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cbai
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Bank
notes
Community Bankers Association of Illinois
appropriateness of using third party
research. While the use of a reliable
third party to aid the bank in its credit
analysis process is acceptable, third
party analysis is neither required nor
appropriate as the only assessment of
credit quality. In the same way that it
is no longer acceptable to rely solely on
credit ratings, a third party cannot be
the only assurance the institution has
to justify credit quality. In the absence
of a third party’s credit rationale, using
third party data is sufficient so long
as the institution can justify a credit
opinion internally.
Amidst much speculation as to how
to implement a robust credit analysis
framework, the FDIC, OCC, and
the Federal Reserve have set out
clear guidelines for what they expect
in determining the permissibility of
municipal investments. Below we have
compiled a summary of those guidelines
to aid your institution in implementing
such a framework. The bottom line is
this: examiners must see proof of an
internal credit analysis process.
Key Factors for
All Municipal Investments
1.) Confirm spread to UST is consistent
with bonds of similar credit quality.
2.) Confirm risk of default is low and
consistent with bonds of similar
credit quality.
3.) Confirm capacity to pay and
assess the financial and operating
performance through internal credit
analysis.
4.) Understand local demographics/
economics. Consider unemployment
data, local employers, income indices,
and home values.
Key Factors for
General Obligation Bonds
1.) Evaluate the soundness of a
municipality’s budgetary position and
review management experience.
2.) Determine the stability of tax
revenues and the issuer’s taxing
authority.
3.) Consider debt profile and level
of unfunded liabilities.
4.) Identify the diversity of
revenue sources.
Key Factors
for Revenue Bonds
1.) Assess the source and strength of
the revenue structure for municipal
authorities.
2.) Consider obligor’s financial condition
and reserve levels.
3.) Compare annual debt service and
debt coverage ratio.
4.) Review credit enhancements, legal
covenants, and nature of the project.
Many banks have already established
internal credit analysis procedures,
utilizing key credit metrics such as
those highlighted in The Baker Group’s
Municipal Credit Profile. As shown
in the example below, this allows the
investor to perform a pre-purchase
credit analysis that is both useful
and efficient. These credit metrics
are derived from the bond’s official
statement, financial statements, and
other relevant filings from the obligor.
Hyperlinks to these documents are
embedded within the Credit Profile,
allowing the investor to perform
further analysis. The Credit Profile
also provides bond level data such
as the purpose of issuance, pledged
security, and tax status; three years of
trend data; macroeconomic indicators
such as unemployment and income
statistics; and the obligor’s pension
funding status.
This kind of reporting has received
positive feedback both from portfolio
managers and examiners, especially
in light of the regulations imposed by
Dodd-Frank. To comply with these
regulatory guidelines, banks are advised
to review the relevant metrics, establish
appropriate benchmarks before the
purchase decision, and perform an
annual post purchase review of each
credit in the portfolio. Clearly, credit
analysis has become an important
issue for bank investment officers.
Now that regulatory expectations are
clarified, banks will need to ensure
that they have in place the reporting
tools, processes, and resources
necessary to properly manage the
investment portfolio.
n
Since 1979, THE BAKER GROUP has
helped its clients improve decision-making,
manage interest rate risk, and maximize
investment portfolio performance. Its proven
approach of total resource integration
utilizing software and products developed
by Baker’s Software Solutions* — combined
with its solid investment experience and
advice — makes Baker the investment firm
of choice for many community financial
institutions. For more information, contact
Drew Simmons at The Baker Group:
800/937.2257,
,
or email:
*THE BAKER GROUP LP is the sole
authorized distributor for the products and
services developed and provided by The
Baker Group Software Solutions, Inc.
THE BAKER GROUP is a preferred
service provider of Community BancService
Corporation, Inc. (CBSC).
In the same way that it is
no longer acceptable to
rely on credit ratings, a third
party cannot be the only
assurance the institution has
to justify credit quality.
”
