Federal Deposit
Insurance Corporation

2009 Annual Report

IV. Financial Statements and Notes

Deposit Insurance Fund (DIF) - Cont.

8. Contingent Liabilities for:

Anticipated Failure of Insured Institutions
The DIF records a contingent liability and a loss provision for DIF-insured institutions that are likely to fail, absent some favorable event such as obtaining additional capital or merging, when the liability is probable and reasonably estimable. The contingent liability is derived by applying expected failure rates and loss rates to institutions based on supervisory ratings, balance sheet characteristics, and projected capital levels.

During the year, the conditions of the banking industry continued to deteriorate. The difficult economic and credit environment continued to challenge the soundness of many DIF-insured institutions. The ongoing weakness in housing and commercial real estate markets led to asset quality problems and volatility in financial markets, which hurt the banking industry performance and weakened many institutions with significant portfolios of residential and commercial mortgages. The impact of the economic deterioration in the banking industry caused a significant increase in the contingent loss reserve. As of December 31, 2009 and 2008, the contingent liabilities for anticipated failure of insured institutions were $44.0 billion and $24.0 billion, respectively.

In addition to these recorded contingent liabilities, the FDIC has identified risk in the financial services industry that could result in an additional loss to the DIF should potentially vulnerable insured institutions ultimately fail. As a result of these risks, the FDIC believes that it is reasonably possible that the DIF could incur additional estimated losses up to approximately $24 billion. The actual losses, if any, will largely depend on future economic and market conditions and could differ materially from this estimate.

During 2009, 140 banks with combined assets of $171.2 billion failed. It is uncertain how long and how deep the current downturn will be. Supervisory and market data suggest that the banking industry will continue to experience elevated levels of stress over the coming year. The FDIC continues to evaluate the ongoing risks to affected institutions in light of the existing economic and financial conditions, and the extent to which such risks will continue to put stress on the resources of the insurance fund.

Litigation Losses
The DIF records an estimated loss for unresolved legal cases to the extent that those losses are considered probable and reasonably estimable. The FDIC recorded probable litigation losses of $300 million and $200 million for the DIF as of December 31, 2009 and 2008, respectively, and has determined that there are no reasonably possible losses from unresolved cases.

Other Contingencies

Representations and Warranties
In an effort to maximize the return from the sale of assets from bank and thrift resolutions, FDIC as receiver offered representations and warranties, and guarantees on certain loan and servicing rights sales. Although these representations and warranties were offered by the receiver, DIF guaranteed the obligations under these agreements. In general, the guarantees, representations, and warranties relate to the completeness and accuracy of loan documentation, the quality of the underwriting standards used, the accuracy of the delinquency status, and the conformity of the loans with characteristics of the pool in which they were sold at the time of sale.

As a result of loans and servicing rights sold in connection with the asset disposition of Indy- Mac Federal Bank, the unpaid principal balance for loans subject to representations and warranties increased by $184 billion to $195 billion as of December 31, 2009. Since the receiverships are the primary guarantors and they have sufficient funds to pay asserted claims, the DIF did not record contingent liabilities from any of the outstanding claims asserted in connection with representations and warranties at December 31, 2009 and 2008.

In addition, until the contracts offering the representations and warranties and guarantees have expired, future losses could be incurred, some as late as 2032. Consequently, the FDIC believes it is possible that losses may be incurred by the DIF from the universe of outstanding contracts with unasserted representation and warranty claims. However, because of the uncertainties surrounding the timing of when claims may be asserted, the FDIC is unable to reasonably estimate a range of loss to the DIF from outstanding contracts with unasserted representation and warranty claims.

Purchase and Assumption Indemnification
In connection with Purchase and Assumption agreements for resolutions, the FDIC in its receivership capacity generally indemnifies the purchaser of a failed institution's assets and liabilities in the event a third party asserts a claim against the purchaser unrelated to the explicit assets purchased or liabilities assumed at the time of failure. The FDIC in its Corporate capacity is a secondary guarantor if and when a receiver is unable to pay. These indemnifications generally extend for a term of six years after the date of institution failure. The FDIC is unable to estimate the maximum potential liability for these types of guarantees as the agreements do not specify a maximum amount and any payments are dependent upon the outcome of future contingent events, the nature and likelihood of which cannot be determined at this time. During 2009 and 2008, the FDIC in its Corporate capacity has not made any indemnification payments under such agreements and no amount has been accrued in the accompanying financial statements with respect to these indemnification guarantees.

FDIC Guaranteed Debt of Limited Liability Companies
During 2009, the FDIC in its corporate capacity offered guarantees on loans issued by newlyformed limited liability companies (LLCs) that were created to dispose of certain residential mortgage loans, construction loans, and other assets of two receiverships. The receiverships transferred a portfolio of assets with an unpaid principal balance of $5.8 billion to the LLCs. Private investors purchased a 40-50 percent ownership interest in the LLCs for $615 million in cash and the LLCs issued notes of $2.1 billion to the receiverships to partially fund the purchase of the assets. The receiverships hold the remaining 50-60 percent equity interest in the LLCs. In exchange for the guarantees, the DIF expects to receive estimated fees totaling $71.4 million, which equals one percent per annum over the estimated life of the notes.

The term of the guarantees extends until the earliest of 1) payment in full of the notes or 2) two years following the maturity date of the notes (12 years). In the event of note payment default by an LLC, the FDIC in its corporate capacity can take one or more of the following remedies: 1) accelerate the payment of the unpaid principal amount of the notes; 2) sell the assets held as collateral; and 3) foreclose on the equity interests of the debtor.

The DIF has recorded a receivable for the estimated guarantee fees of $71.4 million and an offsetting deferred revenue liability, included in the "Interest receivable on investments and other assets, net" and "Accounts payable and other liabilities" line items, respectively. Guarantee fees are recognized as revenue on a straight-line basis over the term of the notes.

The source of payment for the LLC-issued debt is the collections from the LLC assets. If cash flow collections from the LLC assets are insufficient to cover the payments on the notes in accordance with priority of payments, then the FDIC as guarantor is required to make a guarantee payment for any shortfall. The estimated loss of the guarantees to the DIF is based on the discounted present value of the expected guarantee payments by the FDIC, reimbursements to the FDIC for guarantee payments, and guarantee fee collections. Under both a base case and a more stressful modeling scenario, the cash flows from the LLC assets provide sufficient coverage to fully pay the debts by their maturity dates. Therefore, the estimated loss to the DIF from these guarantees is zero.

As of December 31, 2009, the maximum estimated guarantee exposure equals the total outstanding debt of $2.1 billion.