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Regulator Open Session - OCC

Joel Miller

Asset Management Group Leader

Office of the Comptroller of the Currency

April 29, 2009

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OCC – Asset Management Supervision Asset Management Risks

Focus on Market Disruption Issues Managing Asset Management Risk Asset Management Examination Focus Conclusions Appendix I: OCC Guidance

Presentation Overview

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OCC - Asset Management Supervision

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OCC Asset Mgt. Supervision OCC regulates 1600 national banks and 70

limited purpose trust companies Range from large complex banks with global

operations to community banks Approximately half of all national banks have

fiduciary, retail brokerage, investment banking or advisory activities.

About 150 OCC examiners with AM expertise perform on and off-site supervision.

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OCC Asset Mgt. Supervision

Supervision by Risk Objective: Assess a bank’s ability to identify,

measure and monitor risk Risk Assessment System (RAS) – For nine risk

categories, determine: Quantity of risk Quality level of risk management Direction

FFIEC: Uniform Ratings System (CAMELS) FFIEC: Uniform Interagency Trust Ratings System

(UITRS) – OCC focus: Composite Rating

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OCC Asset Mgt. Supervision Integrated risk-based supervision Large Banks: EIC/AM Team Leader Mid-size Banks: EIC/Functional EIC-AM Community Banks: Portfolio Manager/AM

Examiner Supported by five AM Lead Experts and

Washington based AM Policy Group

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Asset Management Risks

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Asset Management Risk Areas Broad Risk Categories - Asset Management

Activities Reputation Strategic Compliance Transaction (Operational)

CAMELS: Management & Earnings Market Disruption – Has highlighted these

risks, especially in certain products and activities

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Asset Management Risk Areas

Reputation and Litigation Risks Market disruption resulted in a substantial

decline in the market value of fiduciary assets across almost all asset classes. Discretionary (managed) accounts and employee

benefit accounts (e.g., 401-k), pose the greatest reputation and litigation risk to bank fiduciaries.

Clients reassessing which asset managers best weathered the storm and moving assets accordingly. Client retention a key focus.

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Asset Management Risk Areas

Valuation of assets in illiquid markets Accounting guidance (FAS 157) requires fair

value to represent current market conditions, but not the price that would be received in a forced or distressed sale.

Pricing services dropped coverage of illiquid securities and bank asset managers and custodians had to seek other pricing sources.

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Asset Management Earnings

Why Focus on AM Earnings? Effects Earnings/CAMELS Significant losses can erode Capital Market disruption

Firmwide high risk initiatives may be driven by earnings pressure

Effective risk management in AM needed to avoid taking on excessive risk to compensate for lost earnings

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Asset Management Risk Areas

Market Sensitive Earnings Decline Asset base and administrative fees contract as market

value of assets declines. Performance fees decline as many alternative

investment strategies have turned negative. Flight to quality – investor movement away from higher

profit margin business (equities) to lower margin cash/cash equivalents (MMMFs) – reduces management fees.

EB Defined Contribution Plans Fees effected by: Reductions in employer match reductions Reductions in employee contributions as a result of layoffs or

uncertainty

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Asset Management Revenue

AM revenue of $6.36 billion in 4Q08 comprised 25% of national banks’ non-interest income and 7% of operating income.

National Bank AM revenue by Call Report category: Fiduciary Revenue $3.6 billion Securities Brokerage Revenue $1.3 billion Annuity Sales Revenue $95 million Investment Banking, Advisory and Underwriting

Revenue $1.4 billion

Source: Call Report. Includes full-service national banks and limited-purpose national trust banks as of 12/31/08.

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Fiduciary Income Linked to Assets under Management Positive correlation between Fiduciary income

and S&P 500. Decline in equity markets = decrease in bank’s

AUM and income.

$2.00$2.50$3.00$3.50$4.00$4.50$5.00$5.50$6.00$6.50$7.00$7.50$8.00$8.50$9.00$9.50

$ B

illi

on

s

0

200

400

600

800

1,000

1,200

1,400

1,600

S &

P 5

00

Income $4.91 $5.25 $5.52 $5.63 $5.92 $6.19 $6.03 $5.87 $6.55 $6.43 $6.51 $6.63 $7.20 $6.78 $7.35 $6.84 $7.18 $7.50 $7.90 $7.40 $8.50 $8.50 $9.00 $8.20 $7.40

S&P 500 885 875 909 994 1,044 1,114 1,124 1,111 1,148 1,192 1,186 1,217 1,228 1,276 1,284 1,278 1,366 1,420 1,471 1,497 1,493 1,388 1,359 1,280 1,003

Dec-02

Mar-03

Jun-03

Sep-03

Dec-03

Mar-04

Jun-04

Sep-04

Dec-04

Mar-05

Jun-05

Sep-05

Dec-05

Mar-06

Jun-06

Sep-06

Dec-06

Mar-07

Jun-07

Sep-07

Dec-07

Mar-08

Jun-08

Sep-08

Dec-08

Source: Call Report. Includes all full-service commercial banks and limited-purpose national trust banks as of 12/31/08.

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Total Fiduciary & Custody Assets All Banks (2004 – 2008)

Total Fiduciary Assets - All Banks

$15.5 $16.1$17.3 $18.3

$20.0$21.8 $22.6 $22.9

$18.2

$0.0

$5.0

$10.0

$15.0

$20.0

$25.0

Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08

Trilli

on

Total Custody Assets - All Banks

$35.7 $36.5$42.3

$47.4 $50.4$57.8 $57.1

$50.3

$33.2

$0.0

$10.0

$20.0

$30.0

$40.0

$50.0

$60.0

$70.0

Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08

Trilli

on

Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks.

Growth in both fiduciary and custody assets leveled off by mid-year 2008, then dropped significantly by end of year.

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Asset Management Risk Areas

AM products and services impacted by ongoing Market Disruption Hedge Funds Securities Lending Auction Rate Securities Collective Investment Funds Money Market Mutual Funds/STIFs

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Asset Management Risk Areas Hedge Fund Issues

Most strategies performing poorly in current market Performance and client liquidity needs lead to increasing

redemption requests Which leads to gates raised/fund lock-ups Risks to bank fund managers.

Decline in earnings potential due to industry contraction Litigation risk Reputation risk

Banks are particularly vulnerable where they placed discretionary client assets in hedge funds and funds-of-funds that are now frozen or in liquidation.

Bank custodians also vulnerable as clients seek out deep pockets to indemnify their hedge fund losses.

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Madoff Fraud Direct and Indirect Exposures

Investments by individuals, foundations, endowments, and pension plans in Madoff “fund” – bank may be acting in a fiduciary capacity

Indirect investments in fund-of-funds that invest a percentage of their assets in a Madoff “fund”

Custodial relationships in which bank holds Madoff “fund” assets

Lending exposure to clients who invested in Madoff “fund.”

Asset Management Risk Areas

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Securities Lending Issues Once viewed as low risk by clients and banks Decline in value of sec-lending pools (e.g. Lehman,

AIG assets) holding reinvested cash collateral: Litigation and settlements Restrictions imposed on customers’ ability to withdraw

assets Many customers now unwilling to take on additional

risk and sec-lending opportunities dry up. For some banks, contraction has substantial decreased

sec-lending business and earnings Banks perceived to be stronger in sec-lending have

prospered in “flight to quality”.

Asset Management Risk Areas

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Asset Management Risk Areas Auction Rate Securities Issues

Regulatory actions - settlements with SEC, FINRA and state regulators that include buy-back schedules and CMPs.

Voluntary ARS buybacks undertaken to preempt litigation. Both voluntary and involuntary buy-backs can be costly

and saddle banks with illiquid securities with corresponding impact on bank earnings, capital and liquidity.

Capital support agreements extended to affiliated funds holding these illiquid securities to buy time and keep ARS off the bank’s books.

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Asset Management Risk Areas

Collective Investment Fund Issues Funds holding illiquid assets such as RE

facing flurry of redemption requests. Industry seeks to avoid liquidating fund assets at fire sale prices.

Expect issuance of new Labor Department regulation, or Congressional action, that will compel substantial new fee and conflict disclosures for employee benefit assets.

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National banks continue to be major players in offering collective investment funds. •66 NBs offer over 1,600 collective investment funds totaling $1.3 trillion.

Source: Call Report. Includes all national and state-chartered commercial banks and national trust banks.

Market Value of Collective Investment & Common Trust Funds Decline

$0.85 $0.90

$1.33

$1.51

$1.74

$2.01 $2.02

$1.30

$1.75$1.67

$2.29

$2.51

$2.68

$2.94 $3.00

$2.00

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

2001 2002 2003 2004 2005 2006 2007 2008

$ t

rill

ion

National Banks

All Banks

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Asset Management Risk Areas

MMMFs and Short Term CIF Issues Sponsors provide support to stabilize NAVs

or unit values. (SIVs, Lehman…) “Flight to safety” from Prime funds to

Treasury and Government funds. Low rates – waived fees Some funds closed or restricted

Government Support Programs

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Pledge Requirements – Reg 9.10

Enhanced FDIC insurance reduces trust pledge requirements: Coverage to $250,000 for certain retirement

accounts Coverage expanded for irrevocable trusts Temporary coverage increase from $100K to $250K

(through 12/31/09) for other accounts Temporary (through 12 /31/09) FDIC guarantee of

certain non-interest bearing accounts FDIC insurance pass-through guidance applies to

individual accounts held in covered non-interest bearing omnibus account.

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Employee Benefits Deposit Prohibition – Problem Banks Banks that are no longer “well capitalized”

or “adequately capitalized” are prohibited from accepting any employee benefit plan deposits. Federal Deposit Insurance Act as amended

in 2006 (12 USC 1821(a)(1)(D)(ii)) imposes this prohibition.

EB depositors still receive pass through coverage, but bank is in violation if it accepts EB deposits, including additions to existing accounts

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Managing Asset Management Risk

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Managing AM Risk Investment Management:

Adhere to prudent investment standards Maintain effective and ongoing due diligence

over external investment managers Maintain effective and ongoing due diligence

over complex and alternative investments Properly conduct and document investment

reviews

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Managing AM Risk Effective valuation policies and

oversight - Valuation of assets in illiquid markets Market disruption has made it difficult to

value suddenly illiquid assets Pricing services dropped coverage of

illiquid securities Accounting guidance (FAS 157) requires

fair value on audited financial statements Improper valuations have been a key

factor in disruption related litigation

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Managing AM Risk Operational Focus:

Potential increase in operating losses and trade errors associated with market volatility

Potential stress on bank controls, operations, and risk management resulting from expense reduction

Impact of loss of key personnel resulting from corporate-wide downsizing

Need for due diligence over sub-custodians as highlighted by recent fraud disclosures

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Asset Management Examination Focus

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Asset Management Risk Areas GLBA/Regulation R

Effective date for most banks - 1/1/09. Must ensure all securities activities conducted by a bank department, including the Treasury desk, comply with broker/dealer requirements.

Bankers need to look across all lines within the bank (e.g., asset management, capital markets and commercial) to ensure compliance with the new regulatory requirements.

Failure to comply could result in securities law violations and rescission of trades to the detriment of the bank.

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Recent OCC Issuances

Conflicts of Interest Associated with Divestiture of Asset Mgt. Affiliates OCC Bulletin 2008-5

Annual Reg 9 Reviews OCC Bulletin 2008-10 Expectations Automated vs. Manual Reviews Unique Assets

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AM Examination Observations Investments

Effective annual reviews Process/oversight Documentation/Exceptions

Understanding, due diligence and oversight of alternative investments (hedge funds)

Oversight of third party investment advisors Proper authorization for use of affiliated funds or

brokers Oversight of pricing for illiquid or thinly traded

assets

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AM Examination Observations

Account Administration and Compliance Inadequate Compliance/Risk Management

programs - testing Accepting direction from authorized parties EB administration/expertise Adequate/current policies and procedures Oversight of account overdrafts

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AM Examination Observations Operations/Internal Controls/Audit

Segregation of duties & dual control Controls over system access Corporate action processing automation BSA audit scope/trust activities Monitor 9.10 pledge requirements

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Conclusions

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Conclusions

Earnings Pressures/Effective Risk Management

Investment Management Due diligence/risks of complex investments

Back to Basics Investment oversight Account Administration Operations

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Appendix I:OCC Guidance

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OCC Asset ManagementHandbooks & Guidance Retirement Plan Services Collective Investment Funds Asset Management Conflicts of Interest Custody Services Investment Management Services Personal Fiduciary Services Retail Nondeposit Investment Sales Insurance Activities A Guide to the National Banking System

http://www.occ.treas.gov/nb/nbguide.pdf

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OCC Handbooks & Guidance OCC 2008–10, Fiduciary Activities of National Banks: Annual

Reviews of Fiduciary Accounts Pursuant to 12 CFR 9.6(c)

OCC 2008-5, Conflicts of Interest: Risk Management Guidance – Divestiture of Certain Asset Management Businesses

OCC 2007–42, Bank Securities Activities: SEC's and Federal Reserve's Final Regulation R

OCC 2007-21, Supervision of National Trust Banks: Revised Guidance: Capital and Liquidity

OCC 2007-7, Soft Dollar Guidance: Use of Commission Payments by Fiduciaries

OCC 2007-6, Registered Transfer Agents: Transfer Agent Registration, Annual Reporting, and Withdrawal from Registration

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OCC Handbooks & Guidance OCC 2006-24, Interagency Agreement on ERISA Referrals

OCC 2004-2, Banks/Thrifts Providing Financial Support to Funds Advised by the Banking Organization or its Affiliates

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QUESTIONS?

Contact:Joel Miller, (202) 874-4493

Joel.Miller@occ.treas.gov