[Federal Register Volume 63, Number 230 (Tuesday, December 1, 1998)]
[Notices]
[Pages 66351-66375]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-31672]
Federal Register / Vol. 63, No. 230 / Tuesday, December 1, 1998 /
Notices
[[Page 66351]]
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DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
[No. 98-117]
Financial Management Policies
AGENCY: Office of Thrift Supervision.
ACTION: Notice of final thrift bulletin.
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SUMMARY: The Office of Thrift Supervision (OTS) is adopting Thrift
Bulletin 13a, which provides guidance on the management of interest
rate risk, investment securities, and derivatives activities. The
Bulletin also describes the guidelines OTS examiners will use in
assigning the ``Sensitivity to Market Risk'' component rating under the
Uniform Financial Institutions Rating System.
EFFECTIVE DATE: December 1, 1998.
FOR FURTHER INFORMATION CONTACT: Ed Irmler, Senior Project Manager,
(202) 906-5730 or Anthony G. Cornyn, Director, Risk Management
Division, (202) 906-5727, Office of Thrift Supervision.
SUPPLEMENTARY INFORMATION: The Office of Thrift Supervision is today
adopting the attached document, Thrift Bulletin 13a (TB 13a),
Management of Interest Rate Risk, Investment Securities, and
Derivatives Activities. This Bulletin provides guidance on a wide range
of topics in the area of interest rate risk management, including
several on which the Federal Financial Institutions Examination Council
(FFIEC) has issued related guidance. OTS believes that adoption of this
Bulletin will simultaneously improve its supervision of interest rate
risk management and reduce regulatory burden on thrift institutions.
The Bulletin updates OTS's minimum standards for thrift
institutions' interest rate risk management practices with regard to
board-approved risk limits and interest rate risk measurement systems.
The guidance in this Bulletin, thus, replaces Thrift Bulletin 13
(Responsibilities of the Board of Directors and Management with Regard
to Interest Rate Risk), Thrift Bulletin 13-1 (Implementation of Thrift
Bulletin 13), and Thrift Bulletin 13-2 (Implementation of Thrift
Bulletin 13). The Bulletin makes several significant changes. First,
under TB 13a, institutions no longer set board-approved limits or
provide measurements for the plus and minus 400 basis point interest
rate scenarios prescribed by the original TB 13. The Bulletin also
changes the form in which those limits should be expressed. Second, the
Bulletin provides guidance on how OTS will assess the prudence of an
institution's risk limits. Third, the Bulletin raises the size
threshold above which institutions should calculate their own estimates
of the interest rate sensitivity of Net Portfolio Value (NPV) from $500
million to $1 billion in assets. Fourth, the Bulletin specifies a set
of desirable features that an institution's risk measurement
methodology should utilize. Finally, the Bulletin provides an extensive
discussion of ``sound practices'' for interest rate risk management.
TB 13a also contains guidance on thrifts' investment and
derivatives activities. As described in the FFIEC's Supervisory
Statement on Investment Securities and End-User Derivative Activities,
(FFIEC Policy Statement), 1 the FFIEC-member agencies have
discontinued use of the three-part test for suitability of investment
securities. Accordingly, the Bulletin describes the types of analysis
institutions should perform prior to purchasing securities or financial
derivatives. The Bulletin also provides guidelines on the use of
certain types of securities and financial derivatives for purposes
other than reducing portfolio risk. The final regulation on financial
derivatives, published elsewhere in this issue of the Federal Register,
as supplemented by the guidance in this final TB 13a, replaces existing
regulations governing futures (12 CFR 563.173), forward commitments (12
CFR 563.174), and options (12 CFR 563.175). TB 13a also replaces
guidance contained in Thrift Bulletin 52 (Supervisory Statement of
Policy on Securities Activities), Thrift Bulletin 52-1 (``Mismatched''
Floating Rate CMOs), and Thrift Bulletin 65 (Structured Notes).
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\1\ 63 FR 20191 (April 23, 1998).
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Finally, TB 13a provides detailed guidelines for implementing part
of the Notice announcing the revision of the Uniform Financial
Institutions Rating System (i.e., the CAMELS rating system), published
by the FFIEC. 2 That publication announced revised
interagency policies, that among other things, established the
Sensitivity to Market Risk component rating (the ``S'' rating). TB 13a
provides quantitative guidelines for an initial assessment of an
institution's level of interest rate risk. Examiners have broad
discretion in implementing those guidelines. It also provides
guidelines concerning the factors examiners consider in assessing the
quality of an institution's risk management systems and procedures.
Guidance on the topic of assigning the ``S'' rating is largely new,
though TB 13a replaces the rather limited guidelines contained in New
Directions Bulletin 95-10.
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\2\ 61 FR 67021 (December 19, 1996).
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Differences Between Proposed and Final Versions of TB 13a
On April 23, 1998, OTS published a proposed TB 13a. 3
The content of the final TB 13a is, in most respects, the same as the
proposed TB 13a. Two significant changes were made, however, in
response to comment letters.
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\3\ 63 FR 20257 (April 23, 1998).
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1. Guidelines for Assessing the Level of Risk
The guidelines examiners will use to initially assess the level of
interest rate risk at an institution, for purposes of assigning the
Sensitivity to Market Risk (``S'') component rating were contained in a
matrix shown as Table 1 in the proposed TB. Based on comments received
and on further analysis, OTS has decided to revise those guidelines.
The revised guidelines are contained in Part IV.A.3 of TB 13a. A
comparison of the ratings that are likely to result from the final
guidelines with those from the proposed guidelines is contained in Part
1.d of the discussion of comments, below.
2. Transactions in Financial Derivatives or Complex Securities that Do
Not Reduce Risk
Part III.A.3 of the proposed TB stated that the use of financial
derivatives or complex securities with high price sensitivity should
generally be limited to transactions that lower an institution's
interest rate risk. An institution using such instruments for purposes
other than reducing portfolio risk should do so in accordance with safe
and sound practices and:
(a) Obtain written authorization from its board of directors to use
such instruments for a purpose other than to reduce risk; and
(b) Ensure that, after the proposed transaction(s), the
institution's Post-shock NPV Ratio would not be less than 6 percent.
As a result of comments received, OTS has decided to reduce the 6
percent threshold in condition (b), above, to 4 percent. The reasons
for this change are discussed below in Part 3.g of the discussion of
comments.
Summary of Comments
The comment period ended on June 22, 1998. OTS received twenty-
seven comments. Commenters included: twenty savings associations, five
trade associations, one law firm, and one
[[Page 66352]]
registered investment adviser. Furthermore, OTS met with
representatives of several institutions and an industry trade group to
discuss the proposed TB. The following summary identifies and discusses
the major issues raised in the comment letters and OTS's responses to
the issues.
1. General Issues
a. Coordination With Banking Agencies
Several commenters argued that OTS should coordinate the TB with
guidance issued by the other banking agencies. A number suggested that
OTS should adopt the guidance that the other federal banking agencies
have adopted with respect to the management of both interest rate risk
and investment and derivatives activities.
As a member of the FFIEC, OTS works closely with the other banking
agencies on the coordination of supervisory policies. When appropriate,
OTS and the other members of the FFIEC adopt uniform
policies.4 At the same time, the members of the FFIEC
recognize that it is not possible to achieve uniformity in all areas of
supervision and regulation. OTS's supervisory efforts have, since at
least the mid-1980s, placed more emphasis on interest rate risk than
have other regulators. This difference in emphasis reflects the nature
of the thrift industry's basic business which has historically given
thrift institutions a propensity toward maturity mismatching. OTS has
utilized the economic value concept (as described in the proposed TB)
to measure interest rate risk since the adoption of the original TB 13
in 1989. The guidelines described in the proposed TB do not represent
so much a new initiative to be coordinated with the other agencies, as
an attempt to update and improve consistency across OTS-regulated
institutions in the application of OTS's existing approach to assessing
interest rate risk.
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\4\ See Section 303 of the Riegle Community Development and
Regulatory Improvement Act of 1994. Pub.L. 103-325 (September 25,
1994).
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The proposed guidelines for investment securities and financial
derivatives are more detailed than those published in the FFIEC Policy
Statement, but are completely consistent with that policy statement.
OTS believes the added level of detail in its guidelines will be
helpful to examiners and will result in greater consistency of
application. OTS also believes the level of detail will be helpful to
institutions, not because OTS has a desire to ``micromanage'' those
institutions, but because OTS wants to reduce needless uncertainty
about how to interpret the guidance and how examiners will apply it.
b. Competitive Equity
A number of commenters argued that thrifts would be harmed
competitively because other financial institutions do not have
comparable guidelines, with respect to either the acquisition of
securities and derivatives or the ``S'' rating. This is not a valid
criticism. The purpose of TB 13a is two-fold: (1) to provide guidance
to thrift institutions on the management of interest rate risk,
including investment and derivative activities, and (2) to describe the
framework that OTS examiners will use in assigning the ``S'' rating
component. Both the proposed guidelines on the management of interest
rate risk and the framework for assigning ``S'' ratings are consistent
with guidelines issued by the other federal banking agencies. The only
significant constraint in the guidelines is on the ability of a small
fraction of the thrift industry to acquire financial derivatives and
some volatile securities for purposes other than reducing market risk.
This aspect of the guidelines is appropriate, as the limitation applies
only to those institutions least able to bear additional risk.
Comparing the fairness of ``S'' ratings at OTS-regulated
institutions with those at other institutions is not a straightforward
exercise because of the typically higher levels of interest rate risk
that one might expect at thrifts. As stated earlier, the proposed
guidelines for the ``S'' rating do not so much reflect a new approach
in the way OTS assesses interest rate risk but rather provide
quantitative guidance to examiners in applying the current assessment
process. Thrifts have competed successfully under that process for a
number of years. Moreover, it is highly unlikely that the guidelines
would result in harsher ``S'' ratings than OTS examiners have assigned
historically. Available evidence (see section 1.d below) indicates that
the opposite might occur.
c. De Facto Capital Requirement
A number of commenters asserted that the proposed guidelines for
assigning the ``S'' rating would create a de facto higher capital
requirement. This criticism is not valid for several reasons. First,
the proposed TB reflects the concept that institutions with higher
levels of capital should have greater freedom to engage in risk-taking.
Thus, for a given amount of interest rate risk--as indicated by the
Sensitivity Measure--institutions with higher Post-shock NPV Ratios
receive better ``S'' components ratings under the guidelines (see
Glossary in TB 13a for definitions of these terms). The fact that
examiners also assign a capital adequacy (i.e., ``C'') component rating
to the institution under the CAMELS rating system does not undermine
the validity of this approach for gauging the level of risk. If capital
appears to be ``double counted'' with this approach to assigning the S
rating, it is only because capital adequacy--the ability to absorb
unexpected losses--is central to evaluating an institution's safety and
soundness.
Second, the CAMELS rating system explicitly calls for consideration
of an institution's capital position in assessing the ``S'' component
rating. For example, the description of the 2 rating says in part :
``The level of earnings and capital provide adequate support for the
degree of market risk taken by the institution [emphasis added].'' \5\
Moreover, other risk assessments under the CAMELS rating system also
consider capitalization. For example, the rating level of 1 of the
asset quality (``A'') component rating is described in the interagency
document as: ``A rating of 1 indicates strong asset quality and credit
administration practices. Identified weaknesses are minor in nature and
risk exposure is modest in relation to capital protection and
management's abilities . . . [emphasis added].'' \6\
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\5\ 61 FR at 67029.
\6\ 61 FR at 67027.
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Third, unlike a regulatory minimum capital requirement, the
guidelines do not establish a minimum level of capital. There are only
two ways in which an institution can achieve compliance with a
regulatory minimum capital requirement--raise additional capital or
shrink the asset base. Under the guidelines, however, institutions have
the third option of reducing the level of interest rate risk in their
portfolio. Even institutions with very low Post-shock NPV Ratios can
receive ratings of 1 or 2 if their level of interest rate risk is also
very low.
Finally, even if one subscribes to the view that the guidelines are
a form of capital requirement, it is doubtful that the guidelines would
require generally higher capital requirements for the industry because
overall CAMELS ratings are unlikely to change, as will be discussed in
section 1.d, below.
Several commenters argued that the guidelines would create
incentives to take additional credit risk. Some institutions that
anticipate receiving a lower ``S'' rating under the proposed guidelines
might choose to reduce
[[Page 66353]]
interest rate risk, while simultaneously increasing credit risk to
maintain profitability levels. Determining the tradeoff between these
two types of risk is not new, however, it is a normal part of the
business of running a depository institution. The institution must
decide for itself what it will do, subject to safety and soundness
considerations.
Several commenters claimed that the guidelines would disadvantage
``traditional'' portfolio lenders that concentrate on making fixed-rate
mortgage loans. Some institutions that concentrate on fixed-rate
mortgages are highly interest rate sensitive and are, therefore, more
prone to receiving a poor ``S'' rating. Nonetheless, many such
institutions would fare quite well under the proposed guidelines
because they maintain relatively high levels of economic capital (NPV),
mitigating the high sensitivity. Other alternatives available to such
an institution are to reduce the extent of the maturity mismatch by
adjusting their product mix or to engage in hedging activities.
Another commenter suggested that OTS should not revise TV 13 at
this time because interest rates have been relatively stable. The
present time offers an ideal opportunity to adopt the proposed changes.
Establishing sound regulatory policies is most difficult during times
of stress or when the industry is unhealthy, because even good policies
may exacerbate problems in some segments of the industry. Today's
industry is stronger than it has been in years, interest rates have
been generally falling, earnings have been solid, the industry is well-
capitalized, and the number of problem institutions is very low. This
is an ideal environment in which to revise sound interest rate risk
guidelines.
d. Anticipated Impact of Guidelines
Table 1, in Part IV.A.3 of the proposed TB, was a matrix containing
the guidelines OTS proposed to use in initially assessing the Level of
Interest Rate Risk in determining the ``S'' component rating. Many
commenters were concerned that those proposed guidelines would
adversely affect the ``S'' component ratings of the industry. Several
commenters urged OTS to review empirical evidence on how institutions
would be affected by the guidelines before adopting the proposal. OTS
did analyze how institutions might be rated under the proposed
guidelines. A summary of this analysis is shown in the table below.
BILLING CODE 6720-01-P
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[GRAPHIC] [TIFF OMITTED] TN01DE98.004
BILLING CODE 6720-01-C
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The first row of the table shows the distribution of the actual
``S'' component ratings assigned during the most recent examination
cycle. About one-third of all institutions received an ``S'' rating of
1 at their most recent examination. More than half received a rating of
2.
The second row shows what the distribution would have been if those
same component ratings had been determined by applying the Proposed
Rating Guidelines in a totally mechanical way (i.e., with no
consideration for the quality of risk management practices, using the
NPV data available at the time of each institution's examination).
Although the proportion of institutions with ``S'' ratings of 3
increased (from 10% of all institutions to 14%), the ratings of many
more institutions improved than worsened under this simple analysis.
These results, however, omit the effect of the examiner's assessment of
the institution's risk management practices.
Table 2, in Part III.C of the proposed TB, described how various
combinations of Level of Interest Rate Risk and Quality of Risk
Management Practices would likely translate into different ratings for
the ``S'' component. The third row of the table here shows the ratings
distribution that would have occurred had the guidelines in Tables 1
and 2 of the proposed TB both been applied mechanically--and had
examiners assessed each institution's Quality of Risk Management
Practices to be of identical quality as the actual Management (``M'')
component rating assigned the institution. The ratings in this row are
significantly harsher than those in the previous row. In fact, they
overstate considerably the amount by which the ratings would worsen
from the previous row. An institution's ``M'' rating is often
downgraded for reasons other than concerns about its interest rate risk
management practices (e.g., asset quality problems, credit underwriting
deficiencies, etc.). Consequently, the ratings that result from using
the ``M'' component rating as a proxy for an examiner's qualitative
assessment of an institution's risk management practices will be overly
severe. If the guidelines in Tables 1 and 2 of the proposed TB had
actually been applied, the proportions of the industry receiving each
``S'' rating would probably have fallen between the proportions shown
in the second and third rows of the table. While broadly similar to the
``S'' ratings actually assigned, it is likely they would have resulted
in somewhat greater numbers of 3 and 4 ratings than were actually
assigned.
After considering the comments and the updated analysis, OTS has
decided to adopt a less stringent set of guidelines for assessing the
level of risk (see Table 1 in the final TB). The remaining two rows of
the table above show how these ``Final Rating Guidelines'' compare with
the actual ``S'' ratings and with the ``Proposed Rating Guidelines.''
The reasons for this change are as follows.
The current ``S'' ratings reflect the evaluation of experienced OTS
examiners. OTS believes that, in the aggregate, its examiners'
conclusions appropriately characterize the current distribution of risk
and risk management practices in the thrift industry. The purpose of
the guidelines is to provide examiners with a common starting point for
assessing an individual institution's sensitivity to interest rate
risk. This, in turn, should help produce more consistent ratings. While
individual institutions' ratings may change as examiners use their
discretion in applying these guidelines, OTS believes the overall
distribution of ratings will likely remain the same.
Consequently, the choice between the two sets of rating guidelines
was based on two factors. First, during the last examination cycle, the
Final Rating Guidelines would have produced more 1 ratings than the
Proposed Rating Guidelines, but would have produced fewer 3 ratings. A
high proportion of 1 ratings might raise ratings expectations of some
institutions that may be unfounded because of examiner concerns with
risk management practices, but this disparity is not a major flaw in
the guidelines. Whether the ``S'' component rating turns out to be a 1
or 2 rarely has a significant effect on the outcome of the overall
examination.
The second factor, the difference in the 3 ratings assigned under
the two sets of rating guidelines, has a greater potential to
substantively affect an institution because it heightens the
possibility that a composite rating of 3 or worse may be assigned.
Absent any consideration of the institution's risk management
practices, the Proposed Rating Guidelines would have resulted in about
15% of OTS thrifts receiving ratings of 3 or worse. In fact, only about
11% of thrifts received ratings of 3 or worse. This suggests that the
Proposed Rating Guidelines might be too harsh, particularly when
qualitative assessments are factored in. The Final Rating Guidelines
would, by themselves, have assigned ratings of 3 or worse to only about
7% of institutions. With the effects of the qualitative assessments
factored in, that proportion might well have increased, but it likely
would have been closer to the proportion of 3s and 4s actually assigned
(11%) than would have been the case under the Proposed Rating
Guidelines. On that basis, the Final Rating Guidelines are preferable.
2. Legal Status of TB 13a and Interest Rate Risk Capital Component
Regulation
OTS received comments regarding the legal status of Thrift Bulletin
13a and the future of the interest rate risk component of the risk
based capital requirement. OTS has addressed these issues in its final
rule on financial derivatives, published elsewhere in today's issue of
the Federal Register.
3. Comments Pertaining to Specific Parts of Proposed TB 13a
a. Limits on Change in NPV
One commenter criticized the two exhibits in Part II.A.1 of the
proposed TB. These exhibits illustrated the interest rate risk limits a
board of directors might establish. The commenter argued that the
exhibits were unrealistically conservative and should be revised to
portray a more typical institution. OTS has decided the exhibits and
much of the accompanying discussion are unnecessary. The final Bulletin
replaces the two exhibits with a simple discussion of how a board might
choose to specify its limits.
b. Prudence of IRR Limits
As described in Part II.A.3 of the proposed TB, an institution's
interest rate risk limits generally will not be considered prudent if
the limits permit NPV ratios that would ordinarily be considered to be
of ``Significant Risk'' or to warrant an ``S'' rating of 3 or worse.
Several commenters objected that this approach is too restrictive of
the board's choices.
OTS has decided to retain this approach for several reasons. First,
it is no more restrictive than the guidelines contained in Table 1 for
assessing the level of interest rate risk (discussed above). Moreover,
this approach is a reasonable basis for assessing board limits and is
consistent with the measurement approach used throughout the TB. If the
board permits a level of risk that would ordinarily be considered
``Significant'' based on OTS's rating guidelines, it would be
inconsistent for OTS to consider those limits to be sufficiently
conservative. The final TB, however, emphasizes that this evaluation is
not a simple pass-or-fail judgment, and, moreover, that it is just one
factor in the examiner's qualitative assessment.
[[Page 66356]]
c. Revision of IRR Limits
Another commenter criticized the discussion in Part II.A.4 of the
proposed TB regarding revisions to a board's interest rate risk limits.
The commenter argued that this discussion imposed unnecessary
``micromanagement'' on the industry. This section addresses the
practice of revising board limits to accommodate existing violations of
previously set limits. This practice is generally inappropriate, has
occurred too frequently at some institutions, and may be indicative of
deficiencies in board oversight. Explicit discussion of such practices
should reduce their incidence.
d. Interest Rate Sensitivity of NPV for Institutions Above $1 Billion
in Assets
Under Part II.B.2 of the proposed TB, institutions with more than
$1 billion in assets would be expected to determine their own NPV
measures. Several commenters recommended that OTS, like the FFIEC,
accept any reasonable model for measuring risk, not just NPV models.
For internal management purposes, institutions are free to use whatever
risk measurement systems they find most useful. However, from a
regulatory perspective, NPV measurements provide a valuable
characterization of an institution's interest rate risk. NPV provides a
consistent measure that considers all future cash flows expected to
result from all on- and off-balance sheet financial instruments, while
also considering embedded options. NPV, thus, provides the agency with
a yardstick against which risk at any thrift may be measured and
compared with that of other institutions. For that reason, OTS collects
financial data that permits it to calculate NPV for all institutions
over $300 million, and many under that size. These NPV estimates are,
however, necessarily based on generic assumptions regarding such
factors as prepayment rates and deposit decay rates. Because of the
importance of ensuring the safety and soundness of large institutions,
OTS believes large institutions should have the means of improving
these regulatory measures and be able to accurately measure NPV
internally, taking into account the institution's individual
characteristics.
Rather than expecting institutions to calculate NPV even if they do
not use it as a management tool, one commenter recommended that OTS
should simply provide such institutions with the OTS NPV results.
However, large institutions have already incurred the cost of
establishing an NPV measurement system based on the guidelines in
Thrift Bulletin 13, published in January 1989. As there will be some
ongoing costs of maintaining that system, OTS did consider exempting
some large institutions from internal NPV modeling. OTS agrees with the
other FFIEC agencies, however, that large, sophisticated institutions
should be capable of measuring the economic value of equity and
assessing their interest rate sensitivity. Accordingly, OTS has not
changed this guideline.
One commenter argued that institutions with internal models should
not have to file Schedule CMR, which provides the financial data used
by the OTS Model. OTS believes there is value in collecting such data
and calculating the OTS NPV estimates even for institutions that also
calculate their own. Any two models will seldom produce exactly the
same results because of differences in their calculation methodologies,
factual data inputs, or assumptions. Hence, the two sets of results may
be used to provide a check on one another. The cost of filing Schedule
CMR for an institution that maintains a sophisticated measurement
system of its own should be minimal. Further, this process permits the
production of peer group comparisons, which provide useful information
for OTS and for boards of directors. No change is being made to the CMR
filing requirements.
e. Investment Securities and Financial Derivatives
Several commenters stated that the proposed guidelines for
investment securities and derivatives in Part III of the proposed TB
are not necessary, and that OTS should adopt the FFIEC Policy Statement
without modification. In issuing that Statement, OTS and the other
agencies recognized that the guidance contained in the FFIEC Policy
Statement might not be sufficient for the purposes of each agency. In
fact, the FFIEC Policy states that, ``Each agency may issue additional
guidance to assist institutions in the implementation of the
statement.'' 7 This language provides the member agencies,
including OTS, with the ability to issue more detailed guidance on
securities and derivatives activities, including guidance on pre-
purchase analysis and stress testing.
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\7\ 63 FR 20191.
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While the FFIEC Policy Statement provides sound guidance on
investment securities and end-user derivatives activities, OTS
determined it would be desirable to explain to the industry how it will
interpret and implement the FFIEC Policy Statement, particularly in
those areas where some additional clarification or specificity is
needed. Accordingly, OTS has decided to use TB 13a to implement the
FFIEC Policy Statement.
f. Analysis and Stress Testing
Several commenters objected to the guidance in Part III.A of the
proposed TB addressing pre-purchase analysis and stress testing of
complex securities and financial derivatives. These commenters also
stated that such guidance conflicts with, or is more onerous than, the
FFIEC Policy Statement. The commenters also asserted that the OTS
guidance would place OTS-supervised institutions at a competitive
disadvantage vis-a-vis non-OTS-supervised institutions.
The FFIEC Policy Statement states that institutions should conduct
a pre-purchase analysis for ``complex instruments, less familiar
instruments, and potentially volatile instruments.'' 8 (The
FFIEC Policy Statement does not define the terms ``complex
instruments,'' ``less familiar instruments,'' or ``potentially volatile
instruments.'') The FFIEC Policy Statement states that:
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\8\ 63 FR at 20195.
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For relatively more complex instruments, less familiar instruments,
and potentially volatile instruments, institutions should fully address
pre-purchase analyses in their policies. Price sensitivity analysis is
an effective way to perform the pre-purchase analysis of individual
instruments. For example, a pre-purchase analysis should show the
impact of an immediate parallel shift in the yield curve of plus and
minus 100, 200, and 300 basis points. Where appropriate, such analysis
should encompass a wider range of scenarios, including non-parallel
changes in the yield curve. A comprehensive analysis may also take into
account other relevant factors, such as changes in interest rate
volatility and changes in credit spreads.9
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\9\ 63 FR at 20195.
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Some commenters may have interpreted this statement to mean that a
pre-purchase analysis showing the price impact of parallel shifts in
the yield curve of plus and minus 100, 200, and 300 basis points is not
expected for complex securities and derivatives. OTS, however,
disagrees with that interpretation. Management should understand the
price sensitivities of investments and derivatives prior to their
acquisition. Moreover, the pre-purchase analysis guidance in the
proposed TB is consistent with the FFIEC Policy Statement. This
guidance
[[Page 66357]]
is designed to foster sound investment practice and should not
disadvantage savings associations vis-a-vis other depository
institutions.
Several commenters indicated that the proposed guidelines for
analyzing/testing securities and derivatives are too detailed and go
beyond the guidance in the FFIEC Policy Statement. OTS has concluded
that the detail in the proposed guidelines is appropriate and is
consistent with the FFIEC Policy Statement.
One commenter stated that the guidelines for analyzing/testing
securities and derivatives should focus only on the plus and minus 200
basis point scenarios. There is considerable benefit to be derived from
evaluating potential investment and derivative transactions in the
context of several alternative scenarios. The advantage of conducting
multiple scenario analysis is that decision-makers will consider
environments that they might otherwise ignore. Moreover, as shown in
the portion of the FFIEC Policy Statement quoted above, OTS and the
other members of the FFIEC agree that the stress testing of securities
and derivatives should not be limited to the plus and minus 200 basis
point rate scenario.
g. Limitation on Transactions Involving Derivatives and Complex
Securities With High Price Sensitivity
A number of commenters criticized Part III.A.3 of the proposed TB
on transactions involving derivatives and complex securities with high
price sensitivity. Under the proposal, an institution should not engage
in a ``risk increasing transaction'' involving derivatives or complex
securities with high price sensitivity if the transaction would cause
the institution's Post-shock NPV Ratio to fall below 6 percent.
One commenter stated that the 6 percent threshold is not needed
because guidelines calling for self-imposed risk limits will serve the
purpose of constraining excessive risk taking. Another commenter noted
that the 6 percent threshold is problematic because some hedging
transactions may reduce risk in some--but not all--interest rate
scenarios. One commenter noted that the threshold may discourage
transactions where the incremental increase in risk may be
insignificant. Another commenter noted that the proposed 6 percent
limitation is more onerous that the former FFIEC ``high-risk test,''
which was recently eliminated.
Upon reconsideration, OTS has concluded that the proposed 6 percent
threshold may be too restrictive, particularly in light of the other
safeguards in the TB. For example, board-approved interest rate risk
limits should discourage institutions from engaging in risk-increasing
transactions that would cause their institution's Post-shock NPV Ratio
to fall to a low level. Moreover, if an institution intends to use
derivatives or complex securities with high price sensitivity for
purposes other than reducing market risk, it should obtain the prior
approval of its board of directors. In addition, the examiner guidance
for assigning ``S'' ratings should discourage institutions with
relatively low Post-shock NPV Ratios from using such instruments for
non-risk-reducing purposes. Accordingly, OTS is lowering the 6 percent
threshold to 4 percent in the final Thrift Bulletin 13a. Under the
guidelines for the ``S'' rating, institutions with less than a 4
percent Post-shock NPV Ratio will typically receive adverse ratings
unless they have very low interest rate sensitivity. In general, the
use of financial derivatives or complex securities with high price
sensitivity should be limited to transactions that lower an
institution's interest rate risk.
h. Significant Transactions
Several commenters objected to guidance, in Part III.A.1 of the
proposed TB, that institutions should conduct a pre-purchase portfolio
sensitivity analysis for any ``significant transaction'' involving
securities or financial derivatives. Under the proposed guidelines, a
significant transaction is defined as any transaction that might
reasonably be expected to increase an institution's Sensitivity Measure
by more than 25 basis points. The definition of a ``significant
transaction,'' was intended to provide a wide ``safe harbor'' for
savings associations by limiting the number of transactions subject to
the incremental portfolio analysis. Very few transactions are likely to
be large enough to meet the 25 basis point test.
Several commenters noted that by defining a ``significant
transaction'' in quantitative terms, OTS might encourage institutions
to circumvent the guidance for pre-purchase analysis by entering into a
series of smaller transactions. One commenter noted that the FFIEC
Policy Statement is silent on what is a significant transaction and
indicated that the definition should be left to management. The FFIEC
Policy states, ``When the incremental effect of an investment position
is likely to have a significant effect on the risk profile of the
institution, it is a sound practice to analyze the effect of such a
position on the overall financial condition of the institution.''
10 Another commenter suggested that the definition of
``significant'' transaction should vary depending on an institution's
financial condition and management sophistication.
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\10\ 63 FR at 20195.
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Although some institutions might enter into smaller transactions to
avoid the proposed guidance on incremental portfolio analysis,
institutions would have little to gain by doing so. It is clearly in an
institution's self-interest to understand how significant transactions
might alter its overall interest rate sensitivity. Moreover, while few
transactions meet the proposed 25 basis point threshold, the analysis
called for by the guidelines should not be a burden to well-run
institutions that have adequate risk monitoring systems in place.
The suggestion that the definition of ``significant'' should vary
with the financial condition and management sophistication of the
institution is reasonable and is consistent with OTS's risk-based
approach to supervision. In this instance, however, OTS believes that
it is more beneficial to provide certainty by adopting a simple rule of
thumb under which incremental portfolio analyses would be expected only
relatively infrequently. Accordingly, OTS has decided to retain the 25
basis point threshold for defining a significant transaction.
i. Definition of Complex Securities
Several commenters criticized the proposed definition of a
``complex security'' in Part III.A of the proposed TB. Several
commenters also noted that identifying selected types of complex
securities for special analysis is inconsistent with the FFIEC Policy
Statement, which did not define the term. A few respondents argued that
the term should be left undefined, fearing that an explicit definition
would discourage thrifts from buying complex securities because such
securities might be viewed negatively by examiners.
OTS and the other members of the FFIEC agree that ``complex
securities'' require more analysis than non-complex securities. The
FFIEC Policy states: ``For relatively more complex instruments, less
familiar instruments, and potentially volatile instruments,
institutions should fully address pre-purchase analysis in their
policies.'' 11 OTS recognizes that the proposed definition
of a ``complex security'' is imprecise. Nevertheless, we believe the
definition will provide guidance and
[[Page 66358]]
will avoid--or at least reduce--disagreements between examiners and
thrift management.
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\11\ 63 FR at 20195.
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Some commenters thought that the proposed definition of a ``complex
security'' was overly broad. Others noted that the proposed definition
included securities that few would consider to be truly complex and
excluded others--such as mortgage-pass-through-securities--that are
actually highly complex. As defined in proposed TB 13a, the term
``complex security'' includes any collateralized mortgage obligation,
real estate mortgage conduit, callable mortgage-pass through security,
stripped-mortgage-backed-security, structured note, and any security
not meeting the definition of an ``exempt security.'' An ``exempt
security'' includes: (1) standard mortgage-pass-through securities, (2)
non-callable, fixed rate securities, and (3) non-callable floating rate
securities whose interest rate is (a) not leveraged (i.e., not based on
a multiple of the index), and (b) at least 400 basis points from the
lifetime rate cap at the time of purchase.
While OTS recognizes that the proposed definition is imperfect and
that certain securities that would be classified as ``complex'' under
the proposed definition, such as ``plain vanilla'' CMO tranches, are
viewed as non-complex securities by some market participants, OTS
doubts that attempts to develop a highly refined definition of a
complex security would be well received. Accordingly, OTS has decided
to leave the proposed definition of a complex security substantially
intact. However, OTS is simplifying the definition of an ``exempt
security.'' Under the modified definition, an ``exempt security''
includes non-callable, ``plain vanilla'' instruments of the following
types: (1) mortgage-pass-through securities, (2) fixed-rate securities,
and (3) floating rate securities.
j. Overemphasis on Price Sensitivity
One respondent suggested that the guidelines for pre-purchase
analysis in the proposed TB should focus on earnings sensitivity and
total return analysis, not just on price sensitivity. OTS agrees that
institutions should not focus on price sensitivity to the exclusion of
other relevant considerations. Accordingly, the final Bulletin has been
modified to stress the importance of taking other factors, such as
total return, into account in conducting pre-purchase analysis.
k. Use of Dealer/Issuer Information
One commenter suggested that Part III.A.1 of the proposed TB be
modified to permit the use of dealer/issuer information in conducting
pre-purchase analysis. The FFIEC Policy states that institutions should
conduct their own in-house pre-acquisition analysis, or to the extent
possible, make use of specific third party analyses that are
independent of the seller or counterparty. Similarly, the proposed TB
states that an institution may rely on an analysis conducted by an
independent third party (i.e., someone other than the seller or
counterparty), provided management understands the analysis and its key
assumptions. Nothing in the FFIEC Policy or TB 13a prohibits an
institution from using information provided by a dealer or issuer;
however, both caution against relying solely on dealer/issuer generated
analysis for pre-purchase analysis.
l. Assessing the Level of Interest Rate Risk
Several commenters objected to the guidelines for determining the
level of interest rate risk, in Part IV.A of the proposed TB.
Commenters argued that NPV is a liquidation model that is not relevant
for a going concern. As defined in the proposed TB, NPV does not
attempt to account for the effects of all future actions by an
institution (e.g., reinvestment decisions, business growth, strategy
changes, etc.). As such, it may technically be considered a liquidation
analysis, but that does not diminish its relevance for ``going
concerns.'' Mutual funds are going concerns, yet their net asset value
is clearly of interest to shareholders. Borrowers may be viewed as
going concerns, yet their net worth is of interest to lenders. A
depository institution's NPV represents the major part of its total
economic value and is, therefore, of concern to both shareholders and
regulators. Furthermore, the value of existing holdings is subject to
less uncertainty than other components of an institution's economic
value, such as the net value of possible future business, the
measurement of which relies on a host of assumptions beyond those
necessary to calculate NPV.
Many commenters argued that the proposed guidelines relied too
heavily on the OTS Model. Most institutions do not have a means of
calculating NPV internally. For those that do, the TB permits examiners
to use internal results in lieu of the results of the OTS Model. The
degree of reliance the examiner will place on the institution's model
is a matter of judgment. It will depend on many factors, including the
perceived quality of the institution's model, the quality of the data
and assumptions used to drive it, and how well the examiner believes
the OTS Model fits the circumstances at the institution. If an
institution has no internal model, or uses an unacceptable method of
calculation, OTS will place primary reliance on the OTS Model to
measure interest rate risk. This is appropriate because it provides
examiners with a means of assessing the level of IRR of all
institutions using a single, objective, standard of measure.
A number of commenters argued that the proposed guidelines are too
focused on NPV, rather than on earnings. Though the proposed TB
encourages institutions to have a means of calculating the interest
rate sensitivity of their projected earnings, NPV provides a superior
measure for regulatory purposes. NPV sensitivity considers all
projected cash flows from all financial instruments and contracts to
which an institution is currently a party. Earnings measures do not
take adequate account of the significant customer options that are
often embedded in financial instruments. Earnings measures also
typically are relatively short-term in nature--most often just 1 to 3
years of future earnings are projected. Earnings measures may, thus,
ignore net cash flows farther in the future, where serious earnings
shortfalls might occur.
Many commenters argued that the proposed guidelines place too much
emphasis on capital, which is already separately evaluated by
examiners. As discussed above, the TB relies strongly on the concept
that institutions with higher levels of economic capital should have
greater freedom to engage in risk-taking. Thus, for a given amount of
interest rate risk--as indicated by the Sensitivity Measure--
institutions with higher Post-shock NPV Ratios receive better ``S''
component ratings under the guidelines in Table 1. The fact that
examiners also assign a capital adequacy (i.e., ``C'') component rating
to the institution does not change the validity of this approach to
gauging the level of risk. If capital appears to be ``double counted''
by this approach, it is only because capital adequacy--the ability to
absorb potential losses--is central to evaluating an institution's
safety and soundness. Moreover, this approach is consistent with the
language of the interagency Uniform Financial Institutions Rating
System for the ``S'' rating. For example, the description of the 2
rating says in part: ``The level of earnings and capital
[[Page 66359]]
provide adequate support for the degree of market risk taken by the
institution [emphasis added].'' 12
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\12\ 61 FR at 67029.
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Several commenters argued that the proposed guidelines for the
level of IRR should not focus on the level of the NPV Ratio, but rather
only on its sensitivity. As explained above, the Uniform Financial
Institutions Rating System explicitly incorporates consideration of
capitalization into the assessment of the ``S'' component rating. It
would be unfair and largely counterproductive to good management to
assign the ``S'' rating on the basis of the Sensitivity Measure alone,
as suggested in this comment.
Consider, for example, two institutions. The first has a Post-shock
NPV Ratio of 1% and the second has a Post-shock NPV Ratio of 15%. Both
have Sensitivity Measures of 300 basis points, indicating that their
Post-shock NPV Ratios are 3 percentage points below their respective
Pre-shock Ratios. While both institutions would suffer the same decline
in economic value in an adverse interest rate environment, the first
institution has much less of a buffer against that risk than the
second. In fact, the level of interest rate risk at the first is
``high'' relative to its ability to bear that risk, while the level of
interest rate risk at the second is ``minimal.'' The proposed rating
guidelines appropriately reflect that difference.
Several commenters argued that OTS provided no rationale for the
NPV levels in Table 1. The matrix in Table 1 establishes guidelines
that, for a given level of the ``S'' rating, permits institutions with
a greater ability to absorb potential losses to take more interest rate
risk. The guidelines also broadly reflect the component ratings
actually assigned by examiners in the past.
Under OTS's New Directions Bulletin 95-10, institutions with Post-
shock NPV Ratios below 4 percent and more than 200 b.p. of interest
rate sensitivity were generally presumed to warrant a component rating
of 4 or 5. Those two thresholds provided the initial features of the
matrix: Post-shock Ratios below 4 percent would be in the lowest row.
The line between ``significant risk'' and ``high risk'' in that row
would be a Sensitivity Measure of 200 b.p. From that starting point,
successively higher rows in the matrix were defined as corresponding to
better levels of the ``S'' rating. Thresholds were chosen to
approximate the proportionate distributions of actual ratings. (As
discussed earlier, in the final TB some thresholds have been modified.)
In recognition of the practical limits on an institution's ability
to reduce risk, the leftmost column of Table 1 (Sensitivity Measure
between 0-100 b.p.) was established so that institutions with very low
Post-shock Ratios but lower than average Sensitivity Measures would not
be adversely rated. Such institutions may have capital adequacy
problems, but are not considered interest rate risk problems.
Several commenters argued that the ratings guidelines should not be
based on today's extremely healthy industry statistics. The economic
environment for the past several years has been highly conducive to
producing healthy, very well-capitalized thrift institutions. It is
possible that OTS may revise the guidelines in the future should
circumstances change. As discussed earlier, the guidelines in the final
TB are somewhat less stringent than the proposed guidelines and may,
thus, mitigate this criticism.
Several commenters suggested alternative matrices for the
guidelines for the level of risk in Table 1.
One commenter proposed determining the level of risk by comparing
an institution's Sensitivity Measure with qualitative factors, such as
planned corrective actions to be taken if rates move adversely. This
proposal, however, would be highly speculative and not take into
account the Post-shock NPV Ratio, which is critical in assessing an
institution's ability to bear risk.
Another commenter objected to the guidelines in Table 1 because the
guidelines suggest that an institution with a Post-shock NPV Ratio of
11.99% and an interest rate Sensitivity Measure of 401 b.p. poses
``significant risk'' while an institution with 2% and 99 b.p. poses
only ``moderate risk.'' The commenter is correct in arguing that the
former institution is better suited to absorb the risk than the latter.
Institutions in the lower left cell of the matrix are, however, special
cases. Institutions in that cell have low NPV ratios and, thus, little
capacity to absorb risk of any kind. There are, however, practical
limits to how far they can reduce their level of interest rate risk.
Thus, if an institution with a Post-shock NPV Ratio below 4% has a
Sensitivity Measure of less than 100 b.p. (which is typically well
below average) the guidelines treat it as having only moderate risk (a
2 rating), rather than significant risk (a 3 rating).
Another commenter proposed revising Table 1 to compare the Interest
Rate Sensitivity Measure with the Pre-shock NPV Ratio (instead of the
Post-shock NPV Ratio actually used in the Table). The commenter argued
that this would avoid ``double counting'' the adverse impact of the
rate shock. The commenter's proposal is based on the premise that the
percentage change in NPV is the relevant measurement standard. OTS
believes that the amount of capital remaining after the adverse shock
is more pertinent. An institution with a large percentage change in NPV
that retains a large amount of NPV is able to bear that risk safely.
A fourth commenter proposed that institutions with a Post-shock NPV
Ratio exceeding 6% warrant a rating of 1, whatever the Sensitivity
Measure. Higher levels of interest rate sensitivity require higher
Post-shock NPV. OTS does not believe the commenter's approach is
sufficiently conservative given (1) the possibility of rapid changes in
interest rates (not necessarily immediate shocks) of more than 200
b.p., (2) the possibility of changes in the shape or the slope of the
yield curve, and (3) inaccuracies in measuring risk.
m. Examiner Use of Guidelines on Level of Risk
One commenter recommended that the guidelines in Table 1, of Part
IV.A.3 of the proposed TB, should focus on more than one time period.
Explicit procedures for analysis of multiple time periods would
complicate the guidelines and would add to the unfounded perception
that OTS is attempting to micromanage the examination process. The
proposed TB stated that examiners should take into consideration any
relevant trends in an institution's interest rate risk. Additional
guidance is not necessary.
One commenter recommended that OTS should warn its examiners that
the NPV levels in the guidelines are ``for discussion purposes and not
standards for assessing risk.'' The proposed guidelines are exactly
that: guidelines. The proposed guidelines establish a common set of
criteria for translating quantitative risk estimates into the
categories described in the ratings descriptions (i.e., ``minimal
risk'', ``moderate risk'', etc.). Rather than relying on hundreds of
examiners to invent their own standards independently and hoping that
those standards will be consistent with one another, the guidelines
provide a common starting point for examiners. They are only starting
points because examiners must consider many complex facts, both
quantitative and qualitative, in their evaluation of the institution's
risk level and in assigning the rating.
Several commenters opined that examiners will not deviate from the
guidelines. The final version of the TB emphasizes that the guidelines
are only
[[Page 66360]]
a starting point in an examiner's assessment of the ``S'' rating. For
example, New Directions Bulletin 95-10, a precursor to the proposed TB,
stated that, ``Institutions with a [Post-shock NPV] Ratio below 4% and
a Sensitivity Measure over 200 basis points will ordinarily receive a 4
or 5 rating for the ``L'' component [rating].'' Yet, examiners did not
assign ratings of 4 or 5 to all institutions that fit this description.
n. Calculation of NPV Ratios
Several commenters discussed the calculation of NPV and the NPV
Ratio. Two argued that the NPV Ratio should be redefined so that
``deposit intangibles'' (i.e., the difference between the face value of
deposits and their economic value) are not treated as assets. OTS
initially presented deposit intangibles as assets on the Interest Rate
Risk Exposure Report to resemble the presentation of core deposit
intangibles on the balance sheet under GAAP. Commenters, however,
pointed out that treating deposit intangibles as assets depresses NPV
ratios. For example, the NPV ratio of the average institution in
December 1997 would have been 10 basis points higher in the base case
(10.34 vs. 10.24 percent) and 19 basis points higher (8.96 vs. 8.77
percent) in the +200 b.p. rate shock scenario, if the deposit
intangibles had been presented as contra-liabilities or if deposits had
simply been shown at their present values. Removing the deposit
intangibles from the asset side would also be more logically consistent
with the purpose of the NPV ratio, which is to relate an institution's
NPV to the size of the institution. An institution does not actually
grow if it replaces a $100 borrowing with $100 of retail accounts, yet
because the latter type of liability contributes to the deposit
intangible, the denominator of the NPV ratio increases.
Accordingly, OTS will study whether it should to move deposit
intangibles to the liability side of the Interest Rate Risk Exposure
Report by reporting deposits at their present value. Though NPV ratios
would generally rise as a result of this format change, the amount of
the change is so small that OTS would not modify the guidelines in
Table 1 to compensate for it. There are many data processing
considerations involved in making such a change, however. The small
amount of improvement in the NPV ratios may not warrant the cost and
potential confusion the change would entail.
One commenter urged OTS to solve the analytical problems involved
in estimating core deposit value sensitivity before finalizing the
proposed TB. Refining the OTS Model is an ongoing activity. Among other
issues, OTS is working on updating its modeling of core deposits.
Examiners are currently using the results of the OTS Model during their
safety and soundness examinations. There is no reason to wait for all
revisions to be completed before finalizing the TB. While the OTS Model
does not yet fully customize its treatment of core deposit behavior to
individual institutions, a degree of customization is performed for
institutions that report several items of additional optional
information (on Schedule CMR, lines 659 through 661). Yet, relatively
few institutions avail themselves of that opportunity.
Another commenter argued that by valuing purchased goodwill as zero
in the calculation of NPV, OTS disadvantages institutions that have
been involved in mergers using purchase accounting. OTS disagrees with
that criticism.
NPV is defined as the economic value of an institution's existing
assets, less the economic value of its existing liabilities, plus the
net economic value of any existing off-balance sheet contracts. In
other words, NPV is the net economic value of an institution's
portfolio of identifiable assets and liabilities. If two institutions
merge, the NPV of the resulting entity will consist of the combined net
economic value of the two portfolios, or more simply, the combined NPV
will be the sum of the individual NPVs. The value of the two portfolios
will not change merely because the institutions have merged. Yet, that
is exactly what would occur if goodwill were included as a component of
the combined institution's NPV; the resulting NPV would be larger than
the sum of the two constituent NPVs. The source of the confusion is
that the commenter is attempting to measure more than just the value of
the portfolio.
Goodwill is defined as the amount by which the purchase price of an
acquired entity exceeds the net fair value of its identifiable assets,
liabilities, and off-balance sheet financial instruments. Thus, by
definition, goodwill represents value over and above the net economic
value of the acquired institution's portfolio of identifiable assets
and liabilities. As a practical matter, goodwill reflects the buyer's
(and seller's) assessment of the economic value of unidentifiable
intangibles (such as a well-trained staff, a good franchise from which
to conduct future business, etc.) at the acquired institution. All
institutions, not just those involved in acquisitions, possess
unidentifiable intangibles that may be expected to have economic value.
Unfortunately, the economic value of such intangibles is extremely
difficult to quantify, and determining how their economic value will
change under different interest rate scenarios makes the task even more
difficult. For those reasons, OTS limits itself to estimating the
interest rate risk inherent in institutions' portfolios of identifiable
financial and non-financial assets and liabilities. It is not that a
broader measure is undesirable, but simply that such a measure is
impractical as a regulatory measure of risk.
Several institutions commented that the OTS Model does not
accurately reflect every institution's circumstances, and that ratings
based on those results are unfair. The OTS Model does rely on many
generic, industry-wide assumptions and circumstances at individual
institutions may differ from these assumptions. There will often be
offsetting errors so that the ``bottom line'' result will still be
reasonable for such an institution, but it is certainly possible that
the OTS Model might materially over-or understate the level of risk at
an institution. There are, however, two defenses against an unfair
rating. The first is the judgment of the examiner. The second defense
is the institution itself. The guidelines explicitly permit the use of
institutions' internal results in assessing the level of risk in
situations where the OTS Model is demonstrably incorrect.
o. Assessing the Quality of Risk Management
One commenter recommended that in assessing the quality of risk
management practices at an institution, discussed in Part IV.B of the
proposed TB, examiners should consider the institution's historical
earnings results. Examiners may well consider an institution's
historical earnings stability in judging the quality of its risk
management practices. All factors that an examiner considers relevant
may bear on his or her assessment.
p. Combining Assessments of the Level of Risk and Risk Management
Practices
A number of commenters stated that the guidelines in Table 2, of
Part IV.C of the proposed TB, place too much weight on quantitative
factors and insufficient weight on qualitative ones (i.e., good risk
management should be able to offset a higher level of risk). The
proposed guidelines shown in Table 2 represent an accurate
implementation of the interagency CAMELS rating system. Moreover, the
proposition that good risk management can fully offset higher levels of
risk is questionable. The interest rate sensitivity of NPV is a
[[Page 66361]]
measure of the amount of risk embedded in the current portfolio. There
is little evidence that managers can successfully anticipate the
magnitude or direction of movements in interest rates. While skillful
management may be able to alter an institution's risk level quickly in
response to changes in market conditions, it is not certain that
management will actually take any action in such an eventuality. For
example, during the interest rate shock that occurred in 1994, few
institutions responded with swift portfolio restructuring.
Practically speaking, however, both the assessment of risk
management practices and the assignment of the S component rating are
currently--and will remain--inexact processes that are heavily
dependent on examiner judgment. Strong risk management practices cannot
help but influence examiners to be inclined favorably toward the
institution in assigning the ``S'' component rating. Accordingly, no
change is being made to the guidelines in Table 2 of the proposal.
The final Thrift Bulletin is set forth below.
Thrift Bulletin 13a: Management of Interest Rate Risk, Investment
Securities, and Derivatives Activities
Summary: This Thrift Bulletin provides guidance to management and
boards of directors of thrift institutions on the management of
interest rate risk, including the management of investment and
derivatives activities. In addition, it describes the framework
examiners will use in assigning the ``Sensitivity to Market Risk'' (or
``S'') component rating.
Thrift Bulletin 13a replaces Thrift Bulletins 13, 13-1, 13-2, 52,
52-1, and 65, and New Directions Bulletin 95-10.
Contents
Part I: Background
A. Definition and Sources of Interest Rate Risk
Part II: OTS Minimum Guidelines Regarding Interest Rate Risk
A. Interest Rate Risk Limits
B. Systems for Measuring Interest Rate Risk
Part III: Investment Securities and Financial Derivatives
A. Analysis and Stress Testing
B. Record-Keeping
C. Supervisory Assessment of Investment and Derivatives
Activities
Part IV: Guidelines for the ``Sensitivity to Market Risk'' Component
Rating
A. Assessing the Level of Interest Rate Risk
B. Assessing the Quality of Risk Management
C. Combining Assessments of the Level of Risk and Risk
Management Practices
D. Examiner Judgment
Part V: Supervisory Action
Appendix A: Evaluating Prudence of Interest Rate Risk Limits
Appendix B: Sound Practices for Market Risk Management
Appendix C: Excerpt from Interagency Uniform Financial Institutions
Rating System
Appendix D: Glossary
Part I: Background
An effective interest rate risk (IRR) management process that
maintains interest rate risk within prudent levels is important for the
safety and soundness of any financial institution. This is especially
true for thrift institutions, which by the nature of their business,
are particularly prone to IRR. In recognition of that fact, 12 CFR
563.176 requires institutions to implement proper IRR management
procedures. In January 1989, OTS issued Thrift Bulletin 13 (TB 13),
Responsibilities of the Board of Directors and Management with Regard
to Interest Rate Risk, to provide guidance in the area of IRR
management. Since TB 13 was first issued, a great deal of progress has
been made in the areas of IRR measurement technology and IRR
management. The present Thrift Bulletin, TB 13a, updates the guidelines
contained in the original TB 13. It also provides guidance implementing
the Federal Financial Institutions Examination Council's Supervisory
Policy Statement on Investment Securities and End-User Derivative
Activities (63 Fed. Reg. 20191 [1998]) and OTS's final rule on
financial derivatives at Section 563.172. The following Thrift
Bulletins are hereby rescinded:
TB 13: Responsibilities of the Board of Directors and Management
with Regard to Interest Rate Risk;
TB 13-1: Implementation of Thrift Bulletin 13;
TB 13-2: Implementation of Thrift Bulletin 13;
TB 52: Supervisory Statement of Policy on Securities Activities;
TB 52-1: ``Mismatched'' Floating Rate CMOs; and
TB 65: Structured Notes.
Also rescinded is New Directions Bulletin 95-10, Interim Policy On
Supervisory Action to Address Interest Rate Risk.
A. Definition and Sources of Interest Rate Risk
The term ``interest rate risk'' refers to the vulnerability of an
institution's financial condition to movements in interest rates.
Although interest rate risk is a normal part of financial
intermediation, excessive interest rate risk poses a significant threat
to an institution's earnings and capital. Changes in interest rates
affect an institution's earnings by altering interest-sensitive income
and expenses. Changes in interest rates also affect the underlying
value of an institution's assets, liabilities, and off-balance sheet
instruments because the present value of future cash flows (and in some
cases, the cash flows themselves) change when interest rates change.
Savings associations confront interest rate risk from several
sources. These include repricing risk, yield curve risk, basis risk,
and options risk.
1. Repricing Risk. The primary form of interest rate risk arises
from timing differences in the maturity and repricing of assets,
liabilities, and off-balance sheet positions. While such repricing
mismatches are fundamental to the business, they can expose a savings
association's income and economic value fluctuations as interest rates
vary. For example, a thrift that funded a long-term, fixed-rate loan
with a short-term deposit could face a decline in both the future
income arising from the position and its economic value if interest
rates increase. These declines occur because the cash flows on the loan
are fixed, while the interest paid on the funding is variable, and
therefore increases after the short-term deposit matures.
2. Yield Curve Risk. Repricing mismatches can also expose a thrift
to changes in both the slope and shape of the yield curve. Yield curve
risk arises when unexpected shifts of the yield curve have adverse
effects on an institution's income or economic value. For example,
suppose an institution has variable-rate assets whose interest rate is
indexed to the 1-year Treasury rate and which are funded by variable-
rate liabilities having the same repricing date but indexed to the 3-
month Treasury rate. A flattening of the yield curve will have an
adverse impact on the institution's income and economic value, even
though a parallel movement in the yield curve might have no effect.
3. Basis Risk. Another source of interest rate risk arises from
imperfect correlation in the adjustment of the rates earned and paid on
different financial instruments with otherwise similar repricing
characteristics. When interest rates change, these differences can
cause changes in the cash flows and earnings spread between assets,
liabilities and off-balance sheet instruments of similar maturities or
repricing frequencies. For example, a strategy of funding a three-year
loan that reprices quarterly based on the three-month U.S. Treasury
bill rate, with a three-year deposit that reprices quarterly based on
three-month LIBOR, exposes the institution to the
[[Page 66362]]
risk that the spread between the two index rates may change
unexpectedly.
4. Options Risk. Interest rate risk also arises from options
embedded in many financial instruments. An option provides the holder
the right, but not the obligation, to buy, sell, or in some manner
alter the cash flows of an instrument or financial contract. Options
may be stand alone instruments such as exchange-traded options and
over-the-counter (OTC) contracts, or they may be embedded within
standard instruments. Instruments with embedded options include bonds
and notes with call or put provisions, loans which give borrowers the
right to prepay balances, adjustable rate loans with interest rate caps
or floors that limit the amount by which the rate may adjust, and
various types of non-maturity deposits which give depositors the right
to withdraw funds at any time, often without any penalties. If not
adequately managed, the asymmetrical payoff characteristics of
instruments with option features can pose significant risk,
particularly to those who sell them, since the options held, both
explicit and embedded, are generally exercised to the advantage of the
holder.
Part II: OTS Minimum Guidelines Regarding Interest Rate Risk
OTS has established specific minimum guidelines for thrift
institutions to observe in two areas of interest rate risk management.
The first guideline concerns establishment and maintenance of board-
approved limits on interest rate risk. The second, concerns
institutions' ability to measure their risk level.
A. Interest Rate Risk Limits
Effective control of interest rate risk begins with the board of
directors, which defines the institution's tolerance for risk. OTS
regulation Sec. 563.176 requires all institutions to establish board-
approved interest rate risk limits.
1. Limits on Change in Net Portfolio Value. All institutions should
establish and demonstrate quarterly compliance with board-approved
limits on interest rate risk that are defined in terms of net portfolio
value (NPV).1 These limits should specify the minimum NPV
Ratio 2 the board is willing to allow under current interest
rates and for a range of six hypothetical interest rate scenarios. The
hypothetical scenarios are represented by immediate, permanent,
parallel movements in the term structure of interest rates of plus and
minus 100, 200, and 300 basis points from the actual term structure
observed at quarter end.3 The level of detail with which the
limits are specified depends on the board's preferences. In their
simplest form, the limits could specify a single minimum NPV Ratio
which would apply to all seven rate scenarios, while more detailed
limits might specify a different minimum NPV Ratio for each of the
scenarios.
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\1\ Net portfolio value (NPV) is defined as the net present
value of an institution's existing assets, liabilities, and off-
balance sheet contracts. In the original TB 13, this measure was
referred to as the ``market value of portfolio equity'' (MVPE). A
detailed description of how OTS defines and calculates NPV is
provided in the manual entitled, The OTS Net Portfolio Value Model.
\2\ An institution's NPV Ratio for a given interest rate
scenario is calculated by dividing the net portfolio value that
would result in that scenario by the present value of the
institution's assets in that same scenario and is expressed in
percentage terms. The NPV ratio is analogous to the capital-to-
assets ratio used to measure regulatory capital, but NPV is measured
in terms of economic values (or present values) in a particular rate
scenario. These limits represent a change in format from those
called for by the original TB 13. They will provide a greater degree
of comparability across institutions and will mesh better with the
OTS guidelines for the Sensitivity to Market Risk component rating,
described later in this Bulletin.
\3\ Institutions that do not file Schedule CMR of the Thrift
Financial Report and do not have a means of calculating NPV should
have suitable alternative limits.
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2. Limits on Earnings Sensitivity. Many institutions also set risk
limits expressed in terms of the interest rate sensitivity of projected
earnings. Such limits can provide a useful supplement to the NPV-based
limits. Although institutions are not required by OTS to establish
limits and conduct analysis in terms of earnings sensitivity, OTS
considers it a good management practice for institutions to estimate
the interest rate sensitivity of their earnings and to incorporate this
analysis into their business plan and budgeting process. The
institution has total discretion over the type of earnings sensitivity
analysis and all details of how that analysis is performed. However,
OTS encourages institutions to develop earnings simulations utilizing
base case and adverse interest rate scenarios and to compare results to
actual earnings on a quarterly basis.
3. Prudence of IRR Limits. In assessing the prudence of their
institution's NPV limits, as well as in evaluating their institution's
current level of risk relative to the rest of the industry, the board
of directors will find it useful to refer to the quarterly OTS
publication, Thrift Industry Interest Rate Risk Measures.4
This publication contains statistical data about key interest rate risk
measures for the industry. The board should also be aware that
examiners will evaluate the institution's IRR limits as part of their
assessment of the quality of the institution's risk management
practices. See Part IV.B.2, Prudence of Limits, and Appendix A,
Evaluating Prudence of Interest Rate Risk Limits, for discussion of
this topic.
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\4\ Thrift Industry Interest Rate Risk Measures is published for
a particular quarter approximately seven weeks after the end of that
quarter. It may be retrieved using the OTS PubliFax system, at (202)
906-5660, or from the OTS World Wide Web site, http://
www.ots.treas.gov/quarter.html
_____________________________________-
4. Revision of IRR Limits. Interest rate risk limits reflect the
board of directors' risk tolerance. Although the board should
periodically re-evaluate the appropriateness of the institution's
interest rate risk limits, particularly after a significant change in
market interest rates, any changes should receive careful consideration
and be documented in the minutes of the board meeting.
If the institution's level of risk at some point does violate the
board's limits, that fact should be recorded in the minutes of the
board meeting, along with management's explanation for that occurrence.
Depending on the circumstances and the board's tolerance for risk, the
board may elect to revise the risk limits. Alternatively, the board may
wish to retain the existing limits and direct management to adopt an
acceptable plan for an orderly return to compliance with the limits.
Recurrent changes to interest rate risk limits for the purpose of
accommodating instances in which the limits have been, or are about to
be, breached may be indicative of inadequate risk management practices
and procedures.
B. Systems for Measuring Interest Rate Risk
Key elements in managing market risk are identifying, measuring,
and monitoring interest rate risk. To ensure compliance with its
board's IRR limits and to comply with OTS regulation Sec. 563.176, each
institution must have a way to measure its interest rate risk. OTS
guidelines for interest rate risk measurement systems are as follows,
though examiners have broad discretion to require more rigorous
systems.
1. Interest Rate Sensitivity of NPV for Institutions below $1
Billion in Assets. Unless otherwise directed by their OTS Regional
Director, institutions below $1 billion in assets may usually rely on
the quarterly NPV estimates produced by OTS and distributed in the
Interest Rate Risk Exposure Report. If such an institution owns complex
securities (see Glossary for definition) whose recorded investment
exceeds 5 percent of total assets, the institution should be able to
measure or have access to measures of the economic value of those
securities under the range of interest rate scenarios
[[Page 66363]]
described in Part II.A.1, Limits on Change in Net Portfolio Value. The
institution may rely on the OTS estimates for the other financial
instruments in its portfolio, unless examiners direct otherwise.
2. Interest Rate Sensitivity of NPV for Institutions above $1
Billion in Assets. Those institutions with more than $1 billion in
assets should measure their own NPV and its interest rate sensitivity.
OTS examiners will look for the following desirable methodological
features in evaluating the quality of such institutions' NPV
measurement systems:
(a) The institution's NPV estimates utilize information on its
financial holdings that is generally more detailed than the information
reported on Schedule CMR.
(b) Value is ascribed only to financial instruments currently in
existence or for which commitments or other contracts currently exist
(i.e., future business is not included in NPV).
(c) Values are, where feasible, based directly or indirectly on
observed market prices.
(d) Zero-coupon (spot) rates of the appropriate maturities are used
to discount cash flows.
(e) Implied forward interest rates are used to model adjustable
rate cash flows.
(f) Cash flows are adjusted for reasonable non-interest costs the
institution will incur in servicing both its assets and liabilities.
(g) Valuations take account of embedded options using, at a
minimum, the static discounted cash flow technique, but preferably
using more rigorous options pricing techniques (which normally produce
a value greater than zero even for out-of-the-money options).
(h) Valuation of deposits is based, at least in part, on
institution-specific data regarding retention rates of existing deposit
accounts and the rates offered by the institution on deposits.
Preferably, the institution would base these valuations on sound
econometric research into such data.
Examiners may determine an institution should use more
sophisticated measurement techniques for individual financial
instruments or categories of instruments where they believe it is
warranted (e.g., because of the volume and price sensitivity of a group
of financial instruments; because of concern that the institution's
results may materially misstate the level of risk; because of the
combination of a low Post-shock NPV Ratio and high Sensitivity Measure;
etc.). In any case, the institution should be familiar with the details
of the assumptions, term structure, and logic used in performing the
measurements. Measures obtained from financial screens or vendors may,
therefore, not always be adequate.
In addition to the prescribed parallel-shock interest rate
scenarios described above, OTS recommends that institutions evaluate
the effects of other stressful market conditions (e.g., non-parallel
movements in the term structure, basis changes, changes in volatility),
as well as the effects of breakdowns in key assumptions (e.g.,
prepayment and core deposit attrition rates).
3. Integration of Risk Measurement and Operations. As part of their
assessment of the quality of an institution's risk management
practices, examiners will consider the extent to which the
institution's risk measurement process is integrated with management
decision-making. Examiners will evaluate whether, in making significant
operational decisions (e.g., changes in portfolio structure,
investments, business planning, derivatives activities, funding
decisions, pricing decisions, etc.), the institution considers their
effect on the level of interest rate risk. Institutions may do this by
using an earnings sensitivity approach, an NPV sensitivity approach, or
any other reasonable approach. The institution has discretion over all
aspects of such analysis. The analysis, however, should not be merely
pro forma in nature, but rather should be an active factor in the
institution's decision-making process. If evidence of such integration
is not apparent, examiner criticism or an adverse rating may result.
Part III: Investment Securities and Financial Derivatives
A. Analysis and Stress Testing
Management should exercise diligence in assessing the risks and
returns (including expected total return) associated with investment
securities and financial derivatives. As a matter of sound practice,
prior to taking an investment position or initiating a derivatives
transaction, an institution should:
(a) Ensure that the proposed transaction is legally permissible for
a savings institution;
(b) Review the terms and conditions of the security or financial
derivative;
(c) Ensure that the proposed transaction is allowable under the
institution's investment or derivatives policies;
(d) Ensure that the proposed transaction is consistent with the
institution's portfolio objectives and liquidity needs;
(e) Exercise diligence in assessing the market value, liquidity,
and credit risk of the security or financial derivative;
(f) Conduct a pre-purchase portfolio sensitivity analysis for any
significant transaction involving securities or financial derivatives
(as described below in Significant Transactions);
(g) Conduct a pre-purchase price sensitivity analysis of any
complex security 5 or financial derivative 6
prior to taking a position (as described below in Complex Securities
and Financial Derivatives).
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\5\ For purposes of this Thrift Bulletin, the term ``complex
security'' includes any collateralized mortgage obligation
(``CMO''), real estate mortgage investment conduit (``REMIC''),
callable mortgage pass-through security, stripped-mortgage-backed-
security, structured note, and any security not meeting the
definition of an ``exempt security.'' An ``exempt security''
includes non-callable, ``plain vanilla'' instruments of the
following types: (1) mortgage-pass-through securities, (2) fixed-
rate securities, and (3) floating-rate securities.
\6\ The following financial derivatives are exempt from the pre-
purchase analysis called for above: commitments to originate,
purchase, or sell mortgages. To perform the pre-purchase analysis
for derivatives whose initial value is zero (e.g., futures, swaps),
the institution should calculate the change in value as a percentage
of the notional principal amount.
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1. Significant Transactions. A ``significant transaction'' is any
transaction (including one involving instruments other than complex
securities) that might reasonably be expected to increase an
institution's Sensitivity Measure by more than 25 basis points. Prior
to undertaking any significant transaction, management should conduct
an analysis of the incremental effect of the proposed transaction on
the interest rate risk profile of the institution. The analysis should
show the expected change in the institution's net portfolio value (with
and without the proposed transaction) that would result from an
immediate parallel shift in the yield curve of plus and minus 100, 200,
and 300 basis points. In general, an institution should conduct its own
analysis. It may, however, rely on analysis conducted by an independent
third-party (i.e., someone other than the seller or counterparty)
provided management understands the analysis and its key assumptions.
Institutions with less than $1 billion in assets that do not have
the internal modeling capability to conduct such an incremental
analysis may use the most recent quarterly NPV estimates for their
institution provided by OTS to estimate the incremental effect of a
proposed
[[Page 66364]]
transaction on the sensitivity of its net portfolio value.7
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\7\ Institutions that are exempt from filing Schedule CMR and
that choose not to file voluntarily, should ensure that no
transaction--whether involving complex securities, financial
derivatives, or any other financial instruments--causes the
institution to fall out of compliance with its board of directors''
interest rate risk limits.
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2. Complex Securities and Financial Derivatives. Prior to taking a
position in any complex security or financial derivative, an
institution should conduct a price sensitivity analysis (i.e., pre-
purchase analysis) of the instrument. At a minimum, the analysis should
show the expected change in the value of the instrument that would
result from an immediate parallel shift in the yield curve of plus and
minus 100, 200, and 300 basis points. Where appropriate, the analysis
should encompass a wider range of scenarios (e.g., non-parallel changes
in the yield curve, changes in interest rate volatility, changes in
credit spreads, and in the case of mortgage-related securities, changes
in prepayment speeds). In general, an institution should conduct its
own in-house pre-acquisition analysis. An institution may, however,
rely on an analysis conducted by an independent third-party (i.e.,
someone other than the seller or counterparty) provided management
understands the analysis and its key assumptions.
Investments in complex securities and the use of financial
derivatives by institutions that do not have adequate risk measurement,
monitoring, and control systems may be viewed as an unsafe and unsound
practice.
3. Risk Reduction. In general, the use of financial derivatives or
complex securities with high price sensitivity 8 should be
limited to transactions and strategies that lower an institution's
interest rate risk as measured by the sensitivity of net portfolio
value to changes in interest rates. An institution that uses financial
derivatives or invests in such securities for a purpose other than that
of reducing portfolio risk should do so in accordance with safe and
sound practices and should:
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\8\ For purposes of this Bulletin, ``complex securities with
high price sensitivity'' include those whose price would be expected
to decline by more than 10 percent under an adverse parallel change
in interest rates of 200 basis points.
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(a) Obtain written authorization from its board of directors to use
such instruments for a purpose other than to reduce risk; and
(b) Ensure that, after the proposed transaction(s), the
institution's Post-shock NPV Ratio would not be less than 4 percent.
The use of financial derivatives or complex securities with high
price sensitivity for purposes other than to reduce risk by
institutions that do not meet the conditions set forth above may be
viewed as an unsafe and unsound practice.
B. Record-Keeping
Institutions must maintain accurate and complete records of all
securities and derivatives transactions in accordance with 12 CFR
562.1. Institutions should retain any analyses (including pre-and post-
purchase analyses) relating to investments and derivatives transactions
and make such analyses available to examiners upon request.
In addition, for each type of financial derivative instrument
authorized by the board of directors, the institution should maintain
records containing:
(a) The names, duties, responsibilities, and limits of authority
(including position limits) of employees authorized to engage in
transactions involving the instrument;
(b) A list of approved counterparties with which transactions may
be conducted;
(c) A list showing the credit risk limit for each approved
counterparty; and
(d) A contract register containing key information on all
outstanding contracts and positions.
The contract registers should specify the type of contract, the
price of each open contract, the dollar amount, the trade and maturity
dates, the date and manner in which contracts were offset, and the
total outstanding positions.
Where deferred gains or losses on derivatives from hedging
activities have been recorded consistent with generally accepted
accounting principles (GAAP), the institution should maintain
appropriate supporting documentation.9
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\9\ In June 1998, the FASB issued SFAS No. 133, ``Accounting for
Derivative Instruments and Hedging Activities.'' Under SFAS No. 133,
all ``derivative instruments,'' as defined therein, including those
used for hedging purposes, would be accounted for at fair value.
Accordingly, under that Standard, deferred gains and losses on
``derivative instruments'' from hedging activities will no longer be
reported.
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C. Supervisory Assessment of Investment and Derivatives Activities
Examiners will assess the overall quality and effectiveness of the
institution's risk management process governing investment and
derivatives activities. In making such assessments, examiners will take
into account compliance with the guidelines set forth above and the
quality of the institution's risk management process. The quality of
the institution's risk management process will be evaluated in the
context of Appendix B, Sound Practices for Market Risk Management.
Part IV: Guidelines for the ``Sensitivity to Market Risk''
Component Rating
Consistent with the interagency Uniform Financial Institutions
Rating System, or CAMELS rating system, of which an excerpt is attached
as Appendix C, the ``Sensitivity to Market Risk'' component rating
(i.e., the ``S'' rating) is based on examiners'' conclusions about two
dimensions: (1) an institution's level of market risk and (2) the
quality of its practices for managing market risk. This section
discusses the guidelines that examiners will use in assessing the two
dimensions and combining those assessments into a component rating.
Because few thrift institutions have significant exposure to foreign
exchange risk or commodity or equity price risks, interest rate risk
will generally be the only form of market risk to be assessed under
this component rating.
A. Assessing the Level of Interest Rate Risk
Examiners will base their conclusions about an institution's level
of interest rate risk--the first dimension for determining the ``S''
component rating--primarily on the interest rate sensitivity of the
institution's net portfolio value. The two specific measures of risk
that will receive examiners' primary attention are the Interest Rate
Sensitivity Measure and the Post-shock NPV Ratio (see Glossary for
definitions).
OTS uses risk measures based on NPV for several reasons. First, the
NPV measures are more readily comparable across institutions than
internally generated measures of earnings sensitivity. Second, NPV
focuses on a longer-term analytical horizon than institutions'
internally generated earnings sensitivity measures. (The interest rate
sensitivity of earnings is typically measured over a short-term horizon
such as a year, while NPV is based on all future cash flows anticipated
from an institution's existing assets, liabilities, and off-balance
sheet contracts.) Third, the NPV-based measures take better account of
the embedded options present in the typical thrift institution's
portfolio.
1. Interest Rate Sensitivity Measure. In assessing the level of
interest rate risk, a high (i.e., risky) Interest Rate Sensitivity
Measure, by itself, may not give cause for supervisory concern when the
institution has a strong capital position. Because an institution's
risk of failure is inextricably linked to capital and, hence, to its
ability to absorb
[[Page 66365]]
adverse economic shocks, an institution with a high level of economic
capital (i.e., NPV) may be able safely to support a high Sensitivity
Measure.
2. Post-Shock NPV Ratio. The Post-shock NPV Ratio is a more
comprehensive gauge of risk than the Sensitivity Measure because it
incorporates estimates of the current economic value of an
institution's portfolio, in addition to the reported capital level and
interest rate risk sensitivity. There are three potential causes of a
low (i.e., risky) Post-shock NPV Ratio: (i) low reported capital; (ii)
significant unrecognized depreciation in the value of the portfolio; or
(iii) high interest rate sensitivity. Although the first two of these,
low reported capital and significant unrecognized depreciation in
portfolio value, may cause supervisory concern (and receive attention
under the portions of the examination devoted to evaluating Capital
Adequacy, Asset Quality, or Earnings), they do not necessarily
represent an ``interest rate risk problem.'' Only when an institution's
low Post-shock Ratio is, in whole or in part, caused by high interest
rate sensitivity is an interest rate risk problem suggested. That
condition is reflected in the guidelines discussed below.
3. Guidelines for Determining the Level of Interest Rate Risk. In
describing the five levels of the ``S'' component rating, the
interagency uniform ratings system established several broad,
descriptive levels of risk: ``minimal,'' ``moderate,'' ``significant,''
``high,'' and ``imminent threat.'' The following interest rate risk
levels are ordinarily indicated for OTS-regulated institutions, based
on the combination of each institution's Post-shock NPV Ratio and
Interest Rate Sensitivity Measure. (These guidelines are summarized in
Table 1 below.) These risk levels are for guidance, they are not
mandatory; examiners utilize them as starting points in their ratings
assessments but have broad discretion to exercise judgment (see Part
IV.D, Examiner Judgment).
An institution with a Post-shock NPV Ratio below 4% and an Interest
Rate Sensitivity Measure of:
(a) More than 200 basis points will ordinarily be characterized as
having ``high'' risk. Such an institution will typically receive a 4 or
5 rating for the ``S'' component.10
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\10\ According to the interagency uniform ratings system (61
Fed. Reg. 67029 [1996]), the level of market risk at a 4-rated
institution is ``high,'' while that at a 5-rated institution is so
high as to pose ``an imminent threat to its viability.'' Under the
Prompt Corrective Action regulation, 12 CFR Part 565, supervisory
action is tied to regulatory capital. An institution's viability is,
therefore, directly dependent on regulatory capital, not on economic
capital. Because regulatory capital can remain positive for an
extended period of time after economic capital has become zero or
negative, the NPV measures are not by themselves indicators of near-
term viability. For an institution's level of interest rate risk to
constitute an imminent threat to viability, the institution will
typically have a high level of interest rate risk and will have
other serious financial problems that place it in imminent danger of
closure.
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(b) 100 to 200 basis points will ordinarily be characterized as
having ``significant'' risk. Such an institution will typically receive
a 3 rating for the ``S'' component.
(c) 0 to 100 basis points will ordinarily be characterized as
having ``moderate'' risk. Such an institution will typically receive a
rating of 2 for the ``S'' component. If the institution's sensitivity
is extremely low, a rating of 1 may be supportable unless the
institution is likely to incur larger losses under rate shocks other
than the parallel shocks depicted in the OTS NPV Model.
An institution with a Post-shock NPV Ratio between 4% and 6% and an
Interest Rate Sensitivity Measure of:
(a) More than 400 basis points will ordinarily be characterized as
having ``high'' risk. Such an institution will typically receive a 4 or
5 rating for the ``S'' component.
(b) 200 to 400 basis points will ordinarily be characterized as
having ``significant'' risk. Such an institution will typically receive
a 3 rating for the ``S'' component.
(c) 100 to 200 basis points will ordinarily be characterized as
having ``moderate'' risk. Such an institution will typically receive a
2 rating for the ``S'' component.
(d) 0 to 100 basis points will ordinarily be characterized as
having ``minimal'' risk. Such an institution will typically receive a
rating of 1 for the ``S'' component.
An institution with a Post-shock NPV Ratio between 6% and 10% and
an Interest Rate Sensitivity Measure of:
(a) More than 400 basis points will ordinarily be characterized as
having ``significant'' risk. Such an institution will typically receive
a 3 rating for the ``S'' component.
(b) 200 to 400 basis points will ordinarily be characterized as
having ``moderate'' risk. Such an institution will typically receive a
2 rating for the ``S'' component.
(c) Less than 200 basis points will ordinarily be characterized as
having ``minimal'' risk. Such an institution will typically receive a
rating of 1 for the ``S'' component.
An institution with a Post-shock NPV Ratio of more than 10% and an
Interest Rate Sensitivity Measure of:
(a) More than 400 basis points will ordinarily be characterized as
having ``moderate'' risk. Such an institution will typically receive a
2 rating for the ``S'' component.
(b) Less than 400 basis points will ordinarily be characterized as
having ``minimal'' risk. Such an institution will typically receive a
rating of 1 for the ``S'' component.
[[Page 66366]]
[GRAPHIC] [TIFF OMITTED] TN01DE98.005
In Table 1 the numbers in parentheses represent the ``S'' component
ratings that examiners would typically use as starting points in their
analysis, assuming there are no deficiencies in the institution's risk
management practices. Examiners may assign a different rating based on
their interpretation of the facts and circumstances at each
institution.
4. Internal vs. OTS Risk Measures. In applying the guidelines
described above, examiners will encounter three general types of
situations regarding the availability of risk measures.
First, if the institution does not have internal NPV measures, but
does file Schedule CMR, examiners will use the NPV measures produced by
OTS. In such instances, examiners must be aware of the importance of
accurate reporting by the institution on Schedule CMR, particularly of
items for which the institution provides its own market value estimates
in the various interest rate scenarios, such as for mortgage derivative
securities. They must also be aware of circumstances in which the OTS
measures may overstate or understate the sensitivity of an
institution's financial instruments.
Second, if the institution does produce its own NPV measures,
examiners will have to decide whether to use the institution's or OTS's
risk measures.
(a) If the institution's own measures and those produced by OTS are
broadly consistent and result in the same risk category (e.g.,
``minimal risk,'' ``moderate risk,'' etc.), the choice between using
the institution's measures or the OTS estimates probably does not
matter, though examiners should attempt to ascertain the reasons for
any major discrepancies between the two sets of results.
(b) If the institution's NPV measures place it in a different risk
category than the OTS measures do, examiners (in consultation with
their Regional Capital Markets group or the Washington Risk Management
Division) should determine which financial instruments are the source
of that discrepancy. If the institution's valuations for those
instruments are judged more reliable than OTS's, the institution's
results will be used to replace the OTS results for those financial
instruments in calculating NPV in the various interest rate scenarios.
(c) If examiners have reason to doubt both the institution's own
measures and those produced by OTS, they may modify (in consultation
with their Regional Capital Markets group or the Washington Risk
Management Division) either or both measures to arrive at NPV measures
that the examiners consider reasonable.
In deciding whether to rely on an institution's internal NPV
measures, examiners will ensure that the institution's measures are
produced in a manner that is broadly consistent with the OTS measures.
(The major methodological points to consider are described in Part
II.B, Systems for Measuring Interest Rate Risk.)
The third situation examiners will encounter is one in which the
institution calculates no internal NPV measures and does not report on
Schedule CMR. Because no NPV results will be available in such cases,
the guidelines are not directly applicable. In addition to reviewing
the institution's balance sheet structure in such cases, examiners will
review whatever interest rate risk measurement and management tools the
institution uses to comply with Sec. 563.176. Depending on their
findings regarding the institution's general level of risk and its risk
management practices, examiners might reconsider the appropriateness of
the institution's continued exemption from filing Schedule CMR.
B. Assessing the Quality of Risk Management
In drawing conclusions about the quality of an institution's risk
management practices--the second dimension of the ``S'' component
rating--examiners will assess all significant facets of the
institution's risk management process. To aid in that assessment,
examiners will refer to Appendix B of this Bulletin which provides a
set of Sound Practices for Market Risk Management. These sound
practices suggest the sorts of management practices institutions of
varying levels of sophistication may utilize. As (i) the size of the
institution increases, (ii) the complexity of its assets, liabilities,
or off-balance sheet contracts increases, or (iii) the overall level of
interest rate risk at the institution increases, its risk management
process should exhibit more of the elements included in the Sound
Practices and should display a greater degree of formality and rigor.
Because there is no formula for determining the adequacy of such
systems, examiners will make that determination on a case-by-case
basis. Examiners will take the following eight factors, among others,
into consideration in assessing the quality of an institution's risk
management practices.
1. Oversight by Board and Senior Management. Examiners will assess
the quality of oversight provided by the institution's board and senior
management. That assessment may have many facets, as described in
Appendix B, Sound Practices for Market Risk Management.
2. Prudence of Limits. Examiners will assess the prudence of the
institution's board-approved interest rate risk limits.
[[Page 66367]]
Ordinarily, a set of IRR limits will raise examiner concerns if the
limits permit the institution to have a Post-shock NPV Ratio and
Interest Rate Sensitivity Measure that would ordinarily warrant an
``S'' component rating of 3 or worse. (For examples of how examiners
will make that determination, see Appendix A, Evaluating Prudence of
Interest Rate Risk Limits.) Depending on the level of concern, such
limits may result in examiner criticism or an adverse ``S'' component
rating.
3. Adherence to Limits. Examiners will assess the degree to which
the institution adheres to its interest rate risk limits. Frequent
exceptions to the board's limits may indicate weak interest rate risk
management practices. Similarly, recurrent changes to the institution's
limits to accommodate exceptions to the limits may reflect ineffective
board oversight.
4. Quality of System for Measuring NPV Sensitivity. Examiners will
consider whether the quality of the institution's risk measurement and
monitoring system is commensurate with the institution's size, the
complexity of its financial instruments, and its level of interest rate
risk. Examiners will generally expect the quality of an institution's
system for measuring the interest rate sensitivity of NPV to be
consistent with the descriptions in Part II.B, Systems for Measuring
Interest Rate Risk.
5. Quality of System for Measuring Earnings Sensitivity. OTS places
considerable reliance on NPV analysis to assess an institution's
interest rate risk. Other types of measures may, however, be considered
in evaluating an institution's risk management practices. In
particular, utilization of a well-supported earnings sensitivity
analysis may be viewed as a favorable factor in determining an
institution's component rating. In fact, all institutions are
encouraged to measure the interest rate sensitivity of projected
earnings. Despite inherent limitations,11 such analyses can
provide useful information to an institution's management.
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\11\ The effectiveness of an earnings sensitivity model to
identify interest rate risk depends on the composition of an
institution's portfolio. In particular, management should recognize
that such models generally do not fully take account of longer-term
risk factors.
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Methodologies used in measuring earnings sensitivity vary
considerably among different institutions. To assist examiners in
reviewing the earnings modeling process, institutions should have clear
descriptions of the methodologies and assumptions used in their models.
Of particular importance are the type of rate scenarios used (e.g.,
instantaneous or gradual, consistent with forward yield curve) and
assumptions regarding new business (i.e., type of assets, dollar
amounts, and interest rates). In addition, formulas for projecting
interest rate changes on existing business (e.g., ARMs, transaction
deposits) should be clearly described and any major differences from
analogous formulas used in the OTS NPV Model should be explained and
supported.
6. Integration of Risk Management with Decision-Making. Examiners
will consider the extent to which the results of an institution's risk
measurement system are used by management in making operational
decisions (e.g., changes in portfolio structure, investments,
derivatives activities, business planning, funding decisions, pricing
decisions). This is of particular significance if the institution's
Post-shock NPV Ratio is relatively low, and thus provides less of an
economic buffer against loss.
Examiners will evaluate whether management considers the effect of
significant operational decisions on the institution's level of
interest rate risk. The form of analysis used for measuring that effect
(earnings sensitivity, NPV sensitivity, or any other reasonable
approach) and all details of the measurement are up to the institution.
That analysis should be an active factor in management's decision-
making and not be generated solely to avoid examiner criticism. In the
absence of such a decision-making process, examiner criticism or an
adverse rating may be appropriate.
7. Investments and Derivatives. Examiners will consider the
adequacy of the institution's risk management policies and procedures
regarding investment and derivatives activities. See Part III of this
Bulletin, Investment Securities and Financial Derivatives, for a
detailed discussion.
8. Size Complexity, and Risk Profile. Under the interagency uniform
ratings descriptions, an institution's risk management practices are
evaluated relative to the institution's ``size, complexity, and risk
profile.'' Thus, a small institution with a simple portfolio and a
consistently low level of risk may receive an ``S'' rating of 1 even if
its risk management practices are fairly rudimentary. A large
institution with these same characteristics would be expected to have
more rigorous risk management practices, but would not be held to the
same risk management standards as a similarly sized institution with
either a higher level of risk or a portfolio containing complex
securities or financial derivatives. An institution making a conscious
business decision to maintain a low risk profile by investing in low
risk products or maintaining a high level of capital may not require
elaborate and costly risk management systems.
C. Combining Assessments of the Level of Risk and Risk Management
Practices
Guidelines examiners will use in assessing an institution's level
of risk and the quality of its risk management practices have been
described in the two previous sections. This section provides
guidelines for combining those two assessments into an ``S'' component
rating for the institution.
The interagency uniform ratings descriptions specify the criteria
for the ``S'' component ratings in terms of the level of risk and the
quality of risk management practices (see Appendix C). For example:
A rating of 1 indicates that market risk sensitivity is well
controlled and that there is minimal potential that the earnings
performance or capital position will be adversely affected. * * *
[emphasis added] \12\
---------------------------------------------------------------------------
\12\ 61 Fed. Reg. 67029 (1996).
Thus, if market risk is less than ``well controlled'' (i.e.,
``adequately controlled,'' ``in need of improvement,'' or
``unacceptable''), the institution does not qualify for a component
rating of 1. Likewise, if the level of market risk is more than
``minimal'' (i.e., ``moderate,'' ``significant,'' or ``high''), the
institution similarly does not qualify for a rating of 1.
Applying the same logic to the descriptions of the 2, 3, 4, and 5
levels of the ``S'' component rating results in the ratings guidelines
shown in Table 2. That table summarizes how various combinations of
examiner assessments about an institution's ``level of interest rate
risk'' and ``quality of risk management practices'' translate into a
suggested rating.\13\
---------------------------------------------------------------------------
\13\ Some of the combinations of risk management quality and
level of risk shown in the table will rarely, if ever, be
encountered (e.g., an institution with ``unacceptable'' risk
management practices, but a ``minimal'' level of risk). For the sake
of completeness, however, all cells of the matrix are shown.
---------------------------------------------------------------------------
Two important caveats must be noted about this table. First, the
two dimensions are not totally independent of one another, because the
quality of risk management practices is evaluated relative to an
institution's level of risk (among other things). Thus, for example, an
institution's risk management practices are more likely to be assessed
as ``well controlled'' if the institution has minimal risk than if it
has a higher level of risk. Second, as described
[[Page 66368]]
further in the next section, the ratings shown in Table 2 provide a
starting point, but examiners have broad discretion to exercise
---------------------------------------------------------------------------
judgment and deviate from them.
[GRAPHIC] [TIFF OMITTED] TN01DE98.006
D. Examiner Judgment
Blind adherence to the guidelines is undesirable. Examiners have a
responsibility to exercise judgment in assigning ratings based on the
facts they encounter at each institution. This section provides a non-
exhaustive list of factors examiners might consider in applying the
``S'' rating guidelines to a particular institution.
1. Judgment in Assessing the Level of Risk. In assessing the level
of interest rate risk, the likelihood that examiners will deviate from
the guidelines in Table 1 is heightened in cases where the Post-shock
NPV Ratio and the Interest Rate Sensitivity Measure are both near cell
boundaries. For example, there is no material difference between an
institution whose Post-shock Ratio and Sensitivity Measure, are,
respectively, 4.01% and 199 b.p. and one where they are 3.99% and 201
b.p., yet the guidelines in Table 1 suggest a 2 rating for the former
and a 4 for the latter. Clearly, the row and column boundaries of the
cells in the table must be interpreted as transition zones or ``gray
areas,'' rather than as precise cut-off points, between suggested
ratings. As such, examiners will more commonly deviate from the stated
guidelines in the vicinity of cell borders than in their interior.
Open-ended cells are another instance where examiners will more
commonly deviate from the guidelines. For example, in assessing an
institution whose Sensitivity Measure is well beyond 400 b.p., an
examiner might very well determine that its level of risk is higher
than the guidelines in the rightmost column of Table 1. In applying the
guidelines in Table 1, many considerations may cause an examiner to
reach a different conclusion than suggested by the guidelines. Such
considerations include the following:
(a) The trend in the institution's risk measures during recent
quarters.
(b) The trend in the institution's risk measures compared with
those of the rest of the industry in recent quarters. (Comparison with
the results for the industry as a whole often provides a useful
backdrop for evaluating an institution's results, particularly during a
period of volatile interest rates.)
(c) The examiner's level of comfort with the overall accuracy of
the available risk measures as applied to the particular products of
the institution.
(d) The existence of items with particularly volatile or uncertain
interest rate sensitivity for which the examiner wants to allow an
added margin for possible error.
(e) The effect of any restructuring that may have occurred since
the most recently available risk measures.
(f) Other available evidence that causes the examiner to favor a
higher or lower risk assessment than that suggested by the guidelines.
2. Judgment in Assessing the Quality of Risk Management Practices.
Conclusions about the quality of risk management practices should be
based, in part, on the institution's level of risk, with less risky
institutions requiring less rigorous risk management practices.
Considerations listed in the Judgment in Assessing the Level of Risk,
above, may therefore cause the examiner to modify his or her assessment
of the institution's risk management practices. In addition, if changes
have occurred in the institution's level of risk since the last
evaluation, the examiner may wish to reassess the quality of the
institution's risk management practices in light of these changes.
Part V: Supervisory Action
If supervisory action to address interest rate risk is needed,
examiners will discuss the problem with management and obtain their
commitment to correct the problem as quickly as practicable.
If deemed necessary, examiners will request a written plan from the
board and management to reduce interest rate sensitivity, increase
capital, or both. The plan should include specific risk measure
targets. If the initial plan is inadequate, examiners will require
amendment and re-submission. Examiners will document the corrective
strategy and results and review progress at case reviewing meetings.
For institutions with composite ratings of 4 or 5, the presumption
of formal enforcement action generally requires a supervisory
agreement, cease
[[Page 66369]]
and desist order, prompt corrective action directive, or other formal
supervisory action. If an institution's interest rate risk increases
between examinations, examiners will consider whether a downgrade of
the ``S'' component rating or the composite rating is warranted.
Examiners will obtain quarterly progress reports (more frequently if
the situation is severe). Where appropriate, examiners may require the
institution to develop the capacity to conduct its own modeling.
Appendix A: Evaluating Prudence of Interest Rate Risk Limits
The basic principle examiners will use in evaluating the prudence
of an institution's risk limits is whether they permit NPV to drop to a
level where the Post-shock NPV Ratio and Sensitivity Measure would
suggest an ``S'' component rating of 3 or worse under the guidelines
for the Level of Risk (reproduced here as Table 1).
[GRAPHIC] [TIFF OMITTED] TN01DE98.007
Examples of Evaluating the Prudence of Interest Rate Risk Limits
The following examples illustrate how OTS examiners will evaluate
an institution's interest rate risk limits. In each example, the
interest rate risk limits approved by the institution's board of
directors are shown in column [b]. These specify a minimum NPV Ratio
for each of the interest rate scenarios shown in column [a]. The NPV
Ratios currently estimated for the institution for each rate scenario
are shown in column [c].
Example Institution A
Institution A has a detailed set of interest rate risk limits by
which the board of directors specifies a minimum NPV Ratio for each of
the seven rate shock scenarios described in Part II.A.1 of this
bulletin.
Institution A--Limits and Current NPV Ratios
Board limits (minimum NPV Institution's current NPV
Rate shock (in basis points) ratios) ratios)
[a] [b] [c]
----------------------------------------------------------------------------------------------------------------
+300................................................ 6.00% 10.00%
+200................................................ 7.00 11.50
+100................................................ 8.00 12.50
0................................................... 9.00 13.00
-100................................................ 10.00 13.25
-200................................................ 11.00 13.50
-300................................................ 12.00 13.75
----------------------------------------------------------------------------------------------------------------
To assess the prudence of Institution A's interest rate risk
limits, examiners will evaluate the risk measures permitted under those
limits relative to the guidelines for the Level of Risk in Table 1. The
Post-shock NPV Ratio permitted by the institution's board limits is
7.00% (from the +200 b.p. scenario in column [b], above). The
Sensitivity Measure permitted by the limits is not known; it depends on
the actual level of the base case NPV Ratio, which will probably be
higher than the limit for the base case scenario. Examiners will,
therefore, use the institution's current Sensitivity Measure (based on
OTS's results or those of the institution) in performing their
evaluation. Institution A's current Sensitivity Measure is 150 basis
points (i.e., [13.00%-11.50%], the NPV Ratios in the 0 b.p. and +200
b.p. scenarios in column [c], above).
Referring to Table 1, the Post-shock NPV Ratio allowed by the
institution's limits falls into the ``6% to 10%'' row and its current
Sensitivity Measure falls into the ``100 to 200 b.p.'' column. The
rating suggested by Table 1 is, therefore, a 1, and Institution A's
risk limits would, thus, probably be considered prudent.14
---------------------------------------------------------------------------
\14\ This example assumes there are no significant deficiencies
in the institution's risk management practices.
---------------------------------------------------------------------------
Example Institution B
[[Page 66370]]
Institution B--Limits and Current NPV Ratios
Board limits Institution's
Rate shock (in basis points) (minimum NPV current NPV
ratios ratios)
[a] [b] [c]
------------------------------------------------------------------------
+300............................ 6.00% 6.00%
+200............................ 7.00 8.50
+100............................ 8.00 11.00
0............................... 9.00 13.00
-100............................ 10.00 14.00
-200............................ 11.00 14.50
-300............................ 12.00 15.00
------------------------------------------------------------------------
Institution B has identical interest rate risk limits as
Institution A, but is considerably more interest rate sensitive than
Institution A at the present time. Institution B's Sensitivity Measure
is 450 b.p. (i.e., [13.00%-8.50%]). For purposes of applying the
guidelines in Table 1 to the limits, the Post-shock NPV Ratio of 7.00%
permitted by the institution's board limits falls into the ``6% to
10%'' row. Its current Sensitivity Measure, however, falls into the
``Over 400 b.p.'' column of Table 1. The rating suggested by the
guidelines is therefore a 3, and Institution B's risk limits would
probably not be considered sufficiently prudent. Even though its limits
are identical to those of Institution A, its much higher current
Sensitivity Measure requires the support of a higher Post-shock NPV
Ratio than the minimum permitted by the board limits.
Example Institution C
Institution C--Limits and Current NPV Ratios
Board limits
Rate shock (in basis points) (minimum NPV Institution's
ratios) current NPV ratios
[a] [b] [c]
------------------------------------------------------------------------
+300............................ 6.00% 6.00%
+200............................ 6.00 8.50
+100............................ 6.00 11.00
0............................... 6.00 13.00
-100............................ 6.00 14.00
-200............................ 6.00 14.50
-300............................ 6.00 15.00
------------------------------------------------------------------------
Institution C has the same current NPV Ratios as Institution B. Its
board of directors has established the institution's interest rate risk
limits as a single minimum NPV Ratio of 6% that applies to all seven
rate shock scenarios. In assessing the prudence of those limits,
therefore, the Post-shock NPV Ratio permitted by the limits is 6.00%.
The current Sensitivity Measure, like that of Institution B, is 450
b.p.
In applying the Table 1 guidelines to the limits, Institution C's
Post-shock NPV Ratio is in either the ``4% to 6%'' or the ``6% to 10%''
row and its Sensitivity Measure in the ``Over 400 b.p.'' column of
Table 1. The rating suggested by the table is, therefore, a 3 or a 4,
and so Institution C's risk limits would also probably not be
considered sufficiently prudent.
Example Institution D
Institution D--Limits and Current NPV Ratios
Board limits
Rate shock (in basis points) (minimum NPV Institution's
ratios) current NPV ratios
[a] [b] [c]
------------------------------------------------------------------------
+300............................ 3.50% 2.50%
+200............................ 3.50 3.25
+100............................ 3.50 3.75
0........................... 3.50 4.00
-100............................ 3.50 4.25
-200............................ 3.50 4.50
-300............................ 3.50 4.75
------------------------------------------------------------------------
Institution D has quite a low base case level of economic capital,
and its board limits recognize that fact by permitting low NPV Ratios.
Furthermore, the institution's level of interest rate risk currently
exceeds the board limits (i.e., the current NPV Ratios in the +200 and
+300 scenarios are below the board's 3.50% minimum). While examiners
[[Page 66371]]
would be very likely to express concern about that aspect of the
institution's risk management process, the limits themselves might
still be viewed as prudent.
To determine whether the institution's limits are prudent,
examiners will use the Post-shock NPV Ratio of 3.50% permitted by the
limits and the institution's current Sensitivity Measure of 75 basis
points (i.e., [4.00%-3.25%]). In applying Table 1, the Post-shock NPV
Ratio permitted by the limits falls into the ``Below 4%'' row and the
current Sensitivity Measure falls into the ``0 to 100 b.p.'' column.
The rating suggested by Table 1 is therefore a 2, and assuming that
Institution A's Sensitivity Measure has been consistently low, its risk
limits would probably be considered prudent. Because of the critical
importance of the Sensitivity Measure in this determination, examiners
might well arrive at a different conclusion if they lack assurance that
the institution has the ability to maintain that measure at its
current, low level. Thus, if the Sensitivity Measure has been volatile
in the past or if examiners have concerns about the quality of the
institution's risk management practices, they might well conclude that
the risk limits are not sufficiently prudent.
Appendix B: Sound Practices for Market Risk Management
This section describes the key elements for effective management of
market risk exposures. These key elements encompass sound practices for
both interest rate risk management and the management of investment and
derivatives activities. The degree of formality and rigor with which an
institution implements these elements in its own risk management system
should be consistent with the institution's size, the complexity of its
financial instruments, its tolerance for risk, and the level of market
risk at which it actually operates.
A. Board and Senior Management Oversight
Effective oversight is an integral part of an effective risk
management program. The board and senior management should understand
their oversight responsibilities regarding interest rate risk
management and the management of investment and derivatives activities
conducted by their institution.
Board of Directors. The board of directors should approve broad
strategies and major policies relating to market risk management and
ensure that management takes the steps necessary to monitor and control
market risk. The board of directors should be informed regularly of the
institution's risk exposures.
The board of directors has ultimate responsibility for
understanding the nature and level of risk taken by the institution.
Board oversight need not involve the entire board, but may be carried
out by an appropriate subcommittee of the board. The board, or an
appropriate subcommittee of board members, should:
Approve broad objectives and strategies and major policies
governing interest rate risk management and investment and derivatives
activities.
Provide clear guidance to management regarding the board's
tolerance for risk.
Ensure that senior management takes steps to measure,
monitor, and control risk.
Review periodically information that is sufficient in
timeliness and detail to allow it to understand and assess the
institution's interest rate risk and risks related to investment and
derivatives activities.
Assess periodically compliance with board-approved
policies, procedures, and risk limits.
Review policies, procedures and risk limits at least
annually.
Although board members are not required to have detailed technical
knowledge, they should ensure that management has the expertise needed
to understand the risks incurred by the institution and that the
institution has personnel with the expertise needed to manage interest
rate risk and conduct investment and derivative activities in a safe
and sound manner.
Senior Management. Senior management should ensure that the
institution's operations are effectively managed, that appropriate risk
management policies and procedures are established and maintained, and
that resources are available to conduct the institution's activities in
a safe and sound manner.
Senior management is responsible for the daily oversight and
management of the institution's activities, including the
implementation of adequate risk management polices and procedures. To
carry out its responsibilities, senior management should:
Ensure that effective risk management systems are in place
and properly maintained. An institution's risk management systems
should include (1) systems for measuring risk, valuing positions, and
measuring performance, (2) appropriate risk limits, (3) a comprehensive
reporting and review process, and (4) effective internal controls.
Establish and maintain clear lines of authority and
responsibility for managing interest rate risk and for conducting
investment and derivatives activities.
Ensure that the institution's operations and activities
are conducted by competent staff with technical knowledge and
experience consistent with the nature and scope of their activities.
Provide the board of directors with periodic reports and
briefings on the institution's market-risk related activities and risk
exposures.
Review periodically the institution's risk management
systems, including related policies, procedures, and risk limits.
Lines of Responsibility and Authority for Managing Market Risk.
Institutions should identify the individuals and/or committees
responsible for risk management and should ensure there is adequate
separation of duties in key elements of the risk management process to
avoid potential conflicts of interest. Institutions should have a risk
management function (or unit) with clearly defined duties that is
sufficiently independent from position-taking functions.
Institutions should identify the individuals and/or committees
responsible for conducting risk management. Senior management should
define lines of authority and responsibility for developing strategies,
implementing tactics, and conducting the risk measurement and reporting
functions.
The risk management unit should report directly to both senior
management and the board of directors, and should be separate from, and
independent of, business lines. The function may be part of, or may
draw its staff from, more general operations (e.g., the audit,
compliance, or Treasury units). Large institutions should, however,
have a separate risk management unit, particularly if the Treasury unit
is also a profit center. Smaller institutions with limited resources
and personnel should provide additional oversight by outside directors
in order to compensate for the lack of separation of duties.
Management should ensure that sufficient safeguards exist to
minimize the potential that individuals initiating risk-taking
positions may inappropriately influence key control functions of the
risk management process such as the development and enforcement of
policies and procedures, the reporting of risks to senior
[[Page 66372]]
management, and the conduct of back-office functions.
B. Adequate Policies and Procedures
Institutions should have clearly defined risk management policies
and procedures. The board of directors has ultimate responsibility for
the adequacy of those policies and procedures; senior management and
the institution's risk management function have immediate
responsibility for their design and implementation. Policies and
procedures should be reviewed periodically and revised as needed.
Interest Rate Risk. Institutions should have written policies and
procedures for limiting and controlling interest rate risk. Such
policies and procedures should be consistent with the institution's
strategies, financial condition, risk-management systems, and tolerance
for risk. An institution's policies and procedures (or documentation
issued pursuant to such policies) should:
Address interest rate risk at the appropriate level(s) of
consolidation. (Although the board will generally be most concerned
with the consolidated entity, it should be aware that accounting and
legal restrictions may not permit gains and losses occurring in
different subsidiaries to be netted.)
Delineate lines of responsibility and identify individuals
or committees responsible for (1) developing interest rate risk
management strategies and tactics, (2) making interest rate risk
management decisions, and (3) conducting oversight.
Identify authorized types of financial instruments and
hedging strategies.
Describe a clear set of procedures for controlling the
institution's aggregate interest rate risk exposure.
Define quantitative limits on the acceptable level of
interest rate risk for the institution.
Define procedures and conditions necessary for exceptions
to policies, limits, and authorizations.
Investment and Derivatives Activities. Institutions should have
written policies and procedures governing investment and derivatives
activities. Such policies and procedures should be consistent with the
institution's strategies, financial condition, risk-management systems,
and tolerance for risk. An institution's policies and procedures (or
documentation issued pursuant to such policies) should:
Identify the staff authorized to conduct investment and
derivatives activities, their lines of authority, and their
responsibilities.
Identify the types of authorized investment securities and
derivative instruments.
Specify the type and scope of pre-purchase analysis that
should be conducted for various types or classes of investment
securities and derivative instruments.
Define, where appropriate, position limits and other
constraints on each type of authorized investment and derivative
instrument, including constraints on the purpose(s) for which such
instruments may be used.
Identify dealers, brokers, and counterparties that the
board or a committee designated by the board (e.g., a credit policy
committee) has authorized the institution to conduct business with and
identify credit exposure limits for each authorized entity.
Ensure that contracts are legally enforceable and
documented correctly.
Establish a code of ethics and standards of professional
conduct applicable to personnel involved in investment and derivatives
activities.
Define procedures and approvals necessary for exceptions
to policies, limits, and authorizations.
Policies and procedures governing investment and derivatives
activities may be embedded in other policies, such as the institution's
interest rate risk policies, and need not be stand-alone documents.
C. Risk Measurement, Monitoring, and Control Functions
Interest Rate Risk Measurement. Institutions should have interest
rate risk measurement systems that capture all material sources of
interest rate risk. Measurement systems should utilize accepted
financial concepts and risk measurement techniques and should
incorporate sound assumptions and parameters. Management should
understand the assumptions underlying their systems. Ideally,
institutions should have interest rate risk measurement systems that
assess the effects of interest rate changes on both earnings and
economic value.
An institution's interest rate risk measurement system should
address all material sources of interest rate risk including repricing,
yield curve, basis and option risk exposures. In many cases, the
interest rate sensitivity of an institution's mortgage portfolio will
dominate its aggregate risk profile. While all of an institution's
holdings should receive appropriate treatment, instruments whose
interest rate sensitivity may significantly affect the institution's
overall results should receive special attention, as should instruments
whose embedded options may have a significant effect on the results.
The usefulness of any interest rate risk measurement system depends
on the validity of the underlying assumptions and accuracy of the
methodologies. In designing interest rate risk measurement systems,
institutions should ensure that the degree of detail about the nature
of their interest-sensitive positions is commensurate with the
complexity and risk inherent in those positions.
Management should assess the significance of the potential loss of
precision in determining the extent of aggregation and simplification
used in its measurement approach.
Institutions should ensure that all material positions and cash
flows, including off-balance-sheet positions, are incorporated into the
measurement system. Where applicable, these data should include
information on the coupon rates or cash flows of associated instruments
and contracts. Any adjustments to underlying data should be documented,
and the nature and reasons for the adjustments should be understood. In
particular, any adjustments to expected cash flows for expected
prepayments or early redemptions should be documented.
Key assumptions used to measure interest rate risk exposure should
be re-evaluated at least annually. Assumptions used in assessing the
interest rate sensitivity of complex instruments should be documented
and reviewed periodically.
Management should pay special attention to those positions with
uncertain maturities, such as savings and time deposits, which provide
depositors with the option to make withdrawals at any time. In
addition, institutions often choose not to change the rates paid on
these deposits when market rates change. These factors complicate the
measurement of interest rate risk, since the value of the positions and
the timing of their cash flows can change when interest rates vary.
Mortgages and mortgage-related instruments also warrant special
attention due to the uncertainty about the timing of cash flows
introduced by the borrowers' ability to prepay.
IRR Limits. Institutions should establish and enforce risk limits
that maintain exposures within prudent levels. Management should ensure
that the institution's interest rate risk exposure is maintained within
self-imposed limits. A system of interest rate risk limits should set
prudent boundaries for the level of interest rate risk for the
institution and, where
[[Page 66373]]
appropriate, should also provide the capability to set limits for
individual portfolios, activities, or business units.
Limit systems should also ensure that positions exceeding limits or
predetermined levels receive prompt management attention.
Senior management should be notified immediately of any breaches of
limits. There should be a clear policy as to how senior management will
be informed and what action should be taken. Management should specify
whether the limits are absolute in the sense that they should never be
exceeded or whether, under specific circumstances, breaches of limits
can be tolerated for a short period of time.
Limits should be consistent with the institution's approach to
measuring interest rate risk.
Interest rate risk limits should be tied to specific scenarios for
movements in market interest rates and should include ``high stress''
interest rate scenarios.
Limits may also be based on measures derived from the underlying
statistical distribution of interest rates, using ``earnings-at-risk''
or ``value-at-risk'' techniques.
Stress Testing. Institutions should measure their risk exposure
under a number of different scenarios and consider the results when
establishing and reviewing their policies and limits for interest rate
risk.
Institutions should use interest rate scenarios that are
sufficiently varied to encompass different stressful conditions.
Stress tests should include ``worst case'' scenarios in addition to
more probable scenarios. Possible stress scenarios might include abrupt
changes in the general level of interest rates, changes in the
relationships among key market rates (i.e., basis risk), changes in the
slope and the shape of the yield curve (i.e., yield curve risk),
changes in the liquidity of key financial markets or changes in the
volatility of market rates. In conducting stress tests, special
consideration should be given to instruments or positions that may be
difficult to liquidate or offset in stressful situations. Management
and the board of directors should periodically review both the design
and the results of such stress tests and ensure that appropriate
contingency plans are in place.
Market Risk Monitoring and Reporting. Institutions should have
accurate, informative, and timely management information systems, both
to inform management and to support compliance with board policy.
Reports for monitoring and controlling market risk exposures should be
provided on a timely basis to the board of directors and senior
management.
The board of directors and senior management should review market
risk reports (i.e., interest rate risk reports and reports on
investment and derivatives activities) on a regular basis (at least
quarterly). While the types of reports prepared for the board and
various levels of management will vary, they should include:
Summaries of the institution's aggregate interest rate
risk and other market risk exposures including results of stress tests;
Reports on the institution's compliance with risk
management policies, procedures, and limits;
Reports comparing the institution's level of interest rate
risk with other savings associations using industry data provided by
OTS;
A summary of any major differences between the results of
the OTS Net Portfolio Value Model and the institution's own results;
and
Summaries of internal and external reviews of the
institution's risk management framework, including reviews of policies,
procedures, risk measurement and control systems, and risk exposures.
D. Internal Controls
Institutions should have an adequate system of internal controls
over their interest rate risk management process. A fundamental
component of the internal control system involves regular independent
reviews and evaluations of the effectiveness of the system.
Internal controls should be an integral part of an institution's
risk management system. The controls should promote effective and
efficient operations, reliable financial and regulatory reporting, and
compliance with relevant laws, regulations, and institutional policies.
An effective system of internal control for interest rate risk should
include:
effective policies, procedures, and risk limits;
an adequate process for measuring and evaluating risk;
adequate risk monitoring and reporting systems;
a strong control environment; and
continual review of adherence to established policies and
procedures.
Institutions are encouraged to have their risk measurement systems
reviewed by knowledgeable outside parties. Reviews of risk measurement
systems should include assessments of the assumptions, parameter
values, and methodologies used. Such a review should evaluate the
system's accuracy and recommend solutions to any identified weaknesses.
The results of the review, along with any recommendations for
improvement, should be reported to senior management and the board, and
acted upon in a timely manner.
Institutions should review their system of internal controls at
least annually. Reviews should be performed by individuals independent
of the function being reviewed. Results should be reported to the
board. The following factors should be considered in reviewing an
institution's internal controls:
Are risk exposures maintained at prudent levels?
Are the risk measures employed appropriate to the nature
of the portfolio?
Are board and senior management actively involved in the
risk management process?
Are policies, controls, and procedures well documented?
Are policies and procedures followed?
Are the assumptions of the risk measurement system well
documented?
Are data accurately processed?
Is the risk management staff adequate?
Have risk limits been changed since the last review?
Have there been any significant changes to the
institution's system of internal controls since the last review?
Are internal controls adequate?
E. Analysis and Stress Testing of Investments and Financial Derivatives
Management should undertake a thorough analysis of the various
risks associated with investment securities and derivative instruments
prior to making an investment or taking a significant position in
financial derivatives and periodically thereafter. Major initiatives
involving investments and derivatives transactions should be approved
in advance by the board of directors or a committee of the board.
As a matter of sound practice, prior to taking an investment
position or initiating a derivatives transaction, an institution
should:
Ensure that the proposed investment or derivative
transaction is legally permissible for a savings institution.
Review the terms and conditions of the investment
instrument or derivative contract.
Ensure that the proposed transaction is allowable under
the institution's investment or derivatives policies.
Ensure that the proposed transaction is consistent with
the
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institution's portfolio objectives and liquidity needs.
Exercise diligence in assessing the market value,
liquidity, and credit risk of any investment security or derivative
instrument.
Conduct a price sensitivity analysis of the security or
financial derivative prior to taking a position.
Conduct an analysis of the incremental effect of any
proposed transaction on the overall interest rate sensitivity of the
institution.
Prior to taking a position in any complex securities or financial
derivatives, it is important to have an understanding of how the future
direction of interest rates and other changes in market conditions
could affect the instrument's cash flows and market value. In
particular, management should understand:
the structure of the instrument;
the best-case and worst-case interest rates scenarios for
the instrument;
how the existence of any embedded options or adjustment
formulas might affect the instrument's performance under different
interest rate scenarios;
the conditions, if any, under which the instrument's cash
flows might be zero or negative;
the extent to which price quotes for the instrument are
available;
the instrument's universe of potential buyers; and
the potential loss on the instrument (i.e., the potential
discount from its fair value) if sold prior to maturity.
F. Evaluation of New Products, Activities, and Financial Instruments
Involvement in new products, activities, and financial instruments
(assets, liabilities, or off-balance sheet contracts) can entail
significant risk, sometimes from unexpected sources. Senior management
should evaluate the risks inherent in new products, activities, and
instruments and ensure that they are subject to adequate review
procedures and controls.
Products, activities, and financial instruments that are new to the
organization should be carefully reviewed before use or implementation.
The board, or an appropriate committee, should approve major new
initiatives involving new products, activities, and financial
instruments.
Prior to authorizing a new initiative, the review committee should
be provided with:
a description of the relevant product, activity, or
instrument;
an analysis of the appropriateness of the proposed
initiative in relation to the institution's overall financial condition
and capital levels; and
a description of the procedures to be used to measure,
monitor, and control the risks of the proposed product, activity, or
instrument.
Management should ensure that adequate risk management procedures
are in place in advance of undertaking any significant new initiatives.
Appendix C: Excerpt From Interagency Uniform Financial Institutions
Rating System 15
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\15\ 61 Fed. Reg. 67029 (1996).
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Sensitivity to Market Risk
The sensitivity to market risk component reflects the degree to
which changes in interest rates, foreign exchange rates, commodity
prices, or equity prices can adversely affect a financial institution's
earnings or economic capital. When evaluating this component,
consideration should be given to: management's ability to identify,
measure, monitor, and control market risk; the institution's size; the
nature and complexity of its activities; and the adequacy of its
capital and earnings in relation to its level of market risk exposure.
For many institutions, the primary source of market risk arises
from non-trading positions and their sensitivity to changes in interest
rates. In some larger institutions, foreign operations can be a
significant source of market risk. For some institutions, trading
activities are a major source of market risk.
Market risk is rated based upon, but not limited to, an assessment
of the following evaluation factors:
The sensitivity of the financial institution's earnings or
the economic value of its capital to adverse changes in interest rates,
foreign exchange rates, commodity prices, or equity prices.
The ability of management to identify, measure, monitor,
and control exposure to market risk given the institution's size,
complexity, and risk profile.
The nature and complexity of interest rate risk exposure
arising from non-trading positions.
Where appropriate, the nature and complexity of market
risk exposure arising from trading and foreign operations.
Ratings
1. A rating of 1 indicates that market risk sensitivity is well
controlled and that there is minimal potential that the earnings
performance or capital position will be adversely affected. Risk
management practices are strong for the size, sophistication, and
market risk accepted by the institution. The level of earnings and
capital provide substantial support for the degree of market risk taken
by the institution.
2. A rating of 2 indicates that market risk sensitivity is
adequately controlled and that there is only moderate potential that
the earnings performance or capital position will be adversely
affected. Risk management practices are satisfactory for the size,
sophistication, and market risk accepted by the institution. The level
of earnings and capital provide adequate support for the degree of
market risk taken by the institution.
3. A rating of 3 indicates that control of market risk sensitivity
needs improvement or that there is significant potential that the
earnings performance or capital position will be adversely affected.
Risk management practices need to be improved given the size,
sophistication, and level of market risk accepted by the institution.
The level of earnings and capital may not adequately support the degree
of market risk taken by the institution.
4. A rating of 4 indicates that control of market risk sensitivity
is unacceptable or that there is high potential that the earnings
performance or capital position will be adversely affected. Risk
management practices are deficient for the size, sophistication, and
level of market risk accepted by the institution. The level of earnings
and capital provide inadequate support for the degree of market risk
taken by the institution.
5. A rating of 5 indicates that control of market risk sensitivity
is unacceptable or that the level of market risk taken by the
institution is an imminent threat to its viability. Risk management
practices are wholly inadequate for the size, sophistication, and level
of market risk accepted by the institution. [Emphasis added.]
Appendix D: Glossary
Alternate Interest Rate Scenarios: Scenarios that depict
hypothetical shocks to, or movements in, the current term structure of
interest rates. As currently utilized in the OTS NPV Model, there are
eight alternate interest rate scenarios, depicting shocks in which the
term structure has been changed by the same amount at all maturities.
The changes currently depicted in the alternate scenarios range from--
400 basis points to +400 basis points. (Institutions need only provide
board limits for scenarios ranging from-300 to +300 basis points.)
Base Case: A term sometimes used for the prevailing term structure
of interest rates (i.e., the current interest rate scenario). Also
known as the ``pre-
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shock'' or ``no shock'' scenario, one not subjected to a change in
interest rates. This is in contrast to, say, the plus or minus 100
basis point rate shock scenarios.
CAMELS Rating System: A uniform ratings system, applied to all
banks, thrifts, and credit unions, which provides an indication of an
institution's overall condition.. The six factors of the CAMELS rating
system represent Capital Adequacy, Asset Quality, Management, Earnings,
Liquidity, and Sensitivity to Market Risk. Quantitative and qualitative
factors are used to establish a rating, ranging from 1 to 5 for each
CAMELS component rating. A rating of 1 represents the best rating and
least degree of concern, while a 5 rating represents the worst rating
and greatest degree of concern. The six CAMELS component ratings are
used in developing the overall Composite Rating for an institution.
Complex Securities: The term ``complex security'' includes any
collateralized mortgage obligation (``CMO''), real estate mortgage
investment conduit (``REMIC''), callable mortgage pass-through
security, stripped-mortgage-backed-security, structured note, and any
security not meeting the definition of an ``exempt security.'' An
``exempt security'' includes non-callable, ``plain vanilla''
instruments of the following types: (1) mortgage-pass-through
securities, (2) fixed-rate securities, and (3) floating-rate
securities.
Composite Rating: A rating that summarizes an institution's overall
condition under the CAMELS rating system. This overall rating is
expressed through a numerical scale of 1 through 5, with 1 representing
the best rating and least degree of concern, and 5 representing the
worst rating and highest degree of concern.
Financial Derivative: Any financial contract whose value depends on
the value of one or more underlying assets, indices, or reference
rates. The most common types of financial derivatives are futures,
forward commitments, options, and swaps. A mortgage derivative
security, such as a collateralized mortgage obligation or a real estate
mortgage investment conduit, is not a financial derivative under this
definition.
Interest Rate Risk: The vulnerability of an institution's financial
condition to movements in interest rates. Changes in interest rates
affect an institution's earnings and economic value.
Interest Rate Risk Exposure Report: A quarterly report, sent by OTS
to all institutions that file Schedule CMR, presenting the results of
the OTS NPV Model for each institution.
Interest Rate Sensitivity Measure: The magnitude of the decline in
an institution's NPV Ratio that occurs as a result of an adverse rate
shock of 200 basis points. The measure equals the difference between an
institution's Pre-shock NPV Ratio and its Post-shock NPV Ratio and is
expressed in basis points. In general, institutions that have
significant imbalances between the interest rate sensitivity (i.e.,
duration) of their assets and liabilities tend to have high Interest
Rate Sensitivity Measures.
MVPE: The abbreviation for Market Value of Portfolio Equity, a term
previously used for Net Portfolio Value. This term is no longer used by
OTS because some of the factors used to determine NPV may not be market
based.
NPV: The abbreviation for Net Portfolio Value which equals the
present value of expected net cash flows from existing assets minus the
present value of expected net cash flows from existing liabilities plus
the present value of net expected cash flows from existing off-balance
sheet contracts.
Post-shock NPV Ratio: Along with the Sensitivity Measure, one of
the two primary measures of interest rate risk used by OTS. The ratio
is determined by dividing an institution's NPV by the present value of
its assets, where both the numerator and denominator are measured after
a 200 basis point increase or decrease in market interest rates,
whichever produces the smaller ratio. A higher Post-shock Ratio
indicates a lower level of interest rate risk. Also sometimes referred
to as the ``Exposure Measure.''
Pre-shock NPV Ratio: Ratio determined by dividing an institution's
NPV by the present value of its assets, where both the numerator and
denominator are measured in the base case. The ratio is a measure of an
institution's economic capitalization. It is also referred to as the
``Base Case NPV Ratio.''
Prompt Corrective Action: A system of enforcement actions,
established under the Federal Deposit Insurance Corporation Improvement
Act of 1991, that regulators are required to take against insured
institutions whose capital falls below certain critical thresholds.
``S'' Component Rating: see ``Sensitivity to Market Risk Component
Rating.''
Schedule CMR: A section of the Thrift Financial Report that is used
by OTS to collect financial data for the OTS NPV Model.
Sensitivity Measure: see ``Interest Rate Sensitivity Measure.''
Sensitivity to Market Risk'' Component Rating: The component rating
in the CAMELS rating system designed to express the degree to which
changes in interest rates, foreign exchange rates, commodity prices, or
equity prices can adversely affect a financial institution's earnings
or economic capital. The rating is based on two components: an
institution's level of market risk and the quality of its practices for
managing market risk. The ``S'' component rating.
Shocked Rate Scenarios: see ``Alternate Interest Rate Scenarios.''
Structured Notes: Structured notes include fixed-income securities
with embedded options or derivative-like features where the bond's
coupon, average life, or redemption value is dependent on a reference
rate, an index, or formula. The term ``structured notes'' includes but
is not limited to: dual-indexed floaters, de-leveraged floaters,
inverse floaters, leveraged inverse floaters, ratchet floaters, range
floaters, leveraged cap floaters, stepped cap/floor floaters, capped
callable floaters, stepped spread floaters, multi-step bonds, indexed
amortization notes, etc. Standard, non-leveraged, floating rate
securities (i.e., those whose interest rate is not based on a multiple
of the index) are not considered structured notes for purposes of this
Thrift Bulletin.
Uniform Financial Institutions Rating System: see ``CAMELS Rating
System'' and ``Composite Rating.''
Value-at-risk: A measure of market risk. An estimate of the maximum
potential loss in economic value over a given period of time for a
given probability level.
Dated: November 20, 1998.
By the Office of Thrift Supervision.
Ellen Seidman,
Director.
[FR Doc. 98-31672 Filed 11-30-98; 8:45 am]
BILLING CODE 6720-01-P
