FDIC Federal Register Citations

[Federal Register: February 17, 1998 (Volume 63, Number 31)]

[Notices]

[Page 7802-7809]

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

[DOCID:fr17fe98-105]

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FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL

Uniform Interagency Trust Rating System

AGENCY: Federal Financial Institutions Examination Council.

ACTION: Notice and request for comment.

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SUMMARY: The Board of Governors of the Federal Reserve System (FRB),

the Federal Deposit Insurance Corporation (FDIC), the Office of the

Comptroller of the Currency (OCC), and the Office of Thrift Supervision

(OTS) (collectively referred to as the federal supervisory agencies),

under the auspices of the Federal Financial Institutions Examination

Council (FFIEC) request comment on proposed changes to the Uniform

Interagency Trust Rating System (UITRS), commonly referred to as the

trust rating system. The proposed revisions update the rating system to

reflect changes that have occurred in the fiduciary services industry

and in supervisory policies and procedures since the rating system was

first adopted in 1978. The proposed changes revise the numerical

ratings to conform to the language and tone of the Uniform Financial

Institution Rating System (UFIRS) rating definitions, commonly referred

to as the CAMELS rating system; reformat and clarify the component

rating descriptions; reorganize the account administration and

conflicts of interest components

[[Page 7803]]

into a new component addressing compliance; emphasize the quality of

risk management processes in each of the rating components,

particularly in the management component; add language in composite

rating definitions to parallel the proposed changes in the component

rating descriptions; and explicitly identify the risk types that are

considered in assigning component ratings. After reviewing public

comments, the FFIEC intends to make appropriate additional changes to

the revised UITRS, if necessary, and adopt a final trust rating system.

The term ``financial institution'' refers to those FDIC insured

depository institutions whose primary Federal supervisory agency is

represented on the FFIEC. Uninsured trust companies that are chartered

by the OCC, members of the Federal Reserve System, or subsidiaries of

registered bank holding companies or insured depository institutions

are also covered by this action.

DATES: Comments must be received by April 20, 1998.

ADDRESSES: Comments should be sent to Joe M. Cleaver, Executive

Secretary, Federal Financial Institutions Examination Council, 2100

Pennsylvania Avenue, NW, Suite 200, Washington, D.C. 20037 (Fax number:

(202) 634-6556). Comments will be available for public inspection

during regular business hours at the above address. Appointments to

inspect comments are encouraged and can be arranged by calling the

FFIEC at (202) 634-6526.

FOR FURTHER INFORMATION CONTACT:

FRB: William R. Stanley, Supervisory Trust Analyst, Specialized

Activities, (202) 452-2744, Division of Banking Supervision and

Regulation, Board of Governors of the Federal Reserve System, Mail Stop

407, 20th and C Streets, NW, Washington, D.C. 20551.

FDIC: John F. Harvey, Trust Review Examiner, (202) 898-6762,

Division of Supervision, Federal Deposit Insurance Corporation, Room

F2078, 550 17th Street, NW, Washington, D.C. 20429.

OCC: Laurie A. Edlund, National Bank Examiner, (202) 874-3828,

Division of Asset Management, Office of the Comptroller of the

Currency, 250 E Street, SW, Washington, D.C. 20219.

OTS: Larry A. Clark, Senior Manager, Compliance and Trust Programs,

(202) 906-5628, Gary C. Jackson, Program Analyst, (202) 906-5653,

Compliance Policy, Office of Thrift Supervision, 1700 G Street, NW,

Washington, D.C. 20552.

SUPPLEMENTARY INFORMATION:

Background Information

The UITRS is an internal supervisory examination rating system used

by the Federal supervisory agencies for evaluating the administration

of fiduciary activities of financial institutions and uninsured trust

companies on a uniform basis and for identifying those institutions

requiring special supervisory attention. The UITRS was adopted in 1978

by the OCC, FDIC and FRB, and in 1988 by the OTS, and is commonly

referred to as the trust rating system. Under the current UITRS, each

financial institution or trust company is assigned a composite rating

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

institution's fiduciary activities. These components address the

following: the capability of management; the adequacy of operations,

controls and audits; the management of fiduciary assets; the adequacy

of account administration practices; the adequacy of practices relating

to self dealing and conflicts of interest; and the quality and level of

earnings. Both the composite and component ratings are assigned on a 1

to 5 numerical scale. A 1 indicates the strongest performance and

management practices, and the least degree of supervisory concern,

while a 5 indicates the weakest performance and management practices

and, therefore, the highest degree of supervisory concern.

The composite rating reflects the overall condition of an

institution's fiduciary activities. The composite ratings are used by

the Federal supervisory agencies to monitor aggregate trends in the

overall administration of fiduciary activities.

The UITRS has proven to be an effective means for the Federal

supervisory agencies to determine the condition of an institution's

fiduciary activities. A number of changes, however, have occurred in

the fiduciary industry and in supervisory policies and procedures since

the rating system was first adopted. The FFIEC's Task Force on

Supervision has reviewed the existing rating system in light of these

industry trends. The Task Force has concluded that the current UITRS

framework continues to provide an effective vehicle for summarizing

conclusions about the condition of an institution's fiduciary

activities. As a result, the FFIEC proposes to retain the basic rating

framework, and the revised rating system will continue to assign a

composite rating based on an evaluation and rating of essential

components of an institution's fiduciary activities. However, the FFIEC

proposes certain enhancements to the rating system.

Discussion of Proposed Changes to the Rating System

1. Alignment of UITRS With UFIRS

The FFIEC is proposing changes to revise the definitions of the

composite and component ratings to align the UITRS rating definitions

with the language and tone of the UFIRS rating definitions. For

example, under the current UITRS a composite 3 rated trust department

is considered generally adequate, while under the UFIRS a composite 3

rated bank exhibits some degree of supervisory concern. The proposed

revision brings the UITRS in line with the language and tone of the

UFIRS.

2. Component Reorganization

The FFIEC is proposing the following changes to the UITRS

components:

(A) The current Account Administration and Conflicts of Interest

components will be eliminated. A new Compliance component will assess

an institution's compliance with the terms of governing instruments,

applicable laws and regulations, sound fiduciary principles, and

internal policies and procedures. The new component will address all

areas assessed in the current Account Administration and Conflicts of

Interest components. In addition, the new component will address

compliance with applicable laws, regulations, and internal policies and

procedures on a broader, institution-wide basis.

(B) While fiduciary earnings will be evaluated at all institutions,

a rating will only be required for those institutions which are

required to file Schedule E of the FFIEC 001 (institutions with more

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

companies). An earnings rating may or may not be required for non-

Schedule E filers, at the option of the Federal supervisory agency.

With this proposed change, the FFIEC recognizes that many small

institutions offer fiduciary services primarily as a service to their

community, with profitability being a secondary consideration.

3. Structure and Format

The FFIEC is proposing to enhance and clarify the component rating

descriptions by reformatting each component into three distinct

sections: (a) An introductory paragraph discussing in general terms the

areas to be considered when rating each component; (b) a bullet-style

listing of the specific evaluation factors to be

[[Page 7804]]

considered when assigning the component rating; and, (c) a brief

qualitative description of the five ratings grades that can be assigned

to a particular component.

4. Composite Rating Definitions

The FFIEC is proposing changes in the composite rating definitions

to parallel the changes in the component rating descriptions. Under the

FFIEC's proposal, the revised composite rating definitions would

contain an explicit reference to the quality of overall risk management

practices. The basic context of the existing composite rating

definitions is being retained. The composite rating would continue to

be based on a careful evaluation of an institution's fiduciary

management, operational and compliance performance.

5. Risk Management

The FFIEC is proposing that the revised rating system emphasize

risk management processes. Changes in the fiduciary services industry

have broadened the range of products and services offered and

accelerated the pace of transactions. These trends reinforce the

importance of institutions having sound risk management processes.

Accordingly, the revised rating system would contain language in each

of the components emphasizing the consideration of processes to

identify, measure, monitor and control risks.

6. Identification of Risk Types

The FFIEC is proposing that the types of risks associated with each

of the component ratings be explicitly identified. For example, the

proposed rating description for the Operations, Internal Controls, and

Audits notes that a primary consideration in assigning the component

rating is an assessment of the transaction risk associated with the

institution's fiduciary operating systems and internal controls.

However, all of the risks affecting fiduciary operations and internal

controls, including but not limited to reputation, strategic, and

compliance risks would also be considered.

Request for Comments

The FFIEC requests comment on the proposed revisions to the trust

rating system (``the proposal''). In addition, the FFIEC invites

comments on the following questions:

1. Does the proposal capture the essential risk areas of the

fiduciary services industry?

2. Does the proposed management component adequately assess the

quality of the board of directors' and management's oversight regarding

its fiduciary responsibility and its ability to identify and manage all

areas of risk involved in the exercise of its fiduciary powers?

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

from the proposal?

4. Are the definitions for the individual components and the

composite numerical ratings in the proposal consistent with the

language and tone of the UFIRS definitions?

Text of the Revised Uniform Interagency Trust Rating System

Uniform Interagency Trust Rating System

Introduction

The Uniform Interagency Trust Rating System (UITRS) was adopted on

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

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

Federal Reserve Board (FRB), and in 1988 by the Federal Home Loan Bank

Board, predecessor agency to the Office of Thrift Supervision (OTS).

Over the years, the UITRS has proven to be an effective internal

supervisory tool for evaluating the fiduciary activities of financial

institutions on a uniform basis and for identifying those institutions

requiring special attention or concern.

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

the Federal supervisory agencies' policies and procedures which have

prompted a review and revision of the 1978 rating system. The revisions

to the UITRS:

<bullet> Realign the UITRS rating definitions to bring them in line

with UFIRS;

<bullet> Reduce the component rating categories from six to five,

combining the Account Administration and Conflicts of Interest

components into a new Compliance component;

<bullet> Make the earnings rating optional, at the Federal

supervisory agency's discretion, for institutions not required to file

the FFIEC 001 Schedule E (institutions with total trust assets of more

than $100 million, and all non-deposit trust companies are required to

file Schedule E); and

<bullet> Explicitly refer to the quality of risk management

processes in the management component, and the identification of risk

elements within the composite and component rating definitions.

The revisions are intended to promote and complement efficient

examination processes. The revisions update the rating system but

retain the basic framework of the original rating system. Consequently,

the revised rating system will not result in additional regulatory

burden to institutions or require additional policies or processes.

The UITRS considers certain managerial, operational, financial and

compliance factors that are common to all institutions with fiduciary

activities. Under this system, the supervisory agencies endeavor to

ensure that all institutions with fiduciary activities are evaluated in

a comprehensive and uniform manner, and that supervisory attention is

appropriately focused on those institutions exhibiting weaknesses in

their fiduciary operations.

Overview

Under the proposed UITRS, the fiduciary activities of financial

institutions are assigned a composite rating based on an evaluation and

rating of five essential components of an institution's fiduciary

activities. These component factors address the following: the

capability of management; the adequacy of operations, controls and

audits; the quality and level of earnings; compliance with governing

instruments, applicable law, and sound fiduciary principles; and the

management of fiduciary assets. Evaluation of the components considers

the size and sophistication, the nature and complexity, and the risk

profile of the institution's fiduciary activities.

Composite and component ratings are assigned based on a 1 to 5

numerical scale. A 1 is the highest rating and indicates the strongest

performance and risk management practices and the least degree of

supervisory concern. A 5 is the lowest rating and indicates the weakest

performance and risk management practices and, therefore, the highest

degree of supervisory concern.

The composite rating generally bears a close relationship to the

component ratings assigned. However, the composite rating is not

derived by computing an arithmetic average of the component ratings.

Each component rating is based on a qualitative analysis of the factors

comprising that component and its interrelationship with the other

components. When assigning a composite rating, some components may be

given more weight than others depending on the situation at the

institution. In general, assignment of a composite rating may

incorporate any factor that bears significantly on the overall

administration of the financial institution's fiduciary activities.

Assigned composite and component ratings are disclosed to the

institution's

[[Page 7805]]

board of directors and senior management.

The ability of management to respond to changing circumstances and

to address the risks that may arise from changing business conditions,

or the initiation of new fiduciary activities or products, is an

important factor in evaluating an institution's overall fiduciary risk

profile and the level of supervisory attention warranted. For this

reason, the management component is given special consideration when

assigning a composite rating.

The ability of management to identify, measure, monitor, and

control the risks of its fiduciary operations is also taken into

account when assigning each component rating. It is recognized,

however, that appropriate management practices may vary considerably

among financial institutions, depending on the size, complexity and

risk profiles of their fiduciary activities. For less complex

institutions engaged solely in traditional fiduciary activities and

whose directors and senior managers are actively involved in the

oversight and management of day-to-day operations, relatively basic

management systems and controls may be adequate. On the other hand, at

more complex institutions, detailed and formal management systems and

controls are needed to address a broader range of activities and to

provide senior managers and directors with the information they need to

supervise day-to-day activities.

All institutions are expected to properly manage their risks. For

less complex institutions engaging in less risky activities, detailed

or highly formalized management systems and controls are not required

to receive strong or satisfactory component or composite ratings.

The following two sections contain the composite rating

definitions, and the descriptions and definitions for the five

component ratings.

Composite Ratings

Composite ratings are based on a careful evaluation of how an

institution conducts its fiduciary activities. The review encompasses

the capability of management, the soundness of policies and practices,

the quality of service rendered to the public, and the effect of

fiduciary activities upon the soundness of the institution. The five

key components used to assess an institution's fiduciary activities

are: the capability of management; the adequacy of operations, controls

and audits; the quality and level of earnings; compliance with

governing instruments, applicable law, and sound fiduciary principles;

and the management of fiduciary assets. The rating scale ranges from 1

to 5, with a rating of 1 indicating the strongest performance and risk

management practices relative to the size, complexity and risk profile

of the institution's fiduciary activities, and the least supervisory

concern. A 5 rating indicates the most critically deficient performance

and risk management practices relative to the size, complexity, and

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

greatest supervisory concern. The composite ratings are defined as

follows:

Composite 1. Administration of fiduciary activities is sound in

every respect and generally all components are rated 1 or 2. Any

weaknesses are minor and can be handled in a routine manner by

management. The institution is in substantial compliance with fiduciary

laws and regulations. Risk management practices are strong relative to

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

activities. Fiduciary activities are conducted in accordance with sound

fiduciary principles and give no cause for supervisory concern.

Composite 2. Administration of fiduciary activities is

fundamentally sound. Generally no component rating should be more

severe than 3. Only moderate weaknesses are present and are well within

management's capabilities and willingness to correct. Fiduciary

activities are conducted in substantial compliance with laws and

regulations. Overall risk management practices are satisfactory

relative to the institution's size, complexity, and risk profile. There

are no material supervisory concerns and, as a result, the supervisory

response is informal and limited.

Composite 3. Administration of fiduciary activities exhibits some

degree of supervisory concern in one or more of the component areas. A

combination of weaknesses exists that may range from moderate to

severe; however, the magnitude of the deficiencies generally does not

cause a component to be rated more severely than 4. Management may lack

the ability or willingness to effectively address weaknesses within

appropriate time frames. Additionally, fiduciary activities may be

conducted in significant noncompliance with laws and regulations. Risk

management practices may be less than satisfactory relative to the

institution's size, complexity, and risk profile. While problems of

relative significance may exist, they are not of such importance as to

pose a threat to the trust beneficiaries generally, or to the soundness

of the institution. The institution's fiduciary activities require more

than normal supervision and may include formal or informal enforcement

actions.

Composite 4. Fiduciary activities generally exhibit unsafe and

unsound practices or conditions, resulting in unsatisfactory

performance. The problems range from severe to critically deficient and

may be centered around inexperienced or inattentive management, weak or

dangerous operating practices, or an accumulation of unsatisfactory

features of lesser importance. The weaknesses and problems are not

being satisfactorily addressed or resolved by the board of directors

and management. There may be significant noncompliance with laws and

regulations. Risk management practices are generally unacceptable

relative to the size, complexity, and risk profile of fiduciary

activities. These problems pose a threat to the account beneficiaries

generally and, if left unchecked, could evolve into conditions that

could ultimately undermine the public confidence in the institution.

Close supervisory attention is required, which means, in most cases,

formal enforcement action is necessary to address the problems.

Composite 5. Fiduciary activities are conducted in an extremely

unsafe and unsound manner. Administration of fiduciary activities is

critically deficient in numerous major respects, with problems

resulting from incompetent or neglectful administration, flagrant and/

or repeated disregard for laws and regulations, or a willful departure

from sound fiduciary principles and practices. The volume and severity

of problems are beyond management's ability or willingness to control

or correct. Such conditions evidence a flagrant disregard for the

interests of the beneficiaries and may pose a serious threat to the

soundness of the institution. Continuous close supervisory attention is

warranted and may include termination of the institution's fiduciary

activities.

Component Ratings

Each of the component rating descriptions is divided into three

sections: a narrative description of the component; a list of the

principal factors used to evaluate that component; and a description of

each numerical rating for that component. Some of the evaluation

factors are reiterated under one or more of the other components to

reinforce the interrelationship among components. The listing of

evaluation factors is in no particular order of importance.

Management. This rating reflects the capability of the board of

directors and

[[Page 7806]]

management, in their respective roles, to identify, measure, monitor

and control the risks of an institution's fiduciary activities. It also

reflects their ability to ensure that the institution's fiduciary

activities are conducted in a safe and sound manner, and in compliance

with applicable laws and regulations. Directors should provide clear

guidance regarding acceptable risk exposure levels and ensure that

appropriate policies, procedures and practices are established and

followed. Senior fiduciary management is responsible for developing and

implementing policies, procedures and practices that translate the

board's objectives and risk limits into prudent operating standards.

Depending on the nature and scope of an institution's fiduciary

activities, management practices may need to address some or all of the

following risks: reputation, operating or transaction, strategic,

compliance, legal, credit, market, liquidity and other risks. Sound

management practices are demonstrated by: active oversight by the board

of directors and management; competent personnel; adequate policies,

processes, and controls that consider the size and complexity of the

institution's fiduciary activities; and effective risk monitoring and

management information systems. This rating should reflect the board's

and management's ability as it applies to all aspects of fiduciary

activities in which the institution is involved.

The management rating is based upon an assessment of the capability

and performance of management and the board of directors, including,

but not limited to, the following evaluation factors:

<bullet> The level and quality of oversight and support of

fiduciary activities by the board of directors and management,

including committee structure and adequate documentation of committee

actions.

<bullet> The ability of the board of directors and management, in

their respective roles, to plan for, and respond to, risks that may

arise from changing business conditions or the introduction of new

activities or products.

<bullet> The adequacy of, and conformance with, appropriate

internal policies, practices and controls addressing the operations and

risks of significant fiduciary activities.

<bullet> The accuracy, timeliness, and effectiveness of management

information and risk monitoring systems appropriate for the

institution's size, complexity, and fiduciary risk profile.

<bullet> Overall level of compliance with laws, regulations, and

sound fiduciary principles.

<bullet> Responsiveness to recommendations from auditors and

regulatory authorities.

<bullet> Strategic planning for fiduciary products and services.

<bullet> The level of experience and competence of fiduciary

management and staff, including issues relating to turnover and

succession planning.

<bullet> The availability of adequate insurance coverage.

<bullet> The availability of competent legal counsel.

<bullet> Extent and nature of pending litigation associated with

fiduciary activities, and its potential impact on earnings, capital,

and the institution's reputation.

<bullet> Process for identifying and responding to fiduciary

customer complaints.

Ratings.

1. A rating of 1 indicates strong performance by management and the

board of directors and strong risk management practices relative to the

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

activities. All significant risks are consistently and effectively

identified, measured, monitored, and controlled. Management and the

board have demonstrated the ability to promptly and successfully

address existing and potential problems and risks.

2. A rating of 2 indicates satisfactory management and board

performance and risk management practices relative to the size,

complexity and risk profile of the institution's fiduciary activities.

Minor weaknesses may exist, but are not material to the sound

administration of fiduciary activities, and are being addressed. In

general, significant risks and problems are effectively identified,

measured, monitored, and controlled.

3. A rating of 3 indicates management and board performance that

need improvement or risk management practices that are less than

satisfactory given the nature of the institution's fiduciary

activities. The capabilities of management or the board of directors

may be insufficient for the size, complexity or risk profile of the

institution's fiduciary activities. Problems and significant risks may

be inadequately identified, measured, monitored, or controlled.

4. A rating of 4 indicates deficient management and board

performance or risk management practices that are inadequate

considering the nature of an institution's fiduciary activities. The

level of problems and risk exposure is excessive. Problems and

significant risks are inadequately identified, measured, monitored, or

controlled and require immediate action by the board and management to

protect the assets of account beneficiaries and to prevent erosion of

public confidence in the institution. Replacing or strengthening

management or the board may be necessary.

5. A rating of 5 indicates critically deficient management and

board performance or risk management practices. Management and the

board of directors have not demonstrated the ability to correct

problems and implement appropriate risk management practices. Problems

and significant risks are inadequately identified, measured, monitored,

or controlled and now threaten the continued viability of the

institution or its administration of fiduciary activities as well as

posing a threat to the safety of the assets of account beneficiaries.

Replacing or strengthening management or the board of directors is

necessary.

Operations, Internal Controls & Auditing. This area encompasses the

department's operating systems and internal controls in relation to the

volume and character of business conducted. The adequacy of audit

coverage must assure the integrity of the financial records, the

sufficiency of internal controls, and the adequacy of the compliance

process.

The institution's fiduciary operating systems, internal controls,

and audit function subject it primarily to transaction and compliance

risk; however, other risks including reputation, strategic, and

financial may be present. The ability of management to identify,

measure, monitor and control these risks is reflected in this rating.

The operations, internal controls and auditing rating is based

upon, but not limited to, an assessment of the following evaluation

factors:

Operations and Internal Controls, including adequacy of:

<bullet> Staff, facilities and operating systems;

<bullet> Records, accounting and data processing systems (including

controls over systems access and such accounting procedures as aging,

investigation and disposition of items in suspense accounts);

<bullet> Trading functions and securities lending activities;

<bullet> Vault controls and securities movement;

<bullet> Segregation of duties;

<bullet> Controls over disbursements (checks or electronic) and

unissued securities;

[[Page 7807]]

<bullet> Controls over income processing activities;

<bullet> Reconciliation processes (depository, cash, vault, sub-

custodians, suspense accounts, etc.);

<bullet> Disaster and/or business recovery programs;

<bullet> Hold-mail procedures and controls over returned mail; and

<bullet> Investigation and proper escheatment of funds in dormant

accounts.

Auditing, including the:

<bullet> Independence, frequency, quality and scope of the internal

and external fiduciary audit function relative to the volume, character

and risk profile of the institution's fiduciary activities;

<bullet> Volume and/or severity of internal control and audit

exceptions and the extent to which these issues are tracked and

resolved; and

<bullet> Experience and competence of the audit staff.

Ratings.

1. A rating of 1 indicates that operations, internal controls, and

audits are strong. All significant risks are consistently and

effectively identified, measured, monitored, and controlled.

2. A rating of 2 indicates that while operations, internal controls

and audits are satisfactory, modest weaknesses may exist. These

weaknesses, however, are not material in nature and, in general, are

effectively identified, measured, monitored, and controlled.

3. A rating of 3 indicates that operations, internal controls and/

or auditing need improvement. One or more of these areas are less than

satisfactory. Problems and significant risks may be inadequately

identified, measured, monitored, or controlled.

4. A rating of 4 indicates deficient operations, internal controls

and/or audits in which one or more of these areas are inadequate or the

level of problems and risk exposure is excessive. Problems and

significant risks are inadequately identified, measured, monitored, or

controlled and require immediate action. Departments with this level of

deficiencies may make little provision for audits of any kind or may

evidence weak or potentially dangerous operating practices in

combination with infrequent or inadequate audits.

5. A rating of 5 indicates critically deficient operations,

internal controls and/or audits. Operating practices, with or without

audits, pose a serious threat to the safety of assets of fiduciary

accounts. Problems and significant risks are inadequately identified,

measured, monitored, or controlled and now threaten the ability of the

institution to continue engaging in fiduciary activities.

Earnings. This area includes an evaluation of the department's

profitability and its effect on the financial condition of the

institution. The use and adequacy of budgets and earnings projections

by functions, product lines and clients are reviewed and evaluated.

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

Earnings are evaluated at all fiduciary examinations. A rating for

the earnings component is assigned as follows:

<bullet> Mandatory Rating of Earnings. Earnings are rated at every

trust examination where the financial institution would, at the time of

the examination, be required to file Schedule E (Trust Income

Statement) of the FFIEC Annual Report of Trust Assets. Schedule E must

be completed by (1) each financial institution with more than $100

million in Total Trust Assets as reported on Schedule A, and (2) by all

non-deposit trust companies, whether or not they report any assets on

Schedule A.

<bullet> Optional Rating of Earnings. If an institution is not

required to file Schedule E of the FFIEC Annual Report of Trust Assets,

this component may be rated at the option of the examining agency and

in accordance with its implementing guidelines.

The earnings rating is based upon, but not limited to, an

assessment of the following evaluation factors:

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

thereof, generated by the institution's fiduciary activities.

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

as those for court accounts.

<bullet> Unusual features regarding the composition of business,

fee schedules and effects of charge-offs or compromise actions.

<bullet> Accounting practices which may contain unusual practices

such as (1) unusual methods of allocating direct and indirect expenses

and overhead and (2) methods of allocating fiduciary income and expense

where two or more fiduciary institutions within the same holding

company family share fiduciary services and/or processing functions.

<bullet> Extent of management's use of budgets, projections and

other cost analysis procedures.

<bullet> Methods used for directors' approval of financial budgets

and/or projections.

<bullet> Management's attitude toward growth and new business

development.

<bullet> New business development efforts, including types of

business solicited, market potential, advertising, competition,

relationships with local organizations, and an evaluation by management

of risk potential inherent in new business areas.

Ratings.

1. A rating of 1 indicates strong earnings. Strong earnings

generally mean five consecutive years of profitable net trust operating

income, in a volume reflecting the institution's size and type of

fiduciary services offered, with indications of continued profitable

operations. Earnings and future prospects are sufficient to support the

continuation of fiduciary activities without engaging in activities

that may result in risks or other factors that would affect the quality

and quantity of earnings. In addition, management makes effective use

of budgets and cost analysis procedures, such as earnings projections

by functions, product lines and clients. Methods used for reporting

such information to, as well as obtaining approvals from the board of

directors, or a committee thereof, are adequate.

2. A rating of 2 indicates satisfactory earnings. Satisfactory

earnings are generally indicated by profitable net trust operating

income in three of the past five consecutive years, with indications of

continued profitable operations. Management's use of budgets and

projections, and other cost analysis procedures, as well as the methods

used for directors' approvals of these financial reports, is generally

satisfactory for the size and complexity of the institution.

A 2 rating may also be assigned where there are five years of

profitable operations (which would normally warrant a 1 rating), if

there are indications that management is entering activities with which

it is not familiar, or where there may be inordinately high levels of

risk present that have not been adequately evaluated. As a result,

continuation of profitable operations is questionable.

Optional Rating of Earnings. In instances where the rating of trust

earnings is optional under these guidelines and the institution is not

generating positive earnings, or where information concerning this area

may not be available in a formal manner, a 2 rating may be assigned if

management has satisfactorily evaluated the positive effect of offering

of fiduciary services to the continued growth of the institution and

its overall earnings. However, management should, at a minimum, (a)

have a reasonable method for measuring income and expense commensurate

with the volume and nature of fiduciary services offered, (b) report

the level of profitability or operating losses to the board of

directors, or a committee thereof, at least annually, and (c) obtain

[[Page 7808]]

approval from the board of directors, or a committee thereof, for

offering fiduciary services. In these instances, the board of directors

may consider the lack of fiduciary profitability to be a cost of doing

business as a full service institution and believe the negative effects

of not offering fiduciary services are more significant than the

expense of administering those services.

3. A rating of 3 indicates less than satisfactory earnings, which

generally means inconsistent or marginally-profitable net trust

operating income over the past five consecutive years. A 3 rating may

also be assigned when operations are generally unprofitable, even if

gross income permits recovery of salary expenses. Over a five year

period, however, the department's earnings trend has shown less ability

to recover salary expense and projections do not indicate a reversal of

this trend. Management may not be making proper use of budgets and

projections, and other cost analysis procedures. Earnings accorded this

rating need to improve to fully support the institution's fiduciary

activities and provide for the associated risks.

Optional Rating of Earnings. In instances where the rating of trust

earnings is optional under these guidelines, this rating may be

assigned if management has a reasonable method for measuring trust

income and expense, but either fails to adequately (a) report the level

of profitability or operating losses to the board of directors, or a

committee thereof, at least annually, or (b) obtain approval from the

board of directors, or a committee thereof, for the offering of the

service. While management may have attempted to identify and quantify

collateral revenue to be earned by offering fiduciary services, it has

decided that these services should be offered as a community service,

even if they cannot be operated profitably.

4. A rating of 4 indicates earnings that are deficient, and do not

support fiduciary activities. Operating losses, when averaged over the

previous five year period, do not generally cover salary or other

direct expenses. In general, this would be indicated by unprofitable

net trust operating income in the past three consecutive years, with

indications of continued unprofitable operations. The five year trend

may indicate erratic fluctuations in net income, the development of a

significant negative trend, nominal earnings, unsustainable earnings,

intermittent losses or a substantial drop in earnings from the previous

year. Business volume and prospects suggest a continuation of this

trend. Budgets are either not used or not followed, and there is no

accountability for failing to adhere to financial targets. Reporting of

earnings information to the board of directors, or a committee thereof,

is inadequate, incomplete, or ineffective.

Optional Rating of Earnings. In instances where the rating of trust

earnings is optional under these guidelines, this rating may be

assigned if management has failed to adequately implement two of the

three minimum standards cited under Rating No. 2 above. Management has

undertaken little or no effort to identify or quantify the collateral

advantages, if any, to the institution from offering fiduciary

services.

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

general, this means unprofitable net trust operating income in the past

five consecutive years, with indications of continued unprofitable

operations. A trust department with this rating is experiencing losses

that have a significant negative impact on the overall earnings of the

institution and that may represent a distinct threat to its viability

through the erosion of its capital. Budgeting is likely to be

nonexistent and/or unrealistic and ineffective. The board of directors,

or a committee thereof, may not be aware of the condition and/or there

is no effective method to communicate such matters to the board on a

regular basis.

Optional Rating of Earnings. In instances where the rating of trust

earnings is optional under these guidelines, this rating may be

assigned if management has failed to adequately implement any of the

three minimum standards described under Rating No. 2 above.

Compliance. The compliance rating component covers an institution's

overall compliance with applicable laws, regulations, accepted

standards of fiduciary conduct, governing account instruments and

internally established policies and procedures. This component

specifically incorporates an assessment of a fiduciary's duty of

undivided loyalty and duties associated with account administration.

Risks associated with account administration are virtually

unlimited because each account is a separate contractual relationship

that contains specific obligations. Risks associated with account

administration include: failure to comply with applicable laws,

regulations or terms of the governing instrument; inadequate account

administration practices; and inexperienced management or inadequately

trained staff. Risks associated with a fiduciary's duty of undivided

loyalty generally stem from engaging in self-dealing or other conflict

of interest transactions. An institution is subject to compliance risk

and strategic risk related to account administration and conflicts of

interest activities. The ability of management to identify, measure,

monitor and control these risks is reflected in this rating. Policies,

procedures and practices pertaining to account administration and

conflicts of interest are evaluated in light of the size and character

of an institution's fiduciary business.

The compliance rating is based upon, but not limited to, an

assessment of the following evaluation factors:

<bullet> Applicable federal and state statutes and regulations,

including, but not limited to, federal and state fiduciary laws, the

Employee Retirement Income Security Act of 1974, federal and state

securities laws, state investment standards, state principal and income

acts, and state probate codes;

<bullet> Terms of governing instruments; and

<bullet> Internally established policies and procedures, including,

but not limited to, those addressing self-dealing and other conflicts

of interest, account administration, and asset (including cash)

management.

Ratings.

1. A rating of 1 indicates strong compliance policies, procedures

and practices. Policies and procedures covering conflicts of interest

and account administration are appropriate for the size and complexity

of the business. Accounts are administered in accordance with governing

instruments, applicable laws and regulations, sound fiduciary

principles, and internal policies and procedures. Any violations are

isolated, technical in nature and easily correctable. All significant

risks are consistently and effectively identified, measured, monitored

and controlled.

2. A rating of 2 indicates fundamentally sound compliance policies,

procedures and practices. Account administration may be flawed by

modest weaknesses in policies, procedures or practices. Management's

practices indicate a determination to minimize the instances of

conflicts of interest. Fiduciary activities are conducted in

substantial compliance with laws and regulations, and any violations

are generally technical in nature. Management corrects violations in a

timely manner and without loss to fiduciary accounts. Significant risks

are effectively identified, measured, monitored, and controlled.

3. A rating of 3 indicates compliance practices that are less than

satisfactory.

[[Page 7809]]

Policies, procedures and controls have not proven effective and may

require strengthening. Fiduciary activities may be in substantial

noncompliance with laws, regulations or governing instruments; however,

losses are minimal. Management may have the ability to effect

compliance; however, the number of violations that exist, or failure to

correct prior violations, are indications that management has not

devoted sufficient time and attention to its compliance

responsibilities. Risk management practices generally need improvement.

4. A rating of 4 indicates institutions with deficient compliance

practices. Account administration is notably deficient. The institution

makes little or no effort to minimize potential conflicts or refrain

from self dealing, and is confronted with a considerable number of

potential or actual conflicts. Numerous substantive and technical

violations of laws and regulations exist and many may remain

uncorrected from previous examinations. Management has not exerted

sufficient effort to effect compliance and may lack the ability to

effectively administer fiduciary activities. The level of compliance

problems is significant and, if left unchecked, may subject the

institution to monetary losses or reputation risk. Risks are

inadequately identified, measured, monitored and controlled.

5. A rating of 5 indicates critically deficient compliance

practices. Account administration is critically deficient or

incompetent and there is a flagrant disregard for the terms of the

governing instruments and interests of account beneficiaries. The

institution frequently engages in transactions that compromise its

fundamental duty of undivided loyalty to account beneficiaries. There

are flagrant or repeated violations of laws and regulations and

significant departures from sound fiduciary principles. Management is

unwilling or unable to operate within the scope of laws and regulations

or within the terms of governing instruments and efforts to obtain

voluntary compliance have been unsuccessful. The severity of

noncompliance presents an imminent monetary threat to account

beneficiaries and creates significant legal and financial exposure to

the institution. Problems and significant risks are inadequately

identified, measured, monitored, or controlled and now threaten the

ability of management to continue engaging in fiduciary activities.

Asset Management. The asset management rating reflects the risks

associated with managing the assets (including cash) of others. Prudent

portfolio management is based on an assessment of the needs and

objectives of each account or portfolio. An evaluation of asset

management should consider the adequacy of processes related to the

investment of all discretionary accounts and portfolios, including

collective investment funds, proprietary mutual funds, and investment

advisory arrangements.

The institution's asset management activities subject it to

reputation, compliance and strategic risks. In addition, each

individual account or portfolio managed by the institution is subject

to financial risks such as market, credit, liquidity, and interest rate

risk, as well as transaction and compliance risk. The ability of

management to identify, measure, monitor and control these risks is

reflected in this rating.

The asset management rating is based upon, but not limited to, an

assessment of the following evaluation factors:

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

governing asset management, considering the size, complexity and risk

profile of the institution's fiduciary activities.

<bullet> The decision making processes used for selection,

retention and preservation of fiduciary assets including adequacy of

documentation, committee review and approval, and a system to review

and approve exceptions.

<bullet> The use of quantitative tools used to measure the various

financial risks in investment accounts and portfolios.

<bullet> The existence of policies and procedures addressing the

use of derivatives or other unusual investment products.

<bullet> The adequacy of procedures related to the purchase or

retention of miscellaneous assets including real estate, notes, closely

held companies, limited partnerships, mineral interests, insurance and

other unique assets.

<bullet> The extent and adequacy of periodic reviews of investment

performance, taking into consideration the needs and objectives of each

account or portfolio.

<bullet> Monitoring of changes in the composition of fiduciary

assets for trends and related risk exposure.

<bullet> Quality of investment research used in the decision-making

process and documentation of the research.

<bullet> Due diligence process for evaluating investment advice

received from vendors and/or brokers (including approved or focus lists

of securities).

<bullet> Due diligence process for reviewing and approving brokers

and/or counter parties used.

This rating may not be applicable for some institutions because

their operations do not include activities involving the management of

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

necessarily be limited to clearing corporations or depositories,

directed agency relationships, security clearance, non-fiduciary

custody relationships, transfer agent and registrar activities. In

institutions of this type, the rating for Asset Management may be

omitted by the examiner in accordance with the examining agency's

implementing guidelines.

Ratings.

1. A rating of 1 indicates strong asset management practices.

Identified weaknesses are minor in nature. Risk exposure is modest in

relation to management's abilities and the size and complexity of the

assets managed.

2. A rating of 2 indicates satisfactory asset management practices.

Moderate weaknesses are present and are well within management's

ability and willingness to correct. Risk exposure is commensurate with

management's abilities and the size and complexity of the assets

managed. Supervisory response is limited.

3. A rating of 3 indicates that asset management practices are less

than satisfactory in relation to the size and complexity of the assets

managed. Weaknesses may range from moderate to severe; however, they

are not of such importance as to pose a threat to the interests of the

account beneficiaries generally. Asset management and risk management

practices generally need to be improved. An elevated level of

supervision is normally required.

4. A rating of 4 indicates deficient asset management practices in

relation to the size and complexity of the assets managed. The levels

of risk are significant and inadequately controlled. The problems pose

a threat to account beneficiaries generally, and if left unchecked, may

subject the institution to losses and could undermine the reputation of

the institution.

5. A rating of 5 represents critically deficient asset management

practices and a flagrant disregard of fiduciary duties. A continuation

of these practices jeopardizes the interests of the beneficiaries

generally, and may pose a threat to the soundness of the institution.

[End of Proposed Text of Uniform Interagency Trust Rating System]

Dated: February 10, 1998.

Joe M. Cleaver,

Executive Secretary, Federal Financial Institutions Examination

Council.

[FR Doc. 98-3802 Filed 2-13-98; 8:45 am]

BILLING CODE 6210-01-P, 6720-01-P, 6714-01-P, 4810-01-P