# Assessments

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URL: https://www.frixlaw.com/law-library/documents/fr%3AE9-4584

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** March 4, 2009
- **Citation:** 74 FR 9525

## Text

FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 327
RIN 3064-AD35
Assessments

AGENCY:

Federal Deposit Insurance Corporation (FDIC).

ACTION:

Final rule.

SUMMARY:

The FDIC is amending our regulation to alter the way in which it differentiates for risk in the risk-based assessment system; revise deposit insurance assessment rates, including base assessment rates; and make technical and other changes to the rules governing the risk-based assessment system.

DATES:

Effective Date:
April 1, 2009.

FOR FURTHER INFORMATION CONTACT:

Munsell W. St. Clair, Chief, Banking and Regulatory Policy Section, Division of Insurance and Research, (202) 898-8967; and Christopher Bellotto, Counsel, Legal Division, (202) 898-3801.

SUPPLEMENTARY INFORMATION:

I. Background

The Reform Act

On February 8, 2006, the President signed the Federal Deposit Insurance Reform Act of 2005 into law; on February 15, 2006, he signed the Federal Deposit Insurance Reform Conforming Amendments Act of 2005 (collectively, the Reform Act).
1

The Reform Act enacted the bulk of the reform recommendations made by the FDIC in 2001.
2

The Reform Act, among other things, required that the FDIC, “prescribe final regulations, after notice and opportunity for comment * * * providing for assessments under section 7(b) of the Federal Deposit Insurance Act, as amended * * *,” thus giving the FDIC, through its rulemaking authority, the opportunity to better price deposit insurance for risk.
3

1
Federal Deposit Insurance Reform Act of 2005, Public Law 109-171, 120 Stat. 9; Federal Deposit Insurance Conforming Amendments Act of 2005, Public Law 109-173, 119 Stat. 3601.

2
After a year long review of the deposit insurance system, the FDIC made several recommendations to Congress to reform the deposit insurance system. See
http://www.fdic.gov/deposit/insurance/initiative/direcommendations.html
for details.

3
Section 2109(a)(5) of the Reform Act. Section 7(b) of the Federal Deposit Insurance Act (12 U.S.C. 1817(b)).

The Federal Deposit Insurance Act, as amended by the Reform Act, continues to require that the assessment system be risk-based and allows the FDIC to define risk broadly. It defines a risk-based system as one based on an institution's probability of causing a loss to the deposit insurance fund due to the composition and concentration of the institution's assets and liabilities, the amount of loss given failure, and revenue needs of the Deposit Insurance Fund (the fund or DIF).
4

4
12 Section 7(b)(1)(C) of the Federal Deposit Insurance Act (12 U.S.C. 1817(b)(1)(C)). The Reform Act merged the former Bank Insurance Fund and Savings Association Insurance Fund into the Deposit Insurance Fund.

Before passage of the Reform Act, the deposit insurance funds' target reserve ratio—the designated reserve ratio (DRR)—was generally set at 1.25 percent. Under the Reform Act, however, the FDIC may set the DRR within a range of 1.15 percent to 1.50 percent of estimated insured deposits. If the reserve ratio drops below 1.15 percent—or if the FDIC expects it to do so within six months—the FDIC must, within 90 days, establish and implement a plan to restore the DIF to 1.15 percent within five years (absent extraordinary circumstances).
5

5
Section 7(b)(3)(E) of the Federal Deposit Insurance Act (12 U.S.C. 1817(b)(3)(E)).

The Reform Act also restored to the FDIC's Board of Directors the discretion to price deposit insurance according to risk for all insured institutions regardless of the level of the fund reserve ratio.
6

6
The Reform Act eliminated the prohibition against charging well-managed and well-capitalized institutions when the deposit insurance fund is at or above, and is expected to remain at or above, the designated reserve ratio (DRR). This prohibition was included as part of the Deposit Insurance Funds Act of 1996. Public Law 104-208, 110 Stat. 3009, 3009-479. However, while the Reform Act allows the DRR to be set between 1.15 percent and 1.50 percent, it also generally requires dividends of one-half of any amount in the fund in excess of the amount required to maintain the reserve ratio at 1.35 percent when the insurance fund reserve ratio exceeds 1.35 percent at the end of any year. The Board can suspend these dividends under certain circumstances. The Reform Act also requires dividends of all of the amount in excess of the amount needed to maintain the reserve ratio at 1.50 when the insurance fund reserve ratio exceeds 1.50 percent at the end of any year. 12 U.S.C. 1817(e)(2).

The Reform Act left in place the existing statutory provision allowing the FDIC to “establish separate risk-based assessment systems for large and small members of the Deposit Insurance Fund.”
7

Under the Reform Act, however, separate systems are subject to a new requirement that “[n]o insured depository institution shall be barred from the lowest-risk category solely because of size.”
8

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

8
Section 2104(a)(2) of the Reform Act amending Section 7(b)(2)(D) of the Federal Deposit Insurance Act (12 U.S.C. 1817(b)(2)(D)).

The 2006 Assessments Rule

Overview

On November 30, 2006, pursuant to the requirements of the Reform Act, the FDIC published in the
Federal Register
a final rule on the risk-based assessment system (the 2006 assessments rule).
9

The rule became effective on January 1, 2007.

9
71 FR 69282. The FDIC also adopted several other final rules implementing the Reform Act, including a final rule on operational changes to part 327. 71 FR 69270.

The 2006 assessments rule created four risk categories and named them Risk Categories I, II, III and IV. These four categories are based on two criteria: capital levels and supervisory ratings. Three capital groups—well capitalized, adequately capitalized, and undercapitalized—are based on the leverage ratio and risk-based capital ratios for regulatory capital purposes. Three supervisory groups, termed A, B, and C, are based upon the FDIC's consideration of evaluations provided by the institution's primary federal regulator and other information the FDIC deems relevant.
10

Group A consists of financially sound institutions with only a few minor weaknesses; Group B consists of institutions that demonstrate weaknesses which, if not corrected, could result in significant deterioration of the institution and increased risk of loss to the insurance fund; and Group C consists of institutions that pose a substantial probability of loss to the insurance fund unless effective corrective action is taken.
11

Under the 2006 assessments rule, an institution's capital and supervisory groups determine its risk category as set forth in Table 1 below. (Risk categories appear in Roman numerals.)

10
The term “primary federal regulator” is synonymous with the statutory term “appropriate federal banking agency.” Section 3(q) of the Federal Deposit Insurance Act (12 U.S.C. 1813(q)).

11
The capital groups and the supervisory groups have been in effect since 1993. In practice, the supervisory group evaluations are based on an institution's composite CAMELS rating, a rating assigned by the institution's supervisor at the end of a bank examination, with 1 being the best rating and 5 being the lowest. CAMELS is an acronym for component ratings assigned in a bank examination: Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk. A composite CAMELS rating combines these component ratings, which also range from 1 (best) to 5 (worst). Generally, institutions with a CAMELS rating of 1 or 2 are assigned to supervisory group A, those with a CAMELS rating of 3 to group B, and those with a CAMELS rating of 4 or 5 to group C.

Table 1—Determination of Risk Category

Capital category
Supervisory group
A
B
C

Well Capitalized
I

III

Adequately Capitalized
II

Undercapitalized
III
IV

The 2006 assessments rule established the following base rate schedule and allowed the FDIC Board to adjust rates uniformly from one quarter to the next up to three basis points above or below the base schedule without further notice-and-comment rulemaking, provided that no single change from one quarter to the next can exceed three basis points.
12

Base assessment rates within Risk Category I varied from 2 to 4 basis points, as set forth in Table 2 below.

12
The Board cannot adjust rates more than 2 basis points below the base rate schedule because rates cannot be less than zero.

Table 2—2007-08 Base Assessment Rates

Risk category
I*
Minimum
Maximum
II
III
IV

Annual Rates (in basis points)
2
4
7
25
40

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

The 2006 assessments rule set actual rates beginning January 1, 2007, as set out in Table 3 below.

Table 3—2007-08 Actual Assessment Rates

Risk category
I*
Minimum
Maximum
II
III
IV

Annual Rates (in basis points)
5
7
10
28
43

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

Risk Category I

Within Risk Category I, the 2006 assessments rule charges those institutions that pose the least risk a minimum assessment rate and those that pose the greatest risk a maximum assessment rate two basis points higher than the minimum rate. The rule charges other institutions within Risk Category I a rate that varies incrementally by institution between the minimum and maximum.

Within Risk Category I, the 2006 assessments rule combines supervisory ratings with other risk measures to further differentiate risk and determine assessment rates. The
financial ratios method
determines the assessment rates for most institutions in Risk Category I using a combination of weighted CAMELS component ratings and the following financial ratios:

• The Tier 1 Leverage Ratio;

• Loans past due 30-89 days/gross assets;

• Nonperforming assets/gross assets;

• Net loan charge-offs/gross assets; and

• Net income before taxes/risk-weighted assets.

The weighted CAMELS components and financial ratios are multiplied by statistically derived pricing multipliers and the products, along with a uniform amount applicable to all institutions subject to the financial ratios method, are summed to derive the assessment rate under the base rate schedule. If the rate derived is below the minimum for Risk Category I, however, the institution will pay the minimum assessment rate for the risk category; if the rate derived is above the maximum rate for Risk Category I, then the institution will pay the maximum rate for the risk category.

The multipliers and uniform amount were derived in such a way to ensure that, as of June 30, 2006, 45 percent of small Risk Category I institutions (other than institutions less than 5 years old) would have been charged the minimum rate and approximately 5 percent would have been charged the maximum rate. While the FDIC has not changed the multipliers and uniform amount since adoption of the 2006 assessments rule, the percentages of institutions that have been charged the minimum and maximum rates have changed over time as institutions' CAMELS component ratings and financial ratios have changed. Based upon June 30, 2008 data, approximately 28 percent of small Risk Category I institutions (other than institutions less than 5 years old) were charged the minimum rate and approximately 19 percent were charged the maximum rate.
13

13
Based upon September 30, 2008 data, approximately 26 percent of small Risk Category I institutions (other than institutions less than 5 years old) were charged the minimum rate and approximately 23 percent were charged the maximum rate.

The
supervisory and debt ratings method
(or
debt ratings method
) determines the assessment rate for large institutions that have a long-term debt issuer rating.
14

Long-term debt issuer ratings are converted to numerical values between 1 and 3 and averaged. The weighted average of an institution's CAMELS components and the average converted value of its long-term debt issuer ratings are multiplied by a common multiplier and added to a uniform amount applicable to all institutions subject to the supervisory and debt ratings method to derive the assessment rate under the base rate schedule. Again, if the rate derived is below the minimum for Risk Category I, the institution will pay the minimum assessment rate for the risk category; if the rate derived is above the maximum for Risk Category I, then the institution will pay the maximum rate for the risk category.

14
The final rule defined a large institution as an institution (other than an insured branch of a foreign bank) that has $10 billion or more in assets as of December 31, 2006 (although an institution with at least $5 billion in assets may also request treatment as a large institution). If, after December 31, 2006, an institution classified as small reports assets of $10 billion or more in its reports of condition for four consecutive quarters, the FDIC will reclassify the institution as large beginning the following quarter. If, after December 31, 2006, an institution classified as large reports assets of less than $10 billion in its reports of condition for four consecutive quarters, the FDIC will reclassify the institution as small beginning the following quarter. 12 CFR 327.8(g) and (h) and 327.9(d)(6).

The multipliers and uniform amount were derived in such a way to ensure that, as of June 30, 2006, about 45 percent of Risk Category I large institutions (other than institutions less than 5 years old) would have been charged the minimum rate and approximately 5 percent would have been charged the maximum rate. These percentages have changed little from quarter to quarter thereafter even though industry conditions have changed. Based upon June 30, 2008, data, and ignoring the large bank adjustment (described below), approximately 45

percent of Risk Category I large institutions (other than institutions less than 5 years old) were charged the minimum rate and approximately 11 percent were charged the maximum rate.
15

15
Based upon September 30, 2008, data, and ignoring the large bank adjustment (described below), approximately 41 percent of Risk Category I large institutions (other than institutions less than 5 years old) were charged the minimum rate and approximately 11 percent were charged the maximum rate.

Assessment rates for insured branches of foreign banks in Risk Category I are determined using ROCA components.
16

16
ROCA stands for Risk Management, Operational Controls, Compliance, and Asset Quality. Like CAMELS components, ROCA component ratings range from 1 (best rating) to a 5 rating (worst rating). Risk Category 1 insured branches of foreign banks generally have a ROCA composite rating of 1 or 2 and component ratings ranging from 1 to 3.

For any Risk Category I large institution or insured branch of a foreign bank, initial assessment rate determinations may be modified up to half a basis point upon review of additional relevant information (the large bank adjustment).
17

17
The FDIC has issued additional Guidelines for Large Institutions and Insured Foreign Branches in Risk Category I (the large bank guidelines) governing the large bank adjustment. 72 FR 27122 (May 14, 2007).

With certain exceptions, beginning in 2010, the 2006 assessments rule charges new institutions in Risk Category I (those established for less than five years), regardless of size, the maximum rate applicable to Risk Category I institutions. Until then, new institutions are treated like all others, except that a well-capitalized institution that has not yet received CAMELS component ratings is assessed at one basis point above the minimum rate applicable to Risk Category I institutions until it receives CAMELS component ratings.

The Need for a Restoration Plan

As part of a separate rule making in November 2006, the FDIC also set the DRR at 1.25 percent, effective January 1, 2007.
18

In November 2006, the FDIC projected that the assessment rate schedule established by the 2006 assessments rule would raise the reserve ratio from 1.23 percent at the end of the second quarter of 2006 to 1.25 percent by 2009. At the time, insured institution failures were at historic lows (no insured institution had failed in almost two-and-a-half years prior to the rulemaking, the longest period in the FDIC's history without a failure) and industry returns on assets (ROAs) were near all time highs. The FDIC's projection assumed the continued strength of the industry. By March 2008, the condition of the industry had deteriorated, and FDIC projected higher insurance losses compared to recent years. However, even with this increase in projected failures and losses, the reserve ratio was still estimated to reach the Board's target of 1.25 percent in 2009. Therefore, the Board voted in March 2008 to maintain the then existing assessment rate schedule.

18
In November 2007 and October 2008, the Board again voted to maintain the DRR at 1.25 percent for 2008 and 2009, respectively. 71 FR 69325 (Nov. 30, 2006) and 72 FR 65576 (Nov. 21, 2007).

Recent failures of FDIC-insured institutions caused the reserve ratio of the Deposit Insurance Fund (DIF) to decline from 1.19 percent as of March 30, 2008, to 1.01 percent as of June 30, 0.76 percent as of September 30, and 0.40 percent (preliminary) as of December 31. Twenty-five institutions failed in 2008, and the FDIC expects a substantially higher rate of institution failures in the next few years, leading to a further decline in the reserve ratio. Already, 14 institutions have failed in 2009. Because the fund reserve ratio fell below 1.15 percent as of June 30, 2008, and was expected to remain below 1.15 percent, the Reform Act required the FDIC to establish and implement a Restoration Plan to restore the reserve ratio to at least 1.15 percent within five years.

The Proposed Rule

On October 7, 2008, the FDIC established a Restoration Plan for the DIF.
19

In the FDIC's view, restoring the reserve ratio to at least 1.15 percent within five years required an increase in assessment rates. Since rates were already three basis points above the base rate schedule, a new rulemaking was required. Consequently, on October 7, 2008, the FDIC Board of Directors also adopted a notice of proposed rulemaking with request for comments on revisions to the FDIC's assessment regulations (the proposed rule or NPR).
20

The NPR proposed that, effective January 1, 2009, assessment rates would increase uniformly by seven basis points for the first quarter 2009 assessment period. Effective April 1, 2009, the NPR proposed to alter the way in which the FDIC's risk-based assessment system differentiates for risk and set new deposit insurance assessment rates. Also effective on April 1, 2009, the NPR proposed to make technical and other changes to the rules governing the risk-based assessment system. The proposed rule was published concurrently with the Restoration Plan on October 16, 2008, with a comment period scheduled to end on November 17, 2008.
21

19
73 FR 61,598 (Oct. 16, 2008).

20
12 CFR 327.

21
See 73 FR 61,560 (Oct. 16, 2008).

On November 7, 2008, the FDIC Board approved an extension of the comment period until December 17, 2008, on the parts of the proposed rulemaking that would become effective on April 1, 2009. The comment period for the proposed 7 basis point rate increase for the first quarter of 2009, with its separate proposed effective date of January 1, 2009, was not extended and expired on November 17, 2008. The final rule on the rate increase for the first quarter of 2009 was approved as proposed by the FDIC Board on December 16, 2008.
22

22
73 FR 78,155 (Dec. 22, 2008).

The FDIC received almost 5,000 comments on the parts of the proposed rule that would become effective on April 1, 2009, including proposed changes in how the FDIC's risk-based assessment system differentiates for risk and corresponding new assessment rates. This final rule implements the remaining changes that the FDIC proposed in the October notice of proposed rulemaking, with some alteration.

II. Overview of the Final Rule

In this rulemaking, the FDIC seeks to improve the way the assessment system differentiates risk among insured institutions by drawing upon measures of risk that were not included when the FDIC first revised its assessment system pursuant to the Reform Act. The FDIC believes that the rulemaking will make the assessment system more sensitive to risk. The rulemaking should also make the risk-based assessment system fairer, by limiting the subsidization of riskier institutions by safer ones. The assessment rate schedule established in this rule should provide sufficient revenue to cover losses resulting from a large volume of institution failures and raise the insurance fund's reserve ratio over time. However, as explained below, the FDIC is simultaneously issuing an interim rule to impose a 20 basis point special assessment (and possible additional special assessments of up to 10 basis points thereafter). The final rule, which differs in several ways from the proposed rule, is set out in detail in ensuing sections, but is briefly summarized here. The final rule will take effect April 1, 2009, and will apply to assessments for the second quarter of 2009 (which will be collected in September 2009) and thereafter.

Risk Category I

The final rule introduces a new financial ratio into the financial ratios method. This new ratio will capture certain brokered deposits (in excess of 10 percent of domestic deposits) that are used to fund rapid asset growth. The new financial ratio in the final rule differs from the one proposed in the NPR in two ways. It excludes 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 (henceforth referred to as reciprocal deposits). It also raises the asset growth threshold from that proposed in the NPR. The final rule also updates the uniform amount and the pricing multipliers for the weighted average CAMELS component ratings and financial ratios.

The final rule provides that the assessment rate for a large institution with a long-term debt issuer rating will be determined using a combination of the institution's weighted average CAMELS component ratings, its long-term debt issuer ratings (converted to numbers and averaged) and the financial ratios method assessment rate, each equally weighted. The new method will be known as the large bank method.

Under the final rule, the financial ratios method or the large bank method, whichever is applicable, will determine a Risk Category I institution's
initial
base assessment rate. The final rule will broaden the spread between minimum and maximum initial base assessment rates in Risk Category I from 2 basis points to an initial range of 4 basis points and adjust the percentage of institutions subject to these initial minimum and maximum rates.

Adjustments

Under the final rule, an institution's total base assessment rate can vary from the initial base rate as the result of possible adjustments. The final rule also increases the maximum possible Risk Category I large bank adjustment from one-half basis point to one basis point. Any such adjustment up or down will be made before any other adjustment and will be subject to certain limits, which are described in detail below.

Under the final rule, an institution's unsecured debt adjustment—the institution's ratio of long-term unsecured debt (and, for small institutions, certain amounts of its Tier 1 capital) to domestic deposits—will lower the institution's base assessment rate.
23

Any decrease in base assessment rates will be limited to five basis points. The unsecured debt adjustment differs from the adjustment proposed in the NPR in several ways. The adjustment is larger for a given amount of unsecured debt (and, for small institutions, Tier 1 capital) and the maximum adjustment of five basis points is larger than the proposed maximum of two basis points in the NPR. The adjustment excludes senior unsecured debt that the FDIC has guaranteed under its Temporary Liquidity Guarantee Program. Finally, the adjustment lowers the threshold for inclusion of a small institution's Tier 1 capital.

23
Long-term unsecured debt includes senior unsecured and subordinated debt.

Also, under the final rule, an institution's secured liability adjustment—which is based on the institution's ratio of secured liabilities to domestic deposits—will raise its base assessment rate. An institution's ratio of secured liabilities to domestic deposits (if greater than 25 percent), will increase its assessment rate, but the resulting base assessment rate after any such increase can be no more than 50 percent greater than it was before the adjustment. The secured liability adjustment will be made after any large bank adjustment or unsecured debt adjustment. This adjustment also differs from the adjustment proposed in the NPR in that an institution's ratio of secured liabilities to domestic deposits must be greater than 25 percent for an adjustment to exist, rather than 15 percent as proposed in the NPR.

Institutions in all risk categories will be subject to the unsecured debt adjustment and secured liability adjustment. In addition, the final rule makes a final adjustment for brokered deposits (the brokered deposit adjustment) for institutions in Risk Category II, III or IV. An institution's ratio of brokered deposits to domestic deposits (if greater than 10 percent) will increase its assessment rate, but any increase will be limited to no more than 10 basis points. The brokered deposit adjustment is as proposed in the NPR and will
include
reciprocal deposits.

Insured Branches of Foreign Banks

The final rule makes conforming changes to the pricing multipliers and uniform amount for insured branches of foreign banks in Risk Category I. The insured branch of a foreign bank's initial base assessment rate will be subject to any large bank adjustment, but not to the unsecured debt adjustment or secured liability adjustment. In fact, no insured branch of a foreign bank in any risk category will be subject to the unsecured debt adjustment, secured liability adjustment or brokered deposit adjustment.

New Institutions

The final rule makes conforming changes in the treatment of new insured depository institutions.
24

For assessment periods beginning on or after January 1, 2010, any new institutions in Risk Category I will be assessed at the maximum initial base assessment rate applicable to Risk Category I institutions.

24
As discussed below, subject to exceptions, the final rule defines a new insured depository institution as a bank or thirft that has not been federally insured for at least five years as of the last day of any quarter for which it is being assessed.

For assessments for the last three quarters of 2009, until a Risk Category I new institution received CAMELS component ratings, it will have an initial base assessment rate that is two basis points above the minimum initial base assessment rate applicable to Risk Category I institutions, rather than one basis point above the minimum rate, as under the final rule adopted in 2006. For these three quarters, all other new institutions in Risk Category I will be treated as established institutions, except as provided in the next paragraph.

Either before or after January 1, 2010: no new institution, regardless of risk category, will be subject to the unsecured debt adjustment; any new institution, regardless of risk category, will be subject to the secured liability adjustment; and a new institution in Risk Categories II, III or IV will be subject to the brokered deposit adjustment. After January 1, 2010, no new institution in Risk Category I will be subject to the large bank adjustment.

Assessment Rates

As explained below, estimated losses from projected institution failures have risen considerably since the NPR was published last fall. Consequently, initial base assessment rates as of April 1, 2009, which are set forth in Table 4 below, are slightly higher than proposed in the NPR.

Table 4—Initial Base Assessment Rates as of April 1, 2009

Risk category
I*
Minimum
Maximum
II
III
IV

Annual Rates (in basis points)
12
16
22
32
45

* Initial base rates that were not the minimum or maximum rate will vary between these rates.

After applying all possible adjustments, minimum and maximum total base assessment rates for each risk category will be as set out in Table 5 below.

Table 5—Total Base Assessment Rates

Risk category I
Risk category II
Risk category III
Risk category IV

Initial base assessment rate
12-16
22
32
45

Unsecured debt adjustment
−5-0
−5-0
−5-0
−5-0

Secured liability adjustment
0-8
0-11
0-16
0-22.5

Brokered deposit adjustment

0-10
0-10
0-10

Total base assessment rate
7-24.0
17-43.0
27-58.0
40-77.5

* All amounts for all risk categories are in basis points annually. Total base rates that are not the minimum or maximum rate will vary between these rates.

These rates and other revisions to the assessment rules take effect for the quarter beginning April 1, 2009, and will be reflected in the fund balance as of June 30, 2009, and assessments due September 30, 2009 and thereafter.

Because the outlook for losses to the insurance fund has deteriorated significantly since publication of the NPR last fall, the FDIC is simultaneously issuing an interim rule that provides for a 20 basis point special assessment on June 30, 2009. The interim rule also provides that the Board may impose additional special assessments of up to 10 basis points thereafter if the reserve ratio of the DIF is estimated to fall to a level that that the Board believes would adversely affect public confidence or to a level which shall be close to zero or negative at the end of a calendar quarter.

The final rule continues to allow the FDIC Board to adopt actual rates that are higher or lower than total base assessment rates without the necessity of further notice and comment rulemaking, provided that: (1) the Board cannot increase or decrease total rates from one quarter to the next by more than three basis points without further notice-and-comment rulemaking; and (2) cumulative increases and decreases cannot be more than three basis points higher or lower than the total base rates without further notice-and-comment rulemaking.

Technical and Other Changes

The final rule also makes technical changes and one minor non-technical change to the assessments rules. These changes are detailed below.

III. Risk Category I: Financial Ratios Method

Brokered Deposits and Asset Growth

The final rule adds a new financial measure to the financial ratios method. This new financial measure, the adjusted brokered deposit ratio, will measure the extent to which brokered deposits are funding rapid asset growth. The adjusted brokered deposit ratio will affect only those established Risk Category I institutions whose total gross assets are more than 40 percent greater than they were four years previously, after adjusting for mergers and acquisitions, rather than 20 percent greater as proposed in the NPR, and whose brokered deposits (less reciprocal deposits) make up more than 10 percent of domestic deposits.
25 26 27

Generally speaking, the greater an institution's asset growth and the greater its percentage of brokered deposits, the greater will be the increase in its initial base assessment rate. Small changes in asset growth rate or brokered deposits as a percentage of domestic deposits will lead to small changes in assessment rates.

25
As discussed below, subject to exceptions, the final rule defines an established depository institution as a bank or thrift that has been federally insured for at least five years as of the last day of any quarter for which it is being assessed.

26
An institution that four years previously had filed no report of condition or had reported no assets would be treated as having no growth unless it was a participant in a merger or acquisition (either as the acquiring or acquired institution) with an institution that had reported assets four years previously.

27
References hereafter to “asset growth” or “growth in assets” refer to growth in gross assets.

If an institution's ratio of brokered deposits to domestic deposits is 10 percent
or
less or if the institution's asset growth over the previous four years is less than 40 percent, the adjusted brokered deposit ratio will be zero and will have no effect on the institution's assessment rate. If an institution's ratio of brokered deposits to domestic deposits exceeds 10 percent and its asset growth over the previous four years is more than 70 percent (rather than 40 percent as proposed in the NPR), the adjusted brokered deposit ratio will equal the institution's ratio of brokered deposits to domestic deposits less the 10 percent threshold. If an institution's ratio of brokered deposits to domestic deposits exceeds 10 percent but its asset growth over the previous four years is between 40 percent and 70 percent, overall asset growth rates will be converted into an asset growth rate factor ranging between 0 and 1, so that the adjusted brokered deposit ratio will equal a gradually increasing fraction of the ratio of brokered deposits to domestic deposits (minus the 10 percent threshold). The asset growth rate factor is derived by multiplying by 3
1/3
an

amount equal to the overall rate of growth minus 40 percent and expressing the result as a decimal fraction rather than as a percentage (so that, for example, 3
1/3
times 10 percent equals 0.33 * * *).
28

The adjusted brokered deposit ratio will never be less than zero. Appendix A contains a detailed mathematical definition of the ratio. Table 6 gives examples of how the adjusted brokered deposit ratio would be determined.

28
The ratio of brokered deposits to domestic deposits and four-year asset growth rate would remain unrounded (to the extent of computer capabilities) when calculating the adjusted brokered deposit ratio. The adjusted brokered deposit ratio itself (expressed as a percentage) would be rounded to three digits after the decimal point prior to being used to calculate the assessment rate.

Table 6—Adjusted Brokered Deposit Ratio

A
Example
B

Ratio of
brokered
deposits to
domestic
deposits

C
Ratio of brokered deposits to domestic deposits minus 10 percent threshold (column B minus 10 percent)
D
Cumulative asset growth rate over four years
E
Asset growth rate factor
F

Adjusted
brokered
deposit ratio
(column C times
column E)

1
5.0%
0.0%
5.0%

0.0%

2
15.0%
5.0%
5.0%

0.0%

3
5.0%
0.0%
35.0%

0.0%

4
35.0%
25.0%
55.0%
0.500
12.5%

5
25.0%
15.0%
80.0%
1.000
15.0%

In Examples 1, 2 and 3, either the institution has a ratio of brokered deposits to domestic deposits that is less than 10 percent (Column B) or its four-year asset growth rate is less than 40 percent (Column D). Consequently, the adjusted brokered deposit ratio is zero (Column F). In Example 4, the institution has a ratio of brokered deposits to domestic deposits of 35 percent (Column B), which, after subtracting the 10 percent threshold, leaves 25 percent (Column C). Its assets are 55 percent greater than they were four years previously (Column D), so the fraction applied to obtain the adjusted brokered deposit ratio is 0.5 (Column E) (calculated as 3
1/3
(55 percent—40 percent, with the result expressed as a decimal fraction rather than as a percentage)). Its adjusted brokered deposit ratio is, therefore, 12.5 percent (Column F) (which is 0.5 times 25 percent). In Example 5, the institution has a lower ratio of brokered deposits to domestic deposits (25 percent in Column B) than in Example 4 (35 percent). However, its adjusted brokered deposit ratio (15 percent in Column F) is larger than in Example 4 (12.5 percent) because its assets are more than 70 percent greater than they were four years previously (Column D). Therefore, its adjusted brokered deposit ratio is equal to its ratio of brokered deposits to domestic deposits of 25 percent minus the 10 percent threshold (Column F).

The FDIC is adding this new risk measure for a couple of reasons. A number of costly institution failures, including some recent failures, involved rapid asset growth funded through brokered deposits. Moreover, statistical analysis reveals a significant correlation between rapid asset growth funded by brokered deposits and the probability of an institution's being downgraded from a CAMELS composite 1 or 2 rating to a CAMELS composite 3, 4 or 5 rating within a year. A significant correlation is the standard the FDIC used when it adopted the financial ratios method in the 2006 assessments rule.

The adjusted brokered deposit ratio generally will include brokered deposits as defined in Section 29 of the Federal Deposit Insurance Act (12 U.S.C. 1831f), and as implemented in 12 CFR 337.6, which is the definition used in banks' quarterly Reports of Condition and Income (Call Reports) and thrifts' quarterly Thrift Financial Reports (TFRs). However, for assessment purposes in Risk Category I, the ratio will not include reciprocal deposits (that is, 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. All other brokered deposits will be included in an institution's ratio of brokered deposits to domestic deposits used to determine its adjusted brokered deposit ratio, including brokered deposits that consist of balances swept into an insured institution by another institution, such as balances swept from a brokerage account.

Based on data as of September 30, 2008, approximately 8.7 percent of institutions in Risk Category I would have exceeded both the 10 percent brokered deposit threshold and 40 percent minimum 4-year cumulative asset growth threshold, so that their adjusted brokered deposit ratio would be greater than zero. A smaller percentage of institutions would actually have been charged a higher rate solely due to the adjusted brokered deposit ratio because the minimum or maximum initial rates applicable to Risk Category I would continue to apply to some institutions both before and after accounting for the effect of this ratio. Only 1.1 percent of Risk Category I institutions would have had an initial base assessment rate more than 1 basis point higher as a result of the adjusted brokered deposit ratio.
29

29
These estimates do not exclude deposits that an institution receives through a deposit placement network on a reciprocal basis and, thus, might overstate the effects on assessment rates for some institutions.

Comments

The FDIC received many comments arguing that brokered deposits should not increase assessment rates for Risk Category I institutions and that the brokered deposit provisions in the NPR do not account for the use to which institutions put these deposits. The FDIC is not persuaded by the arguments. Recent data show that institutions with a combination of brokered deposit reliance and robust asset growth tend to

have a greater concentration in higher risk assets. In addition, there is a statistically significant correlation between the adjusted brokered deposit ratio, on the one hand, and the probability that an institution will be downgraded to a CAMELS rating of 3, 4, or 5 within a year, on the other, independent of the other measures of asset quality contained in the financial ratios method.

The FDIC received several comments, including comments from several industry trade groups, arguing that institutions should be able to have a ratio of brokered deposits to domestic deposits greater than 10 percent without triggering the adjusted brokered deposit ratio and that the minimum asset growth rate required to trigger the adjusted brokered deposit ratio should be greater than 20 percent. The comments disputed the characterization of 20 percent cumulative asset growth over four years as “rapid.” One trade association noted that the proposed minimum growth rate (20 percent) was lower than the nominal GDP growth between third quarter 2004 and third quarter 2007.

The FDIC is persuaded in part. The final rule raises the minimum 4-year asset growth rate required to trigger the adjusted brokered deposit ratio from 20 percent to 40 percent. The final rule also increases from 40 percent to 70 percent the asset growth rate required to make an institution's adjusted brokered deposit ratio equal to its institution's ratio of brokered deposits to domestic deposits less the 10 percent threshold. Additional analysis has revealed that these growth rates are as predictive of downgrade probabilities as those originally proposed and are more consistent with the intent of the ratio, which was to capture only those institutions with rapid asset growth.

However, in the FDIC's view, a ratio of brokered deposits to domestic deposits greater than 10 percent is a significant amount of brokered deposits. Still, for institutions in Risk Category I, brokered deposits alone will not trigger higher rates, but must be combined with significant asset growth.

The FDIC received over 3,300 comment letters arguing that certain reciprocal deposits should not be included in the adjusted brokered deposit ratio.
30

Most of the comments were form letters. Commenters argued that these reciprocal deposits are a stable source of funding. According to the comments, most customers (83 percent) are not seeking the highest rate of interest available and choose to keep their deposit at the same institution when it matures. The commenters also argued that these deposits are local deposits and not out-of-market funds and stated that 80 percent of these deposits are placed with an insured institution within 25 miles of a branch location of the relationship bank. The commenters further argued that the interest rate on these deposits reflects that of local markets since the insured institution that originates the deposit sets the interest rate, rather than a third-party broker. Commenters also argued that these deposits may have franchise value in the event of a bank failure.

30
When an institution receives a deposit through a network on a reciprocal basis, it must place the same amount (but owed to a different depositor) with another institution through the network. Many of the comment letters also argued that these reciprocal deposits should not be included in the brokered deposit adjustment applicable to institutions in Risk Categories II, III and IV. The brokered deposit adjustment applicable to these risk categories is discussed below.

The FDIC is persuaded that reciprocal deposits like those described in the comment letters should not be included in the adjusted brokered deposit ratio applicable to institutions in Risk Category I.
31

(However, as discussed below, reciprocal deposits will be included in the brokered deposits adjustment applicable to institutions in Risk Categories II, III and IV.) The FDIC recognizes that reciprocal deposits may be a more stable source of funding for healthy banks than other types of brokered deposits and that they may not be as readily used to fund rapid asset growth.

31
Excluding these deposits from the Call Report and TFR will require changes to these forms. The FDIC anticipates that the necessary changes will be made beginning with the June 30, 2009 reports of condition.

The FDIC also received several comments arguing that brokered deposits that consist of balances swept into an insured institution by a nondepository institution, such as balances swept into an insured institution from a brokerage account at a broker-dealer, should be excluded from the adjusted brokered deposit ratio.
32

Commenters argued that these sweep accounts are stable, relationship-based accounts. Commenters also stated that the aggregate flows in and out of the sweep accounts tend to offset one another and are thus predictable. Some commenters differentiated between sweeps from affiliated brokerage firms and those from non-affiliated firms. These commenters argued that broker-dealer affiliated sweeps are not rate-sensitive accounts and are not designed to compete with the high rates of interest paid by other insured institutions and, therefore, do not raise the same concerns as other brokered deposits about the high cost of funding of risky banks. The commenters maintained that these accounts are typically used for idle investment funds or as a safe investment and are designed to better manage excess cash. Some commenters suggested that bankers would be willing to separately report sweep balances from an affiliated brokerage.

32
Many of these comment letters also argued that these swept deposits should not be included in the brokered deposit adjustment applicable to institutions in Risk Categories II, III and IV. The brokered deposit adjustment for these risk categories is discussed below.

Some commenters supported excluding brokered deposits swept from
unaffiliated
brokerages through a sweep program, since the deposits have the characteristics of core deposits and are not driven by yield. According to the commenters, there is no price competition; deposits from unaffiliated brokerages are used for the convenience and safety of the customer.

The FDIC is not persuaded by these arguments. In the FDIC's view, deposits swept from broker-dealers can and have contributed to high rates of insured depository institution asset growth and, thus, fall squarely within the type of brokered deposits that the adjusted brokered deposit ratio was meant to capture. In addition, as noted in the NPR, many sweep programs can be structured so that swept balances are not brokered deposits.

Pricing Multipliers, the Uniform Amount, and the Range of Rates

The final rule contains a recalculated uniform amount and recalculated pricing multipliers for the weighted average CAMELS component rating and financial ratios. The uniform amount and pricing multipliers under the final rule adopted in 2006 were derived from a statistical estimate of the probability that an institution will be downgraded to CAMELS 3, 4 or 5 at its next examination using data from the end of the years 1984 to 2004.
33

These probabilities were then converted to pricing multipliers for each risk measure. The new pricing multipliers were derived using essentially the same statistical techniques, but based upon data from the end of the years 1988 to 2006.
34

The new pricing multipliers are set out in Table 7 below.

33
Data on downgrades to CAMELS 3, 4 or 5 is from the years 1985 to 2005. The “S” component rating was first assigned in 1997. Because the statistical analysis relies on data from before 1997, the “S” component rating was excluded from the analysis.

34
For the adjusted brokered deposit ratio, assets at the end of each year are compared to assets at

the end of the year four years earlier, so assets at the end of 1988, for example, are compared to assets at the end of 1984. Data on downgrades to CAMELS 3, 4 or 5 is from the years 1989 to 2007.

Table 7—New Pricing Multipliers

Risk measures *
Pricing multipliers **

Tier 1 Leverage Ratio
(0.056)

Loans Past Due 30-89 Days/Gross Assets
0.575

Nonperforming Assets/Gross Assets
1.074

Net Loan Charge-Offs/Gross Assets
1.210

Net Income before Taxes/Risk-Weighted Assets
(0.764)

Adjusted brokered deposit ratio
0.065

Weighted Average CAMELS Component Rating
1.095

* Ratios are expressed as percentages.
** Multipliers are rounded to three decimal places.

To determine an institution's initial assessment rate under the base assessment rate schedule, each of these risk measures (that is, each institution's financial measures and weighted average CAMELS component rating) will continue to be multiplied by the corresponding pricing multipliers. The sum of these products will be added to a new uniform amount, 11.861.
35

The new uniform amount is also derived from the same statistical analysis.
36

As under the final rule adopted in 2006, no initial base assessment rate within Risk Category I will be less than the minimum initial base assessment rate applicable to the category or higher than the initial base maximum assessment rate applicable to the category. The final rule sets the initial minimum base assessment rate for Risk Category I at 12 basis points and the maximum initial base assessment rate for Risk Category I at 16 basis points.

35
Appendix A provides the derivation of the pricing multipliers and the uniform amount to be added to compute an assessment rate. The rate derived will be an annual rate, but will be determined every quarter.

36
The uniform amount would be the same for all institutions in Risk Category I (other than large institutions that have long-term debt issuer ratings, insured branches of foreign banks and, beginning in 2010, new institutions).

To compute the values of the uniform amount and pricing multipliers shown above, the FDIC chose cutoff values for the predicted probabilities of downgrade such that, using June 30, 2008 Call Report and TFR data: (1) 25 percent of small institutions in Risk Category I (other than institutions less than 5 years old) would have been charged the minimum initial assessment rate; and (2) 15 percent of small institutions in Risk Category I (other than institutions less than 5 years old) would have been charged the maximum initial assessment rate.
37

These cutoff values will be used in future periods, which could lead to different percentages of institutions being charged the minimum and maximum rates.

37
The cutoff value for the minimum assessment rate is a predicted probability of downgrade of approximately 2 percent. The cutoff value for the maximum assessment rate is approximately 15 percent.

In comparison, under the system in place on June 30, 2008: (1) Approximately 28 percent of small institutions in Risk Category I (other than institutions less than 5 years old) were charged the existing minimum assessment rate; and (2) approximately 19 percent of small institutions in Risk Category I (other than institutions less than 5 years old) were charged the existing maximum assessment rate based on June 30, 2008 data.
38

38
For the assessment period ending September 30, 2008, approximately 26 percent of small Risk Category I institutions (other than institutions less than 5 years old) were charged the minimum rate and approximately 23 percent were charged the maximum rate.

Table 8 gives initial base assessment rates for three institutions with varying characteristics, given the new pricing multipliers above, using initial base assessment rates for institutions in Risk Category I of 12 basis points to 16 basis points.
39

39
These are the initial base rates for Risk Category I proposed below.

40
Under the proposed rule, pricing multipliers, the uniform amount, and financial ratios will continue to be rounded to three digits after the decimal point. Resulting assessment rates will be rounded to the nearest one-hundredth (1/100th) of a basis point.

Table 8—Initial Base Assessment Rates for Three Institutions *

A
B
C

D
Institution 1
E

F
Institution 2
G

H
Institution 3

Pricing
multiplier

Risk
measure
value

Contribution to assessment rate

Risk
measure
value

Contribution to assessment rate

Risk
measure
value

Contribution to assessment rate

Uniform Amount
11.861

11.861

11.861

11.861

Tier 1 Leverage Ratio (%)
(0.056)
9.590
(0.537)
8.570
(0.480)
7.500
(0.420)

Loans Past Due 30-89 Days/Gross Assets (%)
0.575
0.400
0.230
0.600
0.345
1.000
0.575

Nonperforming Loans/Gross Assets (%)
1.074
0.200
0.215
0.400
0.430
1.500
1.611

Net Loan Charge-Offs/Gross Asset (%)
1.210
0.147
0.177
0.079
0.096
0.300
0.363

Net Income before Taxes/Risk-Weighted Assets (%)
(0.764)
2.500
(1.910)
1.951
(1.491)
0.518
(0.396)

Adjusted Brokered Deposit Ratio (%)
0.065
0.000
0.000
12.827
0.834
24.355
1.583

Weighted Average CAMELS Component Ratings
1.095
1.200
1.314
1.450
1.588
2.100
2.300

Sum of Contributions

11.35

13.18

17.48

Initial Base Assessment Rate

12.00

13.18

16.00

*Figures may not multiply or add to totals due to rounding.
40

The initial base assessment rate for an institution in the table is calculated by multiplying the pricing multipliers (Column B) by the risk measure values (Column C, E or G) to produce each measure's contribution to the assessment rate. The sum of the products (Column D, F or H) plus the uniform amount (the first item in Column D, F and H) yields the initial base assessment rate. For Institution 1 in the table, this sum actually equals 11.35 basis points, but the table reflects the initial base minimum assessment rate of 12 basis points. For Institution 3 in the table, the sum actually equals 17.48 basis points, but the table reflects the initial base maximum assessment rate of 16 basis points.

Under the final rule, the FDIC will continue to have the flexibility to update the pricing multipliers and the uniform amount annually, without further notice-and-comment rulemaking. In particular, the FDIC will be able to add data from each new year to its analysis and could, from time to time, exclude some earlier years from its analysis. Because the analysis will continue to use many earlier years' data as well, pricing multiplier changes from year to year should usually be relatively small.

On the other hand, as a result of the annual review and analysis, the FDIC may conclude, as it has in this rulemaking, that
additional or alternative
financial measures, ratios or other risk factors should be used to determine risk-based assessments or that a new method of differentiating for risk should be used. In any of these events, the FDIC would again make changes through notice-and-comment rulemaking.

Financial measures for any given quarter will continue to be calculated from the report of condition filed by each institution as of the last day of the quarter.
41

CAMELS component rating changes will continue to be effective as of the date that the rating change is transmitted to the institution for purposes of determining assessment rates for all institutions in Risk Category I.
42

41
Reports of condition include Reports of Income and Condition and Thrift Financial Reports.

42
Pursuant to existing supervisory practice, the FDIC does not assign a different component rating from that assigned by an institution's primary federal regulator, even if the FDIC disagrees with a CAMELS component rating assigned by an institution's primary federal regulator, unless: (1) The disagreement over the component rating also involves a disagreement over a CAMELS composite rating; and (2) the disagreement over the CAMELS composite rating is not a disagreement over whether the CAMELS composite rating should be a 1 or a 2. The FDIC has no plans to alter this practice.

Comments

One industry trade group noted that some banks expressed a concern that the expanded range of rates for Risk Category I, particularly in combination with the proposed adjustment for secured liabilities (discussed below), could result in differences in rates among institutions that are too large compared to differences in risk. This could lead to some institutions bearing disproportionate costs and being competitively disadvantaged. However, another trade group expressed concerns that the range of rates for Risk Category I is too narrow, insufficiently reflecting differences in risk and creating a cross subsidy within the risk category.
43

The FDIC considers the 4-basis point range for the initial base assessment rate in Risk Category I to be appropriate.

43
The same trade group argued that rates for Risk Categories III and IV should be higher than proposed.

IV. Risk Category I: Large Bank Method

For large Risk Category I institutions now subject to the debt ratings method, the final rule derives assessment rates from the financial ratios method as well as long-term debt issuer ratings and CAMELS component ratings. The new method is known as the large bank method. The rate using the financial ratios method is first converted from the range of initial base rates (12 to 16 basis points) to a scale from 1 to 3 (financial ratios score).
44

The financial ratios score is then given a 33
1/3
percent weight in determining the large bank method assessment rate, as are both the weighted average CAMELS component rating and debt-agency ratings.

44
The assessment rate computed using the financial ratios method would be converted to a financial ratios score by first subtracting 10 from the financial ratios method assessment rate and then multiplying the result by one-half. For example, if an institution had an initial base assessment rate of 13, 10 would be subtracted from 13 and the result would be multiplied by one-half to produce a financial ratios score of 1.5.

The weights of the CAMELS components remain the same as in the final rule adopted in 2006. The values assigned to the debt issuer ratings also remain the same. The weighted CAMELS components and debt issuer ratings will continue to be converted to a scale from 1 to 3.

The initial base assessment rate under the large bank method will be derived as follows: (1) An assessment rate computed using the financial ratios method will be converted to a financial ratios score; (2) the weighted average CAMELS rating, converted long-term debt issuer ratings, and the financial ratios score will each be multiplied by a pricing multiplier and the products summed; and (3) a uniform amount will be added to the result. The resulting initial base assessment rate will be subject to a minimum and a maximum assessment rate. The pricing multiplier for the weighted average CAMELS ratings, converted long-term debt issuer rating and financial ratios score is 1.692, and the uniform amount is 3.873.
45

45
Appendix 1 provides the derivation of the pricing multipliers and the uniform amount.

In recent periods, assessment rates for some large institutions have not responded in a timely manner to rapid changes in these institutions' financial conditions. For the assessment period ending June 30, 2008, under the assessment system then in place: (1) 45 percent of large institutions in Risk Category I (other than institutions less than 5 years old) were charged the minimum assessment rate (ignoring large bank adjustments), compared with 28 percent of small institutions; and (2) 11 percent of large institutions in Risk Category I (other than institutions less than 5 years old) were charged the maximum assessment rate (ignoring

large bank adjustments), compared with 19 percent of small institutions.
46

The FDIC's proposed values for pricing multipliers and the uniform amount are such that, using June 30, 2008, data, the percentages of large institutions in Risk Category I (other than new institutions less than 5 years old) that would have been charged the minimum and maximum initial base assessment rates would be the same as the percentages of small institutions that would have been charged these rates (25 percent at the minimum rate and 15 percent at the maximum rate).
47 48

These cutoff values would be used in future periods, which could lead to different percentages of institutions being charged the minimum and maximum rates.

46
For the assessment period ending September 30, 2008, under the assessment system then in place: (1) 41 percent of large institutions in Risk Category I (other than institutions less than 5 years old) were charged the minimum assessment rate (again ignoring large bank adjustments), compared with 26 percent of small institutions; and (2) 11 percent of large institutions in Risk Category I (other than institutions less than 5 years old) were charged the maximum assessment rate (ignoring large bank adjustments), compared with 23 percent of small institutions.

47
The cutoff value for the minimum assessment rate is an average score of approximately 1.601. The cutoff value for the maximum assessment rate is approximately 2.389.

48
A “new” institution, as defined in 12 CFR 327.8(l), is generally one that is less than 5 years old, but there are several exceptions, including, for example, an exception for certain otherwise new institutions in certain holding company structures. 12 CFR 327.9(d)(7). The calculation of percentages of small institutions, however, was determined strictly by excluding institutions less than 5 years old, rather than by using the definition of a “new” institution and its regulatory exceptions, since determination of whether an institution meets an exception to the definition of “new” requires a case-by-case investigation.

Under the final rule adopted in 2006, large institutions that lack a long-term debt issuer rating are assessed using the financial ratios method by itself, subject to the large bank adjustment. This will continue under the final rule.

Under the final rule, the initial base assessment rate for an institution with a weighted average CAMELS converted value of 1.70, a debt issuer ratings converted value of 1.65 and a financial ratios method assessment rate of 13.50 basis points would be computed as follows:

• The financial ratios method assessment rate less 10 basis points would be multiplied by one-half (calculated as (13.5 basis points—10 basis points) × 0.5) to produce a financial ratios score of 1.75.

• The weighted average CAMELS score, debt ratings score and financial ratios score will each be multiplied by 1.692 and summed (calculated as 1.70 × 1.692 + 1.65 × 1.692 + 1.75 × 1.692) to produce 8.629.

• A uniform amount of 3.873 would be added, resulting in an initial base assessment rate of 12.50 basis points.

The FDIC anticipates that incorporating the financial ratios score into the large bank method assessment rate will result in a more accurate distribution of initial assessment rates and in timelier assessment rate responses to changing risk profiles, while retaining the market and supervisory perspectives that debt and CAMELS ratings provide. While the number of potential discretionary adjustments under this revised large bank method cannot be known with certainty, the revised method should create a more accurate distribution of initial rates and, thus, should minimize the number of necessary discretionary adjustments.
49

49
The FDIC has issued additional Guidelines for Large Institutions and Insured Foreign Branches in Risk Category I (the large bank guidelines) governing these large bank adjustments. 72 FR 27122 (May 14, 2007).

Comments

One trade group supported the proposal and specifically noted that the FDIC should move away from the debt rating method. Other comments, including comments from trade groups, argued that the proposed rule would make it harder for a large bank to be eligible for the lowest assessment rates. A commenting bank argued that:

Structuring the rules with a goal to maintain parity between large and small banks would be in violation of [12 U.S.C. 1817(b)(2)(D)]. Arbitrarily establishing targets for percentages of institutions that fall into a given assessment rate is inconsistent with not only the governing statute but the whole concept of risk-based pricing. * * * The fact that, under objective criteria, large banks may have a greater percentage of institutions that qualify for the lowest rate is not an indication that the rule is flawed and needs to change, but may just be a factual representation of the strength of large banks.
50

50
12 U.S.C. 1817(b)(2)(D) provides that, “No insured depository institution shall be barred from the lowest-risk category solely because of size.”

The FDIC disagrees with the commenting bank. The purpose of the new large bank method is to create an assessment system for large Risk Category I institutions that will respond more timely to changing risk profiles, will improve the accuracy of initial assessment rates, relative risk rankings, and will create a greater parity between small and large Risk Category I institutions. The recalibration of the percentages of large institutions that would have been charged the minimum and maximum rates applicable to Risk Category I is intended to better reflect the actual risk posed by large institutions. Under the debt ratings method, the percentage of large Risk Category I institutions that were charged the minimum assessment rate changed little over time despite deteriorating financial conditions. If the financial ratios method, which is based on a combination of objective financial ratios and supervisory ratings, were applied to large Risk Category I institutions, only about 19 percent would have been charged the minimum assessment rate. While the FDIC continues to believe that the financial ratios method alone does not adequately provide the appropriate risk ranking for large and complex institutions, the deterioration in financial ratios is highly indicative of rapidly changing risk profiles, which are not fully reflected in the debt ratings method on a timely basis.

Furthermore, 12 U.S.C. 1817(b)(2)(D) does not prohibit the FDIC from calibrating a risk-based assessment system so that, at a given point in time, an equal percentage of small and large institutions would have been charged the minimum assessment rate, provided that the risks posed were equal, as, in the FDIC's view, they were.

V. Adjustment for Large Institutions and Insured Branches of Foreign Banks in Risk Category I

Under the final rule adopted in 2006, within Risk Category I, large institutions and insured branches of foreign banks are subject to an assessment rate adjustment (the large bank adjustment). In determining whether to make such an adjustment for a large institution or an insured branch of a foreign bank, the FDIC may consider such information as financial performance and condition information, other market or supervisory information, potential loss severity, and stress considerations. Any large bank adjustment is limited to a change in assessment rate of up to 0.5 basis points higher or lower than the rate determined using the supervisory ratings and financial ratios method, the supervisory and debt ratings method, or the weighted average ROCA component rating method, whichever is applicable. Adjustments are meant to preserve consistency in the orderings of risk indicated by assessment rates, to ensure fairness among all large institutions, and to ensure that assessment rates take into account all available information that is relevant to the FDIC's risk-based assessment decision.

The final rule will increase the maximum possible large bank adjustment to one basis point. The adjustment will be made to an institution's initial base assessment rate before any other adjustments are made.

The adjustment cannot: (1) Decrease any rate so that the resulting rate would be less than the minimum initial base assessment rate; or (2) increase any rate above the maximum initial base assessment rate.

The FDIC is amending the maximum size of the adjustment for two primary reasons. First, under the final rule adopted in 2006, the difference between the minimum and maximum base assessment rates in Risk Category I is two basis points. The maximum one-half basis point large bank adjustment represents 25 percent of the difference between the minimum and maximum rates. While an adjustment of this size is generally sufficient to preserve consistency in the orderings of risk indicated by assessment rates and to ensure fairness, there have been circumstances where more than a half a basis point adjustment would have been warranted. The difference between the minimum and maximum base assessment rates will increase from two basis points to four basis points under the final rule. A half basis point large bank adjustment would represent only 12.5 percent of the difference between the minimum and maximum rates and would not be sufficient to preserve consistency in the orderings of risk indicated by assessment rates or to ensure fairness. The increase in the maximum possible large bank adjustment will continue to represent 25 percent of the difference between the minimum and maximum rates, minimizing the potential number of instances where the large bank adjustment is insufficient to fully and accurately reflect the risk that an institution poses.

The purpose of the large bank adjustment is to improve the relative risk ranking of large Risk Category I institutions with respect to their initial assessment rates, not total assessment rates. The FDIC expects that, under the final rule, large bank adjustments will continue to be made infrequently and for a limited number of institutions.
51

The FDIC's view is that the use of supervisory ratings, financial ratios and agency ratings (when available) will sufficiently reflect the risk profile and rank orderings of risk in large Risk Category I institutions in most (but not all) cases.

51
In the seven quarters for which institutions have been assessed since the 2006 assessment rule went into effect, the total number of adjustments in any one quarter has ranged from 2 to 16. For the third quarter of 2008, the FDIC continued or implemented assessment rate adjustments for 16 large Risk Category I institutions, 14 to increase an institution's assessment rate, and 2 to decrease an institution's assessment rate. Additionally, the FDIC sent 2 institutions advance notification of a potential upward adjustment in their assessment rate.

The FDIC expects to further clarify its
Assessment Rate Adjustment Guidelines for Large Institutions and Insured Foreign Branches in Risk Category I
(the Guidelines).
52

The Guidelines will discuss in detail the quantitative and qualitative factors that the FDIC will rely upon when deciding whether to make a large bank adjustment. Until then, the Guidelines will be applied taking into account the changes resulting from this rulemaking.

52
72 FR 27,122 (May 14, 2007).

Comments

An industry trade group and a bank objected to the increase in the large bank adjustment, arguing that the adjustment is arbitrary and subjective. The FDIC disagrees. The large bank method appropriately recognizes the need for subjective, expert judgment-based risk assessments for large banks. Because large institutions are usually complex and often have unique operations, an entirely formulaic approach, while objective, has yielded a distribution of assessment rates that is not sufficiently reflective of the risk. When the FDIC decides to increase or decrease a large institution's assessment rate based upon the large bank adjustment, it does so after reviewing a large set of financial and performance data in addition to making qualitative assessments. While the decision to apply an adjustment cannot be reduced to a formula, the set of data that the FDIC reviews is consistent from one institution to the next and the FDIC strives to make its decisions based on the data as consistent as possible and the reasons for the decisions as clear as possible for the institutions affected. As stated above, the FDIC intends to publish revised Guidelines to further clarify the large bank adjustment process.

Despite the existence of a long-established appeals process for assessment rates, one industry trade group stated that “[B]ankers felt that they were not allowed to effectively challenge the adjustments through the FDIC's appeals process.” The FDIC notes, however, that no institution has yet appealed an adjustment (or the lack thereof) to the Assessment Appeals Committee.
53

53
Only one institution has requested review of its assessment rate; it asked for an adjustment when the FDIC had not given one. However, this institution did not appeal the denial of its request for review to the Assessment Appeals Committee. The FDIC has also received 9 responses to the 29 advance notices of intent to increase an assessment rate using the large bank adjustment that the FDIC has sent out.

VI. Adjustment for Unsecured Debt for all Risk Categories

Under the final rule, an institution's base assessment rate (after making any large bank adjustment) will be reduced from the initial rate using the institution's ratio of long-term unsecured debt (and, for small institutions, certain amounts of Tier 1 capital) to domestic deposits.
54

Any decrease in base assessment rates as a result of this unsecured debt adjustment will be limited to five basis points (rather than two basis points as proposed in the NPR). Unsecured debt will not include any senior unsecured debt that the FDIC has guaranteed under the Temporary Liquidity Guarantee Program.

54
For this purpose, an institution would be “small” if it met the definition of a small institution in 12 CFR 327.8(g)—generally, an institution with less than $10 billion in assets—except that it would not include an institution that would otherwise meet the definition for which the FDIC had granted a request to be treated as a large institution pursuant to 12 CFR 327.9(d)(6).

The unsecured debt adjustment will be determined by multiplying an institution's long-term unsecured debt (plus, if the institution is a small institution, “qualified” amounts of Tier 1 capital as explained below) as a percentage of domestic deposits by 40 basis points (rather than 20 basis points as proposed in the NPR). For example, an institution with a ratio of long-term unsecured debt (plus, if the institution is small, qualified amounts of Tier 1 capital) to domestic deposits of 3.0 percent will see its initial base assessment rate reduced by 1.20 basis points (calculated as 40 basis points × 0.03). An institution with a ratio of long-term unsecured debt (plus, if the institution is small, qualified amounts of Tier 1 capital) to domestic deposits of 13.0 percent will have its assessment rate reduced by five basis points, since the maximum possible reduction will be five basis points. (40 basis points × 0.13 = 5.20 basis points, which exceeds the maximum possible reduction.)

For a small institution, the amount of qualified Tier 1 capital that will be added to long-term unsecured debt will be a portion of the amount of Tier 1 capital that exceeds a ratio of Tier 1 capital to adjusted average assets of 5.0%.
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The percentage of Tier 1 capital that is qualified increases as the amount of Tier 1 capital held by a small institution increases. The qualified amount is set forth in Table 9.

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Adjusted average assets will be used for Call Report filers; adjusted total assets will be used for TFR filers.

Table 9—Amount of Qualified Tier 1 Capital

Range of Tier 1 capital to
adjusted average assets

Amount of Tier 1 capital within range which is qualified
(percent)

≤ 5%
0

> 5% and ≤ 6%
10

> 6% and ≤ 7%
20

> 7% and ≤ 8%
30

> 8% and ≤ 9%
40

> 9% and ≤ 10%
50

> 10% and ≤ 11%
60

> 11% and ≤ 12%
70

> 12% and ≤ 13%
80

> 13% and ≤ 14%
90

> 14%
100

The amount of qualified Tier 1 capital within each of the ranges is summed to determine the total amount of qualified Tier 1 capital for this institution. The sum of qualified Tier 1 capital and long-term unsecured debt as a percentage of domestic deposits will be multiplied by 40 basis points to produce the unsecured debt adjustment.
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The percentage of qualified Tier 1 capital and long-term unsecured debt to domestic deposits will remain unrounded (to the extent of computer capabilities). The unsecured debt adjustment will be rounded to two digits after the decimal point prior to being applied to the base assessment rate. Appendix 2 describes the unsecured debt adjustment for a small institution mathematically.

To illustrate the calculation of qualified Tier 1 capital, consider a small institution with a Tier 1 leverage ratio of 20.0 percent and Tier 1 capital of $2.0 million. The amount of qualified Tier 1 capital is illustrated in Table 10.

Table 10—Example of Qualified Tier 1 Capital for the Unsecured Debt Adjustment

Leverage ratio band
Tier 1 capital within band ($000)
×

Qualified
percentage of Tier 1 capital
(percent)

=

Qualified Tier 1 capital
($000)

0-5%
500

0

0

5%-6%
100

10

10

6%-7%
100

20

20

7%-8%
100

30

30

8%-9%
100

40

40

9%-10%
100

50

50

10%-11%
100

60

60

11%-12%
100

70

70

12%-13%
100

80

80

13%-14%
100

90

90

> 14%
600

100

600

Total
2,000

1,050

As can be seen in Table 10, each band of the Tier 1 leverage ratio (up to the last band) contains $100,000 in Tier 1 capital and the qualified percentage increases linearly until it reaches 100 percent for amounts over 14.0 percent. The total qualified Tier 1 capital for this small institution is $1.05 million, which will be added to any long-term unsecured debt to calculate the institution's unsecured debt adjustment.

The final rule includes more Tier 1 capital in qualified Tier 1 capital than proposed in the NPR. The NPR proposed including the sum of one-half of the amount of Tier 1 capital between 10 percent and 15 percent of adjusted average assets and the full amount of Tier 1 capital exceeding 15 percent of adjusted average assets. The FDIC has concluded, based in part on comments, that the proposal did not give small institutions sufficient credit for Tier 1 capital.

Ratios for any given quarter will be calculated from the report of condition filed by each institution as of the last day of the quarter.

Unsecured debt will consist of senior unsecured liabilities and subordinated debt. A senior unsecured liability is defined as the unsecured portion of other borrowed money.
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Subordinated debt is defined in the report of condition for the reporting period.
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Long-term unsecured debt is defined as unsecured debt with at least one year remaining until maturity. However, unsecured debt will not include any debt that the FDIC has guaranteed pursuant to the Temporary Liquidity Guarantee Program, since this kind of debt will not decrease FDIC losses in the event an institution fails.

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Other borrowed money is reported on the Call Report in Schedule RC, item 16 and on the Thrift Financial Report as the sum of items SC720, SC740, and SC760.

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The definition of “subordinated debt” in the Call Report is contained in the Glossary under “Subordinated Notes and Debentures.” For the June 30, 2008 Call Report, the definition read, in pertinent part, as follows:

Subordinated Notes and Debentures: A subordinated note or debenture is a form of debt issued by a bank or a consolidated subsidiary. When issued by a bank, a subordinated note or debenture is not insured by a federal agency, is subordinated to the claims of depositors, and has an original weighted average maturity of five years or more. Such debt shall be issued by a bank with the approval of, or under the rules and regulations of, the appropriate federal bank supervisory agency. * * *

When issued by a subsidiary, a note or debenture may or may not be explicitly subordinated to the deposits of the parent bank. * * *

For purposes of the final rule, subordinated debt would also include limited-life preferred stock as defined in the report of condition for the reporting period. The definition of “limited-life preferred stock” in the Call Report is contained in the Glossary under “Preferred Stock.” For the June 30, 2008 Call Report, the definition read, in pertinent part, as follows:

Limited-life preferred stock is preferred stock that has a stated maturity date or that can be redeemed at the option of the holder. It excludes those issues of preferred stock that automatically convert into perpetual preferred stock or common stock at a stated date.

At present, institutions separately report neither long-term senior unsecured liabilities nor long-term subordinated debt in the report of condition. In a separate notice of proposed rulemaking, the Federal Financial Institution Examination Council has proposed revising the Call Report to report separately long-term senior unsecured liabilities and subordinated debt that meet this definition. The Office of Thrift Supervision (OTS) has also published a

notice of proposed rulemaking that would adopt similar reporting requirements. The FDIC anticipates that these revisions will be made beginning with the June 30, 2009 Call Report and TFR. However, if they are not, until banks separately report these amounts in the Call Report, the FDIC will use subordinated debt included in Tier 2 capital and will not include any amount of senior unsecured liabilities. These adjustments will also be made for TFR filers until thrifts separately report these amounts in the TFR.

At present, institutions also do not report debt that the FDIC has guaranteed pursuant to the Temporary Liquidity Guarantee Program.
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The FDIC is pursuing the necessary changes to the Call Report and TFR to ensure that these amounts are excluded from the separate report of long-term senior unsecured liabilities and subordinated debt beginning with the June 30, 2009 Call Report and TFR.

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Institutions report this debt to the FDIC shortly after issuing it and also file monthly reports on the amount of this debt outstanding as of the end of each month. However, neither of these reports contains all of the information the FDIC needs to deduct this debt from the unsecured debt adjustment, since neither uses the definition of “unsecured debt” contained in the text. In addition, the monthly report does not contain maturity information.

When an institution fails, holders of unsecured claims, including subordinated debt, receive distributions from the receivership estate only if all secured claims, administrative claims and deposit claims have been paid in full. Consequently, greater amounts of long-term unsecured claims provide a cushion that can reduce the FDIC's loss in the event of failure.

For small institutions (but not large ones), the unsecured debt adjustment includes a portion of Tier 1 capital for two primary reasons. First, cost concerns and lack of demand generally make it difficult for small institutions to issue unsecured debt in the market. For reasons of fairness, the FDIC believes that small institutions that have large amounts of Tier 1 capital should receive an equivalent benefit for that capital. Second, the FDIC does not want to create an incentive for small institutions to convert existing Tier 1 capital into subordinated debt, for example, by having a shareholder in a closely held corporation redeem shares and receive subordinated debt.

Comments

The FDIC received several comments on the proposed unsecured debt adjustment. One commenter found the proposal fair and appropriate.

Another commenter, however, claimed that the proposal would penalize institutions that do not issue long-term unsecured debt. A commenter recommended that the FDIC abandon the separate risk adjustment for unsecured debt. A commenter argued that the proposal uses arbitrary measures when adjusting for risk and ignores the probability of default. The FDIC disagrees with these comments. As noted earlier, greater amounts of long-term unsecured debt provide a cushion that can reduce the FDIC's loss in the event of failure, thus reducing the FDIC's risk.

The FDIC specifically sought comments on the size of the unsecured debt adjustment and whether it should be larger or smaller. Several commenters argued that the proposed two basis point reduction in base assessment rates, which was the maximum reduction possible under the proposal, was arbitrary and too low. Some also argued that the proposed 20 basis point multiplier should be increased. Several noted that the maximum proposed unsecured debt adjustment was much smaller than the maximum proposed secured liability adjustment.

The FDIC has concluded that the proposed 20 basis point multiplier and two basis point maximum reduction were too small. Spreads on depository institution unsecured debt have, on average, approximately doubled since the NPR was published. The FDIC has, therefore, doubled the size of the multiplier, partly to reflect the recent increase in debt spreads and partly to create greater parity between the size of the unsecured debt adjustment and the size of the secured liability adjustment. The FDIC has more than doubled the maximum possible unsecured debt adjustment to ensure that institutions will retain an incentive to issue unsecured debt and, again, to create greater parity between the unsecured debt adjustment and the secured liability adjustment.

Under the final rule, the FDIC estimates that the reduction in industry average assessments arising from the unsecured debt adjustment will exceed the industry average increase in assessments arising from the secured liability adjustment and (for Risk Categories II, III, and IV) the brokered deposit adjustment.

An industry trade group recommended that the unsecured debt adjustment for small institutions include larger amounts of Tier 1 capital. The trade group argued that small institutions should be rewarded for their additional capital and that the proposal did not sufficiently reward them. The trade group suggested that the adjustment include the sum of one-half of the amount of Tier 1 capital between 8 percent and 12 percent of adjusted average assets and the full amount of Tier 1 capital exceeding 12 percent of adjusted average assets. The FDIC agrees that small institutions should receive more credit for Tier 1 capital and, and discussed above, has so provided in the final rule.

Another industry trade group suggested that institutions subject to the large bank method should also be given credit for capital in the unsecured debt adjustment. However, in the FDIC's view, doing so would undo the one of the purposes of including a portion of Tier 1 capital in the unsecured debt adjustment for small banks, which was to give small banks, which generally do not (and generally cannot) issue much unsecured debt, a benefit equivalent to that of large banks. If a large institution's assessment rate does not appropriately factor its capital, the FDIC can use the large bank adjustment to alter the rate (although the FDIC anticipates that the need to do so will seldom arise).

Some comments suggested that the FDIC include all unsecured and subordinated debt in the unsecured debt adjustment, regardless of maturity. One suggested using all unencumbered assets. The FDIC disagrees. Short-term debt is likely to be paid prior to failure and, thus, is unlikely to provide a cushion against FDIC losses.

Some commenters argued that it would be more appropriate to use a ratio of long-term unsecured debt (or unencumbered debt) to
insured
deposits, since insured deposits are the true proxy for the FDIC's risk. The FDIC disagrees. Numerous studies have shown that, as an institution approaches failure, uninsured depositors tend to demand payment. In effect, these uninsured depositors receive full payment on their claims (as if they were insured depositors at failure), leaving the failed institution with fewer assets to satisfy the FDIC's claims.

VII. Adjustment for Secured Liabilities for All Risk Categories

Under the final rule, an institution's base assessment rate may increase depending upon its ratio of secured liabilities to domestic deposits (the secured liability adjustment). An institution's ratio of secured liabilities to domestic deposits, if greater than 25 percent (rather than 15 percent as proposed in the NPR), will increase its assessment rate, but the resulting base assessment rate after any such increase will be no more than 50 percent greater

than it was before the adjustment. The secured liability adjustment will be made after any large bank adjustment or unsecured debt adjustment.

Specifically, for an institution that has a ratio of secured liabilities to domestic deposits of greater than 25 percent, the secured liability adjustment will be the institution's base assessment rate (after taking into account previous adjustments) multiplied by the ratio of its secured liabilities to domestic deposits minus 0.25. However, the resulting adjustment cannot be more than 50 percent of the institution's base assessment rate (after taking into account previous adjustments). For example, if an institution had a ratio of secured liabilities to domestic deposits of 35 percent, and a base assessment rate before the secured liability adjustment of 14 basis points, the secured liability adjustment would be the base rate multiplied by 0.10 (calculated as 0.35 − 0.25), resulting in an adjustment of 1.4 basis points. However, if the institution had a ratio of secured liabilities to domestic deposits of 80 percent, its base rate before the secured liability adjustment of 14 basis points would be multiplied by 0.50 rather than 0.55 (calculated as 0.80 − 0.25), since the resulting adjustment can be no greater than 50 percent of the base assessment rate before the secured liability adjustment.
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Under the final rule, the ratio of secured liabilities to domestic deposits will be rounded to three digits after the decimal point. The resulting amount and adjusted assessment rate will be rounded to the nearest one-hundredth (1/100th) of a basis point.

Ratios of secured liabilities to domestic deposits for any given quarter will be calculated from the report of condition filed by each institution as of the last day of the quarter. For banks, secured liabilities include Federal Home Loan Bank advances, securities sold under repurchase agreements, secured Federal funds purchased and “other secured borrowings,” as reported in banks' quarterly Call Reports. Thrifts also report Federal Home Loan Bank advances in their quarterly TFR, but, at present, do not separately report securities sold under repurchase agreements, secured Federal funds purchased or “other secured borrowings.” The OTS has published a notice of proposed rulemaking to revise the TFR so that thrifts will separately report these items and the FDIC anticipates that this revision will be effective for the June 30, 2009 TFR. Until the TFR is revised, however, any of these secured amounts not reported separately from unsecured or other liabilities by a thrift in its TFR will be imputed based on simple averages for Call Report filers as of June 30, 2008. As of that date, on average, 63.0 percent of the sum of Federal funds purchased and securities sold under repurchase agreements reported by Call Report filers were secured, and 49.4 percent of other borrowings were secured.

Under the final rule adopted in 2006, an institution's secured liabilities do not directly affect its assessments. The exclusion of secured liabilities can lead to inequity. An institution with secured liabilities in place of another's deposits pays a smaller deposit insurance assessment, even if both pose the same risk of failure and would cause the same losses to the FDIC in the event of failure.

To illustrate with a simple example, assume that Bank A has $100 million in insured deposits, while Bank B has $50 million in insured deposits and $50 million in secured liabilities. Each poses the same risk of failure and is charged the same assessment rate. At failure, each has assets with a market value of $80 million. The loss to the DIF would be identical for Bank A and Bank B ($20 million each). The total assessments paid by Bank A and Bank B, however, would not be identical. Because secured liabilities do not figure into an institution's assessment under the final rule adopted in 2006, the DIF would receive twice as much assessment revenue from Bank A as from Bank B over a given period (despite identical FDIC losses at failure).

In general, under the final rule adopted in 2006, substituting secured liabilities for unsecured liabilities (including subordinated debt) raises the FDIC's loss in the event of failure without providing increased assessment revenue. Substituting secured liabilities for deposits can also lower an institution's franchise value in the event of failure, which increases the FDIC's losses, all else equal.
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Overall, whether substituting secured liabilities for deposits increases, decreases, or leaves unchanged the FDIC's loss given failure also depends on how the substitution affects the proportion of insured and uninsured deposits, but FDIC's assessment revenue will always decline with a substitution.

Comments

The vast majority of commenters were opposed to the secured liability adjustment. The few commenters that supported the FDIC's proposal called the secured liability adjustment fair and appropriate, and viewed the logic for the increased charge as clear and compelling. One of the supportive commenters stated that core deposits are more advantageous to an institution than secured liabilities, as they are cheaper and allow cross-selling of products. As a result, prudent institutions show a preference for core funding. The commenter found the proposed threshold to be reasonable.

Many of the commenters opposed to the adjustment suggested that the NPR gave too much weight to risk adjustments based on arbitrary measures, and ignored the probability of default. Commenters argued that the true risk of a bank lies in the quality of its assets, rather than how the assets are funded. Some noted that the presence of unsecured liabilities (as opposed to secured liabilities) is no guarantee of the quality of a bank's assets or that the assets would be sufficient to cover a bank's deposit liabilities in case of bank failure. Commenters believe that the FDIC should abandon the proposed approach of targeting certain funding sources.

Some commenters argued that the proposed secured liability adjustment appears to run contrary to established programs that have implied government support, including borrowings from the Federal Reserve through the Term Auction Facility. Commenters viewed the secured liability adjustment as unfair to institutions that have limited options for funding.

Many of the comments (over 1,100) were particularly concerned about the effect the FDIC's proposal would have on Federal Home Loan Bank (FHLB) advances. Commenters argued that FHLB advances are a stable, reliable source of liquidity, and a key tool for asset/liability management, interest rate risk and net interest margin maintenance. Many commenters suggested that the secured liability adjustment was counterproductive since banks benefit from FHLB dividend income. Many commenters cautioned that deterring the use of FHLB advances (and other secured liabilities) will lead to increased use of riskier funding sources, higher funding costs, and decreased lending. Most of the commenters viewed the proposal as unfairly penalizing institutions that use FHLB advances prudently. Several commenters suggested that FHLB advances should be excluded from any secured liability adjustment for at least five years since some FHLB advances do not mature before the effective date of the proposal.

Many commenters argued against the proposal because they believe it would impair the mission of the FHLB system. The commenters asserted that because the proposal discourages the use of FHLB advances, it would lead to a decline in FHLB earnings. Commenters representing community service groups

expressed concern that any decline in FHLB earnings would undermine FHLB contributions to community down payment and closing cost assistance programs, community investment programs, affordable housing programs, and foreclosure prevention programs. Commenters also noted that FHLBs already regulate the use of their advances.

Commenters also noted the effect the proposal would have on the use of repurchase agreements (repos). Many commenters argued that repos are a safe and effective source to manage liquidity. Others remarked that repos are an important tool used to attract commercial deposits, which can neither be secured nor bear interest. One commenter suggested that the definition of secured liabilities used in the proposal, exclude repos with state and local governments where the securities sold are federal government or agency securities. In addition, the commenter expressed concern that the proposal would put banks at a competitive disadvantage to non-depository institutions.

Commenters also expressed concern that the proposed secured liability adjustment would harm the covered bond market at a time when additional sources of mortgage funding are needed and when bank regulatory agencies have supported development of this market.

Many commenters argued that the 15 percent threshold is arbitrary and simplistic. One commenter suggested raising the threshold to 30 percent. Some comments suggested adjusting the threshold by subtracting the balance that is secured by agency bonds or investment grade securities or by subtracting long-term advances. Other commenters recommended eliminating the secured liability adjustment if the bank has capital above a certain amount.

The FDIC remains generally unpersuaded by these comments, which do not respond to the reasons for the secured liability adjustment. The FDIC has not argued that secured liability funding makes a bank more likely to fail. Rather, as noted above, the primary purpose of the secured liability adjustment is to remedy an inequity. An institution with secured liabilities in place of another's deposits pays a smaller deposit insurance assessment, even if both pose the same risk of failure and would cause the same losses to the FDIC in the event of failure. This result is not fair to institutions that do not rely heavily on secured funding. Substituting secured liabilities for deposits can also lower an institution's franchise value in the event of failure, which increases the FDIC's losses, all else equal. A risk-based system should take this likelihood into account. These arguments apply equally whether an institution's secured liabilities consist of FHLB advances, repurchase agreements or other forms of secured borrowing.

The FDIC intended the secured liability adjustment to apply only to those institutions that rely heavily on secured funding. The revenue loss to the DIF is relatively small until reliance on secured funding becomes significant. To ensure that the adjustment applies only to those institutions that rely heavily on secured funding and impose a significant revenue loss on the DIF, the final rule raises the ratio of secured liabilities to domestic deposits that will trigger the adjustment to 25 percent. As Table 11 demonstrates, as of September 30, 2008, only 10 percent of insured institutions would have had a secured liability adjustment and only 5 percent would have had an increase in assessment rate of greater than 10 percent. Consequently, the adjustment should have no effect on funding choices for the vast majority of institutions and is unlikely to have a significant overall effect on secured borrowing, the FHLB system, affordable housing or foreclosure prevention.

Table 11—Percentage of Institutions Subject to the Secured Liability Adjustment Using Different Thresholds
[As of September 30, 2008]

Minimum ratio of secured
liabilities to domestic

15%
25%

Percentage of all institutions that would have been subject to the secured liability adjustment
24%
10%

Percentage of all institutions that would have had more than a 10% increase in assessment rate due to the secured liability adjustment
10%
5%

Some commenters noted that many states require that banks collateralize any public funds they have on deposit; since public funds pose no additional risk to the DIF, banks should not be penalized by the secured liability adjustment when pledging collateral for the public funds. The FDIC agrees. The FDIC did not, and did not intend to, include collateralized public funds among secured liabilities for purposes of the adjustment. For purposes of the secured liability adjustment, deposits, regardless of whether they are collateralized, are not considered a secured liability.

Many comments focused on the timing of the proposal. Most commenters noted that discouraging alternate funding sources would hurt bank liquidity and tighten credit availability, which is inconsistent with market realities in the current economic downturn. Comments on the general timing of the proposal suggested that it should be delayed until at least the beginning of 2010; others commented that a phase-in schedule for the secured liability adjustment should be used. Commenters thought that a delay in the proposal would decrease the likelihood that the secured liability adjustment would conflict with other policy measures currently being used to increase liquidity. Additionally, commenters asserted that the proposal does not give institutions an opportunity to adjust their funding mix to account for the new assessment rate structure.

In the FDIC's view, the secured liability adjustment will not have any material effect on liquidity and will not conflict with other measures intended to increase liquidity. As noted above, the secured liability adjustment will affect only about 10 percent of the industry and will cause more than a 10 percent increase in assessment rates for only about 5 percent of the industry. The FDIC also sees no reason to delay implementation to allow institutions to adjust their funding mix. The NPR was published in October 2008 and the secured liability adjustment will be based upon data submitted as of June 30, 2009, which allows institutions over eight months to adjust their funding mix.

Some commenters were concerned that the proposed secured liability adjustment would result in sharp increases in assessments when amendments take effect to the Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140) in 2010. FAS 140 will require banks to report assets in special-purpose vehicles and variable-interest entities, which often include securitized assets, on their balance sheets. These assets are presently accounted for off-balance sheet. As a result, commenters argue that the adoption of both FAS 140 and the proposed secured liability adjustment would result in an unintended increase in assessments to certain insured institutions.

FAS 140 has not yet been adopted. As proposed, it would not take effect until 2010. If and when FAS 140 is adopted in final form, the FDIC can then consider whether the secured liability adjustment needs to be modified.

VIII. Adjustment for Brokered Deposits for Risk Categories II, III and IV

In addition to the unsecured debt adjustment and the secured liability adjustment, the final rule states that an institution in Risk Category II, III, or IV will also be subject to an assessment rate adjustment for brokered deposits (the brokered deposit adjustment). This adjustment will be limited to those institutions whose ratio of brokered deposits to domestic deposits is greater than 10 percent; asset growth rates will not affect the adjustment. The adjustment will be determined by multiplying 25 basis points times the difference between an institution's ratio of brokered deposits to domestic deposits and 0.10.
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However, the adjustment will never be more than 10 basis points. The adjustment will be added to the base assessment rate after all other adjustments had been made. Ratios for any given quarter will be calculated from the Call Reports or TFRs filed by each institution as of the last day of the quarter.

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Under the final rule, the ratio of brokered deposits to domestic deposits will be rounded to three digits after the decimal point. The resulting brokered deposit charge will be rounded to the nearest one-hundredth (1/100th) of a basis point.

Significant reliance on brokered deposits tends to increase an institution's risk profile, particularly as the institution's financial condition weakens. Insured institutions—particularly weaker ones—typically pay higher rates of interest on brokered deposits. When an institution becomes noticeably weaker or its capital declines, the market or statutory restrictions may limit its ability to attract, renew or roll over these deposits, which can create significant liquidity challenges.
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An adequately capitalized institution can accept, renew and rollover brokered deposits only by obtaining a waiver from the FDIC. Even then, interest rate restrictions apply. An undercapitalized institution may not accept, renew or rollover brokered deposits at all. Section 29 of the Federal Deposit Insurance Act (12 U.S.C. 1831f).

Also, significant reliance on brokered deposits tends to decrease greatly the franchise value of a failed institution. In a typical failure, the FDIC seeks to find a buyer for a failed institution's branches among the institutions located in or around the service area of the failed institution. A potential buyer usually seeks to increase its market share in the service area of the failed institution through the acquisition of the failed institution and its assets and deposits, but most brokered deposits originate from outside an institution's market area. The more core deposits that the buyer can obtain through the acquisition of the failed institution, the greater the market share of deposits (and the loans and other products that typically follow the core deposits) it can capture. Furthermore, brokered deposits may not be part of many potential buyers' business plans, limiting the field of buyers. Thus, the lower franchise value of the failed institution created by its reliance on brokered deposits leads to a lower price for the failed institution, which increases the FDIC's losses upon failure.

In addition, as noted earlier, several institutions that have recently failed have experienced rapid asset growth before failure and have funded this growth through brokered deposits. The FDIC believes that these reasons warrant the additional charge for significant levels of brokered deposits.

The brokered deposit adjustment, unlike the adjusted brokered deposit ratio applicable to Risk Category I, will include
all
brokered deposits as defined in Section 29 of the Federal Deposit Insurance Act (12 U.S.C. 1831f), and implemented by 12 CFR 337.6, which is the definition used in banks' quarterly Reports of Condition and Income (Call Reports) and thrifts' quarterly Thrift Financial Reports (TFRs), above 10 percent of an institution's assets. The adjustment will include reciprocal deposits, as well as brokered deposits that consist of balances swept into an insured institution by another institution, such as balances swept from a brokerage account.

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. For these reasons, the final rule includes these reciprocal brokered deposits in the brokered deposit adjustment.

To illustrate the brokered deposit adjustment with a simple example, take a Risk Category II institution with an initial base assessment rate of 22 basis points and a ratio of brokered deposits to domestic deposits of 40 percent. Multiplying 25 basis points times the difference between the institution's ratio of brokered deposits to domestic deposits and 10 percent yields 7.5 basis points (calculated as 25 basis points · (0.4 − 0.1)). Because this amount is less than the maximum possible brokered deposit adjustment of 10 basis points, the brokered deposit adjustment will be as calculated, 7.5 basis points. Assuming that the secured liability adjustment for this institution is 2 basis points and that the institution has no other assessment rate adjustments, the total base assessment rate will be 31.5 basis points (calculated as (22 basis points + 2 basis points + 7.5 basis points)).

Comments

Most of the comments on the proposed adjusted brokered deposit ratio (applicable to Risk Category I) also applied to the proposed brokered deposit adjustment (applicable to the other risk categories). The FDIC's response to these comments is as set out in the discussion of the comments on the adjusted brokered deposit ratio, with one major exception. The FDIC has decided to include reciprocal deposits in the brokered deposit adjustment, unlike the adjusted brokered deposit ratio, applicable to Risk Category I, which excludes them. When an institution's condition declines and it falls out of Risk Category I, the statutory and market restrictions on brokered deposits become much more relevant. Even if such an institution remains well capitalized (and the statutory restrictions do not apply), the risk that an institution will become less than well capitalized has increased. These statutory restrictions can cause severe liquidity problems for institutions that rely heavily on brokered deposits. For this reason, the FDIC has decided to include all brokered deposits above 10 percent of an institution's assets in the brokered deposit adjustment.

IX. Insured Branches of Foreign Banks

Because base assessment rates will be higher and the difference between the minimum and maximum initial base assessment rates will increase from two to four basis points under the final rule, the FDIC is making a conforming change for insured branches of foreign banks in Risk Category I. Under the final rule, an insured branch of a foreign bank's weighted average of ROCA component ratings will be multiplied by 5.076 (which will be the pricing multiplier) and 3.873 (which will be a uniform amount for all insured branches of foreign banks) will be added to the product.
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The resulting sum will equal a Risk Category I insured branch of a foreign bank's initial base assessment rate, provided that the amount cannot be less than the minimum initial base assessment rate or greater than the maximum initial assessment rate. A Risk Category I insured branch of a foreign bank's initial base assessment rate will be subject to any large bank adjustment, but total base assessment rates cannot be less than the minimum initial base assessment rate applicable to Risk Category I institutions nor greater than the maximum initial base assessment rate applicable to Risk Category I institutions. Insured branches of a foreign bank not in Risk Category I will be charged the initial base assessment rate for the risk category in which they are assigned.

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An insured branch of a foreign bank's weighted average ROCA component rating will continue to equal the sum of the products that result from multiplying ROCA component ratings by the following percentages: Risk Management—35%, Operational Controls—25%, Compliance—25%, and Asset Quality—15%. The uniform amount for insured branches is identical to the uniform amount under the large bank method. The pricing multiplier for insured branches is three times the amount of the pricing multiplier under the large bank method, since the initial base rate for an insured branch depends only on one factor (weighted average ROCA ratings), while the initial base rate under the large bank method depends on three factors, each equally weighted.

No insured branch of a foreign bank in any risk category will be subject to the unsecured debt adjustment, secured liability adjustment or brokered deposit adjustment. Insured branches of foreign banks are branches, not independent depository institutions. In the event of failure, the FDIC would not necessarily have access to the institution's capital or be protected by its subordinated debt or unsecured liabilities. Consequently, an unsecured debt adjustment appears to be inappropriate. At present, these branches do not report comprehensively on secured liabilities. In the FDIC's view, the burden of increased reporting on secured liabilities would outweigh any benefit.

X. New Institutions

The FDIC also making conforming changes in the treatment of new insured depository institutions.
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For assessment periods beginning on or after January 1, 2010, new institutions in Risk Category I will be assessed at the maximum initial base assessment rate applicable to Risk Category I institutions, as under the final rule adopted in 2006.

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As discussed below, subject to exceptions, the final rule defines a new insured depository institution as a bank or thrift that has not been federally insured for at least five years as of the last day of any quarter for which it is being assessed.

Effective for assessment periods beginning before January 1, 2010, until a Risk Category I new institution receives CAMELS component ratings, it will have an initial base assessment rate that is two basis points above the minimum initial base assessment rate applicable to Risk Category I institutions, rather than one basis point above the minimum rate, as under the final rule adopted in 2006.
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All other new institutions in Risk Category I will be treated as established institutions, except as provided in the next paragraph.

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Certain credit unions that convert to a bank or thrift charter and certain otherwise new insured institutions in a holding company structure may be considered established institutions. Both before and after January 1, 2010, any such institution that is well capitalized but has not yet received CAMELS component ratings will be assessed at two basis points above the minimum initial base assessment rate applicable to Risk Category I institutions.

Either before or after January 1, 2010: no new institution, regardless of risk category, will be subject to the unsecured debt adjustment; any new institution, regardless of risk category, will be subject to the secured liability adjustment; and a new institution in Risk Categories II, III or IV will be subject to the brokered deposit adjustment. After January 1, 2010, no new institution in Risk Category I will be subject to the large bank adjustment.

XI. Assessment Rate Schedule

As explained in the next section, estimated losses from projected institution failures have risen considerably since the NPR was published last fall. Furthermore, certain changes from the NPR made in response to public comments would have the effect of reducing total assessment revenue generated under the proposed rates. Consequently, initial base assessment rates as of April 1, 2009, which are set forth in Table 12 below, are slightly higher than proposed in the NPR.
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In the NPR, the FDIC noted that:

[A]t the time of the issuance of the final rule, the FDIC may need to set a higher base rate schedule based on information available at that time, including any intervening institution failures and updated failure and loss projections. A higher base rate schedule may also be necessary because of changes to the proposal in the final rule, if these changes have the overall effect of changing revenue for a given rate schedule. In order to fulfill the statutory requirement to return the fund reserve ratio to 1.15 percent, the base rate schedule in the final rule could be substantially higher than the proposed base assessment rate schedule (for example, if projected or actual losses at the time of the final rule greatly exceed the FDIC's current estimates).

FR 61,560, 61,572-61,573 (Oct. 16, 2008).

Table 12—Initial Base Assessment Rates

Risk category
I *
Minimum
Maximum
II
III
IV

Annual Rates (in basis points)
12
16
22
32
45

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

The FDIC projects that the minimum initial assessment rate would have to be 20 basis points beginning in the second quarter to increase the reserve ratio to 1.15 percent within 5 years (by the end of 2013). Under the rates shown in table 12 and adopted in this rule, the year-end 2013 reserve ratio is projected to be 0.58 percent. After making all possible adjustments under the final rule, total base assessment rates for each risk

category will be within the ranges set forth in Table 13 below.
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These rates would be in addition to the approximately 1 to 1.2 basis point annual rates that institutions are assessed to pay the interest on Financing Corporation (FICO) bonds.

Table 13—Total Base Assessment Rates after Adjustments*

Risk category I
Risk category II
Risk category III
Risk category IV

Initial base assessment rate
12-16
22
32
45

Unsecured debt adjustment
−5-0
−5-0
−5-0
−5-0

Secured liability adjustment
0-8
0-11
0-16
0-22.5

Brokered deposit adjustment

0-10
0-10
0-10

Total base assessment rate
7-24.0
17-43.0
27-58.0
40-77.5

* All amounts for all risk categories are in basis points annually. Rates for institutions that do not pay the minimum or maximum rate will vary between these rates. Adjustments will be applied in the order listed in the table. The large bank adjustment will be made before any other adjustment.

The new base rate schedule is intended to improve the way the assessment system differentiates risk among insured institutions and make the risk-based assessment system fairer, by limiting the subsidization of riskier institutions by safer ones. They are also intended to increase assessment revenue while the Restoration Plan is in effect.

However, given the FDIC's estimated losses from projected institution failures, the assessment rates adopted in the final rule raise make it likely that the DIF balance and reserve ratio will fall to zero or below this year. The FDIC believes that it is important that the fund not decline to a level that could undermine public confidence in federal deposit insurance. Therefore, the FDIC is simultaneously issuing an interim rule to impose a 20 basis point special assessment on June 30, 2009.
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The interim rule also provides that the Board may impose additional special assessments of up to 10 basis points thereafter, if the reserve ratio of the Deposit Insurance Fund is estimated to fall to a level that that the Board believes would adversely affect public confidence or to a level which shall be close to zero or negative at the end of a calendar quarter.

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12 U.S.C. 1817(b)(5) provides:

Emergency special assessments.—In addition to the other assessments imposed on insured depository institutions under this subsection, the Corporation may impose 1 or more special assessments on insured depository institutions in an amount determined by the Corporation if the amount of any such assessment is necessary—

(A) To provide sufficient assessment income to repay amounts borrowed from the Secretary of the Treasury under [12 U.S.C. 1824(a)] in accordance with the repayment schedule in effect under [12 U.S.C. 1824(c)] during the period with respect to which such assessment is imposed;

(B) To provide sufficient assessment income to repay obligations issued to and other amounts borrowed from insured depository institutions under [12 U.S.C. 1824(d)]; or

(C) For any other purpose that the Corporation may deem necessary.

Actual Rate Schedule, Ability To Adjust Rates and Effective Date

The final rule sets actual rates at the total base assessment rate schedule effective April 1, 2009. The FDIC projects an overall average assessme

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3AE9-4584. Public record. Not legal advice.