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Federal Deposit
Insurance Corporation

Each depositor insured to at least $250,000 per insured bank

2014 Annual Report

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I. Management’s Discussion and Analysis

The Year in Review

OVERVIEW

During 2014, the FDIC continued to fulfill its mission-critical responsibilities. The FDIC adopted and issued final rules on key regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The FDIC also engaged in several community banking and community development initiatives over the past year. In addition, cybersecurity remained a high priority for the FDIC as it worked to strengthen cybersecurity oversight, help financial institutions mitigate this increasing risk, and respond to cyber threats. The sections below highlight some of our accomplishments during the year.

IMPLEMENTATION OF KEY REGULATIONS

Capital Rulemaking and Guidance

In April 2014, the FDIC adopted as final its 2013 interim final capital rule implementing the Basel III capital standards. The Basel III standards strengthen the quality and required level of regulatory capital and, for advanced approaches banks, introduce a new supplementary leverage requirement. The final rule is largely identical to the final capital rule adopted by the Office of the Comptroller of the Currency (OCC) and the Board of Governors of the Federal Reserve System (FRB) in September 2013. Also in April 2014, the FDIC and the other federal banking agencies issued a final rule that strengthens the supplementary leverage capital requirements for the eight largest U.S. bank holding companies (BHCs) and their insured banks. The enhanced leverage requirements in this rule, which are significantly higher than the 3 percent level agreed to by the Basel Committee, should contribute to the stability and resilience of these large institutions and the financial system.

Basel III Final Capital Rule

At its April 2014 meeting, the FDIC Board of Directors (FDIC Board) approved the Basel III interim final rule as a final rule with no substantive changes. The FDIC had issued the July 2013 Basel III rule as an interim final rule in order to consider comments on the enhanced supplementary leverage standards. The Basel III rule became effective January 1, 2015, for banking organizations not subject to the advanced approaches risk-based capital rule. Banking organizations that are subject to the advanced approaches capital requirements have been operating under the new capital rule since January 1, 2014. For all banking organizations, the final rule provides a phase-in period for certain aspects of the rule including the new capital ratios, the capital conservation buffer, and adjustments to and deductions from regulatory capital.

The capital conservation buffer framework provides for gradually increasing limits on capital distributions as a bank’s risk-based capital ratios approach regulatory minimums. S-corporation banks have expressed concern that this framework could increase the frequency with which their shareholders face a tax liability without having received dividends. Under the final rule, banks may make a dividend exception request to their primary federal regulator (PFR), and the regulator can approve the request if warranted based on safety and soundness considerations. In July 2014, the FDIC released a Financial Institution Letter (FIL) describing the factors that will be considered for such requests from S-corporation banks. Absent significant safety and soundness concerns about the requesting bank, the FDIC generally would expect to approve exception requests by well-rated S-corporation banks that are limited to the payment of dividends to cover shareholders’ taxes on their portion of an S-corporation’s earnings.

Regulatory Capital–Proposed Revisions Applicable to Banking Organizations Subject to the Advanced Approaches Risk-Based Capital Rule

In November 2014, the federal banking agencies issued a notice of proposed rulemaking (NPR) regarding certain technical amendments to the advanced approaches risk-based capital rule, to enhance consistency of the U.S. capital rules with international standards for the use of the advanced approaches framework.

Enhanced Supplementary Leverage Ratio Standards for Certain Bank Holding Companies and their Subsidiary Insured Depository Institutions

In April 2014, the federal banking agencies issued a final rule that increases the supplementary leverage requirements for the largest, most systemically important banking organizations and their subsidiary insured depository institutions (IDIs). The new requirements apply to banking organizations with at least $700 billion in total consolidated assets at the top-tier BHC or at least $10 trillion in assets under custody (covered BHCs) and any IDI subsidiary of these bank holding companies (covered IDIs). For covered IDIs, the rule establishes a supplementary leverage ratio of 6 percent as a “well-capitalized” threshold for prompt corrective action (PCA). For covered BHCs, the rule establishes a capital conservation buffer composed of tier 1 capital of 2 percent of total leverage exposure; therefore, these BHCs need to maintain a supplementary leverage ratio of 5 percent to avoid restrictions on capital distributions. These levels are in excess of the Basel III requirement of a 3 percent supplementary leverage ratio, which applies to all advanced approaches banking organizations.

Supplementary Leverage Ratio Final Rule

In September 2014, the FDIC approved an interagency final rule that implements changes to the supplementary leverage ratio calculation that were proposed in April 2014. The supplementary leverage ratio applies to all banking organizations subject to the advanced approaches risk-based capital rules, including the eight entities subject to the enhanced supplementary leverage requirements. The rule aligns the agencies’ rules on the calculation of the denominator of the supplementary leverage ratio with international leverage ratio standards. Among other things, the new rule:

The rule also establishes public disclosure requirements that are effective in March 2015. Supplementary leverage ratio capital requirements incorporating the revised denominator are effective January 1, 2018.

Regulatory Reporting Under the Final Capital Rule

In March 2014, the FDIC and the other federal banking agencies implemented the first stage of revisions to the Consolidated Reports of Condition and Income (Call Report) to align the regulatory capital components and ratios portion of the regulatory capital schedule with the Basel III revised regulatory capital definitions. The agencies also revised the Federal Financial Institutions Examination Council (FFIEC) 101 regulatory capital report for advanced approaches institutions to implement changes to the advanced approaches regulatory capital rules. These regulatory capital reporting changes took effect as of the March 31, 2014, report date for advanced approaches institutions. The Call Report revisions will be applicable to all other institutions as of the March 31, 2015, report date.

In June 2014, the FDIC and the other federal banking agencies issued for comment the second stage of revisions to the Call Report regulatory capital schedule. These revisions would update the risk-weighted assets portion of the schedule to reflect the standardized approach to risk weighting in the Basel III final rules and would take effect as of the March 31, 2015, report date. Following the publication of the proposal, the agencies conducted a banker teleconference to describe the proposed reporting changes and respond to questions. The agencies have modified the report form and instructions in response to comments and technical questions received on the proposal. Final drafts of the revised risk-weighted assets report form and instructions were made available to institutions in January 2015. Subsequently, the agencies also issued the final risk-weighted asset reporting changes for comment and submitted them to the U.S. Office of Management and Budget (OMB) for approval.

In September 2014, the FDIC and the other federal banking agencies issued for comment the proposed FFIEC 102 market risk regulatory report. This new quarterly report would collect key information from the limited number of institutions subject to the Basel III market risk capital rules on how they measure and calculate market risk under these rules. The report would take effect as of the March 31, 2015, report date. After considering technical questions received on the proposal, the agencies finalized the market risk reporting requirements in January 2015, and subsequently issued a final request for comments and submitted the new report to OMB for approval.

Stress Testing Guidance

In March 2014, the FDIC, along with the other federal banking agencies, issued final guidance that outlines high-level principles for implementing Section 165(i)(2) of the Dodd-Frank Act, which requires stress tests for companies with $10 billion to $50 billion in consolidated assets.

The guidance discusses supervisory expectations for the Dodd-Frank Act stress test practices and offers additional details about methodologies that should be employed by these companies. It also underscores the importance of stress testing as an ongoing risk management practice that supports a company’s forward-looking assessment of its risks and better equips the company to address a range of macroeconomic and financial outcomes.

Since the publication of the Annual Stress Test rule in October 2012, the FDIC and other federal banking agencies have received feedback from the industry regarding the resource constraints that covered banks face at the beginning and end of the calendar year arising from competing regulatory and reporting deadlines. The FDIC and other banking agencies are aware that conducting stress testing during the last quarter of a calendar year may also make it difficult for covered banks to timely modify strategic and operational plans for the following year that address any issues identified in the company-run stress test results.

For these reasons, in November 2014, the FDIC, in coordination with the FRB and the OCC, issued a final rule that modifies the dates of the stress test cycle and the corresponding reporting and publication deadlines. The shift in testing, reporting, and disclosure dates will take place for the 2016 company-run stress test cycle and each annual cycle thereafter.

Other Rulemaking and Guidance under the Dodd-Frank Act

The Dodd-Frank Act requires various agencies to publicize regulations in a number of areas. The following is a summary of significant activity relating to the Dodd-Frank Act.

Margin and Capital Requirements for Covered Swap Entities

In September 2014, the FDIC Board approved the interagency notice of proposed rulemaking (NPR) for Margin and Capital Requirements for Covered Swap Entities. This proposed rule would implement certain requirements contained in Sections 731 and 764 of the Dodd-Frank Act, which provide that the largest and most active participants in the over-the-counter derivatives market must collect initial margin and variation margin. The NPR is consistent with the international framework on margin requirements published by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions in September 2013.

The proposed rule applies to these large entities supervised by the agencies and designated by the U.S. Commodity Futures Trading Commission (CFTC) or the U.S. Securities and Exchange Commission (SEC) as swap dealers, major swap participants, security-based swap dealers, or security-based major swap participants. The NPR calls these registered firms “covered swap entities” (CSEs). As of December 15, 2014, 15 insured depository institutions had registered with the CFTC as swap dealers, and as of that date, no IDI had registered with the CFTC as a major swap participant. The SEC has not yet imposed a registration requirement for dealers or major participants in swaps that it regulates.

A CSE would be required to exchange initial margin for non-cleared swaps that it enters into with other swap entities and with financial entities that engage in swap activity above a certain threshold. A CSE would be required to exchange variation margin for uncleared swaps it enters into with another swap entity or with any financial entity. Most community bank swap activities are in amounts too small to be affected by the proposed rule. Also, the proposed rule does not require CSEs to collect margin from commercial end users.

The proposal was published in the Federal Register on September 24, 2014, and the comment period ended November 24, 2014. The agencies are reviewing the comments and plan to issue a final rule in early 2015.

Credit Risk Retention for Securitizations

In October 2014, the FDIC, jointly with the OCC, the FRB, the Department of Housing and Urban Development, the SEC, and the Federal Housing Finance Agency (FHFA), approved a final rule to implement the securitization credit risk retention provisions of Section 941 of the Dodd-Frank Act, which added Section 15G to the Securities Exchange Act of 1934. Section 15G generally requires securitizers of asset-backed securities (ABS) to retain not less than 5 percent of the credit risk of assets collateralizing ABS issuances, and generally prohibits a securitizer from directly or indirectly hedging or otherwise transferring the credit risk the securitizer is required to retain. The final rule provides various exemptions from the risk retention requirements, some of which are required by statute. For example, as required by the Dodd-Frank Act, the final rule exempts ABS collateralized solely by “qualified residential mortgages” (QRM) from risk retention requirements.

The final rule aligns the definition of QRM with the definition of “qualified mortgage” (QM) as prescribed by the Consumer Financial Protection Bureau (CFPB). This alignment is consistent with the statutory requirement that the QRM definition be no broader than the QM definition and take into consideration underwriting and product features that historical loan performance data indicate result in lower risk of default. In addition, the final rule reduces, in some situations to zero, the risk retention requirements for ABS collateralized by commercial mortgages, commercial real estate (CRE) loans, or automobile loans that meet certain underwriting standards. The final rule also provides various transaction-specific risk retention options for revolving pool securitizations, commercial mortgage-backed securities, open market collateralized loan obligations, government-sponsored enterprises, municipal bond repackagings (known as tender option bonds), and asset-backed commercial paper conduits. The final rule prohibits hedging, transferring, or pledging required risk retention until these restrictions lapse, which varies by asset type.

The final rule was published in the Federal Register on December 24, 2014. Compliance with respect to residential mortgage-backed securities is required beginning one year after the date of publication in the Federal Register. For all other classes of ABS, compliance with the final rule is required beginning two years after the date of publication in the Federal Register.

The Volcker Rule

On December 10, 2013, the FDIC, along with the other federal banking agencies, and the SEC, approved a joint final rule to implement the provisions of Section 619 of the Dodd-Frank Act, also known as the “Volcker Rule.” (On that same date, for procedural reasons, the CFTC adopted an identical final rule.)  The Volcker Rule, which added Section 13 to the BHC Act, generally prohibits any banking entity from engaging in proprietary trading or acquiring or retaining an interest in, sponsoring, or having certain relationships with, a hedge fund or private equity fund, subject to certain exemptions. The final rule became effective April 1, 2014.

In January 2014, the FDIC, together with the other federal banking agencies, the SEC, and the CFTC, adopted a joint interim final rule that permits banking entities subject to the Volcker Rule to retain investments in certain collateralized debt obligations backed primarily by trust preferred securities.

To help ensure consistent implementation of the Volcker Rule, the agencies have established an interagency Volcker Rule working group that meets regularly to discuss issues and the application and enforcement of the rule.

During 2014, the agencies posted various joint Frequently Asked Questions (FAQs) on their websites to address certain implementation issues presented by banking entities subject to the Volcker Rule. These FAQs have addressed such matters as:

Minimum Requirements for Appraisal Management Companies

In April 2014, the FDIC, jointly with the OCC, the FRB, the National Credit Union Administration (NCUA), the CFPB, and the FHFA, approved an NPR to implement the minimum requirements for registration and supervision of appraisal management companies (AMCs) in the Dodd-Frank Act. The proposed rule would establish the minimum requirements in Section 1473 of the Dodd-Frank Act (Section 1473) for registration and supervision of AMCs; establish the minimum requirements for AMCs that register with the State under Section 1473; require federally regulated AMCs to meet the minimum requirements of Section 1473 (other than registering with the State); and require the reporting of certain AMC information to the Appraisal Subcommittee of the FFIEC. The comment period closed in June 2014, and the agencies are reviewing and considering the comments received. The agencies expect to issue a final rule in 2015.

Joint Standards for Assessing Diversity Policies and Practices

The FDIC continued to implement the provisions of Section 342 of the Dodd-Frank Act during 2014. Section 342(b)(2)(C) of the Act requires the Office of Minority and Women Inclusion (OMWI) Director of each covered agency to develop standards for assessing the diversity policies and practices of entities regulated by such agency. To implement that requirement and develop those standards, the FDIC’s OMWI continued to work closely in 2014 with the OMWI Directors of the OCC, the NCUA, the FRB, the CFPB, and the SEC. In addition, the FDIC developed standards for increasing the participation of minority- and women-owned businesses (MWOBs) in the agency’s programs and contracts and standards to evaluate agency contractors’ good faith efforts to include minorities and women in their workforce.

In late 2013, proposed standards were published in the Federal Register as a Proposed Interagency Policy Statement Establishing Joint Standards for Assessing the Diversity Policies and Practices of Entities Regulated by the Agencies. The proposed standards describe leading diversity practices for the financial services industry in four key areas: (1) organizational commitment to diversity and inclusion; (2) workforce profile and employment practices; (3) procurement and business practices – supplier diversity; and (4) practices to promote transparency of organizational diversity and inclusion.

The comment period was initially scheduled to end on December 24, 2013, but was extended to February 7, 2014, to facilitate public comment on the policy statement and questions posed by the agencies. The FDIC in coordination with the other agencies have reviewed the comments received and are in the final stages of preparing final joint standards, which will likely be issued in 2015.

Liquidity and Funds Management Rulemaking

Liquidity Coverage Ratio

In September 2014, the FDIC, together with the OCC and the FRB, issued a joint final rule to implement the Liquidity Coverage Ratio (LCR). The final rule requires certain banks to hold a minimum level of liquid assets to support contingent liquidity events that could arise within a 30-day liquidity stress horizon. It also provides a standard way of expressing a bank’s on-balance sheet liquidity position to stakeholders and supervisors.

The requirement applies to large, internationally active banking organizations and their consolidated subsidiary depository institutions with $10 billion or more in total consolidated assets. Covered companies are required to notify their PFR when the LCR drops below 100 percent and develop a remediation plan if the shortfall persists. The rule establishes a shorter phase-in period than the Basel III standard, as it would require covered companies to fully meet the minimum LCR by January 1, 2017, two years earlier than the Basel III requirements. The FRB is also applying a less stringent LCR requirement to certain smaller depository institution holding companies with $50 billion to $250 billion in total assets.

Net Stable Funding Ratio

In October 2014, the BCBS published a final standard to implement the Net Stable Funding Ratio (NSFR). While the LCR focuses on having sufficient high-quality liquid asset buffers to weather a short-term severe stress, the NSFR considers funding over a longer horizon. The NSFR requires banks to maintain a stable funding profile in relation to their on- and off-balance sheet activities, comparing the amount of an entity’s required stable funding to meet asset and off-balance sheet obligations against the available stable funding sources. The FDIC expects that the federal banking agencies will complete an NSFR proposal by year-end 2015.

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