|C' for Capital: Highest Priority in Camel Rating

For bank and thrift executives interested in pursuing strategic opportunities, chances for success would be enhanced greatly by improving the regulatory compliance ratings known as Camel and Macro.

The federal banking agencies use these ratings to measure and assess the overall performance, safety, and soundness of financial institutions.

Camel, which applies to banks, is an acronym for capital, assets, management, earnings, and liquidity. The Office of Thrift Supervision utilizes Macro: management, assets, capital, risk, and operations.

Camel and Macro have been standardized by the Uniform Financial Institutions Rating System, as published by the Federal Financial Institutions Examination Council. However, there has been variation in practice in applying the rating system standards from one regulatory agency to another - and, indeed, by the same agency in different regions of the country. The stated objective of the agencies remains, however, to apply the standards consistently.

Potential Benefits

Perhaps the most profound benefit arising from a favorable composite rating relates to capital. The Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency have issued recent amendments to the core leverage capital regulations.

These amendments set the core capital requirement at 3% of adjusted assets for banks with a composite Camel rating of one. The range rises, to 4% or 5% (or possibly higher) for institutions rated two, three, four, or five. Proposed amendments to the OTS regulations on core capital parallel those of the OCC and the FDIC.

Thus, an institution's Camel or Macro rating directly translates its core capital requirement. A lowered rating can lead to a precipitous increase in an institution's core capital requirement.

Conversely, a favorable or enhanced rating can decrease the institution's regulatory requirement for leverage equity, without the costly necessity of accessing the capital markets.

The cost savings can be illustrated by a simple example: Assume an institution with $1 billion in adjusted assets. If this institution received a composite rating of one, it would need $30 million in leverage equity to meet capital requirements.

If this same institution received a composite rating of two, it would require $40 million - or $10 million more - in core capital. A rating of three could require up to $50 million, depending on the specific core capital requirement established by its primary regulator.

An institution must spend several million dollars annually to raise $10 million to $20 million of core capital. A fraction of that amount could be devoted to overhead expenditures specifically aimed at maintaining or improving that institution's composite rating.

While not formally acknowledged by the regulators, it is widely believed that the capital component generally bears the greatest weight in establishing an institution's composite rating. Moreover, capital has reached a new height of importance in the burgeoning legislative proposals facing the financial services industry today.

For example, the Treasury Department proposal bases business-line and regulatory flexibility on five capital zones. If this legislation passes in substantially its current form, strategic thinking focused on the capital component of an institution's composite rating will take on even greater importance.

Pursuant to the internal policy of each regulatory agency, favorably rated institutions are subject to less frequent on-site examinations. Less frequent and less expansive examinations should result in cost savings to the favorably rated institution.

Other benefits of a favorable composite rating include an enhanced ability to participate in acquisition opportunities - at a time when market share or market penetration has never been more available.

For example, under Resolution Trust Corp. internal guidelines, only institutions with favorable composite ratings are eligible to bid for RTC acquisitions.

Furthermore, public financial institutions or their public holding companies must report core capital levels. These disclosures will necessarily give analysts and the investing public a sense of these companies' core capital requirements and, hence, of their composite ratings.

Such disclosures could affect overall investor confidence. Institutions with strong composite ratings stand to make significant gains in capital, operating flexibility, regulatory scrutiny, market perception - and return.

Downside Possibilities

Along with the negative capital impact, there are serious consequences for failure to maintain or obtain a Macro or Camel rating of one or two. Under the Uniform Financial Institutions Rating System, a composite rating of three is given to institutions that the regulators believe "give cause for supervisory concern and require more than normal supervision to address deficiencies."

A composite rating of four or five reflects much more serious supervisory concerns. Institutions receiving a four or five rating are in danger of significant regulatory enforcement actions.

Under stated OTS policy, thrifts with a composite Macro rating of three, four, or five are presumed to warrant formal enforcement action, unless their regional director documents that their problems are satisfactorily corrected or in the process of full correction.

Many Routes to Formal Enforcement

Formal enforcement actions against such institutions include supervisory agreements, consent-merger agreements, civil money penalties, cease-and-desist orders, removal and/or prohibition orders, suspension during removal and/or prohibition proceedings, capital directives, injunctive actions, and receiverships.

If a thrift is to receive a Macro rating of three, four, or five - due to violations of laws or regulations, unsafe or unsound practices, inaccurate reporting, or breaches of fiduciary duty - its examiners are directed to consider the assessment of a civil money penalty. OTS regulatory guidelines call for the imposition of a civil money penalty without waiting for completion of the examination, if facts sufficient to warrant such a penalty arise during the examination process.

In addition, OTS-regulated institutions with a composite Macro rating of four or five are subject to growth limitations. They cannot increase total assets, beyond net interest credited, without the prior written approval of the OTS. Institutions with Macro ratings of three may also be subject to growth restrictions.

Low-rated institutions will be subject to more frequent and expansive examinations. Such institutions must pay special assessments in addition to the general assessments all institutions must pay to cover the costs of regulatory supervision.

An institution rated Macro three, four, or five may not be allowed to make capital distributions without prior OTS written approval. This may be the case even if the institution would otherwise qualify to do so under a safe-harbor-to-the-capital-distribution rule.

A restricted or prohibited ability to provide a return to shareholders, and the potential negative publicity accompanying this prohibition, may produce irreparable harm to an institution in today's increasingly competitive environment.

Detrimental Consequences

If institutions with Macro three, four, or five composite ratings are subjected to formal enforcement action, adverse collateral consequences will result.

Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 - as amended by the Crime Control Act of 1990 - federal banking regulators must make available to the public, on a monthly basis, all "final orders." These can include cease-and-desist orders and civil money penalty orders, and "written agreements," unless the agency determines that publication would be contrary to the public interest.

Administrative enforcement actions must also be disclosed in connection with OTS applications. Under applicable OTS regulations, these enforcement actions create a "presumptive disqualifier." The OTS may deny a change-in-control application based on the existence of presumptive disqualifiers.

The Financial Institutions Reform, Recovery, and Enforcement Act also requires a depository institution and its holding company to notify the relevant federal banking agency prior to the addition of any director or senior executive, if the institution is in a "troubled condition."

Under OTS guidelines, an entity is deemed to be in "troubled condition" if it is subject to a cease-and-desist order or to a written agreement with the OTS. The OTS may deny the addition of such a director or senior executive.

An enforcement action may also adversely affect the ability of an association or an individual to become eligible or maintain eligibility as a government contractor, for purposes of transactions with the RTC.

Publicly traded financial institutions and public bank and thrift holding companies may be required to disclosure enforcement actions in their periodic public filings, under the rules and regulations of the Securities and Exchange Commission. Disclosure of such enforcement actions may also be required under applicable stock exchange rules and rules of other self-regulatory organizations.

Planning for the future of a financial institution should take into account the impact of a composite rating.

The composite rating currently has a profound impact on the institution's capital requirements, operating flexibility, regulatory scrutiny, market perception, and exposure to enforcement actions. Moreover, an institution's composite rating may likely have further or heightened impact in the future.

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