Appeals of Material Supervisory Determinations: Guidelines
(August 3, 2001)
At its meeting held on July 30, 2001, the Supervision
Appeals Review Committee (Committee) of the Federal Deposit Insurance
Corporation (FDIC) considered the appeal filed by [Bank] (Bank). In its
appeal, the Bank contested certain material supervisory determinations
contained in the safety and soundness examination, dated October 16, 2000,
(Report) prepared by the FDIC.
Upon careful consideration of the issues raised in the
appeal, the Committee determined that the component and composite Uniform
Financial Institution Ratings and the loan classifications assigned at the
examination were appropriate. Commissioner Steven D. Bridges of the Georgia
Department of Banking and Finance, who was provided with a copy of the
Bank’s letter and appeal, has advised the FDIC that the State strongly
believes that the composite “3” rating assigned at the examination was
The Committee’s rationale for the decision rendered in the
Bank’s appeal is presented below.
The Bank appealed eight of the Substandard loan
classifications assigned in the Report. The Acting Director of the Division
of Supervision (Acting Director) granted the appeal of the classification of
the A loan in the amount of $180,000. In addition, the Acting Director
granted the appeal of the $133,000 loan to borrower B. The Committee denied
the Bank’s appeal of the remaining Substandard classifications for the
Customer C: The borrower’s credit history and credit score
information, combined with late payments of this credit, albeit less than 30
days, are indicative of serious deficiencies in repayment capacity. In
addition, a high loan-to-value (LTV) ration of 89 percent provides the
distinct possibility that Bank will sustain some loss on this credit.
Customer D: The Bank indicates that the excess collateral
protection in one loan is available to secure the rest of the borrower’s
loans. However, no documentation was provided by the Bank to show that the
loans are cross-collateralized. Four of the remaining six loans to the
borrower have LTV ratios in excess of 90 percent, and payments are not made
by the due dates. As a result, late fees assessed by the Bank are
eliminating amortization of the principal balance for the majority of the
loans. These facts, combined with concerns about the borrower’s repayment
capacity, as evidenced by his credit history and a lack of cash flow
statements on the income producing properties, support the Substandard
Customer E: The borrowers performance on this credit and
his credit history indicate a problem with repayment capacity. Foreclosure
is imminent and, given the credit’s high LTV ratio, there is a distinct
possibility of loss.
Customer F: The borrower recently filed Chapter 7
bankruptcy, indicating a diminished capacity to repay. Combined with a high
LTV ratio of 89 percent, the potential for loss exists.
Customer G: Serious credit deficiencies, including prior
charge-offs, an outstanding tax lien, and low credit scores, exist. The
Bank’s appeal represents that a second mortgage made by another entity on the
collateral for this loan protects the Bank from loss. However, this
presumption is not considered valid in that the second mortgage was a seller
financing arrangement in what appears to be a ‘no-money-down’ transaction.
The Bank’s appeal also noted that this loan was originated after the
examination’s loan review date. Examiners have the discretion to tailor the
sample of loans reviewed depending upon the particular circumstances of the
bank being examined. In this case, examiners were concerned about
broker-originated loans and appropriately expanded their coverage of that
area. The Committee determined that the inclusion of this credit in the
examiners’ sample and its Substandard classification were appropriate.
Customer H: Payments on this loan have been delinquent and
late fee assessments have increased the principal balance. These facts,
coupled with a high LTV ratio, indicate that a distinct possibility of loss
Customer I: The credit report findings and slow payment
history on this relatively new loan indicate problems with repayment
capacity. This, coupled with a high LTV ratio, indicates that a distinct
possibility of loss exists.
Asset Quality Component Rating
The Report identified $3,790,000 in classified assets.
After adjusting classifications for the appeals granted by the Acting
Director, total classifications are now $3,477,000, or 73.32 percent of Tier
1 capital and the allowance for loan and lease losses (ALLL). This level of
classifications is considered high and is a significant increase over prior
examination levels. In addition, the Bank’s loan delinquency ratio is
excessive at 10.2 percent and has doubled since the last examination.
Also considered in the asset quality component rating are
the inadequacy of the ALLL and deficiencies in loan underwriting, loan
administration, and the loan policy. The Report indicates that the Bank has
raised the acceptable level of LTV ratios for new loans without a
commensurate change or tightening in other traditional underwriting
criteria. In addition, there is no independent review of the loan portfolio
and the loan policy fails to address subprime lending, which represents the
majority of the Bank’s loan portfolio. The Committee concurred with the “3”
rating assigned to the Asset Quality component.
Liquidity Component Rating
As of the date of the examination, the Bank had $5.8
million in zero-coupon brokered deposits obtained through “Service Company
(“SC”). SC was placed in bankruptcy/receivership in July 1998. The receiver
of … filed a class action lawsuit against a number of brokers, banks, and
associated individuals. The Bank and Chairman of the Board …, were named as
defendants in the lawsuit. The suit’s primary purpose was to allow
redemption of the certificates of deposit (CDs) long before the maturity
without the assessment of early withdrawal penalties. At the time of the
examination, there was a tentative settlement agreement proposed that
included significantly reduced prepayment penalties. The suit also sought
compensation for damages stemming from offering and selling unqualified
securities, misrepresentation in securities transactions, breach of
fiduciary duties, constructive and actual fraud, negligent
misrepresentation, and other sources of damages.
The Report indicated that the issues surrounding the
lawsuit placed a severe strain on the Bank’s liquidity position. The
potential for negative publicity and the preponderance of large, volatile
deposits at the Bank might have generated additional deposit run-off that
would have had a negative effect on the bank. Cash and other liquid assets
totaled only $887,000, far less than the CDs. While the securities portfolio
did total $20 million, it mostly consisted of long-term investments, it was
30 percent pledged, and it contained $1.3 million in unrealized
depreciation. Further, although borrowing lines did exist, the Bank’s
borrowings already totaled $8.5 million and the availability and cost of
further advances in an emergency situation was uncertain.
The Bank’s appeal indicates that the SC deposits were
withdrawn subsequent to the examination and that the early withdrawal
penalties received roughly offset the losses taken on the sale of its
long-term securities, which funded the withdrawals. The Bank suggests that
this fact supports its case that the Liquidity component was improperly
rated. However, the Committee must consider the facts that existed at the
time of the examination. While the Bank was able to extract itself from a
potentially critical situation with only minimal losses, as of the date of
the examination, the Liquidity component warranted a rating “4.”
Management Component Rating
The Report documents significant management weaknesses
that need to be corrected. These include weaknesses and deficiencies
involving Bank policies and operations, transactions with affiliates,
employee compensation, Call Report filings, internal routines and controls,
and internal audit. Numerous apparent violations of federal and state laws
and regulations were cited, including Sections 23A and 23B of the Federal
Reserve Act. In addition, there were numerous contraventions of FDIC
Statements of Policy. These weaknesses, combined with identified
deficiencies in asset quality and liquidity, clearly support a rating of “3”
for the Management component.
The Capital, Earnings and Sensitivity to Market Risk
components were all assigned a “3” rating within the Report and were not
appealed by the Bank. As the Committee has upheld the Report’s rating of the
Asset Quality, Liquidity and Management components as “3,” “4,” and “3,”
respectively, the Bank’s overall condition is deemed to warrant a “3”
composite rating. This conclusion is not reached upon a calculation of a
numerical average but is a result of the consideration of the key Report
finding relating to each of the components.
In accordance with the Guidelines for Appeals of Material Supervisory
Determinations, the scope of this review was limited to the facts and
circumstances as they existed at the time of the examination; no
consideration was given to any facts or circumstances that occurred after
that date or any subsequent corrective action
Before deciding your appeal, the Committee considered your
request to appear in person before the Committee. Based upon a review of your
comprehensive appeal letter, dated June 1, 2001, the Committee concluded
that the information relating to the appeal was complete. Accordingly the
Committee determined that no oral presentations, either by the Bank or by
the Division of Supervision, were necessary. Please be assured that the
Bank’s appeal and all of the facts and circumstances related to it received
careful, thorough, and just consideration.
The FDIC’s Office of the Ombudsman will contact you
regarding the allegations made by the Bank concerning the conduct of the
examiner-in-charge. These allegations are not addressed within this letter,
as they do not fall within the scope of the Guidelines for Appeals of
Material Supervisory Determinations.
This decision is considered a final supervisory decision
of the FDIC.
By direction of the Supervision Appeals Review Committee
of the FDIC.