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(a) For TIPS, the yields in the above table are stated at their real yields at purchase, not their effective yields. Effective yields on TIPS include a long-term annual inflation assumption as measured by the CPI-U. The long-term CPI-U consensus forecast is 1.8 percent, based on figures issued by the Congressional Budget Office and Blue Chip Economic Indicators in early 2011.
(b) Includes one Treasury note totaling $1.8 billion which matured on Saturday, December 31, 2011. Settlement occurred on the next business day, January 3, 2012.
(c) All unrealized losses occurred as a result of temporary changes in market interest rates. These unrealized losses occurred over a period of less than a year. Unrealized losses related to the TIPS have converted to unrealized gains by January 31, 2012, and unrealized losses related to the U.S. Treasury notes and bonds existed on just one security that matured with no unrealized loss on January 31, 2012, and thus the FDIC does not consider these securities to be other than temporarily impaired at December 31, 2011.
(a) For TIPS, the yields in the above table are stated at their real yields at purchase, not their effective yields. Effective yields on TIPS include a long-term annual inflation assumption as measured by the CPI-U. The long-term CPI-U consensus forecast is 1.8 percent, based on figures issued by the Congressional Budget Office and Blue Chip Economic Indicators in early 2010.
(b) All unrealized losses occurred as a result of temporary changes in market interest rates. The unrealized loss on one security occurred over a period of less than a year and converted to an unrealized gain by January 31, 2011, and thus the FDIC does not consider the security to be other than temporarily impaired at December 31, 2010.
4. Receivables from Resolutions, Net
The receivables from resolutions include payments made by the DIF to cover obligations to insured depositors (subrogated claims), advances to resolution entities for working capital, and administrative expenses paid on behalf of resolution entities. Any related allowance for loss represents the difference between the funds advanced and/or obligations incurred and the expected repayment. Estimated future payments on losses incurred on assets sold to an acquiring institution under a shared-loss agreement (SLA) are factored into the computation of the expected repayment. Assets held by DIF resolution entities (including structured transaction-related assets; see Note 8) are the main source of repayment of the DIF’s receivables from resolutions.
As of December 31, 2011, there were 426 active receiverships, including 92 established in 2011. As of December 31, 2011 and 2010, DIF resolution entities held assets with a book value of $71.4 billion and $80.4 billion, respectively (including $50.5 billion and $53.4 billion, respectively of cash, investments, receivables due from the DIF, and other receivables). Ninety-nine percent of the current asset book value of $71.4 billion is held by resolution entities established since 2008.
Estimated cash recoveries from the management and disposition of assets that are used to determine the allowance for losses are based on asset recovery rates from several sources including actual or pending institution-specific asset disposition data, failed institution-specific asset valuation data, aggregate asset valuation data on several recently failed or troubled institutions, sampled asset valuation data, and empirical asset recovery data based on failures as far back as 1990. Methodologies for determining the asset recovery rates incorporate estimating future cash recoveries, net of applicable liquidation cost estimates, and discounting based on market-based risk factors applicable to a given asset’s type and quality. The resulting estimated cash recoveries are then used to derive the allowance for loss on the receivables from these resolutions.
For failed institutions resolved using a whole bank purchase and assumption transaction with an accompanying SLA, the projected future shared-loss payments, recoveries, and monitoring costs on the covered assets sold to the acquiring institution under the agreement are considered in determining the allowance for loss on the receivables from these resolutions. The shared-loss cost projections are based on the covered assets’ intrinsic value which is determined using financial models that consider the quality, condition and type of covered assets, current and future market conditions, risk factors and estimated asset holding periods. For year-end 2011 financial reporting, the shared-loss cost estimates were updated for the majority (85% or 235) of the 278 active shared-loss agreements; the remaining 43 were already based on recent loss estimates. The updated shared-loss cost projections for the larger agreements were primarily based on new third-party valuations estimating the cumulative loss of covered assets. The remaining agreements were stratified by receivership age. A random sample of banks within each age stratum was selected for new third-party loss estimations, and valuation results from the sample banks were aggregated and extrapolated to banks within the like age stratum based on asset type and performance status.
Note that estimated asset recoveries are regularly evaluated during the year, but remain subject to uncertainties because of potential changes in economic and market conditions. Continuing economic uncertainties could cause the DIF’s actual recoveries to vary significantly from current estimates.
Whole Bank Purchase and Assumption Transactions with Shared-Loss Agreements
Since the beginning of 2008, the FDIC resolved 281 failures using whole bank purchase and assumption resolution transactions with accompanying SLAs on assets purchased by the financial institution acquirer. The acquirer typically assumes all of the deposits and purchases essentially all of the assets of a failed institution. The majority of the commercial and residential loan assets are purchased under an SLA, where the FDIC agrees to share in future losses and recoveries experienced by the acquirer on those assets covered under the agreement. SLAs are used by the FDIC to keep assets in the private sector and to minimize disruptions to loan customers.
Losses on the covered assets are shared between the acquirer and the FDIC in its receivership capacity of the failed institution when losses occur through the sale, foreclosure, loan modification, or write-down of loans in accordance with the terms of the SLA. The majority of the agreements cover a five- to 10-year period with the receiver covering 80 percent of the losses incurred by the acquirer and the acquiring bank covering 20 percent. Prior to March 26, 2010, most SLAs included a threshold amount, above which the receiver covered 95 percent of the losses incurred by the acquirer. As mentioned above, the estimated shared-loss liability is accounted for by the receiver and is included in the calculation of the DIF’s allowance for loss against the corporate receivable from the resolution. As shared-loss claims are asserted and proven, DIF receiverships satisfy these shared-loss payments using available liquidation funds and/or by drawing on amounts due from the DIF for funding the deposits assumed by the acquirer (see Note 7).
As of December 31, 2011, 249 receiverships have made shared-loss payments totaling $16.2 billion. In addition, DIF receiverships are estimated to pay an additional amount of $26.6 billion over the duration of these SLAs on $135.0 billion in total remaining covered assets.
Concentration of Credit Risk
Financial instruments that potentially subject the DIF to concentrations of credit risk are receivables from resolutions. The repayment of the DIF’s receivables from resolutions is primarily influenced by recoveries on assets held by DIF receiverships and payments on the covered assets under SLAs. The majority of the $155.9 billion in remaining assets in liquidation ($20.9 billion) and current shared-loss covered assets ($135.0 billion) are concentrated in commercial loans ($83.1 billion), residential loans ($52.5 billion), securities ($3.4 billion), and structured transaction-related assets as described in Note 8 ($14.2 billion). Most of the assets in these asset types originated from failed institutions located in California ($43.7 billion), Florida ($18.1 billion), Illinois ($13.2 billion), Puerto Rico ($13.1 billion), Georgia ($12.8 billion) and Alabama ($12.7 billion).
5. Trust Preferred Securities
Pursuant to a systemic risk determination, the Treasury, the FDIC, and the Federal Reserve Bank of New York executed terms of a guarantee agreement on January 15, 2009 with Citigroup to provide loss protection on a pool of approximately $301.0 billion of assets that remained on the balance sheet of Citigroup. In consideration for its portion of the shared-loss guarantee at inception, the FDIC received $3.025 billion of Citigroup’s preferred stock. All shares of the preferred stock were subsequently converted to Citigroup Capital XXXIII trust preferred securities (TruPs) with a liquidation amount of $1,000 per security and a distribution rate of 8 percent per annum payable quarterly. The principal amount is due in 2039.
On December 23, 2009, Citigroup terminated the guarantee agreement, citing improvements in its financial condition. The FDIC incurred no loss from the guarantee prior to the termination of the agreement. In connection with the early termination of the agreement, the FDIC agreed to reduce its portion of the $3.025 billion in TruPs by $800 million. However, pursuant to an agreement between the Treasury and the FDIC, the Treasury agreed to return $800 million in TruPs on behalf of the FDIC from its portion of Citigroup TruPs holdings received as a result of the shared-loss agreement. The FDIC has retained the $800 million of Citigroup TruPs as security in the event payments are required to be made by the DIF for guaranteed debt instruments issued by Citigroup and its affiliates under the TLGP (see Note 16). The FDIC will transfer an aggregate liquidation amount of $800 million in TruPs to the Treasury, plus any related interest, less any payments made or required to be made under the TLGP within five days of the date on which no Citigroup debt remains outstanding under the TLGP. The fair value of these TruPs and related interest are recorded as systemic risk assets (see Note 16).
The remaining $2.225 billion (liquidation amount) of TruPs held by the FDIC is classified as available-for-sale debt securities in accordance with FASB ASC Topic 320, Investments – Debt and Equity Securities. At December 31, 2011, the fair value of the TruPs was $2.213 billion (see Note 15). An unrealized holding gain of $251 million is included in accumulated other comprehensive income.
6. Property and Equipment, Net
The depreciation expense was $78 million and $69 million for 2011 and 2010, respectively.
7. Liabilities Due to Resolutions
As of December 31, 2011 and 2010, the DIF recorded liabilities totaling $32.7 billion and $30.4 billion to resolution entities representing the agreed-upon value of assets transferred from the receiverships, at the time of failure, to the acquirers/bridge institutions for use in funding the deposits assumed by the acquirers/bridge institutions. Ninety-one percent of these liabilities are due to failures resolved under whole-bank purchase and assumption transactions, most with an accompanying SLA. The DIF satisfies these liabilities either by directly sending cash to the receivership to fund shared-loss and other expenses or by offsetting receivables from resolutions when the receivership declares a dividend.
In addition, there was $80 million in unpaid deposit claims related to multiple receiverships as of December 31, 2011 and 2010. The DIF pays these liabilities when the claims are approved.
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.
The banking industry continued recovering in 2011. The industry recorded total net income of $119.5 billion for all of 2011, an increase of nearly 40 percent from 2010 net income. The improvement in industry earnings continued to be driven by declining loan loss provisions, with full-year provisions at their lowest level in four years. At the same time, the pace of U.S. economic growth slowed, unemployment remained at historically high levels, and real estate markets exhibited ongoing weaknesses in many parts of the country. These factors have slowed the improvement in asset quality and contributed to keeping the number of problem institutions and failures well above historic norms. Notwithstanding these challenges, the losses to the DIF from failures that occurred in 2011 fell short of the amount reserved at the end of 2010, as the aggregate number and size of institution failures in 2011 were less than anticipated. The removal from the reserve of banks that did fail in 2011, as well as projected favorable trends in bank supervisory downgrade and failure rates and the smaller size of institutions that remain troubled, all contributed to a decline by $11.2 billion to $6.5 billion in the contingent liability for anticipated failures of insured institutions at the end of 2011.
In addition to these recorded contingent liabilities, the FDIC has identified risk in the financial services industry that could result in additional losses 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 of up to $10.2 billion for year-end 2011 as compared to $24.5 billion for year-end 2010. The actual losses, if any, will largely depend on future economic and market conditions and could differ materially from this estimate.
During 2011, 92 banks failed with combined assets at the date of failure of $36.6 billion. Supervisory and market data suggest that while the financial performance of the banking industry should continue to improve over the coming year, ongoing asset quality problems and limited opportunities for earnings growth will continue to result in an elevated level of stress for the industry. 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.
The DIF records an estimated loss for unresolved legal cases to the extent that those losses are considered probable and reasonably estimable. During 2011, the contingent liability declined by $299 million to $1 million due primarily to a payment of $276 million for a judgment of one legal case for which an allowance was previously recorded. As of December 31, 2011 and 2010, the FDIC has determined that there are no reasonably possible losses from unresolved cases.
IndyMac Federal Bank Representation and Indemnification Contingent Liability
On March 19, 2009, the FDIC as receiver of IndyMac Federal Bank (IMFB) and certain subsidiaries (collectively, sellers) sold substantially all of the assets of IMFB and the respective subsidiaries, including mortgage loans and mortgage loan servicing rights, to OneWest Bank and its affiliates. To maximize sale returns, the sellers made certain representations customarily made by commercial parties regarding the assets and agreed to indemnify the acquirers for losses incurred as a result of breaches of such representations, losses incurred as a result of the failure to obtain contractual counterparty consents to the sale, and third party claims arising from pre-sale acts and omissions of the sellers or the failed bank. Although the representations and indemnifications were made by or are obligations of the sellers, the FDIC, in its corporate capacity, guaranteed the receivership’s indemnification obligations under the sale agreements. The representations relate generally to ownership of and right to sell the assets; compliance with applicable law in the origination of the loans; accuracy of the servicing records; validity of loan documents; and servicing of the loans serviced for others. Until the periods for asserting claims under these arrangements have expired and all indemnification claims quantified and paid, losses could continue to be incurred by the receivership and, in turn, the DIF, either directly, as a result of the FDIC corporate guaranty of the receivership’s indemnification obligations, or indirectly, as a result of a reduction in the receivership’s assets available to pay the DIF’s claims as subrogee for insured accountholders. The acquirers’ rights to assert claims to recover losses incurred as a result of breaches of loan seller representations extend out to March 19, 2019 for the Fannie Mae and Ginnie Mae reverse mortgage servicing portfolios (unpaid principal balance of $16.7 billion at December 31, 2011 compared to $21.7 billion at December 31, 2010), and March 19, 2014 for the Fannie Mae, Freddie Mac and Ginnie Mae mortgage servicing portfolios (unpaid principal balance of $38.5 billion at December 31, 2011 compared to $45.3 billion at December 31, 2010). The acquirers’ rights to assert claims to recover losses incurred as a result of other third party claims (including due to pre-March 19, 2009 acts or omissions) and breaches of servicer representations, including liability with respect to the Fannie Mae, Ginnie Mae and Freddie Mac portfolios as well as the private mortgage servicing portfolio and whole loans (unpaid principal balance of $62.0 billion at December 31, 2011 compared to $74.2 billion at December 31, 2010) expired on March 19, 2011. As of the expiration date of this claim period, notices relating to potential defects were received, but they require review to determine whether a valid defect exists and, if so, the identification and costing of possible cure actions. It is highly unlikely that all of these potential defects will result in losses.
As of December 31, 2011, the IndyMac receivership has paid $5 million in approved claims and has accrued an additional $2 million liability for claims asserted but unpaid. Alleged breaches of origination and servicing representations exist, and review and evaluation is in process for approximately $275 to $345 million in reasonably possible liabilities. In addition, potential losses relating to origination and servicing representations, which currently cannot be determined, may be incurred under other agreements with investors.
The FDIC believes it is likely that additional losses will be incurred, however quantifying the contingent liability associated with the representations and the indemnification obligations is subject to a number of uncertainties, including (1) borrower prepayment speeds; (2) the occurrence of borrower defaults and resulting foreclosures and losses; (3) the assertion by third party investors of claims with respect to loans serviced for them; (4) the existence and timing of discovery of breaches and the assertion of claims for indemnification for losses by the acquirer; (5) the compliance by the acquirer with certain loss mitigation and other conditions to indemnification; (6) third party sources of loss recovery (such as title companies and insurers); (7) the ability of the acquirer to refute claims from investors without incurring reimbursable losses; and (8) the cost to cure breaches and respond to third party claims. Because of these and other uncertainties that surround the liability associated with indemnifications and the quantification of possible losses, the FDIC has determined that, while additional losses are probable, the amount is not estimable.
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 a receivership 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 2011 and 2010, the FDIC in its corporate capacity made no 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 Structured Transactions
The FDIC as receiver uses three types of structured transactions to dispose of certain performing and non-performing residential mortgage loans, commercial loans, construction loans, and mortgage-backed securities held by the receiverships. The three types of structured transactions are 1) limited liability companies (LLCs), 2) securitizations, and 3) structured sale of guaranteed notes (SSGNs).
Under the LLC structure, the FDIC in its receivership capacity contributes a pool of assets to a newly-formed LLC and offers for sale, through a competitive bid process, some of the equity in the LLC. The day-to-day management of the LLC is transferred to the highest bidder along with the purchased equity interest. In many instances, the FDIC in its corporate capacity guarantees notes issued by the LLCs. In exchange for a guarantee, the DIF receives a guarantee fee in either 1) a lump-sum, up-front payment based on the estimated duration of the note or 2) a monthly payment based on a fixed percentage multiplied by the outstanding note balance. The terms of these guarantee agreements generally stipulate that all cash flows received from the entity’s collateral be used to pay, in the following order, 1) operational expenses of the entity, 2) the FDIC’s contractual guarantee fee, 3) the guaranteed notes (or, if applicable, fund the related defeasance account for payoff of the notes at maturity), and 4) the equity investors. If the FDIC is required to perform under these guarantees, it acquires an interest in the cash flows of the LLC equal to the amount of guarantee payments made plus accrued interest thereon. Once all expenses have been paid, the guaranteed notes have been satisfied, and the FDIC has been reimbursed for any guarantee payments, the equity holders receive any remaining cash flows.
Since 2009, private investors purchased a 40- to 50-percent ownership interest in the LLC structures for $1.6 billion in cash and the LLCs issued notes of $4.4 billion to the receiverships to partially fund the purchase of the assets. The receiverships hold the remaining 50- to 60-percent equity interest in the LLCs and, in most cases, the guaranteed notes. The FDIC in its corporate capacity guarantees the timely payment of principal and interest due on the notes. The terms of the note guarantees extend until the earlier of 1) payment in full of the notes or 2) two years following the maturity date of the notes. The note with the longest term matures in 2020. In the event of note payment default, the FDIC as guarantor is entitled to exercise or cause the exercise of certain rights and remedies including: 1) accelerating the payment of the unpaid principal amount of the notes; 2) selling the assets held as collateral; or 3) foreclosing on the equity interests of the debtor.
Securitization and SSGNs
Securitizations and SSGNs (collectively, “trusts”) are transactions in which certain assets or securities from failed institutions are pooled and transferred into a trust structure. The trusts issue 1) senior and/or subordinated debt instruments and 2) owner trust or residual certificates collateralized by the underlying mortgage-backed securities or loans.
Since 2010, private investors purchased the senior notes issued by the trusts for $5.3 billion in cash. The receiverships hold 100 percent of the subordinated debt instruments and owner trust or residual certificates. The FDIC in its corporate capacity guarantees the timely payment of principal and interest due on the senior notes, the latest maturity of which is 2050. In exchange for the guarantee, the DIF receives a monthly payment based on a fixed percentage multiplied by the outstanding note balance. These guarantee agreements generally stipulate that all cash flows received from the entity’s collateral be used to pay, in the following order, 1) operational expenses of the entity, 2) the FDIC’s contractual guarantee fee, 3) interest on the guaranteed notes, 4) principal of the guaranteed notes, and 5) the holders of the subordinated notes and owner trust or residual certificates. If the FDIC is required to perform under its guarantees, it acquires an interest in the cash flows of the trust equal to the amount of guarantee payments made plus accrued interest thereon. Once all expenses have been paid, the guaranteed notes have been satisfied, and the FDIC has been reimbursed for any guarantee payments, the subordinated note holders and owner trust or residual certificates holders receive the remaining cash flows.
All Structured Transactions with FDIC Guaranteed Debt
Through December 31, 2011, the receiverships have transferred a portfolio of loans with an unpaid principal balance of $16.4 billion and mortgage-backed securities with a book value of $7.7 billion to 14 LLCs and 8 trusts. The LLCs and trusts subsequently issued notes guaranteed by the FDIC in an original principal amount of $9.7 billion. To date, the DIF has collected guarantee fees totaling $203 million and recorded a receivable for additional guarantee fees of $106 million, included in the “Interest receivable on investments and other assets, net” line item on the Balance Sheet. All guarantee fees are recorded as deferred revenue, included in the “Accounts payable and other liabilities” line item, and recognized as revenue primarily on a straight-line basis over the term of the notes. At December 31, 2011, the amount of deferred revenue recorded was $134 million. The DIF records no other structured-transaction-related assets or liabilities on its balance sheet.
The estimated loss to the DIF from the guarantees is derived from an analysis of 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 or trust assets provide sufficient coverage to fully pay the debts. Therefore, the estimated loss to the DIF from these guarantees is zero. To date, the FDIC in its corporate capacity has not provided, and does not intend to provide, any form of financial or other type of support to a trust or LLC that it was not previously contractually required to provide.
As of December 31, 2011, the maximum loss exposure is $3.7 billion for LLCs and $3.9 billion for trusts, representing the sum of all outstanding debt guaranteed by the FDIC in its corporate capacity. Some transactions have established defeasance accounts to pay off the notes at maturity. A total of $2.2 billion has been deposited into these accounts.
The Dodd-Frank Act, enacted on July 21, 2010, provides for significant assessment and capitalization reforms for the DIF. In response, the FDIC implemented several changes to the assessment system and developed a comprehensive, long-term fund management plan. The plan is designed to restore and maintain a positive fund balance for the DIF even during a banking crisis and achieve moderate, steady assessment rates throughout any economic cycle. Summarized below are actions taken to implement assessment system changes and provisions of the comprehensive plan.
NEW RESTORATION PLAN
In October 2010, the FDIC adopted a new Restoration Plan to ensure that the ratio of the DIF fund balance to estimated insured deposits (reserve ratio) reaches 1.35 percent by September 30, 2020. The new Plan provides for the following: 1) the period of the Restoration Plan is extended from the end of 2016 to September 30, 2020; 2) institutions may continue to use assessment credits without additional restriction during the term of the Restoration Plan; 3) the FDIC will pursue rulemaking regarding the method that will be used to offset the effect on small institutions (less than $10 billion in assets) of requiring that the reserve ratio reach 1.35 percent by September 30, 2020, rather than 1.15 percent by the end of 2016; and 4) at least semiannually, the FDIC will update its loss and income projections for the fund and, if needed, increase or decrease assessment rates, following notice-and-comment rulemaking, if required.
DESIGNATED RESERVE RATIO
In December 2011, the FDIC adopted a final rule maintaining the designated reserve ratio (DRR) at 2 percent, effective January 1, 2012. The FDIC views the 2 percent DRR as maintaining the DIF at a level that can withstand substantial losses, consistent with the FDIC’s comprehensive, long-term fund management plan.
CALCULATION OF ASSESSMENT
In February 2011, the FDIC adopted a final rule, effective on April 1, 2011, amending part 327 of title 12 of the Code of Federal Regulations to 1) redefine the assessment base used for calculating deposit insurance assessments from adjusted domestic deposits to average consolidated total assets minus average tangible equity (measured as Tier 1 capital); 2) change the assessment rate adjustments; 3) lower the initial base rate schedule and the total base rate schedule for all IDIs to collect approximately the same revenue for the DIF as would have been collected under the old assessment base; 4) suspend dividends indefinitely, and, in lieu of dividends, adopt lower assessment rate schedules when the reserve ratio reaches 1.15 percent, 2 percent, and 2.5 percent; and 5) change the risk-based assessment system for large IDIs (generally, those institutions with at least $10 billion in total assets). Specifically, the final rule eliminates risk categories and the use of long-term debt issuer ratings for large institutions and combines CAMELS ratings and certain forward-looking financial measures into two scorecards: one for most large institutions and another for large institutions that are structurally and operationally complex or that pose unique challenges and risks in case of failure (highly complex institutions).
Annual assessment rates averaged approximately 17.6 cents per $100 and 17.7 cents per $100 of the assessment base for the first quarter of 2011 and all of 2010, respectively. Beginning in the second quarter of 2011, the assessment base changed to average total consolidated assets less average tangible equity (with certain adjustments for banker’s banks and custodial banks), as required by the Dodd-Frank Act. The FDIC implemented a new assessment rate schedule at the same time to conform to the larger assessment base. The annual assessment rate averaged approximately 11.1 cents per $100 of the assessment base for the last three quarters of 2011.
In December 2009, a majority of IDIs prepaid $45.7 billion of estimated quarterly risk-based assessments to address the DIF’s liquidity need to pay for projected near-term failures and to ensure that the deposit insurance system remained industry-funded. The prepaid assessments cover the insurance period from October 2009 through December 2012. An institution’s quarterly risk-based deposit insurance assessment thereafter is offset by the amount prepaid until the amount is exhausted or until June 30, 2013, when any amount remaining is to be returned to the institution. At December 31, 2011, the remaining prepaid amount of $17.4 billion is included in the “Unearned revenue - prepaid assessments” line item on the Balance Sheet.
Prepaid assessments were mandatory for all institutions, but the FDIC exercised its discretion as supervisor and insurer to exempt an institution from the prepayment requirement if the FDIC determined that the prepayment would adversely affect the safety and soundness of the institution.
As of December 31, 2011, the DIF reserve ratio was 0.17 percent of estimated insured deposits.
ASSESSMENTS RELATED TO FICO
Assessments continue to be levied on institutions for payments of the interest on obligations issued by the Financing Corporation (FICO). The FICO was established as a mixed-ownership government corporation to function solely as a financing vehicle for the former FSLIC. The annual FICO interest obligation of approximately $790 million is paid on a pro rata basis using the same rate for banks and thrifts. The FICO assessment has no financial impact on the DIF and is separate from deposit insurance assessments. The FDIC, as administrator of the DIF, acts solely as a collection agent for the FICO. During 2011 and 2010, approximately $795 million and $796 million, respectively, was collected and remitted to the FICO.
10. Other Revenue
TEMPORARY LIQUIDITY GUARANTEE PROGRAM REVENUE
Pursuant to a systemic risk determination in October 2008, the FDIC established the TLGP (see Note 16). In exchange for guarantees issued under the TLGP, the FDIC received fees that were set aside, as deferred revenue, for potential TLGP losses. As losses occur, the FDIC recognizes the loss as a systemic risk expense and offsets the loss by recognizing an equivalent portion of the deferred revenue as systemic risk revenue. This accounting practice isolates systemic risk activities from the normal operating activities of the DIF.
From inception of the TLGP, it has been FDIC’s policy to recognize revenue to the DIF for any deferred revenue not absorbed by losses upon expiration of the TLGP guarantee period (December 31, 2012) or earlier for any portion of guarantee fees determined in excess of amounts needed to cover potential losses. During 2011, the DIF recognized revenue of $2.6 billion for fees held as deferred revenue (see Note 16). In the unforeseen event a debt default occurs greater than the remaining amount held as deferred revenue, to the extent needed, any amount previously recognized as revenue to the DIF will be returned to the TLGP.
11. Operating Expenses
Operating expenses were $1.6 billion for both 2011 and 2010. The chart below lists the major components of operating expenses.
12. Provision for Insurance Losses
Provision for insurance losses was negative $4.4 billion for 2011, compared to negative $848 million for 2010. The negative provision for 2011 primarily resulted from a reduction in the contingent loss reserve due to the improvement in the financial condition of institutions that were previously identified to fail and a reduction in the estimated losses for institutions that have failed in prior years. The following chart lists the major components of the provision for insurance losses.
13. Employee Benefits
PENSION BENEFITS AND SAVINGS PLANS
Eligible FDIC employees (permanent and term employees with appointments exceeding one year) are covered by the federal government retirement plans, either the Civil Service Retirement System (CSRS) or the Federal Employees Retirement System (FERS). Although the DIF contributes a portion of pension benefits for eligible employees, it does not account for the assets of either retirement system. The DIF also does not have actuarial data for accumulated plan benefits or the unfunded liability relative to eligible employees. These amounts are reported on and accounted for by the U.S. Office of Personnel Management (OPM).
Eligible FDIC employees also may participate in a FDIC-sponsored tax-deferred 401(k) savings plan with matching contributions up to 5 percent. Under the Federal Thrift Savings Plan (TSP), the FDIC provides FERS employees with an automatic contribution of 1 percent of pay and an additional matching contribution up to 4 percent of pay. CSRS employees also can contribute to the TSP, but they do not receive agency matching contributions.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The DIF has no postretirement health insurance liability since all eligible retirees are covered by the Federal Employees Health Benefits (FEHB) program. The FEHB is administered and accounted for by the OPM. In addition, OPM pays the employer share of the retiree’s health insurance premiums.
The FDIC provides certain life and dental insurance coverage for its eligible retirees, the retirees’ beneficiaries, and covered dependents. Retirees eligible for life and dental 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. The life insurance program provides basic coverage at no cost to retirees and allows converting optional coverage to direct-pay plans. For the dental coverage, retirees are responsible for a portion of the dental premium.
The FDIC has elected not to fund the postretirement life and dental benefit liabilities. As a result, the DIF recognized the underfunded status (the difference between the accumulated postretirement benefit obligation and the plan assets at fair value) as a liability. Since there are no plan assets, the plan’s benefit liability is equal to the accumulated postretirement benefit obligation. At December 31, 2011 and 2010, the liability was $188 million and $166 million, respectively, which is recognized in the “Postretirement benefit liability” line item on the Balance Sheet. The cumulative actuarial losses (changes in assumptions and plan experience) and prior service costs (changes to plan provisions that increase benefits) were $34 million and $19 million at December 31, 2011 and 2010, respectively. These amounts are reported as accumulated other comprehensive income in the “Unrealized postretirement benefit loss” line item on the Balance Sheet.
The DIF’s expenses for postretirement benefits for 2011 and 2010 were $12 million and $9 million, respectively, which are included in the current and prior year’s operating expenses on the Statement of Income and Fund Balance. The changes in the actuarial losses and prior service costs for 2011 and 2010 of $15 million and $16 million, respectively, are reported as other comprehensive income in the “Unrealized postretirement benefit loss” line item. Key actuarial assumptions used in the accounting for the plan include the discount rate of 4.5 percent, the rate of compensation increase of 4.1 percent, and the dental coverage trend rate of 6.0 percent. The discount rate of 4.5 percent is based upon rates of return on high-quality fixed income investments whose cash flows match the timing and amount of expected benefit payments.
14. Commitments and Off-Balance-Sheet Exposure
The FDIC’s lease commitments total $199 million for future years. The lease agreements contain escalation clauses resulting in adjustments, usually on an annual basis. The DIF recognized leased space expense of $56 million and $45 million for the years ended December 31, 2011 and 2010, respectively.
As of December 31, 2011, estimated insured deposits for the DIF were $7.0 trillion. This estimate is derived primarily from quarterly financial data submitted by IDIs to the FDIC. This estimate represents the accounting loss that would be realized if all IDIs were to fail and the acquired assets provided no recoveries. Included in this estimate was approximately $1.4 trillion of noninterest-bearing transaction deposits that exceeded the basic coverage limit of $250,000 per account, which received coverage under the Dodd-Frank Act beginning on December 31, 2010 to the end of 2012.
15. Disclosures About the Fair Value of Financial Instruments
Financial assets recognized and measured at fair value on a recurring basis at each reporting date include cash equivalents (Note 2), the investment in U.S. Treasury obligations (Note 3) and trust preferred securities (Note 5). The following tables present the DIF’s financial assets measured at fair value as of December 31, 2011 and 2010.
(1) Cash equivalents are Special U.S. Treasury Certificates with overnight maturities valued at prevailing interest rates established by the U.S. Bureau of Public Debt.
(2) The investment in U.S. Treasury obligations is measured based on prevailing market yields for federal government entities.
In exchange for prior shared-loss guarantee coverage provided to Citigroup, the FDIC and the Treasury received TruPs (see Note 5). At December 31, 2011, the fair value of the securities in the amount of $3.009 billion was classified as a Level 2 measurement based on an FDIC-developed model using observable market data for traded Citigroup securities to determine the expected present value of future cash flows. Key inputs include market yields on U.S. dollar interest rate swaps and discount rates for default, call, and liquidity risks that are derived from traded Citigroup securities and modeled pricing relationships.
(1) Cash equivalents are Special U.S. Treasury Certificates with overnight maturities valued at prevailing interest rates established by the U.S. Bureau of Public Debt.
Some of the DIF’s financial assets and liabilities are not recognized at fair value but are recorded at amounts that approximate fair value due to their short maturities and/ or comparability with current interest rates. Such items include interest receivable on investments, assessments receivable, other short-term receivables, accounts payable, and other liabilities.
The net receivables from resolutions primarily include the DIF’s subrogated claim arising from obligations to insured depositors. The resolution entity assets that will ultimately be used to pay the corporate subrogated claim are valued using discount rates that include consideration of market risk. These discounts ultimately affect the DIF’s allowance for loss against the receivables from 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 resolution entity assets (see Note 4), such 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 a fair 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 resolution entity payments to the DIF on the subrogated claim does not necessarily correspond with the timing of collections on resolution entity assets. Therefore, the effect of discounting used by resolution entities should not necessarily be viewed as producing an estimate of fair value for the net receivables from resolutions.
There is no readily available market for guarantees associated with systemic risk (see Note 16).
16. Systemic Risk Transactions
Pursuant to a systemic risk determination, the FDIC established the TLGP for IDIs, designated affiliates and certain holding companies on October 14, 2008, in an effort to counter the system-wide crisis in the nation’s financial sector. The program is codified in part 370 of title 12 of the Code of Federal Regulations.
The FDIC received fees in exchange for guarantees issued under the TLGP and set aside, as deferred revenue, all fees for potential TLGP losses. At inception of the guarantees, the DIF recognized a liability for the non-contingent fair value of the obligation the FDIC assumed over the term of the guarantees. In accordance with FASB ASC 460, Guarantees, this non-contingent liability was measured at the amount of consideration received in exchange for issuing the guarantee. As systemic risk expenses are incurred, the DIF will reduce deferred revenue and recognize an offsetting amount as systemic risk revenue. Not later than the end of the guarantee period (December 31, 2012), any deferred revenue not absorbed by losses during the guarantee period will be recognized as revenue to the DIF.
At its inception, the TLGP consisted of two components: 1) the Transaction Account Guarantee Program (TAG) and 2) the Debt Guarantee Program (DGP). The TAG provided unlimited coverage for noninterest-bearing transaction accounts held by IDIs on all deposit amounts exceeding the fully insured limit of $250,000 through December 31, 2010. During its existence, the FDIC collected TAG fees of $1.2 billion. Total subrogated claims arising from obligations to depositors with noninterest-bearing transaction accounts were $8.8 billion, with estimated losses of $2.2 billion.
The DGP permitted participating entities to issue FDIC-guaranteed senior unsecured debt through October 31, 2009. The FDIC’s guarantee for all such debt expires on the earliest of the conversion date for mandatory convertible debt, the stated date of maturity, or December 31, 2012. Through the end of the debt issuance period, the DIF collected $8.3 billion of guarantee fees and fees of $1.2 billion from participating entities that elected to issue senior unsecured non-guaranteed debt. The fees are included in the “Cash and investments - restricted - systemic risk” line item and recognized as “Deferred revenue - systemic risk” on the Balance Sheet.
Additionally, the FDIC holds $800 million (liquidation amount) of Citigroup TruPs on behalf of the Treasury (and any related interest) as security in the event payments are required to be made by the DIF for guaranteed debt instruments issued by Citigroup or any of its affiliates under the TLGP (see Note 5). At December 31, 2011, the fair value of these securities totaled $796 million, and was determined using the valuation methodology described in Note 15 for other Citigroup TruPs held by the DIF. There is an offsetting liability in the “Deferred revenue -systemic risk” line item, representing amounts to be transferred to the Treasury or, if necessary, paid for guaranteed debt instruments issued by Citigroup or its affiliates under the TLGP. Consequently, there is no impact on the fund balance of the DIF.
The FDIC’s payment obligation under the DGP is triggered by a payment default. In the event of default, the FDIC will continue to make scheduled principal and interest payments under the terms of the debt instrument through its maturity, or in the case of mandatory convertible debt, through the mandatory conversion date. The debtholder or representative must assign to the FDIC the right to receive any and all distributions on the guaranteed debt from any insolvency proceeding, including the proceeds of any receivership or bankruptcy estate, to the extent of payments made under the guarantee.
Since inception of the program, $618.0 billion in total guaranteed debt has been issued. Through December 31, 2011, the FDIC has paid $35 million in claims for principal and/or interest arising from the default of guaranteed debt obligations of six debt issuers. Fifty-nine financial entities (33 IDIs and 26 affiliates and holding companies) had $167.4 billion in guaranteed debt outstanding at December 31, 2011. This compares to $267.1 billion in guaranteed debt outstanding at December 31, 2010. Reported outstanding debt is derived from data submitted by debt issuers.
At December 31, 2011, the DIF recognized a liability of $117 million for debt guarantee obligations that were paid in early 2012 as scheduled under the terms of the debt instruments. This liability is presented in the “Debt Guarantee Program liabilities – systemic risk” line item. The DIF has also recorded a contingent liability of $2 million in the “Contingent liability for systemic risk” line item for probable additional guaranteed debt obligations. The FDIC believes that it is also reasonably possible that additional estimated losses of approximately $93 million could be incurred under the DGP.
The DIF may recognize revenue before the end of the guarantee period for the portion of guarantee fees that was determined to exceed amounts needed to cover potential losses. During 2011, the DIF recognized revenue of $2.6 billion for a portion of DGP guarantee fees previously held as systemic risk deferred revenue (see Note 10). The $2.6 billion relates to fees on debt guarantees that have expired. In addition, the DIF transferred an equal amount of “Cash and investments - restricted - systemic risk” to the DIF’s cash and investments. In the unforeseen event a debt default occurs greater than the remaining amount held as deferred revenue, to the extent needed, any amount previously recognized as revenue to the DIF will be returned to the TLGP.
Because of uncertainties surrounding the outlook for the economy and financial markets, there remains a possibility that the TLGP could incur a loss that would absorb some or all of the remaining guarantee fees. Therefore, it is appropriate to continue the practice of deferring revenue recognition for the remaining $5.7 billion of “Deferred revenue - systemic risk” (which excludes the liability of $925 million to Treasury for the fair value and related interest of the Citigroup TruPs).
(1) As of December 31, 2011, the fair value of investments in U.S. Treasury obligations held by TLGP was $3.1 billion. An unrealized gain of $439 thousand is reported in the “Deferred revenue - systemic risk” line item.
17. Subsequent Events
Subsequent events have been evaluated through April 11, 2012, the date the financial statements are available to be issued.
2011 Failures through April 11, 2012
Through April 11, 2012, 16 insured institutions failed in 2012 with total losses to the DIF estimated to be $1.3 billion.
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