Federal Deposit
Insurance Corporation

I. Management's Discussion and Analysis - The Year in Review

Supervision and Consumer Protection
Supervision and consumer protection are cornerstones of the FDIC's efforts to ensure the stability of and public confidence in the nation's financial system. The FDIC's supervision program promotes the safety and soundness of FDIC-supervised insured depository institutions, protects consumers' rights, and promotes community investment initiatives by FDIC-supervised insured depository institutions.

At year-end 2005, the Corporation was the primary federal regulator for 5,265 FDIC-insured, state-chartered institutions that are not members of the Federal Reserve System (generally referred to as "state non-member" institutions). Through safety and soundness, consumer compliance and Community Reinvestment Act (CRA) examinations of these FDIC-supervised institutions, the FDIC assesses their operating condition, management practices and policies, and their compliance with applicable laws and regulations. The FDIC also educates bankers and consumers on matters of interest and addresses consumers' questions and concerns.

DRR Director Mitchell Glassman, second from left, chairs a meeting of the Hurricane Task Force at Washington Headquarters.

Members of the Dallas Region Hurricane Katrina Task Force (l-r): Randy Taylor, Nann Wright, Stan Ivie, Cheryl Couch and Cynthia Scott.

Hurricane Recovery Assistance
The federal banking regulatory agencies (agencies) worked cooperatively with state banking regulatory agencies and other organizations to determine the operating status of financial institutions located in the areas affected by Hurricanes Katrina and Rita. The agencies quickly released regulatory relief guidance to help rebuild areas affected by these hurricanes and encouraged bankers to work with consumers and business owners experiencing difficulties due to the storms. Exercising their authority under Section 2 of the Depository Institutions Disaster Relief Act of 1992 (DIDRA), the agencies made exceptions to statutory and regulatory requirements relating to appraisals for transactions involving real property in major disaster areas when the exceptions would facilitate recovery from the disaster and would be consistent with principles of safety and soundness.

In the wake of the 2005 hurricane season, the agencies confirmed that the banking industry is resilient in the face of tremendous devastation. There were 280 financial institutions, with approximately $270 billion in total assets, operating in the area impacted by Hurricane Katrina. Only a handful of smaller institutions remain as supervisory concerns. The majority of institutions operating in the path of Hurricane Katrina were well-run, had strong management teams, implemented sound back-up contingency plans, and were well capitalized.

The Federal Financial Institutions Examination Council (FFIEC) announced the formation of an interagency working group to enhance the agencies' coordination and communication on, and supervisory responses to, issues facing the industry in the aftermath of Hurricane Katrina. This working group established a user-friendly, web-based, frequently asked questions forum on the FFIEC's Web site at www.ffiec.gov. The task force will also publish examiner guidance to clarify expectations with respect to the assessment of credit risk and other supervisory issues.

In addition to interagency efforts, the FDIC established a 24-hour hotline and a Web page devoted to assisting hurricane victims to obtain information about their financial institution's operating status, as well as tips on other financial matters, such as replacing identification documents, checks and credit cards.

Safety and Soundness Examinations
As of December 31, 2005, the Corporation had conducted 2,399, or 100 percent of the statutorily required safety and soundness examinations. The number and total assets of FDIC-supervised institutions identified as "problem" institutions (defined as having a composite CAMELS¹ rating of "4" or "5") declined during 2005. As of December 31, 2005, 29 institutions with total assets of $2.9 billion were identified as problem institutions, compared to 44 institutions with total assets of $5.4 billion on December 31, 2004. These changes represent a decrease of 34.1 percent and 46.3 percent, respectively, in the number and assets of problem institutions. During 2005, 36 institutions were removed from problem institution status due to composite rating upgrades, mergers, consolidations or sales and 19 institutions were newly identified as problem institutions. Additionally, two problem institutions converted to State non-member charters and are now under FDIC supervision. The FDIC is required to conduct follow-up examinations of all designated problem institutions within 12 months of the last examination. As of December 31, 2005, 100 percent of all follow-up examinations for problem institutions had been performed on schedule.

Compliance and Community Reinvestment Act (CRA) Examinations
The FDIC conducted 815 comprehensive compliance-CRA examinations, 1,198 compliance-only examinations², and seven CRA-only examinations in 2005, compared to 1,459 joint compliance-CRA examinations, 673 compliance-only examinations, and four CRA-only examinations in 2004. The FDIC conducted 100 percent of all joint and comprehensive examinations within established time frames. As of December 31, 2005, three institutions were assigned a "4" rating for compliance, and no institutions were rated "5." The first "4" -rated institution is currently under an outstanding Cease and Desist Order and an on-site examination was underway at year-end. Management of the second institution executed a Memorandum of Understanding on October 5, 2005. The third institution was examined in 2005 and the Regional Office is currently finalizing a Cease and Desist Order to address the FDIC examination findings.

Relationship Manager Program
On October 1, 2005, the Corporation implemented the Relationship Manager Program for all FDIC-supervised institutions. The program, which was piloted in 390 institutions during 2004, is designed to strengthen communication between bankers and the FDIC, as well as improve the coordination, continuity and effectiveness of regulatory supervision. Each FDIC-supervised institution was assigned a relationship manager, who serves as a local point of contact over an extended period and will often participate in or lead examinations for his or her assigned institution. The program will allow for flexibility in conducting examination activities at various times during the 12- or 18-month examination cycle based on risk or staffing considerations.

IT Examinations
The FDIC has updated its risk-focused information technology (IT) examination procedures for FDIC-supervised financial institutions under its new Information Technology Risk Management Program (IT-RMP). IT-RMP procedures were issued to examiners on August 15, 2005. The new procedures focus on the financial institution's information security program and risk-management practices for securing information assets. The program integrates with the Relationship Manager Program by embedding the IT examination within the Risk Management Report of Examination for all FDIC-supervised financial institutions, regardless of size, technical complexity or prior examination rating. IT-RMP eliminates reporting of IT component ratings and reports only a single technology rating.

Homeland Security
The financial sector is a critical part of the infrastructure in the United States, and the FDIC has taken a leadership role in assisting the financial sector to prepare for emergencies. As a member of the Financial and Banking Information Infrastructure Committee (FBIIC), the FDIC sponsored a series of outreach meetings titled "Protecting the Financial Sector: A Public and Private Partnership." From 2003 to early 2005, the homeland security meetings were held in 29 cities across the United States with the last meeting held in New York City, NY. These meetings provided members of the financial sector with the opportunity to communicate with senior government officials, law enforcement, emergency management personnel and private sector leaders about emergency preparedness. A second round of homeland security meetings started in late 2005 with four meetings held during this timeframe. Homeland Security meetings are planned for 21 cities in 2006.

The FDIC served as the FBIIC's liaison with the Department of Homeland Security (DHS) during 2005 and assisted DHS with items relating to the financial sector.

At the BSA/AML teleconference in the FDIC RAC (l-r): William Spaniel, FFIEC; Bridget Neil, Federal Reserve; Lisa Arquette, FDIC-DSC; John Wagner, OCC; and Timothy Leary, OTS

Bank Secrecy Act
The FDIC is committed to assisting in efforts designed to thwart the inappropriate use of the banking system through activities conducted by terrorists and other criminals. In 2005, the Division of Supervision and Consumer Protection established a new Anti-Money Laundering (AML) and Financial Crimes Branch to focus important resources and attention on our increasing responsibilities in these areas. The new branch brings together specialists to address issues related to Bank Secrecy Act (BSA) compliance, money laundering, financial crimes, terrorist financing, and cyber-fraud.

The FDIC continued in 2005 to play a critical role in the fight against money laundering and terrorist financing. Our efforts included:

• Contributing to the development and implementation of rules and interpretive guidance related to BSA and the USA PATRIOT Act.
  
• Adopting through the FFIEC, comprehensive interagency examination procedures. The new procedures emphasize a banking organization's responsibility to establish and implement risk-based policies and procedures to comply with the BSA and safeguard its operations from money laundering and terrorist financing.
  
• Dedicating more staff to BSA/AML oversight. The number of trained BSA/AML subject matter experts has more than doubled since 2004 to 347 as of year-end. These specialists perform BSA/AML examinations at institutions that have a higher-risk profile due to geographic location, customer base, BSA/AML compliance record, or types of products or services offered.
  
• Providing various forms of examiner and industry training including one outreach session per region, over 70 events hosted by Washington and Regional offices and representation in 212 BSA/AML events sponsored by states and other entities. In total, the banker calls and outreach events reached more than 23,000 bankers and examiners.

Minority-Depository Institutions
The FDIC has long recognized the importance of minority depository institutions and their importance in promoting the economic viability of minority and under-served communities. As a reflection of the FDIC's commitment to minority depository institutions, on April 9, 2002, the FDIC issued a Policy Statement Regarding Minority Depository Institutions. The policy, which can be found at www.fdic.gov/regulations/resources/index.html, implements an outreach program designed to preserve and encourage minority ownership of financial institutions.

Since the adoption of the policy by the FDIC Board of Directors, the program's National Coordinator has maintained contact with various minority depository institution trade associations, and has met periodically with the other Federal banking regulators to discuss the initiatives underway at the FDIC, and to identify opportunities where the agencies might work together to assist minority institutions. All of the FDIC's six DSC Regions have held annual Minority Depository Institution Outreach Programs, made annual contact with each FDIC-supervised minority depository institution, and offered to make return visits to these institutions following the examination process.

During 2004, the FDIC created the Minority Bankers' Roundtable series, a forum designed primarily to explore partnerships between the minority depository institutions community and the FDIC. During 2005, there were six sessions held in: Nashville, Tennessee; New York, New York; Houston, Texas; Santa Monica, California; Atlanta, Georgia, and San Juan, Puerto Rico. The Minority Banker Roundtable and annual Regional outreach events will continue in 2006.

In 2005, the FDIC also provided technical assistance, training and educational programs and held interagency forums to address the unique challenges faced by minority depository institutions. Training and educational programs for minority depository institutions included the FDIC's Director's College Program and the FDIC's Money Smart Program. The FDIC co-hosted Regional Forums with the America's Community Bankers Association and the National Bankers Association in 2005. FDIC also participated in and/or co-sponsored conferences with America's Community Bankers, National Bankers Association, National Association of Chinese American Bankers, Western Independent Bankers, and Puerto Rico Bankers Association.

FDIC also supported the preservation of minority depository institutions in its response to Hurricane Katrina. The FDIC Task Force on Minority Community Banking and Non-Branch Banking met with representatives from the Utah industrial loan company industry to facilitate their assistance to minority depository institutions in the Gulf Coast region affected by Hurricane Katrina. The result has been that as of year-end 2005, the Utah industrial loans companies have pledged more than $18 million in deposits and over $120,000 in direct grants to this effort. Efforts similar to these made by this FDIC task force will continue in 2006.

FDIC will continue its minority depository institution programs in 2006.

Large-Bank Program
In recognition of the increasing concentration of risk exposure in large insured institutions, as well as new challenges posed by the implementation of the Basel II Capital Accord, the FDIC enhanced its large-bank supervision and risk assessment efforts in 2005 by creating two branches—the Large Bank Supervision Branch and the International and Large Bank Policy Branch.

The Large Bank Supervision Branch is responsible for supporting supervisory activities in large banks and establishing minimum standards and supervisory strategies necessary to ensure a consistent approach to large-bank supervision on a national basis. In 2005, Branch staff was actively involved in domestic and international discussions intended to ensure effective implementation of the Basel II Capital Accord, which included participation in numerous "supervisory working group" meetings with foreign regulatory authorities to address Basel II home-host issues.

The International and Large Bank Policy Branch is responsible for supporting supervisory activities in the areas of risk model assessment, economic capital processes, examination work related to market risk under Part 325 Appendix C of the FDIC rules and regulations and other processes that are dependent on quantitative methods. The purpose of Part 325 Appendix C is to ensure that banks with significant exposure to market risk maintain adequate capital to support that exposure. In addition, the International and Large Bank Policy Branch is responsible for policy development regarding large-bank supervision and international matters.

International Stability
The FDIC, as a member of the Consultative Group (CG) with respect to the Middle East-North Africa (MENA) Partnership for Financial Excellence (PFE) initiative, continues to work with the other federal banking agencies, the State Department and the Department of Treasury, to develop technical assistance programs to meet needs in the MENA region. In 2005, the FDIC delivered two courses under the MENA training initiative in 2005: Principles of Bank Resolutions and Receiverships hosted by the Arab Academy for Training and Financial Sciences in Amman, Jordan; and Examination Management hosted by the Central Bank of Tunisia in Tunis. Preparations are underway to establish training venues and course curriculum for these initiative in 2006. The objective of this initiative is to help foster economic growth in the region through the implementation of sound supervisory systems.

The FDIC chairs the Association of Supervisors of Banks of the Americas, (ASBA) Working Group on Deposit Insurance and Bank Resolutions. The Working Group, an outgrowth of actions plans for ASBA's 2004-2008 strategic plan, is charged with promoting best practices and identifying opportunities for improvement in deposit insurance and bank resolutions. Similarly, in 2005, the FDIC also actively participated in ASBA's Working Group on Credit and Operational Risk, which was formed to identify best practices and opportunities for improvement in credit risk and operational risk management policies and procedures among ASBA's membership.

The FDIC fulfilled 20 technical assistance missions in 2005. The missions provided technical support in supervision, deposit insurance, resolutions/receiverships, and legal underpinnings of supervision and insurance. Beneficiaries of these missions included Macedonia, Russia, Tanzania, Thailand, Ukraine, several Latin American countries, and several countries involved in the Partnership for Financial Excellence Program in the Middle East and North Africa. The FDIC also held 60 meetings with representatives from foreign countries, typically representing a country's central bank, bank supervisory authority or deposit insurance agency. Frequent visitors included: Albania (2), Canada (2), China (11), France (2), Japan (6), Korea (8), Malaysia (2), Russia (2), and Taiwan (2).

Chairman Powell praises Michael Jackson, Sandra Thompson and Donna Gambrel for their work on a recent conference on preventing identity theft.

Chicago Region team makes sure bankers get the answers they need (l-r): Art Khan, Sharon Vejvoda, Dan Peters, Angelina Pollard, Ronald Regal, Teresa Sabanty, and Ray Jackson

Identity Theft and Consumer Privacy
In 2005, the FDIC continued to take a leading role in helping banks combat identity theft. The FDIC solicited public comment on its study Putting an End to Account Hijacking Identity Theft published in December 2004 and in June 2005, published a study supplement. The study and the supplement took an in-depth look at identity theft, focusing on account hijacking (the unauthorized use of deposit accounts).

One of the study's conclusions was that increased consumer education and information-sharing could reduce the incidence of identity theft. As a result of these recommendations, the FDIC sponsored four symposia in 2005 in Washington, DC., Atlanta, Los Angeles and Chicago that brought together experts representing federal and state government, the banking industry, consumer groups, and law enforcement who discussed current efforts to combat scams such as phishing, which can lead to account hijacking. The symposium speakers also addressed efforts to educate consumers on avoiding other scams that can lead to identity theft and on the steps to take in the unfortunate event that identity theft should happen to them.

The FDIC is one of several federal agencies charged with implementing the provisions of the Fair and Accurate Credit Transactions Act of 2003 (FACT Act), which substantially amended the Fair Credit Reporting Act, particularly in the areas of consumer access to and quality of credit information, privacy, and identity theft. The FACT Act:

• preserves uniform national standards for the content of consumer report information and creditor access to such information,
  
• improves consumer access to credit information,
  
• improves the quality of reported credit information,
  
• protects privacy,
  
• combats identity theft, and
  
• promotes financial literacy.
  

Consistent with the privacy requirements of the FACT Act, the FDIC worked with other federal agencies to finalize rules in 2005 that permit creditors to obtain, use and share medical information only to the degree necessary to facilitate legitimate operational needs. The FDIC is training its examiners on the concepts underlying the entire FACT Act, and is developing examination procedures to evaluate industry compliance.

Consistent with the identity theft provision of the FACT Act, the FDIC worked with other federal agencies in 2004 to propose rules that would require banks to implement a written identity theft protection program which includes procedures to evaluate red flags that might indicate identity theft. The FDIC, with the other agencies, also finalized rules requiring institutions to properly dispose of consumer information derived from credit reports in order to prevent identity theft and other fraud. The rules on disposal of consumer information became effective on July 1, 2005.

Consumer Complaints and Inquiries
The FDIC's centralized Consumer Response Center (CRC) is responsible for investigating all types of consumer complaints about FDIC-supervised institutions and for answering inquiries about consumer protection laws and banking practices. During 2005, the FDIC received 8,851 complaints, of which 3,307 were against state non-member institutions. Approximately 36 percent of the state non-member bank consumer complaints concerned credit card accounts, with the most frequent complaints involving billing disputes and account errors, loan denials, terms and conditions, collection practices, reporting of erroneous information, credit card fees and service charges, interest rates, and disclosures. The FDIC responded to over 97 percent of written complaints on a timely basis.

The FDIC also responded to 4,042 written and 9,395 telephone inquiries from consumers and members of the banking community about consumer protection issues. In addition, the FDIC responded to over 64,000 written and telephone inquiries from bankers and consumers about the FDIC's deposit insurance program and insurance coverage issues.

Deposit Insurance Education
An important part of the FDIC's role in insuring deposits and protecting the rights of depositors is its responsibility to ensure that bankers and consumers have access to accurate information about FDIC's deposit insurance rules. To that end, the FDIC has an expansive deposit insurance education program consisting of seminars for bankers, electronic tools for estimating deposit insurance coverage, and written and electronic information targeting both bankers and consumers.

During 2005, the FDIC completed development of a major update of its popular Electronic Deposit Insurance Estimator (EDIE) for consumers, an Internet application located on FDIC's Web site that estimates insurance coverage for users' deposit accounts at insured institutions. The new Consumer EDIE offers two different approaches for calculating coverage, one for novice users and one for frequent users. The new Consumer EDIE application is available for public use starting January 2006.

During 2005, the FDIC conducted a nationwide series of telephone/Internet seminars for bankers and a nationwide survey of insured institutions to gather information about current awareness of, and opinions about, the FDIC's existing educational resources on the deposit insurance rules. The FDIC also initiated an effort to encourage more bank trade organizations to sponsor FDIC deposit insurance seminars for their members.

In 2005, the FDIC released several new "job aids" for bankers, including:

• A new 100-minute video for bankers that provides an in-depth review of FDIC deposit insurance coverage, available on CD-ROM and for viewing on the FDIC's Web site.
  
• An Inventory of Deposit Insurance Guidance (IDIG), which is an electronic support system on CD-ROM that includes a searchable database of deposit insurance information and has links to all FDIC deposit insurance publications, application tools and services.
  
• A major update of The Financial Institution Employee's Guide to Deposit Insurance, the FDIC's most authoritative resource on deposit insurance coverage for bankers.

The FDIC also released its two most popular brochures for bank customers — Insuring Your Deposits (a basic primer on deposit insurance coverage) and Your Insured Deposits (a comprehensive guide to deposit insurance coverage) in Chinese and Korean.

The FDIC conducted 27 seminars for financial institution employees and consumer organizations on the rules for deposit insurance coverage. These seminars, which were conducted in a variety of formats, including Internet, teleconference and classroom, provided a comprehensive review of how FDIC insurance works, including the FDIC's rules for coverage of different types of deposit accounts.

Financial Education and Community Development
The FDIC's financial education activities continue to serve as a vital part of the Corporation's efforts to help maintain the stability of the nation's financial system, support community development and strengthen the economy. Since launching its award-winning Money Smart financial education program in 2001, the FDIC has helped thousands of consumers get started on the road to greater financial independence and gain access to mainstream products and services. The FDIC continues to distribute and promote the Money Smart curriculum, which is available in five languages – English, Spanish, Chinese, Korean and Vietnamese.

The FDIC exceeded two of the three program goals for Money Smart. With over 252,000 copies of the curriculum having been distributed, the FDIC has exceeded by more than two times the original distribution goal of 100,000 copies. This year, the FDIC also exceeded its goal to recruit 1,000 partners for Money Smart Alliance. Over 1,200 organizations throughout the country have joined with the FDIC to help deliver and promote financial education. The FDIC has also made significant strides toward achieving the third goal – to provide one million consumers with financial education – more than 589,000 consumers have now been reached. Of the consumers that have taken Money Smart classes, the FDIC is aware of over 82,100 who have subsequently opened bank accounts. Some class participants have become first-time home-buyers and others have engaged in other asset-building activities.

To raise awareness of the FDIC's Money Smart program among Hispanic adults and encourage them to ask about Money Smart classes and products, a summer-long Spanish language advertising campaign included print and radio ads ran in 14 key markets. A total of 1,080 people attended Money Smart classes as a result of the advertising campaign. The FDIC introduced a Spanish-language Web page at www.fdic.gov/quicklinks/spanish.html that contains many consumer-related materials, including Money Smart. In recognition of the FDIC's leadership in financial education and outreach to the Hispanic community, President Bush asked the FDIC to be a part of his national public-private sector partnership to ensure financial education is available consistently and comprehensively to Hispanic communities. The partnership, which includes representatives from the FDIC, U.S. Treasury Department, Small Business Administration, Latino Coalition, U.S. Hispanic Chamber of Commerce and others, is charged with directing federal, non-profit and private resources to areas in need of financial education and coordinating private sector resources to reach Hispanics nationwide.

In 2005, the FDIC provided assistance to the Inter-American Development Bank (IADB) Multilateral Investment Fund, working with Latin American consulates, foreign banks, and U.S. financial institutions and bank trade groups to develop products with special remittance features and offering financial education. The FDIC also organized a Remittance Trade Fair and two panel discussions for the Financial Inclusion & Remittances Sessions at the International Forum on Remittance 2005 held in Washington, DC: Banking the Unbanked: Products and Marketing Strategies in the United States and The Importance of Financial Education: Balancing Competition and Regulation in the Remittance Market. The trade fair provided 30 remittance firms and numerous investors with the opportunity to network and view new innovative electronic transfer products, which can enable community banks, credit unions, credit cooperatives and micro-finance institutions to become more competitive in pricing and product features.

In 2005, the FDIC expanded its efforts with the New Alliance Task Force (NATF), originally launched and continuing in Chicago, to two additional markets – Los Angeles, California and Austin, Texas – with 60 financial institutions participating in those markets. NATF is a broad-based coalition comprised of banks, community-based organizations, bank regulatory agencies, government agencies, representatives from the secondary market and private mortgage insurance companies and the Mexican Consulate. The foundation has also been laid for the launch of NATF in four other markets – Boston, New York City, Raleigh-Durham and Kansas City.

Virtual Supervisory Information On The Net (ViSION)
In February 2005, the FDIC released the fourth and final phase of ViSION, a comprehensive processing and tracking system supporting the Corporation's supervision function. This phase represents the culmination of a five-year and approximately $32 million capital-investment project and brings together – in a single, customized product – detailed information on examination, application, enforcement and numerous other bank activities. The system, which includes such features as automated event notification, deadline tracking, and job-specific role-based security, is used by more than 3,200 federal and state regulators.

Annual Independent Audits and Reporting Requirements
The Corporation amended Part 363 of its regulations by raising the asset-size threshold from $500 million to $1 billion for requirements relating to internal control assessments and reports by management and external auditors. The amendment also relieved covered institutions with total assets of less than $1 billion of the requirement that all outside directors on the audit committee be independent of management; under the amended rule, a majority of independent directors on the audit committee is sufficient. The amendment does not relieve public covered institutions from their obligation to comply with applicable provisions of the Sarbanes-Oxley Act and the Securities and Exchange Commission's implementing rules. The amendments took effect in December 2005.