The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
mm mœmjmt « i m m s % Bs&mcxià 1* Sangren, Assistant Chief Division of Research and Statistica Itererai Deposit Insurance Corporation Ctexifereaee of Bxaniaers ani Assistant & « i a i r i Sixth Federal Deposit Insurance District St* louis, Missouri June 9» 1958 fronds in the holdings of muaicip&i securities fey the Insured aoraercial banks both in the United States as a whole and the Sixth District have been substantially Identical over the past decade» 2h aggregate volume as well as relative to total assets the growth has been substantial, nationwide the Increase in this *e#a©nt o f bask assets was in the order of $k billion to $ lk billion dollars, comprising about 3 percent of total assets at the beginning of the period as compared with a shade over 6 percent currently. from State to State la the group raking up the Sixth District there is a considerable variation in the absolute as well as the relative importance of municipal securities in the asset structure of the banks. Missouri banks now account for almost half of the $TQQ million of nmicipal securities in the District, whereas the banks in Kentucky hold only about .11 percent of the total. Da relative terms Kentucky municipal securities account for about k percent of total assets as compared with s u b t l y m m than 10 percent in Arkansas. But in a U of the States asking up the District the growth trend over the decade has been vigorous. Because of the vigor in growth tread a discussion of investment policy generally with respect to municipal securities would now m m appropriate, the quality of the credits held by banks Is is^gortant. Accordingly, time devoted to a consideration of the rasas for raking qualitative determinations promises to be w e n spent* Finally, you ray have ®am questions regarding bank investment policy or auaicipal security analysis jewing out of specific situations that come to your attention in - a • the field« It 1* sincere hop© that the more or lees formal remarks about this subject will encourage your questions* Hon» specifically* the purpose of my remarks at this time is to develop suggestion* for strengthening your p M l comment# regarding a bank*s investment program as presented on page 2 of the bank examination report* In addition* the detailed discussion of municipal credit analysis may furnish a basis for improving your comments with respect to securities classified as unsuited for bank investment purposes* Bank examination work is effective oily to the extent that the results of review and analysis by the examiner are brought to the attention of the bank under examination in a convincing manner* Bank Investment Policy the key question leading to the general evaluation of the bank's investment program is found in Section 1 of the examination report form-Does the bank have a definite investment policy? answer this question the examiner is obliged to ascertain the policy--if any— followed by Use bank ia managing its portfolio of securities. Depending upon the answer elicited by this question* the examiner will be able to prepare a more detailed casaeat in fart 2 of Hue saMtibaatlan report* Some banks have a fonaal statement of investment policy that serves as a guide to day-to-day operations* Others do not have a formal policy statement but a study of their Investment activities over a period of years reveals a consistent thread which Is for all practical purposes a substantial equivalent* fhen there are some banks that do not have an investment polioy, asiá ai a mattar G ì fact* do &ot saa^f» thelr jsortfoli© with t e fasature of coniiteocy. t e n i tank l a t e & cenalatent Investment policy to guide iti aeleette g ì aeeuritie® tlm tank extener hai i good n n o o to golnt ©ut thi* ahortoteng ia tan e x t e n a t t e report. l^ea* ita purpoae of e o m r k i a g t a a m i t a n t i alio aro appropriate io t e m i pollar statement® ©r io thè thread of laveetmeat policy that om hi discente i& thè cotoni of aecuritiee traaaactìQos* With a serieii ©f caaaaata osa page 2 of successive ssstenatte report foras thè eateaar s^r hi dble to eacourag© a nsaedy dafeets in th@ m a a g e m a t of ita iavaatwmt portfolio* to 9 s U i# t e conatruetive aspcct of back i m t e a t t e eork. Sttffiitet t e t e puxpoeee ©f t e a d i a m a n t e lili ha reference to t e major tettata that t e « a s t a wouJLd expect to fimi in a tank inveatnaat policy atateant* It ehould include s o m gaidance aa rogate t e s i n t e eompositlo» of t e invéntate portfolio, t e ^tettativi standard! t e m a r i t i l a to ba t e l a t e ia t e invasiate portfolio alio are iaportant. U n a H y , ttara la a n d far guidano! aa regarda tei aaturity diafcritatioa g ì t e itesa aateted t e i & m t t e puxpoaaa* tatheaatleal oritela t e tetSag t e a t e of a tank»! investiate portfolio or t e prog&rttes ootetted to t e vartes types of aaoaritte 9Uch a» t e i m l obligations, t e obUgattea ©f State t e tedivistan®, t e ©ter securitie® wuld hi very talpful* da a p r t e t e l m i t e , it ia imponible to davate t e r p t e t e standard** t a w r f vidi departas ite t e investment pattarti of tate similari^ aituate furatati a © t e to poliate t e t ba unaatiaftatoiy m a tetaaeaa uadoahtedly thaaa - k departe*© are fully warraxstad hy t e total «ituatloa la nhloh a bank opereta«* Accordin&ly, a coaaeni *1© the effeet tbat a bank*© coosaítawnt la municipal obligatíons ooaprlee» 1$ perceat of total «u»ts tereaa t e avorage for the State 1« bfe^eetiOB. 7 percent, eertaialy «elle «o be & coKvteing On the other hand, a cooneat t e t a tete t e ütvHted 5 pereeai of It» total aeaete la ounicipal seeurities t e t e t the baide iaek» the eredlt file» and pereosmel qpallfled to select b o t e approprlate te» the tete would suggeet a serlou» weakaesa. t e juetifloattoo ©f any iaveetaaot la municipal aeeurlties h e t e the top qnality credltwiae le virtuaUy impoesibXe» SeverteLeea, tete© do not confine their investente t© the v**y beat grade ©f issues. t e t e » are alway» limitad by the availability of obligationa te» tn rm tm m t purposes. Aceordliigly, a ccraroent a t e t the <*aaUty ©f eeonritiee eeleeted for t e portfolio eaanot be unrelated t© the Individual bank’s alternativa inveeteat opportunltie». To t e exteat t e t a tete deliberately sacrificas qum Uty la order t© augiaent e a t e a ü # t e essiiiitaer ha© a valia te l e for leveling ©ntleiaa at t e eetettei* fh» pateta of aaturlty dlatrlbutloa la vitally ia®©rtet to t e total laveetaeat progra» ©f a t e k nadar eamBsinatloii. C cw am t afeont t e pateta, t e m e r , e s t e be unrelated t© t e ñatee of t e b t e f© opérateos. portfolio* Qm m m XXy teselas» loag-tem leeuee are uaauited t e t e tete % and larga, I suppoae t e aost approprlate teeateat progresa, P&rticularly t e municipal obligations, la t e pattero ©f mote or lea© e<paHy epate mturitiea ©ver a perlod ©f U v e t© seven years. Sueh a diatributioa aftede a eieady Inflo© ©f eaah «hile at t e sao* tía— it * 5 * enable* the bank. to reinvest « bi «qua.I portion. of the portfolio each year s M thereby obtain a laoviog avenge of interest rate returns prevailing la the market* finally, ia oo a bank*® lavestx&s&t portfolio It le yell to give seas igeerai ece#ldfi^tloai jt to a factor that ##** only be described as balance* To the extent that iavestsieat policy departs frm sam rm som ble and balanced pattern, It Is unsound* Although the is not qualified to pass on the laipilty of the iidividuftl items ^oinpytei«^ tbs w»mi <*4p»i ee^pesnt of a bsaifr iavestaeat portfolio, be needs to assure bliaself at tbs very begf,!^!*8^ of bis work that the securities are valid Obligation# « %ies*4oe# reip&rdlsg the ie^allty of an issue osa only be answered satisfactorily by experts la tbe field of «»mi pipati las* legality of Opinions of la the portfolio It Is customary foe* tbe hoyer of «»ttfrfftipai opiatos aovarlas the legality of tbe Moreover* lavestsent Houses usually furnish w«q¿i attorneys covering the be available to the exieadner* to óblela a copy of tbs et tbe time of purchase« dooi. aB!vwyts to cuetoser# es a mattar of course f«a the yieee of tbe attorneys approving tbe legality Of so issue appears la «very sell-prepared circolar offering securities for sale* Of the knotty psoMMws paeaetited to exsedasrs by securities la the investment portfolio, tbs detcmimtioa of credit quality is, X suppose, tbs one aost frequently encountered* The qualitative ratings publiée! by tbe iavestaeat advisory services are of Halted ~ é * usefulness in answering these questiona. % far the bulk of laiaieipal securities ara floate fey n o l i Obligora «tows ^ri^tiror^iia!i«a hm m t been reviewed fey the services. Her Is it likely that the servias» will ever fee in » position to express «a opinio» regarding the quality ©f such eredita sizaply because the dollar aaount of each individual issue is too small and the nuafeer of obligors entirely too great to fee studied systsestiealiy. Accordingly» the beak eaminsr can always expect to fee called apon to f&m mam judgment regarding the quality of a sufestaatiaX volume of laaues held fey the banks fee examines. Shortcut testa far determining the credit quality would fee very helpful. A number of them exist hut they have m t proved to fee very dependable, do it is aliaost impossible to orarempfeaatse the fact that there really are no good shortcuts for evaluating credit quality of municipal obligations. Such a deterainatioc involves an Investment jud#a«3it based upon the relevant facts. Essentially» it is a subjective racier than an objective process in which experience play» a very important part« When the examiner ia called upon to appraise a mmtcipal credit the first question to fee aaiEed is this*. under consideration? M a d la the nature of the security la it a general obligation supported fey the pledge of the full faitii and credit of the issuer or is it the obligation 'Of a business enterprise type of activity whose revenues are derived fren pertesaanee of specific services! Still another possibility is the type of flotation that has m m of the characteristics of both of the preceding securities» namely» a general pledge ©f credit together with specific - T * support such m th* revenues fresi « public utility or the yl«M frets & specified tax* ïfce pattem of analysis will depend upon specific classification of the obligation. la every instance of municipal credit analysis the starting point Is an evaluation of the economic background. For a general obligation this entails a study of the facts regarding the issuing cæssualty. such ss tfes following should be considered: gestions Where is the obligor situated? febat are the characteristics of population trend? «feat other evidences of economic development can be obtained, such as estimate© of per capita incesse, shifts in industry, basic economie facts such as shipping and transportation? Tor a business type of obligation floated by a governmental subdivision, for example, a t o n bridge, the factors bearing upon the location of the project and its general prospects avs important. Toe object of the economic background study is to ascertain elements of strength and weakness that nay have a bearing upon the credit irrespective of its other characteristics. % and large, the Obligations of a cosammity wanting in basic economic strength or a project that is poorly conceived w i n be unsatisfactory irrespective of & U efforts to buttress the credit by legal means «nr otherwise. ïbe debt record or the history of performance on securities that have been floated by the obliger is always a pertinent element in the appraisal of a municipal credit« reassuring* To be sure, a record of default is not But old defaults are poor evidence as regards current willingness to pay* Beccai defaults, however, are »auch mors significant* By recent default, I suppose, am has in mind the pest decada or at the soai 25 years« - a . The deb% eteteoent of the obligor te probably the w t single coapiXatlon ©f date for evaluating a nuntcipal eeeurity* isportant ||§; stateaent te a «tapie enumratian of all of the fundad obligationa that ha** bee» iesued by the ©hligor* la additioa to thie dtreet debt, the statesoent aleo afaould inoXude el! underiying debt, designated. a« eneh« that ineludee the debt of «saller geogrephical apea« that ere eaapletely encomp&aaed by the ©ne m&mr eoneideratioa. Aleo, it vil! indícate the m o m t of overl&gping debt, nasely, the debt of lardar geographieal a r m e that inelude ia psrt the ©a© under oonsideratlon. Takea together, the direet debt, the overlapping debt, and the u»der2yiag debt aahe total debt reetiag oa the eoosunlty under etudy. the Theu^bi the dlnect debt i« the «ole bordea of the obligar uhoee eredit ie beiag aaalyssed, the economic resourcea of the «rea saust furoieh the laeans fbr eupportiag the entire debt, trreepeetive of the obltgor. The crucial elesaent in credit anaXyai« 1« the (Stetemination of the ¡sargia of proteetioo for the holder of the «acurity « s t e study* The sargia of proteotion oosaoept repreeeate the aggregaticm ©f e s t o c o teetifying to the ábillty of the debtor to neet bis obligatioo». ®m? hite of avideace pertineat to the aargia of protection. Tm m are fbr ©3£®B$le, costearlean of the «oouat of direct debt vith the total eeeeeeed m lm or a coaputatioa of per cepita debt are «ueh ©eaeureS' Baportant to note., however, 1« the ífcet that a detemlaatim vith reepect to the isargin of proteetion fbr debt eorvioe ie eubjeetiv* in eharacter. Xt calle fbr the use of ¿udgeent baeed upen m^wciamm in the field ©f iaveatneate. - 9 * îa general# 2 m ratios or small amounts of debt per capita mm a©as»â to b* m iêm im of a strong laargi» of protection, whereas high ratio# or high por capita debt# aro evidence of weakness. But unfortunately there «** no good standards for appraising these ratio«* Assesanoat practico# »''ary fro® place to place and the wealth of a coccumity h## th® ability to shoulder a debt burden, to do «itti furthermore, these ratios tend to lose tlisir significance ss ties gees on because the general property tax, that is# the tas levied, in tarns of a percentage of all property in the area, is declining in importance as a source of revenue. In recent tines conmns&ttes have con« to rely nere sod «ore on other sources of tus iìscoiae and seise tenes» ?»*<»>» Ifeese# of course# produce revenues «gutta apart With respect to general obligations, the facts regarding the tax levies In teres» of «Hinge as coopered with taxation practices elsewhere ore indicative of the sargia of protection for debt service. If some aommunlti©# typically aseses property et «ödest figures and levy low tenes, there is clearly a margin of protection that could be tapped by assessments or tax rates. fhe summary of current financial operations «bowing the AHistr œ of of ®o the extent that a avoids the accixmUatlca of a of protection may be in part upon axiomatic that over a period of years a the cost of debt# the credit Is in the financing of basis of current It - m flnancial operations vithout runntng lato déficits* F&ilur® to âo ao i» évidence of ueakaess* Ai regards the business type of minleipal eaterparlses, the nstboA of ssalyslt la soa» respects le eesler end la otHers nore difflcult. It le casier because tbe deteraimtlo» of crédit sorthiaess 1s not clcuded by tbe appralsel of intangible features tbet ray be importent in s .général piedgc Bot at tbe m m t i m it le rare difflcult becaase it dépends of crédit* upon esiiamtes of revenues and osseuses projected lato tbe future* ! GeneraHy speakiag, tbe crédit analyst is looking foi* évidence that tbe debt service vill be paid wfeen due* Anong otber tMngs, thls salis for s schedul® of raturiti«* over tbe nsar tore s© that changes 1» debt service csa be ideatlfled and the prospects for oovoziag tbm m m tm tbe record, of disburseraata. When tbe examiner 1s called u p m to fora s judgna&t os regards crédit quality tbe accumulation of Inforrntlon essentiel for analytleal purposes 1s one of tbe major problaas. $o b® sure, ee bave rôles applicable to State bocks raafeers of tbe Fédéral Beservo m â tbe national bonks noir setting up rather bijh ra^rarants for data In crédit files. Over a period of years examinera bave sought to persuade baakara to accuralats thîa information* As a practice! natter, bouever, se knoe that tbe crédit files in rasi cases are not good. fbis calls for a never^yding ©truggle m jour part to persuade tankers to assemble, as a miniMiss et least, copies of offerlns circulars* After tbe securities bave been floated crédit data ean be obtalæd froa tbe audit reports. ai and Conclusion fo sum up, then, the record shows that the municipal segment of the investment portfolio held by Insured ecsssercial honks h»#» grown rapidly in the postwar period. The rote of growth varies greatly firn bank to hank but the basic tendencies working in the direction of expansion are present everywhere. Moreover, there le reason to believe that m tine goes on aunlelpal securities will continue to grow in Owing to the prospects for expansion in bank holdings of municipals it Is clear that exazBlners will be confronted with an volume of work in analysing these credits. % to now the analysis of eoasaereial credits has been the princij Accordingly, progress has been made in for purposes of credit analysis, and examiners have developed skill in analysing the pertinent data* St scans clear that efforts aigytg these «miai» lines will be needed in the field of municipal credits* lot only will it be accessary for examiners to encourage banks to assemble information needed for analytical purposes in the municipal Held, but also they will be to develop s k i n in credit analysis techniques. -, the objective of the analyst in reviewing the facts credit is to ascertain the margin of protection for debt service. There are no silvie tests of universal applicability in tills sargia* Sometimes the isargin is so very revealed by simple testi. elements of uncertainty. Typically, the ere« Experience In appraising mmicipal credit situations furnishes the points of reference for guiding opinions as
@FedFRASER