A bank may challenge the rating it received from the Federal Deposit Insurance Corporation (FDIC) under the CAMELS system, the U.S. Court of Appeals for the Seventh Circuit determined, because while the agency has discretion to set appropriate levels of capital for each institution, it does not necessarily mean that the rating as a whole is committed to agency discretion.

What happened

The FDIC conducted a full-scope on-site examination of Builders Bank, insured and regulated by the FDIC, in June 2015. The regulator assigned the bank a rating of 4 under the Uniform Financial Institution Ratings System, commonly referred to as a CAMELS rating because of the six components: capital, asset quality, management, earnings, liquidity and sensitivity. The highest rating is 1 and the lowest is 5.

The bank filed suit against the FDIC under the Administrative Procedure Act (APA), arguing that its rating should have been a 3 and that the lower rating was arbitrary and capricious. A federal district court granted the FDIC's motion to dismiss, holding that the assignment of ratings is committed to agency discretion by law.

Builders appealed. The Seventh Circuit first engaged in a discussion of whether the question was a matter of jurisdiction or another doctrine that foreclosed judicial review, noting that the FDIC bypassed two procedural reasons why it might prevail. First, APA review is normally limited to final agency actions and assignment of a CAMELS rating "does not appear to be a final decision," the panel said. Second, the bank failed to take advantage of the opportunity to have the FDIC's Supervision Appeals Review Committee review the rating before filing suit, the court noted.

But the court ultimately sidestepped the jurisdictional issue to consider the matter of discretion. The FDIC argued that the CAMELS rating was not reviewable because it has the discretion to set appropriate levels of capital. Even accepting this position, the Seventh Circuit noted that capital was only one of six components to the overall rating.

"Each of the six factors is rated separately on a scale of 1 to 5, and the rating as a whole aggregates those six factors," the panel wrote. "Suppose the FDIC's team of examiners were to conclude that the Bank had adequate capital deserving a rating of 1 but that other components were unfavorable, leading to an overall rating of 4. The examiners may be right or wrong about those other issues, but a district court could ask whether the FDIC's final rating was arbitrary, or supported by substantial evidence, without making any inroad on the agency's discretion to evaluate a bank's capital adequacy."

That precise situation occurred in a case from the U.S. Court of Appeals for the Tenth Circuit, where the court in Frontier State Bank v. FDIC reviewed management, liquidity and interest-rate-sensitivity while concluding that capital adequacy was unreviewable. "If those subjects could be reviewed there, notwithstanding the Tenth Circuit's conclusion that capital adequacy is within the FDIC's discretion, they can be reviewed in this litigation as well," the court said.

It might even be possible to review the capital rating itself without infringing on the FDIC's discretion, the Seventh Circuit added. "Suppose the FDIC were to decide that Builders Bank needs $5 million in net capital in order to operate safely but has only $4 million," the court said. Although the $5 million is beyond judicial questioning, "the statute does not insulate the agency's math. If the Bank were to contend that the examiners found that it fell short of $5 million because they had mistakenly treated a $1 million asset as a $1 million liability, turning $6 million of net capital into $4 million by error, a court would not impinge on the statutory discretion by insisting that assets go in one column of the balance sheet and liabilities in the other."

For its part, Builders told the court that it took the FDIC's capital requirement as a given and was only challenging its rating on the other five factors. While the regulator countered that the bank was simply trying to disguise a challenge to a capital decision, the district court did not decide this dispute, the Seventh Circuit said, remanding the question.

"All we hold today is that the presence of capital as one of six components in a CAMELS rating does not necessarily mean that the rating as a whole is committed to agency discretion for purposes of the [APA]," the court wrote.

To read the decision in Builders Bank v. Federal Deposit Insurance Corporation, click here.

Why it matters

The Seventh Circuit decision left open the door for banks to challenge five of the six components in a CAMELS rating: asset quality, management, earnings, liquidity and sensitivity. The court remanded the case to the district court to consider whether one or more of these components may be committed to agency discretion or if they can be challenged by a bank, providing support for the bank's position in a citation to a Tenth Circuit case where a federal panel permitted judicial review of such factors.