FDIC Federal Register Citations

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FEDERAL DEPOSIT INSURANCE CORPORATION

Proposed Assessment Rate Adjustment Guidelines for Large
Institutions and Insured Foreign Branches in Risk Category I

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Notice and request for comment.

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SUMMARY: The FDIC is seeking comment on proposed guidelines it will use

for determining how adjustments of up to 0.50 basis points would be

made to the quarterly assessment rates of insured institutions defined

as large Risk Category I institutions, and insured foreign branches in

Risk Category I, according to the Final Assessments Rule (the final

rule).\1\ These guidelines are intended to further clarify the

analytical processes, and the controls applied to these processes, in

making assessment rate adjustment determinations.

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\1\ 71 Fr 69282 (Nov. 30, 2006).

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DATES: Comments must be submitted on or before March 23, 2007.

ADDRESSES: You may submit comments, identified by ``Adjustment

Guidelines'', by any of the following methods:

Agency Web site: http://www.fdic.gov/regulations/laws/federal.

Follow instructions for submitting comments on the Agency Web

site.

E-mail: Comments@FDIC.gov. Include ``Adjustment

Guidelines'' in the subject line of the message.

Mail: Robert E. Feldman, Executive Secretary, Attention:

Comments, Federal Deposit Insurance Corporation, 550 17th Street, NW.,

Washington, DC 20429.

Hand Delivery/Courier: Guard station at the rear of the

550 17th Street Building (located on F Street) on business days between

7 a.m. and 5 p.m.

Instructions: All comments received will be posted without change

to http://www.fdic.gov/regulations/laws/federal including any personal

information provided. Comments may be inspected and photocopied in the

FDIC Public Information Center, 3501 North Fairfax Drive, Room E-1002,

Arlington, VA 22226, between 9 a.m. and 5 p.m. (EST) on business days.

Paper copies of public comments may be ordered from the Public

Information Center by telephone at (877) 275-3342 or (703) 562-2200.

FOR FURTHER INFORMATION CONTACT: Miguel Browne, Associate Director,

Division of Insurance and Research, (202) 898-6789; Steven Burton,

Senior Financial Analyst, Division of Insurance and Research, (202)

898-3539; and Christopher Bellotto, Counsel, Legal Division, (202) 898-

3801.

SUPPLEMENTARY INFORMATION:

I. Background

Under the final rule, the assessment rates of large Risk Category I

institutions are first determined using either supervisory and long-

term debt issuer ratings, or supervisory ratings and financial ratios

for large institutions that have no publicly available long-term debt

issuer ratings. While the resulting assessment rates are largely

reflective of the rank ordering of risk, the final rule indicates that

FDIC may determine, in consultation with the primary federal regulator,

whether limited adjustments to these initial assessment rates are

warranted based upon consideration of additional risk information. Any

adjustments will be limited to no more than 0.50 basis points higher or

lower than the initial assessment rate and in no case would the

resulting rate exceed the maximum rate or fall below the minimum rate

in effect for an assessment period. Further, upward adjustments will

not take effect without notification being made to the primary federal

regulator and the institution or without consideration of any

additional information provided by the primary federal regulator and

the institution to these notifications; and downward adjustments will

not take effect without notification being made to the primary federal

regulator or without consideration of any additional information

provided by the primary federal regulator to these notifications.

Examples of additional risk information that would be considered in

making such adjustments, and a general description of how this

information would be evaluated, are also discussed in the final rule.

However, in the final rule, the FDIC acknowledged the need to further

clarify its processes for making adjustments to assessment rates and

indicated that no adjustments would be made until additional guidelines

were approved by the FDIC's Board.

The FDIC seeks comments on these proposed guidelines for evaluating

how assessment rate adjustments, if warranted, will be made, and the

size of any adjustments.\2\ Following a 30-day comment period, the FDIC

will review comments and revise the guidelines as appropriate. Although

the FDIC has in this instance chosen to publish the proposed guidelines

and solicit comment from the industry, notice and comment are not

required and need not be employed to make future changes to the

guidelines.

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\2\ These guidelines are also intended to apply to assessment

rate adjustment determinations for insured foreign branches, whose

initial assessment rates are determined from ROCA ratings under the

final rule.

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II. Broad Objectives

In the majority of cases, the use of agency and supervisory

ratings, or the use of supervisory ratings and financial ratios when

agency ratings are not available, will sufficiently reflect the risk

profile and rank orderings of risk in large Risk Category I

institutions. However, in certain cases, the FDIC may need to make

adjustments to assessment rates determined from these inputs in order

to preserve consistency in the orderings of risk indicated by these

assessment rates, ensure fairness among all large institutions, and

ensure that assessment rates take into account all available

information that is relevant to the FDIC's risk-based assessment

decision. The FDIC expects that adjustments will be made relatively

infrequently and for a limited number of institutions. If this is not

the case, the FDIC would likely reevaluate the underlying assessment

rate methodology involving supervisory and long-term debt issuer

ratings, and financial ratios for institutions without long-term debt

issuer ratings.

The following broad objectives helped inform the formulation of a

process for determining how adjustments to an institution's initial

assessment rate, if appropriate, will be made, as well as the

guidelines that will govern the adjustment process:

1. Assessment rates should reflect a logical and reasonable rank

ordering of risk among large Risk Category I institutions. That is,

institutions with similar risk profiles should pay similar assessment

rates; and institutions with higher (lower) risk profiles should pay

higher (lower) assessment rates.

2. Assessment rates for any given quarter should be based on the

most recent information that pertains to an institution's risk profile.

3. The rank ordering of risk represented by assessment rates should

be reconcilable to other risk measures including supervisory ratings,

financial performance information, market information, quantitative

measures of an institution's ability to withstand adverse events, and

loss severity indicators.

4. Assessment rate determinations should consider all available

information relating to both the likelihood of failure and loss

severity in the event of failure. Loss severity information should

include quantitative and qualitative considerations that relate to

potential resolution costs.

[[Page 7879]]

III. Overview of the Adjustment Process

The FDIC adjustment process will include the following steps. In

the first step, an initial risk ranking will be developed for all large

institutions based on their initial assessment rates as derived from

agency and supervisory ratings, or the use of supervisory ratings and

financial ratios when agency ratings are not available, in accordance

with the final rule.

In the second step, the risk rankings associated with these initial

assessment rates will be compared with risk rankings associated with

broad-based and focused risk measures as well as the risk rankings

associated with other market indicators such as spreads on subordinated

debt. Broad-based risk measures include each of the inputs to the

initial assessment rate considered separately, other summary risk

measures such as alternative publicly available debt issuer ratings,

and loss severity estimates, which are not always sufficiently

reflected in the inputs to the initial assessment rate or in other debt

issuer ratings. Focused risk measures include financial performance

measures, measures of an institution's ability to withstand financial

adversity, and factors relating to the severity of losses to the

insurance fund in the event of failure.

In the third step, the FDIC will perform further analysis and

review in those cases where the risk rankings from multiple measures

(such as broad-based risk measures, focused risk measures, and other

market indicators) appear to be inconsistent with the risk rankings

associated with the initial assessment rate. This step will include

consultation with an institution's primary federal regulator and state

banking supervisor. Although any additional information or feedback

provided by the primary federal regulator or state banking supervisor

will be considered in the FDIC's ultimate decision concerning such

adjustments, participation by the primary federal regulator or state

banking supervisory in this consultation process should not be

construed as concurrence with the FDIC's deposit insurance pricing

decisions.

In the final step, the FDIC will notify an institution when it

proposes to make an upward adjustment to the institution's assessment

rate. As indicated in the final rule, notifications involving an upward

adjustment in an institution's initial assessment rate will be made in

advance of implementing such an adjustment so that the institution has

sufficient opportunity to respond to or address the FDIC's concerns.\3\

Adjustments will be implemented after considering institution responses

to this notification along with any subsequent changes either to the

inputs to the initial assessment rate or any other risk factor that

relates to the decision to make an assessment rate adjustment.

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\3\ The institution will also be given advance notice when the

FDIC determines to eliminate any downward adjustment to an

institution's assessment rate.

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The following paragraphs elaborate further on the adjustment

process just described. These paragraphs introduce proposed guidelines

relating to the analytical process, show an example of how these

guidelines will be applied, and present proposed guidelines intended to

serve as controls over the assessment rate adjustment process.

IV. Proposed Guidelines for the Analytical Process and Illustrative

Examples

To ensure consistency, fairness, and transparency, the FDIC

proposes that the following guidelines be applied to its analytical

process for determining how to make adjustments to the assessment rates

of large Risk Category I institutions when appropriate. An example of

how the guidelines would be applied in a sample institution follows the

enumeration of the principal analytical guidelines.

Principal Analytical Guidelines

Guideline 1: The analytical process will focus on identifying

inconsistencies between the rank orderings of risk suggested by initial

assessment rates and the rank orderings of risk indicated by other risk

measures. This process will consider all available information relating

to the likelihood of failure and loss severity in the event of failure.

The purpose of the analytical process is to identify those

institutions whose risk measures appear to be significantly different

than other institutions with similarly assigned initial assessment

rates. This analytical process involves the identification of possible

inconsistencies between the rank orderings of risk associated with the

initial assessment rate and the risk rankings associated with other

risk measures. The intent of this analysis is not to override

supervisory evaluations or to question the validity of long-term debt

issuer ratings or financial ratios when applicable. Rather, the

analysis is meant to ensure that the assessment rates, produced from

the combination of these information sources, result in a reasonable

rank ordering of risk that is consistent with risk profiles of large

Risk Category I institutions.

The starting point in the analytical process will be the comparison

of risk rankings associated with the initial assessment rate to risk

rankings associated with a number of broad-based risk measures. This

analysis will be supplemented with additional comparisons of risk

rankings associated with focused risk measures and other market

indicators to the risk rankings associated with an institution's

initial assessment rate.\4\

The FDIC will consider adjusting an institution's initial

assessment rate when there is sufficient corroborating information from

a combination of broad-based risk measures, focused risk measures, and

other market indicators to support an adjustment. The likelihood of an

adjustment will increase when: (1) The rank orderings of risk suggested

by multiple broad-based measures are directionally consistent and

materially different from the rank ordering implied by the initial

assessment rate; (2) there is sufficient corroborating information from

focused risk measures and other market indicators to support

differences in risk levels suggested by broad-based risk measures; (3)

information pertaining to loss severity considerations raise prospects

that an institution's resolution costs, when scaled by assets, would be

materially higher or lower than those of other large institutions; or

(4) additional qualitative information from the supervisory process or

other feedback provided by the primary federal regulator or state

banking supervisor is consistent with differences in risk suggested by

the combination of broad-based risk measures, focused risk measures,

and other market indicators.

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\4\ Comparisons of risk measures will generally treat as

indicative of low risk that portion of the risk rankings falling

within the lowest X percentage of assessment rate rankings, with X

being the proportion of large Risk Category I institutions assigned

the minimum assessment rate. For example, as of June 30, 2006, 46

percent of large Risk Category I institutions would have been

assigned a minimum assessment rate. Therefore, as of June 30, 2006,

risk rankings from the 1st to the 46th percentile for any given risk

measure would generally have been considered suggestive of low risk.

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The FDIC believes that its insurance pricing determinations should

take into account risk information that relates both to the likelihood

of failure and to the level of insurance fund losses (loss severity)

that might reasonably be expected if an institution were to fail.

Developing risk measures related to loss severity is especially

important since the inputs to the initial assessment rate (supervisory

and agency ratings) relate primarily to the likelihood of failure.

[[Page 7880]]

The loss severity factors the FDIC will consider include both

quantitative and qualitative information. Quantitative information will

be used to develop estimates of deposit insurance claims and the extent

of coverage of those claims by an institution's assets. These

quantitative estimates can in turn be converted into a relative risk

ranking and compared with the risk rankings produced by the initial

assessment rate. Factors that will be used to produce loss severity

estimates include: Estimates for the amount of insured and non-insured

deposit funding at the time of failure; the extent of an institution's

obligations that would be subordinated to depositor claims in the event

of failure; the extent of an institution's obligations that would be

secured or would otherwise take priority over depositor claims in the

event of failure; and the estimated value of assets in the event of

failure.

In addition, the FDIC will consider other qualitative factors that

could magnify or mitigate the resolution costs of a failed institution.

These qualitative factors will be evaluated by determining when a given

risk factor suggests materially higher or lower loss severity risks

relative to the loss severity risks posed by other institutions. These

qualitative factors include, but are not limited to, the following:

The ease with which the FDIC could make quick deposit

insurance determinations and depositor payments in the event of failure

as discussed further below;

The ability of the FDIC to isolate and control the main

assets and critical business functions of a failed institution without

incurring high costs;

The level of an institution's foreign assets relative to

its foreign deposits and prospects of foreign governments using these

assets to satisfy local depositors and creditors in the event of

failure; and

The availability of sufficient information on qualified

financial contracts to allow the FDIC to identify the counterparties

to, and other details about, such contracts in the event of failure.

With respect to the first factor noted above, the FDIC has issued

an Advanced Notice of Proposed Rulemaking (ANPR) on Large Bank Deposit

Insurance Determination Modernization.\5\ This ANPR seeks comment on

whether the FDIC should require certain large institutions to implement

various enhancements to their deposit account systems. The intent of

any required enhancements would be to preserve the FDIC's ability to

make timely deposit insurance determinations and provide insured

depositors speedy access to their funds in the event of a large

institution failure.

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\5\ 71 FR 74857 (December 13, 2006).

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Notwithstanding any requirements that may result from this separate

notice and comment process begun with the ANPR, the FDIC believes that

the existing capabilities of an institution's deposit account systems

should be considered as part of the assessment rate adjustment analysis

process since the presence or absence of these capabilities would

mitigate or magnify the resolution costs likely to be sustained by the

FDIC in the event of failure. These capabilities include the ability of

an institution's systems to place and remove holds on deposit accounts

en masse as well as the ability of an institution to readily identify

the owner(s) of each deposit account (for example, by using a unique

identifier) and identify the ownership category of each deposit

account. As with the other risk factors considered in the analytical

process for making assessment rate adjustments, the FDIC will evaluate

this factor by gauging the capabilities of an institution's deposit

account systems relative to the capabilities of other institutions'

systems. As part of these proposed guidelines, the FDIC is seeking

comment on what information it should use to evaluate the existing

capabilities of institution's deposit account systems.

Guideline 2: Broad-based indicators and other market information

that represent an overall view of an institution's risk will be

weighted more heavily in adjustment determinations than focused

indicators as will loss severity information that has bearing on the

ability of the FDIC to resolve institutions in a cost effective and

timely manner.

While it is prudent to evaluate all available risk information when

determining whether an adjustment in an institution's assessment rate

is necessary, the FDIC recognizes that some risk indicators are more

comprehensive than others and should therefore be weighted more heavily

in assessment rate adjustment decisions. Examples of such comprehensive

or broad-based risk measures include, but are not limited to, each of

the inputs to the initial assessment rate (that is, weighted average

CAMELS ratings, long-term debt issuer ratings, and the combination of

weighted average CAMELS ratings and the five financial ratios used to

determine assessment rates for institutions when long-term debt issuer

ratings are not available), and other ratings intended to provide a

comprehensive view of an institution's risk profile (see the Appendix

for additional descriptions of broad-based risk measures). Likewise,

the FDIC views some market indicators, such as spreads on subordinated

debt, as more important than other market indicators since these

spreads represent an evaluation of risk from institution investors

whose risks are similar to those faced by the FDIC.\6\ The FDIC also

believes that certain qualitative loss severity factors, such as those

discussed in Guideline 1, should be accorded greater weight in

assessment rate determinations relative to other risk measures since

these have a direct bearing on the resolutions costs that would be

incurred by the FDIC in the event of failure.

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\6\ The FDIC recognizes that in order to be comparable, this

spread information would have to be available for debt issues with

sufficient liquidity and adjusted for differing maturities and other

bond-specific characteristics.

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Guideline 3: Focused risk measures and other market indicators will

be used to compare with and supplement the comparative analysis using

broad-based risk measures.

Individual financial ratios, such as a return on assets or a

liquidity ratio, are examples of focused risk measures that, while

important to consider, will generally not be as heavily relied upon as

more comprehensive risk measures in deposit insurance pricing

decisions. Rather, the FDIC will use focused risk measures, along with

other market indicators, to supplement the risk comparisons of broad-

based risk measures with initial assessment rates and to provide

corroborating evidence of material differences in risk suggested by

such comparisons. More specifically, the risk rankings associated with

initial assessment rates will be compared with the risk rankings

suggested by various financial performance measures, other market

indicators, measures of an institution's ability to withstand adverse

events, and loss severity indicators. The focused risk measures and

other market indicators that will be considered during the analysis

process are described in detail in the Appendix. The listing of risk

measures in the Appendix is not intended to be exhaustive, but

represents the FDIC's view of the most important focused risk measures

to consider in the adjustment process. The development of risk

measurement and monitoring capabilities is an ongoing and evolving

process. As a result, the FDIC may revise the listing in the Appendix

over time as a result of these development activities and consistent

with the objective to consider all available risk information in its

assessment rate decisions.

[[Page 7881]]

Guideline 4: Generally, no single risk factor or indicator will

control the decision on whether to make an adjustment.

In general, no single risk indicator such as a profitability ratio

or a capitalization ratio can fully capture the risks posed by large

depository institutions. Rather, the FDIC's intent is to consider all

the information available to it, including supervisory ratings, to

determine if, on balance, the risk indicators support an adjustment to

the institution's initial assessment rate. Even when multiple risk

indicators appear to support an adjustment, additional information

would have to be evaluated, including qualitative supervisory

information from the supervisory process, to further corroborate and

support the need for an adjustment. In certain cases, the FDIC may

determine that an assessment rate adjustment is appropriate when

certain qualitative risk factors pertaining to loss severity suggest

materially higher or lower risk relative to the same types of risks

posed by other institutions. As noted above, the FDIC intends to place

greater weight on these factors since they have a direct bearing on

resolution costs and since these factors are generally not considered

in other risk measures.

Example of the Analytical Process

An example will help illustrate the analytical process used to

identify how assessment rate adjustments will be made through the

application of the above guidelines. In this example, an institution's

initial assessment rate is calculated at 5.55 basis points, which

places it in the 73rd percentile of all large Risk Category I

institutions.

Chart 1 depicts the first step in the analytical process, which is

the comparison of the risk ranking associated with the institution's

initial assessment rate with other broad-based risk measures. In this

case, the risk ranking associated with the institution's initial

assessment rate is materially higher than the risk rankings associated

with a number of broad-based risk measures including its weighted

average CAMELS score, the combination of weighted average CAMELS and

financial ratios that are used to determine assessment rates for

institutions without debt ratings, the institution's Bank Financial

Strength Rating (BFSR) assigned by Moody's, and an estimate of loss

severity (referred to in the chart as a loss severity measure). Based

solely on these broad-based risk measures, the institution's risk

appears more closely aligned to institutions paying around 5.00 and

5.10 basis points. Only the institution's long-term debt issuer ratings

tend to confirm the initial assessment rate risk ranking.

[GRAPHIC] [TIFF OMITTED] TN21FE07.000

To extend this example, the review of broad-based risk measures

would be supplemented with an evaluation of additional focused risk

measures, some of which are shown in Chart 2. For this institution,

several key financial performance measures, including its capital

ratios and problem loan measures, appear to confirm the lower levels of

risk suggested by four of the five broad-based risk measures shown in

Chart 1.

[[Page 7882]]
 

[GRAPHIC] [TIFF OMITTED] TN21FE07.001

When evaluating financial performance information, the FDIC

recognizes the importance of also considering qualitative information

and mitigating factors that relate to these measures. For instance, the

FDIC will:

When evaluating profitability measures, determine how risk

ranking comparisons would be affected when earnings are adjusted to

control for risk (i.e., using risk-adjusted and provision-adjusted

returns), or unusual or nonrecurring earnings or expenses;

When evaluating capital measures, determine how risk

ranking comparisons would be affected when capitalization levels are

adjusted to control for risk (i.e., using risk-based capital measures),

how capital levels compare to historical and anticipated earnings

volatility, and how anticipated capital growth compares to anticipated

asset growth; and

When evaluating asset quality measures, use additional

information from the supervisory process to determine if differences in

risk rankings can be explained by other risk measures, such as

estimated portfolio-level probabilities of default, losses given

default, credit bureau scores, or collateral coverage, or by the

existence or absence of credit risk concentrations and credit risk

mitigants.

Continuing the example, the FDIC would also review other market

risk indicators, as shown in Chart 3, to further supplement the

evaluation of broad-based and focused risk measures. These additional

market risk indicators will be useful in evaluating the risk rankings

suggested by an institution's agency ratings. In this case, market

information relating to the cost of the institution's debt obligations

and other market-based measures are clearly inconsistent with the risk

levels suggested by the institution's long-term debt issuer ratings (as

depicted in Chart 1).\7\

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\7\ This situation might occur when recent changes in an

institution's risk profile have not yet been fully reflected in the

agency rating, or when investors in an institution's obligations

have different views of risk than one or more rating agencies.

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[[Page 7883]]

[GRAPHIC] [TIFF OMITTED] TN21FE07.002

As with the evaluation of performance risk measures, it is

important to consider other factors that may influence any particular

market risk measure. For instance, the FDIC will determine how market

indicator risk rankings are affected when credit spreads or required

rates of return are adjusted to control for differences in maturities,

the existence of any embedded options (e.g., callable vs. non-

callable), and differences in seniority in the event of default.

Extending the example further, the FDIC would also evaluate an

institution's ability to withstand financial stress and the specific

components of its loss severity estimates (referred to collectively as

stress considerations). Chart 4 illustrates the comparison of rank

orderings of two components of an institution's loss severity measure

with the rank ordering associated with its initial assessment rate. As

with other risk measures previously mentioned, these loss severity

components appear to further support a lower level of risk than what is

suggested by the initial assessment rate. Specifically, the institution

has a higher level of non-deposit liabilities, which could serve as a

buffer against losses in the event of failure, than institutions with

similar initial assessment rate risk rankings. The institution also has

a lower level of secured liabilities, which may take priority to FDIC

claims in the event of failure, than institutions with similar initial

assessment rate risk rankings.

[[Page 7884]]

[GRAPHIC] [TIFF OMITTED] TN21FE07.003

To the extent possible, the FDIC will use stress consideration

information to formulate comparisons of risk across institutions.

Sources of this information are varied but might include analyses

produced by the institution or the primary federal regulator, such as

stress test results and capital adequacy assessments, as well as

information about the risk characteristics of institution's lending

portfolios and other businesses. The types of comparisons that might be

possible using this information include evaluating differences between

institutions in the level of protection provided by capital and

earnings to varying stress scenarios and the implications of these

scenarios to loss severity in the event of failure. Other factors that

would be considered when making these comparisons are the degree to

which results are influenced by differences in stress test assumptions

or other model parameters.

To conclude the example, the FDIC would consider lowering this

institution's assessment rate to better align its assessment rate with

the risk levels suggested by other risk measures. In this case, lower

levels of risk are supported by the rank orderings of risk associated

with multiple broad-based measures. These rank orderings of risk are

further supported by risk rankings derived from a number of financial

performance measures, other market indicators, and loss severity

components. Before proceeding with any adjustment, however, the FDIC

will perform additional analyses and review, including the attainment

of corroborating information from the supervisory process, as indicated

in the guidelines that follow.


Additional Analytical Guidelines

Guideline 5: Comparisons of risk information will consider normal

variations in performance measures and other risk indicators that exist

among institutions with differing business lines.

The FDIC recognizes that it would not be reasonable to compare

certain indicators across institutions engaged in fundamentally

different businesses (e.g., comparing a mortgage lender's profitability

and asset quality measures to that of a diversified lender). As a

result, the FDIC will consider the effect of business line

concentrations in its risk ranking comparisons. One possible way to

consider business line concentrations is to evaluate risk rankings when

institutions are grouped by their predominant business activity. The

FDIC's notice of proposed rulemaking for deposit insurance assessments,

issued in July 2006, referenced one possible set of business line

groupings that included processing institutions and trust companies,

residential mortgage lenders, non-diversified regional institutions,

large diversified institutions, and diversified regional

institutions.\8\ Risk ranking comparisons within these business line

groupings is one way the FDIC can control for business line

concentrations when making assessment rate adjustment decisions.

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\8\ See 71 FR 41910 (July 24, 2006).

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Guideline 6: Adjustment will be made only if additional analysis

suggests a meaningful risk differential between the institution's

initial and adjusted assessment rates.

Where material inconsistencies between initial assessment rates and

other risk indicators are present, additional analysis will determine

the magnitude of adjustment necessary to

[[Page 7885]]

align the assessment rate better with the rates of other institutions

with similar risk profiles. The objective of this analysis will be to

determine the amount of assessment rate adjustment that would be

necessary to bring an institution's assessment rate into better

alignment with those of other institutions that pose similar levels or

risk. This process will entail a number of considerations, including:

(1) The number of rank ordering comparisons that identify the

institution as a potential outlier relative to institutions with

similar assessment rates; (2) the direction and magnitude of

differences in rank ordering comparisons; (3) a qualitative assessment

of the relative importance of any apparent outlier risk indicators to

the overall risk profile of the institution, and (4) an identification

of mitigating factors. One example of a mitigating factor might be an

institution that has significantly lower profitability measures than

other institutions with similarly ranked initial assessment rates, but

is engaged in fundamentally lower-risk businesses as evidenced by

superior asset quality measures relative to institutions with similarly

ranked initial assessment rates.

Based upon these considerations, the FDIC will determine the

magnitude of adjustment that would be necessary to better align its

assessment rate with institutions that pose similar levels or risk.

When the assessment rate adjustment suggested by these considerations

is not material, or when there are a number of risk comparisons that

offer conflicting or inconclusive evidence of material inconsistencies,

no assessment rate adjustment will be made.

V. Controls Over the Assessment Rate Adjustment Process

The FDIC proposes to implement various controls over the adjustment

process to ensure fairness and transparency in its pricing decisions.

These controls, many of which are contained in the final rule, are

enumerated in the guidelines below.

Guideline 7: Decisions to adjust an institution's assessment rate

must be well supported.

The FDIC will perform internal reviews of pending adjustments to an

institution's assessment rate to ensure the adjustment is justified,

well supported, based on the most current information available, and

results in an adjusted assessment rate that is consistent with rates

paid by other institutions with similar risk profiles.

Guideline 8: The FDIC will consult with an institution's primary

federal regulator and appropriate state banking supervisor prior to

making any decision to adjust an institution's initial assessment rate

(or prior to removing a previously implemented adjustment).

Participation by the primary federal regulator or state banking

supervisor in this consultation process should not be construed as

concurrence with the FDIC's deposit insurance pricing decisions.

Consistent with current practice, FDIC analysts and management will

consult with the primary federal regulator and state banking

supervisors on an ongoing basis regarding risk issues facing large

institutions and recent events that may influence an institution's

overall risk profile or supervisory ratings. Because of this ongoing

contact, the primary federal regulator and state banking supervisor

should always be aware when the FDIC views a need for an assessment

rate adjustment. Nevertheless, the FDIC will formalize its

determinations with the following steps:

1. The FDIC will formally notify the primary federal regulator, and

state banking supervisors, of the pending adjustment in advance of the

first opportunity to implement any adjustment.

2. Documentation related to any pending adjustment will include a

discussion of why the adjusted assessment rate is more consistent with

the risk profiles represented by institutions with similar assessment

rates.

3. The FDIC will consider any additional information provided by

either the primary federal regulator or state banking supervisor prior

to proceeding with an adjustment of an institution's assessment rate.

Guideline 9: The FDIC will give institutions advance notice of any

decision to make an upward adjustment to its initial assessment rate,

or to remove a previously implemented downward adjustment.

The FDIC will notify institutions when it intends to make an upward

adjustment to its initial assessment rate (or remove a downward

adjustment). This notification will include the reasons for the

adjustment, when the adjustment would take effect, and provide the

institution up to 60 days to respond. Adjustments would not become

effective until the quarterly assessment period following the date the

notification was made. During this subsequent assessment period, the

FDIC will determine whether an adjustment is still warranted based on

an institution's response to the notification as well as any subsequent

changes to an institution's weighted average CAMELS, long-term debt

issuer ratings, financial ratios (when applicable), or other risk

measures used to support the adjustment. The FDIC will also consider

any actions taken by the institution, during the period for which the

institution is being assessed, in response to the FDIC's concerns

described in the notice.

Guideline 10: The FDIC will continually re-evaluate the need for an

assessment rate adjustment.

The FDIC will re-evaluate the need for the adjustment during each

subsequent quarterly assessment period. These evaluations will be based

on any new information that becomes available, as well as any changes

to an institution's weighted average CAMELS, long-term debt issuer

ratings, financial ratios (when applicable), or other risk measures

used to support the adjustment.

The institution can request a review of the FDIC's decision to

adjust its assessment rate.\9\ It would do so by submitting a written

request for review of the assessment rate assignment, as adjusted, in

accordance with 12 CFR 327.4(c). This same section allows an

institution to bring an appeal before the FDIC's Assessment Appeals

Committee if it disagrees with determinations made in response to a

submitted request for review.

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\9\ The institution can also request a review of the FDIC's

decision to remove a previous downward adjustment.

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VI. Timing of Notifications and Adjustments

Upward Adjustments

As noted above, institutions will be given advance notice when the

FDIC determines that an upward adjustment in its assessment rate

appears to be warranted. The timing of this advance notification will

correspond approximately to the invoice date for an assessment period.

For example, an institution would be notified of a pending upward

adjustment to its assessment rates covering the period April 1st

through June 30th sometime around June 15th. June 15th is the invoice

date for the January 1st through March 31st assessment period.\10\

Institutions will have up to 60 days to respond to notifications of

pending upward adjustments.

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\10\ Since the intent of the notification is to provide advance

notice of a pending upward adjustment, the invoice covering the

assessment period January 1st through March 31st in this case would

not reflect the upward adjustment.

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The FDIC would notify an institution of its decision to either

proceed with or not proceed with the upward adjustment approximately 90

days following the initial notification of a

[[Page 7886]]

pending upward adjustment. If a decision were made to proceed with the

adjustment, the adjustment would be reflected in the institution's next

assessment rate invoice. Extending the example above, if an institution

were notified of an upward adjustment on June 15th, it would have 60

days from this date to respond to the notification. If, after

evaluating the institution's response and following an evaluation of

updated information for the quarterly assessment period ending June

30th, the FDIC decides to proceed with the adjustment, it would

communicate this decision to the institution on September 15th, which

is the invoice date for the April 1st through June 30th assessment

period. In this case, the adjusted rate would be reflected in the

September 15th invoice. The adjustment would remain in effect for

subsequent assessment periods until the FDIC determined that the

adjustment is no longer warranted.\11\

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\11\ The timeframes and example illustrated here would also

apply to a decision by the FDIC to remove a previously implemented

downward adjustment as well as a decision to increase a previously

implemented upward adjustment (the increase could not cause the

total adjustment to exceed the 0.50 basis point limitation).

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Downward Adjustments

Decisions to lower an institution's assessment rate will not be

communicated to institutions in advance. Rather, they would be

reflected in the invoices for a given assessment period along with the

reasons for the adjustment. Downward adjustments may take effect as

soon as the first insurance collection for the January 1st through

March 31, 2007 assessment period subject to timely approval of the

guidelines by the Board of the FDIC. Downward adjustments will remain

in effect for subsequent assessment periods until the FDIC determines

that the adjustment is no longer warranted (and subject to the advance

notification requirements indicated above for upward adjustments).\12\

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\12\ As noted in the final rule, the FDIC may raise an

institution's assessment rate without notice if the institution's

supervisory or agency ratings or financial ratios (for institutions

without debt ratings) deteriorate.

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VII. Request for Comment

The FDIC seeks comment on all aspects of the proposed guidelines

for determining how to make adjustments to the initial assessment rates

of large Risk Category I institutions. In particular, the FDIC seeks

comments on:

1. Whether the objectives, listed under the heading Broad

Objectives, for making assessment rate adjustments are appropriate?

2. Whether the proposed guidelines governing the analytical process

are appropriate and sufficient to ensure fairness and consistency in

deposit insurance pricing determinations? More specifically:

a. The appropriateness of considering additional risk information,

including information pertaining to loss severity, to identify possible

inconsistencies between an institution's initial assessment rate and

risk measures of institutions with similar assessment rates;

b. The appropriateness of applying greater emphasis on broad-based

risk measures than more focused measures when making assessment rate

adjustment determinations;

c. The appropriateness of augmenting the analysis of broad-based

risk measures with a review of more focused risk measures;

d. The appropriateness of basing adjustment decisions on

considerations of multiple risk indicators;

e. The appropriateness of assessing financial performance risk

measures relative to other institutions engaged in similar business

activities; and

f. The appropriateness of using additional risk information to

determine the magnitude of adjustment to an institution's assessment

rate that would be necessary to bring its rate into better alignment

with institutions with similar risk measures.

3. What information should the FDIC use to evaluate the qualitative

loss severity factors enumerated under Guideline 1? For example, in the

absence of a final rule that might implement certain requirements

relating to deposit account system capabilities as described in the

Advanced Notice of Proposed Rulemaking on Large Bank Deposit Insurance

Determination Modernization,\13\ to what extent should the FDIC

consider the existing capabilities of deposit account systems? More

specifically, should the FDIC consider whether an institution's systems

have the ability to place and remove holds on deposit accounts en masse

as well as the ability to readily identify the owner(s) of each deposit

account (for example, by using a unique identifier) and identify the

ownership category of each deposit account, be included in risk-based

pricing determinations? If so, what should be the form of information

that would demonstrate the existence of these capabilities, to include

the scope of any account testing and the types of assurances that would

document any such testing (as one example, an institution could

demonstrate these capabilities by performing appropriate testing

against a sufficiently large sample of deposit accounts and by

confirming positive results of this testing to the FDIC in statement

certified by a compliance officer or internal auditor of the

institution)? Additionally, what information could the institution

provide to assist the FDIC in evaluating the ability of the FDIC to

isolate and control the main assets and critical business functions of

a failed institution without incurring high costs; the level of an

institution's foreign assets relative to its foreign deposits and

prospects of foreign governments using these assets to satisfy local

depositors and creditors in the event of failure; and the availability

of sufficient information on qualified financial contracts to allow the

FDIC to identify the counterparties to, and other details about, such

contracts in the event of failure?

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\13\ 71 FR 74857 (December 13, 2006).

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4. Whether there are additional guidelines that should govern the

analytical process to ensure fairness and consistency in deposit

insurance pricing determinations?

5. Whether it is appropriate for the FDIC to consider information,

such as the results of an institution's stress testing or capital

adequacy assessment analyses, that pertains to an institution's ability

to withstand adverse events and if so, how such information should be

incorporated into the analytical process described in these proposed

guidelines?

6. Whether it is appropriate for the FDIC to consider risk

information that will be developed from the implementation of proposed

international capital standards into its analytical process for

determining whether an assessment rate adjustment is appropriate and

the magnitude of any such adjustments?

7. Whether it is appropriate for the FDIC to consider the

willingness and ability of an institution's parent company or its

affiliates to provide financial support to the institution or to

mitigate the FDIC's loss in the event of failure? If so, what factors

or characteristics might be useful in evaluating such considerations?

8. Whether the FDIC should consider certain additional supervisory

information when determining whether a downward adjustment in

assessment rates is appropriate? For example, should the FDIC preclude

from consideration for a downward adjustment those situations where an

institution has an outstanding supervisory order in place that may be

less directly related to the institution's

[[Page 7887]]

safety and soundness (such as a memorandum of understanding or consent

and decree order relating to compliance regulations or the Bank Secrecy

Act)?

9. Whether the proposed guidelines for controlling the assessment

rate adjustment process are sufficient to ensure that adjustment

decisions are justified, fully supported, and take into account

responses and additional information from the primary federal regulator

and the institution?

10. Whether there are additional guidelines that should control the

assessment rate adjustment process?

Appendix--Examples of Risk Measures That Will Be Considered in

Assessment Rate Adjustment Determinations \14\

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\14\ This listing is not intended to be exhaustive but

represents the FDIC's view of the most important risk measures that

should be considered in the assessment rate determinations of large

Risk Category I institutions. This listing may be revised over time

as improved risk measures are developed through an ongoing effort to

enhance the FDIC's risk measurement and monitoring capabilities.

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Broad-Based Risk Measures

Composite and weighted average CAMELS ratings: the

composite rating assigned to an insured institution under the

Uniform Financial Institutions Rating System and the weighted

average CAMELS rating determined under the final rule.

Long-term debt issuer rating: a current, publicly

available, long-term debt issuer rating assigned to an insured

institution by Moody's, Standard & Poor's, or Fitch.

Financial ratio measure: the assessment rate determined

for large Risk Category I institutions without long-term debt issuer

ratings, using a combination of weighted average CAMELS ratings and

five financial ratios as described in the final rule.

Offsite ratings: ratings or numerical risk rankings,

developed by either supervisors or industry analysts, that are based

primarily on off-site data and incorporate multiple measures of

insured institutions' risks.

Other agency ratings: current and publicly available

ratings, other than long-term debt issuer ratings, assigned by any

rating agency that reflect the ability of an institution to perform

on its obligations. One such rating is Moody's Bank Financial

Strength Rating BFSR, which is intended to provide creditors with a

measure of a bank's intrinsic safety and soundness, excluding

considerations of external support factors that might reduce default

risk, or country risk factors that might increase default risk.

Loss severity measure: an estimate of insurance fund

losses that would be incurred in the event of failure. This measure

takes into account such factors as estimates of insured and non-

insured deposit funding, obligations that would be subordinated to

depositor claims, obligations that would be secured or would

otherwise take priority claim over depositor claims, the estimated

value of assets, prospects for ``ring-fencing'' whereby foreign

assets are used to satisfy foreign obligor claims over FDIC claims,

and other factors that could affect resolution costs.

Financial Performance and Condition Measures

Profitability

Return on assets: net income (pre- and post-tax)

divided by average assets.

Return on risk-weighted assets: net income (pre- and

post-tax) divided by average risk-weighted assets.

Core earnings volatility: volatility of quarterly

earnings before tax, extraordinary items, and securities gains

(losses) measured over one, three, and five years.

Net interest margin: interest income less interest

expense divided by average earning assets.

Earning asset yield: interest income divided by average

earning assets.

Funding cost: interest expense divided by interest

bearing obligations.

Provision to net charge-offs: loan loss provisions

divided by losses applied to the loan loss reserve (net of

recoveries).

Burden ratio: overhead expenses less non-interest

revenues divided by average assets.

Qualitative and mitigating profitability factors:

includes considerations such as earnings prospects and

diversification of revenue sources.

Capitalization

Tier 1 leverage ratio: tier 1 capital for Prompt

Corrective Action (PCA) divided by adjusted average assets as

defined for PCA.

Tier 1 risk-based ratio: PCA tier 1 capital divided by

risk-weighted assets.

Total risk-based ratio: PCA total capital divided by

risk-weighted assets.

Tier 1 growth to asset growth: annual growth of PCA

tier 1 capital divided by annual growth of total assets.

Regulatory capital to internally-determined capital

needs: PCA tier 1 and total capital divided by internally-determined

capital needs as determined from economic capital models, internal

capital adequacy assessments processes (ICAAP), or similar

processes.

Qualitative and mitigating capitalization factors:

includes considerations such as strength of capital planning and

ICAAP processes, and the strength of financial support provided by

the parent.

Asset Quality

Non-performing assets to tier 1 capital: nonaccrual

loans, loans past due over 90 days, and other real estate owned

divided by PCA tier 1 capital.

ALLL to loans: allowance for loan and lease losses plus

allocated transfer risk reserves divided by total loans and leases.

Net charge-off rate: loan and lease losses charged to

the allowance for loan and lease losses (less recoveries) divided by

average total loans and leases.

Higher risk loans to tier 1 capital: sum of sub-prime

loans, alternative or exotic mortgage products, leveraged lending,

and other high risk lending (e.g., speculative construction or

commercial real estate financing) divided by PCA tier 1 capital.

Criticized and classified assets to tier 1 capital:

assets assigned to regulatory categories of Special Mention,

Substandard, Doubtful, or Loss (and not charged-off) divided by PCA

tier 1 capital.

EAD-weighted average PD: weighted average estimate of

the probability of default (PD) for an institution's obligors where

the weights are the estimated exposures-at-default (EAD). PD and EAD

risk metrics can be defined using either the Basel II framework or

internally defined estimates.

EAD-weighted average LGD: weighted average estimate of

loss given default (LGD) for an institution's credit exposures where

the weights are the estimated EADs for each exposure. LGD and PD

risk metrics can be defined using either the Basel II framework or

internally defined estimates.

Qualitative and mitigating asset quality factors:

includes considerations such as the extent of credit risk mitigation

in place; underwriting trends; strength of credit risk monitoring;

and the extent of securitization, derivatives, and off-balance sheet

financing activities that could result in additional credit

exposure.

Liquidity and Market Risk Indicators

Core deposits to total funding: the sum of demand,

savings, MMDA, and time deposits under $100 thousand divided by

total funding sources.

Net loans to assets: loans and leases (net of the

allowance for loan and lease losses) divided by total assets.

Liquid and marketable assets to short-term obligations

and certain off-balance sheet commitments: the sum of cash, balances

due from depository institutions, marketable securities (fair

value), federal funds sold, securities purchased under agreement to

resell, and readily marketable loans (e.g., securitized mortgage

pools) divided by the sum of obligations maturing within one year,

undrawn commercial and industrial loans, and letters of credit.

Qualitative and mitigating liquidity factors: includes

considerations such as the extent of back-up lines, pledged assets,

and the strength of contingency and funds management practices.

Earnings and capital at risk to fluctuating market

prices: quantified measures of earnings or capital at risk to shifts

in interest rates, changes in foreign exchange values, or changes in

market and commodity prices. This would include measures of value-

at-risk (VaR) on trading book assets.

Qualitative and mitigating market risk factors:

includes considerations of the strength of interest rate risk and

market risk measurement systems and management practices, and the

extent of risk mitigation (e.g, interest rate hedges) in place.

Other Market Indicators

Subordinated debt spreads: dealer-provided quotes of

interest rate spreads paid on subordinated debt issued by insured

subsidiaries relative to comparable maturity treasury obligations.

Credit default swap spreads: dealer-provided quotes of

interest rate spreads paid by a credit protection buyer to a credit

[[Page 7888]]

protection seller relative to a reference obligation issued by an

insured institution.

Market-based default indicators: estimates of the

likelihood of default by an insured organization that are based on

either traded equity or debt prices.

Qualitative market indicators or mitigating market

factors: includes considerations such as agency rating outlooks,

debt and equity analyst opinions and outlooks, and the relative

level of liquidity of any debt and equity issues used to develop

market indicators defined above.

Risk Measures Pertaining to Stress Conditions

Ability To Withstand Stress Conditions

Concentration measures: measures of the level of

concentrated risk exposures and extent to which an insured

institution's capital and earnings would be adversely affected due

to exposures to common risk factors such as the condition of a

single obligor, poor industry sector conditions, poor local or

regional economic conditions, or poor conditions for groups of

related obligors (e.g., subprime borrowers).

Results of stress tests or scenario analyses: measures

of the extent of capital, earnings, or liquidity depletion under

varying degrees of financial stress such as adverse economic,

industry, market, and liquidity events.

Qualitative and mitigating factors relating to the

ability to withstand stress conditions: includes considerations such

as the comprehensiveness of risk identification and stress testing

analyses, the plausibility of stress scenarios considered, and the

sensitivity of scenario analyses to changes in assumptions.

Loss Severity Indicators

Non-deposit liabilities to total liabilities: the sum

of obligations, such as subordinated debt, that would have a

subordinated claim to the institution's assets in the event of

failure divided by total liabilities.

Secured (priority) liabilities to total liabilities:

the sum of claims, such as trade payables and secured borrowings,

that would have priority claim to the institution's assets in the

event of failure divided by total liabilities.

Foreign deposits to total liabilities: foreign deposits

divided by total liabilities.

Extent of insured assets held in foreign units: amount

of assets held in foreign offices.

Liquidation value of assets: estimated value of assets,

based largely on historical loss rates experienced by the FDIC on

various asset classes, in the event of liquidation.

Qualitative and mitigating factors relating to loss

severity: includes considerations such as the sufficiency of

information and systems capabilities relating to qualified financial

contracts and deposits to facilitate quick and cost efficient

resolution, the extent to which critical functions or staff are

housed outside the insured entity, and prospects for ring-fencing in

the event of failure.

By order of the Board of Directors.

Dated at Washington, DC, this 15th day of February, 2007.

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Executive Secretary.

[FR Doc. E7-2906 Filed 2-20-07; 8:45 am]

BILLING CODE 6714-01-P