Federal Deposit
Insurance Corporation

More recently, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) was enacted to reform, recapitalize and consolidate the federal deposit insurance system. The FIRREA created the Bank Insurance Fund (BIF), the Savings Association Insurance Fund (SAIF) and the FSLIC Resolution Fund (FRF). It also designated the FDIC as the administrator of these three funds. All three funds are maintained separately to carry out their respective mandates.

The BIF and SAIF are insurance funds responsible for protecting depositors in operating banks and thrift institutions from loss due to failure of the institution. The FRF is a resolution fund responsible for winding up the affairs of the former Federal Savings and Loan Insurance Corporation (FSLIC) and liquidating the assets and liabilities transferred from the former Resolution Trust Corporation (RTC).

Pursuant to FIRREA, an active institution’s insurance fund membership and primary federal supervisor are generally determined by the institution’s charter type. Deposits of BIF-member institutions are mostly insured by the BIF; BIF members are predominantly commercial and savings banks supervised by the FDIC, the Office of the Comptroller of the Currency, or the Federal Reserve. Deposits of SAIF-member institutions are mostly insured by the SAIF; SAIF members are predominantly thrifts supervised by the Office of Thrift Supervision (OTS). The Oakar amendment to the Federal Deposit Insurance Act (FDI Act) allows BIF and SAIF members to acquire deposits insured by the other insurance fund without changing insurance fund coverage for the acquired deposits.

Other significant legislation includes the Omnibus Budget Reconciliation Act of 1990 (1990 OBR Act) and the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). These acts made changes to the FDIC’s assessment authority (see Note 10) and borrowing authority (see “Operations of the BIF” below). The FDICIA also requires the FDIC to: 1) resolve troubled institutions in a manner that will result in the least possible cost to the deposit insurance funds and 2) maintain the insurance funds at 1.25 percent of insured deposits or a higher percentage as circumstances warrant.

Recent Legislation
The Deposit Insurance Funds Act of 1996 (DIFA 1996) was enacted to provide for: 1) the capitalization of the SAIF to its designated reserve ratio of 1.25 percent by means of a one-time special assessment on SAIF-insured deposits; 2) the expansion of the assessment base for payments of the interest on obligations issued by the Financing Corporation (FICO) to include all FDIC-insured institutions, i.e., banks and thrifts; 3) beginning January 1, 1997, the imposition of a FICO assessment rate for BIF-assessable deposits that is one-fifth of that paid by SAIF-assessable deposits; 4) the payment of the approximately $790 million annual FICO interest obligation on a pro rata basis between banks and thrifts on the earlier of December 31, 1999 or the date on which the last savings association ceases to exist; 5) the refund of amounts in the BIF in excess of the designated reserve ratio with such refund not to exceed the previous semi-annual assessment; 6) authorization of BIF assessments only if needed to maintain the fund at the designated reserve ratio; and 7) the merger of the BIF and the SAIF on January 1, 1999, if no insured depository institution is a savings association on that date.

The FICO, established under the Competitive Banking Act of 1987, is a mixed-ownership government corporation whose sole purpose was to function as a financing vehicle for the FSLIC.

Operations of the BIF
The primary purpose of the BIF is to: 1) insure the deposits and protect the depositors of BIF-insured banks and 2) resolve failed banks, including managing and liquidating their assets. In addition, the FDIC, acting on behalf of the BIF, examines state-chartered banks that are not members of the Federal Reserve System and provides and monitors assistance to troubled banks.

The BIF is primarily funded from the following sources:1) interest earned on investments in U.S. Treasury obligations; 2) BIF assessment premiums; 3) income earned on and funds received from the management and disposition of assets acquired from failed banks; and 4) U.S. Treasury and Federal Financing Bank (FFB) borrowings, if necessary.

The 1990 OBR Act established the FDIC’s authority to borrow working capital from the FFB on behalf of the BIF and the SAIF. The FDICIA increased the FDIC’s authority to borrow for insurance losses from the U.S. Treasury, on behalf of the BIF and the SAIF, from $5 billion to $30 billion.

The FDICIA also established a limitation on obligations that can be incurred by the BIF, known as the maximum obligation limitation (MOL). At December 31, 1996, the MOL for the BIF was $49 billion.

Use of Estimates
The preparation of the BIF’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 BIF considers cash equivalents to be short-term, highly liquid investments with original maturities of three months or less.

U.S. Treasury Obligations
Securities are intended to be held to maturity and are shown at book value. Book value is the face value of securities plus the unamortized premium or less the unamortized discount. Amortizations are computed on a daily basis from the date of acquisition to the date of maturity. Interest is calculated on a daily basis and recorded monthly using the effective interest method.

Allowance for Losses on Receivables from Bank Resolutions and Investment in Corporate Owned Assets
The BIF records as a receivable the amounts advanced and/or obligations incurred for resolving troubled and failed banks. The BIF 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 assets of assisted or failed banks, net of all estimated liquidation costs.

Litigation Losses
The BIF 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 BIF in its corporate capacity are included in the “Estimated liabilities for: Litigation losses.” The litigation loss estimates related to receiverships are included in the allowance for losses for “Receivables from bank 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 BIF 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 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 BIF 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 BIF, the SAIF and the FRF. The BIF funds its liabilities for these benefits directly to the entity.

Disclosure about Recent Financial AccountingStandards 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 BIF 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 BIF 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.

Depreciation
The FDIC has designated the BIF administrator of buildings owned and used in its operations. Consequently, the BIF includes the cost of these assets in its financial statements and provides the necessary funding for them. The BIF charges other funds a rental fee representing an allocated share of its annual depreciation expense.

The Washington, D.C., office buildings and the L. William Seidman Center in Arlington, Virginia, are depreciated on a straight-line basis over a 50-year estimated life. The San Francisco condominium offices are depreciated on a straight-line basis over a 35-year estimated life.

Related Parties
The nature of related parties and a description of related party transactions are disclosed throughout the financial statements and footnotes.

Reclassifications
Reclassifications have been made in the 1995 financial statements to conform to the presentation used in 1996.

The FDIC, as receiver for failed banks, engages in a variety of strategies at the time of failure to maximize the return from the sale or disposition of assets and to minimize realized losses. A failed bank acquirer can purchase selected assets at the time of resolution and assume full ownership, benefit and risk related to such assets. The receiver may also engage in other types of transactions as circumstances warrant. As described in Note 2, an allowance for loss is established against the receivable from bank resolutions.

As of December 31, 1996 and 1995, the BIF, in its receivership capacity, held assets with a book value of $7 billion and $10 billion, respectively. These assets represent a significant source of repayment of receivables from bank resolutions. The estimated cash recoveries from the management and disposition of these assets (excluding cash and miscellaneous receivables of $3.9 billion at December 31, 1996 and $2.1 billion at December 31, 1995) used to derive the allowance for losses are based in part on a statistical sampling of receivership assets. The potential sampling error is not material to the BIF’s financial statements. These estimated recoveries are regularly evaluated, but remain subject to uncertainties because of changing economic conditions. These factors could affect the BIF’s and other claimants’ actual recoveries from the level currently estimated.

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

The BIF 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.

The estimated liabilities for anticipated failure of insured institutions as of December 31, 1996 and 1995, were $75 million and $279 million, respectively. The estimated liability is derived in part from estimates of recoveries from the management and disposition of the assets of these probable bank failures. Therefore, they are subject to the same uncertainties as those affecting the BIF’s receivables from bank resolutions (see Note 4). This could affect the ultimate costs to the BIF from probable bank failures.

There are other banks where the risk of failure is less certain, but still considered reasonably possible. Should these banks fail the BIF would incur additional losses of about $160 million.

The accuracy of these estimates will largely depend on future economic conditions. In addition, FDIC considers probable losses in setting assessment rates and, as circumstances warrant, may increase assessment rates to recover some or all losses due to anticipated bank failures.

Assistance Agreements
The estimated liabilities for assistance agreements resulted from several large transactions where problem assets were purchased by an acquiring institution under an agreement that calls for the FDIC to absorb credit losses and to pay related costs for funding and asset administration plus an incentive fee.

Asset Securitization Guarantee
As part of the FDIC’s efforts to maximize the return from the sale or disposition of assets and minimize losses from bank resolutions, the FDIC has securitized some receivership assets. To facilitate the securitizations, the FDIC’s BIF provided Limited Guarantees to cover certain losses on the securitized assets up to a specified maximum. In exchange for backing the limited guarantee, the BIF received assets from the receiverships in an amount equal to the expected exposure under the guarantee. The deals were initially structured so that the BIF would neither profit nor suffer a loss as a result of the limited guarantees.

At December 31, 1996 and 1995, the BIF had an estimated liability under the guarantees of $44 million and $126 million, respectively.

During 1996 the BIF returned to receiverships $91.6 million in cash (including interest of $8.4 million) received for backing the limited guarantee. The BIF made this refund as a result of lowering the estimate of expected exposure under one of the guarantees. The following chart summarizes the BIF’s remaining potential exposure under the guarantees.

In May 1995, the BIF reached the FDICIA mandated capitalization level of 1.25 percent of insured deposits.

The DIFA 1996 (see Note 1) provided, among other things, for the elimination of the mandatory minimum assessment formerly provided for in the FDI Act, and for the expansion of the assessment base for payments on the interest on obligations issued by FICO to include all FDIC-insured institutions, including banks. Beginning January 1, 1997, banks will start paying a FICO-assessment. The FICO-assessment rate on BIF-assessable deposits will be one-fifth of the rate paid on SAIF-assessable deposits. On the earlier of December 31, 1999, or the date on which the last savings association ceases to exist, the approximately $790 million annual FICO interest obligation will be paid on a pro rata basis between banks and thrifts.

The FICO assessment will have no financial effect on the BIF since the FICO claim will be assessed separately from the regular assessment, and the FICO assessment is imposed on banks and not on the BIF. The FDIC as administrator of the BIF is acting solely as an agent for the FICO to collect and remit the FICO assessment to the FICO.

The FDIC uses a risk-based assessment system that charges higher rates to those institutions that pose greater risks to the BIF. To arrive at a risk-based assessment for a particular institution, the FDIC places each institution in one of nine risk categories using a two-step process based first on capital ratios and then on other relevant information. The FDIC Board of Directors (Board) reviews premium rates semiannually. The average assessment rate for 1996 was 0.24 cents per $100 of insured deposits.

On November 26, 1996, the FDIC Board of Directors voted to retain the BIF assessment schedule of 0 to 27 cents per $100 of insured deposits (annual rates) for the first semiannual period of 1997.

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 BIF pays its share of the employer’s portion of all related costs.

Although the BIF contributes a portion of pension benefits for eligible employees, it does not account for the assets of either retirement system. The BIF 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.

Due to a substantial decline in the FDIC’s workload, the Corporation developed a staffing reduction program, a component of which is a voluntary separation incentive plan, or buyout. To date, two corporate-wide buyout plans have been offered to eligible employees. The first buyout plan did not have a material financial effect on the BIF, and management believes the second buyout plan will also not have a material financial effect on the fund.

The liability to employees for accrued annual leave is approximately $38.9 million and $43.4 million at December 31, 1996 and 1995, respectively.

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 BIF expensed $6.1 million and $18.8 million for net periodic postretirement benefit costs for the years ended December 31, 1996 and 1995, respectively. For measurement purposes for 1996, 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 2000 of 7.75 percent; and 4) an increase in dental costs for 1997 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.

The net receivable from bank resolutions primarily involves the BIF’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 BIF’s allowance for loss against the net receivable from bank 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 BIF 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 bank resolutions.

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 banks. 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.

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 BIF.