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Deposit Insurance Assessment Appeals: Guidelines & Decisions  

AAC- 2005-02 (July 1, 2005)

X (the “Bank”), by letter dated February 24, 2005, filed an appeal with the Assessment Appeals Committee (“Committee”) of the Federal Deposit Insurance Corporation (“FDIC”). The Bank is appealing a decision issued by the FDIC’s Division of Insurance and Research (“DIR”) on January 26, 2005, denying the Bank’s Request for Review of its supervisory subgroup (“SS”) rating for the January 1, 2005 semiannual period. The Bank seeks reclassification of its SS assignment from “1C” to “1B” for that period.

At its meeting held on April 28, 2005, the Committee allowed the Bank, pursuant to the Guidelines for Appeals of Deposit Insurance Assessment Determinations,1 to appear and make an oral presentation in support of its case for a change in SS rating. The oral presentation was particularly helpful to the Committee in illuminating the issues presented in this appeal. After carefully considering all of the written and oral submissions and the facts of this case, however, the Committee has determined that the Bank’s appeal must be denied.

The Bank was assigned an SS of “C” for the January 1, 2005 assessment period. That assignment was based upon its CAMELS composite rating of “4,” resulting from a Federal Reserve Bank of Minneapolis (“FRB”) examination, in which the FDIC participated, that began on February 2, 2004 and ended on May 12, 2004. September 30, 2004 was the effective date for assigning SS classifications for the first semiannual period of 2005 pursuant to FDIC regulations and procedures. The February 2, 2004 exam was the last exam finalized and transmitted to the Bank by the FRB, its primary federal regulator, on or before the September 30, 2004 cut-off date.

The FDIC participated in an FRB targeted review of the Bank that began on September 7, 2004 and was completed on September 23, 2004. The targeted review did not include assignment of a CAMELS rating.

The reconcilement period for the January 1, 2005 semiannual assessment period began on October 12, 2004 and ended on November 19, 2004. The Bank was flagged for review and its SS rating of “C” was confirmed. The information reviewed included the February 2, 2004 examination; offsite financial information, including the Bank’s June 30, 2005 Call Report; the September 7, 2004 targeted review findings; and correspondence from the Bank and FRB, including the Bank’s efforts to comply with a Written Agreement entered into with the FRB on September 23, 2003.2 The Bank’s December 15, 2004 assessment invoice contained a risk classification of “1C” for the January 2005 semiannual period.

No examination was in-process as of the cut-off date or during the reconcilement period. An FRB examination of the Bank was begun on November 29, 2004, ten days after the reconcilement period ended. Preliminary CAMELS ratings from that exam were not determined until December 16, 2004.

On January 19, 2005, the FRB transmitted the final results of the November 29, 2004 examination to the Bank. The Bank’s CAMELS ratings were 243322, with a composite rating of “3” assigned.

By letter dated December 21, 2004, the Bank requested review of the risk classification assigned to it for the January 2005 period, seeking an upgrade from “1C” to “1B.” According to the Bank, its capital ratios significantly exceeded the requirements of the Written Agreement and had improved each quarter; earnings remained strong; “Marketable Assets” exceeded Bank insured deposits; loan loss reserves were fully funded; the FRB exam of November 29, 2004 had upgraded the Bank’s CAMELS rating to a composite “3”; and the Bank had complied with the Written Agreement as evidenced by a letter from the FRB dated October 14, 2004. For those reasons, the Bank asserted that the risk it posed to the FDIC insurance fund was “extremely remote.”

DIR denied the Bank’s Request for Review by letter dated January 26, 2005. Outlining the process for determining risk classifications for insured institutions, DIR explained that the Bank’s January 2005 risk classification was based primarily on the composite rating assigned at the February 2004 examination, the last finalized composite rating before the September 30, 2004 cut-off date. DIR noted that the FDIC considers other pertinent information during the reconcilement period, and that institutions whose risk profile might have changed since the last exam can be subject to SS upgrades or downgrades, as more recent examination information may reflect.

According to DIR, the FDIC lacked, and therefore could not consider, the results of any exam more recent than February 2, 2004, either at the cut-off date or during the reconcilement period, when the SS was determined.

On February 24, 2005, the Bank appealed DIR’s denial to this Committee. Acknowledging that the last finalized, transmitted report of examination prior to the cut-off date assigned it a CAMELS “4” rating, the Bank asserts that available supervisory information warranted an SS upgrade to “B.” The Bank points out that FRB and FDIC personnel, in the nine month period following the February 2004 exam, had analyzed whether the Bank was in compliance with its Written Agreement and later performed the November 29, 2004 exam. A significant amount of substantive, favorable supervisory information was generated during this period, the Bank asserts, which should have been considered by the FDIC in determining the Bank’s January 2005 SS rating. Such information, in the Bank’s view, goes beyond its CAMELS rating and falls within the “variety of factors” set forth in FIL-90-2003 (Nov. 28, 2003) for assigning SS ratings.

The Bank also contends it was told by FRB and FDIC representatives that the November 29, 2004 examination results, if available by December 31, 2004, would be considered in determining the Bank’s SS for the January 2005 semiannual period. Based on these statements, the Bank asserts that it “reasonably believed that the reconcilement period ended on December 31, 2004.” According to the Bank, previous Committee decisions are not yet public and therefore it could not verify the accuracy of the statements made. Claiming the benefit of the doubt, the Bank urges the Committee to extend the Bank’s reconcilement period until the end of 2004.

SS assignments are made in accordance with the FDIC’s regulations, specifically, 12 C.F.R. § 327.4(a)(2), which requires the FDIC to consider supervisory evaluations provided by an institution’s primary federal regulator and other relevant information in making these assignments.

Under guidelines set forth in FIL-90-2003, the FDIC assigns an SS to each institution for each semiannual assessment period based on a variety of factors, including FDIC review of the results of the last examination finalized and transmitted to the institution by the primary regulator on or before the cut-off date.3 Under the FIL, the cut-off date for the January 1 assessment period is the preceding September 30. The FIL expressly states that the cut-off date relates to the FDIC’s determination of an institution’s risk profile as of that date. The FDIC’s review may also include a review of other written findings that result in a composite rating change by the primary regulator; a review of the finalized results of independent, joint or concurrent FDIC examinations; results of offsite statistical analysis of reported financial statements; or analysis of other pertinent information.

To ensure greater fairness in the application of cut-off dates, and to allow consideration of unusual circumstances, the FDIC continues to look at the information referred to in FIL-90-2003 for a period of approximately six weeks after the cut-off date, in what is known as the “reconcilement” period. As provided in the FIL: “The FDIC continues to consider other pertinent information during a reconcilement period following the cut-off date. Institutions whose risk profile might have changed since their last examination can be subject to supervisory subgroup upgrades or downgrades, as more recent examination information may reflect, during the reconcilement period.” As indicated in the FIL, and in the decisions of this Committee (see, e.g., AAC No. 2004-04, at 4 (Sept. 7, 2004); AAC No. 2003-02 (Aug. 1, 2003)), “other pertinent information” will usually consist of “more recent examination information.” Examinations in process may generate such information. Examinations starting after the cut-off date, however, may not yet provide conclusive information to change an institution’s SS ratings.

The FDIC, in applying the guidelines in the FIL, looks to whether examination results were transmitted in writing to the institution on or before the cut-off date, unless an institution is reviewed during the reconcilement period or there is evidence of a change that is confirmed by an ongoing examination during that period.

According to the Bank, before and during the reconcilement period the FDIC possessed sufficient supervisory information to have concluded that the Bank’s condition warranted an SS upgrade to “B” for the January 2005 semiannual period. However, rather than looking to the factors set out in FIL-90-2003, which would bring the favorable information to light, the Bank asserts that the FDIC considered only the prior CAMELS rating that resulted from the February 2004 examination. In short, the Bank argues that the FDIC reconcilement review of the Bank’s SS was improper. With that in mind, the Committee must focus on the reconcilement review that was performed.

The Bank was flagged because its Statistical CAMELS Offsite Rating (“SCOR”)4 reflected improvements to its condition, and consequently its SCOR disagreed with its “1C” SS assignment. At the time the Bank was reviewed, the Case Manager had available the FRB’s February 2, 2004 Examination Report, the FRB’s September 7, 2004 targeted review, Call Report information as of June 30, 2004, and various correspondence between the Bank and the FRB. The Case Manager noted improvements, including increasing capital ratios, lower charge-off ratios, and improved liquidity indices, credit risk management, and account management guidance practices. Further, the Bank appeared to have substantially complied with the Written Agreement requirements.

The Case Manager, however, also noted that significant risk continued to emanate from the Bank’s subprime credit card program and insufficient information was available as to the adequacy of allowances for loan and lease losses and the potential impact of a large tax-related year-end dividend. The Bank had high (16.5%) delinquency rates, and management continued to focus on the total managed portfolio with limited oversight of the Bank-owned portion of the portfolio. Although the Bank had adopted certain policies and plans, its degree of compliance could not be determined at the time of reconcilement. In addition, the Case Manager had no follow-up information regarding certain items of concern detailed in the February 2, 2004 Examination Report, including significant weaknesses in the adequacy of accounting, audit, and internal control systems, as well as the Bank’s management of operational, legal and reputational risks. Moreover, the findings of the September 7, 2004 targeted review (which assigned no CAMELS rating) indicated the need for more diligent analysis, monitoring and reporting of credit card performance and risk attributes on a legal entity basis.

On November 24, 2004, the FDIC notified the FRB of the results of the reconcilement process for all flagged banks and requested that the FRB contact the FDIC if any case warranted further review. The FRB did not respond as to the Bank’s SS assignment.

The Committee, having examined the reconcilement process applied to the Bank, finds that confirmation of the supervisory subgroup of “C” in the reconcilement review conducted on October 25, 2004 reflected appropriate consideration of the variety of factors set out in FIL-90-2003 in light of the information available at the time.5

Information that supported a ratings upgrade for the Bank did not become available until the on-site November 29, 2004 examination was conducted. The Bank, however, points out that the November 29, 2004 exam used information as of the September 30, 2004 cut-off date, and that the exam ultimately resulted in a composite “3” rating for the Bank. The Bank argues that because the November 29, 2004 exam ultimately determined that an upgrade was merited, its appeal should be granted.

As the Committee has noted in prior cases, the real question presented is not whether an upgrade is ultimately found to be merited, but rather by what date that information became available. See AAC No. 2002-03, at 3 (November 25, 2002). That is the essence of the timing problem the Bank faces. Not until December 16, 2004 was a preliminary composite rating of “3” communicated to the Bank by the FRB. Final examination results were not transmitted to the Bank until the FRB’s January 19, 2005 letter, which upgraded the Bank’s CAMELS ratings from 344333/4 to 243322/3. Both events occurred well after the reconcilement period ended. In short, the November 29, 2004 examination results were obtained too late to affect the Bank’s SS rating for the January 2005 semiannual period.

The timing issue raised by the Bank in this appeal has been considered and consistently decided by this Committee. See AAC No. 2002-03 (Nov. 25, 2002), AAC No. 2003-01 (June 18, 2003), AAC No. 2003-02 (August 1, 2003), AAC No. 2003-03 (September 29, 2003), AAC No. 2003-04 (December 16, 2003), AAC No. 2004-01 (March 22, 2004), AAC No. 2004-03 (July 23, 2004), AAC No. 2004-04 (September 7, 2004), and AAC No. 2004-05 (December 21, 2004). For example, in AAC No. 2002-03, the bank asked the AAC to consider improvements that did not become evident until after the reconcilement period. There, an examination begun shortly after the cut-off date resulted in an improved composite rating, but the results were not available until after the reconcilement period ended. The AAC rejected the bank’s argument because there was no change in rating confirmed in an ongoing examination by its primary federal regulator during the reconcilement period. Here, the Bank’s examination did not begin until after the reconcilement period had ended.

The Bank next asserts that it was informed by regulators that the November 2004 examination would be considered in determining its January 2005 risk assessment if the results were available by December 31, 2004. The Bank interpreted this to mean that the reconcilement period would run through December 31. Without publicly available Committee decisions, the Bank complains that it lacked any basis to correct such misstatements. At the oral presentation, the Bank added that had it known of the November 19, 2004 reconcilement period end date, it would have urged the FRB to conduct an earlier examination.

The Bank did not raise this issue with DIR in its Request for Review. Under the Guidelines for Appeals of Deposit Insurance Assessment Determinations, “[o]nly matters previously reviewed at the division level, resulting in either a written determination or a direct referral to the AAC, may be appealed to the AAC.” (Guidelines, C.) The Guidelines were provided to all insured institutions in FIL-113-2004, dated October 13, 2004. Consequently, this issue is not properly before the Committee and cannot provide the Committee with grounds to sustain the Bank’s appeal. See AAC No. 99-01, at 3 n.9 (May 14, 1999) (matter not raised below is not ripe for Committee consideration on appeal).

In any event, the Committee notes that FDIC field and regional staff recalled no such statements as alleged by the Bank. Moreover, even if the statements alleged were made, they are incorrect and would not bind the Committee. See AAC Case No. 2004-04, at 4 (Sept. 7, 2004).

Finally, it is evident that the Bank was confused as to the length of the reconcilement period. Certainly, FIL-90-2003 does not specify dates governing reconcilement periods - flexibility in the timing of the period would be eliminated if it did. Reconcilement periods currently last approximately six weeks after the cut-off date, although the period can vary. Approximate reconcilement period length is discussed in some AAC decisions, all of which will soon be posted (redacted in conformance with the Guidelines, L) on the FDIC’s Internet website. Review of these decisions would likely have dispelled the Bank’s confusion. Prior to Internet availability, however, the FDIC has at all times relevant to the Bank’s Request for Review made all Committee decisions publicly available by providing paper copies upon request. Indeed, paper copies were provided in response to a request by the Bank prior to the submission of its appeal. Lack of Internet availability to Committee decisions provides no basis for the relief sought.

The Committee has carefully considered all of the oral and written submissions made in this matter. The reconcilement review accorded the Bank was consistent with the FDIC’s process as set out by regulation and in FIL-90-2003. The timing issues raised by the Bank have been previously considered and rejected by the Committee. As in those cases, the requested relief would require, in effect, an extension of the cut-off date and reconcilement period to the point that there would be no effectively applicable time limit. Further, the cut-off date provides certainty for the industry, as well as the FDIC, and it sometimes results in a benefit for institutions that are downgraded after the cut-off date, as it did for this Bank in 2002. Finally, the Bank’s misunderstanding of the reconcilement period end date provides no basis for granting the relief it seeks.

Accordingly, for the reasons set forth in this decision, the Bank’s appeal is denied.

By direction of the Assessment Appeals Committee, dated July 1, 2005.

1   The Guidelines are set out at 69 Fed. Reg. 41479, 41486 (July 9, 2004), and in FDIC Financial Institution Letter (“FIL”) 113-2004 (Oct. 13, 2004).

2  The Bank and the FRB entered into the “Written Agreement” to address a number of issues related, in part, to the credit card operations of the Bank and a non-bank subsidiary of the Bank’s holding company. The Written Agreement covered, among other things, new accounts and portfolio growth, capital and strategic plans, allowances for loan and lease losses, recordation of revenue and income, affiliate transactions and servicing, regulatory communications and cooperation, dividends and interest, compensation, liquidity, accounting and regulatory reporting review.

3  The FDIC Board of Directors (“Board”) addressed the need for cut-off dates in a 1993 rulemaking in which it called “strict application” of the cut-off date “the fairest approach.” 58 Fed. Reg. 34357, 34359 (June 25, 1993). The Board articulated three bases for this view. First, the approach is fair to all institutions and to the deposit insurance funds. Whether upgraded or downgraded after the cut-off date, no insured institution will see the effect of that change until the next semiannual period. Cut-off dates protect the deposit insurance funds, since it is likely that only upgraded institutions would ever seek reclassification of their SS assignment. Second, if changes finalized after the cut-off date were considered, assessment notices would in effect become preliminary notices, subject to later revision for, potentially, hundreds of institutions. Finally, the cut-off date preserves needed predictability for the risk-based assessment system. In endorsing strict application of cut-off dates, the Board allows for exceptions only in “unusual circumstances.”

4 The SCOR system is a model that statistically tests the correlation of financial data to examination ratings. It is one of several criteria that may result in an institution being flagged for reconcilement review. During the October 12 to November 19, 2004 reconcilement period more than 550 institutions were flagged.

5  Reconcilement reviews for all flagged institutions, including the Bank, were completed during the first five weeks of the reconcilement period. During this five-week period, Case Managers reviewed information and submitted written analyses for each flagged institution; each analysis was then reviewed by FDIC Regional Office management. To allow sufficient time for staff analysis and management review of the institutions involved, the process was staggered within the reconcilement period. All flagged institutions cannot be reviewed on the same day, nor can they all be reviewed on the last day of a reconcilement period. The reconcilement review of the Bank was conducted on October 25, 2004. In light of assertions made at the oral presentation, the Committee notes that even considering information available as of the last day of the Reconcilement Period - which would include the Bank’s September 30, 2004 Call Report – an upgrade to the Bank’s SS would not have been warranted.


Last Updated 07/28/2005

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