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Safety & Soundness Examination Preparation?

January 9, 2012

By Dave Anderson, Associate, Bank Strategies LLC


Letís start with this thought.  All examiners do not think alike.  The different agencies/states that examine community banks also do not all think alike.   While Washington can, and has definitely intervened in examiner decisions and ratings, a plus or minus can be the selection of the examination crew by the regulatorís management team.  While I can give you a heads up on a few of these folks, I do not know them all.  I know you have no control over who the next Examiner-in-Charge, Asset Quality Manager, and Operations Manager will be at your bank, but it is important to get to know these examiners with regard to their attitude, willingness to assist, and fairness.  Most EICs will have an initial meeting outlining the scope of the examination.  Then it is your turn to ask questions (hopefully).  Here are a few questions I would cordially ask:

  • Tell me about your experience and what you think about our bank based on surveillance data

  • Do you want a formal loan by loan discussion after you have completed loan review, or do you want to have the loan reviewers contact the loan officers with question     during the course of the examination?

  • What are your major concerns about our bank at this juncture?

  • Can you give me an update on your findings during the examination, say every other day?

  • Will we be allowed to correct documentation/technical loan exceptions during the exam, and if we receive or find the information, will it be considered in our documentation/technical exception ratio relative to the dollar amount of loans reviewed?

  • Will we receive our preliminary CAMELS rating at the exit conference, or are you required to vet your findings with your management before you disclose our ratings?

 Letís back up now to what you should be doing after you receive your most recent examination report.  ďRepeatĒ is a word you never want to see in your next examination report.  As such, it is important to design a correction plan by creating a chart that lists the criticism/violation/finding, who is assigned to correct the deficiency, setting a targeted correction date, and what was done to correct the deficiency.  Donít wait until the last minute because it will become less important to you and you may forget the specifics of the criticism.  If you donít understand the specifics of the finding, either call your regulatory contact or Bank Strategies LLC.  On some occasions a criticism will not be included in the Report of Examination, but will be listed on the exit conference agenda or noted verbally at the exit conference.  These deficiencies should not be ignored and should be included in the correction plan.     


Newly developed and/or revised policies and procedures should be reviewed by another staff member, approved by the directorate, and noted in the minutes.  The same process should be taken with regard to a revised ALLL methodology, loan grading system, or any other process that is changed as a result of a finding at the last examination.  IT and BSA examiners typically have a myriad of findings that often donít get mentioned in the examination report.  Please donít ignore these deficiencies.


The level of loan documentation exceptions is a common criticism at safety and soundness examinations.  If examiners find that documentation exceptions are found on over 25 percent of the dollar amount of loans reviewed, a criticism will likely be included in the examination report.  This finding impacts both the management and asset quality ratings, so it is important to monitor the level of documentation exceptions at you bank.  Inaccurate or ineffective tickler systems are common, and as such, an officer or staff member should be assigned to ensure that the tickler system is accurate.  Approximately three to four months before your next examination a concerted effort should be made by the entire lending staff (loan officers and loan administration personnel) to ensure that up-to-date financial information on borrowers has been obtained and reviewed (balance sheets, income statements, tax returns, cash flows, budgets), insurance coverage is current, final title policies have been obtained, collateral valuations are current, and security agreements have been obtained.  Other less likely exceptions or documentation deficiencies include lack of assignments, hypothecation agreements, mortgages, loan applications, evidence of borrower credit checks, corporate or partnership borrowing authorizations, UCCs (1 and 11), A/R aging reports, inspections, and correspondence.


One dilemma a bank has to consider before an examination is whether to charge off a portion of a loan or the entire loan before the examinationís asset quality date.  If you have a nonperforming loan with insufficient collateral, consideration should be given to taking a charge off prior to the asset quality date to reduce the level of classifications that will be noted at the examination.  If you donít take the charge off, the asset will be classified (most likely loss) by the examiners and your classification ratios will be higher, thereby impacting your asset quality rating.  The same thought process should be taken with regard to OREO.  Your goal should be to get your classification ratio (classified assets/Tier One Capital + ALLL) below 50 percent (15 percent on a weighted basis at FRB member banks).  This ratio is one the single most important ratios examiners use in rating your bank.


Your loan grading system will be an important consideration to an examiner when they review your loans.  If a loan deserves an upgrade (is performing consistently and well secured), and the borrowers financial condition is improving, donít wait for an examiner to upgrade the loan, because they might not.  This is especially true with regard to young examiners or examiners with little loan review experience.  The thinking is, the loan officer must know something about this borrower that I donít, so Iíll leave it in substandard.  Likewise, if a borrower is struggling and/or loan performance or collateral coverage is poor, consideration should be given to grading the loan Substandard before the examiners make that decision for you.  The number of loan downgrades impacts your asset quality and management ratings.


Another factor that impacts your asset quality and management ratings is the level of the ALLL.  If the ALLL is considered underfunded, that could also impact you earnings and capital ratings.  Please refer to http://bankstrategiesllc.com/litmus_testing_your_allowance_fo03282011.htm to litmus test the level of your ALLL.


Planning for your next examination can payoff and increases your chances of a composite upgrade and possibly the removal of an enforcement action.  So make sure to correct all prior examination criticisms, reduce the level of documentation exceptions and classifications if possible, and make sure your ALLL is appropriately funded.  We at Bank Strategies LLC can help you prepare for your next examination.  Please call Dave Anderson at (720)205-1336 or Jim Swanson at (303) 903-9369.

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Contact Information

Phone: 303-903-9369

Mail: 75 S. Joyce Street, Golden CO 80401

EMail: Jim@bankstrategiesllc.com