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Appeals of Material Supervisory Determinations: Guidelines & Decisions
(April 12, 2004)
The Committee consensus was that the Bank continues to be an institution that is well managed and continues to operate at a high level of performance. Nevertheless, after careful deliberation and consideration of all relevant information, the Committee concluded the Bank’s appeal should be denied. The Committee found that the conclusions contained in the Report of Examination accurately reflected the condition of the Bank, and that those conclusions were adequately supported by the facts and findings in the Report of Examination. The Committee determined that the Asset Quality and Management component ratings and the Composite rating were consistent with the FDIC’s practices.
The scope of the Committee’s review was limited to the facts and circumstances as they existed at the time of the examination. Although events that occurred after the examination and any subsequent corrective actions were not considered as part of the Committee’s review, they will be reviewed during future onsite supervisory activities.
The bases for the Committee’s decision are discussed more fully below.
Asset Quality Rating
The Federal Financial Institutions Examination Council’s (FFIEC) Uniform Financial Institutions Rating System states, in part, that an Asset Quality rating of “1” reflects strong asset quality and credit administration practices. While the volume, level, and trend relating to virtually all of the Bank’s qualitative Asset Quality measures present minimal concern, examiners identified noteworthy loan underwriting and administration deficiencies throughout the construction and development and permanent commercial real estate portfolios at the September 2003 examination. These weaknesses are particularly evident in the loans listed as Special Mention. The three relationships listed for Special Mention exhibited underwriting and administration deficiencies, including the absence of, or ineffective analysis of, the principal borrowers’ and/or guarantors’ financial capacities as well as weaknesses in loan review and monitoring. The Committee notes that some of these same loan underwriting and administration deficiencies were also discussed in the FDIC’s July 11, 2000 Report of Examination.
Construction and development lending, whether related to a “spec” home or a multi-unit condominium project, is a higher-risk activity requiring sound credit underwriting and administration to mitigate risk. This is particularly true for real estate markets that have seen a rapid escalation in values, as has the greater Boston market. That weaknesses of the nature and type identified are allowed to continue is not indicative of “strong” credit administration practices. The Committee concludes that the “2” Asset Quality component rating assigned is appropriate.
The Committee, however, agrees that the numerous material loan underwriting and administration weaknesses identified, many of a repeat nature, have both increased credit risk at the Bank and heightened the Bank’s overall risk profile. Furthermore, the Report of Examination enumerates a number of information technology, interest rate risk management, and anti-money laundering weaknesses. The Committee also observes that the Bank’s capital levels provide only adequate support to the Bank’s risk profile. The Committee recognizes the improvements in earnings and liquidity; however, the impact of these improvements on the Bank’s overall risk profile is more than offset by the loan administration and underwriting weaknesses detailed in the Report of Examination.
The Division of Supervision and Consumer Protection’s (DSC) Manual of Examination Policies states that “… management’s ability to respond to changing circumstances and to address risk that may arise from changing business conditions, or the initiation of new activities or products…is an important factor in evaluating a financial institution’s overall risk profile.” Although construction, development, and commercial real estate lending are not new to the Bank, the Bank’s involvement with this type of lending has increased significantly in recent years without corresponding improvements in underwriting policies and procedures and loan administration. The Committee believes one hallmark of strong management teams (and banks) is their proactive implementation of policies and procedures that serve to mitigate risks associated with certain business lines or assets. Rather than proactively implementing sound risk management policies and procedures for the growing construction, development, and commercial real estate segments of the Bank’s loan portfolio, the Bank’s Board/management has continued to rely on risk management policies and procedures that are more suitable for lower-risk residential lending.
The FFIEC’s Uniform Financial Institutions Rating System states that banks rated Composite “1” are basically sound in every respect. The Bank’s financial condition clearly remains satisfactory, but its overall risk profile is sufficiently heightened by weaknesses in the administration of the construction, development, and commercial real estate segments of the Bank’s loan portfolio that some supervisory concern is warranted. The Committee concludes that the Composite “2” rating assigned is appropriate.
Other Issues Raised in the Appeal
By direction of the FDIC’s Supervision Appeals Review Committee.
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