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| .jpeg){wid | **Letter**                                | g){width=" |
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**Interagency Supervisory Guidance for Institutions Affected**

**By Hurricane Katrina**

**PURPOSE**

The federal financial institutions regulatory agencies[^1] and the state
supervisory authorities in Alabama, Louisiana, and Mississippi are
jointly issuing this examiner guidance to outline supervisory practices
to be followed in assessing the financial condition of institutions
directly affected by Hurricane Katrina. This guidance also applies to
examinations of institutions that may be located outside the disaster
area, but have loans or investments to individuals or entities located
in the disaster area. The guidance recognizes that examiners retain
flexibility in their supervisory response, given the unique and
long-term nature of the problems faced by affected institutions.

Hurricane Katrina had a devastating effect on the U.S. Gulf Coast region
that will continue to affect the business activities of the financial
institutions serving this area for the foreseeable future. Some of these
institutions may face significant loan quality issues caused by business
failures, interruptions of borrowers' income streams, increases in
borrowers' operating costs, the loss of jobs, and uninsured or
underinsured collateral damage. Further, as a result of the significant
loss in their tax and revenue base, state and local governments face
major challenges in paying their obligations, which could adversely
affect financial institutions with large investments in county/parish
and municipal securities and loans.

**OVERALL SUPERVISORY ASSESSMENT**

It is critical that supervisory agencies are aware of the true condition
of each affected financial institution. Therefore, examiners should
continue to assign the component and the composite ratings in accordance
with the definitions embodied in the Uniform Financial Institutions
Rating System[^2]. When evaluating the CAMELS components at an affected
financial institution, examiners need to consider the reasonableness of
management\'s plans for responding to the hurricane's ramifications on
its business strategy and future operations, given the economic
conditions in its business markets. In particular, when assessing the
management component, examiners should consider management\'s
effectiveness in responding to the changes in the institution's business
markets caused by this unprecedented disaster and whether the
institution has addressed these issues in its long-term business
strategy.

The examiner's assessment of Hurricane Katrina's effect on the CAMELS
component ratings may result in a lower composite rating for some
affected institutions. However, in considering the supervisory response
for institutions accorded a lower composite rating, examiners should
give appropriate recognition to the extent to which weaknesses are
caused by external problems related to the hurricane and its aftermath.

Examiners should consult with their supervisors to determine what
supervisory action, if any, should be taken. Formal or informal
administrative action that would ordinarily be considered for
lower-rated institutions may not be necessary, provided that prudent
planning and policies are in place and management is pursuing realistic
resolution of the problems facing the institution. In instances where a
formal or informal supervisory response is warranted, supervisors should
tailor the response to management's capabilities and efforts in
resolving the institution's specific issues.

**RISK ASSESSMENT**

Examiners should expect affected institutions to have completed an
initial risk assessment and have a process for refining their
assessments as more complete information becomes available and recovery
efforts proceed. In reviewing management's assessment, examiners should
recognize that the issues faced by institutions are complex and may
involve protracted resolutions. The institution's assessment should
reflect management's best estimate of its asset quality, given the
prevailing economic conditions in its business markets. Management
should be able to explain the disaster's implications on the
institution's earnings and capital, as well as its effect on liquidity
and sensitivity to market risk.

As a part of the ongoing assessment process, examiners need to ensure
that institutions are able to identify all loans and investments
significantly affected by the disaster and any potential loss exposure.
For secured loans, examiners should expect an institution to have a
process for tracking information on the condition of collateral and the
collectibility and timing of insurance. This analysis should be
performed on an individual loan basis and supporting documentation
should be included for significant credits. This process may necessitate
a change in the institution's loan review criteria to reflect the need
to monitor credits affected by the hurricane more frequently.

Institutions that experienced heavy damage to facilities or lost key
personnel may still be working on their assessments. However, examiners
should expect the institution to demonstrate its review methodology and
reasonable progress given the circumstances. Examiners should review
management's assessment to determine whether it is sufficient in scope
and content. The examiner-in-charge should adjust the scope of the
examination depending on the quality and thoroughness of the
institution's internal risk assessment and consider the accuracy of this
evaluation, as appropriate, in the CAMELS ratings.

**CAMELS COMPONENTS**

Examiners should evaluate the CAMELS components according to existing
supervisory guidance. In addition, examiners should consider the
following examination guidelines:

**[Capital Adequacy]{.underline}**

When evaluating the capital component for an affected institution,
examiners should consider any extraordinary expenses, unexpected deposit
growth, contingent liabilities and risks, and loan losses that were
incurred as a result of Hurricane Katrina. If significant declines in
the affected institution's capital ratios have occurred or are
projected, examiners should determine whether the institution's board of
directors has developed a satisfactory capital restoration plan that
provides for capital augmentation in a timely manner.

**[Asset Quality]{.underline}**

**Loan Reviews**. Examiners should expect an institution's loan review
practices to be sufficient to verify that it is adequately identifying
and reporting the risk in its loan portfolio. Examiners also should
identify any recourse arrangements with sold loans or other contractual
agreements that may involve risk to the institution from deteriorating
asset quality. Examiners should recognize that supporting file
documentation may be limited due to unusual circumstances caused by the
disaster. Initially, examiners should verify the accuracy of the
internal assessment by transaction testing. Examiners should consider
expanding the scope of the loan review if the transaction testing
indicates that the internal risk assessment is insufficient.

**New Loans**. Examiners should review a sample of loans originated
after Hurricane Katrina to determine whether the institution's
underwriting standards are appropriate. There may be a number of
legitimate reasons why management may have eased underwriting standards
after Hurricane Katrina to address the needs of its customer base. In
addition, management may have changed its business strategy to focus on
new lines of business or expanded into new markets. Examiners should
note any significant changes in the financial institution's lending
practices and ensure that these activities are consistent with the
institution's loan policies, the board of director's strategic plan, and
prudent underwriting standards.

**Credit Modifications**. Examiners should recognize that the economic
conditions in disaster-affected areas may influence an institution's
course of action as well as the timing of such action. Examiners
generally should not criticize an institution that is attempting to
constructively work with its borrowers in affected areas. Examiners
should review an institution's policies and procedures for providing a
borrower with a loan modification, extension, restructuring, or workout.

Credit modifications, extensions, and restructurings (including
capitalization of interest) do not necessarily indicate imprudent
lending practices. If a performing credit was appropriately modified as
a result of Hurricane Katrina, then absent any unusual circumstances,
examiners should not criticize these practices. Examiners should expect
to see appropriate documentation to support the institution's agreement
with the borrower, including the borrower's recovery plans, source of
repayment, reliance on insurance proceeds, advancement of additional
funds for rebuilding, value of additional collateral, and the condition
of existing collateral. Regardless of the terms of the modification or
workout agreement, examiners should expect the institution to
appropriately recognize credit losses as soon as a loss can be
reasonably estimated. Moreover, examiners should expect the institution
to preserve the integrity of its internal loan grading methodology and
maintain appropriate accrual status on affected credits.

# 

# Nonaccrual. Institutions may find it necessary to allow borrowers in affected areas to defer payment of principal, interest, or both for a reasonable period of time with the expectation that the borrower will resume payments in the future. Nevertheless, accrued interest should be written off (reversed) when it is deemed uncollectible. Examiners should ensure that financial institutions continue to follow applicable regulatory reporting requirements, as well as the institution's internal accounting policies, when reporting nonaccrual assets.

**Insurance Claims**. In many cases, repayment may be dependant on the
collection of insurance claims on covered properties. However,
management may be experiencing some difficulty in contacting the
insurance carrier or may be uncertain regarding the timing and amount of
any potential insurance claims.

Examiners should consider the type, amount and timing of any proposed
settlement offers. If an insurance carrier indicates a valid claim on a
mortgaged property has been accepted, then the negotiated settlement
amount normally would not be subject to adverse classification, barring
any unusual issues. If the validity of an insurance claim is in doubt or
a protracted resolution is likely, then examiners will need to exercise
their judgment in classifying a loan based on its individual facts and
circumstances.

**Classification Standards**. Examiners should rely upon existing credit
classification standards for loans affected by Hurricane Katrina. The
evaluation of each credit should be based upon the fundamental
characteristics affecting the collectibility of a particular credit.
Examiners should review management's assessment of the borrowers'
repayment ability and financial condition as well as the institution's
collateral protection to determine the appropriate credit
classification.

Examiners should apply appropriate credit classification and charge-off
standards in cases where the information available indicates a loan will
not be repaid, or contact with the borrower has not been established.
Examiners should also assess the reasonableness of management's plans
for pursuing foreclosure of collateral on nonperforming assets, given
the unknown environmental risks and other factors. In some cases, the
deferral of foreclosure may be the most prudent course of action.

**Allowance for Loan and Lease Losses** (ALLL). Examiners should review
the institution's methodology for calculating the ALLL. In determining
an appropriate ALLL, management should consider all information
available about the collectibility of the institution's loan portfolio.
Consistent with generally accepted accounting principles (GAAP), the
amounts included in the ALLL for estimated credit losses incurred as a
result of Hurricane Katrina should represent probable losses that can be
reasonably estimated. As institutions obtain additional information
about loans to borrowers affected by the hurricane, management is
expected to reflect revised estimates of loan losses in its regulatory
reports.

For loans to borrowers in the affected area, there may be a period of
time where institutions may find it difficult to accurately determine
the collectibility of loans. Examiners should recognize that management
may need more time than in normal economic conditions to evaluate the
effect of the hurricane on the ability of the borrower to pay, assess
the condition of underlying collateral, and determine potential
insurance proceeds. Examiners should ensure that management has
maintained the ALLL at an appropriate level based on its best estimate
of probable losses within a range of loss estimates.

**Obligations of Taxing Authorities**. Examiners should review the
institution's loan and investment portfolios to determine whether it has
extended credit to taxing authorities via loans or through the purchase
of county/parish or municipal obligations in areas that sustained damage
during Hurricane Katrina. A significant number of communities located on
the Gulf Coast are heavily dependent on local sales, hotel, property,
and income tax revenues. These sources of income have fallen sharply
since the disaster, and the ultimate collection of such loans and
investments may be adversely affected. Some loans and bonds also are
tied to specific facilities, such as hospitals, that may not resume
operations for an extended period.

The agencies and the state supervisory authorities will continue to
treat municipal bonds issued by Hurricane Katrina-affected entities as
investment quality debt securities, provided they were investment
quality before Hurricane Katrina and have not been downgraded
subsequently to below investment quality. For non-rated municipal
bonds[^3], management should monitor the institution's risk exposures in
order to assess whether those bonds continue to be the credit equivalent
of an investment grade security. Many public obligors/issuers have
insurance or have access to debt payment and other reserve funds that
may avert a downgrade in their quality rating. Examiners generally
should classify a bond according to existing guidance if its rating
falls below investment grade.

**Real Estate Values**. The disaster-affected areas and neighboring
evacuee locations have experienced significant fluctuations in real
estate values. For both existing real estate loans and new loans,
examiners should assess the institution's policies and practices with
regard to estimating values on collateral in real estate markets that
have experienced a significant, but possibly temporary, decrease or
increase in real estate values as a result of the hurricane. When
reviewing an institution's estimates of collateral values, examiners
should ascertain whether the values are based on assumptions that are
both prudent and realistic.

**Appraisal Waivers**. The agencies granted a three-year waiver from
their appraisal regulations to institutions affected by Hurricanes
Katrina (ending August 29, 2008) and Rita (ending September 24, 2008).
These appraisal waivers cover real estate-related transactions in
certain Alabama, Mississippi, and Texas counties and Louisiana parishes.
To qualify for the waiver, a financial institution needs to document
that:

\(1\) the property involved was directly affected by these disasters or
the transaction would facilitate recovery from the disaster;

\(2\) there is a binding commitment to fund the transaction that is made
within three years after the date these disasters were declared; and,

\(3\) the value of the real property supports the institution's decision
to enter into the transaction.

When an institution decides to rely on the appraisal waiver for a
particular real estate-related transaction, the institution should
provide sufficient documentation in the loan file to support its credit
decision and valuation of the collateral. Examiners should continue to
review transactions exempted from the appraisal regulations.

**Other Assets**. Examiners should determine whether the institution has
acquired other assets, such as temporary office facilities to replace
destroyed or unusable branches as well as temporary lodging facilities
for employees whose homes have become uninhabitable. Examiners should
assess the short- and long-term effect, including the asset's disposal
when no longer needed, that these assets may have on the institution's
operations and earnings.

**[Management Capability]{.underline}**

When rating management, existing supervisory policy stipulates that
examiners should make a distinction between problems caused by the
institution's management and those due to outside influences. Management
of an institution with problems related to external factors would
warrant a higher rating than management believed substantially
responsible for an institution's problems, provided that prudent
planning and policies are in place and that management is pursuing
realistic resolution of the institution's problems.

Many of the financial institutions affected by Hurricane Katrina are
being confronted with unprecedented issues. Examiners should evaluate
management based on the scope and thoroughness of the institution's
internal risk assessment and, if necessary, its strategic plan for
business restoration. In assessing management, examiners should consider
the institution\'s size, complexity, and risk profile. While management
of an affected institution should be rated upon its ability to properly
identify and manage these risks, examiners should give consideration to
the extraordinary circumstances surrounding many of the decisions made
immediately after the disaster as well as the actions subsequently taken
to resume operations.

In light of this disaster, examiners should assess the adequacy of an
institution's disaster recovery and business continuity plans and
consider whether these plans need to be modified. This review should
include an assessment of management's ability to:

-   Deal with extensive damage to facilities and equipment;

-   Operate with limited staffing;

-   Re-establish internal telecommunications capabilities;

-   Retrieve and restore data systems and electronic information;

-   Handle and reproduce contaminated loan files, legal documents, and
    collateral documentation;

-   Locate and contact third party service providers and key suppliers;

-   Replace contaminated cash and coins;

-   Handle contaminated safe deposit boxes and their contents; and,

-   Locate and contact other key business partners.

**[Earnings]{.underline}**

When evaluating the earnings component of an affected financial
institution, examiners should consider the duration or longevity of any
reductions to core earnings caused by the hurricane. Examiners should
also assess the quantity and quality of prior earnings as well as the
influence that Hurricane Katrina may have on the institution's future
earnings potential. This assessment also should consider the adequacy
and reasonableness of any revisions to the institution's budget and
strategic plan.

**[Liquidity]{.underline}**

Many financial institutions affected by Hurricane Katrina may experience
sharp fluctuations in liquidity resulting from the receipt of FEMA
payments, insurance proceeds, or other disaster-related funds, as well
as outflows of municipal deposits, out-of-area funds, or other large
deposits. In addition, collateral requirements for secured funding
sources (such as a line of credit from a Federal Home Loan Bank) may be
temporarily modified. Examiners should consider the nature and timing of
disaster-related inflows and outflows when reviewing the adequacy of an
institution's liquidity and be cognizant of how management is employing
any influx of liquid resources.

**[Sensitivity to Market Risk]{.underline}**

Many institutions affected by Hurricane Katrina may experience temporary
shifts in their interest rate risk profiles from changes in cash flows
associated with the short-term impact of the disaster. For example, the
amount or timing of cash flows may be altered by deterioration in loan
and bond portfolios or by the prepayment of mortgages via insurance
proceeds.

Examiners should recognize that management may require a reasonable
period of time to fully assess any changes to the institution's interest
rate risk profile, and to distinguish between permanent structural
changes versus short-term fluctuations during a transitional period.
Examiners should ensure that the institution's asset and liability
management models are being reviewed and updated for any unusual
fluctuations in deposit balances, adjustments to loan payments, changes
in interest rates, and other modifications to ensure the integrity,
accuracy, and reasonableness of the models.

[^1]: This includes: the Federal Deposit Insurance Corporation, Board of
    Governors of the Federal Reserve System, Office of the Comptroller
    of the Currency, Office of Thrift Supervision, and National Credit
    Union Administration (collectively, the agencies).

[^2]: Examiners of federally insured credit unions will use the guidance
    in NCUA Letter to Credit Unions 03-CU-04, CAMEL Rating System for
    assigning the CAMEL ratings.

[^3]: A federal credit union may purchase and hold a municipal security,
    as defined in Section 107(7)(K) of the Federal Credit Union Act,
    only if a nationally-recognized statistical rating organization has
    rated it in one of the four highest rating categories.