Compliance Bulletin

Summary of FDIC Deposit Insurance Amendments
March 13, 2009

The FDIC has amended its deposit insurance assessment system to make it more sensitive to risk and to limit subsidization of riskier institutions by safer ones. The rule incorporates into assessment rates institutions’ reliance on brokered deposits when combined with rapid growth. It also lays out adjustments based on institutions’ unsecured debt and secured liabilities. 

The FDIC is simultaneously issuing an interim rule to impose a 20 basis point special assessment and potentially additional special assessments of up to 10 basis points [1]. That assessment, as proposed, applies across the board to all insured institutions and is not risk-based. This 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.

Background

Pursuant to the Federal Deposit Insurance Reform Act of 2005 and the Federal Deposit Insurance Reform Conforming Amendments Act of 2005 (collectively, the “Reform Act”), the FDIC in 2006 created four risk categories—Risk Categories I, II, III and IV—based on capital levels and supervisory ratings. Three capital groups—well capitalized, adequately capitalized, and undercapitalized—are based on the leverage ratio and regulatory risk-based capital ratios. The three supervisory groups—A, B, and C—are based on examinations and other information [2].

In the Risk Category I, supervisory ratings are combined with other risk measures to further differentiate risk and determine assessment rates. The financial ratios method determines the assessment rates for most institutions in this category. It uses a combination of weighted CAMELS component ratings and five financial ratios: (i) Tier 1 leverage ratio; (ii) loans past due 30-89 days/gross assets; (iii) nonperforming assets/gross assets; (iv) net loan charge-offs/gross assets; and (v) net income before taxes/risk-weighted assets. If a large institution [3] has long-term debt issuer ratings (that is, by one of the major ratings services [4]), then the supervisory and debt ratings method (or “debt ratings method”) is used, which incorporates those ratings in calculating the assessment. Under either method, if the derived rate is below a minimum assessment rate, the minimum rate applies. If the derived rate is above the maximum rate, then the maximum rate applies.

Because the Deposit Insurance Fund reserve ratio fell below 1.15% as of June 30, 2008 and was expected to remain below 1.15%, the Reform Act required the FDIC to implement a restoration plan to restore the reserve ratio to at least 1.15% within five years. In its new proposed rule currently out for comment, the FDIC is proposing to extend the restoration period to seven years.


Final Rule

Risk Category I—financial ratios method. The initial risk assessment rate for Risk Category I institutions (except for large institutions that do not have at least one long-term debt issuer rating, discussed below) is determined using the financial ratios method [5]. Under this method, each of six (formerly five) financial ratios and a weighted average of CAMELS component ratings is multiplied by a corresponding pricing multiplier. The sum of these products will be added to or subtracted from a uniform amount, and the resulting sum is equal to the institution’s initial base assessment rate [6]. The FDIC has the flexibility to update the pricing multipliers and the uniform amount annually without further notice and comment rulemaking.

The final rule adds a sixth financial measure to the financial ratios method to account for brokered deposits. The new “adjusted brokered deposit ratio” applies differently to Risk Category I institutions and all others. Risk Category I institutions that have experienced rapid growth—that is, whose total gross assets are more than 40% greater than they were four years previously, after adjusting for mergers and acquisitions—and whose brokered deposits [7] make up more than 10% of domestic deposits, will be affected by the new ratio. If either criterion is not met, the ratio will not affect the institution’s assessment.

Illustrations and examples are provided in Table 6 in the preamble to the rule and in Appendix A. Generally, the greater the institution’s asset growth and its percentage of brokered deposits, the greater the increase in its initial base assessment rate. The new financial ratio reflects the FDIC’s observation that recent failures involved rapid asset growth funded through brokered deposits, and that there is a correlation between these factors and the probability of a CAMELS downgrade of the institution within one year.

As a result of intense lobbying and letter writing, including by CBA, the ratio as applied to Risk Category I institutions (those posing the least risk) excludes reciprocal deposits [8]. However, reciprocal deposits are included in the brokered deposits adjustment applicable to institutions in Risk Categories II, III and IV. Brokered deposits swept into the institution by a non-depository institution, such as balances swept from a brokerage account at a broker-dealer, also count as brokered deposits for assessment purposes on the rationale that they have contributed to high rates of asset growth.

CAMELS rating changes. If a change in an institution’s CAMELS composite rating during a quarter results in its moving out of Risk Category I, its initial base assessment rate for the portion of the quarter that was in Risk Category I is determined using the supervisory ratings in effect before the change and the financial ratios as of the end of the quarter, subject to any large bank adjustment, unsecured debt adjustment, and secured liability adjustment. For the portion of the quarter that the institution was not in Risk Category I the rate, subject to the unsecured debt, secured liability, and brokered deposit adjustments, is determined under the assessment schedule for the appropriate Risk Category. A similar assessment method is used for institutions whose CAMELS rating changes move them into Risk Category I from another category [9].

If an institution’s CAMELS ratings change in a way that would change its initial base assessment rate within Risk Category I, its rate for the period before the change is determined under the financial ratios method using the CAMELS ratings in effect before the change, subject to adjustment pursuant to any large bank, unsecured debt, and secured liability adjustments. The rate for the remainder of the quarter is determined using the CAMELS ratings in effect after the change, subject to the same adjustment as appropriate [10].

Risk Category 1—large bank method. For large Risk Category I institutions now subject to the debt ratings method, assessment rates are determined using the large bank method derived from a combination of the financial ratios method, long-term debt issuer ratings, and CAMELS component ratings [11]. Currently, Risk Category I large institutions are subject to the large institution adjustment based on their financial performance, condition, market or supervisory information, potential loss severity, and stress considerations. The adjustment has been raised from up to 0.5 to one basis point [12].

The adjustment, which could raise or lower an institution’s rate, is 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 adjustment will be made to an institution’s initial base assessment rate before any other adjustments are made. The adjustment cannot result in a rate that is less than the minimum initial base assessment rate, or increase any rate above the maximum initial base assessment rate [13].

Included are detailed rules about how to apply the adjustment when an institution moves to or from Risk Category I because of a change in its CAMELS or ROCA rating [14]. Before making any upward large bank adjustment, the FDIC will notify the institution and its federal regulator and provide an opportunity to respond [15], and will evaluate the need for the adjustment each subsequent assessment period until it determines that an adjustment is no longer warranted [16]. The FDIC reserves the right to make adjustments to an institution’s initial base assessment rate without advance notice if the institution’s supervisory or agency ratings or financial ratios deteriorate [17].

Adjustment for unsecured debt for all Risk Categories. For all institutions (except new institutions), the base assessment rate (after making any large institution adjustment) will be reduced from the initial rate using the institution’s ratio of long-term unsecured debt to domestic deposits [18]. Long-term unsecured debt is defined as unsecured debt with at least one year remaining until maturity [19]. Any decrease in base assessment rates as a result of this adjustment will be limited to five basis points [20]. Unsecured debt does not include any senior unsecured debt that the FDIC has guaranteed under the Temporary Liquidity Guarantee Program (“TLGP”).

As applied to small institutions, an amount of qualified Tier 1 capital [21] is added to long-term unsecured debt to derive the ratio. This is because lack of demand makes it difficult for small institutions to issue unsecured debt, and it would be unfair that small institutions that have large amounts of Tier 1 capital would not receive an equivalent benefit for that capital. Also the FDIC does not want to create an incentive for small institutions to convert existing Tier 1 capital into subordinated debt. Tables 9 and 10 in the preamble to the final rule set out examples and illustrations.

Unsecured debt consists of senior unsecured liabilities and subordinated debt [22]. A senior unsecured liability is defined as the unsecured portion of other borrowed money but does not include any TLGP debt, since this kind of debt will not decrease FDIC losses in the event an institution fails [23]. Subordinated debt refers to the definition in the report of condition for the reporting period and includes limited-life preferred stock also defined in the quarterly report of condition for the reporting period [24].

Currently, institutions do not separately report long-term senior unsecured liabilities or long-term subordinated debt in the reports of condition. The Federal Financial Institution Examination Council elsewhere is proposing a revision of the Call Report to list separately long-term senior unsecured liabilities and subordinated debt in a manner that meets this definition. The OTS has also proposed similar reporting requirements for thrifts. The FDIC states that it anticipates that these revisions will be made beginning with the June 30, 2009 Call Report and TFR. However, if they are not, until institutions 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.

Currently, institutions do not report debt that the FDIC guaranteed under TLGP. The FDIC says it 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.

Adjustment for secured liabilities for all risk categories. For institutions in all risk categories, the base assessment rate may increase based upon an institution’s ratio of secured liabilities to domestic deposits, referred to as the secured liability adjustment [25]. A ratio of greater than 25% will increase the assessment rate by no more than 50% [26]. This adjustment is made after any large institution adjustment or unsecured debt adjustment. See page 47 in the preamble to the rule for an example. The ratio for any given quarter will be calculated from the institution’s report of condition filed as of the last day of the quarter.

For banks, secured liabilities include Federal Home Loan Institution advances, securities sold under repurchase agreements, secured federal funds purchased and “other secured borrowings,” as reported in banks’ quarterly Call Reports [27]. TRF filers currently report FHLB advances but not the others separately. The OTS’s proposal includes a revision of the TFR to have thrifts separately report these items, and the FDIC anticipates that this revision will be effective for the June 30, 2009 TFR. Until the revision these amounts not reported separately will be imputed. Secured liabilities are included because the FDIC believes an institution’s 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. Substituting secured liabilities for deposits can also lower an institution’s franchise value in the event of a failure.

Adjustment for brokered deposits for other Risk Category institutions. In addition to the unsecured debt adjustment and the secured liability adjustment, institutions in Risk Category II, III, or IV will also be subject to an assessment rate adjustment for brokered deposits, including reciprocal deposits. This ratio is called the brokered deposit adjustment. It applies to institutions whose ratio of brokered deposits to domestic deposits exceeds 10% irrespective of asset growth. The adjustment is limited to 10 basis points and is added to the base assessment rate after the unsecured debt and secured liability adjustments are made. Ratios for any given quarter are calculated from the report of condition filed as of the last day of the quarter [28]. The FDIC’s somewhat circular rationale for including reciprocal deposits in Risk Categories II, III, and IV but not I is that when an institution that is heavily reliant on brokered deposits falls out of Risk Category I the statutory and market restrictions can cause significant liquidity problems.

New institutions. 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 under the current rule [29]. A new institution is one that has not been insured for at least five years as of the last day of any quarter for which it is being assessed [30]. 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 [31]. All other new institutions in Risk Category I will be treated as established institutions, except that no new institution in any risk category will be subject to the unsecured debt adjustment, and all new institutions in any risk category will be subject to the secured liability adjustment [32]. Also, new institutions in Risk Categories II, III or IV are subject to the brokered deposit adjustment. After January 1, 2010, no new institution in Risk Category I will be subject to the large institution adjustment.

Assessment rates. The initial base assessment rates [33] as of April 1, 2009 are as follows:

Category I: 12-16 basis points
Category II: 22 basis points
Category III: 32 basis points
Category IV: 45 basis points

When incorporating the three adjustment factors (unsecured debt, secured liability, and brokered deposit), the total range for actual assessment rates [34] are as follows:

Category I: 7 – 24.0
Category II: 17 – 43.0
Category III: 27 – 58.0
Category IV: 40 – 77.5

These rates apply beginning April 1 this year and will be reflected in the June 30, 2009 fund balance and the invoices for assessments due September 30, 2009. The FDIC projects an overall average assessment rate of 15.4 basis points. This compares to 6.4 basis points for all institutions and 5.5 basis points for institutions in Risk Category I (before credit use) [35] in September 30, 2008.

The FDIC Board maintains the authority to adopt actual rates that are higher or lower than total base assessment rates without a formal rulemaking, but any adjustment from one quarter to the next may not be greater than three basis points, and cumulative adjustments can not be more than three basis points higher or lower than the adjusted base rates [36].

The rule also includes a number of technical and other changes, and specific rules for branches of foreign banks. Below is a link to the FDIC’s preamble and final rule: http://www.fdic.gov/news/board/27Feb09_Final_Rule.pdf.

  1. Since issuing the proposal, the FDIC has indicated that it is willing to reduce the special assessment to 10 basis points if a provision in new legislation raises the FDIC’s Treasury line of credit from the current $30 billion to $100 billion.
  2. See 12 CFR 327.9.
  3. Generally, an institution is classified as large if it has assets of $10 billion or more as of December 31, 2006. A small institution has assets of less than $10 billion as of the same date. The rule includes revised methods of determining when a small institution becomes a large one and vice versa, and also a procedure for a small institution to request treatment as a large institution. See 12 CFR 327.8(h) and (g) and 327.8(d)(8).
  4. Defined in 12 CFR 327.8(i).
  5. 12 CFR 327.9(d)(1).
  6. See 12 CFR 327.9(d)(1), which includes a calculation table.
  7. Defined in 12 U.S.C. § 1831f.
  8. Defined in 12 CFR 327.8(s).
  9. 12 CFR 327.9(d)(1)(ii)(A).
  10. 12 CFR 327.9(d)(1)(ii)(B).
  11. 12 CFR 327.9(d)(2).
  12. 12 CFR 327.9(d)(4).
  13. 12 CFR 327.9(d)(4)(ii).
  14. 12 CFR 327.9(d)(4)(i) and (ii).
  15. 12 CFR 327.9(d)(4)(iii)(A) and (B).
  16. If the FDIC intends to make a downward adjustment, it will notify the institution’s primary federal regulator but not the institution. The downward adjustment would apply until the FDIC determines that it is no longer warranted. 12 CFR 327.9(d)(4)(v).
  17. 12 CFR 327.9(d)(4)(vi).
  18. 12 CFR 327.9(d)(5).
  19. 12 CFR 327.8(r).
  20. 12 CFR 327.9(d)(5)(iii).
  21. See Table at 12 CFR 327.9(d)(5)(ii) for a calculation of Tier 1 capital that is incorporated in the unsecured debt adjustment for small institutions.
  22. 12 CFR 327.8(o).
  23. 12 CFR 327.8(p).
  24. 12 CFR 327.8 (q).
  25. 12 CFR 327.9(d)(6).
  26. 12 CFR 327.9(d)(6)(iii).
  27. 12 CFR 327.9(d)(6)(i).
  28. 12 CFR 327.9(d)(7).
  29. 12 CFR 327.9(d)(9)(i)(A).
  30. 12 CFR 327.8(l).
  31. 12 CFR 327.9(d)(9)(i)(B).
  32. 12 CFR 327.9(d)(9)(i)(C).
  33. 12 CFR 327.10(a).
  34. 12 CFR 327.10(b).
  35. At the end of 2008, only 4% of credits remained unused. While the FDIC has the authority to restrict credit use while the restoration plan is in effect, it has decided not to restrict credit use.
  36. 12 CFR 327.10(c)(3).

The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.

© This CBA Regulatory Compliance Bulletin is copyrighted by the California Bankers Association, and may not be reproduced or distributed without the prior written consent of CBA.

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