Bank Analysis School eBook

APPENDIX C: PRE-PURCHASE ANALYSIS AND ONGOING MONITORING OF SECURITIES

Pre-Purchase Analysis The Dodd-Frank Act 1 required banks to move away from relying solely on external credit ratings (e.g., Moody’s, Standard & Poor’s) when assessing the creditworthiness of investments. Instead, banks must perform their own assessment to determine if a bond is “Investment Grade” prior to purchasing the bond. "Investment Grade" means that the bond has a low risk of default and is expected to make full and timely payments of both principal and interest. Certain securities, including common types of investments held by community banks such as U.S. Treasuries, U.S. Agencies, general obligation municipal bonds, and municipal revenue bonds (for well-capitalized banks), are exempt from this "Investment Grade" determination. However, municipal bonds still require an initial credit assessment and ongoing monitoring to ensure they meet safety and soundness standards. Banks and examiners can use resources like the Electronic Municipal Market Access (EMMA) website to research municipal bonds. The depth of due diligence should match the size and complexity of the institution and the risk characteristics of the investments. Ongoing Monitoring After purchasing a bond, banks must regularly assess the issuer’s ability to meet financial commitments. This means ensuring a low risk of default, with full and timely payments of principal and interest expected. Regulators expect banks to understand all risks in their investment portfolio, including credit risk, interest rate risk, liquidity risk, and operational risk.

1 The Dodd-Frank Act was passed in 2010 in response to the financial crisis, wh en some banks suffered significant losses on bonds that had been highly rated by external credit rating agencies.