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Appeals of Material Supervisory Determinations: Guidelines & Decisions

SARC-2002-01 (May 2, 2002)

At its meeting held on April 22, 2002, 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 August 6, 2001 (“Report”), prepared jointly by the FDIC and the Alabama State Banking Department. In accordance with the Guidelines for Appeals of Material Supervisory Determinations, the scope of the Committee’s review was limited to the facts and circumstances as they existed at the time of the examination. Facts or circumstances that occurred after the examination, and any subsequent corrective actions the Bank may have taken, will be reviewed during future on-site supervisory activities.

The Committee found that the ratings assigned at this examination were not inappropriately influenced by outside factors such as pending lawsuits or communication with regulators. The Committee found that the conclusions in the Report were supported by facts presented within the Report.

Upon careful consideration of the issues raised in the appeal, the Committee determined that the component and composite Uniform Financial Institution Ratings assigned at the examination were appropriate. Also, Superintendent of Banks Maria B. Campbell of the Alabama State Banking Department, who was provided with a copy of the Bank’s appeal, has advised the FDIC that she considers the ratings assigned at the examination appropriate.

The Committee’s rationale for the decisions rendered in the Bank’s appeal is presented below.

Capital Component Rating
The Report documented that capital levels at the time of the examination were insufficient to fully support the Bank’s risk profile. The insufficiency of capital appeared more pronounced when consideration is given to the Bank’s weak earnings performance and the volume and trend of problem assets. The need for improvement in the Bank’s capital posture was evident. The Committee concurred with the “3” rating assigned to the Capital component.

Asset Quality Component Rating
The level of risk and problem assets found at this examination and documented in the Report was significant. The ratio of adversely classified assets to capital and reserves was higher at this examination than at the prior examination and the severity of adverse classifications increased, despite the Bank’s taking a high volume of loan losses between examinations. The Report listed a significant number of examples of deficient credit administration practices, some of which were cited as remaining uncorrected from the prior examination. In contrast to what was stated in the appeal, the Report documented non-compliance with several asset quality-related provisions of the Memorandum. The Committee concurred with the “4” rating assigned to the Asset Quality component.

Management Component Rating
The Bank’s financial condition and performance as documented in the Report reflect unfavorable trends and an unsatisfactory risk profile. Deficient management and board performance are documented in the Report. The Report provides evidence that management has inadequately identified, measured, monitored, and controlled risk. Risk management practices were found unacceptable relative to the Bank’s size, complexity, and risk profile. The Report also notes that concerns cited at previous examinations remained uncorrected at this examination. Based on the foregoing, the Committee concurred with the “4” rating assigned to the Management component.

Earnings Component Rating
The Report appropriately identified deficient Bank earnings performance. Earnings were not sufficient to support the Bank’s operations while maintaining adequate capital and Allowance for Loan and Lease Losses (“ALLL”) levels. Capital contributions from the parent company were needed to augment capital. At the time of the examination, earnings had trended downward since 1996. Although outside the purview of this appeal, in hindsight, the Bank did show a small profit for 2001; however, much of this profit can be attributed to realized securities gains. According to the December 31, 2001 Uniform Bank Performance Report (“UBPR”), even with the benefit of securities gains, the Bank’s Return on Average Assets (“ROA”) of 0.40 percent was significantly below its peer group average of 1.20 percent. The Bank’s ROA fell in the 5th percentile of the peer group. The Bank’s performance was similarly poor at the time of the Report. The June 30, 2001 UBPR shows that the Bank’s ROA fell in the 7th percentile of the peer group. The Report also found that the ALLL was severely underfunded. The Report provided evidence of nominal earnings, the development of significant negative trends, and a substantive drop in earnings from previous years. The Committee concurred with the “4” rating assigned to the Earnings component.

Liquidity Component Rating
Considering the factors detailed in the Report, in conjunction with the overall condition of the Bank, the liquidity posture was found less than satisfactory. The relaxation of policy constraints in this area, uncertainties concerning the continued availability of borrowing sources, and the current financial posture of the Bank point toward the need for continued close monitoring and management of the Bank’s liquidity position. Based on the foregoing, the Committee concurred with the “3” rating assigned to the Liquidity component.

Sensitivity to Market Risk Component Rating
The Report identified inadequate supervision of this area by senior management and the board of directors. Risk management practices were deficient for the size, sophistication, and level of market risk accepted by the Bank. Primary areas of concern included the Bank’s liability sensitive position; the lack of board oversight; the lack of conformity with policy guidelines; the loss of key financial management personnel; and the lack of independent review of the interest rate risk management program. The level of earnings and capital provide inadequate support for the degree of market risk taken by the Bank. Lack of reliable data to support the Bank’s interest rate risk profile was also a concern. Based on the foregoing, the Committee concurred with the “4” rating assigned to the Sensitivity to Market Risk Component.

Composite Rating
The Report cited numerous examples of serious financial or managerial deficiencies that contributed to the Bank’s unsatisfactory performance. Many of the weaknesses were also detailed in the violation of Part 364, Appendix A – Standards for Safety and Soundness, of the FDIC Rules and Regulations, cited in the Report. It is evident that, at the time of the examination, management and the board of directors were not satisfactorily addressing the weaknesses and problems of the Bank. Significant apparent violations of federal and state law were cited. As identified and documented in the Report, risk management practices are generally unacceptable relative to the institution’s size, complexity, and risk profile. The findings of the Report reflect that the Bank poses a risk to the deposit insurance fund. The Report also supports the stance that if the problems facing the Bank are not promptly addressed, viability could be threatened.

As the Committee upheld the Report’s rating of all components, the Bank’s overall condition was deemed to warrant a “4” composite rating. This conclusion was not reached upon a calculation of a numerical average but was a result of the consideration of the key Report findings relating to each of the components.

Request to Appear
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 February 21, 2002, 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 consideration.

This decision is considered a final supervisory decision of the FDIC.

By direction of the Supervision Appeals Review Committee of the FDIC.