Assessments, Large Bank Pricing

Federal RegisterFeb 25, 2011

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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 327

RIN 3064-AD66

Assessments, Large Bank Pricing

AGENCY:

Federal Deposit Insurance Corporation (FDIC).

ACTION:

Final rule.

SUMMARY:

The FDIC is amending its regulations to implement revisions to the Federal Deposit Insurance Act made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) by modifying the definition of an institution's deposit insurance assessment base; to change the assessment rate adjustments; to revise the deposit insurance assessment rate schedules in light of the new assessment base and altered adjustments; to implement Dodd-Frank's dividend provisions; to revise the large insured depository institution assessment system to better differentiate for risk and better take into account losses from large institution failures that the FDIC may incur; and to make technical and other changes to the FDIC's assessment rules.

DATES:

Effective Date:

April 1, 2011.

FOR FURTHER INFORMATION CONTACT:

Munsell St. Clair, Chief, Banking and Regulatory Policy Section, Division of Insurance and Research, (202) 898-8967, Rose Kushmeider, Senior Economist, Division of Insurance and Research, (202) 898-3861; Heather Etner, Financial Analyst, Division of Insurance and Research, (202) 898-6796; Lisa Ryu, Chief, Large Bank Pricing Section, Division of Insurance and Research, (202) 898-3538; Christine Bradley, Senior Policy Analyst, Banking and Regulatory Policy Section, Division of Insurance and Research, (202) 898-8951; Brenda Bruno, Senior Financial Analyst, Division of Insurance and Research, (630) 241-0359 x 8312; Robert L. Burns, Chief, Exam Support and Analysis, Division of Supervision and Consumer Protection (704) 333-3132 x 4215; Christopher Bellotto, Counsel, Legal Division, (202) 898-3801; and Sheikha Kapoor, Counsel, Legal Division, (202) 898-3960, 550 17th Street, NW., Washington, DC 20429.

SUPPLEMENTARY INFORMATION:

I. Dates

Except as specifically provided, the final rule will take effect for the quarter beginning April 1, 2011, and will be reflected in the June 30, 2011, fund balance and the invoices for assessments due September 30, 2011.

II. Background

A. Current Deposit Insurance Assessments

At present, for deposit insurance assessment purposes, an insured depository institution is placed into one of four risk categories each quarter, determined primarily by the institution's capital levels and supervisory evaluation. Current annual initial base assessment rates are set forth in Table 1

below.

Within Risk Category I, there are different assessment systems for large and small insured depository institutions, but the possible range of rates is the same for all insured depository institutions in Risk Category I.

Table 1—Current Initial Base Assessment Rates

Risk Category

I *

Minimum

Maximum

III

Annual Rates (in basis points)

* Rates for institutions that do not pay the minimum or maximum rate will vary between these rates.

Within Risk Category I, initial base assessment rates vary between 12 and 16 basis points. For all institutions in Risk Category I, rates depend upon weighted average CAMELS component ratings and certain financial ratios. For a large institution (generally, one with at least $10 billion in assets) that has debt issuer ratings, rates also depend upon these ratings.

Initial base assessment rates are subject to adjustment. An insured depository institution's total base assessment rate can vary from its initial base assessment rate as the result of an unsecured debt adjustment and a secured liability adjustment. The unsecured debt adjustment lowers an insured depository institution's initial base assessment rate using its ratio of long-term unsecured debt (and, for small insured depository institutions, certain amounts of Tier 1 capital) to domestic deposits.

The secured liability adjustment increases an insured depository institution's initial base assessment rate if the insured depository institution's ratio of secured liabilities to domestic deposits is greater than 25 percent.

In addition, insured depository institutions in Risk Categories II, III and IV are subject to an adjustment for large levels of brokered deposits (the brokered deposit adjustment).

Unsecured debt excludes debt guaranteed by the FDIC under its Temporary Liquidity Guarantee Program.

The initial base assessment rate cannot increase more than 50 percent as a result of the secured liability adjustment.

12 CFR 327.9(d)(7).

After applying all possible adjustments, the current minimum and maximum total annual base assessment rates for each risk category are set out in Table 2 below.

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The FDIC may uniformly adjust the total base rate assessment schedule up or down by up to 3 basis points without further rulemaking.

Specifically:

The Board may increase or decrease the total base assessment rate schedule up to a maximum increase of 3 basis points or a fraction thereof or a maximum decrease of 3 basis points or a fraction thereof (after aggregating increases and decreases), as the Board deems necessary. Any such adjustment shall apply uniformly to each rate in the total base assessment rate schedule. In no case may such Board rate adjustments result in a total base assessment rate that is mathematically less than zero or in a total base assessment rate schedule that, at any time, is more than 3 basis points above or below the total base assessment schedule for the Deposit Insurance Fund, nor may any one such Board adjustment constitute an increase or decrease of more than 3 basis points.

12 CFR 327.10(c). On October 19, 2010, the FDIC adopted a new Restoration Plan that foregoes a uniform 3 basis point increase in assessment rates scheduled to go into effect on January 1, 2011. Thus, the assessment rates in this final rule reflect that change.

An institution's assessment is determined by multiplying its assessment rate by its assessment base. Its assessment base is, and has historically been, domestic deposits, with some adjustments. (These adjustments have changed over the years.)

B. The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), enacted in July 2010, revised the statutory authorities governing the FDIC's management of the Deposit Insurance Fund (the DIF or the fund). Dodd-Frank granted the FDIC the ability to achieve goals for fund management that it has sought to achieve for decades but lacked the tools to accomplish: maintaining a positive fund balance even during a banking crisis and maintaining moderate, steady assessment rates throughout economic and credit cycles.

Among other things, Dodd-Frank: (1) Raised the minimum designated reserve ratio (DRR), which the FDIC must set each year, to 1.35 percent (from the former minimum of 1.15 percent) and removed the upper limit on the DRR (which was formerly capped at 1.5 percent) and therefore on the size of the fund;

(2) required that the fund reserve ratio reach 1.35 percent by September 30, 2020 (rather than 1.15 percent by the end of 2016, as formerly required);

(3) required that, in setting assessments, the FDIC “offset the effect of [requiring that the reserve ratio reach 1.35 percent by September 30, 2020 rather than 1.15 percent by the end of 2016] on insured depository institutions with total consolidated assets of less than $10,000,000,000”;

(4) eliminated the requirement that the FDIC provide dividends from the fund when the reserve ratio is between 1.35 percent and 1.5 percent;

and (5) continued the FDIC's authority to declare dividends when the reserve ratio at the end of a calendar year is at least 1.5 percent, but granted the FDIC sole discretion in determining whether to suspend or limit

the declaration or payment of dividends.

Public Law 111-203, § 334(a), 124 Stat. 1376, 1539 (to be codified at 12 U.S.C. 1817(b)(3)(B)).

Public Law 111-203, § 334(d), 124 Stat. 1376, 1539 (to be codified at 12 U.S.C. 1817(nt)).

Public Law 111-203, § 334(e), 124 Stat. 1376, 1539 (to be codified at 12 U.S.C. 1817(nt)).

Public Law 111-203, § 332(d), 124 Stat. 1376, 1539 (to be codified at 12 U.S.C. 1817(e)).

Public Law 111-203, § 332, 124 Stat. 1376, 1539 (to be codified at 12 U.S.C. 1817(e)(2)(B)).

Dodd-Frank also required that the FDIC amend its regulations to redefine the assessment base used for calculating deposit insurance assessments. Under Dodd-Frank, the assessment base must, with some possible exceptions, equal average consolidated total assets minus average tangible equity.

Public Law 111-203, § 331(b), 124 Stat. 1376, 1538 (to be codified at 12 U.S.C. 1817(nt)).

C. Notice of Proposed Rulemaking on Assessment Dividends, Assessment Rates and the Designated Reserve Ratio

Given the greater discretion to manage the DIF granted by Dodd-Frank, the FDIC developed a comprehensive, long-range management plan for the DIF. In October 2010, the FDIC adopted a Notice of Proposed Rulemaking on Assessment Dividends, Assessment Rates and the Designated Reserve Ratio (the October NPR) setting out the plan, which is designed to: (1) Reduce the pro-cyclicality in the existing risk-based assessment system by allowing moderate, steady assessment rates throughout economic and credit cycles; and (2) maintain a positive fund balance even during a banking crisis by setting an appropriate target fund size and a strategy for assessment rates and dividends.

75 FR 66262 (Oct. 27, 2010). Pursuant to the comprehensive plan, the FDIC also adopted a new Restoration Plan to ensure that the DIF reserve ratio reaches 1.35 percent by September 30, 2020, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. 75 FR 66293 (Oct. 27, 2010).

In developing the comprehensive plan, the FDIC analyzed historical fund losses and used simulated income data from 1950 to the present to determine how high the reserve ratio would have to have been before the onset of the two banking crises that occurred during this period to maintain a positive fund balance and stable assessment rates. Based on this analysis and the statutory factors that the FDIC must consider when setting the DRR, the FDIC proposed setting the DRR at 2 percent. The FDIC also proposed that a moderate assessment rate schedule, based on the long-term average rate needed to maintain a positive fund balance, take effect when the fund reserve ratio exceeds 1.15 percent.

This schedule would be lower than the current schedule. Finally, the FDIC proposed suspending dividends when the fund reserve ratio exceeds 1.5 percent.

In lieu of dividends, the FDIC proposed to adopt progressively lower assessment rate schedules when the reserve ratio exceeds 2 percent and 2.5 percent.

Under section 7 of the Federal Deposit Insurance Act, the FDIC has authority to set assessments in such amounts as it determines to be necessary or appropriate. In setting assessments, the FDIC must consider certain enumerated factors, including the operating expenses of the DIF, the estimated case resolution expenses and income of the DIF, and the projected effects of assessments on the capital and earnings of insured depository institutions.

12 U.S.C. 1817(e)(2), as amended by § 332 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

D. Final Rule Setting the Designated Reserve Ratio

In December 2010, the FDIC adopted a final rule setting the DRR at 2 percent (the DRR final rule), but deferred action on the other subjects of the October NPR (dividends and assessment rates) until this final rule. The FDIC's decision to set the DRR at 2 percent was based partly on additional historical analysis, which is described below.

E. Notice of Proposed Rulemaking on the Assessment Base, Assessment Rate Adjustments and Assessment Rates

In a notice of proposed rulemaking adopted by the FDIC Board on November 9, 2010 (the Assessment Base NPR), the FDIC proposed to amend the definition of an institution's deposit insurance assessment base consistent with the requirements of Dodd-Frank, modify the unsecured debt adjustment and the brokered deposit adjustment in light of the changes to the assessment base, add an adjustment for long-term debt held by an insured depository institution where the debt is issued by another insured depository institution, and eliminate the secured liability adjustment. The Assessment Base NPR also proposed revising the current deposit insurance assessment rate schedule in light of the larger assessment base required by Dodd-Frank and the revised adjustments. The FDIC's goal was to determine a rate schedule that would have generated approximately the same revenue as that generated under the current rate schedule in the second quarter of 2010 under the current assessment base. The Assessment Base NPR also proposed revisions to the rate schedules proposed in the October NPR, in light of the changes to the assessment base and the adjustments. These revised rate schedules were also intended to generate the same revenue as the corresponding rates in the October NPR.

F. Notices of Proposed Rulemaking on the Assessment System Applicable to Large Insured Depository Institutions

In April 2010, the FDIC adopted a notice of proposed rulemaking with request for comment to revise the risk-based assessment system for all large insured depository institutions to better capture risk at the time large institutions assume the risk, to better differentiate among institutions for risk and take a more forward-looking view of risk, to better take into account the losses that the FDIC may incur if such an insured depository institution fails, and to make technical and other changes to the rules governing the risk-based assessment system (the April NPR).

The preamble to the Large Bank NPR incorrectly summarized the definition of a “large institution”; however, the definition was correct in the proposed regulation. The final rule, like the proposed regulation, defines a large institution as an insured depository institution: (1) That had assets of $10 billion or more as of December 31, 2006 (unless, by reporting assets of less than $10 billion for four consecutive quarters since then, it has become a small institution); or (2) that had assets of less than $10 billion as of December 31, 2006, but has since had $10 billion or more in total assets for at least four consecutive quarters, whether or not the institution is new. In almost all cases, an insured depository institution that has had $10 billion or more in total assets for four consecutive quarters will have a CAMELS rating; however, in the rare event that such an institution has not yet received a CAMELS rating, it will be given a weighted average CAMELS rating of 2 for assessment purposes until actual CAMELS ratings are assigned. An insured branch of a foreign bank is excluded from the definition of a large institution.

Largely as a result of changes made by Dodd-Frank and the Assessment Base NPR, the FDIC reissued its proposal applicable to large insured depository institutions for comment on November 9, 2010 (the Large Bank NPR), taking into account comments received on the April NPR.

In the Large Bank NPR, the FDIC proposed eliminating risk categories and the use of long-term debt issuer ratings for large institutions, using a scorecard method to calculate assessment rates for large and highly complex institutions, and retaining the ability to make a limited adjustment after considering information not included in the scorecard. In the Large Bank NPR, the FDIC stated that it would not make adjustments until the guidelines for making such adjustments are published for comment and subsequently adopted by the FDIC Board.

G. Update of Historical Analysis of Loss, Income and Reserve Ratios

The analysis set out in the October NPR to determine how high the reserve ratio would have had to have been to have maintained both a positive fund

balance and stable assessment rates from 1950 through 2010 assumed assessment rates based upon an assessment base related to domestic deposits rather than the assessment base required by Dodd-Frank (average consolidated total assets minus average tangible equity).

The FDIC undertook additional analysis (described in the DRR final rule and repeated here) to determine how the results of the original analysis would change had the new assessment base been in place from 1950 to 2010. Due to the larger assessment base resulting from Dodd-Frank, the constant nominal assessment rate required to maintain a positive fund balance from 1950 to 2010 would have been 5.29 basis points (compared with 8.47 basis points using a domestic-deposit-related assessment base). (See Chart 1.)

The historical analysis contained in the October NPR is incorporated herein by reference.

The assessment base resulting from Dodd-Frank, had it been applied to prior years, would have been larger than the domestic-deposit-related assessment base, and the rates of growth of the two assessment bases would have differed both over time and from each other. At any given time, therefore, applying a constant nominal rate of 8.47 basis points to the domestic-deposit-related assessment base would not necessarily have yielded exactly the same revenue as applying 5.29 basis points to the Dodd-Frank assessment base.

Despite these differences, the new analysis applying a 5.29 basis point assessment rate to the Dodd-Frank assessment base resulted in peak reserve ratios prior to the two crises similar to those seen when applying an 8.47 basis point assessment rate to a domestic- deposit-related assessment base.

(See Chart 2.) Both analyses show that the fund reserve ratio would have needed to be approximately 2 percent or more before the onset of the 1980s and 2008 crises to maintain both a positive fund balance and stable assessment rates, assuming, in lieu of dividends, that the long-term industry average nominal assessment rate would have been reduced by 25 percent when the reserve ratio reached 2 percent, and by 50 percent when the reserve ratio reached 2.5 percent.

Eliminating dividends and reducing rates would have successfully limited rate volatility, whichever assessment base was used.

Using the domestic-deposit-related assessment base, reserve ratios would have peaked at 2.31 percent and 2.01 percent before the two crises. (

See

Chart G in the October NPR.) Using the Dodd-Frank assessment base, reserve ratios would have peaked at 2.27 percent and 1.95 percent before the two crises.

Dodd-Frank provides that the assessment base be changed to average consolidated total assets minus average tangible equity.

See

Public Law 111-203, § 331(b). For this simulation, from 1990 to 2010, the assessment base equals year-end total industry assets minus Tier 1 capital. For earlier years (before the Tier 1 capital measure existed) it equals year-end total industry assets minus total equity. Other than as noted, the methodology used in the additional analysis was the same as that used in the October NPR.

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H. Scope of the Final Rule

This final rule encompasses all of the proposals contained in the October NPR, the Assessment Base NPR and the Large Bank NPR, except the proposal setting the DRR, which was covered in the DRR final rule.

I. Structure of the Next Sections of the Preamble

The next sections of this preamble are structured as follows:

• Section II briefly discusses the number of comments received;

• Section III discusses the portion of the final rule related to changes to the assessment base and adjustments to assessment rates proposed in the Assessment Base NPR;

• Subsection IV discusses the portion of the final rule related to dividends and assessment rates proposed in the Assessment Base NPR and the October NPR; and

• Subsection V discusses the portion of the final rule related to the assessment system applicable to large insured depository institutions proposed in the Large Bank NPR.

III. Comments Received

The FDIC sought comments on every aspect of the proposed rules. The FDIC received a total of 55 written comments on the October NPR, the Assessment Base NPR and the Large Bank NPR, although some were duplicative. Comments are discussed in the relevant sections below.

IV. The Final Rule: The Assessment Base and Adjustments to Assessment Rates

A. Assessment Base

As stated above, Dodd-Frank requires that the FDIC amend its regulations to redefine the assessment base used for calculating deposit insurance assessments. Specifically, Dodd-Frank directs the FDIC:

To define the term “assessment base” with respect to an insured depository institution * * * as an amount equal to—

(1) the average consolidated total assets of the insured depository institution during the assessment period; minus

(2) the sum of—

(A) the average tangible equity of the insured depository institution during the assessment period, and

(B) in the case of an insured depository institution that is a custodial bank (as defined by the Corporation, based on factors including the percentage of total revenues generated by custodial businesses and the level of assets under custody) or a banker's bank (as that term is used in * * * (12 U.S.C. 24)), an amount that the Corporation determines is necessary to establish assessments consistent with the definition under section 7(b)(1) of the Federal Deposit Insurance Act (12 U.S.C. 1817(b)(1)) for a custodial bank or a banker's bank.

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, § 331(b), 124 Stat. 1376, 1538 (codified at 12 U.S.C. 1817(nt)).

To implement this requirement, the FDIC, in this final rule, defines “average consolidated total assets,” “average tangible equity,” and “tangible equity,” and sets forth the basis for reporting consolidated total assets and tangible equity.

To establish assessments consistent with the definition of the “risk-based assessment system” under the Federal Deposit Insurance Act (the FDI Act), Dodd-Frank also requires the FDIC to determine whether and to what extent adjustments to the assessment base are appropriate for banker's banks and custodial banks. The final rule outlines these adjustments and provides a definition of “custodial bank.”

1. Average Consolidated Total Assets

The final rule, like the proposed rule, requires that all insured depository institutions report their average consolidated total assets using the accounting methodology established for reporting total assets as applied to Line 9 of Schedule RC-K of the Consolidated

Reports of Condition and Income (Call Report) (that is, the methodology established by Schedule RC-K regarding when to use amortized cost, historical cost, or fair value, and how to treat deferred tax effects). The final rule differs from the proposed rule, however, by allowing certain institutions to report average consolidated total assets on a weekly, rather than daily, basis. The final rule requires institutions with total assets greater than or equal to $1 billion and all institutions that are newly insured after March 31, 2011, to average their balances as of the close of business for each day during the calendar quarter. Institutions with less than $1 billion in quarter-end consolidated total assets on their March 31, 2011 Call Report or Thrift Financial Report (TFR) may report an average of the balances as of the close of business on each Wednesday during the calendar quarter or may, at any time, permanently opt to calculate average consolidated total assets on a daily basis. Once an institution that reports average consolidated total assets using a weekly average reports average consolidated total assets of $1 billion or more for two consecutive quarters, it shall permanently report average consolidated total assets using daily averaging starting in the next quarter.

While some commenters supported the requirement that all institutions average their assets using daily balances, one trade group requested that all institutions be allowed to choose between daily and weekly averages. In the FDIC's view, institutions with at least $1 billion in assets should be able to compute averages using daily balances. (Many already do so.) However, to avoid imposing transition costs on smaller institutions (those with less than $1 billion in assets), the final rule allows these institutions to calculate an average of Wednesday asset balances, unless they opt permanently to report daily averages.

Newly insured institutions incur no transition costs (since they have no existing systems) and, thus, must average using daily balances.

Institutions currently may report a daily average or an average of Wednesday assets on Call Report Schedule RC-K.

Under the final rule, an institution's daily average consolidated total assets equal the sum of the gross amount of consolidated total assets for each calendar day during the quarter divided by the number of calendar days in the quarter. An institution's weekly average consolidated total assets equal the sum of the gross amount of consolidated total assets for each Wednesday during the quarter divided by the number of Wednesdays in the quarter. For days that an office of the reporting institution (or any of its subsidiaries or branches) is closed (

e.g.,

Saturdays, Sundays, or holidays), the amounts outstanding from the previous business day will be used. An office is considered closed if there are no transactions posted to the general ledger as of that date.

In the case of a merger or consolidation, the calculation of the average assets of the surviving or resulting institution must include the assets of all the merged or consolidated institutions for the days in the quarter prior to the merger or consolidation, regardless of the method used to account for the merger or consolidation.

In the case of an insured depository institution that is the parent company of other insured depository institutions, the final rule, like the proposed rule, requires that the parent insured depository institution report its daily or weekly, average consolidated total assets without consolidating its insured depository institution subsidiaries into the calculations.

Because of intercompany transactions, a simple subtraction of the subsidiary insured depository institutions' assets and equity from the parent insured depository institution's assets and equity will not usually result in an accurate statement of the parent insured depository institution's assets and equity. This treatment is consistent with current assessment base practice and ensures that all parent insured depository institutions are assessed only for their own assessment base and not that of their subsidiary insured depository institutions, which will be assessed separately.

The amount of the institution's average consolidated total assets without consolidating its insured depository institution subsidiaries determines whether the institution may report a weekly average.

For all other subsidiaries, assets, including those eliminated in consolidation, will also be calculated using a daily or weekly averaging method, corresponding to the daily or weekly averaging requirement of the parent institution. The final rule clarifies that Call Report instructions in effect for the quarter being reported will govern calculation of the average amount of subsidiaries' assets, including those eliminated in consolidation. Current Call Report instructions state that the calculation should be for the same quarter as the assets reported by the parent institution to the extent practicable, but in no case differ by more than one quarter. However, under the final rule, once an institution reports the average amount of subsidiaries' assets, including those eliminated in consolidation, using concurrent data, the institution must do so for all subsequent quarters.

Finally, for insured branches of foreign banks, as in the proposed rule, average consolidated total assets are defined as total assets of the branch (including net due from related depository institutions) in accordance with the schedule of assets and liabilities in the Report of Assets and Liabilities of U.S. Branches and Agencies of Foreign Banks, but using the accounting methodology for reporting total assets established in Schedule RC-K of the Call Report, and calculated using the appropriate daily or weekly averaging method as described above.

In choosing to require all but smaller insured institutions to report “average consolidated total assets” using daily averaging, the FDIC sought to develop a measure that would be a truer reflection of the assessment base during the entire quarter.

By using a methodology already established in the Call Report, the FDIC believes the reporting requirements for the new assessment base will be minimized. Finally, by using the Call Report methodology for reporting average consolidated total assets, all institutions will report average consolidated total assets consistently.

In this way, the daily averaging requirement is consistent with the actions taken by the FDIC in 2006 when it determined that using quarter-end deposit data as a proxy for balances over an entire quarter did not accurately reflect an insured depository institution's typical deposit level. As a result, the FDIC required certain institutions to report a daily average deposit assessment base.

2. Comments

Commenters favored the use of an existing measure for average consolidated total assets because it will minimize the burden of the rulemaking on institutions.

A few commenters suggested that the FDIC deduct goodwill and intangibles from average consolidated total assets. According to one commenter, a loss in value or write-off of goodwill (unlike other assets) poses no additional risk of loss to the FDIC in the event of a failure of an insured institution; goodwill is not an asset for which the FDIC as receiver could have any expectation of recovery. Moreover, failing to deduct goodwill could lead to anomalous results—two institutions that merge and create goodwill would have a combined assessment base greater than the sum of the two assessment bases separately. The FDIC is not persuaded by these

arguments. Dodd-Frank specifically states that the assessment base should be “average consolidated total assets minus average tangible equity.” Subtracting intangibles from assets as well as equity negates the purposeful use of the word “tangible” in the definition of the new assessment base and, in the FDIC's view, is counter to the intent of Congress.

A number of commenters stated that the FDIC should exclude transactions between affiliated banks from the assessment base to avoid double counting the assets associated with these transactions in the assessment base. Commenters acknowledge that the FDIC currently assesses deposits received from affiliated banks, but believe that, with the requirement to change the assessment base, the FDIC should now exclude transactions between affiliated banks. The FDIC has generally assessed risk at the insured institution level and is not persuaded to change this practice.

3. Tangible Equity

The final rule, like the proposed rule, uses Tier 1 capital as the definition of tangible equity. Although this measure does not eliminate all intangibles, it eliminates many of them, and it requires no additional reporting by insured depository institutions. The FDIC may reconsider the definition of tangible equity once new Basel capital definitions have been implemented.

The final rule, like the proposed rule, defines the averaging period for tangible equity to be monthly; however, institutions that report less than $1 billion in quarter-end consolidated total assets on their March 31, 2011 Call Report or TFR may report average tangible equity using an end-of-quarter balance or may, at any time, opt to report average tangible equity using a monthly average balance permanently. Once an institution that reports average tangible equity using an end-of-quarter balance reports average consolidated total assets of $1 billion or more for two consecutive quarters, it shall permanently report average tangible equity using monthly averaging starting in the next quarter. Newly insured institutions must report monthly averages. Monthly averaging means the average of the three month-end balances within the quarter. For the surviving institution in a merger or consolidation, Tier 1 capital must be calculated as if the merger occurred on the first day of the quarter in which the merger or consolidation actually occurred.

Under the final rule, as in the proposed rule, an insured depository institution with one or more consolidated insured depository institution subsidiaries must report average tangible equity (or end-of-quarter tangible equity, as appropriate) without consolidating its insured depository institution subsidiaries into the calculations. This requirement conforms to the method for reporting consolidated total assets above and ensures that all parent insured depository institutions will be assessed only on their own assessment base and not that of their subsidiary insured depository institutions.

As in the proposed rule, an insured depository institution that reports average tangible equity using a monthly averaging method and that has subsidiaries that are not insured depository institutions must use monthly average data for the subsidiaries. The monthly average data for these subsidiaries, however, may be calculated for the current quarter or for the prior quarter consistent with the method used to report average consolidated total assets.

As in the proposed rule, for insured branches of foreign banks, tangible equity is defined as eligible assets (determined in accordance with Section 347.210 of the FDIC's regulations) less the book value of liabilities (exclusive of liabilities due to the foreign bank's head office, other branches, agencies, offices, or wholly owned subsidiaries). This value is to be calculated on a monthly average or end-of-quarter basis, according to the branch's size.

The FDIC does not foresee a need for any institution to report daily average balances for tangible equity, since the components of tangible equity appear to be subject to less fluctuation than are consolidated total assets. Thus, the definition of average tangible equity in the final rule achieves a true reflection of tangible equity over the entire quarter by requiring monthly averaging of capital for institutions that account for the majority of industry assets and end-of-quarter balances for all other institutions.

Defining tangible equity as Tier 1 capital provides a clearly understood capital buffer for the DIF in the event of the institution's failure, while avoiding an increase in regulatory burden that a new definition of capital could cause.

This methodology should not increase regulatory burden, since institutions with assets of $1 billion or more generally compute their regulatory capital ratios no less frequently than monthly. To minimize regulatory burden for small institutions, the proposal allows these institutions to report an end-of-quarter balance.

The changes needed to implement the new assessment base will require the FDIC to collect some information from insured depository institutions that is not currently collected on the Call Report or TFR. However, the burden of requiring new data will be partly offset by allowing some assessment data that are currently collected to be deleted from the Call Report or TFR.

4. Comments

A number of commenters explicitly supported the use of Tier 1 capital for average tangible equity because this would minimize the burden of the rulemaking on institutions. One trade group asked that institutions with less than $10 billion in assets (as opposed to less than $1 billion) be allowed to report end-of-quarter balances rather than an average of month-end balances on the grounds that these institutions experience few fluctuations in capital and allowing them to report end-of-quarter balances would reduce burden. The FDIC believes that many institutions of this size already determine their capital more frequently than once a quarter, so that the requested change is not needed.

5. Banker's Bank Adjustment

Like the proposed rule, the final rule will require a banker's bank to certify on its Call Report or TFR that it meets the definition of “banker's bank” as that term is used in 12 U.S.C. 24. The self-certification will be subject to verification by the FDIC. The final rule, however, clarifies that banker's banks that have funds from government capital infusion programs (such as TARP and the Small Business Lending Fund), stock owned by the FDIC resulting from bank failures or stock that is issued as part of an equity compensation program will not be excluded from the definition of banker's bank solely for these reasons.

As in the proposed rule, for an institution that meets the definition (with the exception noted below), the FDIC will exclude from its assessment base the average amount of reserve balances “passed through” to the Federal Reserve, the average amount of reserve balances held at the Federal Reserve for the institution's own account, and the average amount of the institution's federal funds sold. (In each case, the average is to be calculated daily or weekly depending on how the

institution calculates its average consolidated total assets.) The collective amount of this exclusion, however, cannot exceed the sum of the bank's average amount of total deposits of commercial banks and other depository institutions in the United States and the average amount of its federal funds purchased. (Again, in each case, the average is to be calculated daily or weekly depending on how the institution calculates its average consolidated total assets.) Thus, for example, if a banker's bank has a total average balance of $300 million of federal funds sold plus reserve balances (including pass-through reserve balances), and it has a total average balance of $200 million of deposits from commercial banks and other depository institutions and federal funds purchased, it can deduct $200 million from its assessment base. Federal funds purchased and sold on an agency basis will not be included in these calculations as they are not reported on the balance sheet of a banker's bank.

Some commenters had asked that the FDIC use the definition of banker's bank contained in 12 U.S.C. 461(b)(9) (which is repeated verbatim in the implementing regulation, 12 CFR 204.121) in lieu of 12 U.S.C. 24. The definition of banker's bank in the final rule adheres to the requirement in Dodd-Frank that the potential assessment base reduction apply to banker's banks “as that term is used in * * * 12 U.S.C. 24.” However, in the FDIC's view, the clarification in the preamble should meet the concerns of these commenters.

As in the proposed rule, the assessment base adjustment applicable to a banker's bank is only available to an institution that conducts less than 50 percent of its business with affiliates (as defined in section 2(k) of the Bank Holding Company Act (12 U.S.C. 1841(k)) and section 2 of the Home Owners' Loan Act (12 U.S.C. 1462)). Providing a benefit to a banker's bank that primarily serves affiliated companies would undermine the intent of the benefit by providing a way for banking companies to reduce deposit insurance assessments simply by establishing a subsidiary for that purpose.

Currently, the corresponding deposit liabilities that result in “pass-through” reserve balances are excluded from the assessment base. The final rule, like the proposal, retains this exception for banker's banks.

A typical banker's bank provides liquidity and other services to its member banks that may result in higher than average amounts of federal funds purchased and deposits from other insured depository institutions and financial institutions on a banker's bank's balance sheet. To offset its relatively high levels of these short-term liabilities, a banker's bank often holds a relatively high amount of federal funds sold and reserve balances for its own account. The final rule, therefore, like the proposed rule, adjusts the assessment base of a banker's bank to reflect its greater need to maintain liquidity to service its member banks.

6. Comments

Several commenters addressed the issue of providing an adjustment to banker's banks. The most common comment among the respondents was a concern that the adjustment for federal funds sold may have unintended consequences for the federal funds market. The commenters argued that federal funds are generally sold on thin margins and that, if non-banker's banks pay even a few basis points of FDIC assessments on federal funds sold when banker's banks do not, the non-banker's banks will not be able to compete in this market. The comments further state that banker's banks alone cannot provide sufficient funding to maintain the federal funds market at its current size and that by providing a deduction from assets solely for banker's banks, the proposal could potentially lead to a considerable contraction of the federal funds market with detrimental implications for bank liquidity. The comments suggested that the FDIC provide a deduction for federal funds sold for all insured depository institutions or, alternatively, assign a zero premium weight to federal funds sold for all institutions.

The FDIC recognizes that, by allowing banker's banks to subtract federal funds sold from their assessment base, the cost of providing those funds for banker's banks will be reduced relative to other banks that are not afforded such a deduction. However, there is no uniform assessment rate for all banks, and since assessment rates will now be applied to an assessment base of average consolidated total assets, the cost—due to the assessment rate—of providing federal funds will potentially differ for every institution. While banker's banks may gain an incentive to sell more federal funds than they currently have and may gain a larger profit from doing so than would some other banks, it is not clear, a priori, what their total cost of funding will be, given that the assessment rate is only one factor in the cost of providing federal funds. Further, it is not likely that non-banker's banks will completely withdraw from providing federal funds as long as the market finds such funding more attractive than the alternatives.

Three commenters called for all excess reserve balances maintained by banker's banks to be included in the banker's bank deduction; some also called for the FDIC to allow a deduction for balances due from other banks. The FDIC clarifies that the proposed deduction for reserve balances held at the Federal Reserve would include all balances due from the Federal Reserve as reported on Schedule RC-A, line 4 of the Call Report. Balances due from other banks include assets that are relatively less liquid, such as time deposits. The FDIC does not believe it is appropriate to include these balances in the banker's bank deduction.

One banker's bank argues that banker's banks are subject to “double taxation” because every dollar on deposit has been received from another bank that is also being assessed a deposit insurance premium on its deposits. In the FDIC's view, there is no double assessment, since each institution is receiving the benefit of deposit insurance and is paying for it. This view is consistent with the treatment of interbank deposits under the current deposit insurance assessment system, which includes these deposits in an institution's assessment base.

Another bank argues that there is no reasonable basis to deny the banker's bank assessment base deduction to banker's banks that conduct business primarily with affiliated insured depository institutions. This bank also argues that the interaffiliate transactions that such a banker's bank engages in result in counting the same assets twice, once at the banker's bank and again at its affiliate, although overall risk is not increased because of cross-guarantees. The FDIC believes that, while such a bank may meet the technical definition of a banker's bank, it does not serve the same function as a true banker's bank. Moreover, as discussed above, the FDIC has generally assessed risk at the insured depository institution level (for example, it currently assesses separately on interaffiliate deposits) and is not persuaded to change this practice. The FDIC cannot invariably collect on cross-guarantees from affiliated institutions, since the guarantor may also be insolvent or could be made insolvent by fulfilling the guarantee.

7. Custodial Bank Definition

The final rule identifies custodial banks as insured depository institutions with previous calendar year-end trust assets (that is, fiduciary and custody and safekeeping assets, as reported on Schedule RC-T of the Call Report) of at least $50 billion or those insured depository institutions that derived more than 50 percent of their revenue (interest income plus non-interest income) from trust activity over the previous calendar year. Using this definition, the FDIC estimates that 62 insured depository institutions would have qualified as custodial banks for deposit insurance purposes using data as of December 31, 2009.

This definition differs from the definition in the Assessment Base NPR, in that it expands the definition to include fiduciary assets and revenue as well as custody and safekeeping assets and revenue. Commenters have convinced the FDIC that fiduciary accounts have a custodial component, which, in many cases, is the primary reason for the account. This change will mean that more institutions will qualify under the definition.

8. Custodial Bank Adjustment

The final rule states that the assessment base adjustment for custodial banks should be the daily or weekly average—in accordance with the way the bank reports its average consolidated total assets—of a certain amount of low-risk assets—designated as assets with a Basel risk weighting of 0 percent, regardless of maturity,

plus 50 percent of those assets with a Basel risk weighting of 20 percent, again regardless of maturity

—subject to the limitation that the daily or weekly average value of these assets cannot exceed the daily or weekly average value of those deposits classified as transaction accounts (as reported on Schedule RC-E of the Call Report) and identified by the institution as being directly linked to a fiduciary or custodial and safekeeping account.

Specifically, all asset types described in the instructions to lines 34, 35, 36, and 37 of Schedule RC-R of the Call Report as of December 31, 2010 with a Basel risk weight of 0 percent, regardless of maturity. These types of assets are also currently reported on corresponding line items in the TFR. These same asset types will be used regardless of changes to the Call Report or TFR.

Specifically, 50 percent of those asset types described in the instructions to lines 34, 35, 36, and 37 of Schedule RC-R of the Call Report (or corresponding items in the TFR) with a Basel risk weighting of 20 percent. These types of assets are also currently reported on corresponding line items in the TFR. These same asset types will be used regardless of changes to the Call Report or TFR.

The final rule differs from the Assessment Base NPR in that it allows the deduction of all 0 percent risk-weighed assets and 50 percent of 20 percent risk-weighted assets without regard to specific maturity (although the purpose of the 50 percent reduction in the 20 percent risk weighted assets is to apply a sufficient haircut to those assets to account for the risk posed by longer-term maturities). Again based upon comments, the FDIC has concluded that transaction accounts associated with fiduciary and custody and safekeeping assets generally display the characteristics of core deposits, justifying a relaxation of the maturity length requirement in the proposal.

All of the commenters on the issue disagreed with limiting the assets eligible for the deduction to those with a stated maturity of 30 days or less. Most of the comments noted that assets with 20 percent or lower Basel risk weightings are high-quality and liquid, regardless of maturity, and one commenter stated that any breakdown of these assets by maturity would require additional reporting as such information is not currently collected. A number of the comments noted that the maturity of an asset is not the only indicator of the asset's liquidity. Comments from the banks generally argued that custodial deposits are relatively stable—akin to core deposits, rather than wholesale deposits—and, as such, it would be imprudent for them to manage their portfolios by matching these deposits strictly to assets with a maturity of 30 days or less.

The final rule also differs from the proposed rule in two other ways. First, it allows a deduction up to the daily or weekly average value of those deposits classified as transaction accounts that are identified by the institution as being linked to a fiduciary or custodial and safekeeping account. The final rule includes fiduciary accounts, rather than just custodial and safekeeping accounts, for the reasons stated above. Second, the final rule limits the deduction to transaction accounts, rather than all deposit accounts, because deposits generated in the course of providing custodial services (regardless of whether there is a fiduciary aspect to the account) are used for payments and clearing purposes, as opposed to deposits held in non-transaction accounts, which may be part of a wealth management strategy.

B. Assessment Rate Adjustments

In February 2009, the FDIC adopted a final rule incorporating three adjustments into the risk-based pricing system.

These adjustments—the unsecured debt adjustment, the secured liability adjustment, and the brokered deposit adjustment—were added to better account for risk among insured depository institutions based on their funding sources. In light of the changes to the deposit insurance assessment base required by Dodd-Frank, the final rule modifies these adjustments. In addition, the final rule adds an adjustment for long-term debt held by an insured depository institution where the debt is issued by another insured depository institution.

74 FR 9525 (March 4, 2009).

1. Unsecured Debt Adjustment

The final rule maintains the long-term unsecured debt adjustment, but the amount of the adjustment is now equal to the amount of long-term unsecured liabilities

an insured depository institution reports times the sum of 40 basis points plus the institution's initial base assessment rate divided by the amount of the institution's new assessment base; that is:

Unsecured debt remains as defined in the 2009 Final Rule on Assessments, with the exceptions (discussed below) of the exclusion of Qualified Tier 1 capital and certain redeemable debt. See 74 FR 9537 (March 4, 2009).

The IBAR is the institution's initial base assessment rate.

UDA = (Long-term unsecured liabilities/New assessment base) * (40 basis points + IBAR)

Thus, if an institution with a $10 billion assessment base issued $100 million in long-term unsecured liabilities and had an initial base assessment rate of 20 basis points, its unsecured debt adjustment would be 0.6 basis points, which would result in an annual reduction in the institution's assessment of $600,000.

All other things equal, greater amounts of long-term unsecured debt can reduce the FDIC's loss in the event of a failure, thus reducing the risk to the DIF. Because of this, under the current assessment system, an insured depository institution's assessment rate is reduced through the unsecured debt adjustment, which is based on the amount of long-term, unsecured liabilities the insured depository institution issues. Adding the initial base assessment rate to the adjustment formula maintains the value of the incentive to issue long-term unsecured debt, providing insured depository institutions with the same incentive to issue long-term unsecured debt that they have under the current assessment system.

Unless this revision is made, the cost of issuing long-term unsecured liabilities will rise (as will the cost of funding for all other liabilities except, in most cases, domestic deposits) as there will no longer be a distinction, in terms of the cost of deposit insurance, among the types of liabilities funding the new assessment base. The FDIC remains concerned that this will reduce the incentive for insured depository institutions to issue long-term unsecured debt. Therefore, the final rule, like the proposed rule, revises the adjustment so that the relative cost of issuing long-term unsecured debt will not rise with the implementation of the new assessment base.

The final rule, like the proposed rule, also changes the cap on the unsecured debt adjustment from the current 5 basis points to the lesser of 5 basis points or 50 percent of the institution's initial base assessment rate. This cap will apply to the new assessment base. This change allows the maximum dollar amount of the unsecured debt adjustment to increase because the assessment base is larger, but ensures that the assessment rate after the

adjustment is applied does not fall to zero.

In addition, the final rule, like the proposed rule, eliminates Qualified Tier 1 capital from the definition of unsecured debt. Under the current assessment system, the unsecured debt adjustment includes certain amounts of Tier 1 capital (Qualified Tier 1 capital) for insured depository institutions with less than $10 billion in assets. Since the new assessment base excludes Tier 1 capital, defining long-term, unsecured liabilities to include Qualified Tier 1 capital would have the effect of providing a double deduction for this capital.

Finally, the final rule, unlike the proposed rule, slightly alters the definition of long-term unsecured debt. At present, and under the proposed rule, long-term unsecured debt is defined as long-term if the unsecured debt has at least one year remaining until maturity. The final rule provides that long-term unsecured debt is long-term if the debt has at least one year remaining until maturity, unless the investor or holder of the debt has a redemption option that is exercisable within one year of the reporting date. Such a redemption option negates the benefit of long-term debt to the DIF.

2. Comments

Some commenters expressed support for increasing the adjustment to 40 basis points plus the initial base assessment rate.

A number of commenters believed that the long-term unsecured liability definition should be expanded to include short-term unsecured liabilities, uninsured deposits and foreign office deposits or all liabilities subordinate to the FDIC. A few commenters also stated that the original, rather than remaining, maturity of unsecured debt should be used to determine whether unsecured debt qualifies as long term.

The FDIC does not believe that the definition of long-term liabilities should be expanded. Short-term unsecured liabilities (including those that were long-term at issuance) provide less protection to the DIF in the event of failure. By the time an institution fails, unsecured debt remaining at an institution is primarily longer-term debt that has not yet come due. Thus, providing a benefit for short-term unsecured debt does not make sense, since this kind of debt is unlikely to provide any cushion to absorb losses in the event of failure. Similarly, the FDIC does not agree that unsecured debt should include foreign office deposits, since there is likely to be a significant reduction in these deposits by the time of failure. In addition, while, under U.S. law, foreign deposits are subordinate to domestic deposits in the event an institution fails, they can be subject to asset ring-fencing that effectively makes them similar to secured liabilities.

One commenter stated that the long-term unsecured liability definition should include goodwill and other intangibles. The FDIC does not agree. The purpose of this adjustment is to provide an incentive for insured depository institutions to issue long-term unsecured debt to absorb losses in the event an institution fails. Goodwill and other intangibles are assets (rather than liabilities) and they provide little to no value to the FDIC in a resolution.

One commenter recommended that the unsecured debt adjustment cap should be increased or removed. The commenter argued that all long-term unsecured claims subordinate to the FDIC reduce the FDIC's risk equally and the cap artificially and arbitrarily mutes the effect. Further, the commenter noted that a bank with a lower initial base assessment rate and arguably less risk to the FDIC should not have a lower cap simply due to its lower initial base assessment rate. The FDIC disagrees. An excessive deduction could create moral hazard. While the FDIC acknowledges that an institution with a lower initial base assessment rate may have a lower cap than one with a higher initial base assessment rate, the FDIC believes that, to avoid the potential for moral hazard that would ensue from an assessment rate at or near zero, all institutions should pay some assessment. Thus, setting the cap at half of the initial base assessment rate is appropriate.

3. Depository Institution Debt Adjustment

Like the proposed rule, the final rule creates a new adjustment, the depository institution debt adjustment (DIDA), which is meant to offset the benefit received by institutions that issue long-term, unsecured liabilities when those liabilities are held by other insured depository institutions.

However, in response to comments, the final rule allows an institution to exclude from the unsecured debt amount used in calculating the DIDA an amount equal to no more than 3 percent of the institution's Tier 1 capital as posing de minimis risk. Therefore, the final rule will apply a 50 basis point DIDA to every dollar (above 3 percent of an institution's Tier 1 capital) of long-term unsecured debt held by an insured depository institution when that debt is issued by another insured depository institution.

Specifically, the adjustment will be determined according to the following formula:

For this reason, the long-term unsecured debt that is subject to the DIDA is defined in the same manner as the long-term unsecured debt that qualifies for the unsecured debt adjustment.

Debt issued by an entity other than an insured depository institution, including such an uninsured entity that owns or controls, either directly or indirectly, an insured depository institution, is not subject to the DIDA.

DIDA = [(Long-term unsecured debt issued by another insured depository institution—3% * Tier 1 capital) * 50 basis points]/New assessment base

An institution should use the same valuation methodology to calculate the amount of long-term unsecured debt issued by another insured depository institution that it holds as it uses to calculate the amount of such debt for reporting on the asset side of the balance sheets.

Although issuance of unsecured debt by an insured depository institution lessens the potential loss to the DIF in the event of an insured depository institution's failure, when this debt is held by other insured depository institutions, the overall risk to the DIF is not reduced as much. For this reason, the final rule increases the assessment rate of an insured depository institution that holds this debt. The FDIC considered reducing the benefit from the unsecured debt adjustment received by insured depository institutions when their long-term unsecured debt is held by other insured depository institutions, but debt issuers generally do not track which entities hold their debt. The FDIC believes that the magnitude of the DIDA will approximately offset the decrease in the assessment rate of the issuing institution, and will discourage insured depository institutions from holding excessive amounts of other insured depository institutions' debt.

4. Comments

A number of commenters noted that the proposed level of 50 basis points for the DIDA is excessive relative to the risk presented to the FDIC. The FDIC disagrees. A fixed level of 50 basis points was established to generally offset the deduction received by the issuing institution of 40 basis points plus the initial base assessment rate. While the initial base assessment rate for the issuing institution may be less or greater than 10 basis points, the FDIC believes that 50 basis points is an appropriate approximation to offset the deduction to the issuing insured depository institution and to discourage insured depository institutions from

holding excessive amounts of each other's debt, which leaves the risk from such debt within the banking system.

A few commenters noted that a 50 basis point increase is punitive towards insured depository institutions that wish to manage a diversified portfolio of earning assets, including unsecured debt issued by strong depository insured institutions. The FDIC recognizes that the 50 basis point charge represents a disincentive to insured depository institutions to purchase the unsecured debt of another insured institution. That is one of the goals of the adjustment. However, the FDIC concedes that a small amount of debt that would otherwise be subject to the DIDA could be held to facilitate prudent portfolio management activities and, as discussed above, has created a de minimis exception.

Another commenter noted that the implementation of the 50-basis point adjustment could cause banks that issue unsecured debt to face reduced access to liquidity and funding, resulting from an increased cost of issuing unsecured debt to insured depository institutions. The FDIC believes that an increase, if any, in the cost of funding as the result of this adjustment will be significantly less than the long-term unsecured debt reduction an issuer receives. Further, the FDIC's exclusion of a de minimis amount of debt issued by insured depository institutions should minimize or eliminate any potential effect. The FDIC's intent is only to permit a net reduction in insurance premiums in the event that the risk of default on unsecured debt issued by an insured depository institution has limited or no effect on any other insured depository institution.

A few commenters stated that a cap should be set for the DIDA. The FDIC disagrees, since a cap would undermine the purpose of the DIDA.

A few commenters stated that the DIDA will result in a reporting burden for insured depository institutions, particularly since CUSIP numbers do not identify industries. The FDIC disagrees. The FDIC believes that a bank should know and understand the attributes of its investments, including, among other things, the name of the issuer and the industry that the issuer operates in. While the FDIC acknowledges some reporting modifications may have to be made at some institutions, the FDIC believes those changes can be accomplished at minimal time and cost.

5. Secured Liability Adjustment

The final rule, like the proposed rule, discontinues the secured liability adjustment. In arguing for the secured liability adjustment the FDIC stated that, “[t]he exclusion of secured liabilities can lead to inequity. An institution with secured liabilities in place of another's deposits pays a smaller deposit insurance assessment, even if both pose the same risk of failure and would cause the same losses to the FDIC in the event of failure.” The change in the assessment base will eliminate the advantage of funding with secured liabilities associated with the current assessment base (domestic deposits), thus eliminating the rationale for continuing the adjustment.

6. Comments

A few commenters stated support for the removal of the secured liability adjustment, although one commenter opined that FHLB funding is more damaging to the FDIC than brokered deposits. On balance, the FDIC believes that including secured liabilities in the assessment base has removed the need for the secured liability adjustment.

7. Brokered Deposit Adjustment

The final rule, like the proposed rule, retains the current adjustment for brokered deposits, but scales the adjustment to the new assessment base by the insured depository institution's ratio of domestic deposits to the new assessment base. The new formula for brokered deposits is the following:

BDA = ((Brokered deposits − (Domestic deposits * 10%))/New assessment base) * 25 basis points

As discussed below, the final rule changes the assessment system for large institutions and eliminates risk categories for these institutions. Based on comments, however, the final rule provides an exemption from the brokered deposit adjustment for certain large institutions. The brokered deposit adjustment will not apply to those large institutions that are well-capitalized and have a composite CAMELS rating of 1 or 2. The FDIC believes that this exemption will result in a more equitable distribution of assessments. The brokered deposit adjustment does not apply to small institutions that are well-capitalized and have a composite CAMELS rating of 1 or 2. The brokered deposit adjustment will continue to apply to all other large institutions and to small institutions in risk categories II, III, and IV when the ratio of brokered deposits to domestic deposits exceeds 10 percent. As discussed, small Risk Category I institutions will continue to be excluded.

The final rule, like the proposed rule, maintains a cap on the adjustment of 10 basis points. The FDIC recognizes that keeping the cap constant could result in an increase in the amount an institution is assessed due to the adjustment, since the cap will apply to a larger assessment base. However, the FDIC remains concerned that significant reliance on brokered deposits tends to increase an institution's risk profile, particularly as its financial condition weakens.

8. Comments

A few commenters noted that the FDIC has not demonstrated a positive correlation between bank failures and the use of brokered deposits, which is inconsistent with a risk-based assessment system. The FDIC disagrees. A number of costly institution failures, including some recent failures, involved rapid asset growth funded through brokered deposits. Moreover, the presence of brokered deposits in a failed institution tends to reduce its franchise value, resulting in increased losses to the DIF.

Numerous comment letters argued that certain types of brokered deposits, including reciprocal deposits and sweeps, should be excluded from the brokered deposit adjustment because they are more stable than other types of brokered deposits. The FDIC considered the substance of these comments when it originally adopted the brokered deposit adjustment and remains unpersuaded. The final rule does not apply the brokered deposit adjustment to a well-capitalized, CAMELS 1- or 2-rated institution. When an institution's condition declines and it becomes less than well capitalized or is not rated CAMELS 1 or 2, statutory and market restrictions on brokered deposits become much more relevant. For this reason, the FDIC has decided to continue to include all brokered deposits above 10 percent of an institution's domestic deposits in the brokered deposit adjustment.

A few commenters noted that Dodd-Frank directs the FDIC to study the definition of brokered deposits. The commenters contend that determining the definition of brokered deposit prior to completion of the study is counter to the intent of Congress. The FDIC will continue to use its current definition for the present, but will examine the definition in light of the completed study and will consider changes then, if appropriate.

One commenter argued for a reduction of the cap from 10 basis points to 6.5 basis points given the increase in assessment base. While the FDIC acknowledges that maintaining the 10 basis point cap could increase the size of the adjustment as a result in the

change in assessment base, the FDIC believes this increase is appropriate. The FDIC remains concerned that significant reliance on brokered deposits tends to increase an institution's risk profile, particularly as it weakens.

V. The Final Rule: Dividends and Assessment Rates

A. Dividends

1. Final Rule

As proposed in the October NPR and consistent with the FDIC's long-term, comprehensive plan for fund management, the final rule suspends dividends indefinitely whenever the fund reserve ratio exceeds 1.5 percent to increase the probability that the fund reserve ratio will reach a level sufficient to withstand a future crisis.

In lieu of dividends, and pursuant to its authority to set risk-based assessments, the final rule adopts progressively lower assessment rate schedules when the reserve ratio exceeds 2 percent and 2.5 percent, as discussed below. These lower assessment rate schedules serve much the same function as dividends in preventing the DIF from growing unnecessarily large but, as discussed in the October NPR, provide more stable and predictable effective assessment rates, a feature that industry representatives said was very important at the September 24, 2010 roundtable organized by the FDIC.

As discussed above, Dodd-Frank continued the FDIC's authority to declare dividends when the reserve ratio at the end of a calendar year is at least 1.5 percent, but granted the FDIC sole discretion in determining whether to suspend or limit the declaration or payment of dividends. Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, § 332, 124 Stat. 1376, 1539 (codified at 12 U.S.C. 1817(e)(2)(B)).

2. Comments

In the October NPR, the FDIC had proposed suspending dividends “permanently.” One trade group, representing community banks, agreed that permanently foregoing dividends:

[I]s much more likely to ensure steady, predictable assessment rates. While we think that the FDIC should never completely rule out the possibility of paying a dividend from the DIF, we believe that at least until the DIF reserve ratio reaches 2.5 percent, it is prudent to forego a dividend in favor of steady, predictable assessment rates.

Another trade group argued that a permanent suspension of dividends is an unnecessary limitation on the FDIC's discretion under Dodd-Frank. The trade group argued that decisions on dividends should be based on facts and circumstances whenever the reserve ratio exceeds 1.5 percent. If the suspension is adopted, the trade group believes that the FDIC should provide that it could be lifted in appropriate circumstances.

The FDIC is persuaded that the word “indefinitely” should be used in place of the word “permanently,” although the distinction is semantic. The rule is not intended to, and in any event, could not abrogate the authority of future FDIC Boards of Directors to adopt a different rule governing dividends.

Another trade group argued that the FDIC should establish a dividend policy to slow the growth of the insurance fund as it approaches an upper limit. In the FDIC's view, the historical analysis set out in the October NPR and updated in the DRR final rule, as described above, reveals that lower rates, like dividends, can effectively slow the growth of the reserve ratio, but can lead to less volatility in effective assessment rates.

B. Assessment Rate Schedules

1. Rate Schedule Effective April 1, 2011

Pursuant to the FDIC's authority to set assessments, the initial and total base assessment rates described in Table 3 below will become effective April 1, 2011. These rates are identical to those proposed in the Assessment Base NPR. (The rate schedule does not include the depository institution debt adjustment.)

Table 3—Initial and Total Base Assessment Rates *

Risk category

Risk category II

Risk category III

Risk category IV

Large and highly complex institutions

Initial base assessment rate

5-9

5-35

Unsecured debt adjustment **

(4.5)-0

(5)-0

Brokered deposit adjustment

0-10

Total Base Assessment Rate

2.5-9

9-24

18-33

30-45

2.5-45

* Total base assessment rates do not include the depository institution debt adjustment.

** The unsecured debt adjustment cannot exceed the lesser of 5 basis points or 50 percent of an insured depository institution's initial base assessment rate; thus for example, an insured depository institution with an initial base assessment rate of 5 basis points will have a maximum unsecured debt adjustment of 2.5 basis points and cannot have a total base assessment rate lower than 2.5 basis points.

The FDIC believes that the change to a new, expanded assessment base should not change the overall amount of assessment revenue that the FDIC would otherwise have collected using the assessment rate schedule under the Restoration Plan adopted by the Board on October 19, 2010.

Several industry trade groups and insured institutions supported this approach. Based on the FDIC's estimations, the rate schedule in Table 3 above will result in the collection of assessment revenue that is approximately revenue neutral.

35 36

Because the new assessment base under Dodd-Frank is larger than the current assessment base, the assessment rates in Table 3 above are lower than current rates.

75 FR 66293 (October 27, 2010).

Specifically, the FDIC has attempted to determine a rate schedule that would have generated approximately the same revenue as that generated under the current rate schedule in the second and third quarters of 2010 using the current assessment base.

As discussed earlier, under Dodd-Frank, the FDIC is required to offset the effect on small institutions (those with less than $10 billion in assets) of the statutory requirement that the fund reserve ratio increase from 1.15 percent to 1.35 percent by September 30, 2020. Thus, assessment rates applicable to all insured depository institutions need only be set high enough to reach 1.15 percent. The Restoration Plan postpones until later this year rulemaking regarding the method that will be used to reach 1.35 percent by the statutory deadline of September 30, 2020, and the manner of offset.

The rate schedule in Table 3 includes a column for institutions with at least $10 billion in total assets. This column represents the assessment rates that will be applied to institutions of this size pursuant to the changes to the large institution pricing system discussed below. The range of total base assessment rates (2.5 basis points to 45 basis points) is the same for institutions of all sizes; however, institutions with at least $10 billion in total assets will not be assigned to risk categories.

The final rule retains the FDIC Board's flexibility to adopt actual rates that are higher or lower than total base assessment rates without the necessity of further notice-and-comment rulemaking, but provides that: (1) The Board cannot increase or decrease rates from one quarter to the next by more than 2 basis points (rather than the current and proposed 3 basis points); and (2) cumulative increases and decreases cannot be more than 2 basis points higher or lower than the total base assessment rates. Retention of this flexibility (with the proportionate reduction in the size of the adjustment) will continue to allow the Board to act in a timely manner to fulfill its mandate to raise the reserve ratio in accordance with the Restoration Plan, particularly in light of the increased uncertainty about expected revenue resulting from the change in the assessment base. The reduction from 3 to 2 basis points was prompted by an industry trade group, which noted that 2 basis points of the new assessment base is approximately equal to 3 basis points of the domestic deposit assessment base.

2. Analysis of Statutory Factors for the New Rate Schedule

In setting assessment rates, the FDIC's Board of Directors is authorized to set assessments for insured depository institutions in such amounts as the Board of Directors may determine to be necessary or appropriate.

In setting assessment rates, the FDIC's Board of Directors is required by statute to consider the following factors:

12 U.S.C. 1817(b)(2)(A).

(i) The estimated operating expenses of the Deposit Insurance Fund.

(ii) The estimated case resolution expenses and income of the Deposit Insurance Fund.

(iii) The projected effects of the payment of assessments on the capital and earnings of insured depository institutions.

(iv) The risk factors and other factors taken into account pursuant to section 7(b)(1) of the Federal Deposit Insurance Act (12 U.S.C Section 1817(b)(1)) under the risk-based assessment system, including the requirement under section 7(b)(1)(A) of the Federal Deposit Insurance Act (12 U.S.C Section 1817(b)(1)(A)) to maintain a risk-based system.

The risk factors referred to in factor (iv) include:

(i) The probability that the Deposit Insurance Fund will incur a loss with respect to the institution, taking into consideration the risks attributable to—

(I) Different categories and concentrations of assets;

(II) Different categories and concentrations of liabilities, both insured and uninsured, contingent and noncontingent; and

(III) Any other factors the Corporation determines are relevant to assessing such probability;

(ii) The likely amount of any such loss; and

(iii) The revenue needs of the Deposit Insurance Fund.

Section 7(b)(1)(C) of the Federal Deposit Insurance Act (12 U.S.C. 1817(b)(1)(C)).

(v) Other factors the Board of Directors has determined to be appropriate.

Section 7(b)(2) of the Federal Deposit Insurance Act, 12 U.S.C. 1817(b)(2)(B).

When the Board adopted the most recent Restoration Plan, it left the current assessment rate schedule in effect and took these statutory factors into account. The Restoration Plan requires that the FDIC update income and loss projections semiannually. The Board's decision to leave current assessment rates in effect was based on the FDIC's most recent projections, which projected lower expected losses for the period 2010 through 2014 than the FDIC's projections in June 2010 (approximately $50 billion rather than approximately $60 billion as projected in June 2010).

Because of the lower expected losses and the additional time provided by Dodd-Frank to meet the minimum (albeit higher) required reserve ratio, the FDIC opted, in the new Restoration Plan, to forego the uniform 3 basis point increase in assessment rates previously scheduled to go into effect on January 1, 2011. The FDIC estimated that the fund reserve ratio will reach 1.15 percent in 2018, even without the 3 basis point uniform increase in rates. As stated above, the final rule changes the current assessment rate schedule such that the new assessment rate schedule (applied against the new assessment base) will result in the collection of about the same amount of assessment revenue as the current assessment rate schedule applied against the domestic deposit assessment base.

The projections also cover expenses and the reserve ratio. The FDIC anticipates that the next semiannual update of projections will occur in the first half of 2011.

For this reason, as stated in the Assessment Base NPR, the new assessment rates and assessment base should, overall, have no effect on the capital and earnings of the banking industry, although the new rates and base will affect the earnings and capital of individual institutions. The great majority of institutions will pay assessments at least 5 percent lower than currently and would thus have higher earnings and capital. However, 117 insured depository institutions, comprising 71 small institutions and 46 large institutions, would pay assessments at least 5 percent higher than they currently do. Appendix 1 contains additional detail on the projected effects of increases or decreases in assessments on the capital and earnings of insured depository institutions.

3. Comments on New Rate Schedule

Comments on the new rate schedule effective April 1, 2011, focused on two areas: The appropriateness of the shift in the rate schedule due to the new assessment base and the speed at which these rates would restore the DIF to 1.15 percent. As stated above, commenters generally supported the rate schedule in light of the new assessment base, since it maintains approximate revenue neutrality.

Several trade groups believed that the FDIC's projection for how quickly the reserve ratio will recover was too pessimistic and, thus, the rate schedule to restore the DIF was too high. A trade group believed that the revenue from the Temporary Liquidity Guarantee Program will allow the reserve ratio to reach 1.35 percent by 2017. A trade group also suggested basing reserve ratio projections on loss rates from the recovery period after the crisis of the early 1990s. Some commenters urged the FDIC to monitor progress of the Restoration Plan and reduce rates if the DIF reserve ratio reaches 1.35 percent more quickly than the FDIC has projected.

The FDIC has projected that the reserve ratio will reach 1.15 percent at the end of 2018. This projection was based on approximately $50 billion in losses from bank failures in 2010 through 2014 with markedly lower losses thereafter. (In fact, losses for 2017 and each year thereafter were assumed to equal average annual losses from 1995 to 2004, a period of very low fund losses.) The FDIC did not include income from the TLGP, because it believes that it is too early to determine the amount that may be transferred to the DIF when the TLGP ends at the end of 2012.

The FDIC does not believe that its projections are too pessimistic. Given the uncertainty of the pace of recovery in the economy and banking industry, as well as the uncertainty inherent in projecting reserve ratios eight years in advance, the FDIC believes that lowering assessment rates now (in addition to foregoing the 3 basis point rate increase previously scheduled to take effect in 2011) would not be prudent. However, under the Restoration Plan, the FDIC is required to update its loss and income projections

for the fund at least semiannually and, if necessary—for example, if there is a change in the projected losses from bank failures—increase or decrease assessment rates to meet the statutory minimum reserve ratio by September 2020. (Such an increase or decrease would not affect the assessment rate schedules below.)

An industry trade group commented that, given the FDIC's decision in October 2010 to forego the uniform 3 basis point increase in assessment rates scheduled to go into effect on January 1, 2011, the FDIC should reassess its cash needs and return excess prepaid assessments earlier, such as by December 2011. The FDIC will continue to monitor its cash resources to determine whether to undertake a rulemaking to return unused portions of the prepayments before the scheduled return date.

4. Rate Schedule Once the Reserve Ratio Reaches 1.15 Percent

Pursuant to the FDIC's authority to set assessments, the initial base and total base assessment rates set forth in Table 4 below will take effect beginning the assessment period after the fund reserve ratio first meets or exceeds 1.15 percent, without the necessity of further action by the FDIC's Board. These rates are identical to those proposed in the Assessment Base NPR. The rates will remain in effect unless and until the reserve ratio meets or exceeds 2 percent. The FDIC's Board will retain its authority to uniformly adjust the total base rate assessment schedule up or down without further rulemaking, but the adjustment cannot exceed 2 basis

points.

The Assessment Base NPR contained a typographical error in the lower range of the total base assessment rates for Risk Category IV. It stated that the range of rates was 29 basis points to 40 basis points; it should have stated that the range was 25 basis points to 40 basis points. The final rule corrects the error.

Table 4—Initial and Total Base Assessment Rates *

[Once the reserve ratio reaches 1.15 percent and the reserve ratio for the immediately prior assessment period Is less than 2 percent

]

Risk category

Risk category II

Risk category III

Risk category IV

Large and highly complex institutions

Initial base assessment rate

3-7

3-30

Unsecured debt adjustment **

(3.5)-0

(5)-0

Brokered deposit adjustment

0-10

Total Base Assessment Rate

1.5-7

7-22

14-29

25-40

1.5-40

* Total base assessment rates do not include the depository institution debt adjustment.

** The unsecured debt adjustment cannot exceed the lesser of 5 basis points or 50 percent of an insured depository institution's initial base assessment rate; thus, for example, an insured depository institution with an initial base assessment rate of 3 basis points will have a maximum unsecured debt adjustment of 1.5 basis points and cannot have a total base assessment rate lower than 1.5 basis points.

When the reserve ratio reaches 1.15 percent, the FDIC believes that it is appropriate to lower assessment rates so that the average assessment rate will approximately equal the long-term moderate, steady assessment rate—5.29 basis points, as discussed in the October NPR and the DRR final rule—that would have been needed to maintain a positive fund balance throughout past crises.

Doing so is consistent with the goals of the FDIC's comprehensive, long-term fund management plan, which are to: (1) Reduce the pro-cyclicality in the existing risk-based assessment system by allowing moderate, steady assessment rates throughout economic and credit cycles; and (2) maintain a positive fund balance even during a banking crisis by setting an appropriate target fund size and a strategy for assessment rates and dividends.

The FDIC arrived at the rate schedule in Table 4 as follows. First, the FDIC determined the rate schedule that would have been needed during a period when insured depository institutions had strong earnings to achieve approximately an 8.5 basis point average assessment rate, which is the long-term, moderate, steady assessment rate that would have been needed to maintain a positive fund balance throughout past crises using a domestic deposit assessment base. Based on the FDIC's analysis of weighted average assessment rates paid immediately prior to the current crisis (when the industry was relatively prosperous, and had both good CAMELS ratings and substantial capital), weighted average rates during times of industry prosperity tend to be somewhat less than 1 basis point greater than the minimum initial base assessment rate applicable to Risk Category I (for rates applicable to a domestic deposit assessment base). The first year in which rates applicable to Risk Category I spanned a range (as opposed to being a single rate) was 2007, when initial assessment rates ranged between 5 and 7 basis points. During that year, weighted average annualized industry assessment rates for the first three quarters varied between 5.41 and 5.44 basis points. (By the end of 2007, deterioration in the industry became more marked and weighted average rates began increasing.) The difference between the minimum rate and the weighted average rate (approximately 0.4 basis points) is 20 percent of the 2 basis point difference between the then existing minimum and maximum rates. 20 percent of the 4 basis point difference between the current, domestic deposit minimum and maximum rates is 0.8 basis points. By analogy, in 2007 the current assessment schedule would have produced average assessment rates of about 12.8 basis points. Thus, to achieve, during prosperous times, approximately an 8.5 basis point average assessment rate, initial base rates would have to be set about 4 basis points lower than current initial base assessment rates (applied against the domestic deposit assessment base). This analysis underlay the rate schedule in the October NPR that was proposed to become effective when the reserve ratio reaches 1.15 percent. As of June 30, 2010, the rate schedule in Table 4 applied against the Dodd-Frank mandated assessment base would have produced approximately the same amount of revenue as the October NPR's proposed rate schedule applied against the domestic deposit assessment base.

The FDIC considers these goals important for several reasons. During an economic and banking downturn, insured institutions can least afford to pay high deposit insurance assessment rates. Moreover, high assessment rates during a downturn reduce the amount that banks can lend when the economy most needs new lending. Consequently, it is important to reduce pro-cyclicality in the assessment system and allow moderate, steady assessment rates throughout economic and credit cycles. As discussed above, at a September 24, 2010 roundtable organized by the FDIC, bank executives and industry trade group representatives uniformly favored steady, predictable assessments and objected to high assessment rates during crises.

It is also important that the fund not decline to a level that could risk undermining public confidence in federal deposit insurance. Furthermore, although the FDIC has significant authority to borrow from the Treasury to cover losses when the fund balance approaches zero, the FDIC views the Treasury line of credit as available to cover unforeseen losses, not as a source of financing projected losses. A sufficiently large fund is a necessary precondition to maintaining a positive fund balance during a banking crisis

and allowing for long-term, steady assessment rates.

5. Rate Schedule Once the Reserve Ratio Reaches 2.0 Percent

In lieu of dividends, and pursuant to the FDIC's authority to set assessments, the initial base and total base assessment rates set forth in Table 5 below will come into effect without further action by the FDIC Board when the fund reserve ratio at the end of the prior assessment period meets or exceeds 2 percent, but is less than 2.5 percent.

These rates are identical to those proposed in the Assessment Base NPR. The FDIC's Board will retain its authority to uniformly adjust the total base rate assessment schedule up or down without further rulemaking, but the adjustment cannot exceed 2 basis points.

New institutions will remain subject to the assessment schedule in Table 4 when the reserve ratio reaches 2 percent. Subject to exceptions, a new insured depository institution is a bank or savings association that has been federally insured for less than five years as of the last day of any quarter for which it is being assessed. 12 CFR 327.8(j).

However, the lowest total base assessment rate cannot be negative.

Table 5—Initial and Total Base Assessment Rates *

[If the reserve ratio for prior assessment period is equal to or greater than 2 percent and less than 2.5 percent]

Risk category

Risk category II

Risk category III

Risk category IV

Large and highly complex institutions

Initial base assessment rate

2-6

2-28

Unsecured debt adjustment **

(3)-0

(5)-0

Brokered deposit adjustment

0-10

Total Base Assessment Rate

1-6

5-20

12-27

23-38

1-38

* Total base assessment rates do not include the depository institution debt adjustment.

** The unsecured debt adjustment could not exceed the lesser of 5 basis points or 50 percent of an insured depository institution's initial base assessment rate; thus, for example, an insured depository institution with an initial assessment rate of 2 basis points will have a maximum unsecured debt adjustment of 1 basis point and could not have a total base assessment rate lower than 1 basis point.

The historical analysis discussed above revealed that, in lieu of dividends, reducing the 5.29 basis point weighted average assessment rate by 25 percent when the reserve ratio reached 2 percent allowed the fund to remain positive during prior banking crises and successfully limited rate volatility. The assessment rates in Table 5 should produce a weighted average assessment rate approximately 25 percent lower than the assessment rates in Table 4 during periods of industry prosperity.

The FDIC arrived at the rate schedule in Table 5 as follows. As described in an earlier footnote, based on the FDIC's analysis of weighted average assessment rates paid immediately prior to the current crisis (when the industry was relatively prosperous, and had both good CAMELS ratings and substantial capital), weighted average rates during times of industry prosperity tend to be somewhat less than 1 basis point greater than the minimum initial base assessment rate applicable to Risk Category I (for rates applicable to a domestic deposit assessment base). Given this relationship, as described in an earlier footnote, the FDIC determined that the rate schedule that would have been needed during prosperous times to achieve approximately an 8.5 basis point average assessment rate would have had a minimum initial base assessment rate of 8 basis points. Similarly, the assessment rate schedule that, when applied to the domestic deposit assessment base would reduce the weighted average assessment rate by approximately 25 percent, would have had a minimum initial base assessment rate of 6 basis points (Table 4 in the October NPR). The FDIC then determined the relative diminution in assessment revenue that would have occurred using Table 4, rather than current assessment rates, applied against the domestic deposit assessment base as of June 30, 2010. Applying the rates in Table 5 rather than those in Table 4 against the Dodd-Frank assessment base as of June 30, 2010, would have produced a similar relative diminution in assessment revenue.

6. Rate Schedule Once the Reserve Ratio Reaches 2.5 Percent

Also in lieu of dividends, and pursuant to the FDIC's authority to set assessments, the initial base and total base assessment rates set forth in Table 6 below will come into effect without further action by the FDIC Board when the fund reserve ratio at the end of the prior assessment period meets or exceeds 2.5 percent.

New institutions will remain subject to the assessment schedule in Table 4 when the reserve ratio reaches 2.5 percent.

However, the lowest initial base assessment rate cannot be negative.

Table 6—Initial and Total Base Assessment Rates *

[If the reserve ratio for the prior assessment period is equal to or greater than 2.5 percent]

Risk category

Risk category II

Risk category III

Risk category IV

Large and highly complex institutions

Initial base assessment rate

1-5

1-25

Unsecured debt adjustment **

(2.5)-0

(4.5)-0

(5)-0

Brokered deposit adjustment

0-10

Total Base Assessment Rate

0.5-5

4.5-19

10-25

20-35

0.5-35

* Total base assessment rates do not include the depository institution debt adjustment.

** The unsecured debt adjustment could not exceed the lesser of 5 basis points or 50 percent of an insured depository institution's initial base assessment rate; thus, for example, an insured depository institution with an initial assessment rate of 1 basis point will have a maximum unsecured debt adjustment of 0.5 basis points and could not have a total base assessment rate lower than 0.5 basis points.

The historical analysis discussed above revealed that, in lieu of dividends, further reducing the 5.29 basis point weighted average assessment rate by 25 percent when the reserve ratio reached 2 percent and by 50 percent when the reserve ratio reached 2.5 percent allowed the fund to remain positive during prior banking crises and successfully limited rate volatility. The assessment rates in Table 6 should produce a weighted average assessment rate approximately 50 percent lower than the assessment rates in Table 4 during periods of industry prosperity.

The FDIC arrived at the rate schedule in Table 6 as follows. As described in an earlier footnote, based on the FDIC's analysis of weighted average assessment rates paid immediately prior to the current crisis (when the industry was relatively prosperous, and had both good CAMELS ratings and substantial capital), weighted average rates during times of industry prosperity tend to be somewhat less than 1 basis point greater than the minimum initial base assessment rate applicable to Risk Category I (for rates applicable to a domestic deposit assessment base). Given this relationship, as described in an earlier footnote, the FDIC determined that the rate schedule that would have been needed during prosperous times to achieve approximately an 8.5 basis point average assessment rate would have had a minimum initial base assessment rate of 8 basis points. Similarly, the assessment rate schedule that, when applied to the domestic deposit assessment base would reduce the weighted average assessment rate by approximately 50 percent, would have had a minimum initial base assessment rate of 4 basis points (Table 5 in the October NPR). The FDIC then determined the relative diminution in assessment revenue that would have occurred using Table 5, rather than current assessment rates, applied against the domestic deposit assessment base as of June 30, 2010. Applying the rates in Table 6 rather than those in Table 4 against the Dodd-Frank assessment base as of June 30, 2010, would have produced a similar relative diminution in assessment revenue.

7. Analysis of Statutory Factors for Future Rate Schedules

The FDIC Board took into account the required statutory factors when adopting the rate schedules that will take effect when the reserve ratio reaches 1.15 percent, 2 percent and 2.5 percent.

These rate schedules were based on the historical analysis in the October NPR and the updated historical analysis in the DRR final rule. These analyses took into account fund operating expenses, resolution expenses and income over many decades to determine assessment rates that would keep the fund positive and assessment rates stable even during crises like those that have occurred within the past 30 years.

As noted earlier, in setting assessment rates, the FDIC's Board of Directors is authorized to set assessments for insured depository institutions in such amounts as the Board of Directors may determine to be necessary. 12 U.S.C. 1817(b)(2)(A). In so doing, the Board must consider certain statutorily defined factors. 12 U.S.C. 1817(b)(2)(B). As reflected in the text, the FDIC has taken into account all of these statutory factors.

As the FDIC stated in the October NPR, it anticipates that when the reserve ratio exceeds 1.15 percent, and particularly when it exceeds 2 or 2.5 percent, the industry is likely to be prosperous. Consequently, to determine the effect on earnings and capital of lowering rates (once the reserve ratio thresholds are met) after taking into account the new assessment base, the FDIC examined the effect of the lower rates on the industry at the end of 2006, when the industry was prosperous. Under that scenario, reducing assessment rates when the reserve ratio reaches 1.15 percent would have increased average after-tax income by 1.25 percent and average capital by 0.14 percent. Reducing assessment rates when the reserve ratio reaches 2 percent would have further increased average after-tax income by 0.62 percent and average capital by 0.07 percent. Similarly, reducing assessment rates when the reserve ratio reaches 2.5 percent would have further increased average after-tax income by 0.61 percent and average capital by 0.07 percent. Decreasing assessment rates as provided in the final rule would not negatively affect the capital or earnings of any insured depository institution.

8. Comments on Future Rate Schedules

Commenters generally favored the establishment of a long-term, steady, predictable rate schedule that does not fluctuate with economic and credit cycles. One trade group stated that “[t]he more consistent and steady the premiums can be, the better bankers are able to plan and continue their work in their local communities.” The FDIC agrees that setting this long-term rate schedule now will bring more stability and transparency to the deposit insurance system.

However, an industry trade group argued that, by maintaining the 4 basis point difference between minimum and maximum Risk Category I initial base assessment rates and applying these rates to a larger assessment base, the proposed assessment rates would effectively widen the assessment spread within Risk Category I. The trade group recommended that the spread be reduced when the FDIC lowers the overall assessment schedule in the future. The FDIC is not convinced. In the FDIC's view, risk differentiation becomes more important during times of banking prosperity, particularly when an expansion continues for a long period. During these periods, insured depository institutions are lending more and taking on more risk and greater risk differentiation allows this risk to be captured.

One trade group argued that these assessment rates would cause the reserve ratio to increase from 1.15 percent to 2 percent within 3 years and were therefore too high. The FDIC disagrees. The FDIC projects that it will take about 9 years for the fund to grow from 1.15 percent to 2 percent, assuming very low fund losses (the average loss rate from 1995 to 2004, a period of very low fund losses) and forward interest rates as of the date the projection was made.

Using forward interest rates as of December 3, 2010, when forward rates were slightly higher than those used in the original projection, the FDIC still projects that it will take 8 years for the fund to grow from 1.15 percent to 2 percent.

This trade group also stated that the rate reductions at 2 and 2.5 percent do not effectively restrict the growth of the insurance fund and instead create an “effective floor” for the fund. The trade group also argued that the FDIC's analysis ignored the large amount of interest income that would be generated by a fund with a reserve ratio of 2 percent, and that this would be particularly significant during periods of stability and low losses to the fund.

As described in the section on dividends above, the FDIC believes the rate decreases do effectively limit the growth of the insurance fund while preventing the moral hazard that would occur if institutions paid no assessments at all. Furthermore, the FDIC's analysis reveals that it would require very low losses over many years for the fund to reach 2.5 percent. Given the experience of the past 30 years, the FDIC considers it unlikely that the fund would experience such a prolonged period of low losses. Moreover, in the FDIC's 75 year history, the fund reserve ratio has never reached 2 percent.

In addition, the rule does not create an effective floor above 2 percent. In the analysis, when the reserve ratio fell below 2 percent, rates did not need to rise above the necessary long-term assessment rate to keep the fund from becoming negative. Instead, rates could be held constant at the long-term assessment rate in keeping with the goal of reducing pro-cyclicality.

Moreover, the FDIC's analysis did not ignore interest income. The analysis simulated fund growth by combining assessment income and investment income earned based on historical interest rates. The analysis covered periods of stability and low losses as well as crisis periods accompanied by high losses. It covered periods of high interest rates as well as low rates. The simulated fund also covered an extended period during which the fund reached or exceeded a reserve ratio of 2 percent. This period was not

accompanied by rapid fund growth, and fund growth was limited by assessment rate reductions. Had fund growth not been interrupted by periods of high losses during the 60-year period, the fund might gradually have reached a much larger size, but, historically, unbroken periods of stability are not the norm—rather they are interrupted by periods of high losses when the fund's growth decreases significantly.

VI. The Final Rule: Risk-Based Assessment System for Large Insured Depository Institutions

A. Overview of the Large Bank Risk-Based Assessment System

The final rule amends the assessment system applicable to large insured depository institutions to better capture risk at the time the institution assumes the risk, to better differentiate risk among large insured depository institutions during periods of good economic and banking conditions based on how they would fare during periods of stress or economic downturns, and to better take into account the losses that the FDIC may incur if a large insured depository institution fails. Except where noted, the final rule adopts the proposals in the Large Bank NPR.

The final rule eliminates risk categories and the use of long-term debt issuer ratings for calculating risk-based assessments for large institutions.

Instead, assessment rates will be calculated using a scorecard that combines CAMELS ratings and certain forward-looking financial measures to assess the risk a large institution poses to the DIF. One scorecard will apply to most large institutions and another to institutions that are structurally and operationally complex or that pose unique challenges and risk in the case of failure (highly complex institutions).

Dodd-Frank requires all federal agencies to review and modify regulations to remove reliance upon credit ratings and substitute an alternative standard of creditworthiness. Public Law 111-203, § 939A, 124 Stat. 1376, 1886 (15 U.S.C. 78o-7 note).

A “highly complex institution” is defined as: (1) An IDI (excluding a credit card bank) that has had $50 billion or more in total assets for at least four consecutive quarters that either is controlled by a U.S. parent holding company that has had $500 billion or more in total assets for four consecutive quarters, or is controlled by one or more intermediate U.S. parent holding companies that are controlled by a U.S. holding company that has had $500 billion or more in assets for four consecutive quarters, and (2) a processing bank or trust company. A processing bank or trust company is an insured depository institution whose last three years' non-lending interest income, fiduciary revenues, and investment banking fees, combined, exceed 50 percent of total revenues (and its last three years fiduciary revenues are non-zero), whose total fiduciary assets total $500 billion or more and whose total assets for at least four consecutive quarters have been $10 billion or more. The final rule clarifies that only U.S. holding companies come within the definition of highly complex institution. Control has the same meaning as in section 3(w)(5) of the FDI Act. See 12 USC 1813(w)(5)(2001). A credit card bank is defined as a bank for which credit card plus securitized receivables exceed 50 percent of assets plus securitized receivables. The final rule makes a technical change to the definition of a highly complex institution to avoid including certain non-complex institutions by requiring, among other things, that for an institution to be defined as a processing bank or trust company (one type of highly complex institution), it must have total fiduciary assets total $500 billion or more.

The scorecards use quantitative measures that are readily available and useful in predicting a large institution's long-term performance.

These measures are meant to differentiate risk based on how large institutions would fare during periods of economic stress. Experience during the recent crisis shows that periods of stress reveal risks that remained hidden during periods of prosperity. As discussed in the Large Bank NPR and shown in Chart 3, over the 2005 to 2008 period, the new measures were useful in predicting performance of large institutions in 2009.

Most of the data are publicly available, but data elements to compute four scorecard measures—higher-risk assets, top 20 counterparty exposures, the largest counterparty exposure, and criticized/classified items—are not. The FDIC proposes that insured depository institutions provide these data elements in the Consolidated Reports of Condition and Income (Call Report) or the Thrift Financial Report (TFR) beginning with the second quarter of 2011.

ER25FE11.003

B. Scorecard for Large Insured Depository Institutions (Other Than Highly Complex Insured Depository Institutions)

The scorecard for large institutions (other than highly complex institutions) produces two scores—a performance score and a loss severity score—that are combined and converted to an initial base assessment rate.

The performance score measures a large institution's financial performance and its ability to withstand stress. To arrive at a performance score, the scorecard combines a weighted average of CAMELS component ratings and certain financial measures into a single performance score between 0 and 100.

The loss severity score measures the relative magnitude of potential losses to the FDIC in the event of a large institution's failure. The scorecard converts a loss severity measure into a loss severity score between 0 and 100. The loss severity score is converted into a loss severity factor that ranges between 0.8 and 1.2.

Multiplying the performance score by the loss severity factor produces a combined score (total score) that can be up to 20 percent higher or lower than the performance score. Any score less than 30 will be set at 30; any score greater than 90 will be set at 90. As discussed below, the FDIC will have a limited ability to alter a large institution's total score based on quantitative or qualitative measures not captured in the scorecard. The resulting total score after adjustment cannot be less than 30 or more than 90. The total score is converted to an initial base assessment rate.

Table 7 shows scorecard measures and components, and their relative contribution to the performance score or loss severity score. Scorecard measures (other than the weighted average CAMELS rating) are converted to scores between 0 and 100 based on minimum and maximum cutoff values for each measure. A score of 100 reflects the highest risk and a score of 0 reflects the lowest risk. A value reflecting lower risk than the cutoff value receives a score of 0. A value reflecting higher risk than the cutoff value receives a score of 100. A risk measure value between the minimum and maximum cutoff values converts linearly to a score between 0 and 100, which is rounded to 3 decimal points. The weighted average CAMELS rating is converted to a score between 25 and 100 where 100 reflects the highest risk and 25 reflects the lowest risk.

Most of the minimum and maximum cutoff values are equal to the 10th and 90th percentile values for each measure, which are derived using data on large institutions over a ten-year period beginning with the first quarter of 2000 through the fourth quarter of 2009—a period that includes both good and bad economic times.

The rank ordering of risk for large institutions as of the end of 2009 (based on a consensus view of staff analysts) is largely based on the information available through the FDIC's Large Insured Depository Institution (LIDI) program. Large institutions that failed or received significant government support over the period are assigned the worst risk ranking and are included in the statistical analysis. Appendix 1 to the NPR describes the statistical analysis.

The percentage approximated by factors is based on the statistical model for that particular year. Actual weights assigned to each scorecard measure are largely based on the average coefficients for 2005 to 2008, and do not equal the weight implied by the coefficient for that particular year (See Appendix 1 to the NPR).

Appendix 2 shows selected percentile values of each scorecard measure over this period. The detailed results of the statistical analysis used to select risk measures and the weights are also provided. An online calculator is available on the FDIC's Web site to allow institutions to determine how their assessment rates will be calculated under this final rule.

Some cutoff values have been updated since the Large Bank NPR to reflect data updates.

Appendix B describes how each scorecard measure is converted to a score.

Table 7—Scorecard for Large Institutions

Scorecard measures and components

Measure weights

(percent)

Component weights

(percent)

Performance Score

P.1

Weighted Average CAMELS Rating

100

P.2

Ability to Withstand Asset-Related Stress

Tier 1 Leverage Ratio

Concentration Measure

Core Earnings/Average Quarter-End Total Assets *

Credit Quality Measure

P.3

Ability to Withstand Funding-Related Stress

Core Deposits/Total Liabilities

Balance Sheet Liquidity Ratio

Loss Severity Score

L.1

Loss Severity Measure

100

* Average of five quarter-end total assets (most recent and four prior quarters).

1. Performance Score

The performance score for large institutions is a weighted average of the scores for three components: (1) Weighted average CAMELS rating score; (2) ability to withstand asset-related stress score; and (3) ability to withstand funding-related stress score. Table 7 shows the weight given to the score for each of these components.

a. Weighted Average CAMELS Rating Score

To compute the weighted average CAMELS rating score, a weighted average of the large institution's CAMELS component ratings is first calculated using the weights shown in Table 8. These weights are the same as the weights used in the financial ratios method, which is currently used to determine assessment rates for all insured depository institutions in Risk Category I.

12 CFR part 327, Subpt. A, App. A (2010).

Table 8—Weights for CAMELS Component Ratings

CAMELS component

Weight

(percent)

A weighted average CAMELS rating converts to a score that ranges from 25 to 100. A weighted average rating of 1 equals a score of 25 and a weighted average of 3.5 or greater equals a score of 100. Weighted average CAMELS ratings between 1 and 3.5 are assigned a score between 25 and 100. The score increases at an increasing rate as the weighted average CAMELS rating increases. Appendix B describes how the FDIC converts a weighted average CAMELS rating to a score.

b. Ability To Withstand Asset-Related Stress Score

The score for the ability to withstand asset-related stress is a weighted average of the scores for the four measures that the FDIC finds most relevant to assessing a large institution's ability to withstand such stress; they are:

• Tier 1 leverage ratio;

• Concentration measure (the greater of the higher-risk assets to the sum of Tier 1 capital and reserves score or the growth-adjusted portfolio concentrations score);

• The ratio of core earnings to average quarter-end total assets; and

In general, these measures proved to be the most statistically significant measures of a large institution's ability to withstand asset-related stress, as described in Appendix 2. Appendix A describes these measures.

The method for calculating the scores for the Tier 1 leverage ratio and the ratio of core earnings to average quarter-end total assets is described in Appendix B.

The score for the concentration measure is the greater of the higher-risk assets to Tier 1 capital and reserves score or the growth-adjusted portfolio concentrations score.

Appendix B describes the conversion of these ratios to scores. Appendix C describes the ratios.

The ratio of higher-risk assets to Tier 1 capital and reserves gauges concentrations that are currently deemed to be high risk. The growth-adjusted portfolio concentration measure does not solely consider high-risk portfolios, but considers most loan portfolio concentrations, along with growth of the concentration.

The score for the credit quality measure is the greater of the criticized and classified items to Tier 1 capital and reserves score or the underperforming assets to Tier 1 capital and reserves score.

Appendix B describes conversion of the credit quality measure into a credit quality score.

The criticized and classified items ratio measures commercial credit quality while the underperforming assets ratio is often a better indicator for consumer portfolios.

Table 9 shows the ability to withstand asset related stress measures, gives the cutoff values for each measure and shows the weight assigned to the measure to derive a score. Appendix B describes how each of the risk measures is converted to a score between 0 and 100 based upon the minimum and maximum cutoff values.

Most of the minimum and maximum cutoff values for each risk measure equal the 10th and 90th percentile values of the measure among large institutions based upon data from the period between the first quarter of 2000 and the fourth quarter of 2009. The 10th and 90th percentiles are not used for the higher-risk assets to Tier 1 capital and reserves ratio and the criticized and classified items ratio due to data availability. Data on the higher-risk assets to Tier 1 capital and reserves ratio are available consistently since second quarter 2008, while criticized and classified items are available consistently since first quarter 2007. The maximum cut off value for the higher-risk assets to Tier 1 capital and reserves measure is close to but does not equal the 75th percentile. The maximum cutoff value for the criticized and classified items ratio is close to but does not equal the 80th percentile value. These alternative cutoff values are based on recent experience since earlier data is unavailable. Appendix 2 includes information regarding the percentile values for each risk measure.

Table 9—Cutoff Values and Weights for Measures To Calculate Ability To Withstand Asset-Related Stress Score

Measures of the ability to withstand asset-related stress

Cutoff values

Minimum

(percent)

Maximum

(percent)

Weights

(percent)

Tier 1 Leverage Ratio

Concentration Measure

Higher-Risk Assets to Tier 1 Capital and Reserves; or

135

Growth-Adjusted Portfolio Concentrations

Core Earnings/Average Quarter-End Total Assets*

Credit Quality Measure

Criticized and Classified Items/Tier 1 Capital and Reserves; or

100

Underperforming Assets/Tier 1 Capital and Reserves

* Average of five quarter-end total assets (most recent and four prior quarters).

The score for each measure is multiplied by its respective weight and the resulting weighted score is summed to arrive at a score for an ability to withstand asset-related stress, which can range from 0 to 100.

Table 10 illustrates how the score for the ability to withstand asset-related stress is calculated for a hypothetical bank, Bank A.

Table 10—Calculation of Bank A's Ability To Withstand Asset-Related Stress Score

Measures of the ability to withstand asset-related stress

Value

(percent)

Score *

Weight

(percent)

Weighted score

Tier 1 Leverage Ratio

6.98

86.00

8.60

Concentration Measure

100.00

35.00

Higher Risk Assets/Tier 1 Capital and Reserves; or

162.00

100.00

Growth-Adjusted Portfolio Concentrations

43.62

76.19

Core Earnings/Average Quarter-End Total Assets

0.67

66.50

13.30

Credit Quality Measure

100.00

35.00

Criticized and Classified Items/Tier 1 Capital and Reserves; or

114.00

100.00

Underperforming Assets/Tier 1 Capital and Reserves

34.25

97.73

Total ability to withstand asset-related stress score

91.90

* In the example, scores are rounded to two decimal points for Bank A. In actuality, scores will be rounded to three decimal places.

Bank A's higher risk assets to Tier 1 capital and reserves score (100.00) is higher than its growth-adjusted portfolio concentration score (76.19). Thus, the higher risk assets to Tier 1 capital and reserves score is multiplied by the 35 percent weight to get a weighted score of 35.00 and the growth-adjusted portfolio concentrations score is ignored. Similarly, Bank A's criticized and classified items to Tier 1 capital and reserves score (100.00) is higher than its underperforming assets to Tier 1 capital and reserves score (97.73). Therefore, the criticized and classified items to Tier 1 capital and reserves score is multiplied by the 35 percent weight to get a weighted score of 35.00 and the underperforming assets to Tier 1 capital and reserves score is ignored. These weighted scores, along with the weighted scores for the Tier 1 leverage ratio (8.60) and core earnings to average quarter-end total assets ratio (13.30), are added together, resulting in the ability to withstand asset-related stress score of 91.90.

c. Comments on Ability To Withstand Asset-Related Stress

The FDIC received a number of comments that relate to scorecard measures used to assess an institution's ability to withstand asset-related stress.

Criticized and Classified Items Ratio

The FDIC received several comments suggesting that the FDIC discount or exclude certain items, such as purchased credit impaired (PCI) loans or performing restructured loans, from the definition of criticized and classified items, since these items do not result in the same degree of loss as other, typical, classified and criticized items.

The FDIC acknowledges that losses associated with various items included in criticized and classified items may vary, depending on collateral, the degree of previous loss recognition and other factors. However, relying on greater detail on these types of assets would increase, not decrease, the complexity of the model and would require additional data elements to be collected from institutions. The FDIC believes that the added complexity and burden of collecting more detailed data outweighs the additional benefit, but, relying upon data obtained through the examination process, will consider the idiosyncratic and qualitative factors that may influence potential losses associated with various criticized and classified items in determining whether to apply a large bank adjustment (discussed below).

One commenter cautioned against potential inconsistencies in reported criticized and classified items, particularly when examination classifications differ from an institution's internal classifications. For the purpose of the large bank scorecard, criticized and classified items are defined as those items that the institution has internally identified as Special Mention, Substandard, Doubtful, or Loss on its own management reports or items identified as Special Mention or worse by an institution's primary federal regulator.

Appendix A of the final rule describes the definition.

Growth-Adjusted Portfolio Concentrations Ratio

Several commenters stated that the growth-adjusted portfolio concentrations ratio unfairly captures growth attributed to the Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140, and Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R), which are one-time accounting adjustments (FAS 166/167).

FDIC analysis shows that asset growth associated with FAS 166/167 guidelines has a one-time effect on only a small number of institutions. Weighing the benefit of collecting additional information on the effect of FAS 166/167 against the added complexity and associated data collection burden, the FDIC has concluded that it would be better to consider the effect of FAS 166/167 as it determines whether to apply a large bank adjustment.

Higher-Risk Assets Ratio

A number of commenters stated that certain elements of the higher-risk assets ratio contain data items that are not Call Report items and could lead to inconsistent reporting among banks. As proposed in the Large Bank NPR, the FDIC will collect all data elements, other than CAMELS ratings, directly from institutions through the Call Reports and TFRs. These measures are defined in Appendix A.

The FDIC also received a number of comments suggesting changes in the definition of leveraged lending, subprime loans and nontraditional mortgages, which are used in the higher-risk assets ratio. These comments are discussed below.

Leveraged Lending

Several commenters asked for a change in the definition of leveraged lending to exclude small business loans, real estate loans or loans for buyout, acquisition, and recapitalization that do not otherwise meet the definition of leveraged lending. Commenters also cautioned against using specific “bright line” financial metrics to determine whether a loan is leveraged. In addition, commenters stated that regular updating of loan data for the purposes of identifying leveraged loans is burdensome and costly.

The FDIC agrees that several of these comments have merit. For the purpose of this rule, leveraged loans exclude all real estate loans and those small business loans with an original amount of $1 million or less.

The FDIC believes that some bright-line metrics are necessary to ensure consistency in reporting among institutions; however, the final rule removes the total liabilities to asset ratio test from the definition of leveraged loans.

Any other commercial loan or security, regardless of the stated purpose, will be considered leveraged only if it meets one of the two remaining criteria described in Appendix C.

The original amount is defined in Appendix C.

The remaining tests for determining whether a loan is leveraged are consistent with the Office of the Comptroller of the Currency's Handbook,

http://www.occ.gov/static/publications/handbook/LeveragedLending.pdf.

Subprime Loans

Several commenters asked that the definition of a subprime loan be revised to comport with the 2001 Interagency Guidance and to exclude loans that have deteriorated subsequent to origination, citing the burden and cost associated with regular updating of borrower information.

One commenter argued against referencing the FICO score in defining subprime loans, stating that the rule should not endorse a specific brand. A couple of commenters cautioned about potential inconsistencies among institutions in identifying subprime loans.

FDIC Press Release PR-9-2001 01-31-2001,

http://www.fdic.gov/news/news/press/2001/pr0901a.html.

To reduce any potential burden, the final rule defines subprime loans as those that meet the criteria for being subprime at origination or refinancing. The definition in the final rule deletes the reference to FICO and other credit bureau scores. While the FDIC is aware that originators often use credit scores in the loan underwriting process, the FDIC has decided not to use a credit score threshold as a potential characteristic of a subprime borrower. Such a definition would require reliance on credit scoring models that are controlled by credit rating bureaus; thus, the models may change materially at the discretion of the credit rating bureaus. There also may be inconsistencies among the various models that the credit rating bureaus use. Research has consistently found that borrower credit history is among the most important predictors of default.

The final rule focuses on credit history as a characteristic of a subprime borrower, but, to avoid underreporting of subprime loans, the definition now includes loans that an institution itself identifies as subprime based upon similar borrower characteristics. Appendix A describes the definition.

See, e.g.,

Board of Governors of the Federal Reserve System,

Report to the Congress on Credit Scoring and Its Effects on the Availability and Affordability of Credit,

August 2007,

http://www.federalreserve.gov/boarddocs/rptcongress/creditscore/creditscore.pdf.

Nontraditional Mortgages

A number of commenters argued that interest-only loans should not be included in the definition of non-traditional mortgages for the higher risk concentration measure, given that the risk they pose differs from other non-traditional mortgages. The FDIC disagrees. The FDIC believes that interest-only loans generally exhibit higher risk than traditional amortizing mortgage loans, particularly in a stressful economic environment. The FDIC understands that qualitative factors such as credit underwriting or credit administration are important in determining potential losses associated with interest-only loans; however, these factors can influence potential losses for any type of loan and, in addition, are not easily measurable systematically. The FDIC will consider these qualitative factors in determining whether to apply a large bank adjustment.

One comment asked for a specific definition of a teaser rate mortgage. For the purpose of the final rule, a teaser-rate mortgage is a mortgage with a discounted initial rate and lower payments for part of the mortgage term.

Averaging the Credit Quality and Concentration Scores

A number of commenters suggested that the FDIC should average the two concentration scores and the two credit quality scores, rather than using the greater of the two scores in each case. The FDIC disagrees. The two credit quality ratios capture credit risk in different ways: the criticized and classified items ratio is more relevant for the performance of an institution's commercial portfolio; the underperforming asset ratio is more relevant for the performance of an institution's retail portfolio. Depending on an institution's asset composition, one measure may better capture the institution's credit quality than another. Therefore, averaging the two scores could understate credit quality concerns.

Similarly, the two concentration ratios are designed to capture different concentration risk. The high-risk asset concentration ratio captures the risk associated with concentrated lending in high-risk areas that directly contributed to the failure of a number of large

institutions during the recent economic downturn. The FDIC recognizes, however, that other types of concentrations may lead to failure in the future, particularly if the concentrations are accompanied by rapid growth, which is what the growth-adjusted portfolio concentration ratio is designed to measure. Recent experience shows that many institutions that subsequently experienced problems eased underwriting standards and expanded beyond their traditional areas of expertise to grow rapidly. Since these two concentration ratios are designed to capture different types of concentration risk, averaging the two scores could reduce the scorecard's ability to differentiate risk.

d. Ability To Withstand Funding-Related Stress Score

The ability to withstand funding-related stress component contains two measures that are most relevant to assessing a large institution's ability to withstand such stress—a core deposits to total liabilities ratio and a balance sheet liquidity ratio, which measures the amount of highly liquid assets needed to cover potential cash outflows in the event of stress.

66 67

These ratios are significant in predicting a large institution's long-term performance in the statistical test described in Appendix 2. Appendix A describes these risk measures. Appendix B describes how each of these measures is converted to a score between 0 and 100.

The final rule clarifies that all securities included in the definition of liquid assets are measured at fair value.

The deposit runoff assumptions proposed in the Large Bank NPR were based on the Basel liquidity measure. The final rule modified deposit runoff rates for the balance sheet liquidity ratio to reflect changes issued by the Basel Committee on Banking Supervision in its December 2010 document, “Basel III: International framework for liquidity risk measurement, standards and monitoring,”

http://www.bis.org/publ/bcbs188.pdf.

The score for the ability to withstand funding-related stress is the weighted average of the scores for two measures. Table 11 shows the cutoff values and weights for these measures. Weights assigned to each of these two risk measures are based on a statistical analysis described in Appendix 2.

Table 11—Cutoff Values and Weights To Calculate Ability To Withstand Funding-Related Stress Score

Measures of the ability to withstand funding-related stress

Cutoff values

Minimum

(percent)

Maximum

(percent)

Weight

(percent)

Core Deposits/Total Liabilities

Balance Sheet Liquidity Ratio

243

Table 12 illustrates how the score for the ability to withstand funding-related stress for hypothetical bank, Bank A, is calculated.

Table 12—Calculation of Bank A's Score for Ability To Withstand Funding-Related Stress

Measures of the ability to withstand funding-related stress

Value

(percent)

Score *

Weight

(percent)

Weighted score

Core Deposits/Total Liabilities

60.25

32.62

19.57

Balance Sheet Liquidity Ratio

69.58

73.48

29.39

Total ability to withstand funding-related stress score

48.96

* In the example, scores are rounded to two decimal points for Bank A. In actuality, scores will be rounded to three decimal places.

e. Comments on the Ability To Withstand Funding-Related Stress

Definition of Core Deposits and Brokered Deposits

Several commenters stated that the definitions for core deposits and brokered deposits as used in the core deposits to total liabilities ratio are outdated and should be revised. These commenters stated that reciprocal deposits, affiliated broker-dealer sweeps and long-term brokered deposits are stable deposits, and therefore, should be included in the definition of core deposits. In the final rule, for this purpose, core deposits exclude all brokered deposits. However, as mentioned in Section III, Dodd-Frank mandated that the FDIC conduct a study to evaluate the existing brokered deposit and core deposit definitions. The FDIC will examine the definition in light of the completed study and will consider changes then, if appropriate.

Balance Sheet Liquidity Ratio

Several commenters argued that unencumbered agency mortgage-backed securities (MBSs) should be included as liquid assets in calculating the balance sheet liquidity ratio, arguing that they are a reliable source of liquidity. These commenters also pointed to the Basel liquidity measures, which include unencumbered agency MBSs as highly liquid assets, with appropriate haircuts.

The FDIC believes that an institution's ability to withstand funding-related stress can be best measured by highly liquid assets that can be readily converted to cash with little or no loss in value, relative to potential short-term funding outflows. While agency MBSs are generally liquid, they are not as highly liquid as other assets included as liquid assets in the definition of balance sheet liquidity ratio, particularly given the greater interest rate risk inherent in these securities.

One commenter noted that deposits owned by a parent should not be subjected to the same runoff rates as other deposits for the purpose of the balance sheet liquidity ratio, given that these deposits behave similarly to long-term unsecured debt. The same comment was made in the context of loss severity. The FDIC disagrees. Parent companies, as well as other creditors, can have incentives to withdraw deposits from a troubled institution. Deposits are not equivalent to long-term unsecured debt.

Calculation of Performance Score

The scores for the weighted average CAMELS rating, the ability to withstand asset-related stress component, and the ability to withstand funding-related stress component are multiplied by their respective weights and the results are summed to arrive at the performance score. The performance score cannot be less than 0 or more than 100, where a score of 0 reflects the lowest risk and a score of 100 reflects the higher risk. In the example in Table 13, Bank A's performance score would be 70.92, assuming that Bank A's score for its weighted average CAMELS score of 50.60, which results from a weighted average CAMELS rating of 2.2.

Table 13—Performance Score for Bank A

Performance score components

Weight

(percent)

Score *

Weighted score

Weighted Average CAMELS Rating

50.60

15.18

Ability to Withstand Asset-Related Stress

91.90

45.95

Ability to Withstand Funding-Related Stress

48.96

9.79

Total Performance Score

70.92

* In the example, scores are rounded to two decimal points for Bank A. In actuality, scores will be rounded to three decimal places.

2. Loss Severity Score

The loss severity score is based on a loss severity measure that estimates the relative magnitude of potential losses to the FDIC in the event of a large institution's failure. The loss severity measure applies a standardized set of assumptions—based on recent failures—regarding liability runoffs and the recovery value of asset categories to calculate possible losses to the FDIC. (Appendix D describes the calculation of this measure.) Asset loss rate assumptions are based on estimates of recovery values for insured depository institutions that either failed or came close to failure. Run-off assumptions are based on the actual experience of insured depository institutions that either failed or came close to failure during the 2007 through 2009 period.

The loss severity measure is a quantitative measure that is derived from readily available data. Appendix A defines this measure. Appendix B describes how the loss severity measure is converted to a loss severity score between 0 and 100. Table 14 shows cutoff values for the loss severity measure. The loss severity score cannot be less than 0 or more than 100.

Table 14—Cutoff Values To Calculate Loss Severity Score

Measure of loss severity

Cutoff values

Minimum

(percent)

Maximum

(percent)

Loss Severity

In the example in Table 15, Bank A's loss severity measure is 23.62 percent, which represents potential losses in the event of Bank A's failure relative to its domestic deposits. This measure would result in a loss severity score of 84.36.

Table 15—Loss Severity Score for Bank A

Measure of loss severity

Ratio

(percent)

Score *

Potential Losses/Total Domestic Deposits (Loss severity measure)

23.62

84.36

* In the example, the score is rounded to two decimal points for Bank A. In actuality, scores will be rounded to three decimal places.

3. Comments on Loss Severity Score

In general, commenters did not oppose including loss severity in the initial base assessment rate calculation. However, many commenters questioned the proposed assumptions regarding the loss rates applied to various asset types and regarding liability runoff rates, arguing that they were too harsh or lacked empirical support. These comments are discussed below.

a. Loss Rate Assumptions

Some commenters disagreed with the loss rates assigned to various asset categories and argued that:

• The FDIC should not discount asset values;

• Using the same loss rates for all institutions is not reasonable and the loan-to-value ratio should be considered in determining the loss rate;

• A zero loss rate should be applied to government-guaranteed loans;

• Loss rates applied to acquired loans booked at fair value are too high; and

• Asset categories (

e.g.,

leases, first-lien home equities, all other loans, all other assets) should be further subdivided to provide the less-risky assets within those categories a lower loss rate.

The FDIC disagrees with these comments. The current value of an institution's assets is not a good indicator of the recovery value of these assets in the event of failure. To estimate potential recovery values, the loss severity measure applies a standardized set of loss rates to various asset categories, based on independent valuations obtained by the FDIC in 2009 on assets expected to be taken into receivership.

The FDIC recognizes that collateral value, the loan-to-value ratio and the existence of a government guarantee may have a bearing on recovery rates; however, data on collateral value and other risk mitigants are not systematically available for all institutions. Also, government guarantees may or may not reduce the FDIC's risk of loss, depending on the agency issuing the guaranty and the transferability of the guaranty in the event of failure. In these cases, the FDIC will consider available information on collateral and other risk mitigants, including the materiality of guarantees, in determining whether to apply a large bank adjustment.

The FDIC does not believe the loss severity measure should systematically try to adjust for loans booked at fair value. Loans booked at fair value are typically not material for most institutions, and, even when they are, their recovery values in the event of failure are often well below current fair values.

The FDIC recognizes that the loss rates applied to broad categories of assets may overstate or understate potential losses, depending on the composition of those assets. However, the FDIC believes that further subdividing asset categories introduces greater complexity and is not practical without imposing undue burden.

b. Runoff Assumptions

A number of commenters stated that the proposed insured deposit growth assumption used in the loss severity measure is too high and unrealistic given the supervisory constraint that will restrict growth as an institution nears failure. The FDIC agrees. Runoff and growth assumptions for deposits proposed in the Large Bank NPR were based on the actual experience of eleven large institutions that failed between 2007 and 2009 over a two-year period leading up to their failure. The FDIC has re-estimated deposit runoffs based on data for all insured depository institutions that failed since 2007—including small institutions, which were added to improve the robustness of the analysis—over a one-year period leading up to their failure, and reduced the growth rate for insured deposits from 32 percent to 10 percent while increasing the run-off rate for uninsured deposits from 28.6 percent to 58 percent.

The changes are primarily due to shorter time-to-failure, not the inclusion of small institutions in the sample. The FDIC believes that data based on shorter time-to-failure (one year) better reflect changes in deposit composition experienced by failed institutions as they approach failure.

This updated analysis also resulted in changing the runoff assumptions for Federal funds purchased and for repurchase agreements. These new assumptions are set forth in Appendix D.

c. Foreign Deposits

Several commenters stated that runoff and ring-fencing assumptions applied to foreign deposits are excessive and unsupported. Foreign deposits are not insured by the FDIC and would be treated as unsecured claims in a receivership. Unsecured claims in a receivership rarely receive any payment since they have a lower priority than domestic deposits. The FDIC believes that these deposits were more stable during the recent crisis primarily because of extraordinary government action, both by the U.S. and European governments. In the absence of “too big to fail” perceptions or policies, the FDIC believes that foreign deposits are more likely to run off than domestic deposits. Moreover, foreign governments may ring-fence assets to protect these deposits and reduce their own losses. As a result, the final rule retains the Large Bank NPR's assumptions regarding foreign deposit runoff.

d. Noncore Funding

In the Large Bank NPR, the FDIC proposed including a noncore funding ratio in the loss severity scorecard as a potential proxy for franchise value. Most commenters stated that the noncore funding ratio should not be included because this risk is considered elsewhere. They also questioned the weight assigned to the measure. The FDIC continues to believe that potential franchise value is an important factor to consider in the overall assessment of loss severity. However, given that liability composition is explicitly considered in the loss severity measure, the final rule eliminates the noncore funding ratio from the loss severity scorecard. Instead, qualitative factors that affect an institution's franchise value will be considered in determining whether to apply a large bank adjustment.

e. Capital

One commenter stated that assuming capital will fall to 2 percent and that assets will be reduced pro rata is unreasonable. The FDIC disagrees. Path-to-failure assumptions are a necessary feature of a potential loss severity calculation, particularly for institutions that are not close to failure. Using assumptions regarding reductions in specific categories of assets introduces significant complexity. The FDIC believes that the pro rata assumption is both reasonable and practical. This may be an area, however, that lends itself to further research and analysis as the FDIC continues to pursue improvements to the risk-based assessment system.

C. Scorecard for Highly Complex Institutions

As mentioned above, those institutions that are structurally and operationally complex or that pose unique challenges and risks in case of failure have a different scorecard with measures tailored to the risks these institutions pose.

The structure and much of the scorecard for a highly complex institution are, however, similar to the scorecard for other large institutions. Like the scorecard for other large institutions, the scorecard for highly complex institutions contains a performance score and a loss severity score. Table 16 shows the measures and components and their relative contribution to a highly complex institution's performance score and loss severity score. As with the scorecard for large institutions, most of the minimum and maximum cutoff values for each scorecard measure used in the highly complex institution's scorecard equal the 10th and 90th percentile values of the particular measure among these institutions based upon data from the period between the first quarter of 2000 and the fourth quarter of 2009.

Three measures used in the highly complex institution's scorecard (that are not used in the scorecard for other large institutions) do not use the 10th and 90th percentile values as cutoffs due to lack of historical data. The cutoffs for these measures are based partly upon recent experience; the maximum cutoffs range from approximately the 75th through the 78th percentile of these measures among only highly complex institutions.

Table 16—Scorecard for Highly Complex Institutions

Measures and components

Measure weights

(percent)

Component weights

(percent)

Performance Score

P.1

Weighted Average CAMELS Rating

100

P.2

Ability to Withstand Asset-Related Stress

Tier 1 Leverage Ratio

Concentration Measure

Core Earnings/Average Quarter-End Total Assets

Credit Quality Measure and Market Risk Measure

P.3

Ability to Withstand Funding-Related Stress

Core Deposits/Total Liabilities

Balance Sheet Liquidity Ratio

Average Short-Term Funding/Average Total Assets

Loss Severity Score

L.1

Loss Severity Measure

100

1. Performance Score

The performance score for highly complex institutions is the weighted average of the scores for three components: weighted average CAMELS rating score, weighted at 30 percent; ability to withstand asset-related stress score, weighted at 50 percent; and ability to withstand funding-related stress score, weighted at 20 percent.

a. Weighted Average CAMELS Rating Score

The score for the weighted average CAMELS rating for highly complex institutions is derived in the same manner as in the scorecard for other large institutions.

b. Ability To Withstand Asset-Related Stress Score

The ability to withstand asset-related stress score contains measures that the FDIC finds most relevant to assessing a highly complex institution's ability to withstand such stress:

• Tier 1 leverage ratio;

• Concentration measure (the greatest of the higher-risk assets to the sum of Tier 1 capital and reserves score, the top 20 counterparty exposure to the sum of Tier 1 capital and reserves score, or the largest counterparty exposure to the sum of Tier 1 capital and reserves score);

• The ratio of core earnings to average quarter-end total assets;

• Credit quality measure (the greater of the criticized and classified items to the sum of Tier 1 capital and reserves score or the underperforming assets to the sum of Tier 1 capital and reserves score) and market risk measure (the weighted average of the four-quarter trading revenue volatility to Tier 1 capital score, the market risk capital to Tier 1 capital score, and the level 3 trading assets to Tier 1 capital score).

Two of the four measures used to assess a highly complex institution's ability to withstand asset-related stress (the Tier 1 leverage ratio and the core earnings to average quarter-end total assets ratio) are determined in the same manner as in the scorecard for other large institutions. However, the method used to calculate the score for the other remaining measures—the concentration measure and the credit quality and market risk measure—differ and are discussed below.

Concentration Measure

As in the scorecard for large institutions, the concentration measure for highly complex institutions includes the higher-risk assets to Tier 1 capital and reserves ratio described in Appendix C. However, the concentration measure in the highly complex institution's scorecard considers the top 20 counterparty exposures to Tier 1 capital and reserves ratio and the largest counterparty exposure to Tier 1 capital and reserves ratio instead of the growth-adjusted portfolio concentrations measure used in the scorecard for large institutions. The highly complex institution's scorecard uses these measures because recent experience shows that the concentration of a highly complex institution's exposures to a small number of counterparties—either through lending or trading activities—significantly increases the institution's vulnerability to unexpected market events. The FDIC uses the top 20 counterparty exposure and the largest counterparty exposure to capture this risk.

Credit Quality Measure and Market Risk Measure Scores

As in the scorecard for large institutions, the ability to withstand asset-related stress component includes a credit quality measure. However, the highly complex institution scorecard also includes a market risk measure that considers trading revenue volatility, market risk capital, and level 3 trading assets. All three risk measures are calculated relative to a highly complex institution's Tier 1 capital and multiplied by their respective weights to calculate the score for the market risk measure. All three risk measures can be calculated using data from an insured depository institution's quarterly Call Reports or TFRs. The FDIC believes that combining these three risk measures better captures a highly complex institution's market risk than any single measure.

The trading revenue volatility ratio measures the sensitivity of a highly complex institution's trading revenue to market volatility. The market risk capital ratio uses historical experience to estimate the effect on capital of potential losses in the trading portfolio due to market volatility.

However, this ratio may not be a good measure of market risk when an institution holds a large volume of hard-to-value trading assets. Therefore, the level 3 trading assets ratio is included as an indicator of the volume of hard-to-value trading assets held by an institution.

Market risk capital is defined in Appendix C of Part 325 of the FDIC Rules and Regulations,.

http://www.fdic.gov/regulations/laws/rules/2000-4800.html#fdic2000appendixctopart325.

The FDIC recognizes that the relevance of credit risk and market risk in assessing a highly complex institution's vulnerability to stress depends on an institution's asset composition. A highly complex institution with a significant amount of trading assets can be as risky as an institution that focuses on lending even though the primary source of risk may differ. In order to treat both types of institutions fairly, the FDIC allocates an overall weight of 35 percent between the credit risk measure and the market risk measure. The allocation will vary depending on the ratio of average trading assets to the sum of average securities, loans, and trading assets (the trading asset ratio) as follows:

• Weight for Credit Quality Measure = (1 − Trading Asset Ratio) * 0.35.

• Weight for Market Risk Measure = Trading Asset Ratio * 0.35.

Table 18 shows cutoff values and weights for the ability to withstand asset-related stress measures.

Table 18—Cutoff Values and Weights for Measures To Calculate Ability To Withstand Asset-Related Stress Score

Measures of the ability to withstand asset-related stress

Cutoff values

Minimum

(percent)

Maximum (percent)

Market risk measures

Weight

Tier 1 Leverage Ratio

10%.

Concentration Measure

35%.

Higher Risk Assets/Tier 1 Capital and Reserves

135

Top 20 Counterparty Exposure/Tier 1 Capital and Reserves; or

125

Largest Counterparty Exposure/Tier 1 Capital and Reserves

Core Earnings/Average Quarter-end Total Assets

20%.

Credit Quality Measure*

35% * (1 − Trading Asset Ratio).

Criticized and Classified Items to Tier 1 Capital and Reserves; or

100

Underperforming Assets/Tier 1 Capital and Reserves

Market Risk Measure*

35% * Trading Asset Ratio.

Trading Revenue

Volatility/Tier 1 Capital

Market Risk Capital/Tier 1 Capital

Level 3 Trading Assets/Tier 1 Capital

* Combined, the credit quality measure and the market risk measure will be assigned a 35 percent weight. The relative weight of each of the two measures will depend on the ratio of average trading assets to sum of average securities, loans and trading assets (trading asset ratio).

c. Ability To Withstand Funding-Related Stress Score

The score for the ability to withstand funding-related stress contains three measures that are most relevant to assessing a highly complex institution's ability to withstand such stress—a core deposits to total liabilities ratio, a balance sheet liquidity ratio, and an average short-term funding to average total assets ratio.

Two of the measures (the core deposits to total liabilities ratio and the balance sheet liquidity ratio) in the ability to withstand funding-related stress score are determined in the same manner as in the scorecard for large institutions, although their weights differ. The FDIC has added the average short-term funding to average total assets ratio to the ability to withstand funding-related stress component of the highly complex institution scorecard because experience during the recent crisis shows that heavy reliance on short-term funding significantly increases a highly complex institution's vulnerability to unexpected adverse developments in the funding market.

Table 19 shows cutoff values and weights for the ability to withstand funding-related stress measures.

Table 19—Cutoff Values and Weights To Calculate Ability To Withstand Funding-Related Stress Measures

Measures of the ability to withstand funding-related stress

Cutoff values

Minimum

(percent)

Maximum (percent)

Weight

(percent)

Core Deposits/Total Liabilities

Balance Sheet Liquidity Ratio

243

Average Short-term Funding/Average Total Assets

d. Calculating the Performance Score

To calculate the performance score for a highly complex institution, the scores for the weighted average CAMELS score, the ability to withstand asset-related stress score, and the ability to withstand funding-related stress score are multiplied by their respective weights and the results are summed to arrive at the performance score.

2. The Loss Severity Score

The loss severity score for highly complex institutions is calculated the same way as the loss severity score for other large institutions.

D. Total Score

1. Calcul

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