C. Office of Inspector General's Assessment of the Management and Performance Challenges Facing the FDIC
2009 Management and Performance Challenges
Under the Reports Consolidation Act, the OIG is required to identify the most significant management and performance challenges facing the Corporation and provide its assessment to the Corporation for inclusion in its annual performance and accountability report. The OIG conducts this assessment yearly and identifies a number of specific areas of challenge facing the Corporation at the time. In identifying the challenges, we consider the Corporation's overall program and operational responsibilities; financial industry, economic, and technological conditions and trends; areas of congressional interest and concern; relevant laws and regulations; the Chairman's priorities and corresponding corporate goals; and the ongoing activities to address the issues involved. Taking time annually to reexamine the corporate mission and priorities as the OIG identifies the challenges helps in planning our work and directing OIG resources to key areas of risk.
Unprecedented events and turmoil in the economy and financial services industry over the past year and a half have impacted every facet of the FDIC's mission and operations and continue to pose challenges. In looking at the recent past and the current environment and anticipating to the extent possible what the future holds, the Office of Inspector General (OIG) believes the FDIC faces challenges in the areas listed below. While the Corporation's most pressing priority has been its continuing efforts to restore and maintain public confidence and stability, challenges have persisted in other areas as well. We would note in particular that the Corporation is devoting significant attention to carrying out its massive resolution and receivership workload, brought on by 140 financial institution failures over the past year, in contrast to 25 failures during 2008 and 3 in 2007. Further, the Chairman has indicated that the FDIC anticipates failures during 2010 to exceed the level in 2009. At the same time, as we pointed out last year, the FDIC faces challenges in maintaining the viability of the Deposit Insurance Fund (DIF), enhancing its supervision of financial institutions, protecting consumers, and managing its growing internal and contractor workforce and other corporate resources. The Corporation will continue to face daunting challenges as it carries out its longstanding mission, responds to emerging issues, and plays a key part in shaping the future of bank regulation.
Restoring and Maintaining Public Confidence and Stability in the Financial System
Importantly, and integral to maintaining confidence and stability in the financial system, notwithstanding the 140 failures of 2009, the FDIC stood behind its deposit insurance commitment, and no depositor lost a single penny of insured deposits. Additionally, over the past year, the FDIC played a key role, along with other regulators, the Congress, the Department of the Treasury, financial institutions, and other stakeholders in a number of temporary financial stability programs that were formed to address crisis conditions. These included the Temporary Liquidity Guarantee Program, Troubled Asset Relief Program, and loan modification programs, to name a few. Some of these have wound down, others are ongoing. The fulfillment of the FDIC's insurance commitment and the successful implementation of programs designed to ensure the flow of credit, strengthen the financial system, and provide aid to homeowners and small businesses have gone a long way in helping to restore confidence and stability in the financial system. Going forward, the Corporation will need to continue to remain poised to address new challenges. For example, emerging problems in the commercial real estate (CRE) sector will likely require attention. While residential real estate markets suffered first during the recent crisis, problems on the commercial side came about later. Sales of commercial real estate slowed dramatically in 2008 and 2009, as vacancy rates and rental rates declined significantly. CRE price declines have also been larger on average than declines in home values, with CRE price indices down by over 40 percent from their fall 2007 high point. The sharp decline is attributable in part to higher required rates of return on the part of investors and deterioration in the availability of credit for commercial real estate financing. Banks will likely increasingly feel the repercussions of stress in the CRE sector in the months ahead, and the FDIC will need to closely monitor the impact of such problems on the institutions it regulates and insures.
Over the past year, the FDIC has also been a proponent of certain changes to the financial regulatory system to further stabilize and shore up confidence in the financial services industry. In that connection, the FDIC Chairman believes we need to move away from the concept of "too big to fail" and create a system of macro-prudential supervision for systemically important financial firms and other large/complex institutions to address the fundamental causes of the recent crisis. These entities make up a significant share of the banking industry's assets. Although the FDIC is not the primary federal regulator for these institutions, it holds significant responsibility as deposit insurer for all. The FDIC has expanded its own presence at such institutions through additional and enhanced on-site and off-site monitoring and oversight. As of the end of December 2009, its Large Insured Depository Institution program covered 109 institutions with total assets of more than $10 trillion. Early identification and remediation of issues that pose risks to the overall financial system will continue to be a challenging task.
In a related vein, the FDIC has also endorsed a resolution mechanism that can effectively address failed financial firms regardless of their size and complexity and assure that shareholders and creditors absorb losses without cost to the tax-payers. Such a mechanism would maintain financial market stability and minimize systemic consequences for the national and international economy. The Corporation may face challenges as it advocates for changes to the supervision and resolution of systemically important financial firms.
As the debate continues over these and other aspects of regulatory reform in the months ahead, the FDIC's continuous coordination and cooperation with the other federal regulators and parties throughout the banking and financial services industries will be critical. The FDIC, along with other regulators, will continue to be subject to increased scrutiny and possible corresponding regulatory reform proposals that may have a substantial impact on the regulatory entities and the programs and activities they currently operate.
Resolving Failed Institutions and Managing Receiverships
A fundamental part of the FDIC mission and perhaps the Corporation's most significant current challenge is efficiently handling the resolutions of failing FDIC-insured institutions and providing prompt, responsive, and effective administration of failing and failed financial institutions in its receivership capacity. The resolution process involves the complex process of valuing a failing federally insured depository institution, marketing it, soliciting and accepting bids for the sale of the institution, considering the least costly resolution method, determining which bid to accept, and working with the acquiring institution through the closing process. The receivership process, also demanding, involves performing the closing function at the failed bank; liquidating any remaining assets; and distributing any proceeds to the FDIC, the bank customers, general creditors, and those with approved claims.
The Corporation is now facing a resolution and receivership workload of huge proportion. One hundred forty institutions failed during 2009, with total assets at failure of $171.2 billion and total estimated losses to the Deposit Insurance Fund of approximately $35.6 billion. During 2009, the number of institutions on the FDIC's "Problem List" also rose to its highest level in 16 years. As of December 31, 2009, there were 702 insured institutions on the "Problem List," indicating a probability of more failures to come and an increased asset disposition workload. Total assets of problem institutions increased to $402.8 billion as of year-end 2009. As of the end of December 2009, the Division of Resolutions and Receiverships was managing 187 active receiverships, with assets totaling about $41 billion.
Of special note, the FDIC is retaining large volumes of assets as part of purchase and assumption agreements with institutions that are assuming the insured deposits of failed institutions. A number of the purchase and assumption agreements include shared-loss arrangements with other parties that involve pools of assets worth billions of dollars and that can extend up to 10 years. From a dollar standpoint, the FDIC's exposure is staggering: as of December 31, 2009, the Corporation was party to 93 shared loss agreements related to closed institutions, with initial covered assets of $126.4 billion. Because the assuming institutions are servicing the assets and the FDIC is reimbursing a substantial portion of the related losses and expenses, there is significant risk to the Corporation. Additionally, the FDIC is increasingly using structured sales transactions to sell assets to third parties that are not required to be regulated financial institutions. Such arrangements need to be closely monitored to ensure compliance with all terms and conditions of the agreements at a time when the FDIC's control environment is continuing to evolve.
It takes a substantial level of human resources to handle the mounting resolution and receivership workload, and effectively administering such a complex workforce will be challenging. DRR staffing grew from approximately 400 employees at the start of 2009 to the year-end staffing level of 1,158 full-time equivalents. The FDIC Board of Directors approved a further increase in the Division's staffing to 2,310 for 2010. Most of these new employees have been hired on non-permanent appointments with terms of up to 5 years. Additionally, over $1.8 billion will be available for contracting for receivership-related services during 2010, and by the end of 2009, DRR already employed over 1,500 contractor personnel. The significant surge in failed-bank assets and associated contracting activities will require effective and efficient contractor oversight management and technical monitoring functions. Bringing on so many contractors and new employees in a short period of time can strain personnel and administrative resources in such areas as employee background checks, which, if not timely and properly executed can compromise the integrity of FDIC programs and operations.
As the Corporation's workforce responds to institution failures and carries out its resolution and receivership responsibilities, it will face a number of challenges. It needs to ensure that related processes, negotiations, and decisions regarding the future status of the failed or failing institutions are marked by fairness, transparency, and integrity. It will be challenged in timely marketing failing institutions to qualified and interested potential bidders, selling assets, and maximizing potential values of failed bank franchises. Over time, these tasks may be even more difficult, given concentrations of assets in the same geographic area, a decreasing pool of interested buyers, and an inventory of less attractive or hard-to-sell assets. It is also possible that individuals or entities that may have been involved in previous institution failures could try to reenter the FDIC's asset purchase and management arena. Appropriate safeguards must be in place to ensure the Corporation knows the backgrounds of its bidders and acquirers to prevent those parties from profiting at the expense of the Corporation. Finally, in order to minimize costs, it will be important to terminate in a timely manner those receiverships not subject to loss-share agreements, structured sales, or other legal impediments.
Ensuring the Viability of the Deposit Insurance Fund (DIF)
A critical priority for the FDIC is to ensure that the DIF remains viable to protect insured depositors in the event of an institution's failure. The basic maximum insurance amount under current law is $250,000 through year-end 2013. Estimated insured deposits based on the current limit rose to $5.4 trillion as of December 31, 2009.
The DIF has suffered from the failures of the past. Estimated losses from failures in 2008 totaled $19.8 billion and from failures in 2009 totaled $35.6 billion. To maintain sufficient DIF balances, the FDIC collects risk-based insurance premiums from insured institutions and invests deposit insurance funds. In September 2009, the FDIC's DIF balance—or the net worth of the fund—fell below zero for the first time since the third quarter of 1992. The fund balance of negative $20.9 billion as of December 31, 2009, reflects a $44 billion contingent loss reserve that has been set aside to cover estimated losses over the next year. Just as banks reserve for loan losses, the FDIC has to set aside reserves for anticipated closings over the next year. Combining the fund balance with this contingent loss reserve showed total DIF reserves with a positive balance of $23.1 billion.
The FDIC Board of Directors closely monitors the viability of the DIF. In February 2009, the FDIC Board took action to ensure the continued strength of the fund by imposing a one-time emergency special assessment on institutions as of June 30, 2009. On two occasions, the Board also set assessment rates that generally increase the amount that institutions pay each quarter for insurance and also made adjustments that expand the range of assessment rates. The Corporation had adopted a restoration plan in October 2008 to increase the reserve ratio to the 1.15 percent designated threshold within five years. In February 2009, the Board voted to extend the restoration plan horizon to seven years and in September 2009 extended the time frame to eight years. As of December 31, 2009, the reserve ratio was negative 0.39 percent.
To further bolster the DIF's cash position, the FDIC Board approved a measure on November 12, 2009, to require insured institutions to prepay 13 quarters' worth of deposit insurance premiums—about $45.7 billion—at the end of 2009. The intent of this measure was to provide the FDIC with the funds needed to carry on with the task of resolving failed institutions in 2010, but without accelerating the impact of assessments on the industry's earnings and capital. The Corporation will face challenges going forward in its ongoing efforts to replenish the DIF and implement a deposit insurance premium system that differentiates based on risk to the fund.
The Corporation will also be continuing to play a leadership role in its work with global partners on such matters as Basel II to ensure strong regulatory capital standards to protect the international financial system from problems that might arise when a major bank or series of banks fail.
Ensuring Institution Safety and Soundness Through an Effective Examination and Supervision Program
The Corporation's bank supervision program promotes the safety and soundness of FDIC-supervised insured depository institutions. As of December 31, 2009, the FDIC was the primary federal regulator for about 5,000 FDIC-insured, state-chartered institutions that were not members of the Federal Reserve System (generally referred to as "state non-member" institutions). The examination of the banks that it regulates is a core FDIC supervisory function. The Corporation also has back-up examination authority to protect the interests of the deposit insurance fund for about 3,000 national banks, state-chartered banks that are members of the Federal Reserve System, and savings associations.
In the current environment, efforts to continue to ensure safety and soundness and carry out the examination function will be challenging in a number of ways. Of particular importance for 2010 is that the Corporation needs to continue to assess the implications of the recent financial and economic crisis and integrate lessons learned and any needed changes to the examination program into the supervisory process. At the same time, it needs to continue to carry out scheduled examinations to ensure the safety and soundness of the thousands of institutions that it regulates. The Corporation has developed a comprehensive "forward-looking supervision" training program for its examiners designed to build on lessons learned over the past year or so and will need to put that training into practice going forward.
As in the past, the Corporation needs to ensure it has sufficient resources to keep pace with its rigorous examination schedule and the needed expertise to address complex transactions and new financial instruments that may affect an institution's safety and soundness. In light of the many changes in financial institution operations over the past year or so, the FDIC's examination workforce may need to review and comment on a number of new issues when they assign examination ratings. With respect to risk management examinations, senior DSC management and examiners will need to continue to adopt the "forward-looking" supervisory approach, carefully assess the institution's overall risks, and base ratings not on current financial condition alone, but rather on consideration of possible future risks. These risks should be identified by rigorous and effective on-site and off-site review mechanisms and accurate metrics that identify risks embedded in the balance sheets and operations of the insured depository institutions so that steps can be taken to mitigate their impact on the institutions.
The Corporation's supervision workload is further compounded by the increased number of problem institutions that exist, as referenced earlier—that is, institutions assigned a composite rating of 4 or 5 under the Uniform Financial Institutions Rating System by its primary federal regulator or by the FDIC if it disagrees with the primary federal regulator's rating. Problem institutions are subject to close supervision with more frequent examinations, visitations, and off-site reviews. They are also subject to enforcement actions requiring corrective actions designed to resolve the bank's deteriorating condition. In light of recent failures, such scrutiny is of paramount importance.
In all cases, examiners need to continue to bring any identified problems to the bank's Board and management's attention, assign appropriate ratings, and make actionable recommendations to address areas of concern. In doing so they will continue to need the full support of senior FDIC management. Subsequently, the FDIC's corrective action and follow-up processes must be effective to ensure institutions are promptly complying with any supervisory enforcement actions—informal or formal—resulting from the FDIC's risk-management examination process. In some cases, to maintain the integrity of the banking system, the Corporation will also need to aggressively pursue prompt actions against bank boards or senior officers who may have contributed to an institution's failure.
The rapid changes in the banking industry, increase in electronic and on-line banking, growing sophistication of fraud schemes, and the mere complexity of financial transactions and financial instruments all create potential risks at FDIC-insured institutions and their service providers. These risks could negatively impact the FDIC and the integrity of the U.S. financial system and contribute to institution failures if existing checks and balances falter or are intentionally bypassed. The FDIC must seek to minimize the extent to which the institutions it supervises are involved in or victims of financial crimes and other abuse. It needs to continue to focus on Bank Secrecy Act examinations to prevent banks and other financial service providers from being used as intermediaries for, or to hide the transfer or deposit of money derived from, criminal activity. FDIC examiners need to be alert to the possibility of other fraudulent activity in financial institutions, and make full use of reports, information, and other resources available to them to help detect such fraud.
Protecting and Educating Consumers and Ensuring an Effective Compliance Program
The FDIC's efforts to ensure that banks serve their communities and treat consumers fairly continue to be a priority. The FDIC carries out its consumer protection role by educating consumers, providing them with access to information about their rights and disclosures that are required by federal laws and regulations, and examining the banks where the FDIC is the primary federal regulator to determine the institutions' compliance with laws and regulations governing consumer protection, unfair or deceptive acts and practices, fair lending, and community investment. The FDIC's compliance program, including examinations, visitations, and follow-up supervisory attention on violations and other program deficiencies, is critical to ensuring that consumers and businesses obtain the benefits and protections afforded them by law. Proactively identifying and assessing potential risks associated with new and existing consumer products will continue to challenge the FDIC.
The FDIC will continue to conduct Community Reinvestment Act (CRA) examinations in accordance with the CRA, a 1977 law intended to encourage insured banks and thrifts to help meet the credit needs of the communities in which they are chartered to do business, including low- and moderate-income neighborhoods, consistent with safe and sound operations. The Corporation needs to maximize the benefits of the interactions between its compliance and risk management functions in the interest of maintaining healthy, viable institutions that serve their communities well.
The FDIC will continue to address its mounting workload of responding to public inquiries from consumers regarding deposit insurance coverage and other concerns stemming from the financial distress they have experienced. Also, the Corporation will continue to emphasize financial literacy to promote the importance of personal savings, responsible financial management, and the benefits and limitations of deposit insurance. It will continue educational and outreach endeavors to disseminate updated information to all consumers, including the unbanked and underbanked, going forward so that taxpayers have the needed knowledge for responsible financial management and informed decision-making.
With respect to consumer protections in the context of possible regulatory reform, the FDIC supports the establishment of a single primary federal consumer-products regulator. In the FDIC's view, such an entity should regulate providers of consumer credit, savings, payment, and other financial products and services. It should have sole rulemaking authority for consumer financial protection statutes and should have supervisory and enforcement authority over all non-bank providers of consumer credit and back-up supervisory authority over insured depository institutions. As with other regulatory reform initiatives, the FDIC may face challenges as it seeks to make this concept a reality in the coming months.
Effectively Managing the FDIC Workforce and Other Corporate Resources
The FDIC's human, financial, IT, and physical resources have been stretched over the past year and the Corporation will continue to face challenges during 2010 in promoting sound governance and effective stewardship of its core business processes and resources. Of particular note, FDIC staffing levels are increasing dramatically. The Board approved a 2010 FDIC staffing level of 8,653, reflecting an increase from 7,010 positions in 2009. These staff—mostly temporary, and including a number of rehired annuitants—will perform bank examinations and other supervisory activities to address bank failures, and, as mentioned previously, an increasing number will be devoted to managing and selling assets retained by the FDIC when a failed bank is sold. The FDIC has opened two new temporary Satellite Offices (East Coast and West Coast) and will open a third in the Midwest for resolving failed financial institutions and managing the resulting receiverships. As referenced earlier, the Corporation's contracting level has also grown significantly, especially with respect to resolution and receivership work.
Opening new offices, rapidly hiring and training many new staff, expanding contracting activity, and training those with contract oversight responsibilities are all placing heavy demands on the Corporation's personnel and administrative staff and operations. When conditions improve throughout the industry and the economy, a number of employees will need to be released and staffing levels will return to a pre-crisis level, which may cause additional disruption to ongoing operations and the working environment. Among other challenges, pre- and post-employment checks for new employees and contractors will need to ensure the highest standards of ethical conduct, and for all employees, the Corporation will seek to sustain its emphasis on fostering employee engagement and morale.
To support these increases in FDIC and contractor resources, the Board approved a nearly $4.0 billion 2010 Corporate Operating Budget, approximately $1.4 billion higher than for 2009. The FDIC's operating expenses are largely paid from the insurance fund, and consistent with sound corporate governance principles, the Corporation's financial management efforts must continuously seek to be efficient and cost-conscious.
Amidst the turmoil in the industry and economy, the FDIC is engaging in massive amounts of information sharing—both internally and with external partners. Its information technology resources need to ensure the integrity, availability, and appropriate confidentiality of bank data, personally identifiable information, and other sensitive information in an environment of increasingly sophisticated security threats and global connectivity. Continued attention to ensuring the physical security of all FDIC resources is also critical.
The FDIC's numerous enterprise risk management activities need to consistently identify, analyze, and mitigate operational risks on an integrated, corporate-wide basis. Such risks need to be communicated throughout the Corporation and the relationship between internal and external risks and related risk mitigation activities should be understood by all involved. To further enhance risk monitoring efforts, the Corporation has established six new Program Management Offices to address risks associated with such activities as shared loss agreements, contracting oversight for new programs and resolution activities, the systemic resolution authority program, and human resource management concerns. These new offices and the contractors engaged to assist them will require additional oversight mechanisms to help ensure their success.
The FDIC OIG is committed to its mission of assisting and augmenting the FDIC's contribution to stability and public confidence in the nation's financial system. Now more than ever, we have a crucial role to play to help ensure economy, efficiency, effectiveness, integrity, and transparency of programs and associated activities, and to protect against fraud, waste, and abuse that can undermine the FDIC's success. Our management and performance challenges evaluation is based primarily on the FDIC's operating environment and available information as of the end of 2009, unless otherwise noted. We will continue to communicate and coordinate closely with the Corporation, the Congress, and other financial regulatory OIGs as we address these issues and challenges. Results of OIG work will be posted at www.fdicig.gov.