CITY OF LAGUNA NIGUEL
AGENDA ITEM
CITY COUNCIL
OCTOBER 17, 2006
TO:
Honorable Mayor and Council Members
FROM:
Cheryl Dyas, Director of Finance
SUBJECT:
Banking Policy and Monitoring Program
SUMMARY:
On February 4, 1997, the Laguna Niguel City Council adopted the Banking Policy
and Monitoring Program. This policy provides guidelines and procedures for
monitoring the financial condition and performance of the commercial banks with
which the City conducts business and to ensure that those banks regularly meet or
exceed Federal regulatory capital requirements. This policy was reviewed at the
September 13, 2006 Investment, Banking and Audit Committee meeting. The
Committee recommends that the policy be amended to include recommendations
made by the City’s independent auditors. It is recommended that the City Council
adopt the City’s Banking Policy and Monitoring Program, as revised.
BACKGROUND:
On February 4, 1997, the Laguna Niguel City Council adopted the Banking Policy and Monitoring
Program. This policy provides guidelines and procedures for monitoring the financial condition
and performance of the commercial banks with which the City conducts business and to ensure
that those banks regularly meet or exceed Federal regulatory capital requirements. The Banking
Policy and Monitoring Program has not been revised since adoption. The Investment, Banking
and Audit Committee directed staff to review bank monitoring regulations, consult with the City’s
attorney and independent auditors, Vavrinek, Trine, Day & Co., LLP and inquire with other local
agencies regarding their policies. Staff presented their report to the Investment, Banking and
Audit Committee on September 13, 2006. The Committee recommended that the Banking Policy
and Monitoring Program be amended to include the complete recommendations made by the
City’s independent auditors.
BANKING REGULATION AND OVERSIGHT:
Banks and savings institutions are regulated by: The Board of Governors of the Federal Reserve
System (FRB); Federal Deposit Insurance Corporation (FDIC); Office of the Comptroller of the
Currency (OCC); and Office of Thrift Supervision (OTS). The FRB and FDIC are independent
agencies of the federal government and the OCC and OTS are separate bureaus of the U.S.
Department of the Treasury. In addition, the California Department of Financial Institutions (DFI)
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regulates banks operating in California. Although each agency has its own jurisdiction and
authority, the collective regulatory and supervisory responsibilities of federal and state banking
agencies include:
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Establishing the rules and regulations that govern institutions’ operations.
Supervising institutions’ operations and activities.
Reviewing and approving organization, conversion, consolidation, merger, or other
changes in control of the institutions and their branches.
Appraising institutions’ financial condition, the safety and soundness of operations, the
quality of management, and compliance with laws and regulations.
In addition to supervision and regulation by the federal and state banking agencies, banks are
subject to a variety of laws, including: the Financial Institutions, Reform, Recovery, and
Enforcement Act of 1989 (FIRREA); Federal Deposit Insurance Corporation Improvement Act of
1991 (FDICIA); Financial Services Modernization Act; Bank Secrecy Act (BSA); USA-Patriot
Act of 2001; and publicly held holding companies are subject to the Securities Act of 1933, the
Securities Exchange Act of 1934 and specific sections of the Sarbanes-Oxley Act of 2002 (SOX),
including Section 404, Management Assessment of Internal Controls.
CURRENT MONITORING PROGRAM:
The monitoring program requires staff to obtain a copy of the quarterly Call Report (Consolidated
Reports of Condition and Income) and to inquire if the City’s primary bank is subject to any
Regulatory Agreement, Memorandum of Understanding, Cease and Desist Order or Prompt
Corrective Action Notice from any State or Federal regulatory agency to identify early-warning
signs or problematic trends. Staff is also required to obtain quarterly Pledged Collateral
Statements for the City’s primary banks to verify compliance with the State public agency deposit
collateral requirements. Finally, the monitoring program requires that the City subscribe to an
independent bank rating service to verify that capital ratios fall within the federal regulatory
requirements for an “adequately capitalized” institution.
The Pledged Collateral Statement is obtained directly from U.S. Bank on a quarterly basis. This
report is not obtained from UBOC since the City does not maintain deposits subject to
collateralization with UBOC. The Call Report for U.S. Bank is obtained through the banks
website and through the Federal Deposit Insurance Corporation for UBOC. These reports are filed
quarterly. The Bauer Financial Report is received quarterly directly from Bauer Financial Reports,
Inc. and presented to the Investment, Banking and Audit Committee at each quarterly meeting.
The Bauer Financial Report provides a summary of some of the data contained in other monitoring
reports. The financial data is compiled using the quarterly Call Reports and the Bauer report
includes whether there is any outstanding enforcement action against the institution by either a
State or Federal regulatory agency using reports released by the regulatory agency or the financial
institution, including the FRB, FDIC and the OCC. In 2003, each of these federal regulatory
agencies implemented regulations in connection with the SOX, including Section 404(a).
Therefore, any enforcement action by the FRB, FDIC or the OCC, against a financial institution
that pertains to the SOX, should be reflected in the quarterly Bauer Financial Reports.
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SARBANES-OXLEY ACT SECTION 404:
Public financial institutions with more than $500 million in assets are subject to the FDICIA and
Sarbanes-Oxley Act (SOX) Section 404. Section 404(a) mandates that registrants (1) take
responsibility for establishing and maintaining adequate internal control structure and procedures
and (2) assess their effectiveness at the end of each fiscal year. Management must create a
management’s Annual Internal Control Report as part of the Annual Report. The report needs to
contain the following:
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A statement of management’s responsibility for establishing and maintaining
adequate internal control over financial reporting for the company.
A statement identifying the framework used by management to evaluate the
effectiveness of this internal control.
Management’s assessment of the effectiveness of internal control as of the end of
the company’s most recent fiscal year.
Disclosure of any material weaknesses.
A statement that its auditor has issued an attestation report on management’s
assessment, which is to be included in the company’s annual report.
Section 404(b) requires the external auditor to attest to, and publicly report on management’s
assessments of the effectiveness of the company’s internal controls and procedures for financial
reporting.
RECOMMENDATION BY INDEPENDENT AUDITORS:
The City currently contracts with Vavrinek, Trine, Day & Co., LLP for independent audit services.
Their local office in Laguna Hills specializes in audits of financial institutions and provided three
recommendations for monitoring as follows:
1. Review the risk-based capital ratios reported in the quarterly Call Reports and compare to
minimum levels as defined by bank regulation. Look for trends (positive or negative) in
the reported capital ratios.
2. Review the company’s annual report for the Report of Independent Registered Public
Accounting Firm. Banks with assets over $500 million are subject to SOX Section 404 and
there will be a standard opinion and a SOX opinion. If there are any material weaknesses
noted, the auditors will have noted that in both opinions.
3. Review trends in loan delinquencies and charge offs. This data is contained in the
quarterly Call Reports.
The City already receives the quarterly Call Reports and can easily identify the capital ratios and
trends in loan delinquencies and charge offs. The City also subscribes to the Bauer Financial
Report, which summarizes the data for recommendation 1 and 3. The City does not currently
monitor tends in capital ratios, loan delinquencies and charge offs.
The City has not been reviewing annual reports for the opinions noted in recommendation 2. The
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annual reports are easily accessible and the City could easily incorporate the review of these
reports into the monitoring program. Attached to the agenda are copies of the following reports for
U.S Bank from their 2005 Annual Report for your review:
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Report of Independent Registered Public Accounting Firm on the Consolidated Financial
Statements
Report of Independent Registered Public Accounting Firm on Internal Control Over
Financial Reporting
Report of Management
POLICIES OF OTHER CITIES:
Staff submitted an inquiry to the finance community through the California Society of Municipal
Finance Officers (CSMFO) soliciting information on other bank monitoring policies in place by
other cities. Staff found no other city with a bank monitoring policy in place.
RECOMMENDATION:
It is recommended by the Investment, Banking and Audit Committee that the Banking Policy and
Monitoring Program be amended to include the complete recommendations made by the City’s
independent auditors and that the City Council adopt the City’s Banking Policy and Monitoring
Program, as revised.
SUBMITTED
BY:
Cheryl Dyas
Director of Finance
REVIEWED
By:
Tim Casey
City Manager
Attachments:
1. Banking Policy and Monitoring Program (with recommended revisions)
2. U.S. Bank Report of Independent Registered Public Accounting Firm on the Consolidated
Financial Statements
3. U.S. Bank Report of Independent Registered Public Accounting Firm on Internal Control
Over Financial Reporting
4. U.S. Bank Report of Management