# Assessments > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2016-11181 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** May 20, 2016 - **Citation:** 81 FR 32180 ## Text FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Part 327 RIN 3064-AE37 Assessments AGENCY: Federal Deposit Insurance Corporation (FDIC). ACTION: Final rule. SUMMARY: The FDIC is amending its rules to refine the deposit insurance assessment system for small insured depository institutions that have been federally insured for at least five years (established small banks) by: Revising the financial ratios method so that it is based on a statistical model estimating the probability of failure over three years; updating the financial measures used in the financial ratios method consistent with the statistical model; and eliminating risk categories for established small banks and using the financial ratios method to determine assessment rates for all such banks (subject to minimum or maximum initial assessment rates based upon a bank's CAMELS composite rating). Under current regulations, deposit insurance assessment rates will decrease once the deposit insurance fund (DIF or fund) reserve ratio reaches 1.15 percent. The final rule preserves the range of initial assessment rates authorized under current regulations. DATES: The final rule is effective July 1, 2016. Applicability date: If the reserve ratio reaches 1.15 percent before that date, the assessment system described in the final rule will become operative July 1, 2016. If the reserve ratio has not reached 1.15 percent by that date, the assessment system described in the final rule will become operative the first day of the calendar quarter after the reserve ratio reaches 1.15 percent. FOR FURTHER INFORMATION CONTACT: Munsell St. Clair, Chief, Banking and Regulatory Policy, Division of Insurance and Research, 202-898-8967; Ashley Mihalik, Senior Policy Analyst, Division of Insurance and Research, 202-898-3793; Nefretete Smith, Counsel, Legal Division, 202-898-6851; Thomas Hearn, Counsel, Legal Division, 202-898-6967. SUPPLEMENTARY INFORMATION: I. Background Policy Objectives The primary purpose of the final rule is to improve the risk-based deposit insurance assessment system applicable to established small banks to more accurately reflect risk. 1 Additional discussion of the policy objectives of the final rule can be found in the notice of proposed rulemaking adopted by the FDIC's Board of Directors (Board) on June 6, 2015. 2 1 12 U.S.C. 1817(b). A “risk-based assessment system” means a system for calculating an insured depository institution's deposit insurance assessment based on the institution's probability of causing a loss to the DIF due to the composition and concentration of the institution's assets and liabilities, the likely amount of any such loss, and the revenue needs of the DIF. See 12 U.S.C. 1817(b)(1)(C). As used in this final rule, the term “bank” is synonymous with the term “insured depository institution” as it is used in section 3(c)(2) of the Federal Deposit Insurance Act (FDI Act), 12 U.S.C. 1813(c)(2). As used in this final rule, the term “small bank” is synonymous with the term “small institution” as it is used in 12 CFR 327.8. In general, a “small bank” is one with less than $10 billion in total assets. 2 See 80 FR at 40838 and 40842 (July 13, 2015). Risk-Based Deposit Insurance Assessments for Established Small Banks Since 2007, assessment rates for established small banks (that is, small banks other than new small banks and insured branches of foreign banks) 3 have been determined by placing each bank into one of four risk categories, Risk Categories I, II, III, and IV. 4 These four risk categories are based on two criteria: Capital levels and supervisory ratings. The three capital groups—well capitalized, adequately capitalized, and undercapitalized—are based on the leverage ratio and three risk-based capital ratios used for regulatory capital purposes. 5 The three supervisory groups, termed A, B, and C, are based upon supervisory evaluations by the small bank's primary federal regulator, state regulator, or the FDIC. 6 Group A consists of financially sound institutions with only a few minor weaknesses (generally, banks with CAMELS composite ratings of 1 or 2); Group B consists of institutions that demonstrate weaknesses that, if not corrected, could result in significant deterioration of the institution and increased risk of loss to the DIF (generally, banks with CAMELS composite ratings of 3); and Group C consists of institutions that pose a substantial probability of loss to the DIF unless effective corrective action is taken (generally, banks with CAMELS composite ratings of 4 or 5). 7 An institution's capital group and supervisory group determine its risk category as set out in Table 1 below. 3 Subject to exceptions, an established insured depository institution is one that has been federally insured for at least five years as of the last day of any quarter for which it is being assessed. 12 CFR 327.8(k). 4 On January 1, 2007, the FDIC instituted separate assessment systems for small and large banks. 71 FR 69282 (Nov. 30, 2006). See 12 U.S.C. 1817(b)(1)(D) (granting the Board the authority to establish separate risk-based assessment systems for large and small insured depository institutions). 5 The common equity tier 1 capital ratio was incorporated into the deposit insurance assessment system effective January 1, 2015. 79 FR 70427 (November 26, 2014). Beginning January 1, 2018, a supplementary leverage ratio will also be used to determine whether an advanced approaches bank is: (a) Well capitalized, if the bank is subject to the enhanced supplementary leverage ratio standards under 12 CFR 6.4(c)(1)(iv)(B), 12 CFR 208.43(c)(1)(iv)(B), or 12 CFR 324.403(b)(1)(vi), as each may be amended from time to time; and (b) adequately capitalized, if the bank is subject to the advanced approaches risk-based capital rules under 12 CFR 6.4(c)(2)(iv)(B), 12 CFR 208.43(c)(2)(iv)(B), or 12 CFR 324.403(b)(2)(vi), as each may be amended from time to time. 79 FR 70427, 70437 (November 26, 2014). The supplementary leverage ratio is expected to affect the capital group assignment of few, if any, small banks. 6 The term “primary federal regulator” is synonymous with the term “appropriate federal banking agency” as it is used in section 3(q) of the FDI Act, 12 U.S.C. 1813(q). 7 A financial institution is assigned a CAMELS composite rating based on an evaluation and rating of six essential components of an institution's financial condition and operations. These component factors address the adequacy of capital (C), the quality of assets (A), the capability of management (M), the quality and level of earnings (E), the adequacy of liquidity (L), and sensitivity to market risk (S). Table 1—Determination of Risk Category Capital group Supervisory group A CAMELS 1 or 2 B CAMELS 3 C CAMELS 4 or 5 Well Capitalized Risk Category I Adequately Capitalized Risk Category II Risk Category III. Under Capitalized Risk Category III Risk Category IV. To further differentiate risk within Risk Category I (which includes most small banks), the FDIC uses the financial ratios method, which combines a weighted average of supervisory CAMELS component ratings 8 with current financial ratios to determine a small Risk Category I bank's initial assessment rate. 9 8 The weights applied to CAMELS components are as follows: 25 percent each for Capital and Management; 20 percent for Asset quality; and 10 percent each for Earnings, Liquidity, and Sensitivity to market risk. These weights reflect the view of the FDIC regarding the relative importance of each of the CAMELS components for differentiating risk among institutions for deposit insurance assessment purposes. The FDIC and other bank supervisors do not use such a system to determine CAMELS composite ratings. 9 New small banks in Risk Category I, however, are charged the highest initial assessment rate in effect for that risk category. Subject to exceptions, a new bank is one 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). Within Risk Category I, those institutions that pose the least risk are charged a minimum initial assessment rate and those that pose the greatest risk are charged an initial assessment rate that is four basis points higher than the minimum. All other banks within Risk Category I are charged a rate that varies between these rates. In contrast, all banks in Risk Category II are charged the same initial assessment rate, which is higher than the maximum initial rate for Risk Category I. A single, higher, initial assessment rate applies to each bank in Risk Category III and another, higher, rate to each bank in Risk Category IV. 10 10 In 2011, the Board revised and approved regular assessment rate schedules. See 76 FR 10672 (Feb. 25, 2011); 12 CFR 327.10. To determine a Risk Category I bank's initial assessment rate, the weighted CAMELS components and financial ratios are multiplied by statistically derived pricing multipliers, the products are summed, and the sum is added to a uniform amount that applies to all Risk Category I banks. If, however, the rate is below the minimum initial assessment rate for Risk Category I, the bank will pay the minimum initial assessment rate; if the rate derived is above the maximum initial assessment rate for Risk Category I, then the bank will pay the maximum initial rate for the risk category. The financial ratios used to determine rates come from a statistical model that predicts the probability that a Risk Category I institution will be downgraded from a CAMELS composite rating of 1 or 2 to a rating of 3 or worse within one year. The probability of a CAMELS downgrade is intended as a proxy for the bank's probability of failure. When the model was developed in 2006, the FDIC decided not to attempt to determine a bank's probability of failure because of the lack of bank failures in the years between the end of the bank and thrift crisis in the early 1990s and 2006. 11 11 See 71 FR 41910, 41913 (July 24, 2006). The financial ratios method does not apply to new small banks or to insured branches of foreign banks (insured branches). 12 12 Insured branches are deemed small banks for purposes of the deposit insurance assessment system. Assessment Rates Under Current Rules In 2011, the FDIC adopted a schedule of assessment rates designed to ensure that the reserve ratio reaches 1.15 percent by September 30, 2020. 13 13 See 76 FR 10672. Among other things, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), enacted in July 2010: (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), 12 U.S.C. 1817(b)(3)(B); (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), 12 U.S.C. 1817(note); and (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] on insured depository institutions with total consolidated assets of less than $10,000,000,000,” 12 U.S.C. 1817(note). On March 15, 2016, the FDIC adopted a final rule to implement the Dodd-Frank Act requirements that the fund reserve ratio reach 1.35 percent by September 30, 2020, and that the effect of the higher minimum reserve ratio on insured depository institutions with total consolidated assets of less than $10 billion be offset. See 81 FR 16059 (Mar. 25, 2016). The initial assessment rates currently in effect for small and large banks are set forth in Table 2 below. 14 14 Before adopting the assessment rate schedules currently in effect, the FDIC undertook a historical analysis to determine how high the reserve ratio would have to have been to have maintained both a positive balance and stable assessment rates from 1950 through 2010. The historical analysis and long-term fund management plan are described at 76 FR at 10675 and 75 FR 66272, 66272-66281 (Oct. 27, 2010). The analysis shows 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. Table 2—Initial Base Assessment Rates [In basis points per annum] Risk category I * Minimum Maximum II III IV Large & highly complex institutions ** Annual Rates (in basis points) 5 9 14 23 35 5-35 * Initial base rates that are not the minimum or maximum will vary between these rates. ** See 12 CFR 327.8(f) and 12 CFR 327.8(g) for the definition of large and highly complex institutions. An institution's total assessment rate may vary from the initial assessment rate as the result of possible adjustments. 15 After applying all possible adjustments, minimum and maximum total assessment rates for each risk category are set forth in Table 3 below. 15 A bank's total base assessment rate can vary from its initial base assessment rate as the result of three possible adjustments. Two of these adjustments—the unsecured debt adjustment and the depository institution debt adjustment (DIDA)—apply to all banks (except that the unsecured debt adjustment does not apply to new banks or insured branches). The unsecured debt adjustment lowers a bank's assessment rate based on the bank's ratio of long-term unsecured debt to the bank's assessment base. The DIDA increases a bank's assessment rate when it holds long-term, unsecured debt issued by another insured depository institution. The third possible adjustment—the brokered deposit adjustment—applies only to small banks in Risk Category II, III and IV and to large and highly complex institutions that are not well capitalized or that are not CAMELS composite 1 or 2-rated. It does not apply to insured branches. The brokered deposit adjustment increases a bank's assessment when it holds significant amounts of brokered deposits. 12 CFR 327.9 (d). Table 3—Total Base Assessment Rates * [In basis points per annum] Risk category I Risk category II Risk category III Risk category IV Large & highly complex institutions ** Initial Base Assessment Rate 5-9 14 23 35 5-35. Unsecured Debt Adjustment *** −4.5 to 0 −5 to 0 −5 to 0 −5 to 0 −5 to 0. Brokered Deposit Adjustment N/A 0 to 10 0 to 10 0 to 10 0 to 10. Total Base Assessment Rate 2.5 to 9 9 to 24 18 to 33 30 to 45 2.5 to 45. * Total base assessment rates do not include the DIDA. ** See 12 CFR 327.8(f) and (g) for the definition of large and highly complex institutions. *** 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. The unsecured debt adjustment does not apply to new banks or insured branches. In 2011, consistent with the FDIC's long-term fund management plan, the Board adopted lower, moderate assessment rates that will go into effect when the DIF reserve ratio reaches 1.15 percent. 16 Pursuant to the FDIC's authority to set assessments, the regulations currently provide that the initial 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 Board. The rates are to remain in effect unless and until the reserve ratio meets or exceeds 2 percent. 17 16 See 76 FR at 10717-720. 17 For new banks, however, the rates will remain in effect even if the reserve ratio equals or exceeds 2 percent (or 2.5 percent). Table 4—Initial and Total Base Assessment Rates * [In basis points per annum] [Once the reserve ratio reaches 1.15 percent 18 ] Risk category I Risk category II Risk category III Risk category IV Large & highly complex institutions ** Initial Base Assessment Rate 3-7 12 19 30 3-30. Unsecured Debt Adjustment *** −3.5 to 0 −5 to 0 −5 to 0 −5 to 0 −5 to 0. Brokered Deposit Adjustment N/A 0 to 10 0 to 10 0 to 10 0 to 10. Total Base Assessment Rate 1.5 to 7 7 to 22 14 to 29 25 to 40 1.5 to 40. * Total base assessment rates do not include the DIDA. ** See 12 CFR 327.8(f) and (g) for the definition of large and highly complex institutions. *** 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. The unsecured debt adjustment does not apply to new banks or insured branches. In lieu of dividends, and pursuant to the FDIC's authority to set assessments and consistent with the FDIC's long-term fund management plan, the Board also adopted a lower schedule of assessment rates that will take effect without further action by the 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, and another, still lower, schedule of assessment rates that will take effect, again, without further action by the Board, when the fund reserve ratio at the end of the prior assessment period meets or exceeds 2.5 percent. 18 The reserve ratio for the immediately prior assessment period must also be less than 2 percent. The Board, by regulation, may adopt rates without further notice and comment rulemaking that are higher or lower than the total assessment rates (also known as the total base assessment rates), provided that: (1) The Board cannot increase or decrease rates from one quarter to the next by more than two basis points; and (2) cumulative increases and decreases cannot be more than two basis points higher or lower than the total base assessment rates. 19 19 See 12 CFR 327.10(f); 76 FR at 10684. The 2015 Notice of Proposed Rulemaking On June 16, 2015, the Board authorized publication of a notice of proposed rulemaking (2015 NPR) to refine the deposit insurance assessment system for established small banks. The 2015 NPR was published in the Federal Register on July 13, 2015. 20 In the 2015 NPR, the FDIC proposed to improve the assessment system applicable to established small banks by: (1) Revising the financial ratios method so that it would be based on a statistical model estimating the probability of failure over three years; (2) updating the financial measures used in the financial ratios method consistent with the statistical model; and (3) eliminating risk categories for all established small banks and using the financial ratios method to determine assessment rates for all such banks. CAMELS composite ratings, however, would be used to place a maximum on the assessment rates that CAMELS composite 1- and 2-rated banks could be charged and minimums on the assessment rates that CAMELS composite 3-, 4- and 5-rated banks could be charged. 20 See 80 FR 40838 (July 13, 2015). The FDIC received a total of 484 comment letters in response to the 2015 NPR. Of these, 45 were from trade groups and 439 were from individuals or banks. These comments addressed many aspects of the proposal, including the loan mix index and the one-year asset growth measure, but the majority of comments expressed concern regarding the proposed treatment of reciprocal deposits in the 2015 NPR. The 2016 Notice of Proposed Rulemaking On January 21, 2016, the Board authorized publication of a second notice of proposed rulemaking (the 2016 revised NPR) to revise the 2015 NPR in response to comments received. The 2016 revised NPR was published in the Federal Register on February 4, 2016. 21 The broad outline of the 2016 revised NPR remained the same as the 2015 NPR, but revised the proposal by: (1) Using a brokered deposit ratio (that treats reciprocal deposits the same as under current regulations)—rather than the core deposit ratio proposed in the 2015 NPR—as a measure in the proposed financial ratios method for calculating assessment rates for all established small banks; (2) removing the existing brokered deposit adjustment applicable to certain established small banks, which is made duplicative by the new brokered deposit ratio; (3) revising the one-year asset growth measure, another of the financial ratios method measures proposed in the 2015 NPR; (4) re-estimating the statistical model underlying the established small bank deposit insurance assessment system; (5) revising the uniform amount and pricing multipliers used in the financial ratios method; and (6) providing that any future changes to the statistical model underlying the established small bank deposit insurance assessment system would go through notice-and-comment rulemaking. 21 See 81 FR 6108 (Feb. 4, 2016). The FDIC received a total of 19 comment letters in response to the 2016 revised NPR. Of these, 7 were from trade groups and 12 were from individuals or banks. Comments addressed both the revisions to the proposal made by the 2016 revised NPR and aspects of the proposal that remained unchanged from the 2015 NPR, such as the loan mix index. All comments, those received on the 2015 NPR and the 2016 revised NPR, were considered in developing this final rule. Comments are discussed in the relevant sections that follow. II. The Final Rule Description of the Final Rule The final rule adopts the proposals in the 2016 revised NPR as proposed. The financial ratios method in the final rule uses the measures described in the right-hand column of Table 5 below. For comparison's sake, the measures currently used in the financial ratios method are set out on the left-hand column of the table. To avoid unnecessary burden, the final rule will not require established small banks to report any new data in their Reports of Condition and Income (Call Reports). 22 The tier 1 leverage ratio is now known as the leverage ratio. Table 5—Comparison of Current and Final Rule Measures in the Financial Ratios Method Current Risk Category I financial ratios method Final rule financial ratios method • Weighted Average CAMELS Component Rating • Weighted Average CAMELS Component Rating. • Tier 1 Leverage Ratio. • Leverage Ratio. 22 • Net Income before Taxes/Risk-Weighted Assets • Net Income before Taxes/Total Assets. • Nonperforming Assets/Gross Assets • Nonperforming Loans and Leases/Gross Assets. • Other Real Estate Owned/Gross Assets. • Adjusted Brokered Deposit Ratio • Brokered Deposit Ratio. • One Year Asset Growth. • Net Loan Charge-Offs/Gross Assets • Loans Past Due 30-89 Days/Gross Assets • Loan Mix Index. All of the measures in the final rule are derived from a statistical model that estimates a bank's probability of failure within three years. Each of the measures is statistically significant in predicting a bank's probability of failure over that period. The estimation of the statistical model uses bank financial data and CAMELS ratings from 1985 through 2011, failure data from 1986 through 2014, and loan charge-off data from 2001 through 2014. 23 Appendix 1 to the Supplementary Information section of the 2015 NPR and the 2016 revised NPR, and appendix E to the 2016 revised NPR, describe the statistical model and the derivation of these measures in detail. 24 23 For certain lagged variables, such as one-year asset growth rates, the statistical analysis also used bank financial data from 1984. 24 See 80 FR at 40857-872 (Appendix 1 in 2015 NPR), 81 FR at 6124-35 (Appendix 1 in 2016 revised NPR), and 81 FR at 6153-55 (appendix E in 2016 revised NPR). Three of the measures in the final rule—the weighted average CAMELS component rating, the leverage ratio, and the net income ratio measure—are identical or very similar to the measures currently used in the financial ratios method. 25 The current nonperforming assets/gross assets measure includes other real estate owned. In the final rule, other real estate owned/gross assets is a separate measure from nonperforming loans and leases/gross assets. 25 The denominator in the net income before taxes/total assets measure is total assets rather than risk-weighted assets as under current rules. Also, the definition of the net income measure no longer refers to extraordinary items. The numerator of the net income measure definition is income before applicable income taxes and discontinued operations for the most recent twelve months, rather than income before income taxes and extraordinary items and other adjustments for the most recent twelve months as in the 2015 NPR and current rules. In the current Call Report, extraordinary items and discontinued operations are combined for reporting purposes. Income for the net income ratio is currently determined before both extraordinary items and discontinued operations. In January 2015, the Financial Accounting Standards Board (FASB) eliminated from U.S. generally accepted accounting principles (GAAP) the concept of extraordinary items, effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2015. In September 2015, the FDIC, the Office of the Comptroller of the Currency, and the Board of Governors of the Federal Reserve System (collectively, the Federal banking agencies) published a joint Paperwork Reduction Act (PRA) notice and request for comment on proposed changes to the Call Report, including the elimination of the concept of extraordinary items and revision of affected data items. See 80 FR 56539 (Sept. 18, 2015). That PRA process is still in progress and the FDIC expects that, at some future time, references to extraordinary items will be removed from the Call Report. Nevertheless, items that would have met the criteria for classification as extraordinary before the effective date of the FASB's accounting change will no longer be reported as such in the Call Report income statement after the effective date of the change. Discontinued operations, however, will continue to be reported in the Call Report income statement as a separate item in the future, and income for the net income ratio will be determined before discontinued operations. Therefore, the FDIC is defining the net income measure to reflect the anticipated Call Report changes. The FDIC recognizes that this final rule may become effective before the Federal banking agencies finalize the proposed Call Report changes. Because the numerator of the net income measure is defined to include income for the most recent twelve months, there may be a transition period in which income for the most recent twelve months may include income from periods before the elimination from GAAP of the concept of extraordinary items has taken effect. For those portions of the most recent twelve months before this elimination has taken effect, income will be determined as income before income taxes and extraordinary items and other adjustments. The remaining three financial measures—the brokered deposit ratio, the one-year asset growth measure and the loan mix index—are described in detail below. 26 The brokered deposit ratio and the one-year asset growth measure replace the current adjusted brokered deposit ratio. 26 Two measures in the current financial ratios method—net loan charge-offs/gross assets and loans past due 30-89 days/gross assets—were analyzed but are not used in the final statistical analysis and are not among the measures in this final rule. Brokered Deposit Ratio Under current assessment rules, brokered deposits affect a small bank's assessment rate based on its risk category. For established small banks that are assigned to Risk Category I (those that are well capitalized and have a CAMELS composite rating of 1 or 2), the adjusted brokered deposit ratio is one of the financial ratios used to determine a bank's initial assessment rate. The adjusted brokered deposit ratio increases a bank's initial assessment rate when a bank has both brokered deposits that exceed 10 percent of its domestic deposits and a high asset growth rate. 27 Reciprocal deposits are not included with other brokered deposits in the adjusted brokered deposit ratio. 28 27 The adjusted brokered deposit ratio can affect assessment rates only if a bank's brokered deposits (excluding reciprocal deposits) exceed 10 percent of its domestic deposits and its assets have grown more than 40 percent in the previous 4 years. 12 CFR part 327, appendix A to subpart A. Few Risk Category I banks have both high levels of non-reciprocal brokered deposits and high asset growth, so the adjusted brokered deposit ratio affects relatively few banks. As of December 31, 2015, the adjusted brokered deposit ratio affected the assessment rate of 111 banks. 28 Reciprocal deposits are deposits that an insured depository institution receives through a deposit placement network on a reciprocal basis, such that: (1) For any deposit received, the institution (as agent for depositors) places the same amount with other insured depository institutions through the network; and (2) each member of the network sets the interest rate to be paid on the entire amount of funds it places with other network members. See 12 CFR 327.8(q). Established small banks in Risk Categories II, III, and IV (those that are less than well capitalized or that have a CAMELS composite rating of 3, 4, or 5) are subject to the brokered deposit adjustment, one of three possible adjustments that can increase or decrease a bank's initial assessment rate. The brokered deposit adjustment increases a bank's assessment rate if it has brokered deposits in excess of 10 percent of its domestic deposits. 29 Unlike the adjusted brokered deposit ratio, the brokered deposit adjustment includes all brokered deposits, including reciprocal deposits, and is not affected by asset growth rates. 29 12 CFR 327.9(d)(3); 12 U.S.C. 1831f. The final rule replaces the adjusted brokered deposit ratio currently used in the financial ratios method with a brokered deposit ratio, defined as the ratio of brokered deposits to total assets, and with a one-year asset growth measure, which is discussed later. The final rule also eliminates the existing brokered deposit adjustment applicable to established small banks outside Risk Category I. Under the new brokered deposit ratio applicable to all established small banks, brokered deposits in excess of 10 percent of total assets may increase assessment rates. For a bank that is well capitalized and has a CAMELS composite rating of 1 or 2, reciprocal deposits will be deducted from brokered deposits. For a bank that is less than well capitalized or has a CAMELS composite rating of 3, 4 or 5, however, reciprocal deposits will be included with other brokered deposits. Most commenters on the 2016 revised NPR discussed the changes related to the brokered deposit ratio. Some commenters supported using a brokered deposit ratio and some expressed support for excluding reciprocal deposits from the brokered deposit ratio for banks that are well capitalized and have a CAMELS composite rating of 1 or 2. This treatment of reciprocal deposits is generally consistent with the 442 comment letters on the 2015 NPR arguing that reciprocal deposits should not be treated as brokered deposits for assessment purposes or, similarly, that the final rule should reflect the current treatment of reciprocal deposits. The brokered deposit ratio as defined in the final rule is also consistent with the 16 comment letters on the 2015 NPR cautioning against penalizing the use of Federal Home Loan Bank advances in determining assessment rates. The final rule does not change the current treatment of Federal Home Loan Bank advances in the small bank deposit insurance assessment system. The FDIC received two comments on the 2016 revised NPR supporting the FDIC's responsiveness to these concerns. The FDIC received two comment letters on the 2016 revised NPR reiterating the argument made in 40 comment letters on the 2015 NPR that reciprocal deposits should be treated as core deposits or are the functional equivalent of core deposits. Commenters argued that reciprocal deposits do not present the same risks as brokered deposits, such as excessive growth or liquidity problems, and therefore should be formally recognized as a low risk, desirable source of funds. One commenter on the 2016 revised NPR argued that reciprocal deposits should not be included with brokered deposits even for banks that are less than well capitalized or have a CAMELS composite rating of 3, 4 or 5, because a bank's deposits are already adequately accounted for under the “L” (“Liquidity”) component of a bank's CAMELS rating. As stated in the 2016 revised NPR, however, the FDIC analyzed the characteristics of reciprocal deposits in its Study on Core Deposits and Brokered Deposits and concluded that, “While the FDIC agrees that reciprocal deposits do not present all of the problems that traditional brokered deposits present, they pose sufficient potential problems—particularly their dependence on a network and the network's continued willingness to allow a bank to participate, and the potential of supporting rapid growth if not based upon a relationship—that they should not be considered core . . .” 30 (Emphasis added.) As the FDIC noted when it adopted the current brokered deposit adjustment and included reciprocal deposits with other brokered deposits in the adjustment, “The statutory restrictions on accepting, renewing or rolling over brokered deposits when an institution becomes less than well capitalized apply to all brokered deposits, including reciprocal deposits. Market restrictions may also apply to these reciprocal deposits when an institution's condition declines.” 31 The brokered deposit ratio, which deducts reciprocal deposits for well-capitalized, well-rated banks, is consistent with these statutory restrictions and with the FDIC Study on Core Deposits and Brokered Deposits. 30 FDIC Study on Core Deposits and Brokered Deposits (2011), 54. 31 74 FR 9525, 9541 (Mar. 9, 2009). 12 U.S.C. 1831f. Three commenters on the 2016 revised NPR reiterated the argument they made in their comments on the 2015 NPR that the FDIC should not charge higher assessment rates to banks that hold brokered deposits, but should instead consider how banks use brokered deposits and whether they remain profitable and well capitalized. The FDIC also received letters on both the 2016 revised NPR and the 2015 NPR suggesting that specific types of brokered deposits—including stable retail deposits, certain custodial accounts, and longer maturing brokered CDs used to manage interest rate risk—be excluded from the brokered deposit ratio, and arguing that these deposits have similar characteristics to reciprocal deposits and are less risky than other brokered deposits. Small banks do not report data on particular types of brokered deposits (other than reciprocal deposits). Because of this lack of data, the FDIC cannot analyze individual types of brokered deposits statistically. In any event, the FDIC's statistical analyses and other studies have found that brokered deposits in general are correlated with a higher probability of failure and, as was acknowledged by one commenter, higher losses upon failure. 32 Collecting additional data on particular types of brokered deposits is not likely to improve the assessment system's ability to distinguish risk enough to warrant the additional reporting burden it would impose on small banks. 32 See FDIC Study on Core Deposits and Brokered Deposits (2011), 38-44, 46-47 and 66-68 (Appendix A: Excerpts from Material Loss Reviews And Summaries of OIG Semiannual Reports to Congress). One-Year Asset Growth Measure In response to comments on the 2015 NPR that the one-year asset growth measure should not penalize normal asset growth, the final rule uses a one-year asset growth measure that increases an established small bank's assessment rate only if it has had one-year asset growth greater than 10 percent. The FDIC received 6 comments on the 2016 revised NPR supporting the change from the asset growth measure as proposed in the 2015 NPR. Some commenters, however, remained concerned that the measure inappropriately penalizes banks for growth that may not be risky, arguing that a bank can exceed the 10 percent threshold for reasons such as the failure of a competitor, economic conditions, or an influx of deposits invested in high-quality assets. A few commenters suggested using CAMELS component ratings, such as a bank's rating for the “A” (“Asset quality”) or “S” (“Sensitivity to market risk”) components, in place of or to limit the effect of the one-year asset growth measure. The one-year asset growth measure will raise assessment rates for established small banks that grow rapidly (other than through merger or by acquiring failed banks), but will not increase assessments for normal asset growth. 33 The FDIC analyzed whether replacing the one-year asset growth measure with the CAMELS component ratings suggested by some commenters would improve the statistical model underlying the small bank assessment system adopted in this final rule. The FDIC's analyses show that, when the asset growth measure is replaced by the CAMELS components suggested by commenters, the components are highly statistically insignificant. 34 35 Thus, these CAMELS components cannot be used to substitute for the one-year asset growth measure. 33 From 1985 through 2014, one-year asset growth rates greater than 10 percent represented approximately the 70th percentile of small banks. A 10 percent one-year asset growth rate measure is generally consistent with the adjusted brokered deposit ratio in the current Risk Category I financial ratios method, which raises assessment rates only when small banks have both four-year asset growth rates in excess of 40 percent and high levels of brokered deposits. 34 Furthermore, some of the results of the analyses suggest that assessment rates would increase for a bank with a better component ratings, rather than decrease. 35 In the analysis of the alternative suggested by commenters, the weighted average of CAMELS component ratings was revised to exclude the components that were included as separate variables. Combining the Brokered Deposit Ratio and One-Year Asset Growth Measure The FDIC received 4 comment letters on the 2016 revised NPR suggesting that the FDIC use a measure that increases assessments only for banks that have both rapid asset growth and high levels of brokered deposits, similar to the current adjusted brokered deposit ratio. Commenters asserted that using separate variables is not supported by the nature of brokered deposit risk or by the statistical model underlying the proposed small bank deposit insurance system. One commenter submitted the results of a statistical analysis it had undertaken that, in the commenter's view, demonstrates that a combined measure performed better in more recent years. (The commenter was unable to use CAMELS ratings in its statistical analysis, since these ratings are confidential.) The FDIC conducted its own backtest of the assessment system in the final rule and compared it with a backtest of an assessment system using a combined measure, as suggested by commenters. The FDIC's comparison revealed that, overall, the assessment system in the final rule actually performed better in recent years, particularly immediately before the recent banking crisis, in discriminating between banks that failed within three years and those that did not. 36 36 The FDIC tested how well the assessment system in the final rule, which uses separate measures for brokered deposits and asset growth, would have differentiated during the recent crisis between banks that failed and those that did not compared to an assessment system that used a combined measure (based on the interaction between brokered deposits and asset growth). In each case, the FDIC, unlike the commenter, was able to use CAMELS component ratings. The FDIC determined out-of-sample accuracy ratios for the assessment system in the final rule and compared these accuracy ratios with accuracy ratios for an assessment system using separate measures to determine how well each version of the system would have differentiated between banks that failed within the projection period and those that did not. The projection period in each case was the three years following the date of the projection; the dates of projection were the last day of the years 2006 through 2011. (An accuracy ratio compares how well a model would have discriminated between banks that failed within the projection period and banks that did not.) For each year's projection, the assessment system in the final rule had accuracy ratios that were equal to or better than the accuracy ratios for the system using a combined measure. In most years of the backtest, the accuracy ratios were similar; in the 2006 projection (predicting failures from 2007 through 2009), however, the accuracy ratio for the assessment system using separate measures was significantly better than the accuracy ratio for the assessment system using a combined measure. (Accuracy ratios are discussed in more detail later.) Moreover, as discussed earlier, brokered deposits pose risks other than enabling banks to engage in rapid asset growth. Brokered deposits increase a bank's probability of failure (even after controlling for asset growth) and increase the loss to the DIF in the event of failure. 37 In addition, rapid asset growth can be funded by liabilities other than brokered deposits. The FDIC's analysis of the 354 banks that, during the recent crisis, grew rapidly in the years before they failed reveals that, while brokered deposits funded a significant amount of growth, other funding sources also contributed significantly to growth. Increasing assessments only for banks that have both high levels of brokered deposits and rapid asset growth would allow small banks to have large amounts of brokered deposits or rapid asset growth without any effect on their assessment rates. 37 See FDIC Study on Core Deposits and Brokered Deposits (2011), 38-44 and 46-47. Loan Mix Index The loan mix index is a measure of the extent to which a bank's total assets include higher-risk categories of loans. The index uses historical industry-wide charge-off rates to identify loan types with higher risk. 38 Each category of loan in a bank's loan portfolio is divided by the bank's total assets to determine the percentage of the bank's assets represented by that category of loan. Each percentage is then multiplied by that category of loan's historical weighted average industry-wide charge-off rate. The products are then summed to determine the loan mix index value for that bank. 38 “Industry-wide” charge-off rates are charge-off rates for all small banks. The loan categories in the loan mix index were selected based on the availability of category-specific charge-off rates over a sufficiently lengthy period (2001 through 2014) to be representative. The loan categories exclude credit card loans. 39 For each loan category's weighted-average industry-wide charge-off rate, the weight for each year's charge-off rate is proportional to the number of bank failures in that year. Thus, charge-off rates from 2008 through 2014, during the recent banking crisis, have a much greater influence on the weighted-average charge-off rate than do charge-off rates from the years before the crisis, when few failures occurred. The weighted averages assure that types of loans that have high charge-off rates during downturns ( i.e., periods marked by significant DIF losses) have an appropriate influence on assessment rates. 39 Credit card loans were excluded from the loan mix index because they produced anomalously high assessment rates for banks with significant credit card loans. Credit card loans have very high charge-off rates, but they also tend to have very high interest rates to compensate. In addition, few small banks have significant concentrations of credit card loans. Table 6 below illustrates how the loan mix index is calculated for a hypothetical bank. Table 6—Loan Mix Index for a Hypothetical Bank 40 Weighted charge-off rate percent Loan category as a percent of hypothetical bank's total assests Product of two columns to the left Construction & Development 4.50 1.40 6.29 Commercial & Industrial 1.60 24.24 38.75 Leases 1.50 0.64 0.96 Other Consumer 1.46 14.93 21.74 Loans to Foreign Government 1.34 0.24 0.32 Real Estate Loans Residual 1.02 0.11 0.11 Multifamily Residential 0.88 2.42 2.14 Nonfarm Nonresidential 0.73 13.71 9.99 1-4 Family Residential 0.70 2.27 1.58 Loans to Depository banks 0.58 1.15 0.66 Agricultural Real Estate 0.24 3.43 0.82 Agriculture 0.24 5.91 1.44 SUM (Loan Mix Index) 70.45 84.79 The weighted charge-off rates in the table are the same for all established small banks. The remaining two columns vary from bank to bank, depending on the bank's loan portfolio. For each loan type, the value in the rightmost column is calculated by multiplying the weighted charge-off rate by the bank's loans of that type as a percent of its total assets. In this illustration, the sum of the right-hand column (84.79) is the loan mix index for this bank. 40 As discussed above, the loan mix index uses loan charge-off data from 2001 through 2014. The table shows industry-wide weighted charge-off percentage rates, the loan category as a percentage of total assets, and the products to two decimal places. In fact, the final rule uses seven decimal places for industry-wide weighted charge-off percentage rates, and as many decimal places as permitted by the FDIC's computer systems for the loan category as a percentage of total assets and the products. The total (the loan mix index itself) uses three decimal places. The FDIC received 30 comments on the 2015 NPR and 11 comments on the revised 2016 NPR (10 from the same commenters who responded to the 2015 NPR) on the loan mix index. These comments expressed views that the loan mix index is a poor indicator of risk because it does not account for factors such as the quality of loan underwriting, geographic variation, risk mitigating factors such as collateral or guarantees, and an individual bank's historical loss ratios. Commenters argued that these factors are more relevant to an individual bank's risk than industry-wide charge-off rates for each loan type based on the most recent financial crisis. Several commenters argued for modifying the loan mix index, while others argued for eliminating the loan mix index and instead using measures of a bank's own average asset quality over time (delinquencies, nonperforming assets, and net charge-offs, for example, as suggested by a banking trade group) or CAMELS component ratings. For several reasons, the loan mix index does not incorporate a bank's quality of loan underwriting, geographic variation, risk mitigating factors, or individual historical loss rates on types of loans. First, as some commenters noted, the data that banks report in the Call Report are not sufficient or specific enough to distinguish these risk factors by loan category. Collecting the data needed to take these factors into account likely would not improve the assessment system's ability to distinguish for risk enough to warrant the additional reporting burden it would impose on small banks. Second, underwriting quality directly or indirectly affects, and is reflected in, several other measures in the financial ratios method, including the weighted average CAMELS component rating, the nonperforming loans and leases measure, the other real estate owned measure, and the net income measure. Therefore, the final rule should not deter a bank from making well underwritten loans of any type, since good underwriting quality will be reflected in other financial and supervisory measures and will reduce the bank's assessment rate. Third, an individual bank's loss rates on the types of loans in the loan mix index do not necessarily demonstrate how the bank will fare in the future. Low loss rates may result from lending in areas that suffered less in the recent downturn. If a bank's low loss rates simply reflect comparatively less stressful conditions in the bank's primary lending area during the past crisis, they will not reveal how the bank would fare during a period of severe stress similar to that recently observed in other areas of the country. Since it is not possible to predict which areas of the country will be affected by the next downturn, the loan mix index uses industry-wide average annual charge-off rates for each category of loan, including commercial and development (C&D) and commercial and industrial (C&I) loans, weighted by the number of bank failures in each year. Although these reasons are sufficient to preclude replacing the loan mix index, the FDIC nevertheless undertook statistical analyses of a trade group's suggestion to replace the loan mix index with a bank's own recent history of delinquencies, nonperforming assets, and net charge-offs. The FDIC tried various combinations of these measures, but the measures did not perform as well as the measures in the statistical model in the final rule in estimating the likelihood of failure. 41 41 Although the measures suggested by the commenters reflect loan quality, including them in the statistical model does not add information beyond that already provided by other measures, since the statistical model in the final rule also relies on six other measures based on a banks' own balance sheet and income statement. The FDIC also analyzed whether replacing the loan mix index with the “A” CAMELS component, as suggested by some commenters, would improve the statistical model. Again, the statistical model in the final rule performed better in estimating failure probability than this alternative. 42 42 Under the suggested alternative, the “A” component was not statistically significant, and some of the results of the analysis suggested that assessment rates should increase for a bank with a better “A” component ratings, rather than decrease. Estimation problems of this nature can occur when new variables are added that are strongly correlated with variables already in a model. Several commenters argued that the loan mix index, which uses charge-off rates from 2001 through 2014, is weighted too heavily by the most recent recession. For example, some commenters cited the failure of agricultural and residential mortgage lenders in the 1980s and early 1990s. Several commenters said that the weighted charge-off rates assigned to C&D and C&I loans are inappropriately high. The loan mix index uses loan charge-off data from 2001 through 2014 to calculate weights for each loan category because charge-off data for some of the loan categories in the loan mix index is not available before 2001. Nevertheless, asset concentrations in commercial real estate (CRE) loans—in particular, C&D loans—have been found to contribute to bank failures in both the recent crisis and the earlier crisis of the 1980s and early 1990s. For example, Material Loss Reviews and Reports to Congress from the FDIC Office of Inspector General (OIG) have concluded that significant concentrations in riskier assets, such as C&D loans (also termed acquisition, development, and construction, or ADC loans), and other CRE loans, contribute to bank failure. 43 The FDIC's analysis of the banking crisis of the 1980s and early 1990s also finds that concentrations of CRE loans (including C&D loans) relative to total assets were higher for banks that subsequently failed than for banks that did not fail. 44 FDIC analysis finds that established small banks that had a ratio of C&D loans to assets of 50 percent or more as of the end of 2008 failed over the next five years at ten times the rate of established small banks with lower ratios. 43 See FDIC Study on Core Deposits and Brokered Deposits (2011), Appendix A: Excerpts from Material Loss Reviews And Summaries of OIG Semiannual Reports to Congress (66-68). 44 FDIC. (December 1997). History of the Eighties—Lessons for the Future, www.fdic.gov/bank/historical/history/contents.html. One banking trade group suggested that the annual industry-wide charge-off rates used to determine charge-off rates in the loan mix index should not be weighted more heavily in years with many bank failures than in years with few bank failures. Annual industry-wide charge-off rates for each type of loan in the loan mix index are weighted by the number of bank failures in each year to assure that types of loans that have high charge-off rates during downturns have an appropriate influence on assessment rates. Loss rates observed in periods characterized by a higher rate of bank failures are more relevant to the risk of loss to the DIF than loss experience in other periods. Nevertheless, the FDIC conducted a backtest of the assessment system in the final rule and compared it with a backtest of an assessment system that uses a loan mix index based on a simple average of industry-wide annual charge-off rates (where each annual charge-off rate is weighted equally) for each loan type, as suggested by the commenter. The FDIC's comparison revealed that the assessment system in the final rule would have performed better, particularly in the early part of the last crisis, in discriminating between banks that subsequently failed within three years and those that did not fail. 45 45 The FDIC tested how well the assessment system in the final rule would have differentiated between banks that failed and those that did not during the recent crisis compared to an assessment system that used a loan mix index based upon simple averages of annual charge-off rates for each loan type. The FDIC used out-of-sample accuracy ratios to test how well each version of the system would have differentiated between banks that failed within the projection period and those that did not. The projection period in each case was the three years following the date of the projection; the dates of projection were the last day of the years 2006 through 2011. (An accuracy ratio compares how well a model would have discriminated between banks that failed within the projection period and banks that did not.) For the projections from the end of 2006 and 2007, accuracy ratios for the assessment system in the final rule were significantly better. For other years, the accuracy ratios were not materially different. (Accuracy ratios are discussed in more detail later.) According to 24 commenters, the use of annual industry-wide charge-off rates weighted by bank failures during the recent crisis could lead banks to reduce certain types of lending and increase others. The loan mix index reflects the performance of loan types over many years and appropriately assigns higher assessment rates to banks with concentrations in types of loans that have been demonstrated over two crises to be more costly to the DIF than to banks that do not have such concentrations. FDIC analysis finds only a small effect—or none at all—on a small bank's assessment rate from an incremental increase in the balance of any loan category (including C&D loans) in the loan mix index. 46 Consequently, the loan mix index should not materially affect banks' lending decisions. 46 The effect on assessment rates of an incremental increase in a loan category balance in the loan mix index varies depending on whether a small bank is paying the minimum or maximum rate applicable to the bank's CAMELS composite rating or is paying a rate between the minimum and maximum under the final rule. For example, a small bank that is paying the maximum assessment rate for a bank with its CAMELS composite rating will continue to pay the maximum rate even if it increases its loan balances, so the marginal effect is zero. Similarly, most small banks that are paying the minimum assessment rate for banks with their CAMELS composite rating will continue to do so even with an incremental increase in any particular type of lending. For a small bank whose assessment rate is between the minimum and maximum rate, an incremental increase in a particular type of lending will, at most, result in only a small increase in a bank's assessment rate. Since the effect of an incremental increase in a loan category balance on a bank's assessment rate will be small, the loan mix index is not likely to have a material effect on a bank's lending decisions. Several commenters on both the 2015 NPR and the 2016 revised NPR criticized the assumption that the future will follow the path of any single past period, noting that future bank failures may be characterized by different portfolio mixes than in the last recession. As discussed above, the method adopted in the final rule is based upon a statistical analysis of the available data. Any empirical analysis necessarily relies upon past data. While there is no guarantee that the risks that led to past failures will necessarily be identical to those that lead to future failures, past experience still provides a sound basis for evaluating risk. As also discussed above, each of the measures used in the final rule, including the loan mix index, is a statistically significant predictor of bank failure. Use of a loan portfolio measure is also consistent with numerous academic papers. 47 47 See 80 FR at 40858. Leverage Ratio The FDIC received 4 comments on the 2016 revised NPR and 14 comments on the 2015 NPR asserting that the weight (or multiplier) assigned to the leverage ratio was too high compared to the current system and “would unfairly penalize banks that meet the 'well capitalized' standard but do not hold excess capital . . . ” Commenters argued that there is no statistical evidence that well-managed banks with strong capital are significantly weakened by not holding more capital and further, excessive capital can be counterproductive. For banks that are well-capitalized and have a CAMELS composite rating of 1 or 2, two commenters suggested reducing the weight of the leverage ratio and capping the benefit at 8 percent. The FDIC disagrees. The greater a bank's capital, the better the bank is able to withstand stress and avoid failure. Consequently, reducing the assessment rate for a bank that holds capital above the minimum level necessary to be considered well capitalized is appropriate. Further, as stated above, each of the measures in the established small bank assessment system is a statistically significant predictor of bank failure, and the multipliers used in the final rule for the leverage ratio and for all of the measures are derived from an empirical, statistical analysis. As also described above, because the final rule eliminates risk categories, applies the financial ratios method to all established small banks, and uses some new measures, the multipliers assigned to the financial measures, including the leverage ratio, are necessarily different from the multipliers in the current Risk Category I financial ratios method. CAMELS Ratings The FDIC received 17 comments on the 2015 NPR and 11 comments on the revised 2016 NPR (5 from commenters who had similar comments on the 2015 NPR) related to the role of CAMELS ratings in determining a bank's assessment rate. The commenters suggested that the FDIC should more heavily weight CAMELS supervisory ratings over other measures, including the loan mix index, the one-year asset growth ratio, and the brokered deposit ratio, because CAMELS ratings reflect more current, bank specific data and judgments by examiners who are familiar with each bank's business model and risks. Some commenters suggested using individual CAMELS component ratings in place of or to limit the effect of other measures. For example, as described above, some commenters suggested using the “A” CAMELS component in place of a loan mix index. For several reasons, these comments have not led to changes in the final rule. First, compared to the current system, the value of the multiplier for the weighted average CAMELS component rating has increased. CAMELS ratings are among the useful predictors of a bank's probability of failure and, as under current rules, continue to be a significant determinant of assessment rates under the final rule. The final rule uses both a bank's financial measures and its weighted average CAMELS component rating to determine an assessment rate. Financial ratios can provide updated information on an institution's risk profile between bank examinations and allow greater differentiation in risk. 48 To take into account idiosyncratic and unquantifiable risks and risk mitigators that are reflected in CAMELS composite ratings, the final rule also establishes minimum and maximum assessment rates for established small banks based on these ratings. Thus, the final rule prevents the assessment system from assigning a rate that reflects either too little risk (for a bank with a CAMELS composite 3, 4, or 5 rating) or too much risk (for a bank with a CAMELS composite 1 or 2 rating). 48 For CAMELS 1- and 2-rated institutions, examinations generally occur on a 12- or 18-month cycle. 12 U.S.C.1820(d). Under interim final rules published on February 29, 2016, the Federal banking agencies increased the number of small banks eligible for an 18-month examination cycle rather than a 12-month cycle to reduce regulatory burden on small, well-capitalized and well-managed institutions and allow the agencies to better focus their supervisory resources on those institutions that present capital, managerial, or other issues of supervisory concern. Qualifying well-capitalized and well-managed banks with less than $1 billion in total assets are eligible for an 18-month examination cycle. See 81 FR 10063 (Feb. 29, 2016). Second, the variables selected and used in the underlying statistical model are consistent with other existing models of bank risk, including FDIC offsite monitoring models and academic literature. For example, FDIC offsite monitoring models measure bank conditions and monitor bank risk using variables that include: The ratio of charge-offs to total assets, asset growth, an index measuring changes in loan mix, and capital. Numerous academic papers discussing models that predict bank failures include explanatory variables that include loan portfolio ratios, rapid asset growth, the ratio of core deposits to total assets, and capital. 49 Rapid asset growth, reliance on brokered deposits, and significant concentrations in riskier assets have all been found to contribute to bank failure. 50 49 See 80 FR at 40858. 50 See FDIC Study on Core Deposits and Brokered Deposits (2011), Appendix A: Excerpts from Material Loss Reviews And Summaries of OIG Semiannual Reports to Congress, 66-68. Third, as stated above, each of the measures in the established small bank assessment system is a statistically significant predictor of bank failure, and the multipliers used in the final rule for weighted average CAMELS component ratings and for all of the financial measures are derived from an empirical, statistical analysis. Commenters did not cite or provide empirical evidence to support their suggestion that a greater weight be assigned to CAMELS supervisory ratings, or that a lower weight (or effectively no weight) be assigned to various financial measures. As described above, because the final rule eliminates risk categories and applies the financial ratios method to all established small banks, and uses some new measures, the multipliers assigned to the financial measures, including the weighted average CAMELS component rating, are necessarily different from the multipliers in the current Risk Category I financial ratios method. In sum, the financial ratios method in the final rule, including the multipliers assigned to the financial measures and weighted average CAMELS component ratings, predicts failures significantly better than the current system. Calculating the Initial Assessment Rate As in the current methodology for Risk Category I small banks, under the final rule the weighted CAMELS components and financial ratios will be multiplied by statistically derived pricing multipliers, the products summed, and the sum added to a uniform amount that is: (a) Derived from the statistical analysis; (b) adjusted for assessment rates set by the FDIC; and (c) applied to all established small banks. 51 The total will equal the bank's initial assessment rate. If, however, the resulting rate is below the minimum initial assessment rate for established small banks, the bank's initial assessment rate will be the minimum initial assessment rate; if the rate is above the maximum, then the bank's initial assessment rate will be the maximum initial rate for established small banks. In addition, if the resulting rate for an established small bank is below the minimum or above the maximum initial assessment rate applicable to banks with the bank's CAMELS composite rating, the bank's initial assessment rate will be the respective minimum or maximum assessment rate for an established small bank with its CAMELS composite rating. This approach allows rates to vary incrementally across a wide range of rates for all established small banks. The conversion of the statistical model to pricing multipliers and the uniform amount is discussed further below and in detail in appendix E to the 2016 revised NPR. 51 Current rules provide that: (1) Under specified conditions, certain subsidiary small banks will be considered established rather than new, 12 CFR 327.8(k)(4); and (2) the time that a bank has spent as a federally insured credit union is included in determining whether a bank is established, 12 CFR 327.8(k)(5). If a Risk Category I small bank is considered established under these rules, but has no CAMELS component ratings, its initial assessment rate is 2 basis points above the minimum initial assessment rate applicable to Risk Category I (which is equivalent to 2 basis points above the minimum initial assessment rate for established small banks) until it receives CAMELS component ratings. Thereafter, the assessment rate is determined by annualizing, where appropriate, financial ratios obtained from all quarterly Call Reports that have been filed, until the bank files four quarterly Call Reports. Under the final rule, for small banks that are considered established under these rules, but do not have a CAMELS composite rating or do not have CAMELS component ratings: 1. If the bank has no CAMELS composite rating, its initial assessment rate will be 2 basis points above the minimum initial assessment rate for established small banks until it receives a CAMELS composite rating; and 2. If the bank has a CAMELS composite rating but no CAMELS component ratings, its initial assessment rate will be determined using the financial ratios method by substituting its CAMELS composite rating for its weighted average CAMELS component rating and, if the bank has not yet filed four quarterly Call Reports, by annualizing, where appropriate, financial ratios obtained from all quarterly Call Reports that have been filed. Adjustments to Initial Base Assessment Rates As discussed above, the final rule eliminates the existing brokered deposit adjustment for established small banks. 52 Under current rules, the brokered deposit adjustment applies to small banks only if they are in Risk Category II, III, and IV. The brokered deposit adjustment increases a bank's assessment when it holds significant amounts of brokered deposits. To avoid assessing banks twice for holding brokered deposits (because the brokered deposit ratio will apply to all established small banks), the final rule eliminates the brokered deposit adjustment for established small banks. 52 As under rules currently in effect, the brokered deposit adjustment will continue to apply to all new small institutions in Risk Categories II, III, and IV, and all large and highly complex institutions, except large and highly complex institutions that are well capitalized and have a CAMELS composite rating of 1 or 2. As under rules currently in effect, the brokered deposit adjustment will not apply to insured branches. As under current rules, the DIDA continues to apply to all banks, and the unsecured debt adjustment continues to apply to all banks except new banks and insured branches. 53 53 As under rules currently in effect, however, no adjustments apply to bridge banks or conservatorships. These banks will continue to be charged the minimum assessment rate applicable to small banks. Assessment Rates The final rule preserves the lower overall range of initial base assessment rates previously adopted by the Board. Under current regulations, once the reserve ratio reaches 1.15 percent, initial base assessment rates will decline automatically from the current range of 5 basis points to 35 basis points to a range of 3 basis points to 30 basis points, as reflected in Table 4. The FDIC adopted the range of initial assessment rates in this rate schedule pursuant to its long-term fund management plan as the FDIC's best estimate of the assessment rates that would have been needed from 1950 to 2010 to maintain a positive fund balance during the past two banking crises. This assessment rate schedule remains the FDIC's best estimate of the long-term rates needed. Consequently, and as discussed in greater detail further below and in appendix E to the 2016 revised NPR, the final rule converts the statistical model to assessment rates within this range of 3 basis points to 30 basis points in a revenue neutral way; that is, in a manner that does not materially change the aggregate assessment revenue collected from established small banks. The final rule eliminates risk categories and adopts the range of initial assessment rates for established small banks set out in Table 7 below, thus maintaining the range of initial assessment rates that the Board has previously determined will go into effect starting the quarter after the reserve ratio reaches 1.15 percent. 54 These rates will remain in effect as long as the reserve ratio is less than 2 percent. Table 7 also includes the maximum assessment rates that apply to CAMELS composite 1- and 2-rated banks and the minimum assessment rates that apply to CAMELS composite 3-rated banks and CAMELS composite 4- and 5-rated banks. 54 See 12 CFR 327.10(b); 76 FR at 10718. 55 The reserve ratio for the immediately prior assessment period must also be less than 2 percent. Table 7—Initial and Total Base Assessment Rates * [In basis points per annum] [After the reserve ratio reaches 1.15 percent] 55 Established small banks CAMELS composite 1 or 2 3 4 or 5 Large & highly complex institutions ** Initial Base Assessment Rate 3 to 16 6 to 30 16 to 30 3 to 30. Unsecured Debt Adjustment *** −5 to 0 −5 to 0 −5 to 0 −5 to 0. Brokered Deposit Adjustment N/A N/A N/A 0 to 10. Total Base Assessment Rate 1.5 to 16 3 to 30 11 to 30 1.5 to 40. * Total base assessment rates in the table do not include the DIDA. ** See 12 CFR 327.8(f) and (g) for the definition of large and highly complex institutions. *** 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. The final rule adopts the range of initial assessment rates for established small banks set out in the rate schedule in Table 8 below, starting the quarter after the reserve ratio reaches or exceeds 2 percent, thus maintaining the range of initial assessment rates that the Board previously determined will go into effect then. These rates will remain in effect as long as the reserve ratio for the prior assessment period is at or above 2 percent but is less than 2.5 percent. Table 8 also includes the maximum assessment rates that apply to CAMELS composite 1- and 2-rated banks and the minimum assessment rates that apply to CAMELS composite 3-rated banks and CAMELS composite 4- and 5-rated banks. Table 8—Initial and Total Base Assessment Rates * [In basis points per annum] [If the reserve ratio for the prior assessment period is equal to or greater than 2 percent and less than 2.5 percent] Established small banks CAMELS composite 1 or 2 3 4 or 5 Large & highly complex institutions ** Initial Base Assessment Rate 2 to 14 5 to 28 14 to 28 2 to 28. Unsecured Debt Adjustment *** −5 to 0 −5 to 0 −5 to 0 −5 to 0. Brokered Deposit Adjustment N/A N/A N/A 0 to 10. Total Base Assessment Rate 1 to 14 2.5 to 28 9 to 28 1 to 38. * Total base assessment rates in the table do not include the DIDA. ** See 12 CFR 327.8(f) and (g) for the definition of large and highly complex institutions. *** 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 2 basis points will have a maximum unsecured debt adjustment of 1 basis point and cannot have a total base assessment rate lower than 1 basis point. The final rule also adopts the range of initial assessment rates for established small banks set out in the rate schedule in Table 9 below, thus again maintaining the range of initial assessment rates that the Board previously determined will go into effect when the fund reserve ratio at the end of the prior assessment period meets or exceeds 2.5 percent. These rates will remain in effect as long as the reserve ratio for the prior assessment period is at or above this level. Table 9 also includes the maximum assessment rates that apply to CAMELS composite 1- and 2-rated banks and the minimum assessment rates that apply to CAMELS composite 3-rated banks and CAMELS composite 4- and 5-rated banks. Table 9—Initial and Total Base Assessment Rates * [In basis points per annum] [If the reserve ratio for the prior assessment period is equal to or greater than 2.5 percent] Established small banks CAMELS composite 1 or 2 3 4 or 5 Large & highly complex institutions ** Initial Base Assessment Rate 1 to 13 4 to 25 13 to 25 1 to 25. Unsecured Debt Adjustment *** −5 to 0 −5 to 0 −5 to 0 −5 to 0. Brokered Deposit Adjustment N/A N/A N/A 0 to 10. Total Base Assessment Rate 0.5 to 13 2 to 25 8 to 25 0.5 to 35. * Total base assessment rates in the table do not include the DIDA. ** See 12 CFR 327.8(f) and (g) for the definition of large and highly complex institutions. *** 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 1 basis point will have a maximum unsecured debt adjustment of 0.5 basis points and cannot have a total base assessment rate lower than 0.5 basis points. With respect to each of the three assessment rate schedules (Tables 7, 8 and 9), the Board retains its authority to uniformly adjust assessment rates up or down from the total base assessment rate schedule without further rulemaking, as long as the adjustment does not exceed 2 basis points. Also, with respect to each of the three schedules, if a bank's CAMELS composite or component ratings change during a quarter in a way that changes the institution's initial base assessment rate, then its assessment rate will be determined separately for each portion of the quarter in which it had different CAMELS composite or component ratings. Conversion of Statistical Model to Pricing Multipliers and Uniform Amount As discussed above, the final rule converts the statistical model to the assessment rates set out in Table 7 in a revenue neutral manner. 56 Specifically, and as described in detail in appendix E to the 2016 revised NPR, the final rule converts the statistical model to assessment rates to ensure that aggregate assessments under the final rule for the assessment period ending December 31, 2015, would have been approximately the same as they would have been under the assessment rate schedule set forth in Table 4 (the rates that, under current rules, will automatically go into effect when the reserve ratio reaches 1.15 percent). 57 56 The final rule converts a linear version of the model, which was estimated in a non-linear manner. (See appendix E to the 2016 revised NPR.) The conversion using a linear version of the model preserves the same rank ordering as the non-linear model, but using the linear version of the model allows initial assessment rates to be expressed as a linear function of the model variables. The FDIC also used a linear version of its original non-linear downgrade probability statistical model when it instituted variable rates within Risk Category 1 effective January 1, 2007. See 71 FR 69282 (Nov. 30, 2006). 57 Initial assessment rates under the rate schedule actually in effect for the fourth quarter of 2015 ranged from 5 basis points to 35 basis points, since the DIF reserve ratio was under 1.15 percent. Table 10 below sets out the pricing multipliers and uniform amounts that result when the FDIC converts the statistical model to the assessment rate schedule set out in Table 7 (with a range of assessment rates from 3 basis points to 30 basis points). 58 Table 10 assumes that the assessment rate schedule in Table 7 is in effect. The uniform amount and pricing multipliers differ for the assessment rates in Tables 8 and 9. Table 10—Pricing Multipliers and the Uniform Amount 58 Model measures Pricing multiplier Weighted Average CAMELS Component Rating 1.519 Leverage Ratio −1.264 Net Income Before Taxes/Total Assets −0.720 Nonperforming Loans and Leases/Gross Assets 0.942 Other Real Estate Owned/Gross Assets 0.533 Brokered Deposit Ratio 0.264 One Year Asset Growth 0.061 Loan Mix Index 0.081 Uniform Amount 7.352 Updating the Statistical Model, Pricing Multipliers and Uniform Amount As discussed above, the statistical analysis used bank financial data and CAMELS ratings from 1985 through 2011, failure data from 1986 through 2014, and loan charge-off data from 2001 through 2014. 59 The FDIC does not anticipate the need for frequent updates, since variables and coefficients in the underlying model are not likely to change much absent a significant number of failures. In any event, any changes to the small bank deposit insurance pricing model will go through notice-and-comment rulemaking. The FDIC received two comments on the 2016 revised NPR supporting the use of notice-and-comment rulemaking for any future changes to the small bank deposit insurance pricing model. 59 Also as discussed above, for certain lagged variables, such as one-year asset growth rates, the statistical analysis also used bank financial data from 1984. Insured Branches of Foreign Banks and New Small Banks The final rule makes no changes to the current rules governing the assessment rate schedules applicable to insured branches or to the assessment rate schedule applicable to new small banks. The final rule also makes no changes to the way in which assessment rates for insured branches and new small banks are determined. III. Expected Effects of the Final Rule Effect on Assessment Rates To illustrate the effects of the final rule on established small bank assessment rates, the FDIC compared actual assessment rates under the current system for established small banks for the fourth quarter of 2015, using a range of initial assessment rates of 5 basis points to 35 basis points, with the assessment rates in Table 7 of this final rule, which has an overall range of initial assessment rates of 3 basis points to 30 basis points; the assessment rates in Table 7 will take effect the quarter after the DIF reserve ratio reaches 1.15 percent. The proportion (and number) of established small banks paying the minimum initial assessment rate would have increased significantly, from 27 percent (1,632 small banks) to 58 percent under the final rule (3,552 small banks). The proportion (and number) of established small banks paying the maximum initial assessment rate would have decreased from 0.6 percent of established small banks (35 small banks) to 0.1 percent of established small banks under the final rule (6 small banks). Chart 1 below graphically compares the distribution of established small bank initial assessment rates under this illustration. The horizontal axis in the chart represents established small banks ranked by risk, from the least risky on the left to the most risky on the right. Because actual risk rankings under the current system differ from risk rankings under the final rule, a particular point on the horizontal axis is not likely to represent the same bank for the current system and the final rule. Thus, the chart does not show how an individual bank's assessment would change under the final rule; it simply compares the distribution of assessment rates under the current system to the distribution under the final rule. ER20MY16.164 Due in large part to the overall decline in rates once the reserve ratio reaches 1.15 percent reflected in Table 7, most established small banks (5,655 or 93 percent) would have had lower total assessment rates under the final rule. 60 Among Risk Category I established small banks, 93 percent would have had rate decreases; the average decrease for these banks would have been 2.6 basis points. Of the Risk Category II, III, and IV established small banks, 97 percent would have had rate decreases; the average decrease would have been 7.1 basis points. A total of 423 established small banks (7 percent of established small banks) would have had rate increases. Of the Risk Category I established small banks, 7 percent would have had rate increases; the average increase would have been 1.6 basis points. Of the Risk Category II, III, and IV established small banks, 3 percent would have had rate increases; the average increase would have been 3.0 basis points. The results of the comparison are similar to those that resulted from like comparisons in the 2015 NPR and 2016 revised NPR. 60 As discussed above, a bank's total assessment rate may vary from the initial assessment rate as the result of possible adjustments. Under the current system, there are three possible adjustments: the unsecured debt adjustment, the DIDA, and the brokered deposit adjustment. Under the final rule, the brokered deposit adjustment is eliminated for established small banks, but the unsecured debt adjustment and the DIDA remain. To further illustrate the effects of the final rule on small bank assessment rates, the FDIC compared hypothetical assessment rates under the final rule with the assessment rates established small banks would have been charged for the fourth quarter of 2015 if the assessment rate schedule in Table 4, which, under current rules, will go into effect when the reserve ratio reaches 1.15 percent, had been in effect. The proportion of established small banks paying the minimum initial assessment rate would also have increased from 27 percent to 58 percent under the final rule, and the proportion of established small banks paying the maximum initial assessment rate would also have decreased from 0.6 percent of established small banks to 0.1 percent of established small banks under the final rule. Chart 2 below graphically compares the distribution of established small bank initial assessment rates under this illustration. ER20MY16.165 Most established small banks (3,400 or 56 percent) would have had lower total assessment rates. Among Risk Category I established small banks, 52 percent would have had rate decreases; the average decrease for these banks would have been 1.3 basis points. Of the Risk Category II, III, and IV established small banks, 93 percent would have had rate decreases; the average decrease would have been 4.6 basis points. 1,235 established small banks (20 percent of established small banks) would have had rate increases. Of the Risk Category I established small banks, 22 percent would have had rate increases; the average increase would have been 1.8 basis points. Of the Risk Category II, III, and IV established small banks, 6 percent would have had rate increases; the average increase would have been 3.3 basis points. Again, the results of the comparison are similar to like comparisons in the 2015 NPR and the 2016 revised NPR. Effect on Capital and Earnings Summary Using balance sheet and trailing twelve month income data as of the fourth quarter of 2015, the FDIC analyzed the effects of the final rule on capital and income in two ways: (1) The effect of the final rule under the rate schedule in Table 7 (with an initial assessment rate range of 3 basis points to 30 basis points (F330)) compared to the current small bank deposit insurance assessment system under the rate schedule in Table 3 (with an initial assessment rate range of 5 basis points to 35 basis points (C535)) (the first comparison); and (2) the effect of the final rule compared to the current small bank deposit insurance assessment system under the rate schedule in Table 4 (with an initial assessment rate range of 3 basis points to 30 basis points; under current rules, this rate schedule will go into effect the quarter after the DIF reserve ratio reaches 1.15 percent (C330)) (the second comparison). Under either comparison, the final rule will cause no small bank to fall below a 4 percent or 2 percent leverage ratio if the bank would otherwise be above these thresholds. Under the first comparison, the final rule will cause no small bank to rise above a 2 percent leverage ratio if the bank would otherwise be below this threshold, but will cause one bank to rise above a 4 percent leverage ratio. Under the second comparison, the final rule will cause no small bank to rise above a 2 percent or 4 percent leverage ratio if the bank would otherwise be below these thresholds. In the first comparison, only approximately 7 percent of profitable established small banks and approximately 5 percent of unprofitable small banks will face a rate increase. All but a very few (20) of these banks will have resulting declines in income (or increases in losses, where the bank is unprofitable) of 5 percent or less. As discussed above, assessment rates for approximately 93 percent of established small banks will decline, resulting in increases in income (or decreases in losses), some of which will be substantial. The effects on earnings of established small banks under the final rule in this comparison do not differ materially from the effects discussed in the 2015 NPR and 2016 NPR. In the second comparison, approximately 21 percent of profitable established small banks and approximately 13 percent of unprofitable established small banks will face a rate increase. All but 76 of these banks will have resulting declines in income (or increases in losses, where the bank is unprofitable) of 5 percent or less. As discussed above, assessment rates for approximately 56 percent of established small banks will decline, resulting in increases in income (or decreases in losses), some of which will be substantial. The effects on earnings of established small banks under the final rule in this comparison do not differ materially from the effects discussed in the 2015 NPR and 2016 revised NPR. In sum, because the final rule is intended to generate the same total revenue from small banks as would have been generated absent the final rule, the final rule should, overall, have no material effect on the capital and earnings of the banking industry, although the final rule will affect the earnings and capital of individual institutions. Detailed Analysis Assumptions and Data The analysis assumes that annual pre-tax income for each established small bank is equal to trailing twelve month income as of the fourth quarter of 2015. The analysis also assumes that the effects of changes in assessments are not transferred to customers in the form of changes in borrowing rates, deposit rates, or service fees. Since deposit insurance assessments are a tax-deductible operating expense, increases in the assessment expense can lower taxable income and decreases in the assessment expense can increase taxable income. Therefore, the analysis considers the effective after-tax cost of assessments in calculating the effect on capital. The effect of the change in assessments on an established small bank's income is measured by the change in deposit insurance assessments as a percent of income before assessments, taxes, and extraordinary items and other adjustments (hereafter referred to as “income”). 61 This income measure is used to eliminate the potentially transitory effects of extraordinary items and taxes on profitability. To facilitate a comparison of the effect of assessment changes, established small banks were assigned to one of two groups: Those that were profitable and those that were unprofitable for the twelve months ending December 31, 2015. For this analysis, data as of December 31, 2015, are used to calculate each bank's assessment base and risk-based assessment rate. The base and rate are assumed to remain constant throughout the one-year projection period. An established small bank's earnings retention and dividend policies also influence the extent to which assessments affect equity levels. If an established small bank maintains the same dollar amount of dividends when it pays a higher deposit insurance assessment under the proposed rule, equity (retained earnings) will be less by the full amount of the after-tax cost of the increase in the assessment. This analysis instead assumes that an established small bank will maintain its dividend rate (that is, dividends as a fraction of net income) unchanged from the weighted average rate reported over the four quarters ending December 31, 2015. 61 As discussed earlier, at present, the Call Report combines extraordinary items with two other adjustments: (1) The results of discontinued operations; and (2) the cumulative effect of changes in accounting principles not reported elsewhere in the Call Report. As discussed in a previous footnote, however, in January 2015, the concept of extraordinary items was eliminated from GAAP for fiscal years and interim periods within those fiscal years beginning after December 15, 2015, and extraordinary items will no longer be reported as such in the Call Report. In addition, the cumulative effect of changes in accounting principles will no longer be reported as an adjustment. The results of discontinued operations, however, will continue to be reported as an adjustment. Because the three adjustments cannot be disaggregate in Call Report data, income in the analysis is measured before all three adjustments, even though only one adjustment will apply in the future. In any event, extraordinary items and the cumulative effect of changes in accounting principles are rarely reported and should have little effect on the analysis. Projected Effects on Capital and Earnings Assuming a Change in the Initial Assessment Rate Range From 5 Basis Points to 35 Basis Points to 3 Basis Points to 30 Basis Points (Assessment Change F330-C535) Under this scenario, the FDIC projects that no established small bank facing an increase in assessments will, as a result of the assessment increase, fall below a 4 percent or 2 percent leverage ratio. No established small bank facing a decrease in assessments will, as a result of the decrease, have its leverage ratio rise above a 2 percent leverage ratio, but one bank will rise above a 4 percent leverage ratio. The FDIC projects that approximately 85 percent of established small banks that were profitable during the 12 months ending December 31, 2015, will have a decrease in assessments in an amount between 0 and 10 percent of income. Table 11 shows that another 8 percent of profitable established small banks will have a reduction in assessments exceeding 10 percent of their income. A total of 407 profitable established small banks will have an increase in assessments, with all but 10 of them facing assessment increases between 0 and 10 percent of their income. Table 11—Effect of the Final Rule on Income for Profitable Established Small Banks [F330 compared to C535] Change in assessments relative to income Institutions Number Percent of total profitable established small banks Assets Assets ($ billions) Percent of total assets of profitable established small banks Decrease over 40% 88 2 18 1 Decrease 20% to 40% 96 2 18 1 Decrease 10% to 20% 283 5 66 2 Decrease 5% to 10% 572 10 154 5 Decrease 0% to 5% 4,335 75 2,328 78 No Change 1 0 0 0 Increase 0% to 5% 388 7 375 13 Increase 5% to 10% 9 0 6 0 Increase 10% to 20% 6 0 3 0 Increase 20% to 40% 2 0 6 0 Increase over 40% 2 0 0 0 All * 5,782 100 2,975 100 * Figures may not add to totals and some percentages may appear incorrect due to rounding. Table 12 provides the same analysis for established small banks that were unprofitable during the 12 months ending December 31, 2015. Table 12 shows that 46 percent of unprofitable established small banks will have a decrease in assessments in an amount between 0 and 10 percent of their losses. Another 48 percent will have lower assessments in amounts exceeding 10 percent income. Only 16 unprofitable banks will have assessment increases, all of them in amounts between 0 and 10 percent of losses. Table 12—Effect of the Final Rule on Income for Unprofitable Established Small Banks [F330 compared to C535] Change in assessments relative to income Institutions Number Percent of total unprofitable established small banks Assets Assets ($ billions) Percent of total assets of unprofitable established small banks Decrease over 40% 47 16 7 11 Decrease 20% to 40% 37 13 12 20 Decrease 10% to 20% 57 19 9 14 Decrease 5% to 10% 49 17 11 18 Decrease 0% to 5% 87 30 20 32 No Change 1 0 0 0 Increase 0% to 5% 15 5 3 5 Increase 5% to 10% 1 0 0 0 Increase 10% to 20% 0 0 0 0 Increase 20% to 40% 0 0 0 0 Increase over 40% 0 0 0 0 All * 294 100 62 100 * Figures may not add to totals and some percentages may appear incorrect due to rounding. Projected Effects on Capital and Earnings Assuming Same Initial Assessment Rate Range (F330-C330) Under this scenario, the FDIC projects that no established small bank facing an increase in assessments will, as a result of the assessment increase, fall below a 4 percent or 2 percent leverage ratio. No established small bank facing a decrease in assessments will, as a result of the assessment decrease, have its leverage ratio rise above the 4 percent or 2 percent threshold. Table 13 shows that 51 percent of established small banks that were profitable during the 12 months ended December 31, 2015, will have a decrease in assessments in an amount between 0 and 10 percent of income. Another 4 percent of profitable established small banks will have a reduction in assessments exceeding 10 percent of their income. A total of 1,208 profitable established small banks will have an increase in assessments, with all but 23 facing assessment increases between 0 and10 percent of their income. Table 13—Effect of the Final Rule on Income for Profitable Established Small Banks [F330 compared to C330] Change in assessments relative to income Institutions Number Percent of total profitable established small banks Assets Assets ($ billions) Percent of total assets of profitable established small banks Decrease over 40% 43 1 7 0 Decrease 20% to 40% 50 1 11 0 Decrease 10% to 20% 121 2 22 1 Decrease 5% to 10% 282 5 79 3 Decrease 0% to 5% 2,655 46 1,160 39 No Change 1,423 25 591 20 Increase 0% to 5% 1,139 20 1,057 36 Increase 5% to 10% 46 1 34 1 Increase 10% to 20% 12 0 7 0 Increase 20% to 40% 7 0 7 0 Increase over 40% 4 0 1 0 All * 5,782 100 2,975 100 * Figures may not add to totals and some percentages may appear incorrect due to rounding. Table 14 provides the same analysis for established small banks that were unprofitable during the 12 months ending December 31, 2015. Table 14 shows that 54 percent of unprofitable established small banks will have a decrease in assessments in an amount between 0 and 10 percent of their losses. Another 30 percent will have lower assessments in amounts exceeding 10 percent of their losses. Only 39 unprofitable banks will face assessment increases, all but 3 of them in amounts between 0 and 10 percent of losses. Table 14—Effect of the Final Rule on Income for Unprofitable Established Small Banks [F330 compared to C330] Change in assessments relative to losses Institutions Number Percent of total unprofitable established small banks Assets Assets ($ billions) Percent of total assets of unprofitable established small banks Decrease over 40% 28 10 5 7 Decrease 20% to 40% 23 8 2 4 Decrease 10% to 20% 38 13 14 22 Decrease 5% to 10% 54 18 7 11 Decrease 0% to 5% 105 36 26 41 No Change 7 2 1 2 Increase 0% to 5% 32 11 6 9 Increase 5% to 10% 4 1 1 2 Increase 10% to 20% 2 1 0 1 Increase 20% to 40% 1 0 0 0 Increase over 40% 0 0 0 0 All * 294 100 62 100 * Figures may not add to totals and some percentages may appear incorrect due to rounding. IV. Backtesting To evaluate the final rule, the FDIC tested how well the assessment system in the final rule would have differentiated between banks that failed and those that did not during the recent crisis compared to the current small bank deposit insurance assessment system. Table 15 compares accuracy ratios for the assessment system in the final rule and the current system. An accuracy ratio compares how well each approach would have discriminated between banks that failed within the projection period and those that did not. The projection period in each case is the three years following the date of the projection (the first column), which is the last day of the year given. Thus, for example, the accuracy ratios for 2006 reflect how well each approach would have discriminated in its projection between banks that failed and those that did not from 2007 through 2009. 62 A “perfect” projection would receive an accuracy ratio of 1; a random projection would receive an accuracy ratio of 0. 63 62 The current small bank deposit insurance assessment system did not exist at the end of 2006 and existed in somewhat different forms in years before 2011. The comparison assumes that the small bank deposit insurance assessment system in its current form existed in each year of the comparison. 63 A “perfect” projection is defined as one where the projection rates every bank that fails over the projection period as more risky than every bank that does not fail. A random projection is one where the projection does no better than chance; that is, any given percentage of banks with projected higher risk will include the same percentage of banks that fail over the projection period. Thus, for example, in a random projection, the 10 percent of banks that receive the highest risk projections will include 10 percent of the banks that fail over the projection period; the 20 percent of banks that receive the highest risk projections will include 20 percent of the banks that fail over the projection period, and so on. Table 15—Accuracy Ratio Comparison Between the Final Rule and the Current Small Bank Deposit Insurance Assessment System Year of projection (A) Accuracy ratio for the final rule * (B) Accuracy ratio for the current small bank assessment system (A −B) Accuracy ratio for the final rule—accuracy ratio for the current system 2006 0.7000 0.3491 0.3509 2007 0.7756 0.5616 0.2141 2008 0.9003 0.7825 0.1178 2009 0.9354 0.9015 0.0339 2010 0.9659 0.9394 0.0265 2011 0.9543 0.9323 0.0219 * The accuracy ratio for the final rule is based on the conversion of the statistical model as estimated based on bank data through 2011 and failure data through 2014. The table contains results that do not differ materially from the comparisons of the assessment system proposed in the 2015 NPR and 2016 revised NPR with the current small bank deposit insurance assessment system. In each comparison, the table reveals that, while the current system did relatively well at capturing risk and predicting failures in more recent years, the system under the final rule would have not only done significantly better immediately before the recent crisis and at the beginning of the crisis, but also better overall. 64 In the early part of the crisis, when CAMELS ratings had not fully reflected the worsening condition of many banks, the system under the final rule would have recognized risk far better than the current system, primarily because the rates under the final rule are not constrained by risk categories. As the crisis progressed and CAMELS ratings more fully reflected crisis conditions, the superiority of the system under the final rule decreased, but it still performed better than the current system. 64 As implied in the footnote to Table 15, the accuracy ratios in the table for the system under the final rule are based on in-sample backtesting. In-sample backtesting compares model forecasts to actual outcomes where those outcomes are included in the data used in model development. Out-of-sample backtesting is the comparison of model predictions against outcomes where those outcomes are not used as part of the model development used to generate predictions. Out-of-sample backtesting, discussed in Appendix 1 of the Supplementary Information section of the 2015 NPR and 2016 revised NPR, also shows that, while the current assessment system for small banks did relatively well at predicting failures in more recent years, the revised system would have done significantly better immediately before the recent crisis and at the beginning of the crisis, but also better overall. See 80 FR at 40857 and 81 FR at 6124. Appendix 1 to the Supplementary Information sections of the 2015 NPR and 2016 revised NPR contains a more detailed description of the FDIC's backtests of the revised system. V. Alternatives Considered In the 2015 NPR and 2016 revised NPR, the FDIC solicited comments on the following alternatives: Different minimum and maximum assessment rates based on CAMELS composite ratings, including higher, lower, or no minimum or maximum initial assessment rates for banks with certain CAMELS ratings; the inclusion of loss given default (LGD) in the statistical model; and no changes to the small bank deposit insurance assessment system. The FDIC received 6 comments in response to the 2015 NPR and 1 comment in response to the 2016 revised NPR related to minimum and maximum initial assessment rates. Specifically, commenters asserted that the proposed minimum and maximum assessment rates were inappropriate. Instead of adjusting the minimum and maximum assessment rates based on CAMELS composite ratings, commenters suggested that CAMELS supervisory ratings should be given a greater weight in the assessment formula. In the FDIC's view, the minimum and maximum assessment rates adopted in the final rule strike the proper balance between maintaining the accuracy of the assessment system in differentiating between banks that will fail and those that will not and reducing the risk that a particular bank's assessment rate might be too high or too low. The FDIC also considered but rejected including LGD in the statistical model. The FDIC received one comment in response to the 2015 NPR supporting the incorporation of LGD into the assessments system once reliable data is available. As described in the 2015 NPR, actual losses for many failed banks during the recent crisis are still estimated, primarily because of the use of loss-sharing agreements that have not yet terminated. The FDIC also considered leaving the small bank deposit insurance assessment system in place unchanged (and two commenters on the 2015 NPR supported this alternative). For the reasons given above, the assessment system in the final rule is superior to the current small bank deposit insurance system. Under the system in the final rule, fewer riskier established small banks will pay lower assessments and fewer safer banks will pay higher assessments than their conditions warrant. VI. Effective Date The final rule is effective July 1, 2016. If the reserve ratio reaches 1.15 percent before that date, the assessment system described in the final rule will become operative July 1, 2016. If the reserve ratio has not reached 1.15 percent by that date, the assessment system described in the final rule will become operative the first day of the calendar quarter after the reserve ratio reaches 1.15 percent. VII. Regulatory Analysis and Procedure A. Regulatory Flexibility Act The Regulatory Flexibility Act (RFA) requires that each federal agency, in connection with a notice of final rulemaking, prepare a final regulatory flexibility analysis describing the impact of the rule on small entities or certify that the final rule will not have a significant economic impact on a substantial number of small entities. 65 Certain types of rules, such as rules of particular applicability relating to rates or corporate or financial structures, or practices relating to such rates or structures, are expressly excluded from the definition of “rule” for purposes of the RFA. 66 The final rule relates directly to the rates imposed on insured depository institutions for deposit insurance and to the deposit insurance assessment system that measures risk and determines each established small bank's assessment rate. Nonetheless, the FDIC is voluntarily undertaking a final regulatory flexibility analysis. 65 See 5 U.S.C. 603, 604 and 605. 66 5 U.S.C. 601. As of December 31, 2015, of the 6,191 FDIC-insured institutions, 67 there were 4,918 small insured depository institutions as that term is defined for purposes of the RFA ( i.e., those with $550 million or less in assets). 68 67 As of December 31, 2015, there were 6,182 insured commercial banks and savings institutions and 9 insured U.S. branches of foreign banks. 68 Throughout this RFA analysis (unlike the rest of this final rule), a “small institution” refers to an institution with assets of $550 million or less; a “small bank,” however, continues to refer to a small insured depository institution for purposes of deposit insurance assessments (generally, a bank with less than $10 billion in assets). One insured branch of a foreign banking association and two insured institutions established within the last five years were excluded from the RFA analysis. For purposes of this analysis, whether the FDIC were to collect needed assessments under existing regulations or under the final rule, the total amount of assessments collected would be the same. The FDIC's total assessment needs are driven by the FDIC's aggregate projected and actual insurance losses, expenses, investment income, and insured deposit growth, among other factors, and assessment rates are set pursuant to the FDIC's long-term fund management plan. This analysis demonstrates how the pricing system in the final rule under the range of initial assessment rates of 3 basis points to 30 basis points (F330) could affect small entities relative to the current assessment rate schedule (C535) and relative to the rate schedule that under current regulations will be in effect when the reserve ratio exceeds 1.15 percent (C330). 69 Using data as of December 31, 2015, the FDIC calculated the total assessments that were collected under rate schedule C535, that would have been collected under rate schedule C330 and that will be collected under the final rule. 69 The analysis is based on total assessment rates, rather than initial assessment rates. The economic impact of the final rule on each small institution for RFA purposes ( i.e., institutions with assets of $550 million or less) was then calculated as the difference in annual assessments under the final rule compared to existing regulations as a percentage of the institution's annual revenue and annual profits, assuming the same total assessments collected by the FDIC from the banking industry. 70 70 For purposes of the analysis, an institution's total revenue is defined as the sum of its interest income and noninterest income and an institution's profit is defined as income before taxes and extraordinary items. Projected Effects on Small Entities Assuming No Change in Initial Assessment Rate Range (F330-C330) Based on the December 31, 2015 data, of the total of 4,918 small institutions, no institution will experience an increase in assessments equal to five percent or more of its total revenue. These figures do not reflect a significant economic impact on revenues for a substantial number of small insured institutions. Table 16 below sets forth the results of the analysis in more detail. Table 16—Percent Change in Assessments Resulting From the Final Rule [Assuming no change in the assessment rate range] Change in assessments Number of institutions Percent of institutions More than 5 percent lower 0 0 0 to 5 percent lower 2,899 59 No change 1,214 25 0 to 5 percent higher 805 16 More than 5 percent higher 0 0 Total 4,918 100 The FDIC performed a similar analysis to determine the impact on profits for small institutions. Based on December 31, 2015 data, of those small institutions with reported profits, 18 institutions will have an increase in assessments equal to 10 percent or more of their profits. Again, these figures do not reflect a significant economic impact on profits for a substantial number of small insured institutions. Table 17 sets forth the results of the analysis in more detail. Table 17 *—Assessment Changes Relative to Profits for Profitable Small Institutions Under the Final Rule [Assuming no change in the initial assessment rate range] Change in assessments relative to profits Number of institutions Percent of institutions Decrease in assessments equal to more than 40 percent of profits 42 1 Decrease in assessments equal to 20 to 40 percent of profits 49 1 Decrease in assessments equal to 10 to 20 percent of profits 113 2 Decrease in assessments equal to 5 to 10 percent of profits 253 5 Decrease in assessments up to 5 percent of profits 2,210 48 No change in assessments 1,207 26 Increase in assessments up to 5 percent of profits 716 15 Increase in assessments equal to 5 to 10 percent of profits 34 1 Increase in assessments equal to 10 to 20 percent of profits 9 0 Increase in assessments equal to 20 to 40 percent of profits 5 0 Increase in assessments equal to more than 40 percent of profits 4 0 Total 4,642 ** 100 * Institutions with negative or no profit were excluded. These institutions are shown in Table 14. ** Figures may not add to totals due to rounding. Table 17 excludes small institutions that either show no profit or show a loss, because a percentage cannot be calculated. The FDIC analyzed the effect of the final rule on these institutions by determining the annual assessment change (either an increase or a decrease) that will result. Table 18 below shows that 18 (seven percent) of the 276 small insured institutions with negative or no reported profits will have an increase of $20,000 or more in their annual assessments. Again, these figures do not reflect a significant economic impact on profits for a substantial number of small insured institutions. Table 18—Change in Assessments for Unprofitable Small Institutions Resulting From the Final Rule [Assuming no change in the initial assessment rate range] Change in assessments Number of institutions Percent of institutions $20,000 or more decrease 115 42 $10,000-$20,000 decrease 53 19 $5,000-$10,000 decrease 28 10 $1,000-$5,000 decrease 30 11 $0-$1,000 decrease 7 3 No change 7 3 $0-$1,000 increase 5 2 $1,000-$5,000 increase 3 1 $5,000-$10,000 increase 4 1 $10,000-$20,000 increase 6 2 $20,000 increase or more 18 7 Total 276 * 100 * Figures may not add to totals due to rounding. Projected Effects on Small Entities Assuming Change in the Initial Assessment Rate Range From 5-35 Bps to 3-30 Bps (F330-C535) Based on the December 31, 2015 data, of the total of 4,918 small institutions, no institution will experience an increase in assessments equal to five percent or more of its total revenue. These figures do not reflect a significant economic impact on revenues for a substantial number of small insured institutions. Table 19 below sets forth the results of the analysis in more detail. Table 19—Percent Change in Assessments Resulting From the Final Rule [Assuming change in the initial assessment rate range from 5-35 bps to 3-30 bps] Change in assessments Number of institutions Percent of institutions More than 5 percent lower 0 0 0 to 5 percent lower 4,660 95 No change 2 0 0 to 5 percent higher 256 5 More than 5 percent higher 0 0 Total 4,918 100 The FDIC performed a similar analysis to determine the impact on profits for small institutions. Based on December 31, 2015 data, of those small institutions with reported profits, 7 institutions will have an increase in assessments equal to 10 percent or more of their profits. Again, these figures do not reflect a significant economic impact on profits for a substantial number of small insured institutions. Table 20 sets forth the results of the analysis in more detail. Table 20*—Assessment Changes Relative to Profits for Profitable Small Institutions Under the Final Rule [Assuming change in the initial assessment rate range from 5-35 Bps to 3-30 Bps] Change in assessments relative to profits Number of institutions Percent of institutions Decrease in assessments equal to more than 40 percent of profits 85 2 Decrease in assessments equal to 20 to 40 percent of profits 90 2 Decrease in assessments equal to 10 to 20 percent of profits 259 6 Decrease in assessments equal to 5 to 10 percent of profits 527 11 Decrease in assessments up to 5 percent of profits 3,440 74 No change in assessments 1 0 Increase in assessments up to 5 percent of profits 226 5 Increase in assessments equal to 5 to 10 percent of profits 7 0 Increase in assessments equal to 10 to 20 percent of profits 5 0 Increase in assessments equal to 20 to 40 percent of profits 0 0 Increase in assessments equal to more than 40 percent of profits 2 0 Total 4,642 ** 100 * Institutions with negative or no profit were excluded. These institutions are shown in Table 17. ** Figures may not add to totals due to rounding. Table 20 excludes small institutions that either show no profit or show a loss, because a percentage cannot be calculated. The FDIC analyzed the effect of the final rule on these institutions by determining the annual assessment change (either an increase or a decrease) that will result. Table 21 below shows that just 7 (3 percent) of the 276 small insured institutions with negative or no reported profits will have an increase of $20,000 or more in their annual assessments. Again, these figures do not reflect a significant economic impact on profits for a substantial number of small insured institutions. Table 21—Change in Assessments for Unprofitable Small Institutions Resulting From the Final Rule [Assuming assessment change in the initial assessment rate range from 5-35 bps to 3-30 bps] Change in assessments Number of institutions Percent of institutions $20,000 or more decrease 181 66 $10,000-$20,000 decrease 44 16 $5,000-$10,000 decrease 28 10 $1,000-$5,000 decrease 5 2 $0-$1,000 decrease 2 1 No change 1 0 $0-$1,000 increase 0 0 $1,000-$5,000 increase 2 1 $5,000-$10,000 increase 5 2 $10,000-$20,000 increase 1 0 $20,000 increase or more 7 3 Total 276 * 100 * Figures may not add to totals due to rounding. The final rule does not directly impose any “reporting” or “recordkeeping” requirements within the meaning of the Paperwork Reduction Act. The compliance requirements for the final rule will not exceed (and, in fact, will be the same as) existing compliance requirements for the current risk-based deposit insurance assessment system for small banks. The FDIC is unaware of any duplicative, overlapping or conflicting federal rules. The final RFA analysis set forth above demonstrates that the final rule will not have a significant economic impact on a substantial number of small institutions within the meaning of those terms as used in the RFA. 71 71 5 U.S.C. 605. B. Small Business Regulatory Enforcement Fairness Act The Office of Management and Budget has determined that the final rule is not a “major rule” within the meaning of the Small Business Regulatory Enforcement Fairness Act of 1996 (Title II, Pub. L. 104-121). C. Riegle Community Development and Regulatory Improvement Act The Riegle Community Development and Regulatory Improvement Act (RCDRIA) requires that the FDIC, in determining the effective date and administrative compliance requirements of new regulations that impose additional reporting, disclosure, or other requirements on insured depository institutions, consider, consistent with principles of safety and soundness and the public interest, any administrative burdens that such regulations would place on depository institutions, including small depository institutions, and customers of depository institutions, as well as the benefits of such regulations. 72 Subject to certain exceptions, new regulations and amendments to regulations prescribed by a Federal banking agency which impose additional reporting, disclosures, or other new requirements on insured depository institutions shall take effect on the first day of a calendar quarter which begins on or after the date on which the regulations are published in final form. 73 72 12 U.S.C. 4802(a). 73 12 U.S.C. 4802(b). In accordance with these provisions and as discussed above, the FDIC considered any administrative burdens, as well as benefits, that the final rule would place on depository institutions and their customers in determining the effective date and administrative compliance requirements of the final rule. Thus, the final rule will be effective no earlier than the first day of a calendar quarter that begins after publication of the rule. C. Paperwork Reduction Act In accordance with the requirements of the Paperwork Reduction Act (“PRA”) of 1995, 74 the FDIC may not conduct or sponsor, and the respondent is not required to respond to, an information collection unless it displays a currently valid Office of Management and Budget (“OMB”) control number. 74 44 U.S.C. 3501 et seq. The final rule does not create any new, or revise any existing, collections of information pursuant to PRA. D. The Treasury and General Government Appropriations Act, 1999—Assessment of Federal Regulations and Policies on Families The F [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2016-11181. Public record. Not legal advice.