SUMMARY:
The Federal Deposit Insurance Reform Act of 2005 requires that the Federal Deposit Insurance Corporation (the FDIC) prescribe final regulations, after notice and opportunity for comment, to provide for deposit insurance assessments under section 7(b) of the Federal Deposit Insurance Act (the FDI Act). In this rulemaking, the FDIC is amending its regulations to create a new risk differentiation system, to establish a new base assessment rate schedule, and to set assessment rates effective January 1, 2007.

EFFECTIVE DATE: January 1, 2007.

FOR FURTHER INFORMATION CONTACT:
Munsell W. St. Clair, Senior Policy Analyst, Division of Insurance and Research, (202) 898-8967; or Christopher Bellotto, Counsel, Legal Division, (202) 898-3801.

SUPPLEMENTARY INFORMATION:

I. Background
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 enacts the bulk of the recommendations made by the FDIC in 2001. The Reform Act, among other things, requires that the FDIC, within 270 days, “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. ²

On July 24, 2006, the FDIC published in the Federal Register, for a 60-day comment period, a notice of proposed rulemaking providing for deposit insurance assessments (the NPR). 71 Fed. Reg. 41910. The FDIC sought public comment on its proposal and received 699 comment letters, including numerous comments from trade organizations.^{3 4} The comments and the final rule providing for assessments are discussed in later sections.

A. The current risk-differentiation framework
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required that the FDIC establish a risk-based assessment system. To implement this requirement, the FDIC adopted by regulation a system that places institutions into risk categories ⁵ based on two criteria: capital levels and supervisory ratings. Three capital groups—well capitalized, adequately capitalized, and undercapitalized, which are numbered 1, 2 and 3, respectively—are based on leverage ratios and risk-based capital ratios for regulatory capital purposes. Three supervisory subgroups, 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. ⁶ Subgroup A consists of financially sound institutions with only a few minor weaknesses; subgroup B consists of institutions that demonstrate weaknesses that, if not corrected, could result in significant deterioration of the institution and increased risk of loss to the insurance fund; and subgroup C consists of institutions that pose a substantial probability of loss to the insurance fund unless effective corrective action is taken. In practice, the subgroup evaluations are generally 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. ⁷ Generally speaking, institutions with a CAMELS rating of 1 or 2 are put in supervisory subgroup A, those with a CAMELS rating of 3 are put in subgroup B, and those with a CAMELS rating of 4 or 5 are put in subgroup C. Thus, in the current assessment system, the highest-rated (least risky) institutions are assigned to category 1A and the lowest-rated (riskiest) institutions to category 3C. The three capital groups and three supervisory subgroups form a nine-cell matrix for risk-based assessments:

Capital Group	Supervisory Subgroup
	A	B	C
1. Well Capitalized	1A	1B	1C
2. Adequately Capitalized	2A	2B	2C
3. Undercapitalized	3A	3B	3C

B. Reform Act provisions
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).⁸

At the same time, the Reform Act also restores 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. ⁹

The Reform Act leaves 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.” ¹⁰ 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.” ¹¹

II. Summary of the Final Rule
The final rule is set out in detail in ensuing sections, but is briefly summarized here.

The final rule consolidates the existing nine risk categories into four and names them Risk Categories I, II, III and IV. Risk Category I replaces the 1A risk category.

Within Risk Category I, the final rule combines supervisory ratings with other risk measures to differentiate risk. For most institutions, the final rule combines CAMELS component ratings with financial ratios to determine an institution’s assessment rate. For large institutions that have long-term debt issuer ratings, the final rule differentiates risk by combining CAMELS component ratings with these ratings. For large institutions within Risk Category I, initial assessment rate determinations may be modified within limits upon review of additional relevant information.

The final rule defines a large institution as an institution that has $10 billion or more in assets. With certain exceptions, beginning in 2010, the final rule treats new institutions (those established for less than five years) in Risk Category I the same, regardless of size, and assesses them at the maximum rate applicable to Risk Category I institutions.

The final rule sets actual rates beginning January 1, 2007, as follows:


	Risk Category
	I*		II	III	IV
	Minimum	Maximum
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.

These rates are three basis points above the base rate schedule adopted in the final rule:

	Risk Category
	I*		II	III	IV
	Minimum	Maximum
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 final rule continues to allow the FDIC Board to adjust rates uniformly from one quarter to the next, except that no single adjustment can exceed three basis points. In addition, cumulative adjustments cannot exceed a maximum of three basis points higher or lower than the base rates without further notice-and-comment rulemaking.

III. General Risk Differentiation Framework
The final rule consolidates the number of assessment risk categories from nine to four. The four new categories will continue to be defined based upon supervisory and capital evaluations, which are both established measures of risk. The consolidation creates four new Risk Categories as shown in Table 1:

Table 1
New Risk Categories


Capital Group	Supervisory Group
	A	B	C
Well Capitalized	I	II	III
Adequately Capitalized
Undercapitalized	III		IV

Risk Category I contains all well-capitalized institutions in Supervisory Group A (generally those with CAMELS composite ratings of 1 or 2); i.e., those institutions that would be placed in the former 1A category. Risk Category II contains all institutions in Supervisory Groups A and B (generally those with CAMELS composite ratings of 1, 2 or 3), except those in Risk Category I and undercapitalized institutions. ¹² Risk Category III contains all undercapitalized institutions in Supervisory Groups A and B, and institutions in Supervisory Group C (generally those with CAMELS composite ratings of 4 or 5) that are not undercapitalized. Risk Category IV contains all undercapitalized institutions in Supervisory Group C; i.e., those institutions that would be placed in the former 3C category. ¹³

Comments
No comments disagreed with the proposed reduction in the number of risk categories from nine to four. However, one comment recommended adding subcategories to Risk Category I to provide a warning to institutions that are moving toward Risk Category II if corrective action is not taken and giving an institution that slips from Risk Category I to Risk Category II an opportunity to show quick improvement. The FDIC does not believe that these subcategories are necessary. For an institution in Risk Category I, its assessment rate will provide the same information. The FDIC also does not believe that special treatment should be accorded an institution that slips from Risk Category I, as opposed to other institutions already in Risk Category II.

Some comments argued that, for CAMELS 3, 4 and 5-rated institutions in Risk Categories II and III, some provision for lower premiums should be made for institutions that augment and maintain strong capital, maintain adequate reserves for loan losses and have a plan for recovery approved by the FDIC. The FDIC does not see a need for special provisions for these institutions, as they have other incentives to improve capital and business operations.

IV. Risk Differentiation within Risk Category I
A. Overview
Risk Category I, as of June 30, 2006, would include approximately 95 percent of all insured institutions. The final rule will further differentiate risk within this category using one of two methods. Both methods share a common feature, namely, the use of CAMELS component ratings. However, each method combines these measures with different sources of information on risk. For small institutions within Risk Category I and for large institutions within Risk Category I that do not have long-term debt issuer ratings, the final rule combines CAMELS component ratings with current financial ratios to determine an institution’s assessment rate. For large institutions within Risk Category I that have long-term debt issuer ratings, the final rule combines CAMELS component ratings with these debt ratings. For all large institutions, initial assessment rates may be modified within limits upon review of additional relevant information.

The risk differentiation methods for institutions in Risk Category I measure levels of risk and result in rank orderings of risk within the category. Within Risk Category I, the final rule assesses those institutions that pose the least risk a minimum assessment rate and those that pose the greatest risk a maximum assessment rate that is two basis points higher than the minimum rate. An institution that poses an intermediate risk within Risk Category I will be charged a rate between the minimum and maximum that will vary by institution. Under the final rule, small changes in an institution’s financial ratios, long-term debt issuer ratings or CAMELS component ratings should produce only small changes in assessment rates.

The final rule defines a large institution as an institution that has $10 billion or more in assets and a small institution as an institution that has less than $10 billion in assets. Also, as described below in Section VII, beginning in 2010, with certain exceptions, the final rule treats new institutions in Risk Category I the same, regardless of size, and assesses them at the maximum rate applicable to Risk Category I institutions.

B. Distribution of assessment rates
As stated above, within Risk Category I, the final rule results in assessing those institutions that pose the least risk a minimum assessment rate and those that pose the greatest risk a maximum assessment rate that is two basis points higher. An institution that poses an intermediate risk within Risk Category I will be charged a rate between the minimum and maximum that will vary incrementally by institution.

In this regard, the final rule differs from the NPR in its application to large institutions. The NPR had proposed assessing large institutions that posed an intermediate risk within Risk Category I one of four rates between the minimum and maximum based on subcategory assignments. A number of comments expressed concern over the proposed use of assessment rate subcategories and the possibility that large increases (and decreases) in assessment rates could result from relatively small changes in risk. Some of these comments recommended using as few as three assessment rate subcategories, and some comments recommended using incremental pricing, as proposed in the NPR for small institutions. The FDIC has decided to adopt an incremental pricing framework for all institutions so that a small change in risk will produce a small change in assessment rates.

Under the final rule, as of June 30, 2006: (1) approximately 45 percent of all institutions that would have been in Risk Category I (other than institutions less than 5 years old) would have been charged the minimum assessment rate; and (2) approximately 5 percent of all institutions that would have been in Risk Category I (other than institutions less than 5 years old) would have been charged the maximum assessment rate. In future periods, different percentages of institutions may be charged the minimum and maximum rates.

Chart 1 shows the cumulative distribution of assessment rates based on June 30, 2006 data, using base assessment rates for institutions in Risk Category I. The chart excludes Risk Category I institutions less than 5 years old.

D

Comments
Percentages of institutions paying the minimum rate
A comment agreed that charging 45 percent of institutions the minimum rate makes sense given the current health of the banking industry. Several comments (including comments from some trade groups), however, suggested that initially charging 45 percent of institutions the minimum rate was arbitrary or inappropriate. These comments suggested initially charging a larger percentage of institutions the minimum rate, at least in part because risk in the banking industry is very low at present.

Two comments expressed the view that the decision to place roughly 45 percent of large institutions in the minimum assessment rate subcategory and 5 percent in the maximum assessment rate subcategory was subjective and arbitrary. In one of these comments, it was suggested that large institutions might be restricted from the lowest premium rate by this decision. Several other comments also urged the FDIC to expand the availability of the minimum assessment rate to a larger proportion of large institutions. Some comments argued for the elimination of premiums altogether for the highest rated large institutions.

The FDIC has found that small institutions with a probability of downgrade to a CAMELS 3 or worse that is equal to or less than the probability of downgrade for the 40th to 50th percentile as of June 30, 2006, had minimal risk of a CAMELS downgrade over time. The remainder of small institutions in the industry had increasing and distinguishable risk of CAMELS downgrades. The FDIC believes it is appropriate to initially assign roughly similar proportions of large and small institutions to the minimum assessment rate to achieve parity. While the initial proportions of large and small institutions being charged the minimum and maximum rates will be similar, the final rule does not fix the proportions for the future. Thus, in future periods, more or less than 45 percent of large (or small) institutions may pay the minimum rate and more or less than 5 percent may pay the maximum rate.

Risk Category I assessment rate spread
Several comments (including comments from trade groups) recommended that the FDIC eliminate or narrow the spread between the minimum and maximum base rates for Risk Category I. Arguments in favor of eliminating or narrowing the spread included:

• The new risk differentiation system is untested and could lead to unintended consequences.
• Improvements in bank risk-management systems, improvements in supervisory evaluations and off-site monitoring, and enhanced supervisory powers enjoyed by the regulators have reduced risk.
• A narrower spread would reduce the adverse effect of changes in subcategories on large banks and the adverse effect of paying the maximum rate on new banks.

Other comments (including comments from some trade groups) recommended increasing the spread between minimum and maximum assessment rates for Risk Category I to 3 basis points. According to these comments, a wider spread would improve risk differentiation and could subject more institutions to incremental rates between the minimum and maximum rates.

The final rule strikes a balance between the arguments for a narrower spread and those for a wider spread. The two basis point spread adopted in the final rule is narrower than the historical loss data would suggest. ¹⁴ However, as the comments have noted, the new system is, as yet, untested.

C. CAMELS ratings
For all institutions in Risk Category I, supervisory ratings will be taken into account in setting assessment rates using a weighted average of an institution’s CAMELS components. This weighted average will be created by combining the components as follows: ¹⁵

Camels Component	Weight
C	25%
A	20%
M	25%
E	10%
L	10%
S	10%

Comments
Almost every comment that discussed the use of CAMELS ratings to differentiate risk within Risk Category I supported their use. One comment questioned their use and a few comments opposed any differentiation within Risk Category I.

One trade group asserted that the FDIC should use a simple, rather than weighted, average of CAMELS components on the grounds that using financial ratios related to these components effectively weights the components. The trade group noted that capital, for example, is already reflected in an institution’s risk category and as a CAMELS component. The trade group also asserted that asset quality is given extra emphasis in the proposed weighting scheme by including several asset quality financial ratios as well as the A rating in the CAMELS component average. With regards to the M component, the trade group asserted that:

Management – the most subjective of all the CAMELS components – must by necessity be involved in all the financial ratios and other examination components. In practice, therefore, it is unlikely that examiners would rate management higher than the other components. Thus, there is always a bias against a high management rating.

Several comments proposed different weighting schemes for large institutions, such as heavier weights for Liquidity, Capital, and Asset quality.

The final rule retains the weights proposed in the NPR to determine the weighted average CAMELS component rating. These weights reflect the view of the FDIC on the relative importance of each of the CAMELS components in differentiating risk among institutions in Risk Category I for deposit insurance purposes.

D. Financial ratios
For small institutions and for large institutions without a long-term debt issuer rating, the final rule uses certain financial ratios, in addition to supervisory ratings, to differentiate risk. The final rule differs slightly from the proposal in the NPR with respect to the financial ratios being used and their definitions.

The financial ratios that will be used are:

• The Tier 1 Leverage Ratio;
• Loans past due 30-89 days/gross assets;
• Nonperforming assets/gross assets; ¹⁶
• Net loan charge-offs/gross assets; and
• Net income before taxes/risk-weighted assets.

The Tier 1 Leverage Ratio has the definition used for regulatory capital purposes. Appendix A defines each of the ratios.

Many comments (including comments from several industry trade groups) opposed including time deposits greater than $100,000 in the definition of volatile liabilities for a variety of reasons, including: (1) these deposits are core deposits or should be so considered; and (2) including them would have an effect on attracting municipal deposits. One comment opposed including brokered deposits in the definition of volatile liabilities on the grounds that they are less volatile than many core deposits. One trade group argued that deposits in excess of $100,000 that are insured by excess deposit insurance should not be included in the definition of volatile liabilities.

The final rule eliminates the basis for these concerns by excluding one of the financial ratios proposed in the NPR, the ratio of volatile liabilities to gross assets. The financial data used to compute volatile liabilities reported by thrifts in the Thrift Financial Reports (TFRs) and reported by banks in their Reports of Condition and Income (Call Reports) were not compatible and could not be made compatible without changes in reporting requirements. ¹⁷

The final rule also excludes the portion of loans and leases that is guaranteed by the U.S. Government, including government agencies and government-sponsored agencies, from the computation of loans past due 30-89 days and from the computation of non-performing assets. These types of guaranteed loans are treated as less risky than other loans for risk-based capital purposes. Moreover, the use of past due and nonaccrual loan measures that do not adjust for these guaranteed loans might overstate credit risk and result in assessment rates that are too high for some institutions.

Comments
Almost all comments (including comments from a trade group) on using financial ratios (in addition to CAMELS ratings) to determine assessment rates supported their use. However, some suggested that different financial ratios be used.

In the NPR, the definition of volatile liabilities did not include Federal Home Loan Bank advances, but the FDIC asked for comment on whether it should. The FDIC received 569 comments on this issue. All but one argued that the definition of volatile liabilities should not include Federal Home Loan Bank advances; one argued that the definition should include these advances. The final rule does not include the volatile liability ratio.

A trade group suggested excluding the loans past due 30-89 days to gross assets ratio on the grounds that loan delinquencies are already considered in two CAMELS components, A (Assets) and M (Management). The final rule retains the loans past due 30-89 days to gross assets ratio. Independent of the CAMELS components, this ratio is statistically significant and highly predictive of CAMELS downgrades and institution failures even when it is considered together with the nonperforming ratio. ¹⁸

A trade group commented that the risk weighting formula used to establish risk weighted assets is biased against residential mortgage lenders. It argued that, since they are secured by property liens, all 1-4 family, owner occupied residential mortgage loans with a loan-to-value ratio under 80 percent should be given a risk weighting of zero.

In the final rule, pre-tax earnings are divided by risk-weighted assets rather than by gross assets to avoid penalizing certain types of institutions, including those that hold low-risk and low-yielding assets. The FDIC’s analysis shows that institutions specializing in mortgage lending are not charged a higher average assessment rate than other institutions under the final rule. Moreover, Call Reports and TFRs currently do not collect separate data on the loan-to-value ratio for 1-4 family, owner occupied residential mortgage loans; thus, it is not feasible to treat loans with a low loan-to-value ratio differently.

This trade group also requested that the FDIC study how mutual institutions are affected by including earnings in the financial ratios. The FDIC found that, while mutual institutions typically have a lower ratio of pre-tax earnings to risk-weighted assets, they typically have a higher Tier 1 leverage ratio and lower non-performing loan and charge-off ratios than other small institutions in Risk Category I. As a result, mutual institutions are not charged a higher average assessment rate than other institutions under the final rule.

Another trade group advocated averaging financial ratios over a period not less than four quarters, arguing that taking “a one-quarter snap shot” can be a misleading indicator of risk, since many financial institutions can experience seasonal variations. By averaging, these seasonalities would be removed.

The final rule uses a four-quarter sum for two of the five financial ratios—the pre-tax earnings and net charge-offs ratios—to reduce volatility related to seasonality. The final rule uses the values of the three other financial ratios as of each quarter-end for several reasons. First, the seasonality of these financial ratios is more modest. Second, with a quarterly computation of assessment rates, the average assessment rate an institution would be charged throughout the year would roughly equate to the assessment rate calculated with average ratios. Third, averaging financial ratios over time has the disadvantage of blunting the effect of changes in an institution’s financial condition that are not related to seasonality; thus, averaging ratios would prevent assessments from fully adjusting to changes in risk.

One trade group supported the FDIC’s use of a Tier 1 leverage ratio and suggested that it should be weighted heaviest among the financial ratios considered. However, several comments (including comments from other trade groups) stated that capital should be measured by a risk-adjusted capital ratio rather than the Tier 1 leverage ratio because a risk-adjusted capital ratio is a better measure of capital adequacy.

Several comments stated that the FDIC should not use a Tier 1 leverage ratio to determine assessment rates for large institutions, in particular. One of these comments argued that this ratio is not an accurate measure of risk, effectively penalizes institutions that invest in high quality short-term assets, such as U.S. government securities, and places U.S. banks at a competitive disadvantage with foreign banks. Another comment suggested that larger institutions might tend to be penalized by inclusion of a leverage ratio.

The final rule uses the Tier 1 leverage ratio. The Tier 1 leverage ratio is highly significant in predicting CAMELS downgrades and failures. Using a risk-based capital measure in place of the Tier 1 leverage ratio does not improve predictive accuracy. For the relatively few large Risk Category I institutions that do not have long-term debt issuer ratings, the FDIC’s ability to adjust assessment rates based on consideration of other risk information, as discussed below, should ensure that these institutions are treated equitably.

Several comments (including comments from several trade groups) stated that the capital measure should include subordinated debt and stated or implied that subordinated debt should reduce assessment rates because it would reduce loss given failure. Several comments (including comments from some trade groups) argued that the statutes governing the risk-based pricing system require that the FDIC take loss given failure into account when determining assessments and that the proposed system does not do so. Because it does not do so, they argue, the assessment system is actuarially unfair. These issues are discussed in a subsequent section (Section IX).

One commenter explicitly argued that, for large institutions in Risk Category I, only CAMELS components should be used to differentiate risk. However, the comment also implied that only CAMELS components should be used for all Risk Category I institutions, including small institutions. The method adopted in the final rule, which combines financial ratios and supervisory ratings, predicts downgrades better than one without financial ratios. For this reason, the final rule does not adopt the method suggested in the comment.

E. Long-term debt issuer ratings
For large institutions with long-term debt issuer ratings, the final rule uses these ratings, in addition to supervisory ratings, to differentiate risk. The final rule uses the current long-term debt issuer rating or ratings assigned by the major U.S. rating agencies. ¹⁹ Debt issuer ratings of holding companies and other third party debt ratings will not be used in the calculation of an assessment rate, but may be considered along with other information in determining whether adjustments to the resulting assessment rate are appropriate. Possible adjustments to assessment rates are discussed in a subsequent section.

Comments
A number of comments (including comments from some trade groups) supported the use of debt issuer ratings as an objective measure of risk in large institutions and as complementary to supervisory ratings. One trade group urged the FDIC to use ratings issued by any nationally recognized credit rating agency; a rating agency requested that its ratings be used. The rating agency also urged the FDIC to consider agency ratings for both small and large institutions when available.

While there is merit in considering ratings provided by other rating agencies, long-term debt issuer ratings issued by the three major U.S. rating agencies are widely accepted and used by market participants to gauge the relative risk of large financial institutions for many purposes, including the determination of required rates of return on institution-issued debt. They provide market-based views of risk that are complementary to supervisory views. ²⁰ The final rule does not incorporate debt issuer rating information into the pricing methodology used for smaller institutions; however, as described in a subsequent section, institutions with assets between $5 billion and $10 billion may request to be treated as a large institution for pricing purposes.

Other comments (including comments from other trade groups) either urged caution in the use of agency ratings on the grounds of bias in favor of large institutions or argued they should not be used. The FDIC’s ability to adjust assessment rates for large institutions, discussed below, should alleviate these concerns.

Several comments urged the FDIC to use holding company debt issuer ratings to determine assessment rates. These comments noted that debt is often issued at the parent level, that holding companies are required to serve as a source of strength to their subsidiary institutions, and that holding company considerations apply to insured subsidiaries due to the cross guarantee liabilities of affiliated institutions.

The long-term debt issuer rating of an insured entity relates directly to the risk in that particular entity. As noted in the NPR, the risk profiles of affiliated institutions within a holding company can differ. Additionally, the value of a cross-guarantee in the future is uncertain because the financial condition of affiliated institutions may, in certain circumstances, weigh against the FDIC’s invoking such cross-guarantee provisions.

Nevertheless, it is prudent to consider all available risk information in setting assessment rates. As discussed below, the FDIC will consider additional information, including any holding company debt issuer ratings, in determining whether the assessment rate for any large institution is appropriate. ²¹

F. Combining supervisory ratings and financial ratios
For small institutions within Risk Category I and for large institutions within Risk Category I that do not have long-term debt issuer ratings, the final rule combines supervisory ratings and financial ratios to determine assessment rates. The financial ratios and the weighted average CAMELS component rating are used to estimate 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. ²² This period covers both periods of stress and strength in the banking industry. ²³ The final rule converts the probabilities of downgrade to specific base assessment rates. The analysis and conversion produced the following multipliers for each risk measure:

Risk Measures*	Pricing Multipliers**
Tier 1 Leverage Ratio	(0.042)
Loans Past Due 30 – 89 Days/Gross Assets	0.372
Nonperforming Assets/Gross Assets	0.719
Net Loan Charge-Offs/Gross Assets	0.841
Net Income before Taxes/Risk-Weighted Assets	(0.420)
Weighted Average CAMELS Component Rating	0.534


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

To determine an institution’s insurance assessment rate under the base assessment rate schedule, each of these risk measures (that is, each institution’s financial ratios and weighted average CAMELS component rating) will be multiplied by the corresponding pricing multipliers. The sum of these products will be added to (or subtracted from) a uniform amount, 1.954. ²⁴ The uniform amount is derived from a statistical analysis. ²⁵ However, no rate within Risk Category I will be less than the minimum assessment rate applicable to the category or higher than the maximum assessment rate applicable to the category. The final rule sets the minimum base assessment rate for Risk Category I at two basis points and the maximum base assessment rate for Risk Category I two basis points higher.

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, as of June 30, 2006: (1) 45 percent of smaller institutions that would have been in Risk Category I (other than institutions less than 5 years old) would have been charged the minimum assessment rate; and (2) 5 percent of smaller institutions that would have been in Risk Category I (other than institutions less than 5 years old) would have been charged the maximum assessment rate. ²⁶ These cutoff values will be used in future periods, which could lead to different percentages of institutions being charged the minimum and maximum rates.

Table 2 gives assessment rates for three institutions with varying characteristics, assuming the pricing multipliers given above, using the base assessment rates for institutions in Risk Category I (which range between a minimum of 2 basis points to a maximum of 4 basis points). ²⁷

Table 2 Base Assessment Rates for Three Institutions
A	B	C	D	E	F	G	F
	Pricing Multiplier	Institution 1		Institution 2		Institution 3
		Risk Measure Value	Contribution to Assessment Rates	Risk Measure Value	Contribution to Assessment Rates	Risk Measure Value	Contribution to Assessment Rates
Uniform Amount	1.954		1.95		1.95		1.95
Tier Leverage Ratio (%)	(0.042)	9.590	(0.40)	8.570	(0.36)	7.500	(0.32)
Loans Past Due 30-89 Days/Gross Assets (%)	0.372	0.400	0.15	0.600	0.22	1.000	0.37
Nonperforming Assets /Gross Assets (%)	0.719	0.200	0.14	0.400	0.29	1.500	1.08
Net Loan Charge-offs /Gross Assets (%)	0.841	0.147	0.12	0.079	0.07	0.300	0.25
Net Income Before Taxes/Risk-Weighted Assets (%)	(0.420)	2.500	(1.05)	1.951	(0.82)	0.518	(0.22)
Weighted Average CAMELS Component Ratings	0.534	1.200	0.64	1.450	0.77	2.100	1.12
Sum of Contributions		1.56		2.13		4.25
Assessment Rate		2.00		2.13		4.00


* Figures may not multiply or add to totals due to rounding. ²⁸

The 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 total assessment rate. For Institution 1 in the table, this sum actually equals 1.56, but the table reflects the assumed minimum assessment rate of 2 basis points. For Institution 3 in the table, the sum actually equals 4.25, but the table reflects the assumed maximum assessment rate of 4 basis points.

Under the final rule, the FDIC will 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 may, from time to time, exclude some earlier years from its analysis. For example, some time during 2007 the FDIC may include data in the statistical analysis covering the period 1984 to 2005, rather than 1984 to 2004. 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 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, changes would be made through notice-and-comment rulemaking.

Under the final rule, the financial 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. ²⁹ In a separate rule, the FDIC has determined that, for purposes of assigning an institution to one of the four risk categories, changes to an institution’s supervisory rating will be reflected as of the date that the rating change is transmitted to the institution. ³⁰ This final rule adopts the same rule with respect to CAMELS component rating changes for purposes of determining assessment rates for all institutions in Risk Category I. ^{31 32}

Using the transmittal date of a ratings change for assessment purposes represents a change from the method proposed in the NPR. Under the NPR, transmittal dates would only have been used in the absence of an examination start date (for example, for a large institution with continuous on-site supervision). Otherwise, in almost all instances, the examination start date would have been used.

The final rule adopts a suggestion contained in a banking trade group comment and alters the proposed rule for several reasons discussed in more detail in the final rule on operational changes to the assessment system. ³³

The final rule also differs from the NPR for large institutions without long-term debt issuer ratings. The NPR proposed determining assessment rates for these institutions from insurance scores using a weighted average CAMELS rating and a financial ratio factor, with each weighted 50 percent. While the supervisory ratings and financial ratios in the final rule are nearly the same as those proposed in the NPR, they are combined differently. ³⁴

The approach in the final rule is simpler because it uses one consistent method for all institutions other than those with at least $10 billion in assets that have long-term debt issuer ratings.

Comments
Supervisory ratings
Several comments supported the use of supervisory ratings. One comment asserted that supervisory ratings are the only reliable method to differentiate risk among financial institutions. One trade group supported using supervisory ratings as one of the variables used to determine assessment rates as proposed in the NPR and opposed either allowing supervisory ratings to “be greater than 50 percent of the overall risk score” or automatically giving supervisory ratings a 50 percent weight for small institutions, which was suggested in the NPR as an alternative method of determining assessment rates. Another trade group urged that “supervisory ratings should never be weighted more than half of the total weight of both the supervisory ratings and financial ratios.” Both trade groups urged these limitations because of the perceived subjectivity of supervisory ratings.

The FDIC has decided not to impose a cap on the contribution that supervisory ratings can make to an institution’s assessment rate for two reasons. First, the final rule combining supervisory ratings and financial ratios does not use a weighting scheme or a risk score. The final rule uses pricing multipliers, which can be either positive or negative, based on a statistical model that relates financial ratios and component ratings to CAMELS downgrades. The pricing multipliers—including the multiplier for the weighted average CAMELS component rating—are based on the actual historical experience of how well financial ratios and weighted average CAMELS component ratings predict whether an institution will be downgraded to a CAMELS composite rating of 3 or worse at its next examination. Second, a cap on the contribution that supervisory ratings can make to an institution’s assessment rate would affect only a small percentage of institutions and the effect would be very small. ³⁵

Updating pricing multipliers
One trade group agreed that the FDIC should have the flexibility to update the pricing multipliers and the uniform amount annually, without further notice-and-comment rulemaking and that adding additional or alternative financial measures, ratios or other risk factors to determine risk-based assessments or adopting a new method of differentiating for risk should be done through notice-and-comment rulemaking. The final rule is consistent with this comment. No comments disagreed.

Additional comments
One trade group urged that the FDIC avoid having low-risk multi-family loans lead to higher assessment rates to avoid chilling this type of lending. The final rule does not target this kind of lending.

G. Combining supervisory ratings with long-term debt issuer ratings
For large institutions that have long-term debt issuer ratings, a combination of these ratings and supervisory ratings will determine assessment rates, using equal weighting for each. The base assessment rate will be derived as follows: (1) CAMELS component ratings will be weighted to derive a weighted average CAMELS rating; ³⁶ (2) long-term debt issuer ratings will be converted to numerical values between 1 and 3 using the conversion values in Appendix B; ³⁷ (3) the weighted average CAMELS rating and converted long-term debt issuer rating will be multiplied by a pricing multiplier and the products will be summed; and (4) a uniform amount, which will always be negative, will be added to the result. The resulting base assessment rate will be subject to a minimum and a maximum assessment rate. The pricing multiplier for both the weighted average CAMELS ratings and converted long-term debt issuer rating will be 1.176, and the uniform amount will be -1.882.

The conversion of long-term debt issuer ratings into numerical values in the final rule differs slightly from the conversion proposed in the NPR. Specifically, the final rule assigns the lowest conversion value of ‘1’ to the best possible long-term debt issuer rating rather than to double A ratings or better (Aa2 or better for Moody’s ratings), and the highest conversion value of ‘3’ to triple B or worse ratings (Baa2 or worse for Moody’s ratings), rather than to double B plus or worse ratings (Ba1 or worse for Moody’s ratings). This revised conversion methodology takes better advantage of the possible range of ratings for large Risk Category I institutions, which are concentrated primarily in the triple B rating range and higher.

Pricing multipliers and the uniform amount for large institutions with debt ratings were derived using cutoff values of the combination of weighted average CAMELS ratings and converted long-term debt issuer ratings (weighted 50 percent each) such that, as of June 30, 2006: (1) approximately 44 percent of large institutions with long-term debt issuer ratings that would have been in Risk Category I (other than institutions less than 5 years old) would have been charged the minimum assessment rate; and (2) approximately 6 percent of the large institutions with long-term debt issuer ratings that would have been in Risk Category I (other than institutions less than 5 years old) would have been charged the maximum assessment rate. ³⁸ The derivation of pricing multipliers and the uniform amount is described in Appendix 1.

Under the final rule, the base assessment rate for an institution with CAMELS component ratings of “222111,” a Moody’s long-term debt issuer rating of “A1,” and a Standard and Poor’s long-term debt issuer rating of “A” would be 2.06 basis points. This rate is calculated as follows:

• The weighted average CAMELS rating is computed by multiplying each component rating by its associated weight to produce values of 0.50, 0.40, 0.50, 0.10, 0.10, and 0.10, respectively. The sum of these values, the weighted average CAMELS rating, is 1.70.
• The Moody’s and Standard and Poor’s long-term debt issuer ratings are converted to numerical values and averaged. The average of the two long-term debt issuer ratings, converted to numerical values of 1.50 and 1.80, respectively, is 1.65.
• The weighted average CAMELS rating and converted long-term debt issuer ratings are multiplied by the pricing multiplier and summed (1.700*1.176 + 1.650*1.176) ³⁹ to produce a value of 3.940. A uniform amount of 1.882 is subtracted from this result to produce a base assessment rate of 2.06 basis points. ⁴⁰

The final rule also differs from the NPR in that it does not use financial ratios to determine assessment rates for any large institution that has long-term debt issuer ratings, and does not use varying weights for long-term debt issuer ratings for institutions with between $10 billion and $30 billion in assets. The final rule simplifies the derivation of assessment rates by applying the same weight to weighted average CAMELS component ratings and long-term debt issuer ratings (when they exist) regardless of an institution’s size.

Several trade groups commented that the proposed risk differentiation methodology for large banks was too complex, in part because of the varying weights given risk factors for institutions between $10 billion and $30 billion in assets. These comments noted that an institution’s assessment rate could change simply because of an increase or decrease in assets even when the institution’s risk profile remained unchanged. After considering comments, the FDIC concluded that this simpler approach for all large institutions with debt issuer ratings achieves the objective of differentiating risk in these large institutions without the need to introduce further complexity in the form of varying weights for large institutions in different size categories.

Additional comments
One trade group expressed concern that dissimilar methods for differentiating risk in large and small institutions could lead to possible inequity among institutions due solely to size. This comment expressed the view that agency and supervisory ratings tend to favor larger institutions, possibly because of diversification considerations.

The FDIC notes that the distribution of current supervisory ratings for large and small institutions does not support this view. Agency debt issuer ratings do take diversification into account, and the FDIC believes that it is appropriate to reflect these considerations in assessment rates. The final rule ensures, as required by statute, that no institution is precluded from the lowest assessment rate solely because of size. This statutory requirement underlies, in part, the FDIC’s decision to initially include roughly similar proportions of large and small institutions in Risk Category I that would be charged minimum and maximum assessment rates. As discussed later, the FDIC will have the ability to adjust an institution's assessment rate when this rate is inconsistent with assessment rates of other large institutions with similar risk profiles.

This comment further noted that financial ratios also could be applied to all large institutions. Another trade group argued that the financial ratios should not be phased out in importance as institutions increase in size and should be used for all large institutions. This comment argued that measurements other than the financial ratios that are combined with supervisory ratings might be necessary to assess the off-balance sheet, securitization, trading, and securities processing activities engaged in by large institutions and to serve as a quality control check on long-term debt issuer ratings.

The FDIC believes that consideration of additional risk information (including financial performance and condition measures), discussed below, will be sufficient to ensure that the range of activities engaged in by banking organizations are fully considered and that debt issuer ratings are appropriately considered in assessment rates.

One comment suggested that business diversification should be more explicitly taken into account in determining deposit insurance premiums. This comment also recommended that the FDIC consider lowering or even eliminating premium rates for institutions that adopt the advanced approaches under the Basel II framework or whose actual capital sufficiently exceeds their Basel II required capital, since these institutions will have demonstrated capital levels and risk management practices that virtually eliminate risk to the deposit insurance fund. The FDIC believes that, in most cases, diversification, capital adequacy, and risk management considerations are reflected in supervisory or agency ratings or in financial ratios and the consideration of additional factors (in Appendix C) ensures that they are taken into account in all cases.

One comment argued that the large institution methodology proposed in the NPR was overly subjective because cutoff values to determine the percentage of institutions that would be charged the minimum and maximum rates would be set quarterly by the FDIC. In fact, under the final rule, minimum and maximum assessment rate cutoff values will be established using data as of June 30, 2006. No change will be made to these cutoff values without further notice and opportunity for comment.

H. Additional provisions relating to large institutions’ assessment rates in Risk Category I
1. Adjustments to a large institution’s assessment rate
To ensure consistency, fairness, and consideration of all available information, the FDIC will determine, in consultation with the primary federal regulator, whether or not to adjust the assessment rates for large institutions derived from either a combination of long-term debt issuer ratings and supervisory ratings or financial ratios and supervisory ratings (when no long-term debt issuer rating is available). The FDIC will make these determinations by evaluating additional risk information including current financial performance and condition information and trends, current market information, information pertaining to an institution’s ability to withstand financial adversity, and information pertaining to severity of losses in the event of failure.

Any adjustments to assessment rates will be limited to 0.50 basis points (higher or lower). Upward adjustments will not take effect without notification to and consideration of responses from both the primary federal regulator and the institution. Downward adjustments will not take effect without notification to and consideration of responses from the primary federal regulator. No rate will be adjusted below the minimum rate for Risk Category I institutions in effect for an assessment period or above the maximum rate for Risk Category I institutions in effect for the period. Rate adjustments in Risk Category I are not meant to (and will not) override supervisory evaluations. ⁴¹

Examples of additional risk factors that will be considered are enumerated in Appendix C. Evaluating this additional risk information on an ongoing basis will help the FDIC ensure that relative levels of risk posed by large Risk Category I institutions are consistently represented by resulting assessment rates. Additional information will be evaluated in the following way:



• Current financial performance indicators such as capital levels, profitability measures, and asset quality measures of each large institution will be compared to those of institutions that are ranked similarly in terms of their assessment rates.
• Current market indicators such as subordinated debt spreads and holding company market indicators of each institution will be compared to market indicators of institutions that are ranked similarly in terms of their assessment rates.
• Recent information pertaining to an institution’s ability to withstand financial stress will be evaluated by comparing this information to that of institutions ranked similarly in terms of their assessment rates. This information includes the internal risk characteristics of an institution’s credit portfolios and other business lines as well as information from internal stress-test models.
• Current loss severity indicators of institutions will be evaluated by comparing this information to that of institutions ranked similarly in terms of their assessment rates. This information includes funding structure considerations such as the extent of priority and subordinated claims, as well as the availability of sufficient information (e.g., information pertaining to the level of insured deposits and qualified financial contracts) to resolve an institution in an orderly and cost-efficient manner.
• Evaluations of financial performance, market information, information pertaining to an institution’s ability to withstand financial stress, and loss severity indicators will focus on: first, identifying those institutions that exhibit significantly different risk profiles, as indicated by risk indicators such as those enumerated above, than institutions with similar assessment rates; and second, where inconsistencies between assessment rates and these risk indicators are identified, determining the assessment rate adjustment that would be necessary to bring an institution’s assessment rate into better alignment with those of other institutions that pose similar levels or risk.

Some comments (including comments from trade groups) indicated that the FDIC should consider certain information pertaining to losses that might be sustained by the insurance fund in the event of failure. For example, some comments indicated the FDIC should explicitly incorporate information about the relative level of subordinated claims into the determination of assessment rates for large institutions. The FDIC believes the final rule does consider loss given failure by explicitly incorporating consideration of this information into decisions of whether or not to adjust an institution’s assessment rate.

In addition to ongoing consultations with the primary federal regulator on whether or not to make assessment rate adjustments, the FDIC will formally notify an institution’s primary federal regulator when it decides to recommend an adjustment in assessment rates and will consider the primary federal regulator’s response to this notification. The FDIC will also notify an institution in advance when the FDIC intends to increase its assessment rate because of the FDIC’s consideration of additional risk information. This notice will include the reasons for the adjustment and when the adjustment will take effect, and provide the institution an opportunity to respond. An institution will, of course, have the right to request a review of any assessment rate that is adjusted in this manner.

After considering an institution’s response to the notice, the FDIC will determine whether an adjustment to an institution’s assessment rate is warranted, taking into account any revisions to weighted average CAMELS component ratings, long-term debt issuer ratings, and financial ratios, as well as any actions taken by the institution to respond to the FDIC’s concerns described in the notice. The FDIC will evaluate the need for the adjustment each subsequent assessment period, until it determines that an adjustment is no longer warranted. The amount of adjustment will in no event be larger than that contained in the initial notice without further notice to, and consideration of responses from, both the primary federal regulator and the institution.

Any downward adjustment in assessment rates will remain in effect for subsequent assessment periods until the FDIC determines that an adjustment is no longer warranted. However, the FDIC will provide advance notice to an institution and its primary federal regulator and give them an opportunity to respond before removing a downward adjustment. Of course, the FDIC may raise an institution’s assessment rate without notice if the institution’s supervisory or agency ratings or financial ratios (for an institution without long-term debt issuer ratings) deteriorate.

The FDIC acknowledges the need to clarify its processes for making any adjustments to ensure fair treatment and accountability and plans to propose and seek comment on additional guidelines for evaluating whether assessment rate adjustments are warranted and the size of the adjustments. The FDIC will not adjust assessment rates until the guidelines are approved by the FDIC’s Board.

2. Timing of evaluations
Under the final rule, a large institution’s risk category will change as of the date the institution is notified of its rating change by its primary federal regulator (or state authority). If the supervisory rating change results in a large institution moving from Risk Category I to Risk Category II, III, or IV, the institution’s assessment rate for the portion of the quarter it was in Risk Category I will be based on its assessment rate for the prior quarter. The assessment rate for that portion of the quarter it was in Risk Category II, III, or IV will be based on the assessment rate for these risk categories.

When a large institution is moved from Risk Category II, III, or IV to Risk Category I during a quarter because of a supervisory rating change, the FDIC will determine the associated assessment rate (subject to adjustment as described above) for that portion of the quarter that the institution was in Risk Category I. The assessment rate for that portion of the quarter it was in Risk Category II, III, or IV will be based on the assessment rate for these risk categories.

When an institution remains in Risk Category I during a quarter, but a CAMELS component or long-term debt issuer rating change during the quarter would affect its assessment rate, the FDIC will determine an assessment rate for each portion of the quarter before and after the change. A long-term debt issuer rating change will be effective as of the date the change is announced by the rating agency. Changes in supervisory ratings will be effective as of the date the institution is notified by its primary federal regulator (or state authority).

The timing of changes in assessment rates due to changes in supervisory or long-term debt issuer ratings described above differs only slightly from the proposal in that it uses, in all cases, the date of transmittal of a supervisory rating change by the primary federal regulator to the institution. The reasons for this change are discussed in a separate rule. ⁴²

One trade group expressed concern about the possibility of retroactive changes in assessment rates and the prospects for accounting restatements. This comment pointed out that CAMELS rating changes often occur one and even two quarters after the start date of an examination. The use of the transmittal date of examination findings rather than start date of an examination to effect changes in assessment rates should alleviate this concern about retroactive accounting adjustments.

Another comment expressed a similar concern that institutions would not be able to plan for the financial impact of assessment rate changes if they were applied retroactively, either because of a change in supervisory or long-term debt issuer ratings, or because of a decision by the FDIC to adjust an institution’s assessment rate. The FDIC believes that the final rule sufficiently addresses this concern since: 1) the transmittal of revised CAMELS ratings or the announcement of revised long-term debt issuer ratings will provide sufficient notice to the institution that a change in assessment rates will occur; and 2) assessment rate changes caused by a decision by the FDIC to adjust an institution’s assessment rate will not become effective before the institution is duly notified and has had an opportunity to respond to the proposed change.

Additional comments
Adjustments to an institution’s assessment rates
A number of comments (including several comments from trade groups) questioned the need for the FDIC to incorporate additional information into its pricing decisions for large institutions. Some of the main objections were that:

• Adjustments would override the evaluations of the primary federal regulator;
• TheFDIC should not be allowed to unilaterally override CAMELS ratings assigned by the primary federal regulator since they are viewed to have better information than the FDIC about the risks posed by these institutions;
• The need for more timely information is not necessary since many large institutions are supervised on a continuous basis;
• Supervisory ratings incorporate all relevant risk information and therefore consideration of additional information is not necessary;
• The application of the FDIC’s discretion over pricing decisions has not been sufficiently described; and
• Many of the additional risk indicators identified in Appendix C of the proposal are vaguely defined and not necessarily aligned with risk.

Several comments specifically criticized the proposal’s use of additional stress consideration factors. For example, some comments stated that these factors were not well developed and expressed concern about the possibly conflicting role such information would play in evaluations by the primary federal regulators and the FDIC.

One trade group supported the FDIC’s consideration of additional risk information to ensure that assessment rates were consistently assigned, that risk information was incorporated into the assessment rate in a timely manner, and that assessment rates reflected consideration of all relevant risk information.

For the reasons described earlier, the FDIC has decided to retain its ability to adjust assessment rates based upon consideration of additional risk factors.

A number of comments supported providing institutions with prior notification relating to any possible increase in assessment rates. However, many of these comments were made in the context of the proposed risk “bucket” or subcategory pricing approach. Given the adoption of an incremental pricing approach for institutions in the incremental pricing range, the FDIC believes advance notice is only needed in two cases based on consideration of additional risk information: (1) where the FDIC intends to make an upward adjustment to a large institution’s assessment rate above that derived from supervisory and long-term debt issuer ratings (or from supervisory ratings and financial ratios); and (2) where it intends to remove a previously made downward adjustment to an institution’s assessment rate.

V. Definitions of Large and Small Institutions and Exceptions
Under a companion final rule making operational changes to the FDIC’s assessment regulations, a Risk Category I institution will be defined as large if it has $10 billion or more in assets and small if it has assets of less than $10 billion. This determination will initially be made as of December 31, 2006. Thereafter, a small Risk Category I institution will be reclassified as a large institution when it reports assets of $10 billion or more for four consecutive quarters. Similarly, a large Risk Category I institution will be reclassified as a small institution when it reports assets under $10 billion for four consecutive quarters. Any reclassification will remain effective for subsequent quarters, unless an institution reports assets that would change its size category (from large to small or vice versa) for four consecutive quarters.

The definition of large and small institutions for Risk Category I institutions in the final rule is the same as that contained in the proposal. One trade group commented that the $10 billion cutoff point for categorizing institutions as either large or small was appropriate given the tendency of larger institutions to have more available risk information. This same comment indicated that large institutions should be evaluated using more information than current financial ratios and CAMELS component ratings given the types of complex activities engaged in by the largest institutions, such as securitization, derivatives, and trading.

As described in the NPR, the final rule makes an exception to the $10 billion size threshold for Risk Category I institutions with between $5 billion and $10 billion in assets that request treatment as a large institution. The FDIC will grant such requests if it determines that it has sufficient information to evaluate the institution’s risk profile adequately under the risk differentiation methods used for large institutions. The absence of long-term debt issuer ratings alone will not preclude the FDIC from granting a request. The assessment rate for an institution without a long-term debt issuer rating would still be derived from supervisory ratings and financial ratios, but would be subject to adjustment. Once a request has been granted, an institution could again request treatment under a different approach after three years, subject to FDIC approval. ⁴³

As discussed in the NPR, small institutions that are affiliated with large institutions will be evaluated separately under the final rule. Specifically, assessment rates for small institutions will be determined using supervisory ratings and financial ratios, whether or not these institutions are affiliated with large institutions.

An institution that disagrees with the FDIC’s determination that it is small or large may request review of the determination pursuant to 12 CFR 327.4(c)

Comments
One comment supported the proposal to allow institutions with between $5 billion and $10 billion in assets to request treatment as a large institution. This comment noted that the proposal will allow flexibility for small institutions that are transitioning to large institutions and want to be evaluated using long-term debt issuer ratings.

Some comments supported: (1) assigning the same assessment rate to all affiliated institutions, possibly by strengthening cross guarantees; (2) assigning the assessment rate of the largest institution in a holding company to all institutions in the holding company; or (3) applying the same method of calculating assessment rates to all institutions in a holding company regardless of size to avoid different assessment rate approaches for institutions within the same holding company. The FDIC acknowledges that often each institution in a holding company derives managerial, operational, and financial support from the parent holding company. However, financial condition and operating performance can and does vary among banks within a holding company. Consequently, the FDIC believes it is necessary to evaluate risk at each insured institution individually. Any modifications to current cross guarantee provisions are outside the scope of this proposal.

VI. Risk Differentiation among Insured Foreign Branches
The final rule for insured foreign branches (insured branches) is substantially similar to the proposed rule. The main difference is the use of incremental pricing for insured branches whose assigned assessment rates fall between the minimum and maximum assessment rates.

Insured branches that are assigned to Risk Category II, III or IV, based on their asset pledge and asset maintenance ratios and supervisory ratings, will be treated in the same manner as other insured institutions in these risk categories. For insured branches that are assigned to Risk Category I, assessment rates will be determined from the supervisory ROCA component ratings assigned to the insured branch. ⁴⁴ Each of these component ratings will be weighted to produce a weighted average ROCA rating. The weights applied to individual ROCA component ratings will be the same as those contained in the NPR: 35 percent, 25 percent, 25 percent, and 15 percent, respectively. An assessment rate for insured branches will be determined by multiplying the average ROCA rating by a pricing multiplier of 2.353 and adding a uniform amount of -1.882 from this product. ⁴⁵ The derivation of the pricing multipliers and uniform amount for insured branches is described in Appendix 2.

As with the large institution risk differentiation approach, the FDIC may adjust these assessment rates up or down by 0.50 basis points after consideration of the additional risk factors described in Appendix C. The same process for making adjustments described to large institution rates, including advance notification and consultation with the primary federal regulator, will apply to insured foreign branches.

The FDIC received no comments on the proposed treatment of insured foreign branches.

VII. New Institutions in Risk Category I
Under the final rule, beginning in 2010, new institutions in Risk Category I generally will be assessed at the same rate, which will be the highest rate charged any other institution in this Risk Category. For this purpose, the final rule on operational changes defines a new institution as one that is not an established institution. ⁴⁶ With three exceptions, beginning in 2010, an established institution, as defined in the final rule on operational changes, will be one that has been chartered as a bank or thrift for at least five years as of the last day of any quarter for which it is being assessed. Before 2010, all Risk Category I institutions will be assessed using either the supervisory ratings and financial ratios method or the supervisory and debt ratings method.

Where an established institution merges or consolidates with a new institution, the surviving or resulting institution will be new unless:


1. The assets of the established institution, as reported in its report of condition for the quarter ending immediately before the merger, exceeded the assets of the new institution, as reported in its report of condition for the quarter ending immediately before the merger; and
2. Substantially all of the management of the established institution continued as management of the resulting or surviving institution. ^{47 48}

However, where a new institution merges into an established institution and the merger agreement was entered into on or before July 11, 2006, the final rule contains a grandfather clause under which the surviving institution will be deemed to be an established institution.

This exception to the definition of a new institution represents a change from the proposed rule. The NPR proposed that, when an established institution merged into or consolidated with a new institution, the surviving or resulting institution would be new, but would be allowed to request that the FDIC determine that it was established. The NPR also proposed that, when a new institution merged into an established institution or when an established institution acquired a substantial portion of a new institution’s assets or liabilities, and the merger or acquisition agreement was entered into after July 11, 2006 (the date that the FDIC’s Board approved the NPR), the FDIC would conduct a review to determine whether the surviving or acquiring institution remained an established institution. The NPR proposed that the FDIC would make determinations based upon factors that included factors similar to the two listed above.

The final rule differs from the NPR in this regard. By specifying the particular circumstances that will allow an institution to be considered established, the final rule will give institutions greater certainty regarding the effects of mergers and consolidations and should reduce the necessity of filing requests for review. The final rule should not result in denying an exception to any institution that would have been considered established under the proposed rule, while still achieving the purpose of the proposed rule.

The second exception was raised in comment letters in response to the FDIC’s specific request for comment on its proposed definition of a new institution. ⁴⁹ This exception will apply to a new institution that is a subsidiary of a holding company with an established institution or that is a subsidiary of an established institution, provided certain criteria are met. Under these circumstances, the institution will be considered established for assessment purposes. ⁵⁰ Specifically, an institution that would otherwise be new will be considered established if it is a wholly owned subsidiary of:



1. A company that is a “bank holding company” under the Bank Holding Company Act of 1956 or a “savings and loan holding company” under the Home Owners’ Loan Act, and:
   1. At least one “eligible” depository institution (as defined in 12 CFR 303.2(r)) that is owned by the holding company has been chartered as a bank or thrift for at least five years as of the date that the otherwise new institution was established; and
   2. The holding company has a composite rating of at least "2" for bank holding companies or an above average or "A" rating for thrift holding companies and at least 75 percent of its depository institution assets are assets of “eligible” depository institutions, as defined in 12 CFR 303.2(r); ^{51 52} or
2. An “eligible” insured depository institution, as defined in 12 CFR 303.2(r), that has been chartered as a bank or thrift for at least five years as of the date that the otherwise new institution was established.

Several comments (including comments from trade groups) argued that, at a minimum, new institutions in a bank holding company should be charged at the same rate as other institutions in the holding company. Arguments for this position included:


• Assessing new institutions at a higher rate will affect a holding company’s decision to charter a new institution or to branch; in the context of mergers and acquisitions, the deal structure could be influenced to retain the seasoned banks post-consolidation solely for the purpose of avoiding high assessments, even though a different structure would otherwise be more appropriate.
• The articles referenced by the FDIC in support of assessing all “new” institutions at a higher rate did not take into account holding company support or enhancements in supervision.
• Holding companies often have considerable banking experience, so that the institution is not really new. Institutions in a holding company typically share management.
The FDIC is persuaded that a new institution within an established holding company structure does not necessarily pose a higher risk than established institutions, in part because of the banking experience within the holding company, and has created an exception from the new bank definition for these institutions. However, the assessment rate for a new institution subsidiary of an insured depository institution or holding company that qualifies for the exception will not necessarily be the same rate charged an affiliate. As with any established institution in Risk Category I, its assessment rate will be determined based upon the risk it poses.

The third exception was also raised in comment letters in response to the FDIC’s specific request for comment on its proposed definition of a new bank. ⁵³ For a credit union that converts to a bank or thrift charter, some comments (including comments from trade groups) urged the FDIC to take into account the period that a credit union has had federal deposit insurance in determining whether it is new or established. As one trade group pointed out:

These institutions have a seasoned loan portfolio, experienced leaders, and an established business history. They have been carefully screened by their new banking regulator.

The final rule takes into account the period that a credit union has been federally insured as a credit union in determining whether it is new or established. ⁵⁴

The final rule also differs from the NPR in its definition of a new institution. Under the NPR, a new institution would have been defined as an institution that had not been chartered as a bank or thrift for at least seven years as of the last day of any quarter for which it was being assessed (subject to the exceptions above).

Several comments (including comments from trade groups) suggested that charging the maximum Risk Category I assessment rate to new institutions for 7 years was too long and favored a shorter period, such as 3 or 5 years (assuming new institutions were assessed separately). One trade group argued that, after three years, an institution’s loan portfolio and its operations should be seasoned enough so that the FDIC can assess the risks of the institution based on financial ratios and CAMELS ratings as it does for other institutions. Other arguments for shortening the period that an institution is considered new included:

• Higher failure rates for new institutions occurred in earlier periods, but not in recent periods, partly because supervision has been enhanced.
• The banking industry uses three years as an estimate of banking maturity; banking supervisors use the same period when reviewing new bank applications.

The FDIC’s decision to assess new institutions separately from established institutions is based on the difficulty of assessing new institutions’ risk with the same risk measures used to assess the risk of established institutions. New institutions undergo rapid changes in the scale and scope of operations for a period of time after being chartered and these changes can make new institutions’ financial condition and performance measures volatile. Moreover, new institutions’ loan portfolios are unseasoned, and their management is often untested, making it difficult to assess loan quality through standard financial performance measures.

These differences between new and established institutions’ financial characteristics could lead to mis-measurement of risk when new institutions are evaluated by the same financial risk measurement model used to evaluate established institutions’ risk. More specifically, the FDIC finds that new institution risk is, in general, underestimated by the manner in which supervisory ratings are combined with financial ratios; however, the degree of underestimation of risk declines with bank age.

Under the final rule, all new institutions in Risk Category I will be assessed at the same rate and this rate will be the highest rate charged any other institution in Risk Category I. The FDIC finds that the failure rates of institutions that have been in existence for less than 5 years are greater than those of established institutions that would have historically paid the highest assessment rate in Risk Category I (the riskiest Risk Category I established institutions). Historical failure rates among institutions that have been in existence between 5 and 7 years, however, are somewhat lower than those of the riskiest Risk Category I established institutions. For this reason, for purposes of setting assessment rates, the final rule defines new institutions as those institutions that have been in existence less than 5 years.

Some comments expressed concern that a combination of factors could result in inequitable treatment for new institutions. These factors included the need to initially charge more than the base rates, the lack of credits for most new institutions, and charging the maximum rate to these institutions. The FDIC recognizes that during the transition from the existing system to the new system, this combination of factors could significantly increase assessment rates for new institutions. Consequently, the final rule delays the effective date of the provisions subjecting new Risk Category I institutions to the maximum Risk Category I rate until January 1, 2010.

Before 2010, a Risk Category I institution that has no CAMELS component ratings shall be assessed at one basis point above the minimum rate applicable to Risk Category I institutions until it receives CAMELS component ratings. If an institution has less than $10 billion in assets or has at least $10 billion in assets and no long-term debt issuer rating, once it receives CAMELS component ratings, its assessment rate will be determined under the supervisory ratings and financial ratios method. The assessment rate will be determined by annualizing, where appropriate, financial ratios obtained from the reports of condition that have been filed, until the earlier of the following two events occurs: (1) the institution files four reports of condition; or (2) if it has at least $10 billion in assets, it receives a long-term debt issuer rating.

Additional comments
No rule for new institutions
Several comments (including comments from trade groups) argued that the FDIC should assess new institutions as other institutions are assessed. Arguments for assessing new institutions as other institutions are assessed included:



• New institutions are scrutinized by examiners more intently and more frequently.
• There is an inherent bias against new institutions in CAMELS ratings.
• Capital is usually higher in new institutions.
• Many new institutions are started by experienced bankers or are spin-offs of established institutions.
• A separate rule for new institutions will undermine public confidence in these institutions.
• A single rate for new institutions does not adequately differentiate risk.
• A new institution has no incentive to reduce its risk because it will not reduce its assessment rate.

The final rule changes the new institution period from seven to five years, but assesses new institutions separately for the reasons described. However, the final rule does delay the effective date of the provisions governing new institutions for three years.

An institution that disagrees with the FDIC’s determination that it is new or established may request review of the determination pursuant to 12 CFR 327.4(c).

Mergers
One trade group opposed treating established institutions that merge into or consolidate with new institutions as new on the grounds that such treatment is unreasonable and prejudicial to shareholders. Other comments also took issue, at least implicitly, with the proposed rule regarding mergers and consolidations. A comment from a trade group, however, stated that the FDIC should judge an individual institution based on the specific risk profile that it presents to the deposit insurance fund:

Generally, a new institution that merges with, acquires or is acquired by an existing depository institution will immediately exhibit certain risk characteristics, such as market penetration, strength of management, amount of capital and experience of the officers and employees of the resulting institution, that will allow the primary federal supervisor of the resulting institution to make a determination whether it most appropriately should be characterized in accordance with the risk profile of the new institution or the established one.

The FDIC has simplified the final rule in response to comments. The final rule allows the FDIC to review the surviving or resulting institution in a merger or consolidation involving both a new and an established institution to determine whether the surviving or resulting institution is new or established based on the criteria previously discussed without, in general, requiring that the institution file a request for review.

VIII. Assessment Rates
A. Rate schedules
Beginning on January 1, 2007, assessment rates will be as shown in the following table:

	Risk Category
	I*		II	III	IV
	Minimum	Maximum
Annual Rates (in basis points)	5	7	10	28	43


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

All institutions in any one risk category, other than Risk Category I, will be charged the same assessment rate. For all institutions in Risk Category I, annual assessment rates will range between 5 and 7 basis points.

The final rule also adopts the base schedule of rates proposed in the NPR: ⁵⁵

	Risk Category
	I*		II	III	IV
	Minimum	Maximum
Annual Rates (in basis points)	2	4	7	25	40


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

The assessment rates that take effect January 1, 2007, will be uniformly 3 basis points higher than the base rate schedule. Under the present assessment system, the Board has adopted a base assessment schedule where it can uniformly adjust rates up to a maximum of five basis points higher or lower than the base rate schedule without the necessity of further notice-and-comment rulemaking, provided that any single adjustment cannot move rates more than five basis points. ⁵⁶ In the NPR, the Board indicated its intention to retain the ability to adjust rates up to five basis points without seeking further public comment. Upon considering the comments received on this issue (discussed below), the Board has decided to retain this feature, but limit its ability to adjust rates without seeking further public comment to three basis points. Hence, the final rule allows the Board to adjust rates uniformly up to a maximum of three basis points higher or lower than the base rates without the necessity of further notice-and-comment rulemaking, provided that any single adjustment from one quarter to the next cannot move rates more than three basis points. ⁵⁷ In the event that the Board uniformly adjusts rates, rates calculated for institutions in Risk Category I in reference to the base assessment rates will be uniformly adjusted by the same amount. Once set by the Board, assessment rates will remain in effect until changed.

Table 3 shows projected reserve ratios assuming different average annual growth rates for insured deposits if the actual rate schedule (as opposed to base rate schedule) adopted in this rule remains in effect through the year in which the reserve ratio first reaches or exceeds the designated reserve ratio (DRR) of 1.25 percent. ⁵⁸

Table 3 Projected Reserve Ratios Assuming Different Growth Rates in Insured Deposits Under the Rate Schedule Adopted in this Rule
Period	Insured Deposit Growth Rate
	3%	4%	5%	6%	7%	8%
2007	1.22%	1.21%	1.20%	1.19%	1.17%	1.16%
2008	1.27%	1.24%	1.22%	1.20%	1.18%	1.16%
2009		1.31%	1.28%	1.25%	1.22%	1.19%
2010					1.26%	1.22%
2011						1.25%


(1) The year-end 2006 reserve ratio is estimated to be 1.21 percent.
(2) Projections of the components of fund balance growth that result in the reserve ratios shown in this table are provided below.

In summary, the Board bases its decision to adopt this rate schedule on the following:

• The Reform Act gives the Board flexibility to achieve the DRR within a time frame that it believes appropriate, rather than treat the DRR as a “hard” annual target. In the Board’s view, reaching the DRR within the third year of the new assessment system would be a reasonable goal, which this rate schedule would facilitate, given the FDIC’s assumptions regarding insured deposit growth.
• An objective of the Reform Act is to allow the fund to increase under favorable conditions so that it can decline under adverse conditions without sharp increases in assessments. The outlook for economic conditions affecting banks remains generally favorable, industry conditions remain strong, and projected reserve ratios under the rate schedule assume very low insurance losses.
• During the next few years, the rate schedule is likely to prevent the reserve ratio from declining below the 1.15 percent statutory lower bound for the DRR and unlikely to raise the reserve ratio above the 1.35 percent threshold that could trigger the payment of dividends.
• It is reasonable to plan for future annual insured deposit growth in the 4-to-6 percent range, down from higher rates observed last year and estimated for this year. Reaching the DRR within three years under this rate schedule assumes that insured deposit growth will be in this range.
• Assessment credits authorized under the Reform Act will limit assessment revenue in the near term.
• Implementation of the rate schedule is unlikely to have a materially adverse effect on the earnings and capital of insured institutions.

B. Factors supporting the rate schedule
As required by statute, the FDIC’s Board of Directors considered the following factors in setting rates:

1. The estimated operating expenses of the Deposit Insurance Fund.
2. The estimated case resolution expenses and income of the Deposit Insurance Fund.
3. The projected effects of the payment of assessments on the capital and earnings of insured depository institutions.
4. The risk factors and other factors taken into account pursuant to 12 U.S.C Section 1817(b)(1) under the risk-based assessment system, including the requirement under 12 U.S.C Section 1817(b)(1)(A) to maintain a risk-based system.
5. Other factors that the Board of Directors determined to be appropriate. ⁵⁹

These factors, including those determined by the Board to be appropriate, are discussed in more detail below.

1. Projected changes to the fund balance from case resolution expenses, operating expenses, investment contributions, and risk-based assessments

Table 4 shows projected changes to the fund balance over the next two years under the rate schedule adopted in this rule. Future changes to the fund balance depend, in turn, on projections and assumptions for insurance losses (case resolution expenses), operating expenses, assessment revenue, and investment contributions. These components of fund balance changes are discussed below.