BASIC EXAMINATION CONCEPTS AND GUIDELINES

BASIC EXAMINATION CONCEPTS AND GUIDELINES

Rationale of Bank Examinations

Maintenance of public confidence in integrity of banking system
Provides best means of determining bank’s adherence with laws and regulations
Protect the deposit insurance fund
Supply an understanding of the nature, relative seriousness and cause of a bank’s problems

Conduct of Examinations

Authority provided by Sections 10(b) and 10(c) of FDI Act
Political communication prohibited related to conduct of examinations

UFIRS

· Composite

1. Sound in every respect; any weaknesses are minor and can be handled in routine manner; capable of withstanding vagaries of business conditions and are resistant to economic instability; substantial compliance with laws and regulations; strongest performance and risk management practices and no cause for supervisory concern.

2. Fundamentally sound; no component more severe than 3; moderate weaknesses within management’s ability and willingness to correct; stable and capable of withstanding business fluctuations; substantial compliance with laws and regulations; risk management practices are satisfactory; no material supervisory concerns.

3. Some supervisory concern in one or more component areas; weaknesses may range from moderate to severe but generally not worse than 4; management may lack ability or willingness to correct deficiencies; generally less capable of withstanding business fluctuations and outside influences; may be in significant noncompliance with laws and regulations; risk management practices may be less than satisfactory; these institutions require more than normal supervision; failure appears unlikely.

4. Unsafe and unsound practices and conditions; serious financial or managerial deficiencies that result in unsatisfactory performance; weaknesses are not satisfactorily addressed; generally not capable of withstanding business fluctuations; may be significant noncompliance with laws; risk management generally unacceptable; close supervision required; institution is a risk to deposit insurance fund; failure distinct possibility if weaknesses not resolved.

5. Extremely unsafe and unsound practices and conditions; critically deficient performance; often inadequate risk management; greatest supervisory concern; volume or severity of problems beyond management’s ability or willingness to correct; immediate financial or other assistance needed; pose a significant risk to deposit insurance fund and failure is highly probable.

Capital Adequacy
Level and quality of capital and overall financial condition
Ability of management to address emerging needs for capital
Nature, trend and volume of problem assets, and adequacy of allowances for loan and lease losses and other valuation reserves
Balance sheet composition, including the nature and amount of intangible assets, market risk, concentration risk, and risks associated with nontraditional activities
Risk exposure represented by off-balance sheet activities
Quality and strength of earnings, and the reasonableness of dividends
Prospects and plans for growth, as well as past experience in managing growth
Access to capital markets and other sources of capital, including support provided by a parent holding company

1. Strong capital level relative to risk profile.

2. Satisfactory capital level relative to risk profile.

3. Less than satisfactory level of capital that does not fully support risk profile; indicates a need for improvement, even if the capital level exceeds minimum regulatory requirements.

4. Deficient level of capital; given risk profile, viability may be threatened; assistance of shareholders or other external sources of financial may be required.

5. Critically deficient level of capital; viability threatened; immediate assistance of shareholders or other external sources of financial support required.

Asset Quality
Adequacy of underwriting standards, soundness of credit administration practices, and appropriateness of risk identification practices
Level, distribution, severity, and trend of problem, classified, nonaccrual, restructured, delinquent, and nonperforming assets for both on- and off-balance sheet transactions
Adequacy of allowance for loan and leases losses and other asset valuation reserves
Credit risk arising from or reduced by off-balance sheet transactions
Diversification and quality of loan and investment portfolios
Extent of securities underwriting activities and exposure to counter-parties in trading activities
Existence of asset concentrations
Adequacy of loan and investment policies, procedures and practices
Ability of management to properly administer its assets, including the timely identification and collection of problem assets
Adequacy of internal controls and management information systems
Volume and nature of credit documentation exceptions

1. Strong asset quality and credit administration practices; identified weaknesses are minor and risk exposure is modest in relation to capital protection and management’s abilities; minimal supervisory concern.

2. Satisfactory asset quality and credit administration practices; level and severity of classifications and other weaknesses warrant a limited level of supervisory attention; risk exposure is commensurate with capital protection and management’s abilities.

3. Asset quality or credit administration practices are less than satisfactory; trends may be stable or indicate deterioration in asset quality or an increase in risk exposure; level and severity of classified assets, other weaknesses, and risks require an elevated level of supervisory concern; generally a need to improve credit administration and risk management.

4. Deficient asset quality or credit administration practices; levels of risk and problem assets are significant, inadequately controlled, and subject the institution to potential losses that may threaten viability.

5. Critically deficient asset quality or credit administration that present an imminent threat to viability.

Management
Level and quality of oversight and support of all institution activities by the board and management
Ability of board an management to plan for and respond to risks that arise from changing business conditions or new activities or products
Adequacies of and conformance with appropriate internal policies and controls addressing the operations and risks of significant activities
Accuracy, timeliness, and effectiveness of management information and risk monitoring systems
Adequacy of audits and internal controls to promote effective operations and reliable financial and regulatory reporting, safeguard assets, and ensure compliance with laws, regulations, and internal policies
Compliance with laws and regulations
Responsiveness to recommendations from auditors and supervisory authorities
Management depth and succession
Extent that board and management is affected by or susceptible to dominant influence of concentration of authority
Reasonableness of compensation policies and avoidance of self-dealing
Demonstrated willingness to serve the legitimate banking needs of the community
Overall performance of the institution and its risk profile

1. Strong performance by management and strong risk management; significant risks are consistently and effectively identified, measured, monitored, and controlled demonstrated ability to promptly and successfully address existing and potential problems and risks.

2. Satisfactory management performance and risk management; minor weaknesses may exist but are not material to safety and soundness and are being addressed; in general, significant risk and problems are effectively identified, measured, monitored, and controlled.

3. Management performance needs improvement or risk management is less than satisfactory; capabilities of management may be insufficient for type, size, or condition of institution; problems and significant risks may be inadequately identified, measured, monitored, or controlled.

4. Deficient management performance or risk management considering nature of activities; level of problems and risk exposure is excessive; problems and significant risks are inadequately identified, measured, monitored, or controlled and require immediate action to preserve the soundness of institution; replacing or strengthening management may be necessary.

5. Critically deficient management performance or risk management practices; management has not demonstrated ability to correct problems and implement appropriate risk management practices; problems and significant risks are inadequately identified, measured, monitored, or controlled and threaten viability; replacing or strengthening management is necessary.

Go to top

Earnings
Level of earnings, including trends and stability
Ability to provide for adequate capital through retained earnings
Quality and sources of earnings
Level of expenses in relation to operations
Adequacy of the budgeting systems, forecasting processes, and management information systems in general
Adequacy of provisions to maintain allowance for loan and lease losses and other valuation allowances
Earning exposure to market risk such as interest rate, foreign exchange, and price risks

1. Earnings are strong; more than sufficient to support operations and maintain adequate capital and allowance levels after consideration of asset quality, growth, and other factors affecting quality, quantity, and trend of earnings.

2. Earnings are satisfactory; sufficient to support operations and maintain adequate capital and allowance levels after consideration of asset quality, growth, and other factors affecting quality, quantity, and trend of earnings; may be static, or experiencing slight decline, if adequate in view of assessment factors.

3. Earnings need improvement; may not fully support operations and provide for accretion of capital and allowance levels.

4. Earnings are deficient; insufficient to support operations and maintain appropriate capital and allowance levels; may be characterized by erratic fluctuations in net income or net interest margin, development of significant negative trends, nominal or unsustainable earnings, intermittent losses, or a substantive drop in earnings from previous years.

5. Earnings are critically deficient; experiencing losses that represent distinct threat to viability through erosion of capital.

Liquidity
Adequacy of liquidity sources compared to present and future needs and ability to meet need without adversely affecting operations or condition
Availability of assets readily convertible to cash without undue loss
Access to money markets and other sources of funding
Level of diversification of funding sources, both on- and off-balance sheet
Degree of reliance on short-term, volatile sources of funds, including borrowing and brokered deposits, to fund longer term assets
Trend and stability of deposits
Ability to securitize and sell certain pools of assets
Capability of management to properly identify, measure, monitor, and control liquidity position, including effectiveness of funds management strategies, liquidity policies, management information systems, and contingency funding plans

1. Strong liquidity levels and well-developed funds management practices; reliable access to sufficient sources of funds on favorable terms to meet present and anticipated liquidity needs.

2. Satisfactory liquidity levels and funds management practices; access to sufficient sources of funds on acceptable terms to meet present and anticipated liquidity needs; modest weaknesses may be evident in funds management practices.

3. Liquidity levels or funds management practices are in need of improvement; may lack ready access to funds on reasonable terms or may evidence significant weaknesses in funds management practices.

4. Deficient liquidity levels or inadequate funds management practices; may not have or be able to obtain a sufficient volume of funds on reasonable terms to meet liquidity needs.

5. Liquidity levels or funds management practices so critically deficient that the continued viability of the institution is threatened. Institutions rated 5 require immediate external financial assistance to meet maturing obligations or other liquidity needs.

Sensitivity to Market Risk
Sensitivity of earnings or economic value of capital to adverse changes in interest rates, foreign exchange rates, commodity prices, or equity prices
Ability to identify, measure, monitor, and control exposure to market risk relative to risk profile
Nature and complexity of interest rate risk exposure arising from nontrading positions
Nature and complexity of market risk exposure arising from trading and foreign operations

1. Market risk sensitivity is well controlled and that there is minimal potential that earnings performance or capital position will be adversely affected; risk management practices are strong for the size, sophistication, and market risk accepted by institution; level of earnings and capital provide substantial support for degree of market risk.

2. Market risk sensitivity is adequately controlled and there is only moderate potential that the earnings performance or capital position will be adversely affected; risk management practices are satisfactory; level of earnings and capital provide adequate support for degree of market risk.

3. Control of market risk sensitivity needs improvement or there is significant potential that earnings performance or capital position will be adversely affected; risk management practices need to be improved; level of earnings and capital may not adequately support the degree of market risk.

4. Control of market sensitivity is unacceptable or there is high potential that earnings performance or capital position will be adversely affected; risk management practices are deficient; level of earnings and capital provide inadequate support for degree of market risk.

5. Control of market risk sensitivity is unacceptable or level of market risk taken by the institution is an imminent threat to its viability; risk management practices are wholly inadequate.

Disclosure of Ratings
Discuss recommended component and composite ratings with senior management within close proximity to conclusion of examination.
Explain tentative and subject to RD approval
Discuss factors considered
Not numerical average
Confidentiality of Part 309

Examination Priorities and Frequency Criteria

Priority is effective surveillance and supervision of banks requiring special supervisory attention.
Section 337.12 and Section 10(d) require annual full-scope on-site examination at least once during each 12-month period.
May be extended to 18 months if:
Total assets $250MM or less
Well capitalized per Part 325
Well managed (PX management “1” or “2”)
Composite “1” or “2” at PX
Not subject to formal enforcement proceeding or order by FDIC, OCC, or FRS
No person acquired control during preceding 12-month period
If schedule not met, provide memorandum to Director, DOS, explaining cause and corrective action
May accept a state examination for “1” or “2” rated banks, stable or improving “3” rated banks if consistent with SCOR, and no adverse trends are noted in available information.
End of examination is defined as earlier of report submission or 60 calendar days from Exam Start Date
Limited scope examinations used for: determining changes in risk profile, monitoring compliance with a corrective program, complying with SCOR follow-up requirements, investigating adverse or unusual situations, determining progress in correcting deficiencies, investigative or supervisory tools, or addressing other situations.
Other situations requiring limited or full scope examinations: newly chartered and insured institutions (within 6 months, full scope exams within first and through third years), institutions converting insured nonmember status (full scope within 12 months of prior exam, limited within 3 months of conversion), change of ownership control (limited scope within 6 months and full scope within 12 months of change), institutions with FDIC assistance or involved in purchase and assumption transactions.
Specialty exams not subject to Section 10(d) but generally concurrent.

Guidelines for Relying on State Examinations

Should contain sufficient information to permit reviewer to make an independent assessment of overall condition and component factors of bank
Adequate documentation maintained
Ability to meet examination objectives (budgeting, staffing, training)
Adequacy of agreements with FDIC

Pre-Examination Activities

· Generally should provide at least 2 weeks notice

Meetings with Directors

Composite “4” or “5” rating – EIC and RD (or designee)
Composite “3” – EIC
Composite “1” or “2” – EIC IF:
36 months or more have elapsed since the last such meeting
management component is “3”, “4”, or “5”
any component is “4” or “5”
any two components are “3”, “4”, or “5”

Examination Program

Procedures separated into Core Analysis, Expanded Analysis, and Impact Analysis
Most effective and efficient examination approach focuses examiner resources on validating management’s ability to identify, measure, monitor, and control risks

Related Examinations

Trust Department
Objective: determine whether its operations or the administration of accounts give rise to possible or contingent liabilities or direct liabilities
Information Systems
Objective: determine the validity and reliability of records produced by automated systems emphasizing evaluation of internal controls
Components rated: audit, management, development and acquisition, and support and delivery (AMDS)

Retention of Workpapers

Line sheets should be retained for one examination beyond the examination at which the cards are purged from the active loan deck
Retention of workpapers beyond one examination should be confined to banks with existing or pending administrative actions, etc.
Officers questionnaires should be retained for minimum of five years

Go to top

CAPITAL

Purposes of Capital

Absorbs losses
Promotes public confidence
Restricts excessive asset growth
Provides protection to depositors and the FDIC insurance funds

Types of Capital-Based Rules

Minimum Leverage Capital Standards – Part 325
Minimum Risk-Based Capital Standards – Part 325, Appendix A
Statement of Policy on Capital Adequacy – Part 325, Appendix B
Prompt Corrective Action – Part 325 and Section 38
Other Areas
Risk-related insurance premiums – Part 327
Brokered deposits – Part 337.6
Limits on extensions of credit to insiders – Part 337.3 and Reg O
Securities Activities – Part 337.4
Activities and Investments of Insured State NM Banks – Part 362
Limitations on Interbank Liabilities – Reg F
Limitations on Fed Discount Window Advances – 10B Federal Reserve Act
Grounds for Appointing Conservator or Receiver Section 11(c)(5)

Capital Adequacy v. Capital Rules

· Adequate capital for safety and soundness purposes may differ significantly from minimum leverage and risk-based standards and the Well Capitalized and Adequately Capitalized definitions that are used in the PCA regulations.

Components of Capital

Leverage Capital
Tier 1 Capital
Common stockholders’ equity (less net unrealized losses on AFS equity securities)
Noncumulative perpetual preferred stock
Minority interests in consolidated subsidiaries

MINUS

Intangible assets (except allowed amounts of mortgage servicing rights and purchased credit card relationships and certain grandfathered supervisory goodwill)
Identified losses (losses other than loans and provisions to ALLL)
Investments in securities subsidiaries subject to 337.4
Deferred tax assets in excess of the limit in 325.5(g)
Risk Based Capital
Tier 2 Capital
Allowance for loan and lease losses up to 1.25% of RWA
Cumulative perpetual preferred stock, long-term preferred stock (original maturity of at least 20 years) and any related surplus
Perpetual preferred stock (where dividend is reset periodically)
Hybrid capital instruments, including mandatory convertible debt
Term subordinated debt and intermediate-term preferred stock (limited to 50% of Tier 1; at least 5 year original maturity and not redeemable by holder prior to maturity)
Up to 45% of pretax net unrealized holding gains on AFS equity securities (optional and may lower Tier 1 RBC ratio)
Tier 2 capital cannot exceed Tier 1 capital
Total Risk Based Capital = Tier 1 + Tier 2

Capital Account Adjustment

Deduct amount of losses in items other than loans from Tier 1
Deduct amount of provision to restore ALLL (after consideration of loan losses) from Tier 1
Deduct loan losses in calculation of ALLL in Tier 2
ORE reserves are not included as capital – reduce ORE by reserve amounts
Capital should be adjusted for liabilities not shown on the books

Minimum Capital Standards

Minimum Leverage Capital – Not less than 3% with CAMELS 1 and not anticipating/experiencing significant growth
Minimum Leverage Capital – Others should have minimum of 100 to 200 bp higher
Minimum Risk Based Capital – 8% with at one-half Tier 1
Must consider other factors when rating capital adequacy

FDIC Statement of Policy on Capital Adequacy

Fundamentally sound and well managed banks are subject to the above minimums (case-by-case determination but generally “1” or “2” rated)
Other banks will be required to maintain higher capital through MOU or Section 8
If higher standard for state or other federal regulator then that is the standard
Capital plans – Section 325.4(b) specifies that any bank with less than the minimum leverage capital requirement is engaging in an unsafe and unsound practice unless it has submitted, and is in compliance with a plan approved by the FDIC to increase Tier 1 leverage capital ratio. Must be filed within 45 days of receiving notice (Call Report, examination, other)
Written agreements – Section 325.4(c) specifies that any bank with a Tier 1 capital to total assets ratio of less than 2% must enter into and be in compliance with a written agreement with the FDIC to increase Tier 1 leverage ratio or may be subject to 8(a) action

Evaluation of Capital Adequacy

Qualitative Considerations
Assets – quality, type, liquidity, and diversification of assets
Earnings – current and historical earnings performance, dividend policies
Liquidity and funds management – lower liquidity or higher interest rate risk the greater capital requirements
Deposit Structure – historical and projected growth of deposits and presence of volatile deposits
Contingent Liabilities – volume and nature
Local Characteristics – clientele, stability and diversity of local economy
Parent Company Relationship – strength/weakness of holding company, debt service requirements
Quality of Management – ability, experience, depth, integrity, and record of management
Quantitative Considerations
Equity Capital to Total Assets
Equity Growth to Asset Growth – erosion if assets growing faster than capital
Dividends as a Percent of Income
Indices of Capital Adequacy in Holding Company Environment
Equity investment in subsidiaries as percentage of holding company net worth
Equity investment in subsidiaries less parent net worth divided by fully consolidated net operating income
Double leverage ratios 1st over 100% double leverage used, 2nd number of years to pay back double leverage
Parent liabilities as a percentage of net worth – indicates extent of leverage
Parent term debt as a percentage of total capitalization (including term debt) – reflects capacity of holding company to incur debt
Future performance must also be considered

Increasing Capital in Operating Banks

Increased earnings retention through higher earnings and/or lower cash dividend rates
Sale of additional capital stock
Direct contribution by owners
Sale or merger with stronger institution
In situations in which above actions are needed, examiner should include prospects in reports
Should include following in ROE
Complete list of present stockholders including net worths and shares held
Information about directors relative to capacity and willingness to purchase stock
List of prominent customers and depositors who are not shareholders but might be interested in acquiring stock
List of other individuals or sources of possible support in the community
Section 2522(c) of the Crime Control Act amended the Bankruptcy Code to require trustee in a Chapter 11 to immediately cure any deficit under any commitment by a debtor to maintain the capital of an insured depository institution

Go to top

LOANS

Lending Policies

General fields of lending in which the bank will engage and the kinds or types of loans within each general field
Lending authority of each loan officer
Lending authority of a loan or executive committee, if any
Responsibility of board in reviewing, ratifying, or approving loans
Guidelines under which unsecured loans will be granted
Guidelines for rates of interest and terms of repayment for secured and unsecured loans
Limitations on the amount advanced in relation to the value of collateral and documentation required for each type of secured loan
Guidelines for obtaining and reviewing real estate appraisals as well as ordering reappraisals when needed
Maintenance and review of complete and current credit files on each borrower
Appropriate and adequate collection procedures including actions to be taken against borrowers who fail to make timely payments
Limitations on maximum volume of loans in relation to total assets
Limitations on the extension of credit through overdrafts
Description of normal trade area and circumstances under which the bank may extend credit outside of such area
Guidelines which at a minimum address the goals for portfolio mix and risk diversification and cover the bank’s plans for monitoring and taking appropriate corrective action if deemed necessary on any concentrations that may exist
Guidelines addressing the bank’s loan review and grading system (Watch list)
Guidelines addressing the bank’s review of the allowance for loan and lease losses
Guidelines for adequate safeguards to minimize potential environmental liability

Loan Review Systems

Promptly identify loans with well-defined credit weaknesses
Provide essential information for determining ALLL adequacy
Identify relevant trends affecting the collectibility of the loan portfolio and isolate potential problem areas
Evaluate the activities of lending personnel
Assess the adequacy of and adherence to loan policies and procedures and to monitor compliance with relevant laws and regulations
Provide the board and senior management an objective assessment of the overall portfolio quality
Provide management with information related to credit quality that can be used for financial and regulatory reporting purposes
Loan review system should include:
Formal credit grading system that can be reconciled with regulatory framework
Identification of loans or loan pools that warrant special attention
Mechanism for reporting identified loans and any correction action taken to senior management and board
Documentation of credit loss experience for various components of the loan and lease portfolio
Written policy including:
Qualifications of loan review personnel
Independence of loan review personnel
Frequency of reviews
Scope of reviews
Depth of reviews (credit quality, sufficiency of credit and collateral documentation, proper lien perfection, proper loan approval, adherence to loan covenants, compliance with internal policies and procedures and applicable laws and regulations, and accuracy and timeliness of credit grades assigned by loan officers)
Review of findings and follow up
Workpaper and report distribution

Allowance for Loan and Lease Losses

Responsibility of board and management
Establish and maintain a loan review system that identifies, monitors, and addresses asset quality problems in a timely manner
Ensure prompt chargeoff of loans, or portions of loans, deemed uncollectible
Ensure the process for determining an adequate allowance level based on comprehensive, adequately documented, and consistently applied analysis
ALLL should be no less than the sum of: for loans and leases classified substandard or doubtful, all estimated credit losses over the remaining effective lives of these loans, for loans and leases that are not classified, all estimated credit losses over the upcoming 12 months, and amounts for estimated losses from transfer risk on international loans.
Should be conservative to reflect a margin for the imprecision inherent in most estimates of expected credit losses.

Portfolio Composition

Commercial loans
Short-term working capital and seasonal loans provide temporary capital in excess of normal needs
Term business loans are granted for acquiring capital assets and may involve greater risk than short-term advances because of the time outstanding.
Accounts receivable financing:
Advantages from borrower’s viewpoint: efficient way to finance an expanding operation, permits borrower to take advantage of purchase discounts because of immediate cash availability, insures a revolving, expanding line of credit, and actual interest paid may be no more than that for a fixed amount unsecured loan.
Advantages from bank’s viewpoint: generates a relatively high yield loan, new business, and a depository relationship; permits continuing relationships with loan-standing customers whose financial conditions no longer warrant unsecured credit; and minimizes potential loss if done on a margin basis.
Can be accomplished by blanket assignment (BBC) or ledgering the accounts
Loan policy in this area should address acquisition of credit information and maintenance of an accounts receivable loan agreement outlining acceptable receivables, a maximum dollar amount due from any one account debtor, financial strength of debtor accounts, aging of accounts receivable, and concentrations of debtor accounts.
Highly Leveraged Transactions (HLTs)
Purpose test – credit is extended or investment is made in a business where the financing transaction involves the buyout, acquisition, or recapitalization of an existing business
HLT Test – also must meet one of the following:
Doubles the subject company’s liabilities and results in a leverage ratio higher than 50%
Results in a leverage ratio higher than 75%
Designated an HLT by a syndication agent
If engaging should have written policy addressing: purpose and use of such financing, permissible lending and investment activities, identification of industries suited for such financing, recognition of unique characteristics and risks associated with high levels of leveraging, broad-based definition that captures the essence of HLTs and includes all credits and investments with similar characteristics and levels of risk, in-house limits relative to capital on exposure for individual credits, specific industries, and aggregate portfolio to be reviewed at least annually by board, recognition of need for independent credit reviews and assessments and MIS to monitor performance, recognition of the need for well-defined standards and separate specific guidelines for policy, approval, and review of HLTs, and acknowledgment that fees are to be recognized in accordance with GAAP (FASB 91).
Oil and/or Gas Reserve-Based Loans
Cash flow generated from the future sale of encumbered oil and/or gas reserves is the primary and in most cases the only intended source of repayment. The engineering report must address pricing, discount factors, and timing.
Classification guidelines without primary or secondary repayment source:
65% of discounted PWFNI should be Substandard
Balance, but not more than 100% of discounted PWFNI of PDP reserves should be Doubtful
Remaining deficiency should be Loss
PUP reserves should be classified more harshly
Real Estate Loans
Real Estate Lending Standards – Section 18(o) implemented by Part 365
Written policy should address:
Portfolio diversification standards
Prudent underwriting standards including loan-to-value limits
Loan administration procedures
Documentation, approval, and reporting requirements
Procedures for monitoring real estate markets within the lending area
Must consider policy statement and be reviewed and approved annually
Internal LTV limits should not exceed:
65% for raw land
75% for land development
80% for commercial, multi-family and other non-residential construction
85% for residential construction
85% for improved property
No limit for owner-occupied residential loans (PMI over 90%)
Government guaranteed loans and loans to be sold in secondary market without recourse are exempted
Loans exceeding supervisory guidelines should be identified in institution’s records and aggregate amount reported to the board at least quarterly. Aggregate amount of loans in excess of supervisory LTV limits should not exceed the institution’s total capital. Moreover, total loans for commercial, agricultural and multi-family residential properties should not exceed 30%.
Signs of troubled real estate market or projects:
Rent concessions or sales discounts resulting in cash flow below projected level in original appraisal
Changes in concept or plan (e.g., condominium to apartment)
Construction delays resulting in cost overruns which may require renegotiation of loan terms
Slow leasing or lack of sustained sales activity and/or increasing cancellations which may result in protracted repayment of default
Lack of any sound feasibility study or analysis
Periodic construction draws which exceed the amount needed to cover construction costs and related overhead expenses
Identified problem credits, past due and non-accrual loans
Types of agricultural lending:
Production loans – short-term notes for operating, generally paid at end of production season
Feeder livestock loans – short-term notes for purchase of and production expenses related to livestock, generally paid when sold for slaughter
Breeder stock loans – intermediate-term notes for purchase of breeding stock, repaid through proceeds from sales of offspring/produce
Machinery and equipment loans – intermediate term loans for purchase of equipment, repaid from cash flow from farm earnings over a number of growing seasons
Farm real estate acquisition loans – long-term loans for acquiring or improving farm real estate, repaid from cash flow from farm earnings
Carryover loans, two types:
Production or feeder livestock loans that are unable to be paid at maturity
Already-existing term debt whose repayment terms or maturities need to be rescheduled because of inadequate cash flow
Classification of agricultural credit
Weak documentation, poor structuring, collateral controls, or other factors may result in a more severe treatment
Managerial skill of the borrower, if supported by historical performance, can be a factor in classification
Portions secured by grain, feeder livestock, and/or breeder livestock will generally be excluded from adverse classification, with following caveats:
On-site inspection within 90 days of examination start date for feeder livestock and grain and 6 months for breeder livestock
Loans secured by grain warehouse receipts are also excluded
Amount excluded should be based on daily, published market value as of examination start date less accrued interest (if significant), marketing and transportation costs, feed, and veterinary expenses
Bank must have satisfactory practices for controlling sales proceeds
Bank must have properly perfected and enforceable security interest
Common lease terms
Net Lease – one in which bank is not directly or indirectly obligated to assume the expenses of maintaining the equipment
Full Payout Lease – one for which the bank expects to realize both the return of its full investment and the cost of financing the property over the term of the lease
Leveraged Lease – one in which the bank as lessor purchases and becomes the owner of equipment by providing a relatively small percentage (20% to 40%) of the capital needed (done by lessee to shelter income from taxation)
Rentals – Which include only those payments reasonably anticipated by the bank at the time the lease is executed

Appraisals

Valuation approaches
Cost approach (except for special purpose facilities, the cost approach is usually inappropriate in a troubled real estate market because construction costs would exceed market value of existing comparable properties)
Sales comparison approach (when adequate sales data is available this method generally gets most weight, comparables often difficult to find for commercial properties)
Income approach (discounted value of NOI, including any reversion value of property when sold)
Appraisal regulation – Part 323
Transactions exempt from Part 323
Transaction value is $250,000 or less
Lien on RE has been taken as collateral in an abundance of caution
Transaction is not secured by RE
Lien on RE has been taken for purposes other than the RE’s value
Transaction is a business loan that: (i) has a transaction value of $1 million or less and (ii) is not dependent on the sale of, or rental income derived from, real estate as the primary source of repayment
Lease of RE is entered into, unless economically equivalent to purchase or sale of RE
Transaction involves existing extension of credit at the institution, provided that: (i) no obvious and material change in the market conditions or physical aspects of the property that threatens the adequacy of protection after the transaction, even with the advancement of new monies, or (ii) no advancement of new monies, other than funds necessary to cover reasonable closing costs
Transaction involves the purchase, sale, investment in, exchange of, or extension of credit secured by, a loan (or similar) and each loan met FDIC regulatory requirements for appraisals at origination
Transactions wholly or partially insured or guaranteed by US government agency (including sponsored)
Transaction qualifies for sale to a government agency or is a residential real estate transaction in which the appraisal conforms to FNMA or FHMLC standards
Regulated institution is acting in a fiduciary capacity and not required to obtain an appraisal under other law
FDIC determines that the services of an appraiser are not necessary in order to protect federal financial and public policy interests or to protect the safety and soundness of the institution
Section 323.4 establishes minimum standards for all appraisals – must be in conformance with USPAP standards
Interagency Appraisal and Evaluation Guidelines (issued October 27, 1994)
Supervisory Policy – will be reviewed as part of examinations
Appraisal and Evaluation Program – board responsible for adopting policies and procedures the establish effective real estate appraisal and evaluation program:
Establish selection criteria and procedures to evaluate and monitor the performance of individuals performing appraisals or evaluations
Provide independence of person performing appraisals or evaluations
Identify appropriate appraisal for various lending transactions
Establish criteria for contents of an evaluation
Provide for receipt of appraisal or evaluation report in timely manner to facilitate the underwriting decision
Assess validity of existing appraisal or evaluations to support subsequent transactions
Establish criteria for obtaining appraisals or evaluations for transactions that are otherwise exempt from the agencies’ appraisal regulations
Establish internal controls that promote compliance with these program standards
Selection of Individuals to Perform Appraisals and Evaluations – criteria should be:
Non-preferential and unbiased
Individual possesses the requisite education, expertise, and competence
Individual selected is capable of rendering an unbiased opinion
Individual selected is independent and has no direct or indirect interest, financial or otherwise, in the property
Independence of Appraisal and Evaluation Function – individual performing should not be involved in loan origination, servicing, or collection of particular loan and should abstain from any vote (etc.) affecting loan
Transactions That Require Appraisals – regulatory guidelines or more stringent
Minimum Appraisal Standards – conform to USPAP; be written and contain sufficient information and analysis to support credit decision; analyze and report appropriate deductions and discounts for proposed construction or renovation, partially leased buildings, non-market lease terms, and tract developments with unsold units; be based upon definition of market value set forth in regulation; and be performed by state-licensed or certified appraisers in accordance with requirements of regulation.
Appraisal Options – Complete or Limited (departures from USPAP) and Self-Contained, Summary, or Restricted (Restricted are generally unacceptable other than ongoing collateral monitoring)
Transactions that Require Evaluations
Transaction value $250,000 or less
Business loan of $1 million or less and the transaction is not dependent on sale of or rental income from real estate as primary repayment source
Involves an existing extension of credit at institution provided that no obvious and material change and no advancement of new monies
Evaluation Content –
Written
Include preparer’s name, address, signature, and effective date of the evaluation
Describe the real estate collateral, its condition, its current and projected use
Describe the source(s) of information used in the analysis
Describe analysis and supporting information
Provide an estimate of real estate’s market value, with any limiting conditions
Qualifications of Individuals Performing Appraisals and Evaluations – real estate related training or experience and knowledge of market relevant to subject property
Valid Appraisals and Evaluations – program should include criteria for determining whether an existing appraisal or evaluation remains valid. Factors to consider include: passage of time, volatility of local market, availability of financing, inventory of competing properties, improvements to or lack of maintenance of the subject property or competing surrounding properties, changes in zoning, and environmental contamination.
Renewals, Refinancings, and Other Subsequent Transactions
Program Compliance – internal controls to promote compliance
Portfolio Monitoring – criteria for obtaining reappraisals or reevaluations as part of a program of portfolio review
Referrals – institutions are encouraged to make referrals directly to state appraiser regulatory authorities when state-licensed or –certified appraiser violates USPAP, state law, or engages in other unethical or unprofessional conduct
Loan Problems
Poor Selection of Risks, examples:
Loans to finance new ad untried business ventures which are inadequately capitalized
Loans based more upon the expectation of successfully completing a business transaction than on sound worth or collateral
Loans for speculative purchase of securities or goods
Collateral loans made without adequate margin of security
Loans made because of other benefits, such as the control of large deposit balances not based upon sound worth or collateral
Loans made without adequate owner equity in underlying real estate security
Loans predicated on collateral which has questionable liquidation value
Loans predicated on the unmarketable stock of a local corporation when the bank is at the same time lending directly to the corporation (conflicting interests of borrowers)
Loans which appear to be adequately protected by collateral or sound worth, but which involve a borrower of poor character risk and credit reputation
Loans which appear to be adequately protected by collateral, but which involve a borrower with limited or unassessed repayment ability
An abnormal amount of loans involving out-of-territory borrowers (excluding banks staffed to handle)
Loans involving brokered deposits or link financing
Overlending
Failure to establish or enforce liquidation agreements
Incomplete credit information
Overemphasis on loan income
Self-dealing
Technical incompetence
Lack of supervision
Lack of attention to changing economic conditions
Competition
Potential problem indicators by document:
Debt instrument – not paying per terms, modified terms, renewals without principal reduction, capitalized interest, high interest rates
Liability ledger – out-of-territory borrowers, unexpected non-amortization or non-reduction of debt
Financial and operating statements – inadequate or declining working capital position, negative trends in receivables, negative trend in inventory, no recent aging of or slowing of receivables, increase in volume of payable, increasing carryover debt, unfavorable trends in sales and profits, expanding expenses, heavy or deteriorating debt load, large dividend or other payments, improved net worth through reappraisals of fixed assets
Cash flow documentation – absence of cash flow statements or projections, projections indicating inability to meet required interest and principal payments, statements reflecting cash flow is provided by sale of assets or nonrecurring situations
Correspondence and credit files – missing and/or inadequate collateral or loan documentation, letters indicating that borrower has suffered financial reverse or has been unable to meet established repayment programs
Collateral – evidence of speculative loan purpose or collateral with inferior marketability characteristics, collateral of questionable value acquired subsequent to extension of credit
Loan Review
Loan sample
Loans listed for special mention or adversely classified at the previous FDIC or state examination
Loans reflected on problem loan list (if exists)
Significant overdue loans as determined from the overdue list or as determined by examiner
Other significant loans which exhibit a high degree of risk that have come to the examiner’s attention in the review of minutes, audit reports, or other sources
Loans to bank insiders and their related interests and insiders of other banks
Caveats: sample watch list to assess accuracy, some notes such as seasoned real estate loans which have not changed should be minimized, should be some review of new file information to assess credit trends, and sufficient volume of different types of loans should be included
Loan classification
Substandard – Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.
Doubtful – Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
Loss – Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.
Special Mention Assets – A Special Mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose and institution to sufficient risk to warrant adverse classification.
Troubled Commercial Real Estate Loan Classification Guidelines
Substandard – Any such troubled real estate loan or portion thereof should be classified Substandard when well-defined weaknesses are present which jeopardize the orderly liquidation of the debt. Well-defined weaknesses include a project’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project’s failure to fulfill economic expectations. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.
Doubtful – Doubtful classifications have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. A Doubtful classification may be appropriate in cases where significant risk exposures are perceived, but loss cannot be determined because of specific reasonable pending factors which may strengthen the credit in the near term. Examiners should attempt to identify loss in the credit where possible thereby limiting the excessive use of the Doubtful classification.
Loss – Advances in excess of calculated current fair value which are considered uncollectible and do not warrant continuance as bankable assets. There is little or no prospect for near term improvement and no realistic strengthening action of significance pending.
Past Due and Nonaccrual
Nonaccrual – loans defaulted for 90 or more days, unless asset is well secured and in the process of collection
Exceptions – residential real estate are exempt (but similar evaluation should be applied), any more stringent state rules should be imposed, and reversal of previously accrued interest is expected
Definitions – “well secured” if collateralized liens on or pledges of real or personal property that have a realizable value sufficient to discharge the debt in full or by the guaranty of a financially responsible party; “in process of collection” if collection is proceeding in due course either through legal action or through collection efforts not involving legal action which are reasonably expected to result in repayment or restoration to a current status
Returning loans to accrual status if all principal and interest amounts contractually due (including arrearage) are reasonably assured of repayment within a reasonable period and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms involving payments of cash or cash equivalents
Interagency retail credit classification policy
Open-end and closed-end credit past due 90 days should be classified Substandard
Closed-end loans past due 120 days and open-end loans past due 180 days should be charged off
Accounts in bankruptcy should generally be charged off within 60 days of notice, anything not charged off should be classified Substandard
Fraudulent loans should be charged off within 90 days of discovery
Loans of deceased persons should be charged off when the loss is determined
Residential real estate loans and home equity loans that are delinquent 90 days or more with LTV greater than 60 percent should be classified Substandard
When residential or home equity loan is 120 days (closed end) or 180 days (open end) a current assessment of value should be made and any balance in excess of the fair value (less cost to sell) should be classified Loss
The less stringent standards for residential real estate do not apply if bank has junior lien without senior lien whatever the LTV
Re-aging (practice of bringing a delinquent account current based on renewed willingness and ability to pay)
Borrower should show a renewed willingness and ability to repay the loan
Account should exist for at least nine months before allowing a re-aging, extension, renewal, referral, or rewrite
Borrower should make ate least three minimum consecutive monthly payments or the equivalent lump sum payment before re-aging
No loan should be re-aged, extended, deferred, renewed, or rewritten more than once within any 12 month period and no loan should be re-aged more than two times within any 5 year period
For open-end credit, an over limit account may be re-aged at its outstanding balance, new credit may not be extended to the borrower until balance falls below designated pre-delinquency credit limit
Loan impairment – when based on current information and events, it is likely an institution will be unable to collect all amounts due. FASBs 114 and 118. Amount of impairment should be measured based on the present value of expected future cash flows discounted at effective interest rate. If less than book value, should be a valuation allowance for difference (is included as part of general ALLL)
Troubled debt restructuring – when a bank grants a concession to a debtor in financial difficulty. FASB 15. Must be reported in Call Reports.
Express determination letters – special tax rules permit a bank to recognize charge off of loans pursuant to specific orders of supervisory authorities or that are classified loss by the institution under applicable regulatory standards for tax purposes. Requires an express determination letter the year the special rules are adopted and an express determination letter must be given at each subsequent examination.

Concentrations

Concentrations are not inherently bad, but do add a dimension of risk which management should consider when formulating plans and policies
If Federal funds sold to any one buyer equals or exceeds 100% of Tier 1 Capital, it should be listed on the Concentrations schedule unless secured by US Government securities

Syndicated Lending

· Two or more banks contracting with a borrower, typically a large or middle market corporation, to provide funds at specified terms under the same credit facility

Go to top

INVESTMENT SECURITIES

Investment Policies

· Factors that should be addressed Quality, Maturity, Diversification, Marketability, Income

Liquidity Considerations

Primary Reserves – consist of cash and demand balances due from other banks (reduced by required reserves)
Secondary Reserves – consist of short-term readily marketable, unpledged securities and other negotiable instruments which can be converted into cash at little risk of loss (includes bankers’ acceptances, high quality open-market commercial paper, Federal funds, call loans to securities brokers and dealers, and other marketable obligations with less than one year maturity)
Investment Account – purpose is to produce maximum yield consistent with safety of principal

Appraisal and Classification of Securities

Undefaulted securities in grades below the four highest securities of equivalent quality will be classified Substandard at the market price and depreciation will be classified Doubtful
Defaulted securities will be classified Substandard based on market price with any depreciation classified Loss
For subinvestment quality municipal GOs not in default, the entire book value will be classified Substandard
For defaulted municipal GOs, if a functioning market is established the market value will be classified Substandard with depreciation Loss, if a function market has not yet been established, the entire book value will be classified Doubtful
For stocks or other marketable securities, the carrying values are adjusted to the lower of aggregate cost or market value on a periodic basis

Other Securities Activities

Mutual funds should be composed of securities that the bank could invest in directly
For financial reporting purposes, mutual fund shares are to be accounted for as marketable equity securities in accordance with FASB 115

PREMISES AND EQUIPMENT

Premises includes land and buildings owned and occupied by the bank, and vaults, fixed machinery and equipment, parking lots used by customers or employees, real estate acquired for future expansion, and any outstanding mortgage or chattel liens thereon. Equipment includes all movable furniture, fixtures, and equipment (including automobiles and other vehicles and any debt thereon). Also includes the amount of stocks, bonds, or other assets indirectly representing premises or equipment of non-majority-owned corporations.
Capitalizing leases is required when one of the following conditions is met:

1. Ownership of the property is transferred to the lessee at the end of the lease term

2. The lease contains a bargain purchase option

3. The lease term represents at least 75% of the estimated economic life of the leased property

4. The present value of the minimum lease payments at the beginning of the lease term is 90% or more of the fair value of the leased property to the lessor at the inception date, less any related investment tax credit retained by or expected to be realized by the lessor

Amount capitalized would be the present value of the minimum required payments over the noncancellable term as defined by the lease plus the present value of the payment required under the bargain purchase option, if any, less any portion of the payments representing administrative expenses such as insurance maintenance and taxes to be paid by the lessor.
Principal determinant of a possible overcommitment in equipment and facilities is the impact on earnings that such a investment has.

Go to top

OTHER REAL ESTATE

Book value – should be booked at time of foreclosure at fair value of property less cost to sell the property. Any loss should be charged to allowance for loan and lease losses. Excess should be reported as a recovery of prior charge-off or current earnings, as appropriate. If partial satisfaction of loan, loan should be reduced by fair value of property. Legal and other direct expenses incurred by the bank in foreclosure should be included in expenses when they are incurred.
Financed Sales of Other Real Estate
Full Accrual Method – disposition is recorded as a sale, profit recognized immediately
Sale consummated
Receivable is not subject to future subordination
Usual risks and rewards of ownership have been transferred
Buyer’s initial investment and continuing investment are adequate to demonstrate a commitment to pay for the property
Instalment Method – recognizes a sale and corresponding loan, profits are recorded as the bank receives payments, interest income is recognized on an accrual basis
Used when down payment is not adequate for full accrual method, but recovery of cost of property is reasonably assured
Cost Recovery Method – Method also recognizes a sale and corresponding loan and may apply when dispositions do not qualify under full accrual or instalment methods. No profit or interest income is recognized until either the aggregate payments exceed the recorded amount of the loan or a change to another accounting method is appropriate. The loan is maintained on nonaccrual status while this method is used.
Reduced-Profit Method – Method is appropriate in those situations where the bank receives an adequate down payment, but the loan amortization schedule does not meet the requirements of the full accrual method. Profits recognized as payments are received; however, profit recognition is based on the present value of the lowest level of periodic payments required under the loan agreement.
Deposit Method – Used in situations where a sale of real estate has not been consummated. Continues to be reported as other real estate. Payments received from the borrower are reported as a liability until sufficient payments or other events have occurred which allow the use of one of the other methods.
Other Real Estate Reserves
Not included in either Tier 1 or Tier 2 Capital
Valuation allowances must be made on an asset-by-asset basis and are netted from the asset’s cost to determine the gross amount for classification.
General reserves should be viewed as a contra-asset to other real estate and netted for the statement of condition.
To the degree general reserves adequately cover the risks inherent in the other real estate portfolio as a whole, the amount of other real estate assets classified Loss will not need to be deducted from Tier 1 capital.

OTHER ASSETS

Prepaid Expenses

Accrued Income Accounts

Acceptances (own bank)

Servicing Assets (only when contractually separated from underlying financial asset by sale or securitization)

Servicing rights carried on the bank’s books should be amortized in proportion to and over the period of estimated net servicing income or net servicing loss. Additionally should be grouped based on one or more predominant risk characteristics of the underlying assets.
Valuation can be accomplished using market price (if available) or an estimation considering prices of similar assets or other techniques such as discounted cash flow analysis (most common), option-pricing models, and matrix pricing.
Under regulatory capital rules, servicing assets are subject to quarterly valuation requirements and a restriction limiting the amount of servicing assets that may be recognized for Tier 1 capital purposes to the lesser of 90% of fair value or 100% of book value (net of valuation allowances). Total amount of mortgage servicing assets, nonmortgage servicing assets, and purchased credit card relations recognized regulatory purposes is limited to no more than 100% of tier 1 capital. In addition maximum allowable amount of total purchased credit card relationships and nonmortgage servicing assets (combined) is limited to 25% of Tier 1.

Suspense Accounts

Cash Items Not in Process of Collection

Future Tax Benefits (deferred tax asset net of deferred tax liability or tax loss carryforwards)

Life Insurance Policies

Goodwill

Amortized on a straight-line basis over period not to exceed 25 years
Excluded for Part 325 consideration

OFF-BALANCE SHEET LENDING ACTIVITIES

Adversely Classified Contingent Liabilities

Category 1 contingent liabilities are those which will give rise to concomitant increase in bank assets. Classification of these contingent liabilities is dependent on the likelihood of the liability becoming direct and the credit risk of the potential acquired asset.
Supplemental classification definitions:
Special Mention – The chance of the contingency becoming an actual liability is at least reasonably possible and the potential acquired assets are considered worthy of special mention.
Substandard – The chance of the contingency becoming an actual liability is at least reasonably possible, and the potential acquired assets are considered no better than Substandard quality.
Doubtful – The chance of the contingency becoming an actual liability is probable, and the potential acquired assets are considered of Doubtful quality.
Loss – The chance of the contingency becoming an actual liability is probable, and the potential acquired assets are not considered of bankable quality. A Loss classification normally indicates that a balance sheet liability should be established to cover the estimated loss.
Total amount of Category 1 contingencies should be reflected on the memorandum section of the Capital Calculations schedule, however, the “potential loss” and estimated loss” designations do not apply.

Types of Off-Balance Sheet Lending

Standby Letters of Credit
Irrevocable commitment on the part of the bank to make payment to a designated beneficiary if the bank’s customer, the account party, defaults on an obligation
Section 337.2(d) requires banks to maintain adequate controls and subsidiary records of SBLCs comparable to records maintained on direct loans.

MANAGEMENT/ADMINISTRATION

Powers, Duties and Responsibilities of Directors

Regulating the Manner in Which All Business of the Bank is Conducted
Corporate Planning
Appointing, Dismissing at Pleasure, and Defining Duties of Officers
Personnel Administration
Honestly and Diligently Administering the Affairs of the Bank
Observance of Laws to Which the Bank is Subject
Avoiding Self-Serving Practices
Paying Such Dividends as May be Properly Paid
Appropriate Internal Control System and Adequate Auditing Program
Management Information System (MIS)

Legal Liabilities of Directors

Directors can be held liable for:
Breach of trust
Negligence which is the proximate cause of loss to the bank
Ultra vires acts, or acts in excess of their powers
Fraud
Misappropriation or conversion of bank assets

Laws and Regulations Pertaining to Bank Directors

Section 18(k) and Part 359 permit the FDIC to prohibit or limit by regulation or order golden parachute payments or indemnification payments
Section 39(c) requires the FDIC to prohibit excessive compensation to executive officers, employees, directors, and principal shareholders as an unsafe and unsound practice.
Section 32 prohibits a troubled institution from adding any individual to the board or employ any individual as a senior executive officer if the appropriate Federal banking agency issues a notice of disapproval before the end of the 30-day period beginning on the date the required notice is received.
Section 19 prohibits, without prior written consent of the FDIC, a person convicted of any criminal offenses involving dishonesty or breach of trust or money laundering, or who has entered into a pretrial diversion or similar program in connection with a prosecution for such offense, from becoming or continuing as an institution-affiliated party.
Part 349 prohibits preferential lending by a bank to executive officer, directors, principal shareholders of another bank when there is a correspondent account relationship between the banks and the opening of a correspondent account relationship between banks when there is a preferential extension of credit by one of the banks to an executive officer, director or principal shareholders of the other bank.
Section 22(g) and 22(h) of the Federal Reserve Act and Regulation O pertain to loans and extensions of credit to executive officers, directors, principal shareholders, and their related interests
Extensions of credit to covered parties be made on substantially the same terms as those prevailing at the time for comparable transactions with unaffected persons.
Aggregate lending limits to insiders are imposed
Payments of overdrafts are also limited
Section 337.3 addresses approvals of extensions of credit to insiders (prior board approval and abstention of insider from decision)
Part 348 prohibits a management official of one depository institution or depository holding company from also serving in a similar function in another depository institution or holding company if the companies are not affiliated and are located in the same area or if the organizations are not affiliated and are very large.

Miscellaneous Management Issues

If a director has a personal financial interest in a loan or other transaction subject to adverse classification, the board should be urged to require that director to strengthen the credit sufficiently to remove the adverse classification within a reasonable time frame or resign from the board.
Problems with “One Man Banks” include deprivation of competent management due to incapacitation of the dominant officer and difficulty in solving problems caused by mismanagement.
Factors to be considered in determining excessive compensation

1. Combined value of all cash and noncash benefits provided to an individual

2. Compensation history of the individual and other individuals with comparable expertise

3. Financial condition of the institution

4. Comparable compensation practices at comparable institutions

5. For post-employment benefits, the projected total cost and benefit to the institution

6. Any connection between the individual and any instance of fraud or insider abuse occurring at the institution

7. Any other factors determined to be relevant

Go to top

INTERNAL ROUTINE & CONTROLS

Basic Elements of an Internal Control System

Organizational Structure
Directors’ Approvals – establish authority levels and review actions taken by officers
Segregation of Duties – duties should be arranged so that no one person dominates any transaction from inception to termination
Rotation of Personnel
Sound Personnel Policies
Vacation Policies
Accounting Procedures
Operating Responsibilities
Current Records
Subsidiary Control Accounts
Audit Trail
Prenumbered Documents
Accounting Manual
Protection of Physical Assets
Cash Control
Joint Custody or Dual Control
Employee Hiring Procedures
Emergency Preparedness Plans
Reporting Shortages

Audit

External Audit (per Statement of Policy)
Audit Committees – all banks are strongly encouraged to establish an audit committee consisting, if possible, entirely of outside directors.
External Audit of Financial Statements – all banks are strongly encouraged to adopt an external auditing program that includes an annual audit of its financial statements by an independent public accountant.
Alternative External Auditing Programs – if determine not to engage an independent public accountant reasons should be documented in minutes. Alternative should adequately cover high-risk areas of that particular bank and be performed by a qualified auditor who is independent of the bank.
State-mandated Auditing Requirements
External Auditors’ Reports – requested to furnish a copy of any reports, including management letters, by the auditor to the FDIC Regional Office. Also, the FDIC requests each bank to notify the appropriate Regional Office when any auditor is initially engaged to perform external auditing procedures and when a change in its auditor occurs.
Troubled Banks – when weaknesses exist, the FDIC should consider adding a condition directing an audit or specified auditing procedures be performed to any contemplated enforcement action.
Internal Audit
Determination that the records of the bank are complete and adequate, and that transactions are promptly and properly recorded in the accounts
In an EDP environment there should be a review of data controls
Determination that assets are adequately safeguarded and properly presented in financial reports, and that liabilities are completely disclosed and accounted for
Assurance that collateral and other nonledger items are properly recorded and protected by effective custodial controls
Check for compliance with applicable statutes and regulations
Review for compliance with policies set forth by management including verification that loans and securities have been properly approved
Accounting for receipt of income and review of expenses to determine that they are authorized, correct in amount, and consistent with bank policy
Appraisal of performance of personnel in accomplishing assigned internal control functions and responsibilities
Validation of the authority granted to members of the organization to be certain there are no departures from established policy
Review of loan losses, operating charge-offs, and the control exercised over recoveries
Evaluation of adequacy of fidelity and casualty insurance in force
Preparation of a proper and complete set of working papers covering each audit
Utilization of accepted verification and confirmation techniques
Establishment and maintenance of an operating manual describing the specific procedures and techniques to be used by the auditor or auditing staff in performing the audit function
Direct verification of loan and deposit balances on a periodic basis
Part 363
Establishes audit and reporting requirements for insured depository institutions with total assets of $500 million or more and their public accountants
Must:
Engage an independent public accountant
Prepare annual financial statement in accordance with generally accepted accounting principles
Produce annual reports
Within 90 days after fiscal year end, an annual report must be filed
Within 15 days after receipt, the institution must submit any management letter, the audit report and any qualification to the audit report, and any other report from the accountant
Within 15 days of occurrence, the institution must provide written notice of the engagement of an accountant, the resignation or dismissal of a previously engaged accountant, and the reasons for such an event
Establish an independent audit committee composed of outside directors independent of management (for institutions exceeding $3 billion, two members must have banking or related financial management expertise, large customers are excluded, and committee must have access to own outside counsel)

Information Systems

Institution should formulate a security plan that addresses physical security, data security, and backup and contingency planning.
Community Workprogram is designed to assist the examiner in evaluation of internal routine and control procedures over in-house and serviced information processing systems and should be used when:
There is no programming or testing performed and software is vendor supported for institutions of any size
Some contract programming and testing is performed for institutions of any size, provided the Systems & Programming section of the workprogram is performed and ARD approval is obtained for institutions greater than $300 million
Workprogram’s ATM, POS, ACH and network sections may be used in any size institution
All applications are serviced by an outside vendor, the workprogram may be used regardless of institution size
Should not be used when the institution services other financial institutions
Reports are to be completed at initial examination of in-house and RJE systems and when an IS composite rating of 3 or worse is likely to be assigned or was assigned at the most recent examination
MIS should be timely, accurate, consistent, complete, and relevant.

Go to top

RELATED ORGANIZATIONS

Bank Holding Companies

Business organization which controls any bank or bank holding company
Conclusive presumption of control exists if the company directly or indirectly controls 25% or more of the voting shares or if it controls in any manner the election of a majority of the directors
Rebuttable presumption of control exists if:

1. Company has controls more than 5% of voting stock if one or more directors or officers serves in any capacity with the bank or holding company and no other person controls as much as 5% of the company

2. Company that controls more than 5% if additional voting securities are controlled by individuals or members of their immediate families who are directors or officers of the company and such holdings aggregate 25% or more of voting securities.

3. Company that enters into an agreement with a bank under which the company exercises significant influence in the general management or operations of the bank

4. Company that enters into an agreement in which a holders rights in voting securities is restricted presumably controls those shares unless it is a mutual agreement among shareholders granting first refusal or incident to a loan transaction or relates to restrictions on transferability and continues only as may reasonably be necessary to obtain approval for acquisition

5. Company the directly or indirectly owns securities that are convertible immediately at option of holder into voting securities presumably owns voting securities

Not holding company if shares acquired through debt previously contracted, ownership involved in underwriting security issue, shares controlled through proxy solicitation, ownership in a fiduciary capacity without discretionary voting power
All bank holding companies must register with the Board of Governors of the Fed and Fed’s prior approval must be obtained prior to formation of any new bank holding company. BHC must get Fed prior approval for acquisition of ownership or control of more than 5% of voting shares in any bank or acquisition of substantially all bank assets or for merger or consolidation with another BHC.
BHC Act prohibits a BHC from owning shares of any company that is not a bank, engaging in any activities other than banking or managing and controlling banks, or furnishing services to or performing services for their subsidiaries except as specifically authorized by the Act or Fed.
Permissible activities:
Ownership of a company holding or operating properties used wholly or substantially by any subsidiary, conducting a safe deposit business, furnishing or performing services to or for holding company and subsidiaries, or liquidating assets acquired from any source prior to the date on which company became a BHC
Indirectly own shares of any company if shares were acquired by a bank in satisfaction of a debt previously contracted or directly hold shares of a company if the shares were acquired by holding company because on e of subsidiaries was ordered to divest (in both cases shares must be sold within two years)
Subsidiary bank may hold or acquire shares in a fiduciary capacity
May hold shares of the kind and amount expressly eligible for investment by national banks
May hold shares of any company provided the shares do not exceed 5% of the outstanding voting share of that company
May hold shares of any investment company provided the investment company is not a BHC and is not engaged in any business other than investing in securities, none of which exceed 5% of the outstanding shares of any company
Nonbank banks were grandfathered in 1987, but cannot expand into businesses it was not lawfully engaged in 1987 and may not cross-market with affiliates unless such activity was conducted in 1987 and may not permit an overdraft by an affiliate on its books or overdraft its account at a Fed bank on behalf of an affiliate and may not increase its assets at an annual rate of more than 7% during any 12 month period.
BHC Act prohibits tying arrangements (conditioning use of any credit, property, or service on the customer’s use or provision of any other credit, property, or service OR prohibiting customer from obtaining credit, property, or service from a competitor)
For banks, loans, discounts, deposits, and trust services are excepted from the prohibition.
BHC Act contains prohibitions related to preferentially loans from correspondents as implemented in Part 349.

Affiliates

· Banking Act of 1933 – any organizations which comes within one or more following categories:

1. Subsidiary – an organization in which the bank directly or indirectly controls a majority of voting shares, controls more than 50% of number of shares voted for election of directors at the last election, or controls in any manner the election of a majority of organization’s directors

2. Common Shareholder – an organization which is controlled through stock ownership or in any manner by the majority shareholders of a bank, by shareholders of a bank who own or control more than 50% of shares voted for bank’s directors at last election, or by trustees for benefit of bank’s shareholders

3. Common Directors – an organization if a majority of its directors are directors of a bank

4. Holding or Controlling – an organization that control a majority of share of a bank, control more than 50% of shares voted for bank’s directors at last election, or control in any manner the election of a majority of bank’s directors

Section 23A
Definition of an affiliate

1. Any company that controls the bank as well as any other company that is controlled by the company controlling the bank (Control is 25% or more of voting securities or election of a majority of the directors). When a bank 80% controlled by a holding company, its transactions with other 80% controlled banks are largely unrestricted except the prohibition of purchasing low quality assets and that all transactions be consistent with safe and sound banking practices.

2. A bank controlled by another bank is an affiliate of controlling institution (80% rule above applies). Non-bank and foreign bank subsidiaries are excluded from definition of affiliate for 23A.

3. Any company which is interlocked with a bank or its holding company by virtue of common ownership or common directors is an affiliate of the bank.

4. A company which is sponsored and advised on a contractual basis by a bank, or by any of the bank’s subsidiaries or affiliates, is an affiliate of the bank.

Restrictions on “Covered Transactions” with Affiliates
Covered transactions consist of:

1. Loans to an affiliate

2. Purchase of securities issued by an affiliate

3. Purchase of nonexempted assets from an affiliate

4. Acceptance of securities issued by an affiliated company as collateral for any loan

5. Issuance of a guarantee, acceptance, or letter of credit on behalf or (for the account of) an affiliate

Aggregate covered transactions are limited to 10% of capital stock and surplus with respect to a single affiliate and 20% of capital and surplus with respect to all affiliates (capital and surplus includes undivided profits, capital reserves, loan valuation reserves, and valuation reserves for securities)
Prohibits a bank from purchasing any low quality asset (classified other than pass, on nonaccrual status, past due more than 30 days, or TDR)
Any transaction between a bank and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices
Collateral requirements:

1. 100% margin if collateral US Government and agency securities, deposits held in the bank which are specifically segregated and earmarked, or obligations which are eligible for rediscount or purchase by a Fed bank

2. 110% margin if collateral is composed of obligations of a state or political subdivision

3. 120% margin if collateral consists of other types of debt instruments including receivables

4. 130% margin if collateral is composed of stocks, leases, or other real or personal property

Section 23B
Definition of affiliate for 23B same as 23A except banks are not affiliates for 23B
Adds the following for restrictions:

1. Requires terms of affiliate transactions be comparable to terms of similar non-affiliate transactions

2. Restricts the extent that a bank may, as a fiduciary, purchase securities and other assets from an affiliate

3. Restrict the purchase of securities where an affiliate is the principal underwriter

4. Prohibits agreements and advertising providing or suggesting that a bank is responsible for the obligations of its affiliates

Go to top

FIDELITY AND OTHER INDEMNITY PROTECTION

Fidelity Insurance Protection

Section 18(e) permits the FDIC to require such coverage and if not complied with, may contract for the coverage and add the cost to the bank’s deposit insurance premium
Scope of Blanket Bond Coverage:
Clause A – Fidelity – Covers losses as a result of dishonest or fraudulent acts by bank’s officers and employees and agents
Clause B – On premises – Loss of property resulting directly from robbery, burglary, misplacement, mysterious unexplainable disappearance and damage thereto or destruction thereof or theft, false pretenses, common law or statutory larceny, committed by a person present in an office or on the premises of insured
Clause C – In transit – Same as B except that the property is covered in transit
Clause D – Forgery or Alteration – Optional coverage for loss through forgery or alteration of checks, drafts, acceptances (electronic items not covered)
Clause E – Securities – Optional coverage for resulting from acquiring, selling, delivering, giving value, extending credit, or assuming liability based on any original security, title document or agreement
Clause F – Counterfeit currency
Claims under Bankers Blanket Bond Coverage – “discovery” or “loss sustained” basis.

ELECTRONIC BANKING

Electronic Capabilities

Information only systems – Level 1 – publicly available information and non-sensitive e-mail capabilities
Electronic information transfer systems – Level 2 – private information and sensitive messages
Fully transactional information system – Level 3

EARNINGS

Analysis of Bank Earnings

Consider existence of bank holding company and level of management fees, extent of dividends, amount of income tax payments upstreamed, and type of earning assets employed by the bank
Focus of income before securities transactions (NOI)
Analyze level and trend, analysis trails (net interest income, noninterest income, overhead expense, allowance for loans and lease losses, income taxes, and dividends), quality of bank earnings, and profit plans and budgets

Go to top

LIQUIDITY AND FUNDS MANAGEMENT

Liquidity

Adequacy determined by analysis of current liquidity position, present and anticipated asset quality, present and future earnings capacity, historical funding requirements, anticipated future funding needs, and options for reducing funding needs or attracting additional funds
Liquidity needs can be satisfied by any combination of disposal of liquid assets, increase in short-term borrowings and/or issuance of additional short-term deposit liabilities, decrease in holdings in long-term assets, increase in long-term liabilities, or increase in capital funds

Asset Management

· Banks which rely solely on asset management focus on adjusting the price and availability of credit and the level of liquid assets held in response to changes in customer asset and liability preferences

Liability Management

Needs can be met through discretionary acquisition of funds on the basis of interest rate competition
Larger banks, contrasted with smaller banks, are generally better able to control the level and composition of their liabilities in that when funds are required, larger banks usually have a variety of options from which to select the least costly method of generating funds
The marginal cost of liquidity, incremental cost of funds acquired, is of paramount importance in evaluating liability sources of liquidity
Risks: purchased funds may not always be available when needed, over-reliance on liability management may cause a tendency to minimize holding of liquid assets (leading to high dependency ratios), bank may incur relatively high costs in obtaining funds due to rate competition (prompting lower quality, higher yielding investments or possibly a negative yield spread to existing assets), banks with limited funding sources should avoid purchasing funds and rely on their own local market, and potential for focusing on lowest cost funds resulting in poor management of interest rate risk

Funds Management Policies and Management Reporting Systems

Typical guidelines established by a sound asset/liability policy:
Provide for establishment of an ALCO (who, responsibilities, meeting frequency, communication with board)
Provide for a periodic review of the bank’s deposit structure
Provide a method of computing cost of funds
Provide a method of loan pricing (considering cost of funds, overhead and administrative costs, and desired profits, and appropriateness of fixed and floating rates)
Determine types, mix, and maturity of investments permitted in conjunction with investment policy
Determine types, mix, volume, and maturities of loans in conjunction with loan policy
Provide for a periodic calculation to determine extent to which long-term assets are funded with short-term liabilities and establish target parameters
Provide for a periodic calculation to measure interest rate risk exposure and establish target parameters
Review performance with the liquidity ratio target and review compliance with required legal reserves
Review possible alternative sources of funds
Provide for tax planning

Borrowings

Justified under these circumstances:
Meet temporary or seasonal loan or cash requirement of customers if period is indeed temporary and the bank is quickly restored to a position where the quantity of its principal assets and cash reserves are in proper relationship to requirements of normal deposit volume
Meet large and unanticipated deposit withdrawals which may arise during periods of economic distress
Serve as an effective management tool whereby banks engaged in money market transactions may borrow on a more or less continuous basis
Types of Borrowings
Federal funds purchased
Federal Reserve Bank discount window
Treasury Tax and Loan accounts
Repurchase Agreements (however, if institution is not required to resell the identical security purchased the transaction is a sale)
Retail Repurchase Agreements
Requires confirmation for repurchase transactions by end of day in which transaction is initiated and any day in which a substitution occurs
Statement of Policy provides guidelines on advertising and marketing these accounts and requires daily confirmation disclosures for overnight hold-in-custody repurchase agreement transactions
To comply with Part 329 the obligation must meet all of the following:

1. Arise from a transfer of direct obligations of the United States or agency thereof

2. Be in denominations of less than $100M

3. Mature in less than 90 days

4. Obligate the bank to repurchase the underlying Federal securities

· Dollar Repurchase Agreements

Safety and Soundness Considerations

Brokered Deposits
Only a well-capitalized institution can accept, renew, or roll over without restriction. Adequately-capitalized institutions must obtain FDIC waiver for such activities and undercapitalized institutions are prohibited from these activities.

MARKET RISK

IRR Concepts

Economic Value of Equity (EVE) represents the net present value of all asset, liability, and off-balance sheet cash flows
Repricing risk results from timing differences between cash flows from assets, liabilities, and off-balance sheet instruments
Basis risk results from weak correlation between coupon rate changes for assets, liabilities, and off-balance sheet instruments
Yield curve risk results from changing rate relationships between different maturities of the same index
Option risk results when a financial instrument’s cash flow timing or amount can changes as a result of market interest rate changes
Price risk results from changes in the value of marked-to-market financial instruments that occur when interest rates change

IRR Management

Board Oversight
Establish strategy and acceptable risk tolerance levels, including policies, risk limits, and management authority and responsibility
Monitor IRR to prevent excessive exposure
Provide adequate IRR management resources
Senior Management Oversight
Implement procedures that translate the board’s policies into clear operating standards
Maintain a measurement system that identifies, measures, and monitors IRR
Establish effective internal IRR controls
Strategies, Risk Limits, and Controls
Risk limits should address the effect of IRR on earnings (net interest margin, net operating income, net income) and capital (EVE, Regulatory capital)
Risk Identification and Measurement
Risk Monitoring and Reporting
Banks should maintain systems that concisely report IRR and the board and management should review those reports at least quarterly
Reports should identify IRR sources and levels, evaluate key assumptions, and verify compliance with policies and risk limits
Independent Review
Considerations should include adherence to policies and risk limits, internal measurement system’s adequacy and accuracy, and personnel resources and expertise and findings should be reported to the board at least annually

IRR Measurement Methods

Gap Analysis
Most common ratio is:

Rate-sensitive Assets less Rate-sensitive Liabilities / Average Earnings Assets

The gap ratio should also be expressed as the percentage risk to net interest income by multiplying the gap ratio by the assumed rate change and the result estimates the change to the net interest margin.
Advantages:
Does not require sophisticated technology
May be relatively simple to develop and use
Can provide clear, easily interpreted results
Weaknesses:
Generally captures only repricing risk
May not identify intraperiod risk
Does not measure EVE
Generally can not analyze complex instruments
Duration analysis
Duration always:
Equals less than maturity for instruments with payments prior to maturity
Equals maturity for zero-coupon instruments
Is lower for instruments with higher coupons
Is lower for amortizing instruments
Assumes a linear price/yield relationship (making it inaccurate for large changes)
MaCaulay duration (simplest form) calculates the weighted average term to maturity of a security’s cash flow
Equal to the sum of the present value of each anticipated cash flow divided by the instrument’s face value
Modified duration estimates price sensitivity for small interest rate changes
An instrument’s modified duration represents the percentage price change given an assumed parallel yield curve shift
Calculated by dividing the instrument’s MaCualey duration is divided by 1 + instrument’s yield
Not accurate for instruments with embedded options or rate sensitive cash flows
Effective duration estimates price sensitivity more accurately than modified duration for instruments with embedded options. It calculates duration using valuation models that contain pricing components
Convexity describes the curvilinear relationship of price/yield relationships
Option free instruments demonstrate positive convexity
Embedded option instruments demonstrate negative convexity
Advantages:
Yields a single IRR number
Considers all cash flow
Can provide more accuracy than maturity gap analysis
Weaknesses:
Accurate duration calculations demand sophisticated accounting and information systems
Duration accurately measures value changes for only relatively small interest rate fluctuations
Simulation Analysis
Simulation analysis determines the effect of interest rate changes on short-term net interest income, net income, and in some cases, EVE.
These systems vary widely and require advanced information systems and technical expertise.

Other Market Risk Factors

Foreign exchange
Commodity price risks
Equity trading and investing

IRR Measurement System Review

Identifying IRR exposures
Determining the system’s capabilities
Evaluating the objective data
Assessing the key assumptions
Reviewing the system’s results
Verifying reasonable system validation

Go to top

APPLICATIONS

Institutions Eligible for Expedited Application Processing

Composite 1 or 2 rating at most recent federal or state examination
Satisfactory or better CRA rating from primary regulatory
Compliance rating of 1 or 2
Well-capitalized
Not subject to cease and desist order, consent order, prompt corrective action directive, written agreement, memorandum of understanding, or other administrative agreement

Factors Considered for Applications by Proposed or Newly Organized Institutions

Financial History and Condition
Adequacy of Capital Structure – for deposit insurance, should be sufficient to provide Tier 1 capital to assets leverage ratio of not less than 8.0% throughout the first three years of operation. Initial capital should normally be in excess of $2 million net of any pre-opening expenses that will be charged to capital after it commences business. In addition, the depository institution must maintain an adequate allowance for loan and lease losses.
Future Earning Prospects
General Character of Management
Risk Presented to the Insurance Fund
Convenience and Needs of the Community to be Served
Consistency of Corporate Powers
Miscellaneous – conflicting applications, operation of trust department requires a separate form

Applications

Deposit Insurance
Establish a Branch or Move Main Office or Branch
Consent to Exercise Trust Powers
Retirement of Capital
Mergers

Change in Bank Control Act

Procedures
Any person seeking to acquire control (25% or more) of any insured bank or holding company, is required to provide sixty days prior written notice to the appropriate agency
In these applications, the burden of sustaining a disapproval falls on the FDIC
Factors for disapproval: would result in a monopoly, substantially lessen competition within any section of the country or otherwise be in restraint of trade, the financial condition of the acquiring party and its potential impact on the bank and prejudice the interest of depositors, competence, experience or integrity of any acquiring person or proposed management, any acquiring party fails to furnish all information required by FDIC, or the effect on the deposit insurance funds
Transactions resulting in a rebuttable presumption of control are not subject along with several other types of transactions. These would require after-the-fact notice.
CEO of an insured bank that makes a loan secured by 25% or more of the voting stock of another insured bank to report the facts to the appropriate regulatory agency (does not apply to new banks)

Go to top

CRIMINAL VIOLATIONS

Interagency Cooperation

Criminal Referrals
FDIC will prepare and file suspicious activity reports directly with FinCEN in the following instances:
Referral made by the institution is deemed inadequate
Suspected criminal conduct discovered by the FDIC has not been reported by the bank

Criminal Statutes

18 USC 215 – Bank Bribery
18 USC 656 – Theft, Embezzlement, and Misapplication of Funds
Requires intent
18 USC 709 – False Advertising or Misuse of FDIC Name
18 USC 1001 – False Statements or Entries
18 USC 1005 – False Entries
18 USC 1007 – Federal Deposit Insurance Corporation Transactions
18 USC 1014 – False Statements on a Loan or Credit Application
18 USC 1029 – Fraud and Related Activity in Connection with Access Devices
18 USC 1030 – Computer Fraud
18 USC 1341 – Mail Fraud
18 USC 1343 – Wire Fraud
18 USC 1344 – Bank Fraud
18 USC 1951 to 1961 – Racketeer Influenced and Corrupt Organizations (RICO)
18 USC 1956 – Laundering of Monetary Instruments
18 USC 1957 – Engaging in Monetary Transactions in Property Derived from Specified Unlawful Activity
18 USC 2113 – Bank Robbery and Incidental Crimes
15 USC 78dd – Foreign Corrupt Practices Act
15 USC 78ff and 78x – Securities Laws
31 USC 5311 – Currency Transactions/Bank Secrecy Act (Also see 31 USC 103)
31 USC 5324 – Structuring Transactions to Evade Reporting Requirements

Go to top

Criminal Referrals

Suspicious Activity Reports shall be filed if:
An employee, officer, director, agent or other institution-affiliated party is suspected of committing or aiding in the commission of a crime involving the institution
A known or suspected crime is committed against the institution, there is actual or potential loss to the institution of $5M or more, and possible suspect(s) (not an employee, officer, director, agent, or IAP) can be identified
A known or suspected crime is committed against the institution, there is actual or potential loss to the institution of $25M or more, and a potential suspect cannot be identified
A financial transaction of $5M or more was conducted or attempted using the institution as a conduit for criminal activity. More specifically, the funds involved in the transaction were derived from illicit activity, the purpose of the transaction was to hide or disguise funds from illicit activities, or the purpose of the transaction was evade the BSA requirements.
Financial institutions are required to file the SAR within 30 days of detecting the criminal activity; however, if management is unable to identify a suspect within 30 days, reporting may be delayed until the earlier of an additional 30 days or until a suspect is identified

Notification to the Bonding Company

· When a bank files an SAR on an employee, it normally will be required to notify its fidelity insurer of the alleged illegal activity but no copy of the SAR may be provided.

NON-DEPOSIT INVESTMENT PRODUCTS

Program Management

Board should adopt an NDIP statement that addresses the cope of activities, policies, procedures, controls, risks and ensures compliance with the Interagency Statement
Networking arrangements should only be made after a thorough review of stability, ability, and reputation of the third party and a networking arrangement should be subject to a detailed written agreement that ensures the third party will conduct NDIP activities within Interagency Statement guidelines

Personnel

· In establishing personnel guidelines, management should evaluate needs such as qualifications, training, and compensation

Disclosures

Minimum disclosures
Not FDIC Insured
Not bank guaranteed
Subject to investment risk, including potential principal loss
Customer accounts should receive minimum disclosures during every NDIP sales presentation. When a customer opens the account, the sales representative should provide clear written and oral disclosures, fully detail any fees, penalties, or redemption charges, obtain a signed customer statement that acknowledges receipt and understanding of all disclosures, and disclose any material relationship between the bank and any third party vendors
An NDIP must not have a name identical to the bank’s name.
Transaction notifications are required by Part 344. Notifications must be in writing and disclose any compensation received from the customer and disclose or acknowledge receipt of compensation from any other source

Sales Setting

· Must be physically distinct from areas in which retail deposits are taken

Suitability

Investment recommendations cannot be made until customer goals, financial information, and other factors are considered
Investment Goals
Risk tolerance
Return objectives
Tax considerations
Liquidity
Financial Information
Assets, liabilities, net worth
Income and expenses
Investment portfolio composition
Taxation
Insurance
Nonfinancial Factors
Age and retirement plans
Family status
Current and anticipated education needs
Current and anticipated health care needs
Unsolicited sales do not require the same amount of analysis. Only the minimum disclosures are required.

Proprietary Products

Policies addressing proprietary products should require separation of duties between trading, sales, management, and accounting; define bank management’s responsibilities; establish an independent review function; and outline strategies for potentially significant events, such as a capital injection.
Disclosures should identify differences in compensation, fees, performance, and risk profile to other products of the bank.

IRAs and Keoughs

Self-directed custodial accounts established by individuals for their own benefit can be offered by banks without trust powers
Asset and accounting controls must segregate customer assets from bank assets and each individual account must be distinguished from other accounts. Documentation should identify and support each account. Suitability guidelines do not apply to self-directed accounts. Illegal investments must not be permitted. Broker selection should be based on best execution and lowest cost. Independent review functions should reconcile deposit and suspense accounts, verify assets and recordkeeping, test physical safekeeping and dual control.

Independent Review

Evaluate customer complaints and resolutions
Analyze exception reports that monitor sales and sales representatives’ performance
Assess sales representative turnover
Investigate unusual redemption patterns
Sample customer account files to verify disclosure, suitability, and activity practices
Interview customers
Employ testers to check disclosure and suitability practices
If bank employees sell or recommend NDIPs, should also:
Identify potential conflicts of interest
Review separation of duties between sales, supervision and accounting functions
Review suitability processes and sample investment recommendations
Evaluate proprietary product operations
If bank has a networking arrangement
Ensure that both parties adhere to the written agreement’s terms and conditions
Verify that third party practices conform with FDIC regulations, the Interagency Statement, and bank policies

Go to top

CIVIL MONEY PENALTIES

Assessment of Civil Money Penalties

To punish the violator according to the degree of culpability and severity of the violation
To deter future violations
Not to affect remedial action
Factors in assessment of CMPs
Evidence that violation or practice or breach of fiduciary duty (vpb) was intentional or was committed with a disregard of the law or with a disregard of the consequences to the institution
Duration and frequency of the vpb
Continuation of the vpb after the respondent was notified or, alternatively, its immediate cessation and correction
Failure to cooperate with the agency in effecting early resolution of the problem
Evidence of concealment of the vpb or, alternatively, voluntary disclosure of the vpb
Any threat of loss, actual loss, or other harm to the institution, including harm to the public confidence in the institution, and the degree of such harm
Evidence that a participant or his or her associates received financial gain or other benefit as a result of the vpb
Evidence of any restitution paid by a participant of losses resulting from the vpb
History of prior vpb, particularly where they are similar to the actions under consideration
Previous criticism of the institution or individual for similar actions
Presence or absence of a compliance program and its effectiveness
Tendency to engage in vpb
Existence of agreements, commitments, orders, or conditions imposed in writing intended to prevent the vpb
Also should meet one of the following criteria
Violation causes the bank to suffer a substantial financial loss
Violation is willful, flagrant, or otherwise evidences bad faith on the part of the bank or individual(s) involved in the violation (including repeated and/or multiple violations)
Violation directly or indirectly involves an insider, or an associate of an insider, who benefits from the transaction in a material of substantial way
Previous supervisory means have not been effective in eliminating or deterring violations
An attempt should be made to have the individual make restitution to the injured bank for all losses suffered, or absent restitution, repay the personal gain or bank loss through the recommended assessment, plus pay a penalty over and above these amounts for violating the law.
Tier 1 penalties up to $5,500 per day may be assessed for most violations
Tier 2 penalties up to $27,500 per day may be assessed if a party commits a violation, recklessly engages in an unsafe and or unsound practice or breaches a fiduciary duty which is a pattern of misconduct, causes more than minimal loss to the institution or results in a pecuniary gain to such party
Tier 3 penalties up to the lessor of $1,100,000 or 1% of total assets may be assessed if a violation, unsafe or unsound practice, or breach of fiduciary duty is knowingly committed and causes a substantial loss to the institution or a substantial pecuniary gain to the violator

FORMAL ADMINISTRATIVE ACTIONS

Section 8(a) – Termination of Insured Status

Bases:
Institution or its directors have committed unsafe or unsound practices
Institution or its directors have violated a law or regulation to which the bank was subject, a written condition imposed by the FDIC in connection with the granting of an application or other request of bank, or any written agreement entered into with the FDIC
Institution is in unsafe or unsound condition to continue operations

Section 8(b) – Cease and Desist Order

Bases:
Bank is engaging, or has engaged, in unsafe or unsound practices
Bank is violating, or has violated, a law, rule, regulation, or any condition imposed in writing by the FDIC with regard to the approval of a request or application or a written agreement entered into with the FDIC
There is reasonable cause to believe the bank is about to do either of the above
Failure to comply with the Order can precipitate 8(a) action, petitioning US District Court to enforce the Order, or imposition of CMPs.

Section 8(c) – Temporary Cease and Desist Order

Bases:
Whenever the FDIC determines the violations or threatened violations or unsafe and unsound practices specified in the Notice of Charges are likely to cause insolvency or substantial dissipation of assets or earnings of the bank, or otherwise seriously prejudice the interests of the depositors prior to the completion of action under Section 8(b)
Becomes effective upon service and remains in effect until Section 8(b) proceedings are complete unless set aside by a court (within 10 days the subject may apply for an injunction setting aside, limiting, or suspending the order)

Section 8(e) – Removal of an Officer or Other IAP

Bases:
IAP has violated any law or regulation, any final cease and desist order, any condition imposed in writing in connection with the granting of an application or other request, or any written agreement, participated in any unsafe or unsound practice in connection with the institution, OR engaged in an act, omission or practice which constitutes a breach of fiduciary duty; AND
By reason of the violation, practice, or breach, the insured depository institution has suffered or will probably suffer financial loss or other damage; the interests of the depositors have been or could be prejudiced; OR the party has received financial gain or other benefit; AND
The violation, practice, or breach involves personal dishonesty on the part of the IAP OR demonstrates willful or continuing disregard for the safety and soundness of the institution

Section 8(g) – Suspension of an IAP

Bases:
If IAP is charged in any information, indictment or complaint authorized by a US Attorney, with the commission of or participation in a crime involving dishonesty or breach of trust which is punishable by imprisonment for a term exceeding one year under state or Federal law and if continued service by the individual may pose a threat to the interests of the bank’s depositors or may threaten to impair public confidence in the bank.

Written Agreements

To address a bank operating with an unsafe or unsound level of capital (Tier 1 less than 2% -Part 325)
Reserved for a bank whose problems are limited essentially to a capital deficiency that has not been caused by the unsafe and unsound practices of its management (not used if Section 8(a), 8(b), or 8(c) action is appropriate)

Capital Directives

Final order issued by the FDIC to a State nonmember bank that fails to maintain capital at or above its minimum capital requirements
Can be taken in conjunction with a formal enforcement action or independently

Prompt Corrective Action Directive

Prompt corrective action is a framework of supervisory actions for insured depository institution which are not adequately capitalized
Section 38(f)(2) requires the appropriate Federal banking agency to take one or more actions listed in that section against institutions which are significantly undercapitalized or undercapitalized institutions which have failed to file or implement a capital restoration plan

Capital Plans

For U, SU, or CU institutions under Part 325, a capital restoration plan must be submitted to RD
Steps the insured depository institution will take to become adequately capitalized
Levels of capital to be attained during each year the plan will be in effect
How the institution will comply with the restrictions in effect under prompt corrective action
Types and levels of activities in which the institution will engage; and
Other information as required
Must be filed within 45 days of institution becoming undercapitalized

Go to top

BANK OF ANYTOWN INSTRUCTIONS

Concentrations

25% of Tier 1 Capital
individual borrower
small, interrelated group of individuals
single repayment source with normal credit risk or greater
individual project
100% of Tier 1 Capital
industry
product line
type of collateral
short-term obligations of one financial institution or affiliate group

Capital Calculations

Possible Tier 1 adjustments
Disallowed intangibles
Securities Subsidiaries Subject to Section 337.4
Assets Other Than Loans & Leases Classified Loss
Additional Amount to be Transferred to Tier 2 for Inadequate ALLL
Estimated Losses in Contingent Liabilities
Differences in Accounts Which Represent Shortages
Losses from Apparent Criminal Violations

FDI Act Topics

Management

Board consists of 5 members
Comptroller of the Currency
Director of the Office of Thrift Supervision
3 Presidential appointees, 1 of whom shall have State bank supervisory experience
No more than 3 members from same political party
1 appointed member will be designated by President as Chairperson for a term of 5 years
Appointed members shall be appointed for a term of 6 years

Bridge Bank

· Means a new national bank organized by the Corporation

REGULATION O SUMMARY

Definitions

Affiliate means any company of which bank is a subsidiary or any other subsidiary of that company
Control means a person directly of indirectly controls 25% or more of any class of voting stock, controls the election of a majority of directors, or has power to exercise controlling influence over management or policies
Presumptive control is a person who is an executive officer or director and directly or indirectly controls more than 10% of voting stock or the person directly or indirectly controls more than 10% of voting stock and no other person controls a greater percentage
Executive officer means a person who participates or has authority to participate (other than in the capacity of a director) in major policymaking functions
Insider means executive officer, director, or principal shareholder, and includes any related interest of such a person
Lending limit is amount equal to limit of loans to a single borrower. This amount is 15% of the bank’s unimpaired capital and unimpaired surplus in the case of loans that are not fully secured and an additional 10% if loans are fully secured by readily marketable collateral with a market value at least equal to the amount of the loan
Unimpaired capital and unimpaired surplus equals the bank’s Tier 1 and Tier 2 capital based on the most recent consolidated report of condition and the balance of the allowance for loan and lease losses not included in the bank’s Tier 2 capital
Principal shareholder that directly or indirectly controls more than 10% of any class of voting stock. Includes shares held by immediate family. This does not include the bank’s holding company.
Related interest is a company that is controlled by that person or a political or campaign committee that is controlled by that person

General Prohibitions

No bank may extend credit to any insider of the bank or insider of its affiliates unless the extension of credit is made on substantially the same terms as, and following credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions by the bank with other persons that are not covered by this part and who are not employed by the bank and does not involve more than the normal risk of repayment or present other unfavorable features.
No bank may extend credit to any insider of the bank or of its affiliates in an amount that, when aggregated with the amount of all other extensions of credit to that person and to all related interests of that person, exceeds the higher of $25M or 5% (up to $500M) of capital and surplus, unless extension has been approved in advance by a majority of the entire board and interested party has abstained from participating directly or indirectly in the voting.
No bank may extend credit to an insider of the bank or its affiliates in an amount in excess of the individual lending limit (15% + 10% secured).
A bank may not extend credit to any insider of the bank or its affiliates unless the extension is in an amount that, when aggregated with the amount of all outstanding extensions of credit by that bank to all such insiders, does not exceed capital and surplus. Banks with deposits of less than $100 million may by an annual resolution of its board increase the general limit to a level not to exceed 2 time capital and surplus.
Exceptions – extensions secured by a perfected security interest in US Government or Agency securities or otherwise guaranteed by the US Government, extensions secured by a perfected security interest in a segregated deposit account in lending bank, or extensions arising from discount of negotiable or nonnegotiable installment consumer paper that is acquired from an insider and carries a full or partial recourse endorsement by the insider
No bank may pay an overdraft of an executive officer or director of the bank or its affiliates (does not apply to principal shareholders or related interests) unless part of a written, preauthorized, interest-bearing extension of credit plan or written, preauthorized transfer of fund from another account of the account holder. Prohibition does not apply to payment of inadvertent overdrafts on an account in an aggregate amount of $1M or less provided not overdrawn for more than 5 business days and executive officer of director charged same fee as any other customer of the bank in similar circumstances.

Additional Restrictions on Loans to Executive Officers or Member Banks

Bank may extend credit to an executive officer in any amount to finance the education of the executive officer’s children or to finance or refinance the purchase, construction, maintenance, or improvement of a residence of the executive officer (1st Lien).
Bank may also extend credit to an executive officer in any amount if extension is secured by US Government obligations or segregated deposit accounts at the lending bank.
For any other purpose, a bank may lend an executive officer 2.5% of capital and surplus with a minimum of $25M and a maximum of $100M (in calculating 2.5% of capital and surplus extensions from above are included)
Extensions to executive officers shall be promptly reported to the bank’s board, made under the same terms and creditworthiness standards as outside borrowers, preceded by submission of a detailed current financial statement of the executive officer, and made subject to a demand clause that can be exercised any time the officer is indebted to any other bank or banks in an aggregate amount greater than the amount allowed for the lending bank.

Records of Banks

Recordkeeping method adopted by a bank shall identify, through an annual survey, all insiders of the bank itself and maintain records of all extensions of credit to insiders of the bank itself, including the amount and terms of each extension
Recordkeeping method adopted by a bank shall maintain records of extensions of credit to insiders of affiliates by survey method (identifying through an annual survey each insider of affiliates) or requiring as part of each extension of credit that the borrower indicate whether the borrower is an insider of an affiliate. In either case, records identifying the amount and terms of extension must be maintained.
Alternative recordkeeping methods for insiders may be employed if at least as effective as the identified methods.

Reports by Executive Officer

· Each executive officer of a bank who becomes indebted to any other bank or banks in an aggregate amount greater than the amount specified for executive officers of the bank, shall within 10 days of the indebtedness reaches such a level, make a written report to the board of the officer’s bank that states the lender’s name, the date and amount of each extension of credit, any security for it, and the purpose of proceeds.

Reports on Credit to Executive Officers

· Each bank shall include with each report of condition a report of all extensions of credit made by a bank to its executive officers since the date of the bank’s previous report of condition.

Disclosure of Credit from Banks to Executive Officers and Principal Shareholders

· Upon a written request from the public, a bank shall make available names of each of its executive officers and each of its principal shareholders to whom, or to whose related interests, the bank had outstanding as of the end of the latest previous quarter of the year, an extension of credit that, when aggregated with all other outstanding extensions of credit at such time from the bank to such person and to all related interests of such person, equaled the lesser of 5% of capital or $500M.

Reporting Requirement for Credit Secured by Certain Bank Stock

· Each executive officer or director of a bank the shares of which are not publicly traded shall report annually to the board of the bank the outstanding amount of any credit that was extended to the executive officer or director that is secured by shares of the bank.

Report by Executive Officers and Principal Shareholders

· An executive officer or principal shareholder (including their related interests) must report on or before January 31 any extension of credit from a correspondent. The report shall include the maximum amount of indebtedness had during the calendar year, the amount of indebtedness as of ten business days before the report is filed, and a description of the terms and conditions of each extension of credit.

Disclosure of Credit from Correspondent Banks to Executive Officers and Principal Shareholders

· Upon written request from the public, a bank shall make available the names of each of its executive officers and principal shareholders whom, or to whose related interests, any correspondent bank of the bank had outstanding at any time during the previous calendar year an extension of credit that when aggregated equaled or exceeded the lesser of 5% of the bank’s capital or $500M.

PART 349

Reports by Executive Officers and Principal Shareholders

Disclosure of Indebtedness of Executive Officers and Principal Shareholders

· Upon written request a bank shall disclose the name of each executive officer or principal shareholder of the bank whose aggregate indebtedness, including indebtedness of related interests of such person, at the bank itself as of the end of the latest calendar quarter or at correspondent banks at any time during the previous calendar year equals or exceeds the lesser of 5% of the bank’s capital or $500M

PART 348

Definitions

· Management official means director, advisory or honorary director of an institution with total assets of $100 million or more, a senior executive officer, a branch manager, any person who has a representative or nominee serving in any of the listed capacities.

Prohibitions

Management official of an institution may not serve at the same time as a management official of an unaffiliated organization if the organizations have offices in the same community (city, town, or village and contiguous cities, towns or villages)
Management official of an institution may not serve at the same time as a management official of an unaffiliated organization if the organizations (or depository institution affiliate thereof) have offices in the same RMSA and each organization has total assets of $20 million or more.
Management official of an institution with assets exceeding $2.5 billion (or an affiliate of such an organization) may not serve at the same time as a management official of an unaffiliated institution with total assets exceeding $1.5 billion (or an affiliate of such an organization), regardless of the location of the two depository institutions.

Small Market Share Exemption

· If a management interlock is not prohibited based on institution sizes and the depository organization (and their depository institution affiliates) hold, in the aggregate, no more than 20 percent of the deposits in each RMSA or community in which both organizations (or affiliates) have offices, a management interlock is exempt from the above prohibitions.

Go to top

PART 337

Standby Letters of Credit

· A bank must maintain adequate control and subsidiary records of its SBLCs comparable to records maintained in connection with the bank’s direct loans so that at all times the bank’s potential liability thereunder and the bank’s compliance with 337 requirements may be determined.

Limits on Extensions of Credit to Executive Officers, Directors, and Principal Shareholders of Insured Nonmember Banks

· Makes Regulation O applicable to nonmember banks. Certain sections are excluded; however, these sections are covered by requirements in this Part and in Part 349.

Securities Activities of Subsidiaries of Insured Nonmember Banks

Limits banks from investing in subsidiaries that are not limited to underwriting investment quality debt securities, underwriting investment quality equity securities, underwriting investment companies not more than 25% of whose investments consist of investments other than investment quality debt and/or equity securities, or underwriting investment companies not more than 25% of whose investments consist of investments other than obligations of the US or US agencies, bank CDs, BAs and other bank money instruments,, short-term corporate debt instruments, and other similar investments.
This section also implements many of the same guidelines as the NDIP Statement of Policy and limits the bank’s ability to make loans that in any way affect the affiliate or company’s underwritten by the affiliate.

Brokered Deposits

Brokered deposit is a deposit obtained, directly or indirectly, from or through the mediation or assistance of a deposit broker.
Deposit broker is any person engaged in the business of placing deposits and an agent who establishes a deposit account to facilitate a business arrangement with an insured depository institution to use the proceeds of the account to fund a prearranged loan.
Well-capitalized institutions may accept, renew roll over brokered deposits without limitations.
Adequately-capitalized institution may not accept any brokered deposit unless it has applied for and been granted a waiver of this prohibition by the FDIC and may not pay more than 75 bp above normal local or national market rates (120% of UST obligations of similar maturity).
Undercapitalized institutions may not accept brokered deposits and may not pay more than 75 bp over normal local or national market rates.

Frequency of Examination

FDIC is required to conduct a full-scope, on-site examination of every insured state nonmember bank at least once during each 12-month period.
18-month period is allowed for bank’s with total assets of $250 million or less, well capitalized, found to be well managed at most recent examination, assigned a rating of 1 or 2 at most recent examination, bank is not subject to an enforcement action, and no person acquired control of the bank during the preceding 12-month period.

PART 363

Applicable to institutions with $500 million or more in assets at the beginning of the fiscal year
Audits of a consolidated holding company’s financial statements satisfies the requirements for subsidiary banks.
Holding company audits can satisfy the requirements of this Part if:
Services and functions are comparable to those required by this part; and
At the beginning of the year the depository institution had total assets less than $5 billion or total assets of $5 billion or more and a composite rating of 1 or 2.

Annual Reporting Requirements

Each institution shall prepare annual financial statements in accordance with GAAP which shall be audited by an independent public accountant.
Each institution annually shall prepare, as of the end of the fiscal year, a management report signed by its CEO and chief accounting or CFO which contains:
Statement of management’s responsibilities for preparing annual financial statements, for establishing and maintaining an adequate internal control structure and procedures for financial reporting and for complying with laws and regulations relating to safety and soundness which are designated by the FDIC and the appropriate federal banking agency
Assessments by management of the effectiveness of such internal control structure and procedures as of the end of fiscal year and the institution’s compliance with such laws and regulations during fiscal year

Filing and Notice Requirements

Within 90 days after the end of its fiscal year, each institution shall file with the FDIC, appropriate federal banking agency, and any appropriate state bank supervisor, two copies of an annual report containing audited annual financial statements, the independent public accountant’s report thereon, management’s statements and assessments, and the independent public accountant’s attestation report concerning the institution’s internal control structure and procedures for financial reporting.
The annual report shall be available for public inspection.

Audit Committees

Each institution shall establish an independent audit committee of its board consisting of outside directors who are independent of management of the institution, the duties of which shall include reviewing with management and the independent public accountant the basis for the reports issued under this part.
Each institution with total assets more than $3 billion, measures as of beginning of fiscal year, shall include members with banking or related financial management expertise, have access to its own outside counsel, and not include any large customers of the institution.

Go to top

PART 364

Operational and Managerial Standards

An institution should have internal controls and information systems that are appropriate to the size of the institution and nature, scope, and risk of its activities
Organization structure that establishes clear lines of authority and responsibility for monitoring adherence to established policies
Effective risk assessment
Timely and accurate financial, operational, and regulatory reports
Adequate procedures to safeguard and manage assets
Compliance with applicable laws and regulations
An institution should have an internal audit system that is appropriate to the size of the institution and the nature and scope of its activities
Adequate monitoring of system of internal controls through an internal audit function (for some institutions a system of independent reviews of key internal controls may be used)
Independence and objectivity
Qualified persons
Adequate testing and review of information systems
Adequate documentation of test and findings and any corrective actions
Verification and review of management actions to address material weaknesses
Review by the institution’s audit committee or board of the effectiveness of the internal audit systems
An institution should establish and maintain loan documentation practices that
Enable the institution to make an informed lending decision and to assess risk, as necessary, on an ongoing basis
Identify the purpose of a loan and the source of repayment, and assess the ability of the borrower to repay the indebtedness in a timely manner
Ensure that any claim against a borrower is legally enforceable
Demonstrate appropriate administration and monitoring of a loan
Take account of the size and complexity of a loan
An institution should establish and maintain prudent credit underwriting practices
Are commensurate with the types of loans the institution will make and consider the terms and conditions under which they will be made
Consider the nature of the markets in which loans will be made
Provide for consideration, prior to credit commitment, of the borrower’s overall financial condition and resources, the financial responsibility of any guarantor, the nature and value of any underlying collateral, and the borrower’s character and willingness to repay as agreed
Establish a system of independent ongoing credit review and appropriate communication to management and to the board
Take adequate account of concentration of credit risk
Are appropriate to the size of the institution and the nature and scope of its activities
Interest Rate Exposure
Manage interest rate risk in a manner that is appropriate to the size of the institution and the complexity of its assets and liabilities
Provide for periodic reporting to management and the board regarding interest rate risk with adequate information for management and the board to assess the level of risk
An institutions asset growth should be prudent
The source, volatility and use of funds that support asset growth
Any increase in credit risk or interest rate risk as a result of growth
Effect of growth on the institution’s capital
An institution should establish and maintain a system that is commensurate with its size and nature and scope of its operations to identify problem assets and prevent their deterioration
Conduct periodic asset quality reviews to identify problem assets
Estimate the inherent losses in those assets and establish reserves that are sufficient to absorb estimated losses
Compare problem asset totals to capital
Take appropriate corrective action to resolve problem assets
Consider the size and potential risks of material asset concentrations
Provide periodic asset reports with adequate information for management and the board to assess the level of asset risk
An institution should establish and maintain a system that is commensurate with the institution’s size and nature and scope of its operations to evaluate and monitor earnings and ensure earnings are sufficient to maintain adequate capital and reserves.
Compare recent earnings trends relative to equity, assets, or other commonly used benchmarks to the institution’s historical results and those of its peers
Evaluate the adequacy of earnings given the size, complexity, and risk profile of the institution’s assets and operations
Assess the source, volatility, and sustainability of earnings, including effect of nonrecurring or extraordinary income or expense
Take steps to ensure that earnings are sufficient to maintain adequate capital and reserves after considering asset quality and growth rate
Provide periodic earnings reports with adequate information for management and board to assess earnings performance
An institution should maintain safeguards to prevent the payment of compensation, fees, and benefits that are excessive or that could lead to material financial loss to the institution

Prohibition on Compensation that Constitutes an Unsafe and Unsound Practice

Compensation will be considered excessive when amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal shareholder
Combined value of all cash and noncash benefits provided to the individual
Compensation history of the individual and other individuals with comparable expertise at the institution
Financial condition of the institution
Comparable compensation practices at comparable institution, based upon such factors as asset size, geographic location, and the complexity of the loan portfolio and other assets
For postemployment benefits, the projected total cost and benefit to the institution
Any connection between the individual and any fraudulent act or omission, breach of trust or fiduciary duty, or inside abuse with regard to the institution
Any other factors the agencies determine to be relevant
Appendix B covers Year 2000 Standards – should not be applicable

Go to top

PART 323

Definitions

Market value means the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.
Transaction values means: for loans or other extensions of credit, the amount of the loan or extension of credit; for sales, leases, purchases, and investments in or exchanges of real property, the market value of the real property interest involved; and for pooling of loans or interests in real property for resale or purchase, the amount of the loan or market value of the real property calculated with respect to each such loan or interest in real property
Important instances in which an appraisal is not required:
Transaction value is $250M or less
Lien on real estate taken as collateral in an abundance of caution
Transaction is not secured by RE
Transaction is a business loan with a transaction value of $1 million or less and is not dependent on the sale of, or rental income derived from, real estate as the primary source of repayment
Transaction involves an existing extension of credit at the lending institution and there has been no obvious and material change in market conditions or physical aspects of the property (even with the advancement of new monies) or there is no advancement of new monies other than funds necessary to cover reasonable closing costs
Evaluations are required for transactions that do not require an appraisal

Minimum Appraisal Standards

· Conform to USPAP; be written and contain sufficient information and analysis to support the institution’s decision to engage in the transaction; analyze and report appropriate deductions and discounts for proposed construction or renovation, partially leased buildings, non-market lease terms, and tract developments with unsold units; be based upon definition of market value; and be performed by state licensed or certified appraiser in accordance with requirements set forth in this part.

Go to top

REGULATION U

Definitions

Carrying credit is credit that enables a customer to maintain, reduce, or retire indebtedness originally incurred to purchase a security that is currently a margin stock
Indirectly secured means any arrangement with the customer under which the customer’s right or ability to sell, pledge, or otherwise dispose of margin stock owned by the customer is in any way restricted while the credit remains outstanding or the exercise of such right is or may be cause for accelerating the maturity of the credit
Margin stock means;
Any equity security registered or having unlisted trading privileges on a national securities exchange
Any OTC security designated as qualified for trading in the National Market System under a designation plan approved by the SEC
Any debt security convertible into a margin stock or carrying a warrant or right to subscribe to or purchase a margin stock
Any warrant or right to subscribe to or purchase a margin stock
Purpose credit is any credit for the purpose, whether immediate, incidental, or ultimate, of buying or carrying margin stock

General Requirements

Maximum loan value of margin stock is 50% of its current market value
Maximum loan value of nonmargin stock and all other collateral is their good faith loan value
Maximum loan value of options – have no value
No lender shall extend any purpose credit, secured directly or indirectly by margin stock, in an amount that exceeds the maximum loan value of the collateral securing the credit
A lender may continue to maintain any credit initially extended in compliance with this part
Purpose statements are required for extensions of credit secured directly or indirectly by any margin stock, in an amount exceeding $100M, the bank shall require its customer to execute Form FR U-1
If revolving or multiple draw agreements, Form FR U-1 must be executed at the time the credit arrangement is originally established and must be amended for each disbursement if all of the collateral for the agreement is not pledged at the time the agreement is originally established.
All purpose credit extended to a customer shall be treated as a single credit and all collateral securing the credit shall be considered in determining whether or not the credit complies with this regulation
A lender that has extended purpose credit secured by margin stock may not subsequently extend unsecured purpose credit to the same customer unless the combined credit does not exceed the maximum loan value

PART 326

Minimum Security Procedures

Board of each insured nonmember bank shall designate a security officer who shall have the authority, subject to approval of the board, to develop, within a reasonable time, but no later than 180 days, and to administer a written security program for each banking office
The security program shall:
Establish procedures for opening and closing for business and for the safekeeping of all currency, negotiable securities, and similar valuables at all times
Establish procedures that will assist in identifying persons committing crimes against the bank and that will preserve evidence that may aid in their identification and prosecution
Retaining a record of any robbery, burglary, or larceny committed against the bank
Maintaining a camera that records activity in the banking offices
Using identification devices, such as prerecorded serial numbered bills, or chemical and electronic devices
Provide for initial and periodic training of officers and employees in their responsibilities under the security program and in proper employee conduct during and after a robbery, burglary or larceny
Provide for selecting, testing, operation and maintaining appropriate security devices:
A means of protecting cash or other liquid assets, such as a vault, safe, or other secure space
A lighting system for illuminating, during hours of darkness, the area around the vault, if the vault is visible from outside the banking office
An alarm system or other appropriate device for promptly notifying the nearest responsible law enforcement officers of an attempted or perpetrated robbery or burglary
Tamper-resistant locks on exterior doors and exterior window that may be opened
Such other devices as the security officer determines to be appropriate
The security officer for each insured nonmember bank shall report at least annually to the bank’s board on the implementation, administration, and effectiveness of the security program

Go to top

PART 350

Requirements for annual disclosure statement

Each bank shall prepare as of December 31 and make available upon request an annual disclosure statement containing at least schedules RC (Balance Sheet), RC-N (Past Due and Nonaccrual Loans, Leases, and Other Assets – column A 30 to 89 and accruing can be omitted), RI (Income Statement), RI-A (Changes in Equity Capital) and RI-B Part II (Changes in Allowance for Loan and Lease Losses) and a disclaimer stating that the FDIC has not reviewed the information. An authorized officer of the bank must sign the annual disclosure statement attesting to its correctness (if not certified by an independent accountant)
Must be available beginning no later than the following March 31 and available until the succeeding year becomes available
A bank may substitute its annual report
Notice of availability must be provided to shareholders and notice must be posted in each banking office

Trust Rating System

Components
Supervision and Organization
Operations, Controls, and Audits
Asset Administration
Conflicts of Interest
Earnings, Volume Trends, and Prospects
Composite Ratings
1 – Trust departments in this group are superior in almost every respect: any critical findings are basically of a minor nature and are not representative of nay fundamental deficiency in policies, practices or procedures. Such departments are in the hands of an experienced and competent staff which has the demonstrated ability to administer existing accounts and anticipated future business in strict conformity with applicable laws and regulations and in accordance with sound fiduciary principles.
2 – Trust departments so rated are fundamentally sound, but do not measure up in one or more respects to the standards of the top rating. Policies, practices and procedures are generally effective, but may reflect modest weaknesses that are readily correctable in the normal course of business. Criticized features may include isolated instances of noncompliance with laws, regulations or management-prescribed policies or procedures, but corrective action without loss to the fiduciaries is assured.
3 – Trust departments in this group conduct their affairs in a generally adequate manner. Policies and procedures governing important phases of administration or operations may be nonexistent or inadequately defined, but practices are generally appropriate to faithfully discharge the department’s fiduciary obligations. Some problems of relative significance may exist, but none are of such importance as to pose a threat to the trust beneficiaries generally or to the soundness of the bank. Management will generally be regarded as adequate in relation to the volume and character of business administered. The supervisory response is ordinarily limited to follow up on correction of criticizable features.
4 – Trust departments so rated have one or more major problems centered in inexperienced or inattentive management, failure to adhere to sound administrative policies, numerous violations of laws or regulation, weak or dangerous operating practices, or an accumulation of unsatisfactory features of lesser importance. Such problems pose a threat to the account beneficiaries generally and, if left unchecked, could evolve into conditions that could ultimately undermine public confidence in the bank. Such departments ordinarily require special supervisory attention.
5 – Trust departments in this group evidence performance or conditions that are critically deficient in numerous major respects arising from incompetent or neglected administration, flagrant and/or repeated disregard of applicable laws and regulations, or willful departure from sound fiduciary principles and practices. Such conditions evidence a flagrant disregard for the interests of the trust beneficiaries and may pose a serious threat to the soundness of the bank. Such departments require immediate corrective action, constant supervisory attention, and the possible imposition of regulatory sanctions.

IS EXAMINATION RATINGS

Components
Audit
Management
Development and Acquisition
Support and Delivery
Composite Ratings
1 – Data centers in this group are sound in almost every respect. If deficiencies are noted, they are minor and can be handled routinely and without further supervisory involvement.
2 – Data centers in this group are fundamentally sound, but may reflect modest weaknesses. Deficiencies are generally corrected in the normal course of business. Therefore, the need for supervisory response is usually limited.
3 – Data centers in this group experience a combination of adverse factors that require prompt corrective action. Problems are well defined and require more than ordinary supervisory concern and monitoring. The overall strength of management and supporting staff and the financial capacity of the data center is such as to make operation failure only a remote possibility.
4 – Data centers in this group are operating under unacceptable conditions that could impair future viability. A high potential for operational and/or financial failure is present. Still weaknesses are not so severe as to threaten the immediate failure of the data center. Immediate affirmative action and supervision by the regulator are necessary.
5 – Data centers in this group exhibit a combination of weaknesses and adverse trends that are pronounced to a point that threatens the ultimate continuation of the operation. Immediate affirmative action and continuous supervision, as required by the regulator, are necessary.

Go to top

ETHICS

Gifts from Outside Sources

An employee may not accept a gift from a prohibited source or a gift given because of the employee’s official position
Gift does not include:
Food and refreshments other than as part of a meal
Greeting cards and items wit little intrinsic value
Loans from banks and other financial institutions on terms generally available to the public
Opportunities and benefits available to the public or a class consisting of all Government employees
Rewards and prizes given to competitors in contests unless employee’s entry is part of official duties
Pension and other benefits resulting from continued participation in an employee welfare and benefits plan maintained by a former employer
Anything paid for by the Government
Any gift accepted by the Government under specific statutory authority: travel, subsistence, and related expenses
Anything for which market value is paid by the employee
Prohibited source means any person who:
Is seeking official action by the employee’s agency
Does business or seeks to do business with the employee’s agency
Conducts activities regulated by the employee’s agency
Has interests that may be substantially affected by performance or nonperformance of the employee’s official duties
Is an organization a majority of whose members are described in above
Exceptions:
Gifts of $20 or less (not exceeding $50 in calendar year) not including cash or equivalent
Gifts based on a personal relationship
Discounts and similar benefits offered to all Government employees
Awards and honorary degrees

Gifts Between Employees

An employee may not directly or indirectly give or receive a gift to or make a donation toward a gift for an official superior or solicit a contribution from another employee for a gift to either his own or the other employee’s official supervisor
Does not limit gifts based on a personal relationship
Exceptions, On an occasional basis the following may be given to an official superior or accepted from a subordinate or other employee receiving less pay:
Items, other than cash, with an aggregate market value of $10 or less
Food and refreshments shared among several employees

· Etc.

· Conflicts of financial interests requires an employee to disqualify himself from acting on any related matter

FDIC Examiner Specific

An examiner cannot accept an extension of credit from a state nonmember bank accept a generally available credit card from an institution outside of the employee’s field office territory
Employees are prohibited from accepting credit from an institution for two years after the employee’s last personal and substantial participation with an institution.
If an employee has an outstanding extension of credit he shall not participate in any matter affecting the institution.
Employees may retain, but not renegotiate (may request an exception), a pre-existing extension of credit.
An employee shall not acquire, own, or control a security of an FDIC-insured institution or any affiliate. Exceptions for businesses exempt from BHC Act, retaining already owned stock, and acquiring through inheritance, gift, stock split, involuntary stock dividend, merger, acquisition, or other change in corporate ownership.
An employee is prohibited from dealings with former employees for one year.
An employee will not participate in any matter of an employer if the employee’s spouse, child, parent, brother, sister, or a member of the employee’s household is a party to the matter.
An employee shall not be employed by an FDIC-insured institution.
Examiners may not use the gift exceptions available to Government employees.
FDIC employees may not accept travel or related expenses from a non-federal source.

SUPERVISORY POLICY STATEMENT ON SECURITIES AND END-USER DERIVATIVE ACTIVITIES

Board and Senior Management Oversight

Board should approve major policies for conducting investment activities, including establishment of risk limits.
Board should also ensure management has requisite skills, review portfolio activity and risk levels, and require management to demonstrate compliance with approved risk limits.
Senior management is responsible for daily management of institution’s investments including establishing and enforcing policies and procedures. Management should ensure that the risk management process is commensurate with the size, scope, and complexity of the institution’s holdings.

Risk Management Process

An effective risk management process for investment activities includes:
Policies, procedures, and limits
The identification, measurement, and reporting of risk exposure
A system of internal controls
Potential investment objectives
Generating earnings
Providing liquidity
Hedging risk exposures
Taking risk positions
Modifying and managing risk profiles
Managing tax liabilities
Meeting pledging requirements
Included in an independent review of investment activities:
Compliance with and appropriateness of investment policies, procedures, and limits
Appropriateness of risk measurement system given nature, scope, and complexity of activities
Timeliness, integrity, and usefulness of reports to the board and senior management

Risks of Investment Activities

Market Risk – adverse changes in value of its holdings arising from movements in interest rates, foreign exchange rates, equity prices, or commodity prices.
Policy should specify the types of market risk analyses that should be conducted for various types or classes of instruments, including pre-purchase analysis and on an ongoing basis.
Credit Risk – an issuer or counterparty will fail to perform on an obligation.
Approval process of dealers, investment bankers, and brokers should include review of financial statements and ability to honor commitments and an inquiry into the general reputation (regulators or organizations).
Liquidity Risk – cannot easily sell, unwind, or offset a particular position at a fair price because of inadequate market depth.
Operational (Transactional) Risk – deficiencies in information systems or internal controls will result in unexpected loss.
Legal Risk – contracts are not legally enforceable or documented correctly.

Go to top

INTERAGENCY GUIDANCE ON SUBPRIME LENDING

Subprime Lending

· Extending credit to borrowers who exhibit characteristics indicating a significantly higher risk of default than traditional bank lending customers.

Capitalization

· Agencies believe that subprime lending activities can present a greater than normal risk for institutions and the deposit insurance funds; therefor, the level of capital needed to support this activity should be commensurate with the additional risks.

Risk Management

Administration procedures should be in writing and should detail:
Billing and statement procedures
Collection procedures
Content, format, and frequency of management reports
Asset classification criteria
Methodology to evaluate the adequacy of the ALLL
Criteria for allowing loan extensions, deferrals, and re-agings
Foreclosure and repossession policies and procedures
Loss recognition policies and procedures

Examination Objectives

Evaluate the extent of subprime lending activities and whether management has adequately planned for this activity
Assess whether the institution has the financial capacity to conduct this high-risk activity safely without an undue concentration of credit without overextending capital resources
Ascertain if management has committed the necessary resources in terms of technology and skilled personnel to manage the program
Evaluate whether management has established adequate lending standards and is maintaining proper controls over the program
Determine whether the institution’s contingency plans are adequate to address the issues of alternative funding sources, back-up purchasers of the securities or the attendant servicing functions, and methods of raising additional capital during a period of an economic downturn or when financial markets become volatile
Review securitization transactions for compliance with FASB 125 and this guidance, including whether the institution has provided any support to maintain the credit quality of loan pools it has securitized
Analyze the performance of the program, including profitability, delinquency, and loss experience
Consider management’s response to adverse performance trends, such as higher than expected prepayments, delinquencies, charge-offs, customer complaints, and expenses
Determine if the institution’s compliance program effectively manages fair lending and consumer protection compliance risks associated with subprime lending operations

Go to top

CALL REPORT DEFINITIONS

Business Combinations

Pooling of interests – bank and business being acquired are added together on a line-by-line basis without any adjustments for fair market value. For the year in which a pooling of interest occurs, income and expenses must be reported as though the companies had combined at the beginning of the year.
Purchase acquisition – assets and liabilities of acquired business must be recorded on the books of the combined bank at their fair value. Deferred tax asset or liabilities created when the assets or liabilities differ between book value and fair value. Excess over net fair value of assets and liabilities acquired or assumed is purchased goodwill. Goodwill is should be amortized over their estimated useful lives, generally not to exceed 25 years and no amount should be written during the first year.
Push down accounting – establishment of new accounting basis for a bank as a result of a substantive change in control. When a bank is purchased, yet retains its separate corporate existence, the assets and liabilities of the acquired bank are restated to their fair values as of the acquisition date. These values, including any goodwill, are reflected in the separate financial statements of the acquired bank. Required for change in control of at least 95% of voting stock if not publicly traded. Required if reports filed with SEC are presented on a push down basis.

Foreclosed Assets

· If an asset is sold shortly after it is received in a foreclosure or repossession, it would generally be appropriate to substitute the value received in the sale (net of selling costs) that had been estimated at the time of foreclosure or repossession. Any adjustments should be made to the loss charged against the allowance.

Loan Fees

· FASB 91 requires loan origination fees should be deferred and recognized over the life of the related loan as an adjustment of yield and certain direct loan origination costs should be deferred and recognized over the of the related loan as a reduction of the loans yields. On individual loans these should be netted. Generally recognized over contractual term of note.

Loss Contingencies

· Estimated loss from a loss contingency must be accrued by a charge to income if it is probable that an asset has been impaired or a liability incurred and the amount of the loss can be reasonably estimated.

Nonaccrual Status

Banks shall not accrue interest, amortize deferred net loan fees or costs, or accrete discount on any asset which is maintained on a cash basis because of deterioration in the financial condition of the borrower, for which payment in full of principal or interest is not expected, or upon which principal or interest has been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection.
Nonaccrual assets may be restored to accrual status when none of its principal and interest is due and unpaid and the bank expects repayment of the remaining contractual principal and interest or then it otherwise becomes well secured and in the process of collection.
Trading Activities
Gains Trading – purchase of a security and subsequent sale of the same security at a profit after a short holding period, while securities acquired for this purpose that cannot be sold at a profit are typically retained in AFS or HTM portfolio.
When Issued Securities Trading – buying and selling of securities in the period between the announcement of an offering and the issuance and payment date of securities. Similar results to gains trading.
Pair Offs – security purchase transactions that are closed-out or sold at, or prior to, settlement date. In a pair off the institution commits to purchase a security, then prior to settlement date will pair off the purchase with a sale of the same security.
Extended Settlements – securities acquired through use of a settlement period in excess of the regular-way settlement periods in order to facilitate speculation.
Repositioning Repurchase Agreements – funding technique offered by a dealer in an attempt to enable an institution to avoid recognition of loss. Trade a bad security at an elevated price for a security purchased at an elevated price.
Short sales.

Go to top

PART 327

Capital Factors

Well Capitalized (1)
Total risk based ratio - 10.0% or greater
Tier 1 risk based ratio - 6.0% or greater
Tier 1 leverage ratio - 5.0% or greater
Adequately Capitalized (2)
Does not meet standards for Well Capitalized
Total risk based ratio – 8.0% or greater
Tier 1 risk based ratio – 4.0% or greater
Tier 1 leverage ratio - 4.0% or greater
Undercapitalized (3)
Does not meet standards for Adequately Capitalized

Supervisory Risk Factors

·A

· Composite 1 or 2

·B

· Composite 3

·C

· Composite 4 or 5

BIF Base Assessment Schedule (cents per $100)

	A	B	C
1	4	7	21
2	7	14	28
3	14	28	31

BIF Adjusted Assessment Schedule (1997 and beyond) (cents per $100)

	A	B	C
1	0	3	17
2	3	10	24
3	10	24	27

PART 325

Minimum Leverage Capital Requirement

3% - fundamentally sound, well managed, no significant growth “1”
4% – for all other institutions
Below these levels will prohibit any application from being approved and is required to file a written capital restoration plan within 45 days of date the bank receives notice
Operating below these levels represents an unsafe or unsound practice unless in compliance with an approved plan to restore capital levels

Miscellaneous

Valuation of mortgage servicing assets, purchased credit card relationships and nonmortgage servicing assets will be equal to the lesser of 90% of fair value or 100% of remaining unamortized book value. These assets will be limited to 100% of Tier 1 capital. In addition purchased credit card relationships and nonmortgage servicing assets will be limited to 25% of Tier 1 capital.
Deferred tax assets are limited to the lesser of the amount of deferred tax assets that are dependent upon future taxable income that is expected to be realized within one year of the calendar quarter-end date or 10% of Tier 1 capital. Deferred tax assets are treated consistently to the item to which they relate (unrealized losses, intangible assets, etc.)

Prompt Corrective Action Capital Categories

Well Capitalized
Total Risk Based Capital – 10.0% or greater
Tier 1 Risk Based Capital – 6.0% or greater
Leverage Ratio – 5.0% or greater
Not subject to an written agreement
Adequately Capitalized
Total Risk Based Capital – 8.0% or greater
Tier 1 Risk Based Capital – 4.0% or greater
Leverage Ratio – 4.0% or greater OR 3.0% or greater and 1 rated not experiencing growth
Undercapitalized
Total Risk Based Capital – less than 8.0%
Tier 1 Risk Based Capital – less than 4.0%
Leverage Ratio – less than 4.0% OR less than 3.0% and 1 rated not experiencing growth
Significantly Undercapitalized
Total Risk Based Capital – less than 6.0%
Tier 1 Risk Based Capital – less than 3.0%
Leverage Ratio – less than 3.0%
Critically Undercapitalized
Tangible equity to total assets equal to or less than 2.0%
FDIC may reclassify a bank in the W, A, or U category one category lower if:
Unsafe and unsound condition
Unsafe or unsound practice

Mandatory and Discretionary Supervisory Actions Under Section 38

All banks are subject to restrictions on payment of capital distributions and management fees
U, S, C banks are subject to:
Restricting payment of capital distributions and management fees
Requiring that the FDIC monitor the condition of the bank
Requiring submission of a capital restoration plan
Restricting the growth of the bank’s assets
Requiring prior approval of certain expansion proposals
S, C banks or banks has failed to submit or implement an acceptable capital restoration plan:
Restriction on compensation paid to senior executive officers of the institution
C banks – these actions require prior written FDIC approval:
Entering into any material transaction other than in the usual course of business
Extending credit for any highly leveraged transaction
Amending the institution’s charter or bylaws
Making any material change in accounting methods
Engaging in any covered transaction (23A)
Paying excessive compensation or bonuses
Paying interest on new or renewed liabilities at a rate that would increase the institution’s weighted average cost of funds to a level significantly exceeding prevailing rates of interest on insured deposits in the institution’s normal market areas
Making any principal or interest payment on subordinated debt beginning 60 days after becoming C except that this restriction

Appendix A

Tier 1 Capital

Common stockholders’ equity capital
Noncumulative perpetual preferred stock
Minority interests in the equity capital accounts of consolidated subsidiaries
MINUS
Intangible assets other than allowed amounts of mortgage servicing assets, nonmortgage servicing assets, and purchased credit card relationships
Unconsolidated banking and finance subsidiaries. Also on a case-by-case basis the FDIC can exclude associated companies (20% to 50% owned)

Tier 2 Capital

Allowance for loan and lease losses up to 1.25% of risk-weighted assets
Cumulative perpetual preferred stock, long-term preferred stock (original maturity of at least 20 years)
Perpetual preferred stock where the dividend is reset periodically based in whole or part on the bank’s current credit standing
Hybrid capital instruments
Term subordinated debt and intermediate term preferred stock (original average maturity of 5 years or more) (maximum of 50% of Tier 1 capital)
Net unrealized holding gains on equity securities (subject to limits)
Maximum amount of Tier 2 capital is 100% of Tier 1 capital after deductions

Limited Life Supplementary Capital Instruments

· Should be reduced by 1/5 of the original amount each year during the instrument’s last five years before maturity, leaving no value when they have a remaining maturity of less than a year.

Unrealized gains on equity securities and unrealized gains (losses) on other assets.

· Up to 45% of pretax net unrealized holding gains on AFS equity securities with readily determinable fair values may be included in Tier 2 capital. Other securities are not generally considered.

Risk Weights for Balance Sheet Assets

· Category 1 – 0%

· Cash

Gold bullion in bank’s vaults or in another bank’s vaults on an allocated basis
Direct claims on OECD central governments
Direct claims on US Government Agencies (GNMA, VA, FHA, FmHA, ExIm Bank, OPIC, CCC, SBA)
Federal Reserve Bank stock
Category 2 – 20%
Short-term claims on US depository institutions and foreign banks
Portions of claims collateralized by cash held in a segregated deposit account of the lending bank
Cash items in process of collection, both foreign and domestic
Long-term claims on US depository institutions and OECD banks
Claims on US Government-sponsored agencies (FHLMC, FNMA, FCS, FHLB, SLMA)
Portions of claims collateralized by securities issued by or guaranteed by OECD central governments, US Government agencies, US Government sponsored agencies
Conditional guarantees by OECD central governments and US Government Agencies
GO claims on states or other political subdivisions of US or OECD countries
Other multilateral lending institutions or regional development institutions in which the US Government is a stakeholder
Category 3 – 50%
Loans fully secured by first liens (and junior liens if have first lien) on a residential property made on prudent basis and not 90 days or more past due or nonaccrual
Loans to builders with substantial project equity for the construction of residences that have been presold under firm contracts
Loans secured by first liens on multifamily residential properties <=80% LTV 1.20 DSC
Privately issued MBS that are composed of loans qualifying for inclusion in this category
Revenue bonds, loans, etc. (not including IDBs) to states or political subdivisions of US or OECD countries
Category 4 – 100%
All other assets

Conversion Factors for Off Balance Sheet Items

100% Conversion Factor
Financial SBLC (irrevocable)
Forward agreements
50% Conversion Factor
Performance standby letters of credit
Unused portions of commitments with an original maturity exceeding one year
20% Conversion Factor
Commercial letters of credit
0% Conversion Factor
Unused portions of commitments with an original maturity of one year or less
Unused portions of retail credit card lines and related plans if unconditional option to cancel at any time

Conversion Factor Matrix for Derivative Contracts

	IR	ExR/Gold	Equity	PM not Gold	Other
1 yr or less	0.0%	1.0%	6.0%	7.0%	10.0%
1 yr to 5 yr	0.5%	5.0%	8.0%	7.0%	12.0%
More than 5 yr	1.5%	7.5%	10.0%	8.0%	15.0%

Go to top