Purpose The federal financial institution regulatory
agencies,
1 in consultation with the Conference
of State Bank Supervisors, are jointly issuing this examiner guidance
to outline the supervisory practices to be followed in assessing the
condition of institutions
2 directly affected by an event that results
in a presidential declaration of a major disaster with individual
assistance.
3 This guidance also applies to institutions that may be located
outside the disaster area, but have loans to or investments in individuals
or entities located in the disaster area. Examiners should be flexible
in their supervisory response after considering the unique and potential
long-term nature of the issues confronting affected institutions.
A major disaster generally has a devastating effect that
can continue to impact the business activities of the institutions
serving the affected area for an extended period. Some of these institutions
may face extensive asset quality issues caused by business failures,
interruptions of borrowers’ income streams, increases in borrowers’
operating costs, the loss of jobs, and uninsured or underinsured collateral
damage. Further, as a result of a substantial loss in their tax and
revenue base, state and local governments in the affected area may
face major challenges in paying their obligations, which could adversely
affect institutions with large investments in municipal securities
and loans.
The supervisory agencies understand institutions affected
by a major disaster may need to focus on the recovery of personnel
and physical operations. The supervisory agencies will work with those
institutions to determine their needs and to reschedule any examinations,
as needed. The supervisory agencies’ staff will continue to monitor
all affected institutions through their off-site processes. Further,
management at affected institutions experiencing significant operational
difficulties may request an extension for filing quarterly Reports
of Condition and Income or other reports.
Overall Supervisory Assessment It is essential that the supervisory agencies maintain
a clear understanding of the condition of each institution affected
by a major disaster and the effectiveness of each institution’s business
continuity plans. To promote consistency across the supervisory agencies,
examiners will continue to assign the component and composite ratings
of impacted institutions in accordance with the definitions in the
Uniform Financial Institutions Rating System, commonly referred
to as the CAMELS rating
4 and the interagency
Rating System for
U.S. Branches and Agencies of Foreign Banking Organizations, commonly
referred to as the ROCA rating.
5When evaluating the composite and component ratings for
CAMELS or ROCA at an institution affected by a major disaster, examiners
should review management’s response plans and assess the reasonableness
of those plans given the institution’s business strategy and operational
capacity in the distressed economic and business environment. In particular,
when assessing the management component, examiners should consider
management’s effectiveness in responding to the changes in the institution’s
business markets and whether the institution has addressed these issues
in its longer-term business strategy and future response plans.
The examiner’s assessment may result in assigning a lower
component or composite rating for some affected institutions. However,
in considering the supervisory response for institutions accorded
a lower rating, examiners should give appropriate recognition to the
extent to which weaknesses are caused by external problems related
to the major disaster and its aftermath.
Examiners should consult with their supervisory agencies’
management to determine whether supervisory action, if any, should
be taken. Formal or informal administrative action that would ordinarily
be considered for lower-rated institutions may not be necessary, provided
the institution’s management has appropriately planned for continuity
of operations; implemented prudent policies; and is pursuing realistic
resolution of the issues confronting the institution. In instances
where a formal or informal supervisory action is warranted, examiners
should tailor their response to capabilities and efforts of the institution’s
management in resolving the institution’s specific issues.
Effectiveness of Institution’s Risk Assessment Examiners should expect management at
affected institutions to conduct initial risk assessments and have
a process for refining such assessments as more complete information
becomes available and recovery efforts proceed. The institution’s
risk assessment should reflect management’s best estimate of the institution’s
asset quality, given the prevailing economic conditions in its business
markets. In addition to determining the effect on asset quality, management
should be able to explain the disaster’s implications on the institution’s
earnings and capital, as well as its effect on funding, liquidity,
operations, and sensitivity to market risk.
The assessment of operational risk should address the
effectiveness of the institution’s operational capability and its
business continuity plan. Institution management should be able to
explain its review and assessment methodology and demonstrate reasonable
progress, given the circumstances. An institution that experienced
heavy damage to its facilities or delays in key personnel returning
to work may need more time to complete its initial operational risk
assessment.
Examiners should determine whether the risk assessments
are sufficient in scope and content. In reviewing the assessments,
examiners should recognize that the issues confronting affected institutions
are complex and may involve protracted resolution. Examination scope
may need to be adjusted depending on the quality and thoroughness
of the risk assessment. The quality of an institution’s assessments
can be considered, as appropriate, in the examiner’s assessment of
CAMELS ratings or the ROCA rating.
Components of the CAMELS Rating or ROCA Rating When assessing the component ratings for CAMELS or ROCA,
examiners should consider the following:
When evaluating
the capital component for affected institutions, examiners should
consider any asset losses, extraordinary expenses, unexpected deposit
growth, contingent liabilities, and risks that were incurred as a
result of a major disaster. If substantial declines in the affected institution’s
capital ratios have occurred or are projected, examiners should determine
whether management has developed a satisfactory capital restoration
plan that provides for capital augmentation in a timely manner if
the decline is not attributed to a temporary surge in deposits.
The supervisory agencies recognize affected institutions
may experience significant temporary balance sheet growth due to unusually
large deposit inflows from insurance proceeds or other funds. Such
growth may result in a temporary decline in institutions’ regulatory
capital ratios. If such a situation results in a meaningful decline
in regulatory capital, management should be prepared to discuss its
plans for addressing the situation in light of the institution’s financial
condition. In assessing supervisory options, the primary federal regulator
will consider whether an institution maintains a fundamentally sound
financial condition and evidence that a decline in regulatory capital
ratios would be temporary.
Asset Quality
When assessing asset quality, examiners should consider
whether management has been able to identify all loans and investments
substantially affected by a major disaster and any potential loss
exposure. For secured loans, examiners should expect management to
have a process for tracking information on the condition of collateral
and the collectability and timing of insurance proceeds. This analysis
should be performed on an individual loan basis and supporting documentation
should be included for significant credits. This process may necessitate
a change in management’s loan review criteria to reflect the need
to monitor loans affected by a major disaster more frequently. Examiners
also should consider management’s efforts to address the following
issues.
Loan reviews. Examiners should expect an institution’s
loan review practices to be sufficient to verify that it is adequately
identifying and reporting the risk in its portfolio. Examiners should
identify any recourse arrangements with sold loans or other contractual
agreements that may involve increased risk to the institution.
Examiners should recognize that supporting file documentation
may be limited due to unusual circumstances caused by the disaster.
Examiners should verify the accuracy of management’s risk assessment
by transaction testing and consider expanding the scope of the loan
review if transaction testing indicates that management’s risk assessment
is insufficient.
New loans. In keeping with existing practices,
examiners should review a sample of loans originated after a major
disaster to determine whether the institution’s underwriting standards
are appropriate. There may be a number of legitimate reasons why management
may have eased underwriting standards after a major disaster to address
the needs of its customer base. In addition, management may have changed
its business strategy to focus on new lines of business or expand
into new markets. Examiners should note any substantial changes in
the institution’s lending practices and assess whether these activities
are consistent with the institution’s loan policies, the board of
directors’ strategic plan, and prudent credit underwriting standards
and administration practices.
Credit modifications. Examiners should recognize
that the economic conditions in disaster-affected areas may influence
an institution’s course of action as well as the timing of such action.
Examiners generally should not criticize an institution that is attempting
to work constructively with its borrowers in affected areas. Examiners
should review an institution’s policies and procedures for providing
a borrower with a credit renewal, extension, or modification. The
supervisory agencies have found that prudent credit modifications
are often in the best interest of the institution and the borrower.
Institutions that implement prudent loan workout arrangements after
reviewing a borrower’s financial condition after a major disaster
will not be subject to criticism for engaging in these efforts even
if the restructured loans have weaknesses that result in adverse credit
classification.
In addition, renewed, extended, or modified loans to borrowers
who have the ability to repay their debts according to reasonable
modified terms will not be subject to adverse classification solely
because the value of the underlying collateral has declined to an amount
that is less than the loan balance. Examiners should review appropriate
documentation to support management’s agreement with the borrower,
including the borrower’s recovery plans, source of repayment, reliance
on insurance proceeds, advancement of additional funds for rebuilding,
value of additional collateral, and the condition of existing collateral.
Regardless of the terms of the renewal, extension, or
modification agreement, examiners should expect management to appropriately
report credits that meet the definition of a troubled debt restructuring
according to U.S. Generally Accepted Accounting Principles (GAAP)
and recognize credit losses as soon as a loss can be reasonably estimated.
Moreover, examiners should expect management to preserve the integrity
of the institution’s internal loan grading methodology and maintain
appropriate accrual status on affected loans.
Nonaccrual. Management may find it appropriate
to allow borrowers in affected areas to defer payment of principal,
interest, or both for a reasonable period of time with the expectation
that the borrower will resume payments in the future. Nevertheless,
accrued interest should be reversed (written off) when it is deemed
uncollectible. Examiners should ensure that institutions continue
to follow applicable regulatory reporting requirements, as well as
the institutions’ internal accounting policies, when reporting nonaccrual
assets.
Insurance claims. In many cases, loan repayment
may be dependent on borrowers settling the insurance claims that they
filed with their insurance companies on insured properties. However,
there may be uncertainty regarding the timing and amount of potential
insurance claims. Examiners should consider the type, amount, and
timing of proposed settlement offers. If an insurance company indicates
a valid claim has been accepted, then the negotiated settlement amount
normally would not be subject to adverse classification, barring any
unusual issues, and examiners should use judgment in determining the
appropriate classification for the balance of the loan, if any. If
the validity of an insurance claim is in doubt or a protracted resolution
is likely, then examiners should exercise judgment in classifying
a loan based on the specific facts and circumstances.
Classification standards. Examiners
should rely upon existing credit classification standards for loans
affected by a major disaster. The assessment of each loan should be
based upon the fundamental characteristics affecting the collectability
of that particular credit. Examiners should review management’s assessment
of the borrower’s repayment ability and financial condition as well
as the institution’s collateral protection to determine the appropriate
credit classification.
Examiners should apply appropriate credit classification
and charge-off standards in cases where the information indicates
a loan will not be repaid or the institution, despite its reasonable
efforts, has been unable to establish contact with the borrower. Examiners
should also assess the reasonableness of management’s plans for pursuing
foreclosure of collateral on nonperforming assets, given the unknown
environmental risks and other factors that may affect the condition
of the collateral. In some cases, the deferral of foreclosure may
be the most prudent course of action.
Allowance for Loan and Lease Losses (ALLL).7 Examiners should review an institution’s methodology
for calculating the ALLL. In determining an appropriate ALLL, management
should consider all information available about the collectability
of the institution’s loan portfolio, including any changes in the
institution’s lending practices as a result of a major disaster. Consistent
with U.S. GAAP, the amounts included in the ALLL for estimated credit
losses incurred as a result of a major disaster should represent probable
losses that can be reasonably estimated. As an institution obtains
additional information about loans to borrowers affected by a major
disaster, management is expected to reflect revised estimates of loan
losses in the ALLL and subsequent regulatory reports.
There may be a period of time when an institution
has difficulty in accurately determining the collectability of loans
to borrowers in the affected areas. Examiners should recognize that
management may need more time than in normal economic conditions to
evaluate the effect of a major disaster on the ability of the borrower
to pay, assess the condition of underlying collateral, and determine
potential insurance proceeds. Examiners should ensure management has
maintained the ALLL at an appropriate level based on its best estimate
of probable losses within a range of loss estimates.
Obligations of taxing authorities. Examiners
should review the institution’s loan and investment portfolios to
determine whether credit has been extended to taxing authorities via
loans or through the purchase of state, county, parish, or other municipal
obligations in areas that sustained damage during a major disaster.
Communities in an affected area may be heavily dependent on local
sales, hotel, property, and income tax revenues. These sources of
income generally fall sharply after a major disaster, and the ultimate
collection of such loans and investments may be adversely affected.
Some loans and bonds may also be tied to specific facilities, such
as hospitals, that may not resume operations for an extended period.
Examiners should ensure that affected institutions monitor
their risk exposures in municipal bonds in order to assess whether
those bonds continue to be the credit equivalent of an investment
grade security and are appropriately classified, consistent with the
Uniform Agreement on the Classification and Appraisal of Securities
Held by Depository Institutions.8 Many public obligors and issuers have insurance or have access
to debt payment and other reserve funds that help ensure the full
and timely repayment of principal and interest for the projected life
of the asset or exposure. However, examiners should ensure that management
is using all available information to ensure credit risk assessments
are timely, accurate, and consistent with internal policies, as well
as regulatory and accounting requirements.
Real estate values. Affected areas and neighboring
evacuee locations often experience substantial fluctuations in real
estate values after a major disaster. For both existing and new real
estate loans, examiners should assess the institution’s policies and
practices for valuing collateral in real estate markets that have
experienced a substantial, but possibly temporary, decrease or increase
in real estate values as a result of a major disaster. When reviewing
an institution’s estimates of collateral values, examiners should
ascertain whether the values are based on assumptions that are prudent
and realistic.
Appraisal exceptions related to major disasters. The supervisory agencies may exercise their authority to grant an
exception to statutory and regulatory appraisal requirements in areas
that the president declares a major disaster with individual assistance.
9 If granted, such exceptions apply
to all real estate-related financial transactions secured by real
property in the affected area and are subject to conditions the supervisory
agencies impose. To date, these conditions have primarily consisted
of requiring institutions to determine and document that:
1.
The
transaction involves real property within the area declared a major
disaster;
2.
There
is a binding commitment to fund the transaction that is made within
a specified time frame after the disaster is declared; and
3.
The
value of the real property supports an institution’s decision to enter
into the transaction.
When an institution relies on a major
disaster-related
appraisal exception for a specific real estate-related transaction,
the institution should provide sufficient documentation to support
its credit decision and valuation of the collateral based on alternative
valuation methods, including evaluations.
10 Examiners should continue to review institutions’ use of such
exceptions to exempt real estate-related transactions from the appraisal
regulations.
Other assets and premises. Examiners should determine
whether the institution has acquired other assets, such as temporary
equipment and office facilities to replace destroyed or unusable branches
as well as temporary lodging facilities for employees whose homes
have become uninhabitable. Examiners should assess the short- and
long-term effect these assets may have on the institution’s operations
and earnings to the extent warranted, including the disposal of such
assets when no longer needed. Examiners should review management’s
impairment assessment of destroyed or damaged long-lived assets after
a major disaster.
Management
Capability When rating an institution’s
management, existing supervisory policy instructs examiners to distinguish
between problems caused by the institution’s management and those
due to a major disaster. Management of an institution with problems
related to a major disaster and its aftermath would warrant a higher
rating than management that is otherwise substantially responsible
for an institution’s problems, provided that prudent planning and
policies are in place and management is pursuing realistic resolution
of the institution’s problems.
Many institutions affected by a major disaster may be
confronted with unprecedented issues. In addition to an institution’s
risk assessment, examiners should evaluate management based on the
scope and thoroughness of the institution’s internal risk assessment
and business continuity plan, and, if necessary, its plan for business
restoration. In assessing management, examiners should consider the
institution’s asset size, complexity, and risk profile. While management
of an affected institution should be rated on its ability to properly
identify and manage these risks, examiners should give consideration
to the extraordinary circumstances surrounding many of the decisions
made immediately after a major disaster as well as the actions subsequently
taken to resume operations.
Examiners should assess the effectiveness of an institution’s
disaster recovery and business continuity plans and consider whether
these plans need to be modified.
11 This review
should include an assessment of management’s ability to:
- Communicate before, during, and after a major disaster,
including:
- o Addressing staffing issues, such as:
- Operating with limited staff
due to personnel needing to respond to personal concerns arising from
the major disaster;
- Identifying and informing
essential personnel needed to conduct operations on how and where
they will perform those functions; and
- Keeping staff informed of
plans to share information throughout the major disaster;
- o Apprising customers on ways to receive
updated information regarding the insti-tution’s operational capabilities;
and
- o Notifying key third-party service
providers and suppliers of the potential need to take preemptive action
before the event and initiate business continuity plans after the
event.
- Deal with extensive damage to facilities, equipment,
and records, if needed, such as;
- o Establishing temporary facilities;
- o Obtaining replacement equipment
and supplies;
- o Handling and reproducing contaminated
loan files and legal and collateral documents;
- o Replacing contaminated cash and coins;
and
- o Handling contaminated safe deposit
boxes and their contents.
- Retrieve and restore data systems, electronic information,
and operational capabilities.
Risk Management of a Branch
or Agency of a FBO The aftermath of
a major disaster will likely present different challenges to the FBO
head office of a branch or agency as well as local management. When
considering risk management of branches and agencies of FBOs, examiners
should focus on the assessment factors outlined in the Board’s SR
Letter 00-14,
Enhancements to the Interagency Program for Supervising
the U.S. Operations of Foreign Banking Organizations12 and consider these factors in the context of the major disaster.
Examiners should evaluate the level of support provided by the home
office in restoring operations and the appropriateness of risk management
in light of the changing operating environment and economic conditions
due to a major disaster.
When evaluating the earnings of
an affected institution, examiners should consider the duration of
any reductions to core earnings caused by a major disaster. Examiners
should also assess the quantity and quality of prior earnings as well
as the influence that a major disaster may have on the institution’s
future earnings potential. This assessment also should consider the
adequacy and reasonableness of any revisions to the institution’s
budget and strategic plan.
Liquidity Many institutions affected
by a major disaster may experience sharp fluctuations in liquidity
resulting from the receipt of Federal Emergency Management Agency
payments, insurance proceeds, or other disaster-related funds, as
well as outflows of municipal deposits, out-of-area funds, or other
large deposits. In addition, collateral requirements for secured funding
sources (such as a line of credit from a Federal Home Loan Bank) may
be temporarily modified. Examiners should consider the nature and
timing of disaster-related inflows and outflows when reviewing the
adequacy of an institution’s liquidity and be cognizant of how management
is employing any influx of liquid resources.
Although the ROCA rating does not contain a liquidity
component rating, funding, liquidity risk, and risk management are
important factors in the assessment of branches and agencies of FBOs.
Examiners should assess the effect of a major disaster on liquidity
as part of the risk-management component of the ROCA rating.
Sensitivity to Market Risk Many institutions affected by a major disaster may
experience temporary shifts in their interest rate risk profiles from
changes in cash flows associated with the short-term effect of the
disaster. For example, the amount or timing of cash flows may be altered
by deterioration in loan and bond portfolios or by the prepayment
of mortgages with insurance proceeds.
Examiners should recognize that management may require
a reasonable period of time to fully assess any changes to the institution’s
interest rate risk profile and to distinguish between permanent structural
changes versus short-term fluctuations during a transitional period.
Examiners should determine whether management has procedures for reviewing
and updating its asset and liability management models for any unusual
fluctuations in deposit balances, adjustments to loan payments, changes
in interest rates, and other modifications to ensure the integrity,
accuracy, and reasonableness of the models.
The ROCA rating does not contain a component for market
sensitivity. However, exam
iners should consider sensitivity in the form
of the interest rate risk profile, risk management, and effects from
a major disaster in the assessment of the risk-management component
of the ROCA rating.
Issued jointly by the Board
of Governors of the Federal Reserve System, the Federal Deposit Insurance
Corporation, the Office of the Comptroller of the Currency, and the
National Credit Union Administration on December 15, 2017 (SR-17-14).
