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 95-43 (SRV)
August 7, 1995

TO THE OFFICER IN CHARGE OF SUPERVISION
          AT EACH FEDERAL RESERVE BANK


SUBJECT: Revised Bank Holding Company Surveillance Procedures

                        The purpose of this letter is to finalize revisions to the bank holding company (BHC) surveillance procedures effective with the June 1995 F.R. Y-9 results. These procedures supersede the procedures established by SR letter 89-31, dated December 21, 1989, and SR letter 94-47, dated August 22, 1994.  

Scope of Changes

                        Changes made to the Systemwide BHC surveillance program have been designed to meet the following objectives:

  • Incorporate SEER and CAMEL ratings into BHC surveillance program

    The SEER (System to Estimate Examination Ratings) rating model has been a primary tool for the Systemwide bank surveillance program for the past two years.  This model identifies, based upon the most recent Call Report data, banks that exhibit financial characteristics of those in lower-rated categories.

    As the condition of a consolidated holding company is typically highly correlated with the condition of its bank subsidiaries, the revised BHC surveillance procedures utilize both the off-site SEER ratings and on-site CAMEL ratings of bank subsidiaries to identify deteriorating holding companies.

  • Vary the number of exceptions based on condition of banking industry

    The financial exception criteria utilized by the BHC program since 1989 have been based on the relative percentile ranking of composite and parent-only performance ratios.  This rank-based approach has identified a relatively constant number of exceptions regardless of changing banking conditions.

    To achieve a BHC program that is more sensitive to changes in the condition of the banking industry, the revised financial criteria identify outliers based on either (a) a poor relative percentile ranking, or (b) absolute levels of key financial ratios that meet minimum benchmarks.

  • Incorporate supplemental screens into the BHC surveillance process

    A supplemental investment activities screen that identifies holding companies with high levels of unrealized securities depreciation relative to Tier 1 capital has been incorporated into the revised BHC surveillance program.   Additional supplemental criteria may include BHCs identified through growth screens, and screens based on the F.R. Y-11 nonbank reporting series.

  • Provide monitoring tool for BHCs with assets below $150 million

    By providing a comparison of bank subsidiary CAMEL/SEER rating results to BOPEC ratings for all BHCs, the revised program provides a mechanism to monitor the approximately 4,000 top-tier holding companies with assets below $150 million that were not previously covered by the Systemwide BHC surveillance program.  While written analyses will not be required for these companies, Reserve Bank and Board personnel responsible for these smaller BHCs will now be provided with a common surveillance tool to help prioritize which of these companies merit increased supervisory focus.  

  • Enhance quarterly communication with Reserve Bank surveillance staff

    The Board Surveillance Section will send a quarterly letter to all Reserve Banks to inform them of the most recent quarter's surveillance results, which may include notification that no exception BHCs were identified in your District.  This letter will also notify Reserve Banks that the surveillance cycle has begun, and when written analyses should be submitted to the Board.  

    A quarterly letter from Reserve Banks to the Surveillance Section is being established in order to provide Reserve Banks with a mechanism to report on BHCs not identified in the Board screening process, but whose condition has deteriorated significantly since the last inspection.  In addition, in cases where a written analysis is not required for an exception BHC, Reserve Banks should identify such BHCs in their quarterly letter, as discussed below.  


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Exception List Coverage

                        For the purpose of identifying exception list companies requiring follow-up analysis, the BHC surveillance program applies to top-tier holding companies which (a) file the F.R. Y-9C report; (b) have consolidated assets of $150 million or more; (c) have a composite BOPEC rating of 1, 2, or 3; (d) have not been designated as an "atypical" BHC by the responsible Reserve Bank; and (e) are not part of the top 50 population.

Quarterly BHC Surveillance Process

                        Quarterly BHC surveillance results will be provided to the Surveillance staff at each Reserve Bank within 5 business days following the finalization of F.R. Y-9 data.  Reserve Banks are requested to perform the following BHC surveillance procedures:

  • Review BHC condition

    Review each BHC in your District identified as an exception to determine if its condition appears to have worsened significantly since the company's last inspection.  (Criteria for the BHC exception list are presented in Appendix A.)

    As the revised BHC program requires written analyses for all companies identified as exceptions, subject to the limitations discussed below, Reserve Banks are no longer required to assign surveillance notations to BHCs meeting the exception criteria.  Reserve Banks may, however, choose to continue annotating companies for their internal use.  

  • Prepare written analysis

    Prepare a written analysis for bank holding companies on the exception list, as outlined in Appendix B.  

    Written analyses are to be submitted within 30 days following receipt of the BHC surveillance results to Marsha Reidhill, Manager of the Surveillance Section at the Board (Stop 153).  In some instances a targeted, on-site visitation/examination may be necessary to complete the written analysis for a BHC.  When the Reserve Bank determines that an on-site presence is warranted, the deadline for submitting the written analysis will be extended to 45 days following receipt of the exception list.  Ms. Reidhill should be notified within the 30-day deadline, however, with the names of the BHCs identified for a visitation/examination.  

    Reserve Banks are also encouraged to provide a written analysis in cases when a holding company's condition has been determined to have deteriorated significantly since its most recent inspection, but the company does not appear on the quarterly exception listing.  

    If the Reserve Bank has no BHCs appearing on the exception list and does not otherwise identify any deteriorating companies, it is requested to send a quarterly letter to the Board's Surveillance Section noting this fact within 30 days following receipt of the surveillance results.

  • Conditions for exemption from written analysis requirement

    If a written analysis has already been provided for an exception list BHC during one of the previous two quarters -- and there has been no meaningful change in the company's condition since this analysis -- it is not necessary to prepare an additional write-up.  In these instances the Reserve Bank should make reference to the prior analysis in its quarterly letter to the Surveillance Section, and provide an update on the status of the supervisory action or strategy outlined in the earlier analysis.

    In addition, if there is an open or completed inspection with the same as-of-date as the current surveillance cycle for an exception list BHC, a written analysis is not required if the scope of the inspection includes an analysis of the factors causing the BHC to be placed on the exception list.1 In these cases, the Reserve Bank should provide a statement in its quarterly letter as to whether or not the inspection includes such an analysis.  A written analysis is still required for surveillance purposes, however, if the inspection does not address the factors causing the BHC to be identified as an exception.  

    While surveillance results will be provided for the top 50 BHCs, a written analysis is not required for these organizations due to the high level of on-site activity and off-site monitoring already in place throughout the System.  

  • Written requirement for investment activities exceptions

    A written analysis is required for investment activities exceptions (as outlined in Appendix B, part 3(e)) when one or both of the following conditions apply: 1) the organization manages the investment process on a consolidated or global basis (i.e, the parent company or lead bank formulates and possibly implements the investment strategy for the parent company and bank subsidiaries); or 2) the majority of the organization's bank subsidiary assets are comprised of state member bank assets.   These conditions are included to address the supervisory constraints Reserve Banks face when dealing with bank subsidiaries that are not part of the Federal Reserve's regulatory jurisdiction.  

    If the above written requirement conditions do not apply, Reserve Banks are requested to provide a brief summary (Appendix B, part 3(f)) of the primary regulator's findings/actions with respect to the bank subsidiaries' investment activities.  This provision is intended to insure that the primary regulator is aware of potential concerns with subsidiary banks' investment activities, and also to insure that the BHC is acting as a source of strength to these particular bank subsidiaries.  If this information is not available from the primary regulator(s), Reserve Banks are asked to provide the names of these BHCs in their quarterly letter to the Surveillance Section.  

    Also, an investment activities analysis is not required for a BHC if the Reserve Bank is in the process of preparing or has provided (in one of the previous two quarters) an investment activities analysis for one of the BHC's state member bank subsidiaries.  This provision is intended to prevent duplication with the bank surveillance program.  If there are investment activity concerns at the parent company that differ significantly from the subsidiary bank's activities, however, the Reserve Bank should discuss these concerns in the quarterly letter to the Surveillance Section.  

  • Stock price exceptions and written requirement

    Stock price monitoring procedures, as outlined in SR letter 94-47, dated August 22, 1994, are being discontinued as part of this revised BHC program.  All Reserve Banks now have local Bloomberg terminals that allow for custom queries, daily monitoring of BHC stock prices, and easy comparison to the S&P banking industry index.  Because of these technological advances, Reserve Banks have the ability to track irregular stock price movements on a much more timely basis than once a quarter as part of the surveillance cycle.  Therefore, stock price monitoring procedures are being eliminated from the BHC surveillance program.  Reserve Banks are expected to continue monitoring stock prices of BHCs in their district, and may identify any BHC with irregular stock price movement as an exception during the regular surveillance process.

  • Atypical BHCs

    In order to improve data reliability and to identify institutions for assignment to the appropriate BHCPR (Bank Holding Company Performance Report) peer group, Reserve Banks should continue to identify atypical bank holding companies on an annual basis.  Atypical BHCs could include those whose parent equity in nonbank subsidiaries is one-third or more than their equity in bank subsidiaries; those that choose not to consolidate material nonbank subsidiaries; and those BHCs that are directly owned by banks.  BHCs may also be considered atypical due to other characteristics as determined at the Reserve Bank's discretion.

    Reserve Banks should annually submit a list of atypical BHCs to the Manager of Surveillance at the Board.  Submissions are due March 31 and should include atypical BHCs as of the previous December 31.  A letter should also be sent by the Reserve Bank in cases where no atypicals are identified.

    The atypical BHC list should provide (1) the name, location and RSSD ID of the company; (2) the reason why the BHC is considered atypical; and (3) whether the company was included on the list during the prior year.  BHCs coming off of the prior year's atypical listing should be similarly identified and discussed.

    Reserve Banks should monitor atypical bank holding companies on a quarterly basis, and provide a written analysis for an atypical company when deemed appropriate.  

                        If you should have any questions concerning any of the above, please contact Marsha Reidhill, Manager of the Surveillance Section, at (202) 452-2767 or Celeste Blackburn, Senior Financial Analyst in the Surveillance Section, at
(202) 736-1922.  


Stephen C. Schemering
Deputy Director


CROSS REFERENCE: Bank Holding Company Supervision Manual - Section 4080
SUPERSEDES: SR 89-31 (FIS), December 21, 1989
SR 94-47 (FIS), August 22, 1994


Appendix A


Federal Reserve System Bank Holding Company Surveillance Program
Exception List Criteria


        Three surveillance screens are used to identify quarterly exceptions for BOPEC 1-, 2- and 3-rated top-tier BHCs with consolidated assets of $150 million or greater that file the F.R. Y-9C report, as outlined below:

  1. Rating Screen

    The rating screen provides a comparison between the bank component ("B") in a BHC's BOPEC rating and the asset-weighted CAMEL and SEER ratings for the company's bank subsidiaries, and includes companies meeting the criteria below:

    Bank Component ("B") BOPEC Rating Weighted CAMEL Rating Or
    Weighted SEER Rating
    1 3 + 3 +
    2 3 + 3 +
    3 4 + 4 +

  2. Financial Screen

    The financial screen uses three consolidated ratios from the BHCPR (Appendix C), and identifies exceptions as companies that meet the cut-off criteria for at least two of these ratios.  There are two ways a company can qualify as an exception: (1) meet the minimum relative criteria for two of the ratios, indicating a BHC with a poor percentile ranking relative to its BHCPR peer group; or (2) meet the absolute criteria for two of the ratios, indicating a BHC with a low level of earnings or capital, or a high level of nonperforming assets.  Specific criteria are presented on the following page:  

      Last 4-Qtr Return on Avg. Assets Tier 1 Leverage Ratio Nonperforming & 90+ Days Past Due Ratio
    Peer Ranking Criteria Percentile of
    5 or less
    Percentile of
    5 or less
    Percentile
    of
    95 or more
    Ratio Level Criteria 0.5%
    or less
    5.0%
    or less
    5.0%
    or more

  3. Investment Activities Screen

    The investment activities screen identifies BHCs whose ratio of total unrealized securities depreciation (after-tax) to Tier 1 capital is -15 percent or worse; and whose leverage ratio, adjusted for total securities depreciation, is less than 5 percent.


Appendix B


Federal Reserve System Bank Holding Company Surveillance Program Supervisory Follow-up Requirements


                         The BHC surveillance program requires specific supervisory follow-up for companies appearing on the quarterly exception list (certain exemptions and conditions affect the written requirement).

                        In addition, Reserve Banks may choose to perform follow-up analysis in cases when a holding company's condition has deteriorated significantly since its most recent inspection, but the company does not appear on the quarterly exception listing.

                        The follow-up action consists of providing written documentation of the factors causing the BHC to appear on the exception list and recommending specific corrective action to key Reserve Bank staff responsible for inspection scheduling and staffing.

                        The written analysis is to include the following sections:

  1. Heading, including BHC's name, location, total assets, BOPEC rating and date of last inspection; lead bank name, location, charter, total assets, CAMEL rating and date of last examination; reason for appearance on exception list; and Reserve Bank analyst's name.  For investment activities exceptions, also include ratio of total securities depreciation to Tier 1 capital and the leverage ratio adjusted for total securities depreciation.

  2. Background, including a summary of prior surveillance results.  For investment activities exceptions, also include a brief summary of the investment process (i.e., who formulates and approves the investment strategy and how it is implemented for the organization).

  3. Analysis of current period's surveillance results, highlighting key changes in the BHC's condition during the most recent quarter and since the most recent inspection.  In particular, this analysis should explicitly discuss whether or not the factors identified as being responsible for the company's appearance on the exception list present any cause for supervisory concern.  Any areas where the current period's surveillance results are believed to be misleading or inaccurate should be detailed in this section.

    Additional guidance regarding the analysis section is provided below:

    1. The analysis should make note of any acquisitions, mergers or de novo activities responsible for the BHC meeting the exception criteria.

    2. For BHCs meeting the CAMEL rating exception criteria, the analysis should explicitly discuss the factors underlying the CAMEL rating as presented in the examination findings.  

    3. For BHCs meeting the SEER rating exception criteria, the analysis should explicitly discuss the factors responsible for the SEER results, as presented in SEER Schedule 1A.  

    4. For BHCs meeting the financial exception criteria, the analysis should explicitly discuss the ratios identified by the financial screen.  

    5. For BHCs requiring a written analysis of investment activities, include a discussion of:  

      • the securities portfolio composition and maturity;
      • investment strategy;    
      • management's ability to understand and manage the risks inherent in the investment portfolio, including a discussion of risk limits (e.g., are the limits appropriate and is the BHC in compliance with these limits);
      • the ability and intent to hold securities with unrealized losses, and any contingency plans if the ability to hold these securities is tested;
      • the susceptibility of the portfolio to further depreciation (quantify if possible);
      • hedging strategies, if any;
      • liquidity position of the BHC, including a discussion of the structure of the funding base and concentration of funding sources; and
      • overall impact of securities depreciation on the financial condition of the BHC.

    6. For BHCs failing the investment activities screen but not meeting the conditions requiring a written analysis of investment activities, provide a brief summary of the primary regulator's findings/actions with respect to the bank subsidiaries' investment activities.

  4. Conclusion, summarizing the BHC's condition and the key factors supporting the analysis.

  5. Corrective action, detailing supervisory follow-up actions resulting from the current period's surveillance results.  If no further actions are to be taken or recommended, state the reason for this decision and the date and scope of the next scheduled inspection.  

  6. Sign-off of an Officer in Charge of Bank Holding Company Supervision, and an Officer in Charge of Bank Holding Company Surveillance, and if there are any investment activities exceptions, a Capital Markets Coordinator.  It is sufficient for these signatures to appear once on the cover letter accompanying the individual BHC analyses.

Appendix C

Ratio Definitions for F.R. Y-9C Reporter Financial Screen


Composite BHC Financial Ratios (Used to Determine Exceptions)

LAST FOUR-QUARTER RETURN ON AVERAGE ASSETS:  (BHCPR Ratio SR856)

Net Income Over Last Four Quarters / Average Assets Over Last Four Quarters


TIER 1 LEVERAGE RATIO:  (BHCPR Ratio SR561)

Tier 1 Capital / Adjusted Average Assets


NONPERFORMING AND 90+ DAYS PAST DUE RATIO:  (BHCPR Ratio SR628)

(Nonaccrual and 90+ Days Past Due Loans and Leases + Real Estate Acquired) / (Total Loans and Leases + Real Estate Acquired)


Parent Company Financial Ratios (For Supplemental Information)

DOUBLE LEVERAGE:  (BHCPR Ratio SR183)

Equity Investment in Subsidiaries / Equity Capital


PARENT CASH FLOW:  (BHCPR Ratio SR188)

(Cash Flow From Operations + Noncash Items + Operating Expense) / (Operating Expense + Dividends)



Footnotes

1.  These factors include a rating screen (SEER and CAMEL ratings), a financial screen (capital, asset quality, and earnings), and an investment activities screen.  Return to text


SR letters | 1995