SARC-98-07 (September 22, 1998)

Your appeal of a material supervisory determination was decided by the Supervision Appeals Review Committee (“Committee”) of the Federal Deposit Insurance Corporation on September 15, 1998. The committee considered [Bank] (“Bank”) appeal of various conclusions of the February 10, 1998, joint Safety and Soundness examination. After careful review, we have concluded that the examination findings relating to the assessment of management, the effectiveness of the outstanding Memorandum of Understanding, and the assigned composite rating are appropriate. The State of Hawaii Division of Financial Institutions (“the State”) Commissioner Lynn Y. Wakatsuki was provided a copy of your letter of appeal; she has responded that the State concurs with the ratings and overall findings of the report of examination.

We have given careful consideration to the issues raised in your appeal letter dated July15, 1998. Although we have concluded that the ratings and the overall findings of the report were accurately reflected in the report, we do recognize the efforts taken by management since the examination, particularly your submission of the “Informal Proposal” to Regional Director Masa on April 20, 1998. The Strategic Plan and Profit Plan included in that proposal require expanded discussion and corrected financial data; however, we view these documents as an initial positive step by management to address the criticisms noted in the examination report. We hope you will continue and increase your efforts to correct deficiencies and strengthen areas of identified weakness.

This appeal was reviewed separately from the proposed enforcement action being considered. As stated in the April 4, 1995 Financial Institutions Letter entitled “Guidelines for Appealing Material Supervisory Determinations,” decisions to initiate formal or informal enforcement actions may not be appealed. Questions raised in the appeal letter regarding the assessment of management were reviewed in the context of the composite rating, management rating, and the assessment of management’s efforts to comply with the Memorandum of Understanding as of the examination date. We also noted your concern that the institution’s minority status was not discussed or considered in the examination findings. The Committee’s findings on these issues are presented below along with an explanation of the reason for the decision.

Management Assessment and Rating
You appeal the examination report’s overall conclusions regarding board oversight and management effectiveness, but dispute very few of the many specific findings regarding management deficiencies. While information is provided regarding the basis for the board’s approval of three credits which were either adversely classified or listed as a concentration of credit, the classification and listing of those credits is not appealed. You have supplied substantial information regarding how “Realtor” operated for the benefit of Bank. However, this does not eliminate the deficiency that was cited in the examination report: management did not maintain records documenting financial benefit to Bank resulting from Realtor’s activities or the amount of the company’s expenses paid by Bank.

The examination report lists numerous management weaknesses in addition to those you address in the appeal. Not disputed in your appeal are criticisms regarding: credit administration weaknesses; ineffective loan review; lack of a realistic and comprehensive budget; failure to report to the board the high degree of interest rate risk and to devise a strategy to lower that risk; absence of documented discussion and notification to the board regarding the shift from core deposit funding to short term borrowings; and inadequate monitoring and control of the information systems conversion which resulted in Bank’s books being out of balance for 16 months.

The examination report acknowledges that the Hawaiian economy has been declining, but primarily attributes the deterioration in Bank’s condition to poor management and board supervision. We believe the extent and nature of the weaknesses cited in the report are significant and they have contributed to the decline in Bank’s condition. This decline is evidenced by Bank’s trend of increasing adversely classified assets and past due loans, and deteriorating earnings. Even if favorable economic conditions had resulted in overall satisfactory financial indicators despite the many management deficiencies noted during the examination, it would still be appropriate to detail those weaknesses in the examination report and to consider them in assigning a management component rating.

The comments in your appeal regarding the influence of Year 2000 matters on the assessment of management are noted. Since the Committee has already separately considered and addressed management’s response to Year 2000 concerns, we believe it is inappropriate to revisit the issue in this appeal.

The Uniform Financial Institutions Rating System’s definition of a management component rating of “4” includes the following statement: “Problems and significant risks are inadequately identified, measured, monitored, or controlled and require immediate action by the board and management to preserve the soundness of the institution.” The Committee believes the situation at … fits this definition; therefore, the management component rating of “4” is accurate.

Compliance with the Outstanding Memorandum of Understanding
In your appeal, you state that …has substantially complied with the Memorandum of Understanding (“MOU”) and that the informal action has been effective. Since the examination closed, Bank has taken some steps toward complying with certain MOU provisions. However, per outstanding guidelines on processing appeals, in determining whether the MOU was effective or not at the time of the examination, we can only look to the institution’s circumstances at that time, not several months later.

The primary disagreement regarding the MOU seems to stem from differing interpretations of the first two provisions of the document. These two provisions address board oversight/responsibilities and providing for management that is qualified to restore the institution to sound condition. You characterize these two provisions as being vague and ambiguous, but you believe Bank should be considered to be in compliance with them. The findings of the examination report clearly indicate Bank’s board and senior management were not complying with the intent of the first two provisions of the MOU because they failed to adequately supervise and effectively manage the institution. This is evidenced by the numerous management deficiencies cited in the examination report and referenced in the previous section of this letter.

Compliance with the management provisions of the MOU is key to achieving compliance with the remaining provisions and in determining the effectiveness of the action. Bank’s declining financial condition and extensive management weaknesses as noted in the examination report, it is evident to the Committee that the MOU had not been effective and that the examination report is accurate in reflecting that conclusion.

Composite Rating
You appeal the composite rating of “4”, but, other than the management rating, do not dispute any component ratings. The examination report reflects an institution with poor asset quality, deficit earnings, declining capital, marginal liquidity, and substantial risk to an increase in interest rates. The Committee believes the assigned component ratings accurately reflect the examination findings and that those findings support a composite “4” rating.

Minority-Owned Institution Considerations
In addition to the objections noted above, the appeal letter also contends that the report of examination is deficient because the institution’s minority status and FDIC policies and procedures regarding minority-owned institutions were not discussed and considered in the examination findings. The absence of discussion of Bank’s minority status in the report of examination is not an appealable issue under the aforementioned Guidelines for Appealing Material Supervisory Determinations. Nevertheless, we are sensitive to your concerns on this issue and wish to address the questions you have raised regarding the supervision of minority institutions.

The appeal asks, in part, “…How is its examination of Bank and its ROE different from a non-minority financial institution? How does the ROE reflect a recognition and intent to implement said law and policy?” The FDIC’s April 3, 1990 Policy Statement on Encouragement and Preservation of Minority Ownership of Financial Institutions defines the role of the Division of Supervision in encouraging and preserving minority institutions in the “Discussion” section as follows:

One very effective method of preserving minority ownership is to maintain the health of existing minority-owned depository institutions. In this regard, DOS is committed to a program of regular examination of all banks for which it has primary supervisory responsibility. This examination program is intended to detect and to work with management to correct deteriorating trends. Correction of any adverse trends in institutions normally is handled through regular supervisory channels. In the event that management is unable to effect correction because of a lack of resources or technical expertise, DOS will provide assistance where practical. [Italics added for emphasis]

The “Procedures” section of the policy statement further clarifies that the Division of Supervision will help minority-owned institutions in need of assistance primarily through the normal supervisory process:

Through its normal supervision, the FDIC will be aware of institutions in need of remedial or preventative attention. Field examiners and regional office staff will make suggestions and offer assistance, which an institution is free to accept. Institutions are also urged to make their needs known to the regional directors who will do all they can to help. [Italics added for emphasis]

The intent of the foregoing policy statement is not to handle supervisory measures differently for a minority institution than for a non-minority institution. The report of examination was not, and should not be, prepared differently for the thrift because it is a minority institution. The conclusions and concerns detailed throughout the report of examination were not, and should not be, biased because an institution is, or is not, a minority institution. Instead, the intent of the policy statement is to assist minority-owned institutions, where practical, in correcting deteriorating trends. Your institution has requested special assistance in accordance with the policy statement on two separate occasions, and the San Francisco Regional Office has honored your requests by providing examiners to offer advice and make recommendations about corrective measures needed to address the institution’s deficiencies. Further requests for special assistance will be considered in light of the institution’s particular circumstances.

In accordance with the Guidelines for Appealing Material Supervisory Determinations, the scope of this review was limited to the facts and circumstances that existed at the time of the examination; no consideration was afforded any changes occurring after that date or to any subsequent corrective action. However, the San Francisco Regional Office will consider any such efforts in its determination of the proposed supervisory response.

This determination is considered the Federal Deposit Insurance Corporation’s final supervisory decision.

By direction of Supervision Appeals Review Committee of the Federal Deposit Insurance Corporation.