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FDIC Federal Register Citations

[Federal Register: February 17, 1998 (Volume 63, Number 31)]
[Notices]               
[Page 7802-7809]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr17fe98-105]
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FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL
 
Uniform Interagency Trust Rating System
AGENCY: Federal Financial Institutions Examination Council.
ACTION: Notice and request for comment.
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SUMMARY: The Board of Governors of the Federal Reserve System (FRB), 
the Federal Deposit Insurance Corporation (FDIC), the Office of the 
Comptroller of the Currency (OCC), and the Office of Thrift Supervision 
(OTS) (collectively referred to as the federal supervisory agencies), 
under the auspices of the Federal Financial Institutions Examination 
Council (FFIEC) request comment on proposed changes to the Uniform 
Interagency Trust Rating System (UITRS), commonly referred to as the 
trust rating system. The proposed revisions update the rating system to 
reflect changes that have occurred in the fiduciary services industry 
and in supervisory policies and procedures since the rating system was 
first adopted in 1978. The proposed changes revise the numerical 
ratings to conform to the language and tone of the Uniform Financial 
Institution Rating System (UFIRS) rating definitions, commonly referred 
to as the CAMELS rating system; reformat and clarify the component 
rating descriptions; reorganize the account administration and 
conflicts of interest components
[[Page 7803]]
into a new component addressing compliance; emphasize the quality of 
risk management processes in each of the rating components, 
particularly in the management component; add language in composite 
rating definitions to parallel the proposed changes in the component 
rating descriptions; and explicitly identify the risk types that are 
considered in assigning component ratings. After reviewing public 
comments, the FFIEC intends to make appropriate additional changes to 
the revised UITRS, if necessary, and adopt a final trust rating system.
    The term ``financial institution'' refers to those FDIC insured 
depository institutions whose primary Federal supervisory agency is 
represented on the FFIEC. Uninsured trust companies that are chartered 
by the OCC, members of the Federal Reserve System, or subsidiaries of 
registered bank holding companies or insured depository institutions 
are also covered by this action.
DATES: Comments must be received by April 20, 1998.
ADDRESSES: Comments should be sent to Joe M. Cleaver, Executive 
Secretary, Federal Financial Institutions Examination Council, 2100 
Pennsylvania Avenue, NW, Suite 200, Washington, D.C. 20037 (Fax number: 
(202) 634-6556). Comments will be available for public inspection 
during regular business hours at the above address. Appointments to 
inspect comments are encouraged and can be arranged by calling the 
FFIEC at (202) 634-6526.
FOR FURTHER INFORMATION CONTACT:
    FRB: William R. Stanley, Supervisory Trust Analyst, Specialized 
Activities, (202) 452-2744, Division of Banking Supervision and 
Regulation, Board of Governors of the Federal Reserve System, Mail Stop 
407, 20th and C Streets, NW, Washington, D.C. 20551.
    FDIC: John F. Harvey, Trust Review Examiner, (202) 898-6762, 
Division of Supervision, Federal Deposit Insurance Corporation, Room 
F2078, 550 17th Street, NW, Washington, D.C. 20429.
    OCC: Laurie A. Edlund, National Bank Examiner, (202) 874-3828, 
Division of Asset Management, Office of the Comptroller of the 
Currency, 250 E Street, SW, Washington, D.C. 20219.
    OTS: Larry A. Clark, Senior Manager, Compliance and Trust Programs, 
(202) 906-5628, Gary C. Jackson, Program Analyst, (202) 906-5653, 
Compliance Policy, Office of Thrift Supervision, 1700 G Street, NW, 
Washington, D.C. 20552.
SUPPLEMENTARY INFORMATION:
Background Information
    The UITRS is an internal supervisory examination rating system used 
by the Federal supervisory agencies for evaluating the administration 
of fiduciary activities of financial institutions and uninsured trust 
companies on a uniform basis and for identifying those institutions 
requiring special supervisory attention. The UITRS was adopted in 1978 
by the OCC, FDIC and FRB, and in 1988 by the OTS, and is commonly 
referred to as the trust rating system. Under the current UITRS, each 
financial institution or trust company is assigned a composite rating 
based on an evaluation and rating of six essential components of an 
institution's fiduciary activities. These components address the 
following: the capability of management; the adequacy of operations, 
controls and audits; the management of fiduciary assets; the adequacy 
of account administration practices; the adequacy of practices relating 
to self dealing and conflicts of interest; and the quality and level of 
earnings. Both the composite and component ratings are assigned on a 1 
to 5 numerical scale. A 1 indicates the strongest performance and 
management practices, and the least degree of supervisory concern, 
while a 5 indicates the weakest performance and management practices 
and, therefore, the highest degree of supervisory concern.
    The composite rating reflects the overall condition of an 
institution's fiduciary activities. The composite ratings are used by 
the Federal supervisory agencies to monitor aggregate trends in the 
overall administration of fiduciary activities.
    The UITRS has proven to be an effective means for the Federal 
supervisory agencies to determine the condition of an institution's 
fiduciary activities. A number of changes, however, have occurred in 
the fiduciary industry and in supervisory policies and procedures since 
the rating system was first adopted. The FFIEC's Task Force on 
Supervision has reviewed the existing rating system in light of these 
industry trends. The Task Force has concluded that the current UITRS 
framework continues to provide an effective vehicle for summarizing 
conclusions about the condition of an institution's fiduciary 
activities. As a result, the FFIEC proposes to retain the basic rating 
framework, and the revised rating system will continue to assign a 
composite rating based on an evaluation and rating of essential 
components of an institution's fiduciary activities. However, the FFIEC 
proposes certain enhancements to the rating system.
Discussion of Proposed Changes to the Rating System
1. Alignment of UITRS With UFIRS
    The FFIEC is proposing changes to revise the definitions of the 
composite and component ratings to align the UITRS rating definitions 
with the language and tone of the UFIRS rating definitions. For 
example, under the current UITRS a composite 3 rated trust department 
is considered generally adequate, while under the UFIRS a composite 3 
rated bank exhibits some degree of supervisory concern. The proposed 
revision brings the UITRS in line with the language and tone of the 
UFIRS.
2. Component Reorganization
    The FFIEC is proposing the following changes to the UITRS 
components:
    (A) The current Account Administration and Conflicts of Interest 
components will be eliminated. A new Compliance component will assess 
an institution's compliance with the terms of governing instruments, 
applicable laws and regulations, sound fiduciary principles, and 
internal policies and procedures. The new component will address all 
areas assessed in the current Account Administration and Conflicts of 
Interest components. In addition, the new component will address 
compliance with applicable laws, regulations, and internal policies and 
procedures on a broader, institution-wide basis.
    (B) While fiduciary earnings will be evaluated at all institutions, 
a rating will only be required for those institutions which are 
required to file Schedule E of the FFIEC 001 (institutions with more 
than $100 million in total trust assets, and all non-deposit trust 
companies). An earnings rating may or may not be required for non-
Schedule E filers, at the option of the Federal supervisory agency. 
With this proposed change, the FFIEC recognizes that many small 
institutions offer fiduciary services primarily as a service to their 
community, with profitability being a secondary consideration.
3. Structure and Format
    The FFIEC is proposing to enhance and clarify the component rating 
descriptions by reformatting each component into three distinct 
sections: (a) An introductory paragraph discussing in general terms the 
areas to be considered when rating each component; (b) a bullet-style 
listing of the specific evaluation factors to be
[[Page 7804]]
considered when assigning the component rating; and, (c) a brief 
qualitative description of the five ratings grades that can be assigned 
to a particular component.
4. Composite Rating Definitions
    The FFIEC is proposing changes in the composite rating definitions 
to parallel the changes in the component rating descriptions. Under the 
FFIEC's proposal, the revised composite rating definitions would 
contain an explicit reference to the quality of overall risk management 
practices. The basic context of the existing composite rating 
definitions is being retained. The composite rating would continue to 
be based on a careful evaluation of an institution's fiduciary 
management, operational and compliance performance.
5. Risk Management
    The FFIEC is proposing that the revised rating system emphasize 
risk management processes. Changes in the fiduciary services industry 
have broadened the range of products and services offered and 
accelerated the pace of transactions. These trends reinforce the 
importance of institutions having sound risk management processes. 
Accordingly, the revised rating system would contain language in each 
of the components emphasizing the consideration of processes to 
identify, measure, monitor and control risks.
6. Identification of Risk Types
    The FFIEC is proposing that the types of risks associated with each 
of the component ratings be explicitly identified. For example, the 
proposed rating description for the Operations, Internal Controls, and 
Audits notes that a primary consideration in assigning the component 
rating is an assessment of the transaction risk associated with the 
institution's fiduciary operating systems and internal controls. 
However, all of the risks affecting fiduciary operations and internal 
controls, including but not limited to reputation, strategic, and 
compliance risks would also be considered.
Request for Comments
    The FFIEC requests comment on the proposed revisions to the trust 
rating system (``the proposal''). In addition, the FFIEC invites 
comments on the following questions:
    1. Does the proposal capture the essential risk areas of the 
fiduciary services industry?
    2. Does the proposed management component adequately assess the 
quality of the board of directors' and management's oversight regarding 
its fiduciary responsibility and its ability to identify and manage all 
areas of risk involved in the exercise of its fiduciary powers?
    3. Are there any components which should be added to or deleted 
from the proposal?
    4. Are the definitions for the individual components and the 
composite numerical ratings in the proposal consistent with the 
language and tone of the UFIRS definitions?
Text of the Revised Uniform Interagency Trust Rating System
Uniform Interagency Trust Rating System
Introduction
    The Uniform Interagency Trust Rating System (UITRS) was adopted on 
September 21, 1978 by the Office of the Comptroller of the Currency 
(OCC), the Federal Deposit Insurance Corporation (FDIC), and the 
Federal Reserve Board (FRB), and in 1988 by the Federal Home Loan Bank 
Board, predecessor agency to the Office of Thrift Supervision (OTS). 
Over the years, the UITRS has proven to be an effective internal 
supervisory tool for evaluating the fiduciary activities of financial 
institutions on a uniform basis and for identifying those institutions 
requiring special attention or concern.
    A number of changes have occurred in both the banking industry and 
the Federal supervisory agencies' policies and procedures which have 
prompted a review and revision of the 1978 rating system. The revisions 
to the UITRS:
    <bullet> Realign the UITRS rating definitions to bring them in line 
with UFIRS;
    <bullet> Reduce the component rating categories from six to five, 
combining the Account Administration and Conflicts of Interest 
components into a new Compliance component;
    <bullet> Make the earnings rating optional, at the Federal 
supervisory agency's discretion, for institutions not required to file 
the FFIEC 001 Schedule E (institutions with total trust assets of more 
than $100 million, and all non-deposit trust companies are required to 
file Schedule E); and
    <bullet> Explicitly refer to the quality of risk management 
processes in the management component, and the identification of risk 
elements within the composite and component rating definitions.
    The revisions are intended to promote and complement efficient 
examination processes. The revisions update the rating system but 
retain the basic framework of the original rating system. Consequently, 
the revised rating system will not result in additional regulatory 
burden to institutions or require additional policies or processes.
    The UITRS considers certain managerial, operational, financial and 
compliance factors that are common to all institutions with fiduciary 
activities. Under this system, the supervisory agencies endeavor to 
ensure that all institutions with fiduciary activities are evaluated in 
a comprehensive and uniform manner, and that supervisory attention is 
appropriately focused on those institutions exhibiting weaknesses in 
their fiduciary operations.
Overview
    Under the proposed UITRS, the fiduciary activities of financial 
institutions are assigned a composite rating based on an evaluation and 
rating of five essential components of an institution's fiduciary 
activities. These component factors address the following: the 
capability of management; the adequacy of operations, controls and 
audits; the quality and level of earnings; compliance with governing 
instruments, applicable law, and sound fiduciary principles; and the 
management of fiduciary assets. Evaluation of the components considers 
the size and sophistication, the nature and complexity, and the risk 
profile of the institution's fiduciary activities.
    Composite and component ratings are assigned based on a 1 to 5 
numerical scale. A 1 is the highest rating and indicates the strongest 
performance and risk management practices and the least degree of 
supervisory concern. A 5 is the lowest rating and indicates the weakest 
performance and risk management practices and, therefore, the highest 
degree of supervisory concern.
    The composite rating generally bears a close relationship to the 
component ratings assigned. However, the composite rating is not 
derived by computing an arithmetic average of the component ratings. 
Each component rating is based on a qualitative analysis of the factors 
comprising that component and its interrelationship with the other 
components. When assigning a composite rating, some components may be 
given more weight than others depending on the situation at the 
institution. In general, assignment of a composite rating may 
incorporate any factor that bears significantly on the overall 
administration of the financial institution's fiduciary activities. 
Assigned composite and component ratings are disclosed to the 
institution's
[[Page 7805]]
board of directors and senior management.
    The ability of management to respond to changing circumstances and 
to address the risks that may arise from changing business conditions, 
or the initiation of new fiduciary activities or products, is an 
important factor in evaluating an institution's overall fiduciary risk 
profile and the level of supervisory attention warranted. For this 
reason, the management component is given special consideration when 
assigning a composite rating.
    The ability of management to identify, measure, monitor, and 
control the risks of its fiduciary operations is also taken into 
account when assigning each component rating. It is recognized, 
however, that appropriate management practices may vary considerably 
among financial institutions, depending on the size, complexity and 
risk profiles of their fiduciary activities. For less complex 
institutions engaged solely in traditional fiduciary activities and 
whose directors and senior managers are actively involved in the 
oversight and management of day-to-day operations, relatively basic 
management systems and controls may be adequate. On the other hand, at 
more complex institutions, detailed and formal management systems and 
controls are needed to address a broader range of activities and to 
provide senior managers and directors with the information they need to 
supervise day-to-day activities.
    All institutions are expected to properly manage their risks. For 
less complex institutions engaging in less risky activities, detailed 
or highly formalized management systems and controls are not required 
to receive strong or satisfactory component or composite ratings.
    The following two sections contain the composite rating 
definitions, and the descriptions and definitions for the five 
component ratings.
Composite Ratings
    Composite ratings are based on a careful evaluation of how an 
institution conducts its fiduciary activities. The review encompasses 
the capability of management, the soundness of policies and practices, 
the quality of service rendered to the public, and the effect of 
fiduciary activities upon the soundness of the institution. The five 
key components used to assess an institution's fiduciary activities 
are: the capability of management; the adequacy of operations, controls 
and audits; the quality and level of earnings; compliance with 
governing instruments, applicable law, and sound fiduciary principles; 
and the management of fiduciary assets. The rating scale ranges from 1 
to 5, with a rating of 1 indicating the strongest performance and risk 
management practices relative to the size, complexity and risk profile 
of the institution's fiduciary activities, and the least supervisory 
concern. A 5 rating indicates the most critically deficient performance 
and risk management practices relative to the size, complexity, and 
risk profile of the institution's fiduciary activities, and the 
greatest supervisory concern. The composite ratings are defined as 
follows:
    Composite 1. Administration of fiduciary activities is sound in 
every respect and generally all components are rated 1 or 2. Any 
weaknesses are minor and can be handled in a routine manner by 
management. The institution is in substantial compliance with fiduciary 
laws and regulations. Risk management practices are strong relative to 
the size, complexity, and risk profile of the institution's fiduciary 
activities. Fiduciary activities are conducted in accordance with sound 
fiduciary principles and give no cause for supervisory concern.
    Composite 2. Administration of fiduciary activities is 
fundamentally sound. Generally no component rating should be more 
severe than 3. Only moderate weaknesses are present and are well within 
management's capabilities and willingness to correct. Fiduciary 
activities are conducted in substantial compliance with laws and 
regulations. Overall risk management practices are satisfactory 
relative to the institution's size, complexity, and risk profile. There 
are no material supervisory concerns and, as a result, the supervisory 
response is informal and limited.
    Composite 3. Administration of fiduciary activities exhibits some 
degree of supervisory concern in one or more of the component areas. A 
combination of weaknesses exists that may range from moderate to 
severe; however, the magnitude of the deficiencies generally does not 
cause a component to be rated more severely than 4. Management may lack 
the ability or willingness to effectively address weaknesses within 
appropriate time frames. Additionally, fiduciary activities may be 
conducted in significant noncompliance with laws and regulations. Risk 
management practices may be less than satisfactory relative to the 
institution's size, complexity, and risk profile. While problems of 
relative significance may exist, they are not of such importance as to 
pose a threat to the trust beneficiaries generally, or to the soundness 
of the institution. The institution's fiduciary activities require more 
than normal supervision and may include formal or informal enforcement 
actions.
    Composite 4. Fiduciary activities generally exhibit unsafe and 
unsound practices or conditions, resulting in unsatisfactory 
performance. The problems range from severe to critically deficient and 
may be centered around inexperienced or inattentive management, weak or 
dangerous operating practices, or an accumulation of unsatisfactory 
features of lesser importance. The weaknesses and problems are not 
being satisfactorily addressed or resolved by the board of directors 
and management. There may be significant noncompliance with laws and 
regulations. Risk management practices are generally unacceptable 
relative to the size, complexity, and risk profile of fiduciary 
activities. These problems pose a threat to the account beneficiaries 
generally and, if left unchecked, could evolve into conditions that 
could ultimately undermine the public confidence in the institution. 
Close supervisory attention is required, which means, in most cases, 
formal enforcement action is necessary to address the problems.
    Composite 5. Fiduciary activities are conducted in an extremely 
unsafe and unsound manner. Administration of fiduciary activities is 
critically deficient in numerous major respects, with problems 
resulting from incompetent or neglectful administration, flagrant and/
or repeated disregard for laws and regulations, or a willful departure 
from sound fiduciary principles and practices. The volume and severity 
of problems are beyond management's ability or willingness to control 
or correct. Such conditions evidence a flagrant disregard for the 
interests of the beneficiaries and may pose a serious threat to the 
soundness of the institution. Continuous close supervisory attention is 
warranted and may include termination of the institution's fiduciary 
activities.
Component Ratings
    Each of the component rating descriptions is divided into three 
sections: a narrative description of the component; a list of the 
principal factors used to evaluate that component; and a description of 
each numerical rating for that component. Some of the evaluation 
factors are reiterated under one or more of the other components to 
reinforce the interrelationship among components. The listing of 
evaluation factors is in no particular order of importance.
    Management. This rating reflects the capability of the board of 
directors and
[[Page 7806]]
management, in their respective roles, to identify, measure, monitor 
and control the risks of an institution's fiduciary activities. It also 
reflects their ability to ensure that the institution's fiduciary 
activities are conducted in a safe and sound manner, and in compliance 
with applicable laws and regulations. Directors should provide clear 
guidance regarding acceptable risk exposure levels and ensure that 
appropriate policies, procedures and practices are established and 
followed. Senior fiduciary management is responsible for developing and 
implementing policies, procedures and practices that translate the 
board's objectives and risk limits into prudent operating standards.
    Depending on the nature and scope of an institution's fiduciary 
activities, management practices may need to address some or all of the 
following risks: reputation, operating or transaction, strategic, 
compliance, legal, credit, market, liquidity and other risks. Sound 
management practices are demonstrated by: active oversight by the board 
of directors and management; competent personnel; adequate policies, 
processes, and controls that consider the size and complexity of the 
institution's fiduciary activities; and effective risk monitoring and 
management information systems. This rating should reflect the board's 
and management's ability as it applies to all aspects of fiduciary 
activities in which the institution is involved.
    The management rating is based upon an assessment of the capability 
and performance of management and the board of directors, including, 
but not limited to, the following evaluation factors:
    <bullet> The level and quality of oversight and support of 
fiduciary activities by the board of directors and management, 
including committee structure and adequate documentation of committee 
actions.
    <bullet> The ability of the board of directors and management, in 
their respective roles, to plan for, and respond to, risks that may 
arise from changing business conditions or the introduction of new 
activities or products.
    <bullet> The adequacy of, and conformance with, appropriate 
internal policies, practices and controls addressing the operations and 
risks of significant fiduciary activities.
    <bullet> The accuracy, timeliness, and effectiveness of management 
information and risk monitoring systems appropriate for the 
institution's size, complexity, and fiduciary risk profile.
    <bullet> Overall level of compliance with laws, regulations, and 
sound fiduciary principles.
    <bullet> Responsiveness to recommendations from auditors and 
regulatory authorities.
    <bullet> Strategic planning for fiduciary products and services.
    <bullet> The level of experience and competence of fiduciary 
management and staff, including issues relating to turnover and 
succession planning.
    <bullet> The availability of adequate insurance coverage.
    <bullet> The availability of competent legal counsel.
    <bullet> Extent and nature of pending litigation associated with 
fiduciary activities, and its potential impact on earnings, capital, 
and the institution's reputation.
    <bullet> Process for identifying and responding to fiduciary 
customer complaints.
    Ratings.
    1. A rating of 1 indicates strong performance by management and the 
board of directors and strong risk management practices relative to the 
size, complexity and risk profile of the institution's fiduciary 
activities. All significant risks are consistently and effectively 
identified, measured, monitored, and controlled. Management and the 
board have demonstrated the ability to promptly and successfully 
address existing and potential problems and risks.
    2. A rating of 2 indicates satisfactory management and board 
performance and risk management practices relative to the size, 
complexity and risk profile of the institution's fiduciary activities. 
Minor weaknesses may exist, but are not material to the sound 
administration of fiduciary activities, and are being addressed. In 
general, significant risks and problems are effectively identified, 
measured, monitored, and controlled.
    3. A rating of 3 indicates management and board performance that 
need improvement or risk management practices that are less than 
satisfactory given the nature of the institution's fiduciary 
activities. The capabilities of management or the board of directors 
may be insufficient for the size, complexity or risk profile of the 
institution's fiduciary activities. Problems and significant risks may 
be inadequately identified, measured, monitored, or controlled.
    4. A rating of 4 indicates deficient management and board 
performance or risk management practices that are inadequate 
considering the nature of an institution's fiduciary activities. The 
level of problems and risk exposure is excessive. Problems and 
significant risks are inadequately identified, measured, monitored, or 
controlled and require immediate action by the board and management to 
protect the assets of account beneficiaries and to prevent erosion of 
public confidence in the institution. Replacing or strengthening 
management or the board may be necessary.
    5. A rating of 5 indicates critically deficient management and 
board performance or risk management practices. Management and the 
board of directors have not demonstrated the ability to correct 
problems and implement appropriate risk management practices. Problems 
and significant risks are inadequately identified, measured, monitored, 
or controlled and now threaten the continued viability of the 
institution or its administration of fiduciary activities as well as 
posing a threat to the safety of the assets of account beneficiaries. 
Replacing or strengthening management or the board of directors is 
necessary.
    Operations, Internal Controls & Auditing. This area encompasses the 
department's operating systems and internal controls in relation to the 
volume and character of business conducted. The adequacy of audit 
coverage must assure the integrity of the financial records, the 
sufficiency of internal controls, and the adequacy of the compliance 
process.
    The institution's fiduciary operating systems, internal controls, 
and audit function subject it primarily to transaction and compliance 
risk; however, other risks including reputation, strategic, and 
financial may be present. The ability of management to identify, 
measure, monitor and control these risks is reflected in this rating.
    The operations, internal controls and auditing rating is based 
upon, but not limited to, an assessment of the following evaluation 
factors:
    Operations and Internal Controls, including adequacy of:
    <bullet> Staff, facilities and operating systems;
    <bullet> Records, accounting and data processing systems (including 
controls over systems access and such accounting procedures as aging, 
investigation and disposition of items in suspense accounts);
    <bullet> Trading functions and securities lending activities;
    <bullet> Vault controls and securities movement;
    <bullet> Segregation of duties;
    <bullet> Controls over disbursements (checks or electronic) and 
unissued securities;
[[Page 7807]]
    <bullet> Controls over income processing activities;
    <bullet> Reconciliation processes (depository, cash, vault, sub-
custodians, suspense accounts, etc.);
    <bullet> Disaster and/or business recovery programs;
    <bullet> Hold-mail procedures and controls over returned mail; and
    <bullet> Investigation and proper escheatment of funds in dormant 
accounts.
    Auditing, including the:
    <bullet> Independence, frequency, quality and scope of the internal 
and external fiduciary audit function relative to the volume, character 
and risk profile of the institution's fiduciary activities;
    <bullet> Volume and/or severity of internal control and audit 
exceptions and the extent to which these issues are tracked and 
resolved; and
    <bullet> Experience and competence of the audit staff.
    Ratings.
    1. A rating of 1 indicates that operations, internal controls, and 
audits are strong. All significant risks are consistently and 
effectively identified, measured, monitored, and controlled.
    2. A rating of 2 indicates that while operations, internal controls 
and audits are satisfactory, modest weaknesses may exist. These 
weaknesses, however, are not material in nature and, in general, are 
effectively identified, measured, monitored, and controlled.
    3. A rating of 3 indicates that operations, internal controls and/
or auditing need improvement. One or more of these areas are less than 
satisfactory. Problems and significant risks may be inadequately 
identified, measured, monitored, or controlled.
    4. A rating of 4 indicates deficient operations, internal controls 
and/or audits in which one or more of these areas are inadequate or the 
level of problems and risk exposure is excessive. Problems and 
significant risks are inadequately identified, measured, monitored, or 
controlled and require immediate action. Departments with this level of 
deficiencies may make little provision for audits of any kind or may 
evidence weak or potentially dangerous operating practices in 
combination with infrequent or inadequate audits.
    5. A rating of 5 indicates critically deficient operations, 
internal controls and/or audits. Operating practices, with or without 
audits, pose a serious threat to the safety of assets of fiduciary 
accounts. Problems and significant risks are inadequately identified, 
measured, monitored, or controlled and now threaten the ability of the 
institution to continue engaging in fiduciary activities.
    Earnings. This area includes an evaluation of the department's 
profitability and its effect on the financial condition of the 
institution. The use and adequacy of budgets and earnings projections 
by functions, product lines and clients are reviewed and evaluated. 
Risk exposure that may lead to negative earnings is also evaluated.
    Earnings are evaluated at all fiduciary examinations. A rating for 
the earnings component is assigned as follows:
    <bullet> Mandatory Rating of Earnings. Earnings are rated at every 
trust examination where the financial institution would, at the time of 
the examination, be required to file Schedule E (Trust Income 
Statement) of the FFIEC Annual Report of Trust Assets. Schedule E must 
be completed by (1) each financial institution with more than $100 
million in Total Trust Assets as reported on Schedule A, and (2) by all 
non-deposit trust companies, whether or not they report any assets on 
Schedule A.
    <bullet> Optional Rating of Earnings. If an institution is not 
required to file Schedule E of the FFIEC Annual Report of Trust Assets, 
this component may be rated at the option of the examining agency and 
in accordance with its implementing guidelines.
    The earnings rating is based upon, but not limited to, an 
assessment of the following evaluation factors:
    <bullet> The level and consistency of profitability, or the lack 
thereof, generated by the institution's fiduciary activities.
    <bullet> Dependence upon non-recurring fees and commissions, such 
as those for court accounts.
    <bullet> Unusual features regarding the composition of business, 
fee schedules and effects of charge-offs or compromise actions.
    <bullet> Accounting practices which may contain unusual practices 
such as (1) unusual methods of allocating direct and indirect expenses 
and overhead and (2) methods of allocating fiduciary income and expense 
where two or more fiduciary institutions within the same holding 
company family share fiduciary services and/or processing functions.
    <bullet> Extent of management's use of budgets, projections and 
other cost analysis procedures.
    <bullet> Methods used for directors' approval of financial budgets 
and/or projections.
    <bullet> Management's attitude toward growth and new business 
development.
    <bullet> New business development efforts, including types of 
business solicited, market potential, advertising, competition, 
relationships with local organizations, and an evaluation by management 
of risk potential inherent in new business areas.
    Ratings.
    1. A rating of 1 indicates strong earnings. Strong earnings 
generally mean five consecutive years of profitable net trust operating 
income, in a volume reflecting the institution's size and type of 
fiduciary services offered, with indications of continued profitable 
operations. Earnings and future prospects are sufficient to support the 
continuation of fiduciary activities without engaging in activities 
that may result in risks or other factors that would affect the quality 
and quantity of earnings. In addition, management makes effective use 
of budgets and cost analysis procedures, such as earnings projections 
by functions, product lines and clients. Methods used for reporting 
such information to, as well as obtaining approvals from the board of 
directors, or a committee thereof, are adequate.
    2. A rating of 2 indicates satisfactory earnings. Satisfactory 
earnings are generally indicated by profitable net trust operating 
income in three of the past five consecutive years, with indications of 
continued profitable operations. Management's use of budgets and 
projections, and other cost analysis procedures, as well as the methods 
used for directors' approvals of these financial reports, is generally 
satisfactory for the size and complexity of the institution.
    A 2 rating may also be assigned where there are five years of 
profitable operations (which would normally warrant a 1 rating), if 
there are indications that management is entering activities with which 
it is not familiar, or where there may be inordinately high levels of 
risk present that have not been adequately evaluated. As a result, 
continuation of profitable operations is questionable.
    Optional Rating of Earnings. In instances where the rating of trust 
earnings is optional under these guidelines and the institution is not 
generating positive earnings, or where information concerning this area 
may not be available in a formal manner, a 2 rating may be assigned if 
management has satisfactorily evaluated the positive effect of offering 
of fiduciary services to the continued growth of the institution and 
its overall earnings. However, management should, at a minimum, (a) 
have a reasonable method for measuring income and expense commensurate 
with the volume and nature of fiduciary services offered, (b) report 
the level of profitability or operating losses to the board of 
directors, or a committee thereof, at least annually, and (c) obtain
[[Page 7808]]
approval from the board of directors, or a committee thereof, for 
offering fiduciary services. In these instances, the board of directors 
may consider the lack of fiduciary profitability to be a cost of doing 
business as a full service institution and believe the negative effects 
of not offering fiduciary services are more significant than the 
expense of administering those services.
    3. A rating of 3 indicates less than satisfactory earnings, which 
generally means inconsistent or marginally-profitable net trust 
operating income over the past five consecutive years. A 3 rating may 
also be assigned when operations are generally unprofitable, even if 
gross income permits recovery of salary expenses. Over a five year 
period, however, the department's earnings trend has shown less ability 
to recover salary expense and projections do not indicate a reversal of 
this trend. Management may not be making proper use of budgets and 
projections, and other cost analysis procedures. Earnings accorded this 
rating need to improve to fully support the institution's fiduciary 
activities and provide for the associated risks.
    Optional Rating of Earnings. In instances where the rating of trust 
earnings is optional under these guidelines, this rating may be 
assigned if management has a reasonable method for measuring trust 
income and expense, but either fails to adequately (a) report the level 
of profitability or operating losses to the board of directors, or a 
committee thereof, at least annually, or (b) obtain approval from the 
board of directors, or a committee thereof, for the offering of the 
service. While management may have attempted to identify and quantify 
collateral revenue to be earned by offering fiduciary services, it has 
decided that these services should be offered as a community service, 
even if they cannot be operated profitably.
    4. A rating of 4 indicates earnings that are deficient, and do not 
support fiduciary activities. Operating losses, when averaged over the 
previous five year period, do not generally cover salary or other 
direct expenses. In general, this would be indicated by unprofitable 
net trust operating income in the past three consecutive years, with 
indications of continued unprofitable operations. The five year trend 
may indicate erratic fluctuations in net income, the development of a 
significant negative trend, nominal earnings, unsustainable earnings, 
intermittent losses or a substantial drop in earnings from the previous 
year. Business volume and prospects suggest a continuation of this 
trend. Budgets are either not used or not followed, and there is no 
accountability for failing to adhere to financial targets. Reporting of 
earnings information to the board of directors, or a committee thereof, 
is inadequate, incomplete, or ineffective.
    Optional Rating of Earnings. In instances where the rating of trust 
earnings is optional under these guidelines, this rating may be 
assigned if management has failed to adequately implement two of the 
three minimum standards cited under Rating No. 2 above. Management has 
undertaken little or no effort to identify or quantify the collateral 
advantages, if any, to the institution from offering fiduciary 
services.
    5. A rating of 5 indicates critically deficient earnings. In 
general, this means unprofitable net trust operating income in the past 
five consecutive years, with indications of continued unprofitable 
operations. A trust department with this rating is experiencing losses 
that have a significant negative impact on the overall earnings of the 
institution and that may represent a distinct threat to its viability 
through the erosion of its capital. Budgeting is likely to be 
nonexistent and/or unrealistic and ineffective. The board of directors, 
or a committee thereof, may not be aware of the condition and/or there 
is no effective method to communicate such matters to the board on a 
regular basis.
    Optional Rating of Earnings. In instances where the rating of trust 
earnings is optional under these guidelines, this rating may be 
assigned if management has failed to adequately implement any of the 
three minimum standards described under Rating No. 2 above.
    Compliance. The compliance rating component covers an institution's 
overall compliance with applicable laws, regulations, accepted 
standards of fiduciary conduct, governing account instruments and 
internally established policies and procedures. This component 
specifically incorporates an assessment of a fiduciary's duty of 
undivided loyalty and duties associated with account administration.
    Risks associated with account administration are virtually 
unlimited because each account is a separate contractual relationship 
that contains specific obligations. Risks associated with account 
administration include: failure to comply with applicable laws, 
regulations or terms of the governing instrument; inadequate account 
administration practices; and inexperienced management or inadequately 
trained staff. Risks associated with a fiduciary's duty of undivided 
loyalty generally stem from engaging in self-dealing or other conflict 
of interest transactions. An institution is subject to compliance risk 
and strategic risk related to account administration and conflicts of 
interest activities. The ability of management to identify, measure, 
monitor and control these risks is reflected in this rating. Policies, 
procedures and practices pertaining to account administration and 
conflicts of interest are evaluated in light of the size and character 
of an institution's fiduciary business.
    The compliance rating is based upon, but not limited to, an 
assessment of the following evaluation factors:
    <bullet> Applicable federal and state statutes and regulations, 
including, but not limited to, federal and state fiduciary laws, the 
Employee Retirement Income Security Act of 1974, federal and state 
securities laws, state investment standards, state principal and income 
acts, and state probate codes;
    <bullet>  Terms of governing instruments; and
    <bullet> Internally established policies and procedures, including, 
but not limited to, those addressing self-dealing and other conflicts 
of interest, account administration, and asset (including cash) 
management.
    Ratings.
    1. A rating of 1 indicates strong compliance policies, procedures 
and practices. Policies and procedures covering conflicts of interest 
and account administration are appropriate for the size and complexity 
of the business. Accounts are administered in accordance with governing 
instruments, applicable laws and regulations, sound fiduciary 
principles, and internal policies and procedures. Any violations are 
isolated, technical in nature and easily correctable. All significant 
risks are consistently and effectively identified, measured, monitored 
and controlled.
    2. A rating of 2 indicates fundamentally sound compliance policies, 
procedures and practices. Account administration may be flawed by 
modest weaknesses in policies, procedures or practices. Management's 
practices indicate a determination to minimize the instances of 
conflicts of interest. Fiduciary activities are conducted in 
substantial compliance with laws and regulations, and any violations 
are generally technical in nature. Management corrects violations in a 
timely manner and without loss to fiduciary accounts. Significant risks 
are effectively identified, measured, monitored, and controlled.
    3. A rating of 3 indicates compliance practices that are less than 
satisfactory.
[[Page 7809]]
Policies, procedures and controls have not proven effective and may 
require strengthening. Fiduciary activities may be in substantial 
noncompliance with laws, regulations or governing instruments; however, 
losses are minimal. Management may have the ability to effect 
compliance; however, the number of violations that exist, or failure to 
correct prior violations, are indications that management has not 
devoted sufficient time and attention to its compliance 
responsibilities. Risk management practices generally need improvement.
    4. A rating of 4 indicates institutions with deficient compliance 
practices. Account administration is notably deficient. The institution 
makes little or no effort to minimize potential conflicts or refrain 
from self dealing, and is confronted with a considerable number of 
potential or actual conflicts. Numerous substantive and technical 
violations of laws and regulations exist and many may remain 
uncorrected from previous examinations. Management has not exerted 
sufficient effort to effect compliance and may lack the ability to 
effectively administer fiduciary activities. The level of compliance 
problems is significant and, if left unchecked, may subject the 
institution to monetary losses or reputation risk. Risks are 
inadequately identified, measured, monitored and controlled.
    5. A rating of 5 indicates critically deficient compliance 
practices. Account administration is critically deficient or 
incompetent and there is a flagrant disregard for the terms of the 
governing instruments and interests of account beneficiaries. The 
institution frequently engages in transactions that compromise its 
fundamental duty of undivided loyalty to account beneficiaries. There 
are flagrant or repeated violations of laws and regulations and 
significant departures from sound fiduciary principles. Management is 
unwilling or unable to operate within the scope of laws and regulations 
or within the terms of governing instruments and efforts to obtain 
voluntary compliance have been unsuccessful. The severity of 
noncompliance presents an imminent monetary threat to account 
beneficiaries and creates significant legal and financial exposure to 
the institution. Problems and significant risks are inadequately 
identified, measured, monitored, or controlled and now threaten the 
ability of management to continue engaging in fiduciary activities.
    Asset Management. The asset management rating reflects the risks 
associated with managing the assets (including cash) of others. Prudent 
portfolio management is based on an assessment of the needs and 
objectives of each account or portfolio. An evaluation of asset 
management should consider the adequacy of processes related to the 
investment of all discretionary accounts and portfolios, including 
collective investment funds, proprietary mutual funds, and investment 
advisory arrangements.
    The institution's asset management activities subject it to 
reputation, compliance and strategic risks. In addition, each 
individual account or portfolio managed by the institution is subject 
to financial risks such as market, credit, liquidity, and interest rate 
risk, as well as transaction and compliance risk. The ability of 
management to identify, measure, monitor and control these risks is 
reflected in this rating.
    The asset management rating is based upon, but not limited to, an 
assessment of the following evaluation factors:
    <bullet> The adequacy of overall policies, practices and procedures 
governing asset management, considering the size, complexity and risk 
profile of the institution's fiduciary activities.
    <bullet> The decision making processes used for selection, 
retention and preservation of fiduciary assets including adequacy of 
documentation, committee review and approval, and a system to review 
and approve exceptions.
    <bullet> The use of quantitative tools used to measure the various 
financial risks in investment accounts and portfolios.
    <bullet> The existence of policies and procedures addressing the 
use of derivatives or other unusual investment products.
    <bullet> The adequacy of procedures related to the purchase or 
retention of miscellaneous assets including real estate, notes, closely 
held companies, limited partnerships, mineral interests, insurance and 
other unique assets.
    <bullet> The extent and adequacy of periodic reviews of investment 
performance, taking into consideration the needs and objectives of each 
account or portfolio.
    <bullet> Monitoring of changes in the composition of fiduciary 
assets for trends and related risk exposure.
    <bullet> Quality of investment research used in the decision-making 
process and documentation of the research.
    <bullet> Due diligence process for evaluating investment advice 
received from vendors and/or brokers (including approved or focus lists 
of securities).
    <bullet> Due diligence process for reviewing and approving brokers 
and/or counter parties used.
    This rating may not be applicable for some institutions because 
their operations do not include activities involving the management of 
any fiduciary assets. Functions of this type would include, but not 
necessarily be limited to clearing corporations or depositories, 
directed agency relationships, security clearance, non-fiduciary 
custody relationships, transfer agent and registrar activities. In 
institutions of this type, the rating for Asset Management may be 
omitted by the examiner in accordance with the examining agency's 
implementing guidelines.
    Ratings.
    1. A rating of 1 indicates strong asset management practices. 
Identified weaknesses are minor in nature. Risk exposure is modest in 
relation to management's abilities and the size and complexity of the 
assets managed.
    2. A rating of 2 indicates satisfactory asset management practices. 
Moderate weaknesses are present and are well within management's 
ability and willingness to correct. Risk exposure is commensurate with 
management's abilities and the size and complexity of the assets 
managed. Supervisory response is limited.
    3. A rating of 3 indicates that asset management practices are less 
than satisfactory in relation to the size and complexity of the assets 
managed. Weaknesses may range from moderate to severe; however, they 
are not of such importance as to pose a threat to the interests of the 
account beneficiaries generally. Asset management and risk management 
practices generally need to be improved. An elevated level of 
supervision is normally required.
    4. A rating of 4 indicates deficient asset management practices in 
relation to the size and complexity of the assets managed. The levels 
of risk are significant and inadequately controlled. The problems pose 
a threat to account beneficiaries generally, and if left unchecked, may 
subject the institution to losses and could undermine the reputation of 
the institution.
    5. A rating of 5 represents critically deficient asset management 
practices and a flagrant disregard of fiduciary duties. A continuation 
of these practices jeopardizes the interests of the beneficiaries 
generally, and may pose a threat to the soundness of the institution.
[End of Proposed Text of Uniform Interagency Trust Rating System]
    Dated: February 10, 1998.
Joe M. Cleaver,
Executive Secretary, Federal Financial Institutions Examination 
Council.
[FR Doc. 98-3802 Filed 2-13-98; 8:45 am]
BILLING CODE 6210-01-P, 6720-01-P, 6714-01-P, 4810-01-P

Last Updated 02/17/1998 regs@fdic.gov