- 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.
