If a Bank Objects to Its CAMELS Ratings, Can It Seek Judicial Review?

According to the FDIC, the answer is no — despite the fact that the unavailability of review would seem to be contrary to fundamental precepts of administrative law, as codified in the Administrative Procedure Act (APA)  – not to mention notions of fairness and due process.

The CAMELS rating system is the centerpiece of bank supervision.  Officially called the Uniform Financial Institution Ratings System (UFIRS), it was created in 1979 by the Federal Financial Institutions Examination Council, and is used by examiners as a scorecard to evaluate an institution’s “financial condition and operations” – in other words, its safety and soundness.  It evaluates a bank across six categories – Capital, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk, especially interest rate risk (hence the name “CAMELS”) – and assigns a composite rating, all on a scale of 1 (best) to 5.  The significance of the CAMELS rating is hard to understate, because a bad rating can result in a bank being prohibited from expanding through investment, merger, or adding a branch. And it can take years to improve a rating.

In Builders Bank v. FDIC, a case currently pending in the U.S. District Court for the Northern District of Illinois, the (now-dissolved) bank has challenged the FDIC’s assignment of its composite rating as being too low in light of the bank’s capital position and other indicators that the bank’s condition was stronger than the FDIC believed it to be at the time it assigned the rating.  In January 2017, the Seventh Circuit recognized that there would appear to be circumstances in which a bank could seek such review, and remanded the case to the District Court to consider the specific facts of Builders Bank in light of that conclusion.

One of the fundamental precepts of administrative law is that an administrative agency’s action may be reviewed by the courts, which can invalidate arbitrary and capricious agency action.  The law is clear that there is a strong presumption in favor of judicial review of agency action.  This presumption can be overcome only if: (1) a statute precludes judicial review; or (2) the agency’s action is committed to its discretion by law.  Neither is met here.  Yet, the FDIC is inappropriately attempting to use this narrow exception in the APA to avoid judicial review.

The FDIC asserts that the assignment of CAMELS ratings is unchallengeable by a bank in court because the FDIC has sole discretion to assign CAMELS ratings.  The FDIC supports this assertion by arguing that neither Congress nor the agencies have established meaningful standards that a court could apply in evaluating the reasonableness of the FDIC’s assignment of a CAMELS rating.   In other words, the FDIC (i) has total discretion to assign a rating and (ii) this rating is unreviewable because the FDIC, among other entities, has not articulated a standard that governs its assignment of a bank’s ratings.

The Clearing House, joined by the American Bankers Association and the Independent Community Bankers Association, filed an amici brief in this case last month arguing that under the APA, judicial review of CAMELS ratings is available in certain cases.  The trades argue that judicial review is not precluded by any statute, and, contrary to the FDIC’s position, the UFIRS, as well as other FDIC regulations and guidance, create standards that are sufficient to permit judicial review of CAMELS ratings in specific cases.

As noted, the Seventh Circuit in January of this year agreed with this position – holding that there would appear to be circumstances in which a bank could seek such review, noting that, in fact, the substance of certain CAMELS components have been reviewed by courts in the past – such as in the 10th Circuit case, Frontier State Bank v. Fed. Deposit Ins. Corp . 

As mentioned above, this reviewability is important, because CAMELS ratings and the UFIRS can significantly impact the businesses of financial institutions, as those ratings are integrated into multiple aspects of the FDIC’s regulations and the regulations of other federal banking agencies.  For example, a poor CAMELS rating will result in an FDIC-regulated bank being deemed not “well-managed,” which will prevent its affiliates from being able to engage in certain financial activities, including underwriting, investment advisory, and insurance activities.  In addition, together with asset size, a bank’s CAMELS rating determines the premium it must pay into the FDIC’s deposit insurance fund.  Poor CAMELS ratings also make FDIC-regulated banks subject to higher capital requirements and more frequent examinations.  Under the rules of the other federal banking agencies, a poor CAMELS rating can hinder a bank’s ability to engage in mergers and acquisitions and to make basic changes to its business, such as opening new branches or moving existing branches, and appointing new directors and senior executive officers.

Banks may theoretically challenge a CAMELS rating through an intra-agency appeals process.  However, as documented by Professor Julie Andersen Hill, there are significant deficiencies with those processes – including that there are “few [intra-agency] appeals” by banks, that banks “rarely win” FDIC appeals, and that use of financial institution intra-agency appeals processes is limited by the fact that “[s]ome financial institutions believe that appealing is futile [and] [o]thers fear retaliation.”  These flawed agency appeals processes further highlight the importance of the availability of judicial review for CAMELS ratings in certain circumstances.

Even though financial institutions do not routinely challenge their CAMELS ratings in court, it is critical that they retain this option in the exceptional case where such review is necessary and appropriate.