To the Board of Directors
The Federal Deposit Insurance Corporation
In accordance with Section 17 of the Federal Deposit Insurance Act, as amended, we are responsible for conducting audits of the financial statements of the two funds administered by the Federal Deposit Insurance Corporation (FDIC). In our audits of the Deposit Insurance Fund’s (DIF) and the FSLIC Resolution Fund’s (FRF) financial statements for 2008 and 2007, we found
the financial statements as of and for the year ended December 31, 2008, and 2007, are presented fairly, in all material respects, in conformity with U.S. generally accepted accounting principles;
FDIC had effective internal control over financial reporting (including safeguarding assets) and compliance with laws and regulations for each fund as of December 31, 2008; and
no reportable noncompliance with laws and regulations we tested.
The following sections discuss in more detail (1) these conclusions; (2) our audit objectives, scope, and methodology; and (3) agency comments and our evaluation.
Opinion on DIF’s Financial Statements
The financial statements, including the accompanying notes, present fairly, in all material respects, in conformity with U.S. generally accepted accounting principles, DIF’s assets, liabilities, and fund balance as of December 31, 2008, and 2007, and its income and fund balance and its cash flows for the years then ended.
As discussed in note 7 to DIF’s financial statements, FDIC’s insured financial institutions faced increased challenges in 2008. Financial market disruptions evolved into a crisis that impacted the condition of the industry as a whole and the soundness of some FDIC-insured institutions. Declining housing and equity prices, financial market turmoil, and deteriorating economic conditions exerted significant stress on banking industry performance, contributing to the failure of some institutions and threatening the viability of others, particularly those having significant exposure to high risk residential mortgages or residential construction loans. In 2008, 25 insured institutions with combined assets of about $361 billion failed, costing the DIF an estimated $18 billion. Further, at year-end, the DIF recognized losses totaling an estimated $24 billion associated with insured institutions the banking regulators have determined are likely to fail. Supervisory and market data suggest that the banking industry will continue to experience elevated levels of stress over the coming year. In addition to the losses reflected on the DIF’s financial statements as of December 31, 2008, FDIC has identified additional risk that could result in further estimated losses to the DIF of $25.1 billion should potentially vulnerable insured institutions ultimately fail. FDIC continues to evaluate the ongoing risks to affected institutions in light of the deterioration in economic and financial conditions, and the effect of such risks on the DIF. Actual losses, if any, will largely depend on future economic and market conditions and could differ materially from FDIC’s estimates. As discussed in note 15 to DIF’s financial statements, through May 20, 2009, 33 institutions have failed during 2009 at an estimated cost to the DIF of $4.5 billion.
At December 31, 2008, the DIF’s fund balance was $17.3 billion, and its ratio of reserves to estimated insured deposits was 0.36 percent. In accordance with the Federal Deposit Insurance Reform Act of 2005, FDIC adopted a restoration plan in October 2008 calling for an increase in the assessment rates charged to insured institutions to replenish the fund’s reserves to the minimum ratio of 1.15 percent of insured deposits within a 5-year period. In March 2009, the FDIC amended the restoration plan to extend to 7 years the period to replenish the DIF’s reserves to the statutory minimum ratio, and announced its intent to charge an emergency special assessment to raise assessment revenue to help meet the requirements of the restoration plan.2 In addition to assessment revenue, the DIF has other resources available to carry out its insurance responsibilities. At December 31, 2008, the DIF had $27.9 billion in investments in U.S. Treasury obligations that provide a ready source of funds to carry out its insurance activities. In addition, as discussed in note 1 to DIF’s financial statements, FDIC has a note agreement with the Federal Financing Bank enabling it to borrow up to $100 billion, and, until recently, it had authority to borrow up to $30 billion from the U.S. Treasury. However, the actual amount that can be borrowed from these entities is limited by a statutory formula. Application of this formula, based on the DIF’s December 31, 2008 financial statements, effectively limits the amount DIF can borrow from these sources to $69 billion. Recently enacted legislation increased its borrowing authority with the U.S. Treasury to up to $100 billion, and provides for additional authority to temporarily increase this amount to up to $500 billion if such amounts are deemed necessary for DIF to carry out its insurance responsibilities.3
The deteriorating economic and market conditions in 2008 resulted in the federal government taking extraordinary measures to avoid further adverse effects on economic conditions and financial stability. The Department of the Treasury, in consultation with the President and upon recommendation of the boards of the FDIC and the Federal Reserve, invoked a provision of the Federal Deposit Insurance Corporation Improvement Act of 1991—the “systemic risk” provision—during 2008 to counter identified systemwide crises in the nation’s financial sector. As discussed in note 14 to DIF’s financial statements, following a systemic risk determination in October 2008, FDIC established the Temporary Liquidity Guarantee Program, consisting of a (1) Debt Guarantee Program, under which FDIC would guarantee newly issued senior unsecured debt up to prescribed limits issued by insured institutions and certain holding companies, and (2) Transaction Account Guarantee Program, under which FDIC would provide unlimited coverage for non-interest bearing transaction accounts held by insured institutions. FDIC charges fees to participants that are to be used to cover any losses under both guarantee programs. As of December 31, 2008, the amount of debt guaranteed by FDIC under the Debt Guarantee Program was $224 billion, while FDIC’s maximum exposure under the Transaction Account Guarantee Program was $680 billion. Consequently, the total exposure under the Temporary Liquidity Guarantee Program was $904 billion as of December 31, 2008. Another systemic risk determination, made in November 2008 and finalized in January 2009, involved FDIC, in conjunction with the U.S. Treasury and the Federal Reserve, providing guarantees against potential losses on a portfolio of Citigroup’s assets in exchange for 3,025 shares of preferred stock with a liquidation preference value of $1 million per share. Under the agreement, FDIC’s maximum exposure under the guarantee is $10 billion. Subsequent to 2008, FDIC, in conjunction with the U.S. Treasury and the Federal Reserve, reached agreement to provide guarantees against potential losses on a portfolio of Bank of America’s assets in exchange for a projected liquidation preference amount of $1 billion in preferred stock and warrants. Under the tentative agreement, FDIC’s maximum exposure under the guarantee would be $2.5 billion.
On March 23, 2009, the Treasury announced the Public-Private Investment Program, under which it will make targeted investments in multiple Public-Private Investment Funds (PPIF) that will purchase qualifying real-estate assets from participating financial institutions. Under this program, the objective of which is to remove troubled real-estate loans and securities backed by loan portfolios from the balance sheets of financial institutions to stimulate the flow of credit, the PPIFs will purchase and manage pools of such assets, using a combination of private sector and Treasury-investment equity to purchase the assets. As discussed in note 15 to DIF’s financial statements, under the Legacy Loans component of this program, FDIC will provide a guarantee of the PPIF’s debt financing to purchase the loans, in exchange for a debt guarantee fee. The FDIC guarantee will be collateralized by the PPIF loan pools. The total exposure to FDIC, and to the DIF, under this proposed program is unknown at this time.
Opinion on FRF’s Financial Statements
The financial statements, including the accompanying notes, present fairly, in all material respects, in conformity with U.S. generally accepted accounting principles, FRF’s assets, liabilities, and resolution equity as of December 31, 2008, and 2007, and its income and accumulated deficit and its cash flows for the years then ended.
Opinion on Internal Control
FDIC management maintained, in all material respects, effective internal control over financial reporting (including safeguarding assets) and compliance as of December 31, 2008, that provided reasonable assurance that misstatements, losses, or noncompliance material in relation to the financial statements for each fund would be prevented or detected on a timely basis. Our opinion is based on criteria established under 31 U.S.C. 3512 (c), (d), commonly known as the Federal Managers’ Financial Integrity Act (FMFIA).
We did identify certain control deficiencies during our 2008 audits. However, we do not consider these control deficiencies to be significant deficiencies.4 We will be reporting separately to FDIC management on these matters.
Compliance with Laws and Regulations
Our tests for compliance with selected provisions of laws and regulations disclosed no instances of noncompliance that would be reportable under U.S. generally accepted government auditing standards. However, the objective of our audits was not to provide an opinion on overall compliance with laws and regulations. Accordingly, we do not express such an opinion.
Objectives, Scope, and Methodology
FDIC management is responsible for (1) preparing the annual financial statements in conformity with U.S. generally accepted accounting principles; (2) establishing, maintaining and assessing internal control to provide reasonable assurance that the broad control objectives of FMFIA are met and evaluating the effectiveness of internal control over financial reporting; and (3) complying with applicable laws and regulations.
We are responsible for obtaining reasonable assurance about whether (1) the financial statements are presented fairly, in all material respects, in conformity with U.S. generally accepted accounting principles, and (2) management maintained, in all material respects, effective internal control, the objectives of which are the following:
financial reporting—transactions are properly recorded, processed, and summarized to permit the preparation of financial statements in conformity with U.S. generally accepted accounting principles, and assets are safeguarded against loss from unauthorized acquisition, use, or disposition, and
compliance with laws and regulations—transactions are executed in accordance with laws and regulations that could have a direct and material effect on the financial statements.
We are also responsible for (1) expressing an opinion on FDIC’s internal control over financial reporting based on our audit and (2) testing compliance with selected provisions of laws and regulations that could have a direct and material effect on the financial statements.
In order to fulfill these responsibilities, we
examined, on a test basis, evidence supporting the amounts and disclosures in the financial statements;
assessed the accounting principles used and significant estimates made by management;
evaluated the overall presentation of the financial statements;
obtained an understanding of the entity and its operations, including its internal control related to financial reporting (including safeguarding assets) and compliance with laws and regulations;
assessed the risk that a material misstatement exists;
tested relevant internal controls over financial reporting and compliance, and evaluated the design and operating effectiveness of internal control based on the assessed risk;
considered FDIC’s process for evaluating and reporting on internal control based on criteria established by FMFIA;
tested compliance with certain laws and regulations, including selected provisions of the Federal Deposit Insurance Act, as amended, and the Federal Deposit Insurance Reform Act of 2005; and
performed such other procedures as we considered necessary in the circumstances.
We believe our audit provides a reasonable basis for our opinions.
We did not evaluate all internal controls relevant to operating objectives as broadly defined by FMFIA, such as those controls relevant to preparing statistical reports and ensuring efficient operations. We limited our internal control testing to controls over financial reporting and compliance. Because of inherent limitations in internal control, internal control may not prevent, or detect and correct, misstatements. We also caution that projecting our evaluation to future periods is subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with controls may deteriorate.
We did not test compliance with all laws and regulations applicable to FDIC. We limited our tests of compliance to those laws and regulations that we judged could have a direct and material effect on the financial statements for the year ended December 31, 2008. We caution that noncompliance may occur and not be detected by these tests and that such testing may not be sufficient for other purposes.
We performed our work in accordance with U.S. generally accepted government auditing standards.
FDIC Comments and Our Evaluation
In commenting on a draft of this report, FDIC’s Chief Financial Officer (CFO) reported the agency was pleased to receive unqualified opinions on the DIF and FRF financial statements and that we reported it had effective control over financial reporting and compliance with laws and regulations for each fund. FDIC’s CFO also stated that as FDIC commits additional resources to further the recovery of the financial markets and economy, the agency will continue to ensure that effective financial management remains a priority. Furthermore, the CFO added that FDIC recognizes the significance that internal control plays in an agency achieving its mission and goals, and therefore, will seek continual improvement in its internal control environment.
The complete text of FDIC’s comments is reprinted in appendix I.
Steven J. Sebastian
Financial Management and Assurance
May 20, 2009
2 Congress recently extended the restoration plan period to eight years. Pub. L. No. 111-22, div. A, title II, §204 (b) (May 20, 2009). back
3 Pub. L. No. 111-22, div. A, title II, §204 (c) (May 20, 2009). back
4 A significant deficiency is a control deficiency, or combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. A material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis. back