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Comptroller of the Currency

Administrator of National Banks

OCC Asset Management Risks

Stephanie Boccio, National Bank ExaminerAsset Management DivisionOffice of the Comptroller of the Currency

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Discussion Topics

•Asset Management Operating Environment

•Risk Management Issues & Initiatives

• Issues that may Impact the AM Operating Environment

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Discussion Topics

Asset Management

Operating Environment

4Source: Call Report RC-T

After significant growth in 2004, the level of fiduciary assets in the national banking system stabilized during 2005. Custody assets grew by 16% in 2005 as JP Morgan’s and Citibank’s custody assets grew by a combined $2.3 trillion.

•We continue to receive and evaluate inquiries from major players in the asset management business line regarding possible conversion into the national banking system.

•As the OCC’s asset management business line has increased, both in volume and complexity, a major concern is staffing levels and expertise to appropriately supervise this activity.

• National banks account for 44% of all fiduciary assets held by commercial banks and nearly 47% of all custody and safekeeping assets held by commercial banks.

Fiduciary and Custody Assets

Growth in Fiduciary Assets

National Banks

$3.81

$4.99

$6.87$7.54

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

Mar

-02

Jun-

02Sep

-02

Dec

-02

Mar

-03

Jun-

03Sep

-03

Dec

-03

Mar

-04

Jun-

04Sep

-04

Dec

-04

Mar

-05

Jun-

05Sep

-05

Dec

-05

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Growth in Custody Assets

National Banks

$3.65 $4.47

$14.85

$17.21

$0.00

$5.00

$10.00

$15.00

$20.00

Mar

-02

Jun-

02Sep

-02

Dec

-02

Mar

-03

Jun-

03Sep

-03

Dec

-03

Mar

-04

Jun-

04Sep

-04

Dec

-04

Mar

-05

Jun-

05Sep

-05

Dec

-05

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� The top 10 national banking groups reported a combined $6.38 trillion or 85% of all fiduciary assets and a combined $16.78 trillion or 98% of all custody assets.

� Nonetheless, fiduciary activities are present in over 550 community & mid-size banks or nearly 30% of all national banks.

Source: Call Report RC-T

Custody Assets - National Banks

$16.78

$0.43

$0.00

$3.12

$6.25

$9.37

$12.49

$15.61

$18.74

Top 10 All other

$ T

rill

ion

s

Fiduciary and custody assets are highly concentrated in a few large banking groups, however, fiduciary activities are present in community and mid-size banks as well as uninsured limited-purpose national trust banks.

Concentration of Fiduciary & Custody Assets

Fiduciary Assets - National Banks

$6.38

$1.16

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

Top 10 All other

$ T

rill

ion

s

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Banks Exercising Fiduciary Powers All Banks

December 31, 2005

Source: Call Report

Includes Commercial Banks and Trust Companies

Account Type Total Assets # of Accounts Average Size

Personal Trust & Agency $1.0 trillion 6% 890,000 $1,171,000

Investment Management $1.3 trillion 8% 1,858,000 $707,000

Retirement

DB $5.2 trillion 30% 243,000 $21,258,000

DC $1.8 triilion 11% 657,000 $2,766,000

Other $2.4 trillion 14% 14,196,000 $165,000

Corporate Trust $2.6 trillion 15% 397,000 $6,635,000

Other $2.9 trillion 16% 150,000 $19,501,000

Total Fiduciary Assets $17.3 trillion 100% 18,390,000

Custody/Safekeeping $36.5 trillion 6,102,000 $5,978,000

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Fiduciary & Related Services

Profit Margins2002 – 2004

Trust Asset Size Groups

$25+ Billion $5 - $25 Billion $1 - $5 Billion $500M - $1 Billion All Banks

2002 35.37% 23.89% 29.63% 31.95% 33.90%

2003 33.73% 19.33% 31.13% 33.72% 32.43%

2004 32.73% 16.08% 34.98% 28.56% 31.48%

Profit Margin is derived by dividing Net Fiduciary Income by Gross Fiduciary RevenueSource: Call Report Schedule RC-T

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Discussion Topics

Risk Management Issues & Initiatives

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Asset Management DivisionRadar Screen

Principal areas of Asset Management risk exposure.

Bank’s sales programs; risks to bank and customersRetail Brokerage & Annuities

Impact of adverse publicity, litigation, fraud, or underperformance Reputation Risk

SEC redefining permissible bank activities; functional supervision.Gramm-Leach Bliley Act

Trading practices, valuations, and participant eligibility. Collective Investment Funds

Correlation of asset management earnings to market changes.Market Sensitivity of Earnings

AML program covers all activities, including trust & asset management, private banking, insurance and non-deposit investments.

Anti-money Laundering

AM related exposure as investment adviser, purchaser of discretionary investments for clients, and provider of admin. services to HFs.

Hedge Funds

Focus on NTBs that are not affiliated with a bank, thrift, or BHC. Evaluate capital, liquidity and profitability.

National Trust Banks

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National Trust Bank Charters

� Conversion and consolidation of fiduciary and custody operations continues.

� Significant decline in de novo NTB charters

� OCC has raised the bar

� Industry consolidation

� Increased scrutiny post-INTRUST, Security Trust, and Circle Trust.

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National Trust Bank Risks

� OCC Bulletin 2000-26 Supervision of NTBs –Capital & Liquidity requires national trust banks to annually:� Perform ongoing capital and liquidity analysis

� Maintain adequate capital and liquidity based upon the risk posed by their lines of business, profitability and anticipated growth

� Examiners review this analysis and determine whether Operating Agreements, CALMAs, or other supervisory resources are warranted.

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Hedge Funds/Alternative Investments

� Heightened risks – reputation, litigation and customer indemnification risks� Appropriateness for fiduciary accounts

� Retailization/Suitability

� Expansion of bank AM services to hedge funds

� Due diligence and investment oversight costlier than for traditional investment strategies� Lack of transparency

� Recent frauds

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BSA Compliance - Five Elements

� System of Internal Controls

� Designated Responsible Individual

� Training

� Independent Audit or Compliance Testing

� Customer Identification Process

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Asset Management Income

� In 2005, AM income of $23.8 billion comprised 16% of all national bank non-interest income.

� How do we identify AM income?

� AM income reported in two Call Report categories -Schedules RI and RC-T:

� Fiduciary and Fiduciary Related Income.

� Investment banking, advisory, brokerage, and underwriting fees and commissions

� A recommended change to the Call Report will result in a separation of brokerage from dealer activities.

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� Accounting for the effects of conversions, national banks recorded fiduciary income of $15.18 billion in

2005 compared with $13.61 billion in 2004.

� Nearly 250 national banks report gross fiduciary income greater than 20% of their total non-interest income.

� For banks with fiduciary income, fiduciary income and brokerage/investment banking income account for nearly 20% of total non-interest income.

Source – RI – NIIExcludes “Other Non-interest Income”

Fiduciary and custody income increased by 12% in 2005. This business activity is a significant source of revenue for many national banks.

Fiduciary & Custody Income: National Banks

$19.9

$13.6

$8.7$6.5

$4.2

$7.3 $8.0

$2.1

$21.8

$15.2$13.3

$8.2

$3.0

$7.4$8.6

$2.2

$0.0

$5.0

$10.0

$15.0

$20.0

$25.0

$ B

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2004 2005

Trend in Non-interest Income - National Banks with Fiduciary Income

Deposit Svc Charges Fiduciary Trading Securitization

G/L Sale Assets Servicing Brokerage/Investment Banking Insurance

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Market Sensitivity of Asset Management Earnings

� Market Sensitive Income� AM income linked to assets under management (AUM).

� Decline in equity markets – reduces bank’s AUM and income.

� Strong correlation between AM income and S&P 500.

� Hedging activity approved for a National Trust Bank. Designed to offset decline in AM earnings w/ gains from S&P 500 put options.

� Interest Rate Sensitivity� Declining yields brake AUM growth

� As interest rates compress and investors seek flexibility of money market funds over long bonds, AM income declines. Margins thinner on MMFs than other investment products.

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� Fiduciary revenue is highly correlated to movements in the equity market. As the S&P 500 declined in 2001, 2002 and early 2003, we saw a dip in quarterly revenues of approximately 10%. But as the market rebounded in late 2003, 2004 and into 2005, we saw a corresponding increase in quarterly revenues.

� Due to the highly competitive nature of the AM business line, AM Lead Experts are concerned that banks are increasingly accepting new and complex accounts without appropriately pricing for the additional costs and risk exposure associated with managing these accounts.

Source: Call Report RC-TS&P 500 data is the quarter-end 90-day moving average

Banks reported a combined $26.8 billion in fiduciary revenue in 2005 compared to $24.6 billion reported in 2004.

Fiduciary Revenue (All Banks)

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

$5.50

$6.00

$6.50

$7.00

$7.50

$ B

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0

200

400

600

800

1,000

1,200

1,400

S &

P 5

00

Income $5.60 $5.47 $5.10 $5.62 $5.45 $5.67 $5.36 $4.91 $5.25 $5.52 $5.63 $5.92 $6.19 $6.03 $5.87 $6.55 $6.43 $6.51 $6.63 $7.20

S&P 500 1,291 1,223 1,188 1,109 1,132 1,090 933 885 875 909 994 1,044 1,114 1,124 1,111 1,148 1,192 1,186 1,217 1,228

Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05

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Managed Assets Held in Personal Trust & Agency Accounts – All Banks

Source: Call Report

Stocks

66.18%

Real Estate

3.90%

Other Notes/Bonds

3.76%

All Other

6.16%

State/Municipal Obligations

9.74%

US Gov Obligations

4.76%

Noninterest-bearing

Deposits

0.06%

MM Mutual Funds

4.37%

Interest-bearing deposits

1.07%

December 31, 2005

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Potential Vulnerabilities to Asset Management Income

� New Products and Services� Hedge Fund and alternative investment strategy risks.

� Competition� Performance critical – underperformance leads to loss of AUM; reduces ability to attract new business

� Finite customer base – asset managers pursuing same high net worth customers. Are assets worth managing?

� Pricing – Reduced mutual fund and brokerage fees.

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Collective Fund Issues

� Use of Financial Intermediaries� Bank must ensure relationships between parties (plan sponsor/intermediary/bank) are documented.

� Bank must ensure intermediary’s processes are effective to limit access to CIFs only to eligible EB plan participants. Particularly important if CIFs are made available through NSCC.

� Bank cannot delegate its fiduciary obligation to operate CIF consistent with CIF plan requirements and 12 CFR 9.18.

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Gramm-Leach Bliley Issues

� Awaiting latest proposal from SEC.

� Guidance to date has created uncertainty for traditional bank fiduciary and custody activities.

� Recent industry complaints that SEC is expanding exams into bank activities as part of their registered adviser sub and transfer agent exams.

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Retail Sales of Non-Deposit Investment Products

� NASD and SEC looking at variable rate annuity sales.

� Concern over fixed rate annuities as interest rates rise and customers learn full impact of surrender charges.

� Retail Non-Deposit Interagency Statement of 1994 still applies.

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Reputation Risks

� Reputation – Where will regulators/class action suits focus next? Mutual funds; annuities; hedge funds?

� Performance – Will customers leave when performance lags?

� Conflicts of Interest – Revenue sharing, use of affiliated advisers, proprietary funds, etc.

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Discussion Topics

Issues That May Impact the AM Operating Environment

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SEC RegulationRedemption Fees

� Increased disclosures re: market timing

� Redemption fees may be established by each mutual fund

� Impacts bank relationships with third party vendors and other financial intermediaries.

� Redemption fee tracking issues created for bank omnibus accounts.

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SEC Proposal –4:00 Hard Close

� Potential Operational Impacts:

� Pressure to meet 4:00 hard close, if adopted.

� Implementation of controls to comply with alternative method, if adopted.

� Impact on bank relationships with third party vendors and other financial intermediaries.

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Other SEC Proposals –

� Pricing of fund shares – fair valuation alternative

� Enhanced disclosures regarding fund fees, 12b-1 fees, servicing fees, incentive payments, etc.

� Soft dollars, narrowing of definition of research

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SEC Proposals –OCC Considerations

� Potential impact of SEC rulemakings on OCC requirements -� Could affect common and collective fund rules (§ 9.18), particularly for funds traded on NSCC

� Could affect recordkeeping and confirmation rules (12 CFR 12), particularly securities trading policies and procedures, and personal holdings disclosures.

� Impact on bank relationships with third party vendors and other financial intermediaries.

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OCC Publications

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OCC Asset ManagementHandbooks

� Conflicts of Interest - 6/2000

� Asset Management - 12/2000

� Investment Management - 8/2001

� Custody and Securities Lending - 1/2002

� Personal Fiduciary Services - 8/2002

� Internal and External Audits - 4/2003

� FFIEC BSA/AML Exam Manual – 6/2005

� Collective Investment Funds – 10/2005

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Comptroller of the Currency

Administrator of National Banks

Contact Information

•Phone: 202-874-5208

•Fax: 202-874-9390

•Email: Stephanie.Boccio@occ.treas.gov