To the Board of Directors
Federal Deposit Insurance Corporation
We have audited the
statements of financial position as of December 31, 1997 and 1996, of the three funds
administered by the Federal Deposit Insurance Corporation (FDIC), the related statements
of income and fund balance (accumulated deficit), and the statements of cash flows for the
years then ended. In our audits of the Bank Insurance Fund (BIF), the Savings Association
Insurance Fund (SAIF), and the FSLIC Resolution Fund (FRF), we found
-- the financial statements of each fund were reliable in all
material respects;
-- although certain internal controls should be improved, FDIC
management fairly stated that internal controls in place on December 31, 1997, were
effective in safeguarding assets from material loss, assuring material compliance with
relevant laws and regulations, and assuring that there were no material misstatements in
the financial statements of the three funds administered by FDIC; and
-- no reportable noncompliance with laws and regulations we
tested.
The following sections discuss our conclusions in more detail.
They also present information on (1) the scope of our audits, (2) the current status of
FRF liquidation activities and funding, (3) FDIC's Year 2000 efforts, (4) FDIC's progress
in addressing reportable conditions1 identified during our 1996 audits, and a reportable
condition identified during our 1997 audits, (5) recommendations from our 1997 audits, and
(6) the Corporation's comments on a draft of this report and our evaluation.
OPINION ON BANK INSURANCE FUND'S
FINANCIAL STATEMENTS
The financial statements and accompanying notes present fairly,
in all material respects, in conformity with generally accepted accounting principles, the
Bank Insurance Fund's financial position as of December 31, 1997 and 1996, and the results
of its operations and its cash flows for the years then ended.
At FDIC's request, we provided an audit opinion in March 1998 on
the Bank Insurance Fund's financial statements in order to facilitate FDIC's Securities
and Exchange Commission (SEC) reporting needs resulting from BIF's 1996 asset
securitization transaction.
As discussed in note 7 of BIF's financial statements, FDIC has securitized some BIF
receivership assets in two separate securitization deals as part of FDIC's efforts to
maximize the return from the sale or disposition of assets. The deals were accomplished
through the creation of Real Estate Mortgage Investment Conduit (REMIC) trusts. To
facilitate the securitizations, BIF provided limited guarantees to cover certain losses on
the securitized assets up to a specified maximum. Because of the limited guarantee
provided by BIF, and the public holding of the securities from the 1996 securitization,
the REMIC trust was required to include BIF's audited financial statements as an exhibit
in its Form 10-K report for the year ended December 31, 1997.
OPINION ON SAVINGS ASSOCIATION INSURANCE
FUND'S FINANCIAL STATEMENTS
The financial statements and accompanying notes present fairly,
in all material respects, in conformity with generally accepted accounting principles, the
Savings Association Insurance Fund's financial position as of December 31, 1997 and 1996,
and the results of its operations and its cash flows for the years then ended.
OPINION ON FSLIC RESOLUTION FUND'S
FINANCIAL STATEMENTS
The financial statements and accompanying notes present fairly,
in all material respects, in conformity with generally accepted accounting principles, the
FSLIC Resolution Fund's financial position as of December 31, 1997 and 1996, and the
results of its operations and its cash flows for the years then ended.
As discussed in note 9 of FRF's financial statements, a
contingency exists from the over 120 lawsuits pending against the United States government
in the United States Court of Federal Claims. These lawsuits assert that certain
agreements were breached when Congress enacted and the Office of Thrift Supervision
implemented legislation affecting the thrift industry.
On July 1, 1996, the United States Supreme Court concluded that
the government is liable for damages in three other cases, consolidated for appeal to the
Supreme Court, in which the changes in regulatory treatment required by the Financial
Institutions Reform, Recovery, and Enforcement Act (FIRREA) led the government to not
honor its contractual obligations. However, because the lower courts had not determined
the appropriate measure or amount of damages, the Supreme Court returned the cases to the
Court of Federal Claims for further proceedings. Until the amount of damages is determined
by the court, the amount of costs from these three cases is uncertain. Further, with
respect to the other pending cases, the outcome of each case and the amount of any
possible damages remain uncertain.
Claims against the federal government are generally paid from the
Judgment Fund, a permanent, indefinite appropriation established by 31 U.S.C. 1304, and
administered by the Department of the Treasury. However, the Department of the Treasury
may determine that payment of a judgment is otherwise provided for by another dedicated
source of funds. FDIC believes that FRF should not be considered a dedicated source of
funds for payment of such judgments against the United States. Because the Department of
the Treasury has not yet determined the source of payment for these judgments, the extent
to which FRF will be responsible for any payments is uncertain.
OPINION ON FDIC MANAGEMENT'S ASSERTIONS
ABOUT THE EFFECTIVENESS OF INTERNAL CONTROLS
For the three funds administered by FDIC, we evaluated FDIC
management's assertions about the effectiveness of its internal controls designed to
-- safeguard assets against loss from unauthorized acquisition,
use, or disposition;
-- assure the execution of transactions in accordance with
provisions of selected laws and regulations that have a direct and material effect on the
financial statements of the three funds; and
-- properly record, process, and summarize transactions to permit
the preparation of reliable financial statements and to maintain accountability for
assets.
FDIC management fairly stated that those controls in place on
December 31, 1997, provided reasonable assurance that losses, noncompliance, or
misstatements material in relation to the financial statements would be prevented or
detected on a timely basis. FDIC management made this assertion based on criteria
established under the Federal Managers' Financial Integrity Act of 1982 (FMFIA). FDIC
management, in making its assertion, also fairly stated the need to improve certain
internal controls.
Our work also identified the need to improve certain internal
controls, as described in a later section of this report. The weakness in internal
controls, although not considered a material weakness,2 represents a significant
deficiency in the design or operation of internal controls which could have adversely
affected FDIC's ability to fully meet the internal control objectives listed above. The
internal control weakness relates to FRF only, and although the weakness did not
materially affect FRF's financial statements, misstatements may nevertheless occur in
other FDIC-reported financial information for FRF as a result of the internal control
weakness. The weakness is discussed in detail in a later section of this report.
COMPLIANCE WITH LAWS
AND REGULATIONS
Our tests for compliance with selected provisions of laws and
regulations disclosed no instances of noncompliance that would be reportable under
generally accepted government auditing standards. However, the objective of our audits was
not to provide an opinion on overall compliance with laws and regulations. Accordingly, we
do not express such an opinion.
OBJECTIVES, SCOPE, AND METHODOLOGY
FDIC's management is responsible for
-- preparing the annual financial statements in conformity with
generally accepted accounting principles;
-- establishing, maintaining, and evaluating the internal control
to provide reasonable assurance that the broad control objectives of FMFIA are met; and
-- complying with applicable laws and regulations.
We are responsible for obtaining reasonable assurance about
whether (1) the financial statements are free of material misstatement and presented
fairly, in all material respects, in conformity with generally accepted accounting
principles and (2) FDIC management's assertion about the effectiveness of internal
controls is fairly stated, in all material respects, based upon the criteria established
under FMFIA. We are also responsible for testing compliance with selected provisions of
laws and regulations and for performing limited procedures with respect to certain other
information in FDIC's annual financial report.
In order to fulfill these responsibilities, we
-- examined, on a test basis, evidence supporting the amounts and
disclosures in the financial statements;
-- assessed the accounting principles used and significant
estimates made by management;
-- evaluated the overall presentation of the financial
statements;
-- obtained an understanding of the internal controls related to
safeguarding assets, compliance with laws and regulations, including the execution of
transactions in accordance with management's authority, and financial reporting;
-- tested relevant internal controls over safeguarding, compliance, and financial
reporting and evaluated management's assertion about the effectiveness of internal
controls; and
-- tested compliance with selected provisions of the Federal
Deposit Insurance Act, as amended; the Chief Financial Officers Act of 1990; and the
Federal Home Loan Bank Act, as amended.
We did not evaluate all internal controls relevant to operating
objectives as broadly defined by FMFIA, such as those controls relevant to preparing
statistical reports and ensuring efficient operations. We limited our internal control
testing to those controls necessary to achieve the objectives outlined in our opinion on
management's assertion about the effectiveness of internal controls. Because of inherent
limitations in any internal control, losses, noncompliance, or misstatements may
nevertheless occur and not be detected. We also caution that projecting our evaluation to
future periods is subject to the risk that controls may become inadequate because of
changes in conditions or that the degree of compliance with controls may deteriorate.
We conducted our audits between July 1997 and May 1998. Our
audits were conducted in accordance with generally accepted government auditing standards.
FDIC provided comments on a draft of this report. FDIC's comments
are discussed and evaluated in a later section of this report.
CURRENT STATUS OF FRF'S
LIQUIDATION ACTIVITIES AND FUNDING
FDIC, as administrator of FRF, is responsible for liquidating the
assets and liabilities of the former Resolution Trust Corporation (RTC), as well as the
former FSLIC's assets and liabilities.3 As shown in table 1, the majority of FRF's losses
from liquidation activities have been realized as of December 31, 1997.
Table 1: FRF's Realized and Unrealized Losses as of December 31, 1997
(Dollars in billions)
|
FRF-RTC |
FRF-FSLIC |
Total FRF |
Realized losses |
$83.2 |
$41.4 |
$124.6 |
Unrealized losses |
1.6 |
0.8 |
2.4 |
Total realized and unrealized losses (accumulated deficit) |
$84.8 |
$42.2 |
$127.0 |
The accumulated deficit for FRF includes losses
that have already been realized, as well as future estimated losses from assets and
liabilities not yet liquidated. Losses are realized when failed financial institution
assets in receiverships are disposed of and the proceeds are not sufficient to repay
amounts payable to FRF. Losses are also realized if assets that FRF purchases from
terminating receiverships are later sold for less than the purchase price. Losses are also
realized when certain estimated liabilities associated with FRF's liquidation activities
are paid out. Uncertainties still exist with regard to the unrealized losses, and the
final amount will not be known with certainty until all remaining assets and liabilities
are liquidated.
In total, $135.5 billion was received to cover liabilities and losses associated with the
former FSLIC and RTC resolution activities. Of the $135.5 billion total, $91.3 billion4
was received by RTC through December 31, 1995, the date of RTC's termination, to cover
losses and expenses associated with failed institutions from its caseload. FRF received
$44.2 billion to cover the liabilities and losses associated with the former FSLIC
activities.
As shown in table 2, after reducing the total amount of funding
received by the amount of recorded accumulated deficit, an estimated $8.5 billion in
available funds will remain. The RTC Completion Act requires FDIC to deposit in the
general fund of the Treasury any funds transferred to RTC pursuant to the Completion Act
but not needed for RTC-related losses. Also, after providing for all outstanding RTC
liabilities, FDIC must transfer to the Resolution Funding Corporation (REFCORP) the net
proceeds from the sale of RTC-related assets. Any such funds transferred to REFCORP pay
the interest on REFCORP bonds issued to provide funding for the early RTC resolutions. Any
payments to REFCORP benefit the U.S. Treasury, which is otherwise obligated to pay the
interest on the bonds. Separately, any FSLIC-related funds remaining are to be deposited
to the U.S. Treasury. The final amount of unused funds will not be known with certainty
until all of FRF's remaining assets and liabilities are liquidated.
Table 2: Estimated Unused Funds After Completion of FRF's Liquidation Activities
(Dollars in billions)
|
FRF-RTC |
FRF-FSLIC |
Total FRF |
Total funds received |
$91.3 |
$44.2 |
$135.5 |
Less: accumulated
deficit |
84.8 |
42.2 |
127.0 |
Estimated unused funds |
$ 6.5 |
$ 2.0 |
$ 8.5 |
INFORMATION ON FDIC'S
YEAR 2000 EFFORTS
The Year 2000 computing crisis is a sweeping and urgent information technology challenge
facing public and private organizations.5 In addition to facing Year 2000 issues with its
internal systems, FDIC, as administrator of the deposit insurance funds, faces exposure
and potential loss from banks and thrifts that fail to adequately address their own Year
2000 system issues. In addition, as regulator, FDIC has responsibility to ensure that the
banks it oversees are adequately addressing systems issues related to the Year 2000.
In February 1998, we testified on FDIC's progress in addressing
the Year 2000 challenges it faces.6 In summary, we found that FDIC is taking action to
address its Year 2000 risks. With regard to FDIC's efforts to correct its internal
systems, we concluded that at the time of our testimony, FDIC was behind in assessing
whether its systems were Year 2000 compliant. In response, FDIC has revised its project
plan to include earlier completion dates for certain phases of the project and is
allocating resources to support the plan. In addition, as discussed in the notes to FDIC's
financial statements,7 FDIC is currently assessing, testing, modifying, or replacing its
automated systems in order to ensure that they become Year 2000 compliant.
We also testified that FDIC is devoting considerable effort and
resources to ensure that the banks it oversees mitigate their Year 2000 risks. FDIC is
also working closely with the other banking regulators to provide guidance and supervision
for the banking and savings institution industries as a whole. However, as discussed in
the notes to BIF's and SAIF's financial statements, as of December 31, 1997, the potential
exposure to the deposit insurance funds resulting from the Year 2000 problem was not
estimable. During 1998, FDIC is continuing its monitoring efforts, and is gathering
additional data to analyze and estimate potential exposure to the insurance funds from the
potential Year 2000 problems of the banks and thrifts it insures. We will evaluate FDIC's
analysis of exposure to the insurance funds from banks' and savings institutions' Year
2000 problems during our audits of FDIC's 1998 financial statements.
REPORTABLE CONDITIONS
The following sections discuss (1) FDIC's progress in addressing
reportable conditions identified during our 1996 audits and (2) reportable conditions
found during our 1997 audits.
Progress on Weaknesses
Identified in Previous Audits
In our 1996 audit report on the three funds administered by FDIC, we identified two
reportable conditions which affected FDIC's ability to ensure that internal control
objectives were achieved.8 These weaknesses related to FDIC's internal controls designed
to ensure that (1) contracted asset servicers properly safeguarded failed institution
assets and accurately reported financial information to FDIC and (2) data used in the
calculation of the year-end allowance for losses was adequately reviewed for accuracy
prior to inclusion in the year-end calculation.
First, during our 1996 audits, we found that FDIC had limited
assurance that contracted asset servicers properly safeguarded failed institution assets
and accurately reported financial information to FDIC because of deficiencies in FDIC's
contractor oversight program. Specifically, FDIC's contractor oversight procedures did not
ensure that (1) contracted asset servicers had adequate controls over daily collections
and bank reconciliations, (2) servicers' fees and reimbursable expenses were valid,
accurate, and complete, and (3) servicers' loan system calculations relating to the
allocation of principal and interest were accurate.
During 1997, FDIC implemented a contracted asset servicer visitation program to address
the specific areas of weaknesses noted during our 1996 audits. Also, FDIC completed an
interdivisional memorandum of understanding to clarify the roles and responsibilities
related to contractor oversight. As a result, we found that FDIC's new procedures ensured
that contracted asset servicers had adequate controls over daily collections and bank
reconciliations and loan system calculations relating to the allocation of principal and
interest. Although we continued to find instances where FDIC oversight personnel did not
ensure that servicer fees and expenses were valid and accurate, we concluded that the
extent of the problems was not significant to BIF's and FRF's financial statements. We
will discuss this matter further in a management letter.
During our 1997 audits, we found that the action FDIC took to
address the second reportable condition was not fully effective. Therefore, we are
continuing to report the weakness regarding integrity of data used for calculating the
allowance for losses as a reportable condition. Additional details are provided below.
Reportable Condition
Identified in 1997
FDIC estimates recoveries on assets acquired from failed financial institutions and uses
these estimates to calculate the allowance for losses on receivables from resolution
activities and investment in corporate-owned assets. FDIC uses multiple data sources to
calculate the estimated recoveries from these assets. Generally, FDIC estimates recoveries
on loans, real estate owned, equity in subsidiaries, and other assets (including furniture
and fixtures and miscellaneous receivables) using its Standard Asset Valuation Estimation
(SAVE) process. FDIC values securities and other types of equity interests outside of its
SAVE process.
During our 1996 audits, we found that FDIC did not have effective
procedures in place to ensure that recovery estimates received from the various sources
were adequately reviewed for accuracy prior to being included in the year-end calculation
of the allowance for losses. In response to our finding, FDIC implemented enhanced review
procedures intended to mitigate the occurrence of errors and ensure the quality and
reasonableness of the recovery estimates. The new procedures required certification that
recovery estimates submitted for inclusion in the allowance for loss calculations had been
formally reviewed for accuracy.
During our 1997 audits, we continued to note problems with
recovery estimates for FRF assets not valued as part of FDIC's SAVE process. For example,
we found that significant errors were made in estimating the recoveries for a portfolio of
partnership interests, causing the portfolio to be undervalued by $125 million. In
addition, we found unsupported recoveries and other errors in the estimated recoveries for
another portfolio of debt and equity securities causing the portfolio to be overvalued by
$26 million. The estimated recoveries for both the partnership interests and debt and
equity securities portfolios described above had been certified and reviewed for accuracy
by FDIC personnel. The combined effect of the above valuation errors was an understatement
of FRF's estimated recoveries and an overstatement of its allowance for losses on amounts
due from receiverships.
FRF assets valued outside of FDIC's SAVE process were valued
using various, inconsistent methods with varying degrees of examination of underlying
documentation. This situation, combined with ineffective verification and review increases
the risk that errors will occur and remain undetected by FDIC.
In addition to the weaknesses described above, we noted other
less significant matters involving FDIC's system of internal accounting controls and
FDIC's electronic data processing controls which we will be reporting separately to FDIC
in two management letters.
RECOMMENDATIONS
In order to address the above weakness, we recommend that the Chairman of FDIC direct the
heads of the Division of Resolutions and Receiverships and the Division of Finance to
implement an improved process for estimating recoveries for securities and other assets
currently being valued outside of its Standard Asset Valuation Estimation process. The
process should have the objectives of producing valid and defensible estimates for
financial statement purposes. In addition, FDIC should reemphasize the importance of the
review and certification procedures for the estimated recoveries on assets valued outside
of its standard asset valuation process.
CORPORATION COMMENTS AND OUR EVALUATION
In commenting on a draft of this report, FDIC acknowledged the
reportable condition cited in our report and described its planned approach to improve the
reliability of estimated recovery value for FRF assets valued outside of the SAVE process.
We plan to evaluate the adequacy and effectiveness of these corrective actions as part of
our audits of FDIC's 1998 financial statements. FDIC's comments also address the progress
made in addressing the reportable condition regarding contractor oversight discussed in
our 1996 report.
Robert W. Gramling
Director, Corporate Audits
and Standards
May 15, 1998
1 Reportable conditions involve matters coming to the auditor's attention relating to
significant deficiencies in the design or operation of internal controls that, in the
auditor's judgment, could adversely affect an entity's ability to (1) safeguard assets
against loss from unauthorized acquisition, use, or disposition, (2) ensure the execution
of transactions in accordance with management's authority and in accordance with laws and
regulations, and (3) properly record, process, and summarize transactions to permit the
preparation of financial statements and to maintain accountability for assets.
2 A material weakness is a reportable condition in which the design or operation of the
internal control does not reduce to a relatively low level the risk that losses,
noncompliance, or misstatements in amounts that would be material in relation to the
financial statements may occur and not be detected within a timely period by employees in
the normal course of their assigned duties.
3 On January 1, 1996, FRF assumed responsibility for all
remaining assets and liabilities of the former RTC.
4 FIRREA provided an initial $50 billion to RTC. The Resolution
Trust Corporation Funding Act of 1991 provided an additional $30 billion. The Resolution
Trust Corporation Refinancing, Restructuring, and Improvement Act of 1991 provided $25
billion in December 1991, of which $6.7 billion was obligated prior to the April 1, 1992
deadline. In December 1993, the RTC Completion Act removed the April 1, 1992, deadline,
thus making the remaining $18.3 billion available to RTC for resolution activities. Prior
to RTC's termination on December 31, 1995, RTC drew down $4.6 billion of the $18.3 billion
that was made available by the RTC Completion Act.
5 For the past several decades, information systems have typically used two digits to
represent the year, such as "98" for 1998, in order to conserve electronic data
storage and reduce operating costs. In this format, however, 2000 is indistinguishable
from 1900 because both are represented as "00." As a result, if not modified,
computer systems or applications that use dates or perform date- or time-sensitive
calculations may generate incorrect results beyond 1999.
6 Year 2000 Computing Crisis: Federal Deposit Insurance
Corporation's Efforts to Ensure Bank Systems Are Year 2000 Compliant
(GAO/T-AIMD-98-73, February 10, 1998).
7 See the following notes to FDIC's financial statement: number
16 for BIF; number 13 for SAIF; and number 17 for FRF.
8 Financial Audit: Federal Deposit Insurance Corporation's
1996 and 1995 Financial Statements (GAO/AIMD-97-111, June 30, 1997).