Federal Deposit
Insurance Corporation

Legislative History
The U.S. Congress created the Federal Savings and Loan Insurance Corporation (FSLIC) through the enactment of the National Housing Act of 1934.

The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) abolished the insolvent FSLIC, created the FSLIC Resolution Fund (FRF), and transferred the assets and liabilities of the FSLIC to the FRF (except those assets and liabilities transferred to the RTC), effective August 9, 1989. The FRF is responsible for winding up the affairs of the former FSLIC.

FIRREA was enacted to reform, recapitalize and consolidate the federal deposit insurance system. In addition to the FRF, FIRREA created the Resolution Trust Corporation (RTC), the Bank Insurance Fund (BIF), and the Savings Association Insurance Fund (SAIF). FIRREA also designated the Federal Deposit Insurance Corporation (FDIC) as the administrator of the FRF, BIF, and SAIF. All three funds are maintained separately to carry out their respective mandates.

The RTC was created to manage and resolve all thrifts previously insured by the FSLIC for which a conservator or receiver was appointed during the period January 1, 1989, through August 8, 1992. In order to provide funds to the RTC for use in thrift resolutions, FIRREA established the Resolution Funding Corporation (REFCORP).

RTC’s resolution responsibility was extended through subsequent legislation from the original termination date of August 8, 1992. Resolution responsibility transferred from the RTC to the SAIF on July 1, 1995.

The RTC Completion Act of 1993 (1993 RTC Act) terminated the RTC as of December 31, 1995. All remaining assets and liabilities of the RTC were transferred to the FRF on January 1, 1996. The FDIC must transfer to the REFCORP the net proceeds from the FRF’s sale of RTC assets, once all liabilities of the RTC have been paid. Any such funds transferred to the REFCORP pay the interest on the REFCORP bonds issued to fund the early RTC resolutions. Any such payments benefit the Treasury, which would otherwise be obligated to pay the interest on the bonds.

Operations of the FRF
The FRF will continue until all of its assets are sold or otherwise liquidated and all of its liabilities are satisfied. Upon the dissolution of the FRF, any funds remaining (after payments to REFCORP, if any) will be paid to the U.S. Treasury.

The FRF has been primarily funded from the following sources: 1) U.S. Treasury appropriations; 2) amounts borrowed by the RTC from the Federal Financing Bank (FFB); 3) funds received from the management and disposition of assets of the FRF; 4) the FRF’s portion of liquidating dividends paid by FRF receiverships; and 5) interest earned on one-day U.S. Treasury investments purchased with proceeds of 3) and 4). If these sources are insufficient to satisfy the liabilities of the FRF, payments will be made from the U.S. Treasury in amounts necessary, as are appropriated by Congress, to carry out the objectives of the FRF.

To facilitate efforts to wind up the resolution activity of the FRF, Public Law 103-327 provides $827 million in funding to be available until expended. The FRF received $165 million under this appropriation on November 2, 1995. In addition, Public Law 104-208 authorized the use by the Department of Justice of $26.1 million of the original $827 million in funding, thus reducing the amount available to be expended to $635.9 million.

FIRREA established an Inspector General for the RTC and authorized appropriations necessary for the operation of the Office of the Inspector General (OIG). These appropriated funds are used to offset the operating expenses incurred by the OIG, which totalled $1.6 million during 1996. The appropriation authority expired as of September 30, 1996. The OIG received $152.3 million of appropriated funds from the U.S. Treasury since it was established.

General
These financial statements pertain to the financial position, results of operations and cash flows of the FRF and are presented in accordance with generally accepted accounting principles (GAAP). These statements do not include reporting for assets and liabilities of closed insured thrift institutions for which the FRF acts as receiver or liquidating agent. Periodic and final accountability reports of the FRF’s activities as receiver or liquidating agent are furnished to courts, supervisory authorities and others as required.

The statutorily-mandated merger of the RTC into the FRF as of January 1, 1996 resulted in a significant, one-time transfer of assets and liabilities. For this reason, providing comparative information would be impractical on a fully consistent basis of accounting. Accordingly, we have presented FRF financial statements for 1996 only.

Use of Estimates
The preparation of the FRF’s financial statements in conformity with GAAP requires FDIC management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates. Where it is reasonably possible that changes in estimates will cause a material change in the financial statements in the near term, the nature and extent of such changes in estimates have been disclosed.

Cash and Cash Equivalents
The FRF considers cash equivalents to be short-term, highly liquid investments with original maturities of three months or less.

Allowance for Losses on Receivables from Thrift Resolutions and Investment in Corporate Owned Assets
The FRF records as a receivable the amounts advanced and/or obligations incurred for resolving troubled and failed thrifts. The FRF also records as an asset the amounts advanced for investment in corporate owned assets. Any related allowance for loss represents the difference between the funds advanced and/or obligations incurred and the expected repayment. The latter is based on estimates of discounted cash recoveries from the assets of assisted or failed thrift institutions, net of all estimated liquidation costs. Estimated cash recoveries also include dividends and gains on sales from equity instruments acquired in resolution transactions.

Estimated Liabilities for Assistance Agreements
The FRF establishes an estimated liability for probable future assistance payable to acquirers of troubled thrifts under its financial assistance agreements.

Litigation Losses
The FRF accrues, as a charge to current period operations, an estimate of probable losses from litigation. The FDIC’s Legal Division recommends these estimates on a case-by-case basis. The litigation loss estimates related to the FRF in its corporate capacity are included in the “Estimated liability for: Litigation losses.” The litigation loss estimates related to receiverships are included in the allowance for losses for “Receivables from thrift resolutions, net.”

Receivership Operations
The FDIC is responsible for controlling and disposing of the assets of failed institutions in an orderly and efficient manner. The assets, and the claims against them, are accounted for separately to ensure that liquidation proceeds are distributed in accordance with applicable laws and regulations. Also, the income and expenses attributable to receiverships are accounted for as transactions of those receiverships. Liquidation expenses incurred by the FRF on behalf of the receiverships are recovered from those receiverships.

Cost Allocations Among Funds
Certain operating expenses (including personnel, administrative and other indirect expenses) not directly charged to each fund under the FDIC’s management are allocated on the basis of the relative degree to which the operating expenses were incurred by the funds.

The FDIC includes the cost of buildings used in operations in the BIF’s financial statements. The BIF charges the FRF a rental fee representing an allocated share of its annual depreciation. The cost of furniture, fixtures and equipment purchased by the FDIC on behalf of the three funds under its administration is allocated among these funds on a pro rata basis. The FRF expenses its share of these allocated costs at the time of acquisition because of their immaterial amounts.

Postretirement Benefits Other Than Pensions
The FDIC established an entity to provide the accounting and administration of postretirement benefits on behalf of the FRF, the BIF, and the SAIF. The FRF funds its liabilities for these benefits directly to the entity.

Disclosure about Recent Financial Accounting Standards Board Pronouncements
The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 125, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” in June 1996, effective for transactions occurring after December 31, 1996. The FRF will generally be unaffected by its provisions since most transactions subject to SFAS 125 occur at the receivership level and not at the fund level. To the extent that the FRF may be affected, the FDIC’s current accounting practices are consistent with the rules contained in SFAS 125. Other recent pronouncements issued by the FASB have been adopted or are either not applicable or not material to the financial statements.

Wholly Owned Subsidiary
The Federal Asset Disposition Association (FADA) is a wholly owned subsidiary of the FRF. The FADA was placed in receivership on February 5, 1990. However, due to outstanding litigation, a final liquidating dividend to the FRF will not be made until the FADA’s litigation is settled or dismissed. The investment in the FADA is accounted for using the equity method and is included in “Other assets, net” (Note 6).

Related Parties
National Judgements, Deficiencies, and Charge-offs Joint Venture Program. The former RTC purchased assets from receiverships, conservatorships, and their subsidiaries to facilitate the sale and/or transfer of selected assets to several Joint Ventures in which the former RTC retained a financial interest.

Limited Partnership Equity Interests. Former RTC receiverships were holders of limited partnership equity interests as a result of various RTC sales programs which included the National Land Fund, Multiple Investor Fund, N-Series and S-Series programs.

The nature of other related parties and descriptions of other related party transactions are disclosed throughout the financial statements and footnotes.

The FRF’s investment in corporate owned assets is comprised of amounts that: 1) the former FSLIC and the former RTC paid to purchase assets from troubled or failed thrifts and 2) the FRF pays to acquire receivership assets, terminate receiverships and purchase assets covered under assistance agreements. The majority of these assets are real estate and mortgage loans.

The methodology used to derive the allowance for losses for corporate owned assets is the same as that for receivables from thrift resolutions.

The FRF recognizes income and expenses on these assets. Income consists primarily of the portion of collections on performing mortgages related to interest earned. Expenses are recognized for administering the management and liquidation of these assets.

Assistance Agreements
The “Estimated liabilities for: Assistance agreements” represents, on a discounted basis, an estimate of future assistance payments to acquirers of troubled thrift institutions. The dollar amount before discounting was $18 million and $91 million, as of December 31 and January 1, 1996, respectively. The discount rates applied as of December 31 and January 1, 1996 were 5.6 percent and 5.5 percent, respectively, based on U.S. money rates for federal funds.

The number of assistance agreements outstanding as of December 31 and January 1, 1996 were 36 and 47, respectively. The last agreement is scheduled to expire in July 2000.

Litigation Losses
The FRF records an estimated loss for unresolved legal cases to the extent those losses are considered to be probable in occurrence and reasonably estimable in amount. In addition, the FDIC’s Legal Division has determined that losses from unresolved legal cases totaling $265 million are reasonably possible. This includes $12 million in losses for the FRF in its corporate capacity and $253 million in losses for the FRF related to receiverships (see Note 2).

There exists an additional category of contingencies with respect to FRF that arises from supervisory goodwill and other capital forbearances granted to the acquirers of troubled thrifts by the Federal Home Loan Bank Board in the 1980’s. Subsequently, FIRREA imposed minimum capital requirements on thrifts and limited the use of supervisory goodwill and other forbearances to meet these capital requirements. There are currently approximately 120 cases pending which result from the elimination of supervisory goodwill and forbearances.

To date, one of these cases litigated in the district court has resulted in a final judgment of $6 million against FDIC, which FDIC paid from FRF in accordance with the court’s order. There is a second district court case to which FDIC is a party defendant where a judgment of $26.9 million (plus post judgment interest) has been entered and for which a reserve has been established (the judgment is on appeal to the court of appeals). The remainder of these cases are pending in the Court of Federal Claims with the United States as the named defendant. FDIC believes that judgments in such cases are properly paid from the Judgment Fund, a permanent, indefinite appropriation established by 31 U.S.C. 1304. However, whether and the extent to which FRF will be the source for paying other judgments in such cases is uncertain.

Eligible FDIC employees (i.e., all permanent and temporary employees with appointments exceeding one year) are covered by either the Civil Service Retirement System (CSRS) or the Federal Employee Retirement System (FERS). The CSRS is a defined benefit plan, which is offset with the Social Security System in certain cases. Plan benefits are determined on the basis of years of creditable service and compensation levels. The CSRS-covered employees also can contribute to the tax-deferred Federal Thrift Savings Plan (TSP).

The FERS is a three-part plan consisting of a basic defined benefit plan that provides benefits based on years of creditable service and compensation levels, Social Security benefits and the TSP. Automatic and matching employer contributions to the TSP are provided up to specified amounts under the FERS.

Eligible FDIC employees also may participate in an FDIC-sponsored tax-deferred savings plan with matching contributions. The FRF pays its share of the employer’s portion of all related costs.

Although the FRF contributes a portion of pension benefits for eligible employees, it does not account for the assets of either retirement system. The FRF also does not have actuarial data for accumulated plan benefits or the unfunded liability relative to eligible employees. These amounts are reported and accounted for by the U.S. Office of Personnel Management. The liability to employees for accrued annual leave is approximately $13.7 million and $26.1 million at December 31 and January 1, 1996, respectively.

The FDIC provides certain health, dental and life insurance coverage for its eligible retirees, the retirees’ beneficiaries and covered dependents. Retirees eligible for health and/or life insurance coverage are those who have qualified due to: 1) immediate enrollment upon appointment or five years of participation in the plan and 2) eligibility for an immediate annuity. Dental coverage is provided to all retirees eligible for an immediate annuity.

The FDIC is self-insured for hospital/medical, prescription drug, mental health and chemical dependency coverage. Additional risk protection was purchased from Aetna Life Insurance Company through stop-loss and fiduciary liability insurance. All claims are administered on an administrative services only basis with the hospital/medical claims administered by Aetna Life Insurance Company, the mental health and chemical dependency claims administered by OHS Foundation Health Psychcare Inc., and the prescription drug claims administered by Caremark.

The life insurance program, underwritten by Metropolitan Life Insurance Company, provides basic coverage at no cost to retirees and allows converting optional coverages to direct-pay plans. Dental care is underwritten by Connecticut General Life Insurance Company and provides coverage at no cost to retirees.

The FRF expensed $3.1 million for net periodic postretirement benefit costs for the year ended December 31, 1996. For measurement purposes, the FDIC assumed the following: 1) a discount rate of 5.75 percent; 2) an average long-term rate of return on plan assets of 5.75 percent; 3) an increase in health costs in 1996 of 10.75 percent (inclusive of general inflation of 3.00 percent), decreasing to an ultimate rate in the year 2000 of 7.75 percent; and 4) an increase in dental costs in 1996 and thereafter of 4.00 percent (in addition to general inflation). Both the assumed discount rate and health care cost rate have a significant effect on the amount of the obligation and periodic cost reported.

If the health care cost rate was increased one percent, the accumulated postretirement benefit obligation as of December 31, 1996, would have increased by 20.4 percent. The effect of this change on the aggregate of service and interest cost for 1996 would be an increase of 26.2 percent.

Securitization Reserve Fund
In order to maximize the return from the sale or disposition of assets and to minimize the realized loss, RTC engaged in numerous securitization transactions. Through 1996, the RTC sold through its mortgage-backed securities program $42.4 billion of receivership, conservatorship and Corporate loans to various trusts which issued regular pass-through certificates.

To increase the likelihood of full and timely distributions of interest and principal to the holders of the regular pass-through certificates, and thus the marketability of such certificates, a portion of the proceeds from the sale of the certificates was placed in credit enhancement reserve funds (reserve funds) to cover future credit losses with respect to the loans underlying the certificates. The reserve funds’ structure limits the receivership exposure from credit losses on loans sold through the FRF securitization program to the balance of the reserve funds. The initial balances of the reserve funds are reduced for claims paid and recovered reserves.

In October 1996, the reserve funds and related allowance to cover future estimated losses on the reserve were transferred from the receiverships to FRF in its corporate capacity. The $5.4 billion transferred to FRF was exactly offset by amounts owed by the receiverships to FRF; thus, there was no change in FRF’s net assets as a result of this transaction.

Through December 1996, the amount of claims paid was approximately 14% of the initial reserve funds. At December 31 and January 1, 1996, reserve funds related to the RTC securitization program totalled $6.3 billion and $6.8 billion, respectively. At December 31 and January 1, 1996, the allowance for estimated future losses which would be paid from the securitization fund totalled $.5 billion and $1.1 billion, respectively.

Representations and Warranties
The RTC provided guarantees, representations and warranties on approximately $114 billion in unpaid principal balance of loans sold and approximately $157 billion in unpaid principal balance of loans under servicing right contracts which had been sold.

In 1996, the FRF estimated Corporate losses related to the representations and warranties claims as part of the FRF’s allowances for losses. The allowance for these losses was $494 and $810 million as of December 31, 1996 and January 1, 1996, respectively. Future losses on representations and warranties could significantly increase or decrease over the remaining life of the loans that were sold, which could be as long as 20 years.

Letters of Credit
The RTC had adopted special policies for outstanding conservatorship and receivership collateralized letters of credit. These policies enabled the RTC to minimize the impact of its actions on capital markets. In most cases, these letters of credit were used to guarantee tax exempt bonds issued by state and local housing authorities or other public agencies to finance housing projects for low and moderate income individuals or families. As of December 31, 1996, there were pledged securities as collateral of $130 million to honor these letters of credit. The corporation established an estimated liability against this pledged collateral of $25 million.

Leases
The FRF’s allocated share of FDIC’s lease commitments totals $61.9 million for future years. The lease agreements contain escalation clauses resulting in adjustments, usually on an annual basis. The allocation to the FRF of FDIC’s future lease commitments is based upon current relationships of the workloads among FRF, BIF and SAIF. Changes in the relative workloads among the three funds in future years could change the amount of FDIC’s lease payments which will be allocated to FRF. The FRF recognized leased space expense of $32.8 million for the year ended December 31, 1996.

As of December 31, 1996, the FRF had $81.3 and $3.6 billion in gross receivables from thrift resolutions and investment in corporate owned assets, respectively. An allowance for loss of $76.9 and $3.4 billion, respectively, has been recorded against these receivables. Of the total receivables, $29 billion was attributable to institutions in Texas, $11.4 billion was attributable to institutions located in California, $5.7 billion was attributable to institutions located in Florida and $5.1 billion was attributable to institutions located in Arizona. The liquidating entities’ ability to make repayments to FRF is largely influenced by the economy of the area in which they are located.

Additionally, the FRF had $13 million in assistance agreement covered assets, net of estimated capital loss.

Cash equivalents are short-term, highly liquid investments and are shown at current value. The carrying amount of short-term receivables, accounts payable, liabilities incurred from thrift resolutions and the estimated liabilities for assistance agreements approximates their fair market value. This is due to their short maturities or comparisons with current interest rates.

The net receivable from thrift resolutions primarily involves the FRF’s subrogated claim arising from payments to insured depositors. The receivership assets which will ultimately be used to pay the corporate subrogated claim are valued using discount rates which include consideration of market risk. These discounts ultimately affect the FRF’s allowance for loss against the net receivable from thrift resolutions. Therefore the corporate subrogated claim indirectly includes the effect of discounting and should not be viewed as being stated in terms of nominal cash flows.

Although the value of the corporate subrogated claim is influenced by valuation of receivership assets, such receivership valuation is not equivalent to the valuation of the corporate claim. Since the corporate claim is unique, not intended for sale to the private sector, and has no established market, it is not practicable to estimate its fair market value.

The FDIC believes that a sale to the private sector of the corporate claim would require indeterminate, but substantial discounts for an interested party to profit from these assets because of credit and other risks. In addition, the timing of receivership payments to the FRF on the subrogated claim do not necessarily correspond with the timing of collections on receivership assets. Therefore the effect of discounting used by receiverships should not necessarily be viewed as producing an estimate of market value for the net receivables from thrift resolutions.

Like the corporate subrogated claim, the securitization credit reserves involve an asset which is unique, not intended for sale to the private sector, and has no established market. There, it is not practicable to estimate the fair market value of the securitization credit reserves. These reserves are carried at their net realizable value which is the book value of the reserves less the related allowance for loss (see Note 14).

The majority of the net investment in corporate owned assets (except real estate) is comprised of various types of financial instruments (investments, loans, accounts receivable, etc.) acquired from failed thrifts. Like receivership assets, corporate owned assets are valued using discount rates which include consideration of market risk. However, corporate owned assets do not involve the unique aspects of the corporate subrogated claim, and therefore the discounting can be viewed as producing a reasonable estimate of fair market value.

In the first quarter of 1997, management negotiated with the National Treasury Employees Union (NTEU) a change in employee health benefits. This change involves a conversion from the FDIC health plan to the Federal Employees Health Benefits (FEHB) plan. This conversion will involve all employees with five or more years until retirement eligibility.

Assuming enabling legislation is also passed, the conversion will also affect all retirees and employees within five years of retirement. Management does not expect the conversion, which will become effective on January 1,1998, to result in an accounting loss to the FRF.