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2007 Annual Report

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I. Management's Discussion and Analysis

The Year in Review
In 2007, the FDIC continued its work on high-profile policy issues, ranging from implementation of deposit insurance reform to finalizing capital reform. In addressing these and other issues, the Corporation published numerous Notices of Proposed Rulemaking (NPRs) throughout the year, seeking comment from the public. The Corporation also continued to focus on a strong supervisory program and reorganized examination teams that inspected financial institutions that originate significant volumes of subprime loans and nontraditional loan products. The FDIC continued expansion of financial education programs, providing Money Smart training to hundreds of public school teachers. It also sponsored and co-sponsored major conferences and participated in local and global outreach initiatives.

Highlighted in this section are the Corporation's 2007 accomplishments in each of its three major business lines – Insurance, Supervision and Consumer Protection, and Receivership Management – as well as its program support areas.

Insurance
The FDIC insures bank and savings association deposits. As insurer, the FDIC must continually evaluate and effectively manage how changes in the economy, the financial markets and the banking system affect the adequacy and the viability of the Deposit Insurance Fund.

Implementation of Deposit Insurance Reform
On November 2, 2006, the FDIC Board of Directors adopted a final rule on assessments as part of the implementation of the Federal Deposit Insurance Reform Act of 2005 (Reform Act). The new rule enables the FDIC to more closely tie each bank's assessments to the risk that it poses to the Deposit Insurance Fund.

Effective January 1, 2007, assessment rates ranged from 5 to 7 basis points for Risk Category I institutions, 10 basis points for Risk Category II institutions, 28 basis points for Risk Category III institutions and 43 basis points for Risk Category IV institutions. These rates are uniformly 3 basis points greater than the base assessment rates also adopted by the Board in November 2006. The Board retains the flexibility to adjust rates without further notice-and-comment rulemaking, provided that no such adjustment can be greater than 3 basis points in any quarter; that these adjustments cannot result in rates more than 3 basis points above or below the base rates; and that rates cannot be negative. The table on the following page shows the distribution of institutions among the risk categories as well as within Risk Category I.

Some members of the Deposit Insurance Reform Implementation Team with Chairman Sheila Bair, Vice Chairman Martin Gruenbert and Directory Thomas Carry.


Distribution of Institutions and Assessment Base Among Risk Categories:
Quarter Ending September 30, 2007
Risk Category Annual Rate in Basis Points Number of Institutions Percent of Total Institutions Assessment base Percent of Total Assessment Base
I - Minimum 5 2,709 32% $3,872 56%
I - Middle 5.01 - 6.00 3,088 36% 2,078 30%
I - Middle 6.01 - 6.99 1,422 17% 456 7%
I - Maximum 7 859 10% 296 4%
II 10 422 5% 163 2%
III 28 64 1% 14 0%
IV 43 7 0% 1 0%
Total   8,571 100% $6,880 100%
Note: Institutions are categorized based on supervisory ratings, debt ratings and financial data as of September 30, 2007. Rates do not reflect the application of assessment credits. Percentages may not add to 100 percent due to rounding.

Within Risk Category I, the FDIC determines an assessment rate from three primary sources of information the supervisory component ratings for all insured institutions, the financial ratios for most institutions, and the long-term debt issuer ratings for large institutions that have them. Generally, for those institutions in Risk Category I with less than $10 billion in assets and those with $10 billion or more in assets that do not have long-term debt issuer ratings, assessment rates are based on a combination of financial ratios and CAMELS1 component ratings. Generally, for those institutions in Risk Category I with $10 billion or more in assets that have long-term debt issuer ratings, assessment rates are determined from weighted average CAMELS component ratings and long-term debt issuer ratings.

For all large Risk Category I institutions, additional risk factors are considered to determine whether the assessment rates should be adjusted. This additional information includes market data, financial performance measures, considerations of the ability of an institution to withstand financial stress, and loss severity indicators. Any adjustment is limited to no more than ½ basis point up or down. In February 2007, the FDIC released for public comment proposed guidelines on how it would determine such adjustments. The FDIC Board approved final guidelines in May 2007.

Institutions that contributed to the build-up of the insurance funds through 1996 received an aggregate $4.7 billion in one-time credits under the Reform Act to offset future deposit insurance assessments. These credits were allocated to institutions based on their 1996 assessment base shares.

The average annualized assessment rate (weighted by each institution's assessment base), before accounting for the use of credits, was approximately 5.4 basis points for the first three quarters of 2007. Approximately 68 percent of all institutions (71 percent of institutions in Risk Category I) were able to offset their first, second, and third quarter 2007 assessments entirely using credits.

During the first half of 2007, the FDIC completed substantial modifications to its information systems in order to implement the changes to risk-based assessment rates, track credit use and availability for each institution, incorporate changes to the calculation and reporting of the assessment base, and deliver the invoices for the first quarter assessments by the June 2007 deadline.

In September 2007, the FDIC issued an Advance Notice of Proposed Rulemaking (ANPR), seeking comments on alternative methods for allocating dividends as part of a permanent final rule to implement the dividend requirements of the Reform Act. In October 2006, the Board adopted a temporary rule governing dividends, which expires at the end of 2008. The comment period for the Dividend ANPR closed on November 19, 2007.

International Capital Standards
The FDIC, as insurer, has a substantial interest in ensuring that bank capital regulation effectively safeguards the federal bank safety net against excessive loss. During 2007, the FDIC participated in the Basel Committee on Banking Supervision (BCBS) and many of its subgroups. The FDIC also participated in various U.S. regulatory efforts aimed at interpreting international capital standards and establishing sound policy and procedures for implementing these standards.

Ensuring the adequacy of insured institutions' capital under Basel II remained a key objective for the FDIC. In 2007, the FDIC devoted substantial resources to domestic and international efforts to ensure these new rules are designed and implemented appropriately. These efforts, in conjunction with other federal financial regulators, included publishing a final rule for the implementation of the advanced approaches of Basel II as well as proposed examination guidance. This guidance is intended to provide the industry with regulatory perspectives for implementation. In concert with regulators from other U.S. banking agencies and other Basel Committee member countries, the FDIC also participated in a review of supervisory and regulatory supplemental capital measures currently being used to ensure bank capital adequacy.

The Basel II Final Rule was published in the Federal Register on December 7, 2007, with an effective date of April 1, 2008. The findings of the fourth quantitative impact study (QIS-4), which were completed in 2005, suggested that, without modification, the Basel II framework could result in an unacceptable decline in minimum risk-based capital requirements. As a result, the agencies have included safeguards against the possibility that the new rules do not work as intended. For instance, the agencies have agreed, by regulation, not to allow any bank to exit its transitional risk-based capital floors unless and until the agencies publish a study giving the new rules a clean bill of health or unless identified defects are remedied. If any agency allows its banks to exit the floors in a way that departs from this consensus approach, the rule requires that agency to publish a report explaining its reasoning. In addition, the agencies have retained the U.S. leverage ratio and Prompt Corrective Action requirements.

Through its supervisory program, the FDIC continues to work with certain insured state non-member bank subsidiaries of banking organizations that plan to operate under the new capital accord, to review and assess implementation plans and progress towards meeting qualification requirements.

Domestic Capital Standards
The FDIC is involved in efforts to revise the existing risk-based capital standards for banks that will not be subject to the advanced approaches of Basel II. As such, the FDIC has taken a lead role in developing a proposed rule that would implement the standardized approach of Basel II (Basel II Standardized NPR). The proposed rule is intended to modernize the risk-based capital rules for banks that do not use the advanced approaches of Basel II, and minimize potential competitive inequities that may arise between banks that adopt Basel II and banks that remain under the existing rules. The agencies have indicated that they expect to issue the Basel II Standardized NPR during the first quarter of 2008.

Identifying and Addressing Risks to the Deposit Insurance Fund
During 2007, the FDIC continued to research and analyze trends in the banking sector, financial markets and the overall economy to identify emerging risks to the banking industry and the Deposit Insurance Fund. The identified risks were highlighted throughout the year in presentations and written reports. The FDIC redesigned its Large Insured Depository Institution (LIDI) program to ensure uniform reporting of critical risks posed by institutions with assets over $10 billion. The information captured through this program is used to support business line activities related to supervision, insurance and resolutions. Institution-specific concerns were directed to FDIC regional offices for appropriate action. The FDIC continued to analyze the regional economies affected by hurricanes Katrina and Rita throughout the year.

Center for Financial Research
During 2007, the FDIC's Center for Financial Research (CFR) co-sponsored two major research conferences: the 17th Annual Derivatives Securities and Risk Management Conference and the seventh Annual Bank Research Conference.

The 17th Annual Derivatives Securities and Risk Management Conference, which the FDIC co-sponsored with Cornell University's Johnson Graduate School of Management and the University of Houston's Bauer College of Business, was held in April 2007 at FDIC's Virginia Square facility and attracted over 100 researchers from around the world. Conference presentations focused on technical and mathematical aspects of risk measurement and securities pricing, and included several presentations on Basel II-related topics.

The CFR and The Journal of Financial Services Research (JFSR) hosted the seventh Annual Bank Research Conference in September with over 100 attendees. The conference included the presentation of 12 papers, a nationally recognized guest speaker, Francis A. Longstaff - Allstate Professor of Insurance and Finance, Anderson School of Management, UCLA, an expert panel, and discussions on timely issues affecting the financial system. The conference theme focused on liquidity in the financial system. Experts discussed analyses on such topics as asset prices and liquidity, liquidity in the equity and options markets, and issues involving commercial bank liquidity and bank lending.

The CFR also hosted the Basel Research Task Force Annual Workshop in May. The workshop included a two-day session with research paper presentations and discussions by staff members of Basel Committee institutions. Approximately 85 researchers and policy makers attended the workshop. Many represented foreign central banks and financial supervisory agencies. Additionally, the FDIC along with the Federal Reserve Bank of Chicago, the University of Kansas School of Business, and The Journal of Financial Services Research, co-sponsored the Mergers and Acquisitions of Financial Institutions Conference in November.

Ten CFR working papers were published in 2007 on topics including risk measurement, exchange rate exposure, and financial institution credit and retail banking relationships.

Other Risk Identification Activities
The FDIC researched and analyzed emerging risks and trends in the banking sector, financial markets and the overall economy to identify issues affecting the banking industry and the DIF. During 2007, the FDIC focused significant attention on the condition of housing markets and the problems facing subprime mortgage borrowers and their lenders. The FDIC also continued to analyze the regional economies adversely affected by hurricanes Katrina and Rita throughout the year. A consumer finance research section was formed in late 2007 to examine a variety of consumer-related issues, including fair lending, consumer credit access, small business credit access, new consumer financial services, and home mortgage finance.

In 2007, the FDIC began publishing FDIC Quarterly, which incorporates information previously available in the Quarterly Banking Profile and other FDIC publications. FDIC Quarterly discusses current conditions, trends and changes in the performance of insured institutions, and issues affecting the economy and the banking system. In 2007, FDIC Quarterly analyzed such topics as the case for subprime loan modifications, the privatization of deposit insurance, the effectiveness of financial education programs, and the popularity of individual development accounts (matched savings accounts that enable low-income families to save money for a particular financial goal, such as buying a home, paying for post-secondary education, or starting or expanding a small business). In addition, quarterly FDIC State Profiles were released for each state during 2007.

Throughout the year, the FDIC conducted numerous outreach activities addressing economic and banking risk analyses. Presentations were made to financial institutions and related trade groups, bank directors' colleges, community groups, foreign visitors and other regulators.



1 The CAMELS composite rating represents the adequacy of Capital, the quality of Assets, the capability of Management, the quality and level of Earnings, the adequacy of Liquidity, and the Sensitivity to market risk, and ranges from "1" (strongest) to "5" (weakest).


Last Updated 04/23/2008 communications@fdic.gov