCRs. The appeal asserts that the SO’s analysis regarding the circumstance described in 12 CFR 3.402(c) inaccurately concludes that the bank has experienced losses or is expected to have losses resulting in capital inadequacy. The appeal also argues that the SO’s analysis of the circumstance described in 12 CFR 3.402(e) is flawed because it inaccurately concludes that the bank has significant exposure to declines in the economic value of its capital due to changes in interest rates.
The appeal also contends that the level of IMCRs required are higher than necessary relative to the bank’s risk profile and are significantly higher than the minimum capital ratios prescribed in 12 CFR 3.10. The appeal asserts that the bank’s risk profile is modest and even decreasing, given its good asset quality and solid earnings in the prior year. The appeal further states that the SO provided scant analysis of 12 CFR 3.403(a) through (c) in support of the higher IMCRs and instead proposes lower IMCRs.
The appeal contends that the 60-day time frame to comply with the IMCRs is not appropriate. The appeal further notes that the time frame conflicts with the relevant regulations the SO cited in support of its decision to impose the higher IMCRs and that the time frame for compliance would require actions that would impair the safety and soundness of the bank. The appeal instead proposes a longer time frame to achieve the minimum capital ratios.
The Ombudsman conducted a comprehensive review of the appeal using the following supervisory standards in effect at the time of the decision:
The Ombudsman concurred with the SO on all issued appealed.
The Ombudsman concurred with the circumstances listed in 12 CFR 3.402(b), (c), and (e) in light of the bank’s earnings and capital positions and determined that the SO’s analysis supported the decision to establish IMCRs. The circumstance described under 12 CFR 3.402(c) states, “A national bank or Federal savings association has, or is expected to have, losses resulting in capital inadequacy.” The bank’s earnings are less than satisfactory and were rated 3 well in advance of the SO’s decision to establish IMCRs. In two consecutive prior years, the bank would have reported material net losses because of poor core earnings performance, if not for significant nonrecurring or extraordinary income. During a recent examination, the SO found that the bank’s condition continued to deteriorate, strategic initiatives implemented over the prior one-year period placed further stress on the bank’s net interest margin (NIM), and earnings remained insufficient to fully support operations, accrete capital, and maintain an adequate allowance for credit losses. These findings coupled with a past due matter requiring attention (MRA) on capital and strategic planning support a conclusion that the bank is reasonably expected to report losses resulting in capital inadequacy.
The circumstance described under 12 CFR 3.402(e) states, “A national bank or Federal savings association with significant exposure to declines in the economic value of its capital due to changes in interest rates.” As a result of management and board actions, the bank is poorly positioned for the existing level of elevated market rates and has a poor outlook for rising interest rates. The bank’s capital levels cannot withstand additional declines. In addition, weaknesses exist within management’s documentation of key assumptions, scenarios employed, and back-testing variances for the bank’s asset liability model, as described in an interest rate risk (IRR) management-focused MRA. The combination of these findings along with the potential for future losses support the conclusion that the bank has significant exposure to declines in the economic value of capital due to changes in interest rates.
12 CFR 3.402(b) states, “A national bank or Federal savings association receiving special supervisory attention.” While the bank did not dispute this circumstance in its appeal, the Ombudsman found it also applies to the bank.
The Ombudsman concurred with the level of IMCRs required by the IMCR decision notification, and the relevant factors identified by the SO in 12 CFR 4.303(a) through (d) to support those levels. The minimum capital ratios outlined in 12 CFR 3.10(a) do not consider a bank’s risk profile. Accordingly, these ratios are not appropriate for all banks and do not provide a meaningful basis for comparison to the IMCRs established for the bank under 12 CFR 3.403. Per 12 CFR 3.402, the OCC may require higher minimum capital ratios for a bank in view of its circumstances. Per 12 CFR 3.403, the appropriate minimum capital ratios for an individual bank cannot be determined solely through the application of a rigid mathematical formula or wholly objective criteria. Instead, the minimum capital ratios are necessarily based in part on subjective judgment grounded in agency expertise and may consider certain inexhaustive factors listed in 12 CFR 3.403.
The SO appropriately considered the factor identified in 12 CFR 3.403(a), “The conditions or circumstances leading to the OCC’s determination that higher minimum capital ratios are appropriate or necessary for the bank.” The bank’s high and increasing risk profile, strategic decisions and resulting declines in earnings performance and capital levels and increased IRR exposure, and the past due capital and strategic planning MRA are the primary conditions or circumstances supporting the higher level of IMCRs required.
The Ombudsman concurred that “[t]he exigency of those circumstances or potential problems” noted in 12 CFR 3.403(b) also applied. In addition to above comments, capital ratios have continually declined over several years despite significant asset growth during the same period. The board issued an excessive level of dividends in a prior two-year period, and while reduced from previous years, the board continued to declare dividends in the most recent year despite receiving prior supervisory correspondence rating the capital and earnings components as less than satisfactory or 3. Finally, the board did not act to inject additional capital or take substantive measures to improve capital ratios after receiving these findings.
The SO appropriately considered the factor in 12 CFR 3.403(c), “The overall condition, management strength, and future prospects of the bank.” Conclusions resulting from the most recent examination noted that board and management performance needs improvement and rated the component a 3. The examination also identified a past due strategic and capital planning MRA, two new MRAs related to IRR management and liquidity risk management, and weak or insufficient quality of risk management conclusions for interest rate, liquidity, operational, and strategic risk categories that are additional indications of less than satisfactory board and management administration of the bank. The bank did not dispute most of these conclusions, and the Ombudsman concurred with the SO for the conclusions that the bank did dispute.
In addition, the board did not act on its own to improve capital levels based on the bank’s deteriorating condition. Before establishing the IMCRs, management and the board had the time and opportunity to improve the bank’s high and increasing risk profile and declining earnings performance and capital levels communicated in the prior report of examination yet failed to implement effective strategies and corrective actions to do so.
Finally, the SO appropriately considered the factor in 12 CFR 3.403(d), “The bank’s liquidity, capital, risk asset and other ratios compared to the ratios of its peer group.” As of the most recent examination, key metrics for the bank’s liquidity, capital, earnings, and IRR ratios were trending negative from one year prior and compared with the bank’s uniform bank performance report peer group. This included declining levels of core deposits as a percent of liabilities, increased net noncore funding dependence, declining capital ratios and return on average assets, declining NIM, and ratios demonstrating increased IRR exposure.
The Ombudsman concurred with the SO that the 60-day time frame stipulated by the IMCR decision notification is appropriate. The bank’s current capital levels do not fully support the bank’s high and increasing risk profile, and the board and management must demonstrate a sense of urgency in increasing capital levels. The board and management are responsible for the bank’s condition, ensuring the bank maintains appropriate capital levels, and for operating the bank in a safe and sound manner consistent with applicable laws and regulations.
