EVERYTHING IS “SPECIAL” A REGULATOR’S VIEW OF UNIQUE ASSETS

1. EVERYTHING IS “SPECIAL”A REGULATOR’S VIEW OF UNIQUE ASSETS PRESENTED BY STEVAN SAVICH SENIOR TRUST EXAMINER FOR THE FEDERAL RESERVE BANK OF CHICAGO IOWA TRUST ASSOCIATION ANKENY, IOWA OCTOBER 4, 2013

2. DISCLAIMER • The following presentation was created from my own experiences and therefore do not necessarily express the views of The Federal Reserve Bank of Chicago and/or The Board of Governors of The Federal Reserve System.

3. DEFINITION OF UNIQUE ASSETS • TRADITIONAL • Cash • Certificates of Deposit • Treasury Notes and Bonds • Fixed Income (Municipal and Corporate) • Equities (Common and Preferred) • Mutual Funds (Fixed, Equities, and Composite) All of the above can be Domestic or International

4. DEFINITION OF UNIQUE ASSETS (continued) • UNIQUE • Real Estate Holdings • Farms • Closely Held Business Interests • Mineral Interests • Life Insurance Policies • Promissory Notes and Loans

5. DEFINITION OF UNIQUE ASSETS (continued) • TANGIBILIES • Autos/Trucks/Motorcycles (anything with an engine) • Art (paintings/sculptures/other) • Jewelry • Antiques/Toys • Precious Metals/Coins • Fur Coats • Designer Purses and Shoes • Sports Memorabilia • Other Memorabilia • Anything of Value (either dollar value or emotional value)

6. OBTAINING AND MAINTAINING SPECIAL ASSETS • In-Kind versus Purchased • Initial review and right of refusal • Market Value versus Carrying Value versus Control Value • Source of valuation: original inventory/in-house research/third party • Retention • Per policy/Investment Policy Statement/Investment Objective/In Writing • Maintenance/Safekeeping/Verification/Appraisal/Fee Schedule/Sale • Concerns • Diversification Desire

7. ADMININSTRATION OF UNIQUE ASSETS • Real Estate and Farms • Types of real estate holdings may include personal residences, residential income properties, commercial properties, and unimproved lots/acreage • Factors to consider: current or planned use/geographic location/size of the parcels and future marketability/risks involved with planned construction or development/potential environmental pollution/net yields from investing/potential cash flow/appreciation • Every property should be reviewed at least annually • If received in kind, property should be physically inspected as soon as possible to determine its condition, verify lease and renters, and ensure that adequate insurance is in force • Procedures should be established to provide for the maintenance of adequate income and expense records • Ticklers or other methods should be used to monitor timely payment of insurance premiums, mortgages and real estate taxes • Procedures should also be established to monitor payments and collector delinquent rent • Appraisal review procedures should be established • Outside management firms may be hired and annual due diligence reviews are required the firm • Farm management should include guidelines for: sale of crops or livestock/operating expenses/ repairs and maintenance of buildings and equipment/safekeeping of seed and fertilizers/verifying the amount of commodities in storage • Farm management agreements and plans should be three years in duration for optimal returns

8. ADMININSTRATION OF UNIQUE ASSETS (continued) • Closely-Held Business Interests • Definition: stock or other securities of a corporate entity whose stock is not actively traded /not available to the public • Partnerships (general or limited)/sole proprietorships/joint ventures • Biggest risk: limited marketability due to concentrated ownership especially if a minority interest • Evaluation of both the trust department’s expertise and its actual management • Actual management may range from: serving as officers or directors of the corporation/operating the business/liquidation of the assets • Compliance required with laws, governing instruments, standards of prudence, with a realization of the potential for liability • The trust department should periodically request financial information from the business, develop a method of evaluating the financial condition, and document it conclusions

9. ADMININSTRATION OF UNIQUE ASSETS (continued) • Mineral Interests • Oil/Natural Gas/Timber/Mineral (coal/sand/gravel/precious and semi-precious stones) • Evidence of title, such as copies of deeds and title opinions should be maintained • Usually, title to land is a surface right and does not include mineral rights • Status of the property, whether leased or unleased/producing or non-producing, should be determined • If working interests, trust department should have copy of operating agreement • Adequate property and liability insurance should be obtained • Proper bookkeeping and management information systems (MIS) in place

10. ADMININSTRATION OF UNIQUE ASSETS (continued) • Tangibles • Location, Location, Location • Valuation • Safekeeping • Handling concerns • Use by owner may be prohibited • Goal is to maintain established value

11. PRACTICES MATCH POLICIES AND PROCEDURES • A bank's board of directors is ultimately responsible for the supervision and administration of the bank’s fiduciary activities • The level and quality of oversight and support of fiduciary activities by the board of directors and management, including committee structure and adequate documentation of committee actions • The ability of the board of directors and management, in their respective roles, to plan for, and respond to, risks that may arise from changing business conditions or the introduction of new activities or products • The adequacies of, and conformance with, appropriate internal policies, practices and controls addressing the operations and risks of significant fiduciary activities • The accuracy, timeliness, and effectiveness of management information and risk monitoring systems appropriate for the institution's size, complexity, and fiduciary risk profile • The overall level of compliance with laws, regulations, and sound fiduciary principles • Responsiveness to recommendations from auditors and regulatory authorities

12. FIDUCIARY RISK MANAGEMENT PROGRAM EXPECTATIONS • In SR Letter 95-51 (dated November 14, 1995), the Board of Governors staff stated that taking and managing risks are fundamental to the business of providing financial services. An institution’s establishment of a management structure that adequately identifies, measures, monitors, and controls the risks involved in its various products and lines of business has always been considered safe and sound conduct. • In SR Letter 96-10 (dated April 24, 1996), the Board of Governors staff indicated that changes in the nature and complexity of fiduciary activities, have created a need to revise fiduciary examination procedures to emphasize the organization’s ability to manage effectively the risks associated with fiduciary activities. The letter lists several elements of a sound risk management system. • Management should therefore consider the entire spectrum of risks associated with offering fiduciary services.

13. FIDUCIARY RISK MANAGEMENT PROGRAM EXPECTATIONS (continued) • Based on these fiduciary risks, the establishment of a sound risk management program is believed warranted. Such a program includes, but is not limited to: • active board and senior management oversight; • written policies and procedures, which provide the basis for specific internal controls and consistent practices; • adequate risk measurement, monitoring, and management information systems; • comprehensive internal controls; • various trust related committees and the documentation of their decision processes; and • completion of internal/external trust audits, compliance reviews, and quality assurance programs.

14. ANNUAL ASSET REVIEWS AND MEASURING PERFORMANCE • Regulation 12 CFR 9.6 states that at least once during every calendar year, a review shall be conducted of all assets of each fiduciary account for which the bank has investment discretion to evaluate whether they are appropriate, individually and collectively, for the account. • OCC Bulletin 2008-10 states that these reviews need to definitively state whether each account is in compliance with its investment objectives, within assigned performance benchmarks(s), and administrative requirements: • Addresses the importance of ensuring that all account assets, including unique and hard-to-value assets, are reviewed for appropriateness and consistency with account investment objectives. • http:/www.occ.gov/news-issuances/bulletins/2008/bulletin-2008-10.html

15. INVESTMENT POLICY STATEMENT (IPS) The investment policy statement process can be done in the following steps: • Initial discovery • Discussion and agreement • Creating the IPS: • All key factual data about the client, including where the client’s assets are held, the amount of their assets under your management, and the identification of the trustees or interested parties to the account. This can be as detailed or as simple as desired. •  A discussion and review of the client’s investment objectives, investment time horizon, anticipated withdrawals or deposits, need for reserves or liquidity, and attitudes regarding tolerance for risk and volatility. • Any constraints and restrictions on the assets, such as liquidity and marketability requirements, diversification concentrations, the advisor’s investment strategy (including tax management), locations of assets by account type (taxable versus tax-deferred), how client accounts that are not being managed (if any) will be handled, and any transaction prohibitions. • The security types and asset classes to be included in or excluded from the portfolio, and the basic allocation among asset categories and the variance (rebalancing) limits for this allocation. • The monitoring and control procedures and responsibilities of each party, including the investment portfolio benchmarks(s) to be used to gauge performance. 4. Investment implementation 5. Ongoing communication 6. Monitoring and adjustment .

16. TRENDING UNIQUE ASSET ISSUES • Unique assets are not part of the annual account review • Benchmark performance does not include unique assets • Written trust policy and procedures manual are not customized to match current practices of the trust department • Due diligence is not performed on third-party service providers • On-site visitation of real estate/farm/timber/oil and mineral production is not done on a regular basis • Retention letters are not regularly obtained and/or a lack of a non-responsive trust department policy • Safekeeping of unique tangible assets is unsatisfactory/unsafe • Inter-trust transaction policy is lacking and/or prior Board of Directors approval is not obtained

17. LEADING RISK INDICATORS • Loss due to error and resulting remediation • Charge offs and recoveries • Litigation (pending, threaten, and settled) • Client complaints • Trust fee schedule exceptions • Lost business

18. REGULATORY GUIDANCE • OCC and FDIC Trust Examination Manuals • OCC Asset Management Unique and Hard-to-Value Assets Handbook • http://www.occ.gov/publications/publication-by-type/comptrollers-handbook/Unique and Hard-to-Value Asset Booklet.pdf • OCC Bulletins • FRB SR Letters • Federal and State Law

19. QUESTIONS? • STEVAN SAVICH • (312) 322-8480 • stevan.savich@chi.frb.org