[Federal Register Volume 72, Number 244 (Thursday, December 20, 2007)]
[Notices]
[Pages 72442-72450]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-24742]


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DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

[Docket ID OTS-2007-0009]


Savings and Loan Holding Company Rating System

AGENCY: Office of Thrift Supervision, Treasury.

[[Page 72443]]


ACTION: Final guidance--Savings and Loan Holding Company Rating System.

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SUMMARY: The Office of Thrift Supervision (OTS) is revising its savings 
and loan holding company (SLHC) rating system to better reflect and 
communicate its supervisory expectations. The new SLHC rating system 
revises component descriptions to better emphasize risk management and 
adopts a numeric rating scale.

DATES: The revised rating system will be applied to all SLHC 
examinations beginning on or after January 1, 2008.

FOR FURTHER INFORMATION CONTACT: Donna Deale, Director, Holding 
Companies and Affiliates, (202) 906-7488.

SUPPLEMENTARY INFORMATION:

Background

    OTS has a well-established program for meeting its statutory 
responsibilities with respect to SLHCs and the thrift industry. Holding 
company supervision is an integral part of this oversight program, and, 
OTS routinely takes steps to enhance its risk-focused supervision of 
these enterprises. On April 9, 2007, the OTS published a notice in the 
Federal Register (72 FR 17618) requesting comment on proposed revisions 
to the SLHC rating system.
    The SLHC rating system is an internal rating system used by the OTS 
as a management information and supervisory tool that defines the 
condition of all SLHCs in a systematic manner. It provides an 
evaluation of the SLHC's condition for use by the supervisory community 
and identifies any practices requiring supervisory responses and 
actions. The SLHC rating system also provides a measurement tool to 
discuss the enterprise's condition with SLHC management.
    OTS implemented the former SLHC rating system in 1988. Since the 
introduction of this rating system, banking organizations and SLHCs 
have become more complex. Several SLHCs have significant international 
operations and many engage in multiple types of financial activities. 
In addition, certain SLHCs that existed prior to the enactment of 
activities restrictions in the Gramm-Leach-Bliley Act engage in 
commercial, manufacturing, and other retail activities. As of June 
2007, SLHCs had aggregate consolidated assets of $8.5 trillion.
    Given the diversity of the SLHCs supervised by OTS and OTS's risk 
focused holding company examination approach, the examinations and 
ratings must document our assessment of the risk profile of the holding 
company enterprise as well as management's ability to identify, 
measure, monitor, and control risks. OTS believes that the proposed 
changes further this objective and, therefore, OTS is adopting the 
proposed SLHC rating system with minor clarifications to reflect 
comments received.

Summary of Changes to Examination Components

    The former SLHC rating system has four examination components: 
Capital, Earnings, Organizational Structure and Relationship. The 
revised SLHC rating system changes two of the existing four examination 
components--Organizational Structure and Relationship. OTS is making 
this change to place greater emphasis on risk management. The number of 
components and OTS's risk focused examination approach remain 
unchanged.
    The revised SLHC rating system includes a review of two components 
that focus on financial condition (Capital and Earnings) and two other 
components (Organizational Structure and Risk Management) that focus on 
the activities and operations conducted within the enterprise and the 
SLHC's risk management practices.
    With the exception of the ratings changes discussed later in this 
document, OTS is not changing its philosophy on evaluating the 
financial components (Capital and Earnings). OTS will continue to 
evaluate capital adequacy relative to a given enterprise's risk 
profile.
    Within the Organizational Structure component, examiners will 
assess inherent risk in the context of lines of business, operations, 
affiliate relationships, concentrations, and other exposures. The most 
significant types of risk are defined in the proposed rating 
description for the Organizational Structure component. Based on its 
experience regulating SLHCs and on a review of similar guidance by 
other banking and supervisory agencies, OTS compiled a comprehensive 
list of risks that SLHC enterprises face.
    OTS is changing the name of the ``R'' component from Relationship 
to Risk Management. Within the Risk Management component, examiners 
will evaluate corporate governance; board of directors and senior 
management oversight; policies, procedures, and limits; risk monitoring 
and management information systems; and internal controls. OTS 
recognizes that each SLHC must have the flexibility to tailor risk 
management programs to its size, complexity, and inherent risks. OTS 
also recognizes that its most complex holding companies are highly 
integrated and may manage risk on an enterprise-wide basis, both within 
and across business lines and legal entities.

Summary of Changes to Rating System

    OTS is adopting a new rating scale for SLHCs. An effective rating 
system must include an accurate assessment of each enterprise's 
financial and managerial condition. The rating system must be flexible 
and apply to holding companies of all sizes and complexity. The former 
rating scale did not facilitate meaningful distinctions in the 
strengths and weaknesses of an enterprise. Therefore, OTS is adopting a 
five-point numeric scale similar to the Uniform Financial Institution 
Ratings System (UFIRS) and the OTS CAMELS rating system. The five-point 
scale will be used for both composite and component ratings assigned to 
SLHCs. The use of a five-point scale will better reflect issues of 
supervisory concern and will provide more distinction in the 
supervisory assessment of condition. A five-point scale also correlates 
with and is more comparable to the thrift and bank holding company 
rating systems.
    The new SLHC rating system incorporates one other change to the 
ratings definitions. Historically, OTS has based the rating of the 
holding company enterprise on its effect on its subsidiary thrift. OTS 
has encountered situations where it has supervisory concerns within the 
holding company enterprise, which did not have a direct impact on the 
thrift. OTS believes that using the effect on the thrift subsidiary as 
a SLHC rating criterion can lead to misinterpretation of the rating. It 
also may not be as accurate in portraying the condition of the SLHC 
enterprise as ratings criteria based on financial condition, 
operations, and risk profile.
    After thoroughly evaluating the language in the ratings 
definitions, OTS believes that language emphasizing the SLHC's effect 
on its thrift subsidiary limits the supervisory purpose of the rating. 
The SLHC's effect on its thrift subsidiary will continue to be an 
important consideration in the examination process, but the rating 
descriptions do not include such language as rating criterion.
    The changes will elevate the prominence of risk management; better 
align holding company examination components with OTS's supervisory 
process; and provide a more accurate assessment of the condition of 
SLHCs. OTS recognizes that it bases certain guidance and administrative 
processes on the current SLHC rating scale and definitions.

[[Page 72444]]

    The OTS assessment regulation is set forth in 12 CFR Part 502 
Subpart A. Of particular relevance to the holding company rating 
changes, section 502.29 outlines how OTS determines the condition 
component for SLHCs. OTS does not intend to amend the holding company 
assessment regulations at the current time. Instead, OTS will update 
these regulations at a later date after most holding companies are 
assigned a rating under the new holding company rating system. Until 
the regulation is changed, the holding company assessment condition 
component will be charged if the most recent composite rating of any 
SLHC in the holding company structure is ``Unsatisfactory'' under the 
previous holding company rating system, or, a ``4'' or ``5'' under the 
new holding company rating system. This is consistent with the 100 
percent condition component surcharge applied to ``4'' and ``5'' rated 
thrift institutions. Similarly, an ``Unsatisfactory'' rating carries 
the presumption that formal enforcement action is required. For this 
purpose, as well as for any other OTS regulatory or guidance references 
to ``Unsatisfactory,'' OTS will consider a composite ``4'' or ``5'' 
holding company rating comparable.

Comments Received and Changes Made

    The OTS received seven comments regarding the proposed revisions to 
the SLHC rating system. The comments came from four SLHCs and three 
trade associations. Commenters generally supported changes to the 
rating system, agreeing that the new rating system will elevate the 
prominence of risk management, better align holding company examination 
components with OTS's supervisory process, and provide a more accurate 
assessment of the condition of SLHCs.

General Comments

    A few commenters encouraged OTS to rely on functional regulators 
that have primary oversight of insurance and other financial 
activities. The revised rating system does not signal a shift in OTS 
supervisory practices of coordinating with and relying to the greatest 
extent possible on the work of functional regulators. OTS is committed 
to avoiding unnecessary regulatory duplication and will continue to 
work closely with functional regulators.
    Commenters also asked about revisions to the Holding Companies 
Handbook and implementation of the revised ratings changes. OTS will 
phase in the revised rating system for holding company examinations 
that commence on or after January 1, 2008. To facilitate SLHCs' 
understanding of the new rating descriptions, OTS will include not only 
the composite rating, but also any component ratings assigned, in each 
holding company's report of examination. Additionally, in their 
meetings with management or the board of directors, examination staff 
will further explain how they reached their rating conclusions using 
the revised SLHC rating system.
    OTS will simultaneously begin the process of updating the Holding 
Companies Handbook to reflect the changes to the SLHC rating system. 
Other references in guidance or regulations using terminology connected 
to the existing rating system will not be immediately updated; however, 
today's guidance clarifies the most significant references that affect 
unsatisfactorily rated SLHCs.
    Another commenter asked OTS to address the likelihood of additional 
costs or assessments as a result of the new supervisory approach. As 
previously indicated, OTS anticipates that the changes will elevate the 
prominence of risk management; better align holding company examination 
components with OTS's supervisory process; and provide a more accurate 
assessment of the condition of SLHCs. OTS does not view these changes 
as a significant change in approach; rather the changes will better 
reflect current supervisory practices and the condition of SLHCs. OTS 
does not anticipate that the changes will result in significant 
additional costs or increases in the assessment charged to SLHCs.
    The same commenter asked how OTS would tailor the ratings to 
address non-complex SLHCs for which much of the rating component detail 
is not materially relevant. Given the diverse nature of SLHCs, OTS 
recognizes that each SLHC must have the flexibility to tailor programs 
to its size, complexity, and inherent risks. OTS expectations vary 
accordingly. Furthermore, OTS will continue the policy of not requiring 
examiners to assign component ratings for non-complex institutions. 
Thus, if as the commenter suggests, an item is not materially relevant, 
the examiner may choose not to individually rate that component.

Composite Definition Comments

    One commenter thought that the references to ``consolidated 
financial strength'' or ``financial condition'' in the composite rating 
descriptions could be interpreted as a shift in the overall weight that 
OTS places on capital and earnings by moving from two component 
references to a single measure. OTS does not intend such a shift and 
has clarified composite definitions to track more closely with the CORE 
components.

Capital and Earnings Definition Comments

    Two commenters questioned the use of the word ``abundant'' in 
describing the level of capital and cash flow associated with a ``1'' 
rating. One of those commenters noted that the word ``abundant'' does 
not have a generally accepted meaning in financial or supervisory 
literature. In defining the rating levels, OTS tried to choose words 
that do not have a specific meaning within an existing regulatory 
framework. For example, if OTS had chosen ``well-capitalized,'' users 
could misinterpret the wording as having the same meaning as when used 
in the Prompt Corrective Action regulations (12 CFR 564.4). Because of 
the diverse holding company population, OTS intends the wording to 
provide flexibility without associating it with specific measures. OTS 
agrees, however, that the word ``abundant'' may overstate the amount of 
capital expected to achieve a Capital Rating of ``1'', and, therefore, 
has changed the description to ``more than sufficient.'' Further, after 
considering this comment, OTS has also decided to change the use of the 
word ``adequate'' in the Capital Rating 2 description. When used in 
capital component rating descriptions, the word ``adequate'' may be 
associated with other predefined usages. Therefore, references to 
``adequate'' in the Capital ``2'' rating description have been changed 
to ``sufficient.''
    Another commenter asked that OTS articulate the regulatory and 
economic capital considerations that examiners will use in determining 
capital adequacy. OTS has long held that a savings and long holding 
company must have a prudential level of capital to support their risk 
profile. In fact, the lack of any specific capital requirement makes it 
essential to consider all aspects of an organization's risk profile to 
determine if capital is adequate on a case-by-case basis. Therefore, it 
is particularly important that complex SLHCs assess their capital 
adequacy and future capital needs in a systematic and comprehensive 
manner in light of their risk profiles and business plans.
    Examiners will evaluate internal capital management processes to 
determine whether they meaningfully tie the identification, monitoring, 
and evaluation of risk to the SLHC's capital needs. OTS recognizes that 
internal capital adequacy assessment processes will vary depending on 
the nature, size and complexity of the enterprise. Examiners will place 
increasing reliance

[[Page 72445]]

on a holding company's internal assessment of capital adequacy based on 
their confidence in the SLHC's demonstrated ability to reflect risk in 
its own determination of capital needs. Consistent with OTS's current 
approach to evaluating capital adequacy by considering capital in a 
variety of different ways,\1\ the SLHC's economic capital calculation 
will serve as an additional measure to consider.
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    \1\ The OTS Holding Companies Handbook guides examiners to 
consider tangible capital, GAAP equity, and to calculate a 
regulatory proxy measure that give ``capital-like'' regulatory 
treatment for certain items such as trust preferred securities and 
other hybrid instruments.
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    OTS also received a couple of questions about how the revised 
ratings will work in the Basel environment. OTS acknowledges that there 
are open issues related to the adoption of the Basel framework and OTS 
will need to address these as they relate to SLHCs.

Organizational and Risk Management Comments

    Two commenters suggested that the evaluation of risks faced by a 
holding company would be more meaningful if done in the context of the 
holding company's ability to manage those risks. These commenters 
believe that the risk component rating framework could be enhanced by 
clarifying how the interplay between the inherent risks identified in 
the ``O--Organizational Structure'' component and risk management 
controls in the ``R--Risk Management'' component connect to form an 
assessment of the holding company's residual risk. While OTS 
appreciates the concern noted, the final rating descriptions maintain a 
division of identifying the inherent risk within the Organizational 
Structure component and evaluating the risk management controls within 
the Risk Management component. In the same way that OTS considers both 
Capital and Earnings in evaluating the financial condition of a holding 
company enterprise, OTS will evaluate two components to assess the 
residual risk within the holding company enterprise. OTS believes there 
is value in separately identifying the inherent risks within a 
corporate enterprise. The Organizational Structure component evaluates 
the overall activities and underlying risk to understand what is in the 
corporate enterprise and the resulting exposures. OTS recognizes that 
effective risk management will mitigate many of the risks identified. 
Examiners will reflect the net or residual risk after considering the 
``O'' and the ``R'' components, as well as the financial components, in 
the composite rating.
    One of the comments also asked OTS to clarify how examiners will 
conduct the risk management rating assessment of the SLHC if the 
enterprise were to include the subsidiary institution as part of its 
enterprise risk management program. OTS recognizes that larger, more 
complex SLHC enterprises will have an enterprise-wide risk management 
(ERM) program. ERM promotes a consolidated vision of corporate goals, 
objectives, and strategies, and it makes sense to include the 
subsidiary institution in such a program. An effective ERM program must 
include taking an entity level portfolio review of risk. While an 
institution may be part of a SLHC's ERM program, this does not change 
OTS's expectation that the institution's board of directors and 
management will oversee, and be accountable for, the institution's risk 
management function.

Proposed Text of the Savings and Loan Holding Company Rating System

Holding Company Rating System

    The holding company rating system is used to assess a holding 
company's Capital, Organizational Structure, Risk Management, and 
Earnings. Using this system, OTS comprehensively and uniformly 
evaluates all holding company enterprises, focusing supervisory 
attention on the holding company enterprises that are complex or 
exhibit financial and operational weaknesses or adverse trends. The 
rating system:
     Identifies problem or deteriorating holding company 
enterprises.
     Categorizes holding company enterprises with deficiencies 
in particular areas.
     Assesses the aggregate strength of the SLHC industry.
Each holding company enterprise receives a composite rating based on 
the evaluation factors. Examiners will assign component ratings to all 
complex or high-risk holding companies; they may assign component 
ratings to noncomplex and low risk holding companies at their 
discretion. Examiners will disclose the composite ratings and any 
component ratings assigned in the report of examination.
    Examiners will assign a composite and component ratings based on a 
1 to 5 numeric scale. A ``1'' rating is the highest rating, indicating 
the strongest performance and practices and least degree of supervisory 
concern. A ``5'' rating is the lowest rating, indicating the weakest 
performance and the highest degree of supervisory concern. In most 
cases, a composite rating of ``4'' or ``5'' will result in formal 
enforcement action. In addition, a rating of ``4'' or ``5'' will be 
treated as ``Unsatisfactory'' as that term is used in OTS regulations 
and guidance (for example, see 12 CFR 502.29 for purposes of 
determining the condition component in a holding company's assessment 
calculation or 12 CFR 563.555 in defining a savings and loan holding 
company that is in troubled condition).
    Examiners will use the following descriptions to assign composite 
and component ratings to SLHCs.

Description of the Rating System Elements

Composite Rating

    The composite rating is the overall assessment of the holding 
company enterprise as reflected by its organizational structure, risk 
management, capital and earnings. The composite rating encompasses both 
a forward-looking and current assessment of the consolidated 
enterprise, as well as an assessment of the relationship between the 
companies in the enterprise. The composite rating is not a simple 
numeric average of the CORE components; rather, the composite rating 
reflects OTS's judgment of the relative importance of each component to 
the operation of the holding company enterprise. Some components may 
receive more weight than others depending on the SLHC's activities and 
risk profile. Assignment of a composite rating may incorporate any 
factor that significantly affects the overall condition of the holding 
company enterprise, although generally the composite rating is closely 
related to the component ratings assigned.
    Composite 1. A holding company enterprise in this group is sound in 
almost every respect and generally has components rated 1 or 2. Any 
weaknesses are minor, and the board of directors and management can 
correct them in the normal course of business. The enterprise is able 
to withstand economic, financial, and risk exposure changes because of 
an effective organizational structure, solid risk management practices, 
more than sufficient capital and strong earnings. Cash flow is more 
than sufficient and adequately services debt and other obligations. 
This holding company enterprise exhibits strong performance and risk 
management practices relative to its size, complexity, and risk 
profile.
    Composite 2. A holding company enterprise in this group is 
fundamentally sound but may have modest weaknesses. The board of 
directors and management are capable and willing to correct any 
weaknesses.

[[Page 72446]]

Generally, no component rating should be more severe than 3 for this 
holding company enterprise. The organizational structure, risk 
management practices, capital and earnings create stability, and this 
holding company enterprise is capable of withstanding business 
fluctuations. Cash flow is adequate to service obligations. Overall, 
risk management practices are satisfactory relative to the enterprise's 
size, complexity, and risk profile.
    Composite 3. A holding company enterprise in this group raises some 
degree of supervisory concern in one or more of the component areas, 
with weaknesses that range from moderate to severe. The magnitude of 
the deficiencies is generally not severe enough to rate a component 
more severely than 4. Management may lack the ability or willingness to 
effectively address weaknesses within appropriate time frames. The 
holding company enterprise's capital structure and earnings leave it 
less resistant to adverse business conditions. The effectiveness of the 
organizational structure and risk management practices may be less than 
satisfactory relative to the enterprise's size, complexity, and risk 
profile. However, there is only a remote threat to the holding company 
enterprise's continued viability.
    Composite 4. A holding company enterprise in this group has serious 
financial or managerial deficiencies that result in unsatisfactory 
performance. The supervisory concerns, which management and the board 
are not satisfactorily addressing, range from severe to critically 
deficient. A holding company enterprise in this group generally does 
not have sufficient capital and earnings to withstand adverse business 
fluctuations. The effectiveness of the organizational structure and 
risk management practices are generally unacceptable relative to the 
enterprise's size, complexity, and risk profile. The enterprise may 
place undue pressure on subsidiaries to meet its cash flow by 
upstreaming imprudent dividends or fees. Unless there is prompt action 
to correct these conditions, future viability could be impaired.
    Composite 5. The magnitude and character of the risk management or 
financial weaknesses of a holding company enterprise in this category 
could lead to insolvency without immediate aid from shareholders or 
supervisory action. The volume and severity of problems are beyond the 
board and management's ability or willingness to control or correct. 
The effectiveness of the organizational structure and risk management 
practices are inadequate relative to the enterprise's size, complexity, 
and risk profile. The inability to prevent liquidity or capital 
depletion places the holding company enterprise's continued viability 
in serious doubt.

Capital Adequacy (C) Component Rating

    C reflects the adequacy of an enterprise's consolidated capital 
position, from a regulatory perspective and an economic capital 
perspective, as appropriate to the holding company enterprise. During 
OTS's review of capital adequacy, OTS will consider the risk inherent 
in an enterprise's activities and the ability of capital to absorb 
unanticipated losses, support business activities including the level 
and composition of the parent company and subsidiaries' debt, and 
support business plans and strategies.
    Capital Rating 1. A rating of 1 indicates that the consolidated 
holding company enterprise maintains a more than sufficient amount of 
capital to support the volume and risk characteristics of its business 
lines and products; to provide a significant cushion to absorb 
unanticipated losses; and to fully support the level and composition of 
borrowing. In addition, the enterprise has more than sufficient capital 
to support its business plans and strategies, it has the ability to 
enter capital markets to raise additional capital as necessary, and it 
has a strong capital allocation and planning process.
    Capital Rating 2. A rating of 2 indicates that the consolidated 
holding company enterprise maintains sufficient capital to support the 
volume and risk characteristics of its business lines and products; to 
provide a sufficient cushion to absorb unanticipated losses; and to 
support the level and composition of borrowing. In addition, the 
enterprise has sufficient capital to support its business plans and 
strategies, it has the ability to enter capital markets to raise 
additional capital when necessary, and it has a satisfactory capital 
allocation and planning process.
    Capital Rating 3. A rating of 3 indicates that the consolidated 
holding company enterprise may not maintain sufficient capital to 
support the volume and risk characteristics of certain business lines 
and products; the unanticipated losses arising from the activities; or 
the level and composition of borrowing. In addition, the enterprise may 
not maintain a sufficient capital position to support its business 
plans and strategies, it may not have the ability to enter into capital 
markets to raise additional capital as necessary, or it may not have a 
sufficient capital allocation and planning process. The capital 
position of the consolidated holding company enterprise could quickly 
become insufficient if there is deterioration in operations.
    Capital Rating 4. A rating of 4 indicates that the capital level of 
the consolidated holding company enterprise is significantly below the 
amount needed to ensure support for the volume and risk characteristics 
of certain business lines and products; the unanticipated losses 
arising from activities; and the level and composition of borrowing. In 
addition, the weaknesses in the capital position prevent the enterprise 
from supporting its business plans and strategies, it may not have the 
ability to enter into capital markets to raise additional capital as 
necessary, or it has a weak capital allocation or planning process.
    Capital Rating 5. A rating of 5 indicates that the level of capital 
of the consolidated holding company enterprise is critically deficient. 
Immediate assistance from shareholders or other external sources of 
financial support is required.

Organizational Structure (O) Component Rating

    The O component is an assessment of the operations and risks in the 
holding company enterprise. In the O component, OTS evaluates the 
organizational structure, considering the lines of business, affiliate 
relationships, concentrations, exposures, and the overall risk inherent 
in the structure.
    OTS's analysis under the O component considers existing as well as 
potential issues and risks. OTS pays particular attention to the 
following types of risk in assigning the O rating:

------------------------------------------------------------------------
         Type of risk                         Description
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Credit/Asset.................  Credit risk arises from the potential
                                that a borrower or counterparty will
                                fail to perform on an obligation. Asset
                                risk is the risk related to market
                                changes or performance of a financial
                                asset.
Market.......................  Market risk is the risk to a financial
                                institution's condition resulting from
                                adverse movements in market rates or
                                prices, such as interest rates, foreign
                                exchange rates, or equity prices.

[[Page 72447]]

 
Liquidity....................  Liquidity risk is the potential that an
                                institution will be unable to meet its
                                obligations as they come due because of
                                an inability to liquidate assets or
                                obtain adequate funding (funding
                                liquidity risk) or that it cannot easily
                                unwind or offset specific exposures
                                without significantly lowering market
                                prices because of inadequate market
                                depth or market disruptions (market
                                liquidity risk).
Operational..................  Operational risk arises from the
                                potential that inadequate information
                                systems, operational problems, breaches
                                in internal controls, fraud, or
                                unforeseen catastrophes will result in
                                unexpected losses. Transaction risk
                                arises from problems with service or
                                product delivery. This risk is a
                                function of internal controls,
                                information systems, employee integrity,
                                and operating processes.
Legal/Compliance.............  Legal risk arises from the potential that
                                unenforceable contracts, lawsuits, or
                                adverse judgments can disrupt or
                                otherwise negatively affect the
                                operations or condition of a banking
                                organization. Compliance risk is the
                                risk to earnings or capital arising from
                                violations of, or nonconformance with,
                                laws, rules, regulations, prescribed
                                practices, or ethical standards.
Reputation...................  Reputation risk is the potential that
                                negative publicity regarding an
                                institution's business practices,
                                whether true or not, will cause a
                                decline in the customer base, costly
                                litigation, or revenue reductions.
Country/Sovereign............  Country risk arises from the general
                                level of political, financial, and
                                economic uncertainty in a country, which
                                impacts the value of the country's bonds
                                and equities. Sovereign risk is the risk
                                that a central bank will impose foreign
                                exchange regulations that will reduce or
                                negate the value of foreign exchange
                                contracts. It also refers to the risk of
                                government default on a loan made to a
                                country or guaranteed by it.
Contagion/Systemic...........  Contagion entails the risk that financial
                                difficulties encountered by a business
                                line or subsidiary of a holding company
                                could have an adverse impact on the
                                financial stability of the enterprise
                                and possibly even on the markets in
                                which the constituent parts operate.
                                Systemic risk is defined by financial
                                system instability, potentially
                                catastrophic, caused or exacerbated by
                                idiosyncratic events or conditions in
                                financial intermediaries. Impacted areas
                                include: market value of positions,
                                liquidity, credit-worthiness of
                                counterparties and obligors, default
                                rates, liquidations, risk premia, and
                                valuation uncertainty.
Concentration................  The exposure to losses due to a
                                concentration (assets, liabilities, off-
                                balance-sheet) at the subsidiary,
                                business line, and/or enterprise level.
Intra-Group Transactions.....  Exposures to risk that result from
                                transactions between affiliates.
Strategic And Execution......  Strategic and execution risk is the risk
                                to earnings or capital arising from
                                adverse business decisions or improper
                                implementation of those decisions. This
                                risk is a function of the compatibility
                                of an organization's strategic goals,
                                the business strategies developed to
                                achieve those goals, the resources
                                deployed against these goals, and the
                                quality of implementation. The resources
                                needed to carry out business strategies
                                are both tangible and intangible. They
                                include communication channels,
                                operating systems, delivery networks,
                                and managerial capacities and
                                capabilities. Strategic risk focuses on
                                more than an analysis of the written
                                strategic plan. It focuses on how plans,
                                systems, and implementation affect the
                                enterprise's franchise value. It also
                                incorporates how management analyzes
                                external factors that impact the
                                strategic direction of the company.
------------------------------------------------------------------------
                                Insurance
------------------------------------------------------------------------
Pricing and Underwriting Risk  The risk that pricing and underwriting
                                practices are inadequate to provide for
                                the risks assumed.
Reserving Risk...............  The risk that actual losses or other
                                contractual payments reflected in
                                reported reserves or other liabilities
                                will be greater than estimated.
------------------------------------------------------------------------

    Organizational Structure Rating 1. A rating of 1 indicates that the 
organizational structure, including the nature and level of risks 
associated with the affiliates' activities, poses minimal concern. 
Management controls and monitors intra-group exposures. Any concerns 
posed by strategic plans, the control environment, concentrations, 
legal or reputational issues, or other types of risk within the 
enterprise are minor, and management and the board can address them in 
the normal course of business.
    Organizational Structure Rating 2. A rating of 2 indicates that the 
organizational structure exhibits minor weaknesses, but the nature and 
level of risks associated with the holding company's activities are 
unlikely to be material concerns. Intra-group exposures, including 
servicing agreements, are generally acceptable, but isolated 
transactions or exposures may present limited cause for regulatory 
concern. Concerns posed by strategic plans, the control environment, 
concentrations, legal or reputational issues, or other types of risks 
within the enterprise are modest, and management and the board can 
address them in the normal course of business.
    Organizational Structure Rating 3. A rating of 3 indicates that 
there are organizational structure weaknesses that raise supervisory 
concern. The nature and level of risks associated with the holding 
company activities are moderately likely to cause concern. Intra-group 
exposures, including servicing agreements, may have the potential to 
undermine the financial condition of other companies in the enterprise. 
Strategic growth plans, weaknesses in the control environment, 
concentrations, legal or reputational issues, or other types of risk 
within the enterprise may cause regulatory concern. The enterprise may 
have one or more entities in the structure that could adversely affect 
the operation of other entities in the enterprise if management does 
not take corrective action.
    Organizational Structure Rating 4. A rating of 4 indicates that 
there are weaknesses in the organizational structure of the enterprise, 
and/or the nature and level of risks associated with the holding 
company's activities are, or have a considerable likelihood of 
becoming, a cause for concern. Intra-group exposures, including 
servicing agreements, may also have the immediate potential to 
undermine the operations of companies in the enterprise. Strategic 
growth plans, weaknesses in the control environment, concentrations, 
legal or reputational

[[Page 72448]]

issues, or other types of risk within the enterprise may be of 
considerable cause for regulatory concern. The weaknesses identified 
could seriously affect the operation of one or more companies in the 
enterprise.
    Organizational Structure Rating 5. A rating of 5 indicates that 
there are substantial weaknesses in the organizational structure of the 
enterprise, and/or the nature and level of risks associated with the 
activities are, or pose a high likelihood of becoming, a significant 
concern. Strategic growth plans, a deficient control environment, 
concentrations, legal or reputational issues, or other types of risk 
within the enterprise may be of critical concern to one or more 
companies in the enterprise. The weaknesses identified seriously 
jeopardize the continued viability of one or more companies in the 
enterprise.

Risk Management (R) Component Rating

    R represents OTS's evaluation of the ability of the directors and 
senior management, as appropriate for their respective positions, to 
identify, measure, monitor, and control risk. The R rating underscores 
the importance of the control environment, taking into consideration 
the complexity of the enterprise and the risk inherent in its 
activities.
    The R rating includes an assessment of four areas: board and senior 
management oversight; policies, procedures, and limits; risk monitoring 
and management information systems; and internal controls. These areas 
are evaluated in the context of inherent risks as related to the size 
and complexity of the holding company's operations. They provide a 
consistent framework for evaluating risk management and the control 
environment. Moreover, a consistent review of these four areas provides 
a clear structure and basis for discussion of the R rating.

------------------------------------------------------------------------
   Risk management element                    Description
------------------------------------------------------------------------
Governance/Board and Senior    This area evaluates the adequacy and
 Management Oversight.          effectiveness of board and senior
                                management's understanding and
                                management of risk inherent in the
                                holding company enterprise's activities,
                                as well as the general capabilities of
                                management. It also considers
                                management's ability to identify,
                                understand, and control the risks within
                                the holding company enterprise, to hire
                                competent staff, and to respond to
                                changes in risk profile or changes in
                                the holding company's operating sectors.
Policies, Procedures, and      This area evaluates the adequacy of
 Limits.                        policies, procedures, and limits given
                                the risks inherent in the activities of
                                the consolidated enterprise and its
                                stated goals and objectives. OTS's
                                analysis considers the adequacy of the
                                enterprise's accounting and risk
                                disclosure policies and procedures.
Risk Monitoring and            This area assesses the adequacy of risk
 Management Information         measurement and monitoring, and the
 Systems.                       adequacy of the holding company's
                                management reports and information
                                systems. Includes a review of the
                                assumptions, data, and procedures used
                                to measure risk and the consistency of
                                these tools with the level of complexity
                                of the enterprise's activities.
Internal Controls............  This area evaluates the adequacy of
                                internal controls and internal audit
                                procedures, including the accuracy of
                                financial reporting and disclosure and
                                the strength and influence of the
                                internal audit team. Includes a review
                                of the independence of control areas
                                from management and the consistency of
                                the scope coverage of the internal audit
                                team with the complexity of the
                                enterprise.
------------------------------------------------------------------------
                                Insurance
------------------------------------------------------------------------
Reinsurance..................  Reinsurance is purchased by insurance
                                companies to transfer risk. It provides
                                a means to transfer risk for specific
                                lines of business or geographic
                                territories to provide catastrophe
                                protection or to stabilize or reduce
                                volatility in underwriting results.
------------------------------------------------------------------------

    Risk Management Rating 1. A rating of 1 indicates that management 
effectively identifies and controls all major enterprise risks. 
Management is fully prepared to address risks emanating from new 
products and changing market conditions. The board and management are 
forward-looking and active participants in managing risk. Management 
ensures that appropriate policies and limits exist and that the board 
understands, reviews, and approves them. Policies and limits are 
supported by risk monitoring procedures, reports, and management 
information systems that provide management and the board with the 
information and analysis necessary to make timely and appropriate 
decisions in response to changing conditions. Risk management practices 
and the enterprise's infrastructure are flexible and highly responsive 
to changing industry practices and current regulatory guidance. Staff 
has sufficient expertise and depth to manage the risks assumed. 
Internal controls and audit procedures are sufficiently comprehensive 
and appropriate to the size and activities of the holding company. 
There are few noted exceptions to the enterprise's established policies 
and procedures, and none is material. Management effectively and 
accurately monitors and manages the enterprise consistent with 
applicable laws, regulations, and guidance, and in accordance with 
internal policies and procedures. Risk management processes are fully 
effective in identifying, monitoring, and controlling risks.
    Risk Management Rating 2. A rating of 2 indicates that the 
enterprise's management of risk is largely effective, but exhibits some 
minor weaknesses. Management and the board demonstrate a responsiveness 
and ability to cope successfully with existing and foreseeable risks in 
the business plans. While the enterprise may have some minor risk 
management weaknesses, management and the board have recognized and are 
resolving these problems. Overall, board and senior management 
oversight, policies and limits, risk monitoring procedures, reports, 
and management information systems are satisfactory and effective. 
Risks are controlled and do not require additional supervisory 
attention. The holding company enterprise's risk management practices 
and infrastructure are satisfactory, and management makes appropriate 
adjustments in response to changing industry practices and current 
regulatory guidance. Staff expertise and depth are generally 
appropriate to

[[Page 72449]]

manage the risks assumed. Internal controls may display modest 
weaknesses or deficiencies, but they are correctable in the normal 
course of business. The examiner may have recommendations for 
improvement, but the weaknesses noted should not have a significant 
effect on the condition of the enterprise.
    Risk Management Rating 3. A rating of 3 signifies that there are 
moderate deficiencies in risk management practices and, therefore, 
there is a cause for additional supervisory attention. One or more of 
the four elements of sound risk management is not acceptable, which 
precludes the enterprise from fully addressing one or more significant 
risks to its operations. Certain risk management practices need 
improvement to ensure that management and the board are able to 
identify, monitor, and control all significant risks. In addition, the 
risk management structure may need improvement in areas of significant 
business activity, or staff expertise may not be commensurate with the 
scope and complexity of business activities. Management's response to 
changing industry practices and regulatory guidance may not be 
sufficient. The internal control system may be lacking in some 
important aspects, leading to continued control exceptions or failure 
to adhere to written policies and procedures. The risk management 
weaknesses could have adverse effects if management does not take 
corrective action.
    Risk Management Rating 4. A rating of 4 represents deficient risk 
management practices that fail to identify, monitor, and control 
significant risk exposures in material respects. There is a general 
lack of adequate guidance and supervision by management and the board. 
One or more of the four elements of sound risk management is deficient 
and requires immediate and concerted corrective action by the board and 
management. The enterprise may have serious identified weaknesses that 
require substantial improvement in internal control, accounting 
procedures, or adherence to laws, regulations, and supervisory 
guidance. The risk management deficiencies warrant a high degree of 
supervisory attention because, unless properly addressed, they could 
seriously affect the condition of the holding company enterprise.
    Risk Management Rating 5. A rating of 5 indicates a critical 
absence of effective risk management practices in identifying, 
monitoring, or controlling significant risk exposures. One or more of 
the four elements of sound risk management is wholly deficient, and 
management and the board have not demonstrated the capability to 
address these deficiencies. Internal controls are critically weak and 
could seriously jeopardize the continued viability of the enterprise. 
If not already evident, there is an immediate concern about the 
reliability of accounting records and regulatory reports and the 
potential for losses if corrective measures are not taken immediately. 
Deficiencies in the enterprise's risk management procedures and 
internal controls require immediate and close supervisory attention.

Earnings (E) Component Rating

    E reflects the consolidated holding company enterprise's overall 
financial performance, including measures such as the quality of 
consolidated earnings, profitability, and liquidity. OTS's review of 
this area considers the level, trend, and sources of earnings on a 
consolidated level as well as for material legal entities or business 
lines. OTS also assesses the ability of earnings to augment capital and 
to provide ongoing support for an enterprise's activities.
    Within this component, OTS also considers the liquidity of the 
enterprise. This rating reflects the consolidated holding company 
enterprise's ability to attract and maintain the sources of funds 
necessary to achieve financial efficiency, support operations, and meet 
obligations. OTS evaluates the funding conditions for each of the 
material legal entities in the holding company structure to determine 
if any weaknesses exist that could affect the funding profile of the 
consolidated enterprise.
    Earnings Rating 1. A rating of 1 indicates that the consolidated 
holding company enterprise's overall financial performance is solid. 
The quantity and quality of earnings for material business lines and 
subsidiaries are sufficient to make full provision for the absorption 
of losses and/or accretion of capital in light of asset quality and 
business plan objectives. The enterprise has strong liquidity levels 
along with well-developed funds management practices. The parent 
company and subsidiaries have reliable and sufficient access to sources 
of funds on favorable terms to meet present and anticipated liquidity 
needs.
    Earnings Rating 2. A rating of 2 indicates that the consolidated 
holding company enterprise's financial performance is adequate. The 
quantity and quality of the earnings for major business lines and 
subsidiaries are generally adequate to make provision for the 
absorption of losses and/or accretion of capital in light of asset 
quality and business plan objectives. The enterprise maintains 
satisfactory liquidity levels and funds management practices. The 
parent company and subsidiaries have access to sufficient sources of 
funds on acceptable terms to meet present and anticipated liquidity 
needs. Modest weaknesses in funds management practices may be evident, 
but management and the board can correct those weaknesses in the normal 
course of business.
    Earnings Rating 3. A rating of 3 indicates that the consolidated 
holding company enterprise's financial performance exhibits modest 
weaknesses. Major business line and subsidiary earnings are not fully 
adequate to make provisions for the absorption of losses and the 
accretion of capital in relation to the business plan objectives. The 
financial performance of this enterprise may reflect static or 
inconsistent earnings trends, chronically insufficient earnings, or 
less than satisfactory asset quality. This enterprise's liquidity 
levels or funds management practices may need improvement. The 
enterprise may lack ready access to funds on reasonable terms or may 
evidence significant weaknesses in funds management practices at the 
parent company or subsidiary levels. However, these deficiencies are 
correctable in the normal course of business with sufficient board and 
management attention.
    Earnings Rating 4. A rating of 4 indicates that the consolidated 
holding company enterprise's financial performance is weak. Major 
business line or subsidiary earnings are insufficient to provide for 
losses and the necessary accretion of capital. The enterprise may 
exhibit erratic fluctuations in net income, poor earnings (and the 
likelihood of a further downward trend), intermittent losses, 
chronically depressed earnings, or a substantial drop from previous 
performance. The liquidity levels or funds management practices of this 
holding company enterprise may be deficient. The enterprise may not 
have or be able to obtain a sufficient volume of funds on reasonable 
terms to meet liquidity needs at the parent company or subsidiary 
levels.
    Earnings Rating 5. A rating of 5 indicates that the consolidated 
holding company enterprise has poor financial performance and one or 
more business lines or subsidiaries are experiencing losses. In 
addition, such losses, if not reversed, represent a distinct threat to 
the enterprise's solvency through

[[Page 72450]]

erosion of capital. Further, the liquidity levels or funds management 
practices are critically deficient and may threaten continued 
viability. The enterprise requires immediate external financial 
assistance to meet maturing obligations or other liquidity needs.

    Dated: December 14, 2007.

    By the Office of Thrift Supervision.
John M. Reich,
Director.
[FR Doc. E7-24742 Filed 12-19-07; 8:45 am]
BILLING CODE 6720-01-P