Foreword These guidelines address asset management as a line of business in which national banks and their operating subsidiaries use their skill in managing asset portfolios which can consist of performing loans, problem loans, other real estate owned and other assets. National banks are permitted to service such assets for timely disposition to facilitate recovery of costs. Asset management services may be provided to: o The Resolution Trust Corporation (RTC) or the Federal Deposit Insurance Corporation (FDIC) in their capacities as conservators or receivers of banks or savings associations. o Any bank or savings association, under a national bank's legal authority to furnish correspondent banking services. o Any third party who acquires assets from the RTC or the FDIC in their capacities as conservators or receivers. Contractual provisions may require that the RTC or the FDIC share in the cash flow generated as a result of the actions of the asset manager. Various aspects of this business have previously been offered by banks. To limit the inherent risks and associated exposure, national banks are encouraged to engage in asset management through the legal entity of an operating subsidiary after notifying the OCC pursuant to 12 CFR 5.34. National banks benefit primarily from the fee income this business generates and, indirectly, from the credit analysis skills developed by employees while serving in an asset management subsidiary. At a minimum, the risks posed by this activity are operating risks, financial risks, and legal risks. These risks are addressed in the following manner: operating risks, by employing experienced management and staff to carry out sound policies and procedures; financial risks, through well structured contractual agreements and compensation arrangements; legal risks, by both attending to operating risks through indemnities in contracts, and by legally separating the contracting vehicle (the operating subsidiary) from the national bank sponsoring it. Assessment of a national bank's capability to engage in asset management requires a somewhat different approach than that used to assess a bank's condition. The difference lies in the treatment of prior credit quality problems. Whereas the existence of significant asset quality problems might normally discourage expansion of a national bank's business, asset management uses skills developed as a result of resolving those problems. After a national bank has fully addressed the management of its own asset workout requirements, it may have the capacity to undertake work of the same type for others. To assess adherence to these guidelines, examiners should review management processes and formally adopted policies and procedures. National banks should demonstrate full understanding of the risks inherent in asset management; sufficient experience (whether gained through workout of its own assets or otherwise) in successfully managing those risks; and implementation of appropriate policies and procedures. Asset Management Contracting Generally, asset management is the process for resolution of under-performing, non-performing, or foreclosed assets. The process enables the client institution to recover all or part of its costs by maximizing the net present value of cash proceeds from an asset. An asset manager carries out, for compensation, resolution of assets on behalf of its owner. However, legal title to the assets remains with the owner and does not pass to the asset manager. Resolution may be achieved by: o Restructuring a loan, whether by reducing the principal balance, extending or modifying payment terms, or lowering the interest rate, to enable a borrower to repay the debt as restructured. o Repayment by enforcing contractual obligations of obligors/guarantor(s). o Sale of a loan to a third party at a discount. o Foreclosure to seize loan collateral and obtain repayment by its sale. Asset Management Activities Many of the major types of activities undertaken by asset managers share common operational aspects, such as record maintenance and report preparation. Also, many asset management contracts will include some, but not all, of those activities. Asset management may be undertaken either directly or indirectly. For example, the national bank as asset manager may directly resolve assets for the client or merely advise the client on activities that can be permissibly undertaken for the client. If these activities are also undertaken in a consulting capacity (such as providing advice on the development of policies and procedures), they may be subcontracted by the operating subsidiary to the affiliates of the parent bank. These transactions should always be conducted in a manner consistent with the asset management agreement with the client, and restrictions on operations of the affiliates and on their transactions, including sections 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c, 371c-1). Although this list is not inclusive, these are the major types of asset management activities and the steps for their performance: o General Asset Administration. Provide physical records management and inventory control of assets by institution, loan type, asset type, borrower name, appraised value, estimated recovery value, gross book value and other financial data, personnel assignments of asset management/marketing/legal. Sort, retrieve, and distribute asset information. Perform varied accounting functions from billing to generating accounts payable. Provide management and accounting reports according to client requirements. o Loan Servicing. Provide loan setup and servicing of performing and non- performing loans, lock-box functions, collections, and escrow analysis. Coordinate site and environmental inspections. Analyze, track and obtain insurance coverages. Perform investor accounting functions and prepare servicing reports. Pursue charge-offs, deficiency, and other judgments. Prepare and provide litigation reports as required by the client. o Loan Sales Advice and Assistance. Assist and advise in analyzing, evaluating, structuring for best execution, pricing, packaging, marketing, and selling designated pools of assets. (The activities described arguably could be read to encompass sales of interests in loan pools. In undertaking any transactions as asset manager, a national bank must act consistently with applicable laws and regulations, including the Glass-Steagall Act and the various securities laws.) The ways to provide that assistance are to: -- Develop a Sales Plan. Review loans to develop a plan for stratifying and pricing them. Assist in selecting a due diligence contractor. Develop plans for managing due diligence, marketing, and selling loans. -- Submit the Sales Plan for Client Approval. Prepare and submit a detailed plan defining the characteristics of the loan package to be created and marketed, the types of loans in each package, and the marketing procedures by which the asset manager will effect sale of each package. -- Execute an Approved Sales Plan. Have due diligence conducted on the loan package. Recommend and structure the best execution for the portfolio. Prepare and deliver a report recommending the specific loans to be included in the sale of a loan package. Develop and recommend a comprehensive marketing campaign specifically designed to effect the sale of the loan package. -- Market, Sell and Transfer Loan Packages. Implement marketing campaign, including the development of advertising. Evaluate and assist in negotiating bids. Coordinate purchaser(s) due diligence. Assist in negotiating purchase agreement terms. Coordinate the transfer of loans in accordance with the terms of the purchase agreement, including the assignment and delivery of loans. Transfer servicing and make required notifications. o Debt Restructuring. Analyze both single loan and large complex borrower relationships with multiple types of loan/collateral. Develop and negotiate restructuring proposals. Convert findings into concise case memorandum formats. o Management of Construction and Development Loans. Perform all phases of construction contract administration to include review and analysis of all contract documents on loans in progress through project closeout and conversion to permanent loan status. Review and make recommendations on loans in a non-performing status, including evaluation of current status, past expenditures, cost-to-complete requirements, and feasibility to cease or continue funding. Convert findings to case reports. Take over management of projects when required. Coordinate external legal activity to gain control of assets. o Asset Business Plans. Prepare asset business plans covering all asset types, including budget requirements (income and expenses), marketing techniques, and disposition strategies. o Bankruptcy Analysis. Make business recommendations for small to complex proceedings. Evaluate borrower asset search findings and have knowledge of all types of assets involved in bankruptcy proceedings. Interface with legal counsel to coordinate both business and legal aspects of cases. o Appraisals. Provide personnel and systems to track assets, request, review and reconcile appropriate appraisals for real estate and non- real estate assets in compliance with client guidelines. Provide reports as requested. o Property Management. Evaluate developer or third-party management under construction loan status. Interact with municipalities and arrange maintenance of land development projects. o Marketing. Evaluate disposition strategies. Create marketing programs, including bulk sales, auctions and single asset sales. Price non-real estate and real estate assets. Engage and monitor real estate brokers. Prepare marketing status and disposition reports. Negotiate complex contracts to facilitate sales under client guidelines. Liquidate various types of non-real estate assets. Analyze and dispose of business operations and joint- venture investments and negotiate sale of stock, ownership interests and other assets according to client guidelines. o Financial Advisory Services. Act as a financial advisor and assist in the evaluation of asset portfolios. Prepare rating agency presentations. Negotiate and work with the rating agencies to maximize size and rating of offerings. Act as placement agent for private sales. (Certain activities undertaken by an operating subsidiary acting as a financial advisor may be subject to greater restrictions than if undertaken in the parent bank.) Compensation Arrangements Compensation for asset management activities is defined by the contract between the asset manager and the client. However, whether the contract is standardized or negotiated, a balance is sought between the client's desire to minimize cost and to ensure that the asset manager has proper incentives to resolve the assets. The compensation arrangement required to achieve this balance will vary both with the type(s) of assets to be managed and the perceived difficulty of resolution. Major types of contractual arrangements are: o Management Fee Contract. The asset manager agrees to provide services for either a fixed flat fee or reimbursement of defined costs plus a flat fee. o Disposition Fee Contract. The asset manager agrees to provide services for reimbursement of defined costs plus a percentage of proceeds from liquidation (often on a sliding scale according to the cash realized from liquidation). Government agency contracts generally use this type of compensation arrangement. o Contingent Fee Contract. The asset manager agrees to provide services for a percentage (often on a sliding scale) of proceeds from the liquidation of assets. The asset manager receives no reimbursement of costs under this type of contract. Examiners should bear in mind that whenever any portion of compensation depends solely on cash flow generated from the resolution of assets, it is to some degree contingent on successfully resolving the assets. More detailed guidance on how to assess the risk posed by various types of contracts is given in the section entitled, "Financial Risks." Risks and Supervision Asset management is an activity which, if performed in a professional manner and with due attention to appropriate contractual safeguards, poses an acceptable level of risk to a participating institution. Prior to initiation of those activities, each national bank should ascertain that management fully understands the risks involved and that appropriate written policies, procedures, and legal safeguards are in place. Particular attention should be paid to the national bank's ability to provide experienced management and staff for this activity. Generally, the level of risk posed to a bank by asset management activities may be reduced somewhat, but not eliminated, when they are performed by an operating subsidiary rather than directly by the bank. In national banks where an operating subsidiary is not used, examiners should carefully assess whether or not capital support above the level required for an asset management operating subsidiary is needed to offset this increased level of risk. Also, examiners should consider whether the bank has the existing management and staff to support such activities. Operating Risks Operating risks of asset management contracting are: o Risks from failure to perform. o Risks from mismanagement. These risks may be controlled by developing and enforcing sound written policies and procedures, by employing appropriately experienced and trained management and staff, and by careful business planning. Prior to contracting with any party as an asset manager, a national bank should demonstrate that it has: o Identified the types of asset management services to be offered to potential clients. For example, a national bank that has become adept at restructuring non-performing loans to manufacturing companies because of prior problems in its own portfolio, might decide to offer a similar service to other national banks or savings associations. This would be an appropriate use of the national bank's investment in developing this ability. It may be inappropriate, however, for the national bank to offer restructuring services for non-performing construction loans. The ability to perform each type of asset management service should be recognized by management before the national bank assumes those activities. Examiners should therefore assess whether the services to be offered by a national bank truly reflect its abilities, and whether management has a full understanding of the risks involved. A national bank attempting to perform activities for which it is ill-prepared may be exposed to client litigation or operating losses due to its inability to perform contractual services. o Management and personnel experienced in performing the services which the national bank proposes to offer. Examiners should assess whether the reassignment of existing management and staff to asset management contracting will affect negatively the national bank's ability to manage its own portfolio. Examiners should determine whether the national bank has developed appropriate training capacity to meet replacement requirements. If the national bank intends to subcontract with outside firms and/or consultants for many services, the screening process and contractual arrangements should be reviewed. o Written policies and procedures. All personnel that provide asset management services should be trained in the national bank's policies and procedures for their particular functions. Written policies and procedures should be provided to employees for their guidance and reviewed and updated regularly. Examiners should carefully assess whether those procedures are adequate and are being followed. Employees should be questioned to ascertain their familiarity with policies and procedures. When a client provides certain policies and procedures for the national bank to follow (as is common with RTC contracts), examiners should assess whether they are applied by employees assigned to that client's contract. Examiners should assess separately bank policies and procedures on conflicts of interest. They should ensure that those policies and procedures segregate asset management functions from lending functions. Further, they should review carefully any lending activity relating to asset management to determine that credit standards are no less stringent than those applied to other national bank borrowers. o Financial management and information systems. Examiners should assess whether the national bank's financial management and information systems are adequate to process the increased work load generated by asset management activities. In particular, systems should be assessed for their ability to: -- Manage and account for client funds separately from national bank funds. -- Track and report on client funds. -- Track client-owned assets. -- Monitor subcontracting activity and account for disbursements. Financial management policies and procedures should ensure that client contractual requirements for funds management (both receipts and disbursements) are followed. If client pre- approval for disbursements is required, examiners should determine whether employees know of these requirements and follow them. The national bank should have adequate safeguards in place to ensure data integrity. Examiners should review those safeguards for adequacy in their review of asset management activities. In addition to good management and information systems, the national bank should demonstrate that its budgeting process for asset management activities is adequate and budgets are followed. Examiners should review the national bank's procedures for developing bids to ensure that bids are realistic and pose no threat to the national bank's operating income (see "Financial Risks" below). o Internal audit. Internal audit of asset management contracting should be no less stringent than that applied to other areas of the national bank. Under no circumstances should internal audit have a reporting relationship with asset management contracting managers. o Physical security. Certain asset management activities involve the application of pressure (both by legal action and persuasion) on borrowers to pay loans and, often, actions to secure collateral from defaulted borrowers and guarantors. National banks undertaking this type of service should make appropriate arrangements to ensure the physical security of their records and employees. Financial Risks The financial risks of asset management contracting are: o Risks to operating income. o Risks arising from litigation. Generally, both types of risk arise from the failure of a national bank to protect itself adequately through contracts and indemnities. The risks to operating income are described in this section and risks arising from litigation are discussed under the "Legal Risks" section. An asset management contract may cover up to the following three types of compensation: o Reimbursement of expenses. Arrangements may be made to reimburse direct out-of-pocket expenses (e.g., costs of maintenance for real estate managed under contract); direct asset management expenses (e.g., salaries, benefits, and travel expenses of bank employees assigned to a client's contract); and indirect expenses (e.g., reimbursement of a pro rata share of bank senior management's salaries and benefits). o Management fees. Arrangements vary according to the client and the type of assets being managed. Generally, the more difficult an asset is to resolve, the more likely that a flat fee arrangement will be used. When assets are relatively easier to resolve, management fees are more often calculated as a percentage of net cash collections (cash collected less defined expenses of collection). Flat fee arrangements are also used in contracts when the asset manager is primarily engaged in restructuring loans rather than resolving them, or in the provision of other, non-resolution activities, such as information services. o Incentive fees. These are used either on a stand-alone basis (contingency fee contract) when the asset manager receives a defined percentage of gross cash collections, or as part of a more complex arrangement when incentive fees are paid as an additional incentive above management fees when the asset manager achieves defined collection targets. Examiners should focus on the degree of risk to which a national bank is exposed to an operating loss as a result of the contract. Generally, any risk of loss is minimized when direct out-of-pocket expenses and direct asset management expenses are reimbursed. However, examiners should bear in mind that in contracts where these reimbursements depend on cash flow generated from the resolution of managed assets, full reimbursement may not occur because of the failure of the asset manager to generate the required cash flow from asset resolutions. Therefore, when the assets to be resolved are extremely illiquid (e.g., a portfolio of unimproved land situated in a depressed real estate market), a backup provision for client reimbursement of these expenses may be appropriate. Examiners should also verify that the asset manager periodically evaluates the financial condition of its clients in order to ascertain their ability to fulfill contractual obligations to make payments. The maximum operating financial risk to an asset manager is incurred in contingency fee contracts. These contracts may contain no provision for reimbursement of expenses except from cash flow generated by the resolution of assets. They may also require a national bank to forecast accurately both its costs and estimated cash flows from assets in developing a suitable contingency fee. As this situation requires the national bank to provide operating capital to fund expenses from its own resources, examiners should assess carefully the ability of the national bank both to successfully resolve the type of assets involved and to carry expenses until cash flow is generated. Contracts of this type are generally suitable only for national banks with significant asset management experience and the financial capacity to bear unanticipated operating losses. Appropriate capital support for asset management activities varies according to the legal entity used and the compensation arrangements entered into via management contracts. Appropriate capitalization has the following two components: o Operating capital -- Should be sufficient to cover out-of- pocket and direct expenses between reimbursements and to fund overhead of asset management operations. Thus cash capital or lines of credit should be adequate to fund operations between reimbursement dates, with an appropriate reserve. In contingency fee contracts, significantly larger amounts of operating capital may be appropriate. Examiners should assess whether banks use a disproportionate amount of their (consolidated) capital to support asset management subsidiaries. o Contingency reserve capital -- Is required to support national bank asset management operations. An asset manager may be exposed to lawsuits arising from mismanagement, environmental liability, or other causes. The use of appropriate indemnities and the legal entity of an operating subsidiary can protect the bank from the consequences of legal action. As a general rule, when asset management activities are undertaken without the protections offered by using an operating subsidiary, significantly greater contingency reserve capital may be required. Examiners should make that clear to banks that do not intend to use an operating subsidiary. o Total Capitalization -- May affect a determination of the legal separateness of asset management activities of an operating subsidiary from the parent bank when in litigation. Examiners should verify that the parent bank has obtained opinion of counsel regarding the adequacy of the operating subsidiary's capital for this purpose and that a court is not likely to pierce the corporate veil between the operating subsidiary and the bank. Legal Risks Legal risks of asset management contracting are: o General business risks. o Environmental risks. The asset management business may often involve significant amounts of litigation both for and against an asset manager and its client. Examiners should ensure that litigation-related activities are managed appropriately and that management tracks and monitors all law suits. Failure to effectively manage litigation-related activity may result in significant losses to an asset manager through either direct losses in litigation or a failure to control legal expenses. Business litigation risks may arise from the failure of the asset manager to fulfill contractual terms, improper management or embezzlement of client funds, lender liability suits directed against the client and asset management contractor, consumer credit collection laws, actions of subcontractors, and employment-related law suits. Environmental risks could result from the national bank's asset management activities being considered liable for environmental cleanup for certain assets, particularly real estate, under its management. National bank strategies to limit these risks are: o Using an operating subsidiary to house asset management activities. All appropriate corporate formalities (e.g., board of directors meetings) should be observed to maintain the legal separateness of the operating subsidiary. o Capitalizing the operating subsidiary adequately. o Purchasing insurance, including fidelity bond, comprehensive general, automobile and workers' compensation coverages. o Requiring that clients provide indemnities to the asset management subsidiary for its actions and, in particular, for environmental liability. o Requiring clients to provide factual information on each asset placed under management, such as court filing dates and tax payment dates. This information may reduce the basis for disputes between asset manager and client. o Requiring client approval of individual asset management plans. This establishes the client's expectations for the asset manager's performance and budgets or projected expenses. o Entering into agreements with subcontractors that provide appropriate protections, such as insurance and indemnities. o Conducting regular operational and compliance audits to ensure adherence to both client contractual requirements and internal policies and procedures. o Designing well-documented policies and procedures, including those intended to avoid environmental liability. o Providing adequate training and supervision of employees, including regular reviews to ensure execution of that training. In assessing those measures, examiners should pay close attention, not only to the presence of appropriate indemnities from clients, but also to the ability of the indemnifying client to fulfill its obligations. National bank policies and procedures should, for example, require estimates of potential environmental and other liability which may arise from performance of an asset management contract. They should also include an analysis of the client's financial capacity (whether directly or from insurance) to honor indemnities against that exposure. Finally, national banks engaging in certain asset management activities, should also know the requirements of the Glass- Steagall Act and the risks and costs pertaining to compliance with the federal securities laws from issuing securities or engaging in potentially registrable activities. Sample Supervisory Questions The following questions address a national bank's ability to offer asset management and are directed primarily at national banks who enter this business for the first time. o What types of asset management services does the national bank intend to offer? Does the bank have prior experience in the types of asset management services to be offered? How, and to whom, will those services be offered? o Will the proposed asset management contracting activity cause an adverse impact on the national bank's management and resources? How will that problem be addressed? Will consultants be used extensively? o What legal entity will be used to provide asset management services? How will it be capitalized? Has the national bank sought advice of counsel about protecting itself from litigation that could arise from the improper execution of these services? How will the national bank protect itself from possible environmental liability? o Has the national bank management developed a business plan for asset management services? Is it realistic? How will the national bank benefit from entering this business? o What national bank resources (financial and management information systems) will be used to support asset management contracting? How will the national bank be compensated for this use of resources? Are these appropriate systems to support asset management services? o What policies and procedures will be used by the asset management operation? Are these procedures written? How are staff members trained to use them? o What form of contract (management fee/disposition fee/contingency fee) will the national bank offer? Is capital support adequate for this type of compensation arrangement? Is the form of contract appropriate to the type of assets to be managed? o Have the national bank's internal audit personnel been trained to audit asset management activities? To whom does the audit staff report its findings? Examples of asset management contracts and asset disposition and management plans will appear in the Asset Management Reference Manual to be distributed to OCC district and field offices and duty stations. Many functions undertaken as part of asset management activities can be supervised by using existing OCC guidelines (e.g., data processing activities). Examiners should also refer to the appropriate sections of the Comptroller's Handbook for National Bank Examiners for supervisory guidance.