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- Hi, I'm Tyler Hosier, a Risk Management Examiner
in the Omaha, Nebraska, Field Office.
- And I'm Chasity Dschaak, a Risk Management Examiner
in the Fargo, North Dakota, Field Office.
- In this module, we will discuss
the importance of investment policies and procedures,
as well as related regulatory expectations.
We will start from the broad perspective
of the entire investment portfolio
and then focus on the municipal portfolio.
- The bank's board of directors
is responsible for adopting written policies
that clearly outline its investment goals
and risk tolerance.
Policies should define the nature and complexity
of the bank's investment activities.
The scope and depth of each bank's policy
will vary depending on the investment activities.
However, there are some common elements
the FDIC looks for in an investment policy.
- Chasity, what are the common elements
that each investment policy should contain?
- Typically, the first element that we see addressed
is portfolio objectives,
such as return goals and performance targets.
Additional elements include:
Authorized investments, including guidelines
for new products or initiatives;
Investment lines of authority,
including naming responsible personnel;
Specific risk limits
consistent with the board's risk tolerance;
Pre-purchase analysis and ongoing monitoring guidelines
based on the types, exposure levels,
and characteristics of investments;
Routine measurement of the performance
and risk level of the investment portfolio,
and the related reporting requirements;
Accounting and taxation guidance consistent
with outstanding standards, opinions,
and interpretations;
And, finally, an independent review program appropriate
for the bank's investment activities.
In the remainder of this module,
we will discuss several of these items
as they relate to the municipal bond portfolio.
- Investment policies should establish
authorized types of municipal holdings.
Principal types include:
General obligation bonds issued by states, cities,
counties, and school districts;
Revenue obligation bonds
issued by water and sewer districts,
as well as toll road, bridge, hospital,
and housing authorities;
And other municipal issuances, which commonly include:
Municipal notes, which are short-term debt instruments,
payable from the general fund
or another pre-determined revenue source;
Industrial development bonds,
including special assessment bonds;
And certificates of participation,
subject to an annual appropriation
by the municipality.
- Now, we will discuss potential policy risk limits
related to municipal investments.
Investment policies should establish risk limits,
which can vary based on the nature
and complexity of the investment activities.
The risk limits can be expressed
as an aggregate percent of the investment portfolio,
capital, and/or total assets.
Geographic limits identify
maximum exposure to a specific location,
such as a region, state, county, or city.
All municipal securities, loans,
and other exposures within a defined geographic location
should be included.
Issuer limits restrict exposure to a single obligor,
and may also be governed by state lending limit laws.
Sector and type limits identify maximum exposure
to certain sectors or types of securities
within the municipal market.
Maturity limits can be defined
in terms of maximum final maturity,
a maturity distribution range, or a combination of the two.
Finally, the investment policy may incorporate limits
by credit rating band,
which can be based on internal credit grades
and/or external credit ratings.
The policy could also establish limits for non-rated bonds.
Remember, regulatory changes do not prohibit bank management
from using external credit ratings
as one component of its analysis process.
Further, many state banking statutes
continue to use credit ratings to determine permissibility.
- To ensure compliance with outstanding regulatory guidance,
the investment policy should define the scope
of pre-purchase analysis and ongoing monitoring procedures,
consistent with the nature and complexity
of the board's approved investment activities.
The policy should also:
Establish underwriting criteria to meet safety
and soundness standards.
Outline the acceptable use of third-party analysis,
as well as due diligence expectations
for third-party arrangements.
And determine whether credit ratings issued by Nationally
Recognized Statistical Rating Organizations,
or NRSROs, will be considered as one part of the analysis.
Effective investment activity oversight and assessment
of portfolio performance require
accurate risk measurement systems
and routine board reporting.
The investment policy should outline
risk measurement systems that are commensurate
with the approved investment activities
and portfolio complexity.
The risk measurement systems should identify
higher-risk securities and measure the credit,
interest rate, and liquidity risks
within the total portfolio.
The systems should also summarize
portfolio diversification.
Routine board reporting is a critical aspect
of management oversight and should be clearly detailed
in the investment policy.
The board reports should summarize investment activity,
risk measures, and compliance with policy limits.
The board's review of investment portfolio
management reports, along with relevant discussions
regarding investment strategy,
should be formally documented in the board minutes.
The final policy component we will discuss
is independent review of investment activities.
Chasity, what are some regulatory expectations
for an appropriate independent review program?
- Well, Tyler, municipal investment activities
should be included in the bank's overall
independent review program.
Independent review may encompass external audits,
an internal audit program, or a combination of the two.
At many banks, an evaluation by bank personnel
independent of the portfolio management function
will suffice.
The program's scope and formality
should correspond to the size and complexity
of the bank's investment activities.
The independent review should evaluate the appropriateness
of risk management practices that are in place.
The program should assess compliance
with investment policy guidance, pre-purchase analysis
and ongoing monitoring procedures,
and board-established risk limits.
The review should also assess the timeliness, integrity,
and usefulness of internal risk measurement
and reporting systems.
Finally, management should develop a program
that tracks independent review exceptions
and documents corrective action.
- As we conclude this module, let's summarize the key points.
The bank's board should establish
written investment policies that provide
sufficient guidance to senior management.
The policies should be consistent
with regulatory guidance,
and include authorized investments,
risk limits, analysis and monitoring expectations,
as well as measurement and reporting requirements.
The FDIC expects the depth and detail of investment policies
and procedures to be consistent
with the complexity and risk profile
of the intended investment activities.