OCC Asset Management Risks

Transcription

1 Comptroller of the Currency Administrator of National Banks OCC Asset Management Risks Stephanie Boccio, National Bank Examiner Asset Management Division Office of the Comptroller of the Currency 1

2 Discussion Topics Asset Management Operating Environment Risk Management Issues & Initiatives Issues that may Impact the AM Operating Environment 2

3 Discussion Topics Asset Management Operating Environment 3

4 Fiduciary and Custody Assets After significant growth in 2004, the level of fiduciary assets in the national banking system stabilized during 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. Growth in Fiduciary Assets National Banks Growth in Custody Assets National Banks trillion $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 $3.81 $4.99 $6.87 $7.54 trillion $20.00 $15.00 $10.00 $5.00 $0.00 $3.65 $4.47 $14.85 $17.21 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 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 Source: Call Report RC-T 4

5 Concentration of Fiduciary & Custody Assets 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. 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. $7.00 Fiduciary Assets - National Banks $6.38 Custody Assets - National Banks $6.00 $18.74 $16.78 $5.00 $15.61 $ Trillions $4.00 $3.00 $2.00 $1.16 $ Trillions $12.49 $9.37 $6.25 $1.00 $0.00 Top 10 Source: Call Report RC-T All other $3.12 $0.00 Top 10 $0.43 All other 5

6 Banks Exercising Fiduciary Powers All Banks December 31, 2005 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 Source: Call Report Includes Commercial Banks and Trust Companies 6

7 Fiduciary & Related Services Profit Margins Trust Asset Size Groups $25+ Billion $5 - $25 Billion $1 - $5 Billion $500M - $1 Billion All Banks % 23.89% 29.63% 31.95% 33.90% % 19.33% 31.13% 33.72% 32.43% % 16.08% 34.98% 28.56% 31.48% Profit Margin is derived by dividing Net Fiduciary Income by Gross Fiduciary Revenue Source: Call Report Schedule RC-T 7

8 Discussion Topics Risk Management Issues & Initiatives 8

9 Asset Management Division Radar Screen Principal areas of Asset Management risk exposure. National Trust Banks Hedge Funds Anti-money Laundering Market Sensitivity of Earnings Collective Investment Funds Focus on NTBs that are not affiliated with a bank, thrift, or BHC. Evaluate capital, liquidity and profitability. AM related exposure as investment adviser, purchaser of discretionary investments for clients, and provider of admin. services to HFs. AML program covers all activities, including trust & asset management, private banking, insurance and non-deposit investments. Correlation of asset management earnings to market changes. Trading practices, valuations, and participant eligibility. Gramm-Leach Bliley Act Retail Brokerage & Annuities Reputation Risk SEC redefining permissible bank activities; functional supervision. Bank s sales programs; risks to bank and customers Impact of adverse publicity, litigation, fraud, or underperformance 9

10 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. 10

11 National Trust Bank Risks OCC Bulletin 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. 11

12 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 12

13 BSA Compliance - Five Elements System of Internal Controls Designated Responsible Individual Training Independent Audit or Compliance Testing Customer Identification Process 13

14 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. 14

15 Fiduciary & Custody Income: National Banks Fiduciary and custody income increased by 12% in This business activity is a significant source of revenue for many national banks. Accounting for the effects of conversions, national banks recorded fiduciary income of $15.18 billion in 2005 compared with $13.61 billion in 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. Trend in Non-interest Income - National Banks with Fiduciary Income $25.0 $20.0 $19.9 $21.8 $ Billion $15.0 $10.0 $5.0 $0.0 $13.6 $8.7 $15.2 $13.3 $6.5 $7.3 $8.0 $8.2 $4.2 $2.1 $ $7.4 $8.6 $2.2 Deposit Svc Charges Fiduciary Trading Securitization G/L Sale Assets Servicing Brokerage/Investment Banking Insurance Source RI NII Excludes Other Non-interest Income 15

16 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. 16

17 $ Billions $7.50 $7.00 $6.50 $6.00 $5.50 $5.00 $4.50 $4.00 $3.50 $3.00 $2.50 $2.00 Banks reported a combined $26.8 billion in fiduciary revenue in 2005 compared to $24.6 billion reported in 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-T S&P 500 data is the quarter-end 90-day moving average Fiduciary Revenue (All Banks) 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 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, ,044 1,114 1,124 1,111 1,148 1,192 1,186 1,217 1, ,400 1,200 1,000 S & P 500

18 Managed Assets Held in Personal Trust & Agency Accounts All Banks December 31, 2005 Noninterest-bearing Deposits 0.06% Other Notes/Bonds 3.76% All Other 6.16% Interest-bearing deposits 1.07% Real Estate 3.90% MM Mutual Funds 4.37% US Gov Obligations 4.76% Stocks 66.18% State/Municipal Obligations 9.74% Source: Call Report 18

19 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. 19

20 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

21 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. 21

22 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. 22

23 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. 23

24 Discussion Topics Issues That May Impact the AM Operating Environment 24

25 SEC Regulation Redemption 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. 25

26 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. 26

27 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 27

28 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. 28

29 OCC Publications 29

30 OCC Asset Management Handbooks 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/

31 Comptroller of the Currency Administrator of National Banks Contact Information Phone: Fax: