Federal Deposit
Insurance Corporation

2008 Annual Report

I. Management's Discussion and Analysis

The Year in Review
The year 2008 proved to be an extremely busy time for the FDIC. In addition to the normal course of business, the Corporation had a major role in creating and implementing government initiatives associated with the Temporary Liquidity Guarantee Program (TLGP) and the Troubled Asset Relief Program. Also, additional resources were needed in response to the increased workload resulting from resolving numerous bank failures. The FDIC continued its work on high-profile policy issues and published numerous Notices of Proposed Rulemaking (NPRs) throughout the year, seeking comment from the public. The Corporation also continued to focus on a strong supervisory program. The FDIC continued expansion of financial education programs with the creation of Money Smart for young adults. The FDIC also sponsored and co-sponsored major conferences and participated in local and global outreach initiatives.

Highlighted in this section are the Corporation’s 2008 accomplishments in each of its three major business lines – Insurance, Supervision and Consumer protection, and Receivership Management – as well as its program support areas.

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

Temporary Liquidity Guarantee Program
On October 13, 2008, the Secretary of the Treasury, in consultation with the President and acting upon the recommendations of the FDIC Board of Directors and the Board of Governors of the Federal Reserve System, made a systemic risk determination under section 13(c)(4)(G) of the Federal Deposit Insurance Act (FDIA). The next day, the FDIC announced and implemented the Temporary Liquidity Guarantee Program. The TLGP consists of two components: an FDIC guarantee of certain newly issued senior unsecured debt (the debt guarantee program) and an FDIC guarantee in full of non-interest bearing transaction accounts (the transaction account program). Coverage under both components of the TLGP was provided without charge to all eligible entities for the first 30 days.

After issuing an interim final rule on October 23, 2008, the FDIC received more than 700 comments. Based on those comments, the FDIC made several significant changes to the final rule, which the FDIC adopted on November 21, 2008.

The final rule provided that, under the debt guarantee program, the FDIC will guarantee in full, through maturity or June 30, 2012, whichever comes earlier, senior unsecured debt issued by a participating entity between October 14, 2008, and June 30, 2009, up to a maximum of 125 percent of the par value of the entity’s senior unsecured debt that was outstanding as of the close of business September 30, 2008, and that was scheduled to mature on or before June 30, 2009. Banks, thrifts, bank holding companies, and certain thrift holding companies were eligible to participate. In a change from the original terms of the debt guarantee program, the final rule excluded, effective December 5, 2008, all debt with a term of 30 days or less from the definition of senior unsecured debt. The FDIC began charging institutions participating in the debt guarantee program for debt issued on or after November 13, 2008, a fee based on the amount and term of the debt issued. Fees range from 50 to 100 basis points on an annualized basis, depending on the term of the debt.

The final rule also provided that, under the transaction account program, the FDIC will guarantee in full all domestic noninterest-bearing transaction deposit accounts held at participating banks and thrifts through December 31, 2009, regardless of dollar amount. The guarantee also covers negotiable order of withdrawal accounts (NOW accounts) at participating institutions – provided the institution commits to maintaining interest rates on the account at no more than 0.50 percent – and Interest on Lawyers Trust Accounts (IOLTAs) and functional equivalents. The FDIC will assess participating institutions a 10 basis point annual rate surcharge on covered accounts that are not otherwise insured.

The final rule required all institutions to elect whether or not to participate in one or both of the two components of the TLGP by December 5, 2008. As of December 31, 2008, approximately 56 percent of all eligible entities had opted in to the Debt Guarantee Program and 64 financial entities – 39 insured depository institutions and 25 bank and thrift holding companies and nonbank affiliates – had $224 billion in guaranteed debt outstanding. Approximately 87 percent of FDIC-insured institutions opted in to the Transaction Account Guarantee Program, with insured institutions reporting 522,862 non-interest-bearing transaction accounts over $250,000. These accounts totaled $814 billion, of which $684 billion in deposit accounts was guaranteed under the program.

The TLGP does not rely on the taxpayer or the Deposit Insurance Fund to achieve its goals. Participants in the program must pay assessments for coverage. If fees do not cover costs in the TLGP, the FDIC will impose a special assessment under the systemic risk provisions of the Federal Deposit Insurance Act.

Restoration Plan and Rulemaking on Assessments
Recent and anticipated bank failures significantly increased Deposit Insurance Fund losses, resulting in a decline in the reserve ratio. As of December 31, 2008, the reserve ratio stood at 0.36 percent, down from 0.76 percent at September 30, 1.01 percent at June 30, and 1.19 percent as of March 31. The Federal Deposit Insurance Reform Act of 2005 (the Reform Act) requires that the FDIC’s Board of Directors adopt a restoration plan when the Deposit Insurance Fund’s reserve ratio falls below 1.15 percent or is expected to within six months.

On October 7, 2008, the FDIC Board adopted a restoration plan to raise the reserve ratio to at least 1.15 percent within five years and a proposed rule that would raise assessment rates beginning January 1, 2009, and make other changes to the assessment system effective April 1, 2009. The other changes were primarily to ensure that riskier institutions will bear a greater share of the proposed increase in assessments. On December 16, 2008, the Board adopted a final rule raising assessment rates for the first quarter of 2009. On February 27, 2009, the Board amended the restoration plan to extend its horizon from five years to seven years due to extraordinary circumstances. It also adopted a final rule setting rates beginning the second quarter of 2009 and making other changes to the risk-based pricing system.

Rates for the First Quarter of 2009
On December 16, 2008, the FDIC adopted a final rule raising risk-based assessment rates uniformly by seven basis points for the first quarter 2009 assessment period. The higher revenue will be reflected in the fund balance as of March 31, 2009. Assessment rates for the first quarter of 2009 will range from 12 to 50 basis points. Institutions in the lowest risk category – Risk Category I – will pay between 12 and 14 basis points.

Changes to Risk-Based Assessments Effective the Second Quarter of 2009
Effective April 1, 2009, the final rule adopted on February 27, 2009, widens the range of rates overall and within Risk Category I. Initial base assessment rates will range between 12 and 45 basis points – 12 to 16 basis points for Risk Category I. The initial base rates for Risk Categories II, III, and IV will be 22, 32 and 45 basis points, respectively. An institution’s total base assessment rate may be less than or greater than its initial base rate as a result of additional adjustments (discussed below). For Risk Category I, total base assessment rates may be as low as seven basis points or as high as 24 basis points. A Risk Category IV institution could have a total base assessment rate as high as 77.5 basis points (see Chart).

Note: Institutions are categorized based on supervisory ratings, debt ratings and financial data as of December 31, 2008. Rates do not reflect the application of assessment credits. Percentages may not add to 100 percent due to rounding.

Large Risk Category I Institutions
Beginning in the second quarter of 2009, the assessment rate for a large institution with a debt rating will depend on (1) long-term debt ratings, (2) the weighted average CAMELS¹ component rating, and (3) the rate determined from the financial ratios method, the method used for smaller banks. Each of the three components will receive a one-third weight. The maximum amount of the rate adjustment for large banks based on additional information about risks will be increased from 1⁄2 basis point to one basis point.

The FDIC anticipates that incorporating the financial ratios method into the large bank method assessment rate will result in a more accurate distribution of initial assessment rates and in timelier assessment rate responses to changing risk profiles, while retaining the market and supervisory perspectives that debt and CAMELS ratings provide.

Brokered Deposits
For institutions in Risk Category I, the financial ratios method will include a new financial ratio that may increase the rate of an institution relying significantly on brokered deposits to fund rapid asset growth. This will only apply to institutions with brokered deposits (less reciprocal deposits)² of more than 10 percent of domestic deposits and cumulative asset growth of more than 40 percent over the last four years, adjusted for mergers and acquisitions. Like the other financial ratios used to determine rates in Risk Category I, a small change in the value of the new ratio may lead to only a small rate change, and it would not cause an institution’s rate to fall outside of the 12-16 basis point initial range. A number of costly institution failures, including some recent failures, had experienced rapid asset growth before failure and had funded this growth through brokered deposits.

For institutions in risk categories II, III, or IV, the FDIC proposes to increase an institution’s assessment rate above its initial rate if its ratio of brokered deposits to domestic deposits is greater than 10 percent, regardless of the rate of asset growth. Such an increase would be capped at 10 basis points. As an institution’s financial condition weakens, significant reliance on brokered deposits tends to increase its risk profile. Insured institutions – particularly weaker ones – typically pay higher rates of interest on brokered deposits. When an institution becomes noticeably weaker or its capital declines, the market or statutory restrictions may limit its ability to attract, renew or roll over these deposits, which can create significant liquidity challenges. Also, significant reliance on brokered deposits tends to greatly decrease the franchise value of a failed institution.

Secured Liabilities
For institutions in any risk category, assessment rates will rise above initial rates for institutions relying significantly on secured liabilities. Assessment rates will increase for institutions with a ratio of secured liabilities to domestic deposits of greater than 25 percent, with a maximum increase of 50 percent above the rate before such adjustment. Secured liabilities generally include Federal Home Loan Bank advances, repurchase agreements, secured Federal Funds purchased, and other secured borrowings.

The exclusion of secured liabilities can lead to inequity. An institution with secured liabilities in place of another’s deposits pays a smaller deposit insurance assessment, even if both pose the same risk of failure and would cause the same losses to the FDIC in the event of failure. Substituting secured liabilities for deposits can also lower an institution’s franchise value in the event of a failure, which increases the FDIC’s losses, all else equal. Furthermore, substituting secured liabilities for unsecured liabilities (including subordinated debt) raises the FDIC’s loss in the event of failure without providing increased assessment revenue.

Unsecured Debt and Tier I Capital
Institutions will receive a lower rate if they have long-term unsecured debt, including senior secured and subordinated debt with a remaining maturity of one year or more. For a large institution, the rate reduction would be determined by multiplying the institution’s long-term unsecured debt as a percentage of domestic deposits by 40 basis points. The maximum allowable rate reduction would be five basis points. For a small institution (those with less than $10 billion in assets), the unsecured debt adjustment would also include a certain amount of Tier I capital. The percentage of Tier I capital qualifying for inclusion in the unsecured debt adjustment gradually increases for greater amounts of Tier I capital exceeding five percent Tier I leverage ratio threshold.³

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

Summary of Base Rate Determination
For second quarter 2009, the minimum and maximum initial base assessment rates, range of possible rate adjustments, and minimum and maximum total base rates are as follows:

Base Rates and Actual Rates
The rates adopted by the Board are both base rates and actual rates. The FDIC would continue to have the authority to adopt actual rates that were higher or lower than total base assessment rates without the necessity of further notice and comment rulemaking, provided that: (1) the Board could not increase or decrease rates from one quarter to the next by more than three basis points without further notice-and-comment rulemaking; and (2) cumulative increases and decreases could not be more than three basis points higher or lower than the total base rates without further notice-and-comment rulemaking.

Center for Financial Research
The Center for Financial Research (CFR) was founded by the Corporation in 2004 to encourage and support innovative research on topics that are important to the FDIC’s role as deposit insurer and bank supervisor. During 2008, the CFR co-sponsored three major research conferences.

The 18th Annual Derivatives Securities and Risk Management Conference, which the FDIC
co-sponsored with Cornell University’s Johnson Graduate School of Management and the University of Houston’s Bauer College of Business, was held in April 2008 at the FDIC’s Virginia Square facility. The conference attracted over 100 researchers from around the world. Conference presentations focused on technical and mathematical aspects of risk measurement and securities pricing, and included several presentations on Basel II related topics.

The CFR and The Journal for Financial Services Research (JFSR) hosted the eighth Annual Bank Research Conference in September with over 100 attendees. The conference included the presentation of six papers and focused on issues in securitization and credit risk transfer. Experts discussed analyses on a range of topics, including liquidity issues, lessons learned from the collapse of the auction rate municipal bond market, the laying off of credit risk, and the subprime credit crisis of 2007.

The CFR and the Federal Reserve Bank of Cleveland co-sponsored the “Identifying and Resolving Financial Crises” conference in April 2008. Papers were presented and discussed on topics including the theory and evidence on the resolution of financial firms, identifying policies that lead to contagion or correlated risk, and contingency planning for crises.

The CFR hosted its annual Fall Workshop in October, which included two all-day sessions with research paper presentations and discussions. The Workshop was attended by about 85 researchers and policy makers. Twelve CFR working papers were completed and published through November 2008 on topics dealing with deposit insurance, risk measurement, credit contagion, and the global syndicated loan market.

Consumer Research
The FDIC has pursued a research agenda that explores consumer financing products and trends, supports FDIC consumer policy initiatives and supervisory objectives, and proactively uses FDIC research results to identify and address major risks in the consumer protection area. As part of this agenda, the FDIC has prepared a series of articles for the FDIC Quarterly on the unbanked, the underserved, and alternative financial services.

During the year, two articles were completed within this series. One article, “Building Assets, Building Relationships: Bank Strategies for Encouraging Lower-Income Households to Save”
was published in the fourth quarter 2007 FDIC Quarterly (2008 Volume 2, Number 1). This article describes some savings strategies and products that banks have used to build profitable relationships that also benefit lower-income consumers. Another article, “An Introduction to the FDIC’s Small-Dollar Loan Pilot Program,” was issued electronically on August 10, 2008, and published in the second quarter 2008 FDIC Quarterly (2008, Volume 2, Number 3). The article summarizes the key parameters of the pilot, the small-dollar loan program proposals that participating banks described in their applications, and the first quarter 2008 results.

Participants in the International Association of Deposit Insurers conference.

International Outreach
Growing concerns surrounding the weakening global economy made 2008 a significant and active year for the FDIC’s international activities. The failure of Northern Rock in the United Kingdom in February 2008 began an upward trend in FDIC consultations with foreign governments considering developing, modernizing, or otherwise strengthening their deposit insurance systems. Efforts included arranging and conducting training sessions, technical assistance missions and foreign visits, leadership roles in international organizations and participating in bilateral consultations with foreign regulators.

With FDIC’s Vice Chairman as President of the International Association of Deposit Insurers (IADI) and Chair of the IADI Executive Council, the FDIC had a critical role in fulfilling IADI’s mission throughout the year. In October 2008, the FDIC hosted the seventh annual IADI Conference and Annual General Meeting. The conference themes, Financial Stability and Economic Inclusion, provided an excellent platform for over 250 distinguished presenters and guests from 60 countries to discuss the issues facing global banking and the economy and what steps can be taken by deposit insurers to promote financial stability and inclusion around the world. As Chair of the IADI Training and Conference Standing Committee, the FDIC developed and hosted an executive training program designed to promote core principles and best practices of resolutions management for 39 individuals from 25 countries. The Cross Border Resolution Group (CBRG) of the Basel Committee on Bank Supervision (BCBS), co-chaired by the FDIC, continued its work analyzing national legal and policy regimes for crisis management and resolution of cross-border banks, presenting an interim report to the Basel Committee in December. A subgroup of the CBRG, also co-chaired by the FDIC, in collaboration with IADI and European Forum of Deposit Insurers (EFDI) began work this year to develop an internally agreed-upon set of Recommended Core Principles for Effective Deposit Insurance Systems.

As a member of the Association of Supervisors of Banks in the Americas (ASBA) Board of Directors, the FDIC championed the importance of financial education and highlighted the success of its Money Smart program as a means of promoting healthy economic and banking growth in the Americas. The FDIC’s leadership within ASBA also included providing technical training to ASBA members on supervision of operational risk, bank supervision and resolution. In 2008, the FDIC continued to build its relationship with the EFDI and participated in a joint EFDI/FDIC conference in Dublin on Financial Integration and the Safety Net.

The FDIC entered into a number of Memoranda of Understanding (MOU) this year, three regarding information sharing between bank supervisors of Hong Kong, Mexico and Spain, as well as technical assistance agreements with Colombia’s deposit insurer, Fondo De Garantias De Instituciones Financieras (FOGAFIN), and the United Kingdom’s (UK) Financial Services Authority (FSA). The MOU with the UK provides for formal information-sharing and contingency planning arrangements in connection with cross-border banking activities in the U.S. and the UK. The FDIC’s consultation with the UK has included numerous discussions to share detailed information on the FDIC’s experience in resolution management and asset disposition and consultation on key components of proposed legal changes to the resolution regime for banks in the UK. In addition, the FDIC Chairman met with the FSA Chairman, the Deputy to the Exchequer of Her Majesty’s Treasury, the Governor of the Bank of England and the CEO of the Financial Services Compensation Scheme (FSCS) to continue the dialogue and exchange of information.

In its continuing commitment to fostering sound banking in China, the FDIC and the People’s Bank of China co-sponsored a seminar on rural finance held at the FDIC’s Dallas Regional Office. The seminar provided 55 participants from both countries, including rural finance experts in banking, financial regulation, and academia, with an opportunity to share experiences and engage each other in a dialogue on the challenges, best practices, and innovations in rural finance in their countries today. The FDIC also traveled to China to participate in the U.S.-China Bilateral Bank Supervisors meetings, hosted by the China Banking Regulatory Commission (CBRC).

Footnotes:
1 The CAMELS component ratings represent either the adequacy of Capital, the quality of Assets, the capability of Management, the quality and level of Earnings, the adequacy of Liquidity, and the Sensitivity to market risk, and ranges from “1” (strongest) to “5” (weakest). back

2 Certain deposits that an insured depository institution receives through a deposit placement network on a reciprocal basis would be excluded from the adjusted brokered deposit ratio in Risk category I. They would not be excluded, however, from the brokered deposit adjustment applicable to risk categories II, III, and IV. back

3 For a Tier I leverage ratio between 5 percent and 6 percent, 10 percent of Tier I capital within this range would qualify for the unsecured debt adjustment; for a Tier I leverage ratio between 6 percent and 7 percent, 20 percent of Tier I capital within this range would qualify; for a Tier I leverage ratio between 7 percent and 8 percent, 30 percent of Tier I capital within this range would qualify; and so forth. Thus, all Tier I capital above a 14 percent leverage ratio would qualify for inclusion in the unsecured debt adjustment. back