FDIC Federal Register Citations

[Federal Register: October 13, 1998 (Volume 63, Number 197)]

[Notices]

[Page 54704-54711]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr13oc98-83]

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FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL

Uniform Interagency Trust Rating System

AGENCY: Federal Financial Institutions Examination Council.

ACTION: Notice.

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SUMMARY: The Federal Financial Institutions Examination Council (FFIEC)

is revising the Uniform Interagency Trust Rating System (UITRS),

commonly referred to as the trust rating system. The 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 changes revise

the definitions for the numerical ratings to conform to the language

and tone of the Uniform Financial Institutions 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 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 changes in the component rating descriptions; and

explicitly identify the types of risk that are considered in assigning

component ratings.

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 notice. The Federal supervisory agencies

participating in this notice are: 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).

DATES: Effective October 13, 1998.

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

175, 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, Mail Stop 7-7, 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

On February 17, 1998, the FFIEC published a notice in the Federal

Register (February Notice), 63 FR 7802, requesting comment on proposed

revisions to the Uniform Interagency Trust Rating System (UITRS). 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 on

September 21, 1978 by the Office of the Comptroller of the Currency

(OCC), the Federal Deposit Insurance Corporation (FDIC), and the Board

of Governors of the Federal Reserve System (FRB), and in 1988 by the

Federal Home Loan Bank Board, predecessor agency to the Office of

Thrift Supervision (OTS).

Under the UITRS, each institution is assigned a composite rating

based on an evaluation and rating of essential components of an

institution's fiduciary activities. The composite rating reflects the

overall condition of an institution's fiduciary activities and is used

by the Federal supervisory agencies to monitor aggregate trends in the

overall administration of fiduciary activities. Under the former UITRS,

each financial institution or trust company was assigned a composite

rating based on an evaluation and rating of six essential components of

an institution's fiduciary activities. These components addressed: 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,

[[Page 54705]]

therefore, the highest degree of supervisory concern.

The UITRS has proven to be an effective way 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. As a result, the FFIEC is making

certain enhancements to the rating system, but is retaining its basic

framework. The UITRS enhancements:

<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> Require Earnings to be rated only in institutions with

more than $100 million in total trust assets, and in all non-deposit

trust companies. An earnings rating is not required for the remaining

institutions (those institutions not required to file Schedule E

¹); however, each Federal supervisory agency has the option

of requiring the earnings of these institutions to be rated using the

alternate rating definitions where applicable.

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\1\ Schedule E is the Trust Income Statement of the FFIEC Annual

Report of Trust Assets (FFIEC 001). Schedule E is required to be

filed by each financial institution with total trust assets of more

than $100 million as reported on line 18, column F of Schedule A,

and by all non-deposit trust companies, whether or not they report

any assets on Schedule A.

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<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.

Comments Received and Changes Made

The FFIEC received two public comments from industry trade

associations regarding the proposed revisions to the UITRS. Both

commenters generally favored the changes made, in particular the

emphasis on risk management, the changes to the UITRS to conform to the

language and tone of the UFIRS, and the considerations given to the

earnings component when evaluating a small trust department.

Examiners field tested the revised rating system during 61 bank and

thrift fiduciary examinations conducted between February and May 1998.

The examiners provided comments regarding the revised rating system.

Examiner response was generally favorable, and no significant problems

or unanticipated rating differences were encountered between the former

and updated UITRS. Some of the examiner comments recommended clarifying

changes to various aspects of the revised rating system.

The FFIEC carefully considered each comment and examiner response

and made certain changes. The following discussion describes the

comments received (both through public comment and agency field

testing) and changes made to the UITRS in response to those comments.

The updated UITRS is included at the end of this Notice.

February Notice Specific Questions

In addition to requesting general comments regarding the proposed

system, the FFIEC invited comments on four specific questions:

(1) Does the proposal capture the essential risk areas of the

fiduciary services industry?

The majority of the responses to this question were positive, and

no changes were made.

(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?

The majority of the responses to this question were positive, and

no changes were made.

(3) Are there any components which should be added to or deleted

from the proposal?

The majority of the responses received regarding the components

were favorable. A number of examiners recommended strengthening the

conflict of interest section of the Compliance component. Several

examiners also requested clarification of the application of the

optional earnings rating to the Earnings component. These concerns are

addressed later in this Notice.

(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?

The majority of the responses to this question were positive. The

agencies received several examiner comments recommending changes to

address minor inconsistencies in wording throughout the UITRS. Many of

these minor wording changes were made to improve the consistency of the

rating system.

Compliance Component

The February notice combined the former Account Administration and

Conflicts of Interest components into a new Compliance component. The

new component assesses the institution's compliance with the terms of

governing instruments, applicable laws and regulations, sound fiduciary

principles, and internal policies and procedures. In addition, the new

component addresses compliance with applicable laws, regulations, and

internal policies and procedures on a broader, institution-wide basis

by focusing on compliance and strategic risk.

Several examiners expressed concern that the new rating component

de-emphasizes the seriousness of self-dealing and conflicts of

interest. The FFIEC emphasizes that self-dealing and other conflicts of

interest, and the associated risks to the institution, continue to be

areas of great importance and concern. The intent of the new Compliance

component was not to de-emphasize the seriousness or importance of

self-dealing or other conflicts of interest. Accordingly, the

description of the new component and its rating definitions has been

revised and expanded to clarify the importance of these issues.

Earnings Component

Under the former UITRS, an Earnings rating was required for all

institutions. The February notice proposed several changes to the

Earnings component. An earnings rating would be required for

institutions with more than $100 million in total trust assets (as

reported on FFIEC 001 Schedule A, line 18, column F) and for non-

deposit trust companies. An earnings rating would not be required for

the remaining institutions (those institutions not required to file

Schedule E of FFIEC 001); however, each Federal supervisory agency

would have the option of requiring the earnings of these institutions

to be rated using either the rating definitions designated for Schedule

E filers or, in accordance with the agency's implementing guidelines,

the definitions for the alternate ratings.

The majority of the comments received on the Earnings component

changes were positive; however, several examiners requested that the

FFIEC clarify various aspects of this component. In response, the FFIEC

added an evaluation factor section for the alternate earnings rating,

and separated the two rating definitions. In addition, each agency will

issue implementing guidance addressing the

[[Page 54706]]

applicability of the Earnings rating to its supervised institutions.

Implementation Date

The FFIEC recommends that the Federal supervisory agencies

implement the updated UITRS January 1, 1999. This date ensures that

institutions with examinations commenced in 1999 will be assessed under

the updated UITRS.

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 Board

of Governors of the Federal Reserve System (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.

A number of changes have occurred in both the banking industry and

the Federal supervisory agencies' policies and procedures which

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 the Uniform Financial Institutions Rating System (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> Require Earnings to be rated only in institutions with

more than $100 million in total trust assets, and in all non-deposit

trust companies. An earnings rating is not required for the remaining

institutions (those institutions not required to file FFIEC 001

Schedule E); ² however, each Federal supervisory agency has

the option of requiring the earnings of these institutions to be rated

using the alternate rating definitions where applicable.

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\2\ Schedule E is the Trust Income Statement of the FFIEC Annual

Report of Trust Assets (FFIEC 001). Schedule E is required to be

filed by each financial institution with total trust assets of more

than $100 million as reported on line 18, column F of Schedule A,

and by all non-deposit trust companies, whether or not they report

any assets on Schedule A.

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<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.

These revisions are intended to promote and complement efficient

examination processes. The revisions update the rating system but

retain its basic framework. 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 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 components 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

(including self-dealing and conflicts of interest laws and

regulations), and sound fiduciary principles; and the management of

fiduciary assets.

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. Evaluation of the composite and

components considers the size and sophistication, the nature and

complexity, and the risk profile of the institution's fiduciary

activities.

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 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

[[Page 54707]]

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 (including self-

dealing and conflicts of interest laws and regulations), and sound

fiduciary principles; and the management of fiduciary assets. The

composite ratings are defined as follows:

Composite 1. Administration of fiduciary activities is sound in

every respect. 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 reveal

some 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 cause significant losses to the institution and 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 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> The overall level of compliance with laws, regulations,

and sound fiduciary principles.

[[Page 54708]]

<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 adequacy of insurance coverage.

<bullet> The availability of competent legal counsel.

<bullet> The extent and nature of pending litigation associated

with fiduciary activities, and its potential impact on earnings,

capital, and the institution's reputation.

<bullet> The process for identifying and responding to fiduciary

customer complaints.

Ratings. 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 are proactive, and have demonstrated the ability to

promptly and successfully address existing and potential problems and

risks.

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.

Moderate 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.

A rating of 3 indicates management and board performance that needs

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, and risk profile of the

institution's fiduciary activities. Problems and significant risks may

be inadequately identified, measured, monitored, or controlled.

A rating of 4 indicates deficient management and board performance

or risk management practices that are inadequate considering the size,

complexity, and risk profile of the 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.

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, and pose 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 rating reflects the

adequacy of the institution's fiduciary operating systems and internal

controls in relation to the volume and character of business conducted.

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. Other risks including reputation, strategic, and financial risk

may also 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 the 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;

<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:

<bullet> The 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> The volume and/or severity of internal control and

audit exceptions and the extent to which these issues are tracked

and resolved; and

<bullet> The experience and competence of the audit staff.

Ratings. A rating of 1 indicates that operations, internal

controls, and auditing are strong in relation to the volume and

character of the institution's fiduciary activities. All significant

risks are consistently and effectively identified, measured, monitored,

and controlled.

A rating of 2 indicates that operations, internal controls and

auditing are satisfactory in relation to the volume and character of

the institution's fiduciary activities. Moderate weaknesses may exist,

but are not material. Significant risks, in general, are effectively

identified, measured, monitored, and controlled.

A rating of 3 indicates that operations, internal controls or

auditing need improvement in relation to the volume and character of

the institution's fiduciary activities. One or more of these areas are

less than satisfactory. Problems and significant risks may be

inadequately identified, measured, monitored, or controlled.

A rating of 4 indicates deficient operations, internal controls or

audits. One or more of these areas are inadequate or the level of

problems and risk exposure is excessive in relation to the volume and

character of the institution's fiduciary activities. Problems and

significant risks are inadequately identified, measured, monitored, or

controlled and require immediate action. Institutions with this level

of deficiencies may make little provision for audits, or may evidence

weak or potentially dangerous operating practices in combination with

infrequent or inadequate audits.

A rating of 5 indicates critically deficient operations, internal

controls 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 rating reflects the profitability of an

institution's fiduciary activities 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.

[[Page 54709]]

Risk exposure that may lead to negative earnings is also evaluated.

An evaluation of earnings is required for all institutions with

fiduciary activities. An assignment of an earnings rating, however, is

required only for institutions that, at the time of the examination,

have total trust assets of more than $100 million, or are a non-deposit

trust company (those institutions that would be required to file

Schedule E of FFIEC 001).

For institutions where the assignment of an Earnings rating is not

required by the UITRS, the Federal supervisory agency has the option to

assign an earnings rating using an alternate set of ratings. A rating

will be assigned in accordance with implementing guidelines adopted by

the supervisory agency. The definitions for the alternate ratings are

included in the revised UITRS and may be found in the section

immediately following the definitions for the required ratings.

The evaluation of earnings is based upon, but not limited to, an

assessment of the following factors:

<bullet> The profitability of fiduciary activities in relation

to the size and scope of those activities and to the overall

business of the institution.

<bullet> The overall importance to the institution of offering

fiduciary services to its customers and local community.

<bullet> The effectiveness of the institution's procedures for

monitoring fiduciary activity income and expense relative to the

size and scope of these activities and their relative importance to

the institution, including the frequency and scope of profitability

reviews and planning by the institution's board of directors or a

committee thereof.

For those institutions for which a rating of earnings is mandatory,

additional factors should include the following:

<bullet> The level and consistency of profitability, or the lack

thereof, generated by the institution's fiduciary activities in

relation to the volume and character of the institution's business.

<bullet> Dependence upon non-recurring fees and commissions,

such as fees for court accounts.

<bullet> The effects of charge-offs or compromise actions.

<bullet> Unusual features regarding the composition of business

and fee schedules.

<bullet> Accounting practices that contain practices such as (1)

unusual methods of allocating direct and indirect expenses and

overhead, or (2) unusual 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> The 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. A rating of 1 indicates strong earnings. The institution

consistently earns a rate of return on its fiduciary activities that is

commensurate with the risk of those activities. This rating would

normally be supported by a history of consistent profitability over

time and a judgement that future earnings prospects are favorable. In

addition, management techniques for evaluating and monitoring earnings

performance are fully adequate and there is appropriate oversight by

the institution's board of directors or a committee thereof. Management

makes effective use of budgets and cost analysis procedures. Methods

used for reporting earnings information to the board of directors, or a

committee thereof, are comprehensive.

A rating of 2 indicates satisfactory earnings. Although the

earnings record may exhibit some weaknesses, earnings performance does

not pose a risk to the overall institution nor to its ability to meet

its fiduciary obligations. Generally, fiduciary earnings meet

management targets and appear to be at least sustainable. Management

processes for evaluating and monitoring earnings are generally

sufficient in relationship to the size and risk of fiduciary activities

that exist, and any deficiencies can be addressed in the normal course

of business. A rating of 2 may also be assigned to institutions with a

history of profitable operations if there are indications that

management is engaging in activities with which it is not familiar, or

where there may be inordinately high levels of risk present that have

not been adequately evaluated. Alternatively, an institution with

otherwise strong earnings performance may also be assigned a 2 rating

if there are significant deficiencies in its methods used to monitor

and evaluate earnings.

A rating of 3 indicates less than satisfactory earnings. Earnings

are not commensurate with the risk associated with the fiduciary

activities undertaken. Earnings may be erratic or exhibit downward

trends, and future prospects are unfavorable. This rating may also be

assigned if management processes for evaluating and monitoring earnings

exhibit serious deficiencies, provided the deficiencies identified do

not pose an immediate danger to either the overall financial condition

of the institution or its ability to meet its fiduciary obligations.

A rating of 4 indicates earnings that are seriously deficient.

Fiduciary activities have a significant adverse effect on the overall

income of the institution and its ability to generate adequate capital

to support the continued operation of its fiduciary activities. The

institution is characterized by fiduciary earnings performance that is

poor historically, or faces the prospect of significant losses in the

future. Management processes for monitoring and evaluating earnings may

be poor. The board of directors has not adopted appropriate measures to

address significant deficiencies.

A rating of 5 indicates critically deficient earnings. In general,

an institution with this rating is experiencing losses from fiduciary

activities that have a significant negative impact on the overall

institution, representing a distinct threat to its viability through

the erosion of its capital. The board of directors has not implemented

effective actions to address the situation.

Alternate Rating of Earnings. Alternate ratings are assigned based

on the level of implementation of four minimum standards by the board

of directors and management.

These standards are:

<bullet> Standard No. 1--The institution has reasonable methods

for measuring income and expense commensurate with the volume and

nature of the fiduciary services offered.

<bullet> Standard No. 2--The level of profitability is reported

to the board of directors, or a committee thereof, at least

annually.

<bullet> Standard No. 3--The board of directors periodically

determines that the continued offering of fiduciary services

provides an essential service to the institution's customers or to

the local community.

<bullet> Standard No. 4--The board of directors, or a committee

thereof, reviews the justification for the institution to continue

to offer fiduciary services even if the institution does not earn

sufficient income to cover the expenses of providing those services.

Ratings. A rating of 1 may be assigned where an institution has

implemented all four minimum standards. If fiduciary earnings are

lacking, management views this as a cost of doing business as a full

service institution and believes that the negative effects of not

offering fiduciary services are more significant than the expense of

administrating those services.

A rating of 2 may be assigned where an institution has implemented,

at a minimum, at least three of the four standards. This rating may be

assigned if the institution is not generating positive earnings or

where formal

[[Page 54710]]

earnings information may not be available.

A rating of 3 may be assigned if the institution has implemented at

least two of the four standards. While management may have attempted to

identify and quantify other revenue to be earned by offering fiduciary

services, it has decided that these services should be offered as a

service to customers, even if they cannot be operated profitably.

A rating of 4 may be assigned if the institution has implemented

only one of the four standards. Management has undertaken little or no

effort to identify or quantify the collateral advantages, if any, to

the institution from offering fiduciary services.

A rating of 5 may be assigned if the institution has implemented

none of the standards.

Compliance. This rating reflects an institution's overall

compliance with applicable laws, regulations, accepted standards of

fiduciary conduct, governing account instruments, duties associated

with account administration, and internally established policies and

procedures. This component specifically incorporates an assessment of a

fiduciary's duty of undivided loyalty and compliance with applicable

laws, regulations, and accepted standards of fiduciary conduct related

to self-dealing and other conflicts of interest.

The compliance component includes reviewing and evaluating the

adequacy and soundness of adopted policies, procedures, and practices

generally, and as they relate to specific transactions and accounts. It

also includes reviewing policies, procedures, and practices to evaluate

the sensitivity of management and the board of directors to refrain

from self-dealing, minimize potential conflicts of interest, and

resolve actual conflict situations in favor of the fiduciary account

beneficiaries.

Risks associated with account administration are potentially

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 may be exposed to compliance,

strategic, financial and reputation 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> Compliance with 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> Compliance with the terms of governing instruments;

<bullet> The adequacy of overall policies, practices, and

procedures governing compliance, considering the size, complexity,

and risk profile of the institution's fiduciary activities;

<bullet> The adequacy of policies and procedures addressing

account administration;

<bullet> The adequacy of policies and procedures addressing

conflicts of interest, including those designed to prevent the

improper use of ``material inside information'';

<bullet> The effectiveness of systems and controls in place to

identify actual and potential conflicts of interest;

<bullet> The adequacy of securities trading policies and

practices relating to the allocation of brokerage business, the

payment of services with ``soft dollars'' and the combining,

crossing, and timing of trades;

<bullet> The extent and permissibility of transactions with

related parties, including, but not limited to, the volume of

related commercial and fiduciary relationships and holdings of

corporations in which directors, officers, or employees of the

institution may be interested;

<bullet> The decision making process used to accept, review, and

terminate accounts; and,

<bullet> The decision making process related to account

administration duties, including cash balances, overdrafts, and

discretionary distributions.

Ratings. A rating of 1 indicates strong compliance policies,

procedures and practices. Policies and procedures covering conflicts of

interest and account administration are appropriate in relation to the

size and complexity of the institution's fiduciary activities. 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.

A rating of 2 indicates fundamentally sound compliance policies,

procedures and practices in relation to the size and complexity of the

institution's fiduciary activities. Account administration may be

flawed by moderate 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.

A rating of 3 indicates compliance practices that are less than

satisfactory in relation to the size and complexity of the

institution's fiduciary activities. Policies, procedures and controls

have not proven effective and require strengthening. Fiduciary

activities may be in substantial noncompliance with laws, regulations

or governing instruments, but losses are no worse than minimal. While

management may have the ability to achieve compliance, the number of

violations that exist, or the 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.

A rating of 4 indicates an institution with deficient compliance

practices in relation to the size and complexity of its fiduciary

activities. 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.

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

[[Page 54711]]

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. This 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 discretionary assets including

adequacy of documentation, committee review and approval, and a

system to review and approve exceptions.

<bullet> The use of quantitative tools 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 complex 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> The monitoring of changes in the composition of

fiduciary assets for trends and related risk exposure.

<bullet> The quality of investment research used in the

decision-making process and documentation of the research.

<bullet> The due diligence process for evaluating investment

advice received from vendors and/or brokers (including approved or

focus lists of securities).

<bullet> The due diligence process for reviewing and approving

brokers and/or counter parties used by the institution.

This rating may not be applicable for some institutions because

their operations do not include activities involving the management of

any discretionary assets. Functions of this type would include, but not

necessarily be limited to, directed agency relationships, securities

clearing, 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. However, this component

should be assigned when the institution provides investment advice,

even though it does not have discretion over the account assets. An

example of this type of activity would be where the institution selects

or recommends the menu of mutual funds offered to participant directed

401(k) plans.

Ratings. 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.

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.

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 significance as to generally pose a threat to the

interests of account beneficiaries. Asset management and risk

management practices generally need to be improved. An elevated level

of supervision is normally required.

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.

A rating of 5 represents critically deficient asset management

practices and a flagrant disregard of fiduciary duties. These practices

jeopardize the interests of account beneficiaries, subject the

institution to losses, and may pose a threat to the soundness of the

institution.

Dated: October 7, 1998

Keith J. Todd,

Executive Secretary, Federal Financial Institutions Examination

Council.

[FR Doc. 98-27328 Filed 10-9-98; 8:45 am]

BILLING CODE 6210-01-P 25%, 6720-01-P 25%, 6714-01-P 25%, 4810-33-P 25%