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Board of Governors of the Federal Reserve System

Supervision and Regulation Letters

SR 06-2

Enhancements to the System's Off-Site Bank Surveillance Program

February 2, 2006
Revised June 5, 2014

Seal of the Board of Governors of the Federal Reserve System
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C.  20551
DIVISION OF BANKING
SUPERVISION AND REGULATION
SR 06-2
February 2, 2006
Revised June 5, 2014

On June 5, 2014, this letter was revised to indicate that surveillance write-ups for Watch List banks are not required (in most cases) for institutions with a CAMELS composite rating of 4 or 5 or certain institutions with a CAMELS composite rating of 3. Previously, a surveillance write-up generally was required for each Watch List bank, with the exception of institutions subject to continuous supervision and its own write-up requirements. See the revised discussion under “State Member Bank Watch List Program” and revised footnote #3.
TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
SUBJECT:   Enhancements to the System's Off-Site Bank Surveillance Program
Since 1994, the Federal Reserve has used two econometric models jointly known as SEER or the System to Estimate Examination Ratings to monitor the condition and performance of state member banks.  These surveillance models have played an important role in the Federal Reserve's supervisory process, supporting risk-focused examinations by identifying changes in the financial condition of banks that warrant examiner review.  In the time since the System implemented these models, however, new banking laws and regulations, financial innovation, and changing business practices have substantially affected the activities of U.S. banks.  In addition, supervisory practices have evolved as the Federal Reserve has refined its risk-focused examination approach and increased its emphasis on the evaluation of risk identification and control processes at banking organizations.

Accordingly, in 2004 the Federal Reserve formed a working group to develop and recommend options for enhancing the econometric models used in the System's off-site surveillance programs.  The group's primary objective was to develop a modeling framework that improved upon the performance of the SEER models in identifying weak and potentially weak banks and that considered the effect of nontraditional activities on banking risk.  Other important areas of focus included designing supporting reports to clearly link model results to the primary areas of examination focus and developing training materials to ensure the most effective possible use of off-site model results.  Based on the recommendations of this group, the Federal Reserve is now replacing the SEER models with a new econometric framework referred to as the Supervision and Regulation Statistical Assessment of Bank Risk model or SR-SABR.  This change is being implemented using December 31, 2005 Call Report data.

This SR letter briefly describes the new model, details the screening thresholds for SR-SABR within the State Member Bank Watch List program, and updates Watch List follow-up procedures.  Most of the procedures adopted when the Watch List Program was implemented in 2000 will remain in place and are restated below.  Some Watch List procedures have been clarified to reflect experience gained with the Watch List process since 2000.

Supervision and Regulation Statistical Assessment of Bank Risk Model

The SR-SABR model assigns a two-component surveillance rating to each bank.  The first component is the current composite CAMELS rating assigned to the bank.  The second component is a letter (A, B, C, D, or F), reflecting the model's assessment of the relative strength or weakness of a bank compared to other institutions within the same CAMELS rating category.1   An SR-SABR rating that includes an "A" denotes a bank with particularly strong financial and supervisory indicators compared to other banks within its CAMELS rating category.  An SR-SABR rating including an "F" indicates that a bank is reporting poor financial results or showing other signs of significant weakness compared to similarly rated banks.  For example, a 1A rating signifies a 1-rated bank that reports strong financial and supervisory indicators when compared to all 1 and 2 rated banks, while a 1F indicates that, while the bank currently maintains the strongest possible composite CAMELS rating, its financial or other supervisory indicators place it among the weakest of the banks currently rated either 1 or 2.  SR-SABR ratings that include a "B" generally correspond to banks with financial and supervisory measures that are comparable to most banks in the CAMELS rating category.  Those with a "C" have weaker measures than those of most other banks in their CAMELS rating category and those with a "D" have significantly weaker financial or supervisory measures compared to other banks in their rating category.

Three separate econometric models contribute to SR-SABR surveillance ratings.  Two of the models estimate the probability of an adverse supervisory rating change for a bank if it was examined within the next quarter.  The first estimates the probability of an adverse rating change for banks currently rated CAMELS 1 or 2.  The second estimates the probability of an adverse rating change for banks currently rated 3, 4, or 5.2   Together these models are used to assign an "adverse change" rating.  They utilize seven financial variables computed using Call Report data and seven supervisory variables that have been statistically significant in explaining adverse ratings assigned over the past three years.  The third model is retained from the SEER framework and estimates the probability that a bank will fail or become critically undercapitalized within the next two years.  This model is referred to as the "viability" model and includes 11 financial variables computed using Call Report data.  It was estimated based on financial results for the large group of banks that failed in the late 1980s and early 1990s. 

For further information on SR-SABR, examiners and analysts should contact the designated Surveillance Contact at their respective Reserve Bank.  The Surveillance Resources page located on the Board's Division of Banking Supervision and Regulation intranet website also includes more detailed background information on SR-SABR.

State Member Bank Watch List Program

The Watch List program applies to all state member banks and includes both state member banks with known weaknesses and those with characteristics that could affect supervisory assessments of the quality of bank management or of the overall safety and soundness of a bank.  It helps to ensure that weaknesses existing at supervised banks are being addressed appropriately and that potential emerging problems can be promptly identified in between regularly scheduled on-site safety and soundness examinations.  With adoption of the SR-SABR model, state member banks are included on a Watch List when they meet any of the following criteria:

  • Overall SR-SABR surveillance rating of 1D, 1F, 2D, or 2F;
  • CAMELS composite rating of 3 or worse;
  • Management or Risk Management component rating of 3 or worse;
  • Composite rating in either of the worst two categories under the Trust, Information Technology, Consumer Compliance, or Community Reinvestment Act rating systems.

Reserve Banks and Board staff may also add state member banks to the Watch List for reasons other than those listed above.  For example, they may elect to include selected de novo banks, banks reporting rapid asset or loan growth or significant changes in business mix, and other institutions with financial characteristics that suggest the need for heightened off-site monitoring in between on-site examinations.

Quarterly Watch List Procedures

Board staff will notify Surveillance Contacts at each Reserve Bank when the preliminary quarterly Watch List is available (upon the finalization of quarterly Call Report processing).  To assist examiners and analysts in interpreting SR-SABR model results, Board staff will also notify Surveillance Contacts when SR-SABR Schedule of Risk Factors Reports (SRFs) are available in the Performance Report Information and Surveillance Monitoring (PRISM) application.  The SRFs highlight financial ratios which cause the model to flag a bank as particularly strong or weak.  These reports also include peer statistics to highlight the relative position of a bank compared to other institutions with similar CAMELS composite ratings.  In addition, supplemental monitoring screens will be available to assist in analyzing Watch List banks and in identifying other banks that may require additional supervisory attention.

Upon notification from Board staff that quarterly surveillance materials are ready for review, Reserve Banks should perform the following procedures:

  • Review and modify Watch List.

    Reserve Banks should review the preliminary Watch List and add any other state member banks from their districts that have significant safety and soundness weaknesses.  For each bank to be added, the Reserve Bank should submit the name, ID RSSD number, location, asset size, and the reasons for its inclusion by e-mail to the Manager of the Surveillance—Metric Systems Section at the Board within five business days of receiving the preliminary Watch List.  Reserve Banks may also recommend removal of banks that they have previously added to the Watch List and that no longer appear to warrant Watch List status.  In these cases, they should also provide a brief written rationale to Board staff for removing any banks from the Watch List.  Ten days after the distribution of the draft, the Watch List will be deemed final, and the timeframe for completing all follow-up work will commence.

  • Assess the financial condition and risk profile of each final Watch List bank.

    Reserve Banks should review each final Watch List bank in their districts to assess the bank's financial condition and risk profile.  Reserve Banks should consider recent examination findings for the bank and its affiliates, relevant information included in correspondence between the bank and the Reserve Bank, and other outside sources of information.  Reserve Banks should also use all appropriate surveillance tools in evaluating each bank, including the Uniform Bank Performance Report, results of the System Bank Monitoring Screens, Bank Holding Company Performance Reports, and System BHC Monitoring Screen results.

  • Determine whether the safety and soundness examination schedule should be accelerated for each Watch List bank.

    In cases where substantial deterioration in a bank's financial condition is evident or where a bank's risk profile has increased significantly, Reserve Banks should commence an on-site review of the bank no later than 60 days after the release of the final Watch List.  Unless an on-site examination has been completed within the last six months or the Reserve Bank can document that SR-SABR results do not reflect material safety and soundness concerns, Reserve Banks should generally accelerate examinations when a state member bank is assigned an SR-SABR rating of 1F, 2F, or 3F.  The scope of on-site reviews conducted for Watch List banks may vary, depending on the risk factors present and knowledge about the bank and its management.  In some cases, discussing the issues with management may suffice; in others, a full-scope safety and soundness examination may be necessary.

  • Prepare surveillance write-ups for Watch List banks, as applicable.

    No more than 30 days after receiving the quarter's final Watch List, Reserve Banks should document conclusions on the Watch List banks in a write-up posted to the System's Central Data and Text Repository (CDTR) using the Banking Organization National Desktop (BOND) application.3  Each write-up should be posted as a "State Member Bank Watch List Write-up" and assigned an "as of date" that corresponds to the quarterly surveillance cycle.  The write-ups should:

    • Briefly summarize the cause for a bank's appearance on the Watch List and assess whether it poses risks to the safety and soundness of the bank;
    • Detail the supervisory actions that have been taken in response to safety and soundness concerns;
    • Describe bank management's response to safety and soundness concerns;
    • Address whether the current CAMELS rating accurately reflects the bank's condition, considering adverse SR-SABR results, when applicable;
    • Assess whether the timing of the next safety and soundness examination should be accelerated; and,
    • Describe the Reserve Bank's plans for addressing any safety and soundness issues over the next quarter.

    For state member banks that have been included on the Watch List in the prior quarter, write-ups should focus on new developments or changes in the condition or performance of the bank.  Key background information, however, should be carried forward so that the write-up serves as a stand-alone summary document of the bank's current condition and prospects for improvement.  For Watch List banks not subject to a write-up requirement, Reserve Banks should continue to review surveillance results with a focus on determining whether there is a need to alter supervisory strategy (for example, accelerate the next examination).

Questions about these procedures should be directed to the following staff in the Surveillance—Metric Systems Section: Matt Mattson, Manager, at (202) 452-2943; or Elizabeth Perez, Supervisory Financial Analyst, at (202) 452-2214.

signed by
Richard Spillenkothen
Director
Division of Banking
Supervision and Regulation


Supersedes:
SR Letter 00-7, “System Bank Watch List Program”
 
Notes:
  1. For banks currently rated 1 or 2, CAMELS rating category refers to all banks with satisfactory (1 or 2) CAMELS ratings.  Banks with less than satisfactory CAMELS ratings are compared only to other banks with the same CAMELS rating. Return to text
  2. For 5 rated banks, an adverse rating change is defined as the continuation of the current rating.  Return to text
  3. In general, Reserve Banks should create a separate quarterly Watch List document for each bank on the Watch List that meets any of the following criteria: SR-SABR rating of 1D, 1F, 2D, 2F, 3D or 3F; Management or Risk Management rating of 3 or worse coupled with CAMELS composite rating of 1 or 2; flagged specialty examination rating; or discretionary Watch List placement.  Institutions with a CAMELS composite rating of 4 or 5 are monitored through separate procedures.  Similarly, quarterly Watch List documents generally are not necessary for banks with an SR-SABR rating of 3A, 3B, or 3C, as problems have been identified, and further deterioration is not strongly indicated.  An exception to the above framework is that separate quarterly Watch List documents are not required for bank subsidiaries of banking organizations subject to continuous supervision and its own quarterly write-ups.  In such cases, the factors required for a quarterly Watch List write-up, if applicable, may be addressed within the standard quarterly documentation posted to the CDTR, as part of the continuous supervision process.  Reserve Bank Surveillance Contacts should notify the Manager of the Surveillance—Metric Systems Section of the specific CDTR documents addressing these requirements.    Return to text
Last update: June 5, 2014