[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
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