Summary of FDIC’s Proposed Restoration Plan and Changes in the Risk-Based Premium Classification System
On Oct. 7, 2008, the FDIC proposed a five-year recapitalization plan for its insurance fund, involving significantly higher premiums.1 Even with this aggressive plan, the FDIC projects that the fund reserve ratio will continue to fall for the remainder of 2008 and into 2009, to a low of 0.65-0.70 percent, as reserves for anticipated failures increase. Higher assessment revenue is projected to begin to increase the fund’s reserve ratio gradually later in 2009, rising to 1.25 percent by 2013. At the same time, the FDIC proposed changes to the risk-based premium classification system, with higher risk grading for banks that use secured funding (including Federal Home Loan Bank advances) or brokered deposits to fund growth, and lower risk for highly capitalized banks.2 The FDIC is seeking public comment on the two proposals through Nov. 17. ABA will submit comments, and we would appreciate banker feedback on the proposals. Please share any thoughts with Rob Strand, 202.663.5350, rstrand@aba.com. Premium Rates Double The FDIC proposes to increase by 7 basis points (b.p.) the entire premium assessment schedule for the first quarter of 2009.3 This means that the premium for well-capitalized and CAMELS 1 and 2 banks (Category I) will be between 12 b.p. and 14 b.p. (currently 5 b.p. to 7 b.p.). Starting in the second quarter, the FDIC proposes to adjust the risk-based premium calculation to include new risk classification factors. While the rate for Category I banks will be between 10 b.p. and 14 b.p., adjustments to the calculation can lower premiums below the base rates and raise premiums above the ceiling rate. The table on the next page shows the premium rates and the distribution of banks likely to be in each. ABA has estimated that with losses of $6 billion per year for five years and annual insured deposit growth of four percent, the required premium would average 9 basis points (8 b.p. to 12 b.p. for Category I banks). FDIC’s outlook, we feel, makes two conservative assumptions: • The FDIC expects that the income resulting from its proposed assessment schedule will return the insurance fund reserve ratio to 1.26 percent in five years. With a schedule one b.p. lower, the reserve ratio would be above 1.15 percent within the five-year period. The FDIC stated that it is “prudent to provide this margin for error in the event that losses exceed staff’s best estimate or insured deposit growth is more rapid than expected.”
FDIC, Federal Register 73(201), p. 61598, www.fdic.gov/regulations/laws/federal/2008/08restoreplan.pdf. FDIC, Federal Register 73(201), pp. 61560‐97, www.fdic.gov/regulations/laws/federal/2008/08propose1016.pdf. 3 The FDIC Board elected to retain the current risk classification scheme for the first quarter of 2009 because there is insufficient time to implement the proposed revisions to the system any earlier.
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The FDIC assumes insured deposits will grow by five percent annually, the average over the last 5 to 10 years, over the next five years. Had a more reasonable growth rate been used – such as three percent, reflective of an economy in recession and slow income growth – the base assessment rate would have been 8 b.p., rather than 10 b.p. It is instructive to note that in the troubled early 1990s, insured deposit growth was negative. The FDIC’s analysis does not factor in the benefits that may result from the passage of the Emergency Economic Stabilization Act of 2008. Distribution of Total Base Assessment Rates and Domestic Deposits* Data as of June 30, 2008 Risk Category Base Assessment Rate (b.p.) 8.00 - 10.00 10.01 - 12.00 12.01 - 14.00 14.01 - 21.00 18.00 - 20.00 20.01 - 40.00 28.00 - 30.00 30.01 - 55.00 43.00 - 45.00 45.01 - 77.50 Number of Banks 1,834 2,674 2,588 632 346 242 72 49 9 5 Percent of Banks 22% 32% 31% 7% 4% 3% 1% 1% 0% 0% Domestic Deposits ($ in billions) $807 $3,048 $1,633 $590 $205 $692 $8 $19 $6 $23 Percent of Domestic Deposits 11% 43% 23% 8% 3% 10% 0% 0% 0% 0%
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I
II III IV
* Because of data limitations, secured liability adjustments for TFR filers are calculated using imputed values based on simple averages of Call Report filers as of June 30, 2008. Unsecured debt adjustments are calculated using “Qualifying subordinated debt and redeemable preferred stock” included in Tier 2 capital. New Factors Proposed to Calculate Premiums Not only will premiums increase, but the factors used to calculate the premiums will change. These include (1) “excessive” use of brokered deposits tied to rapid growth; (2) “excessive” use of secured liabilities; and (3) lower assessments (even below the 10 b.p. base rate) for very high levels of capital for small banks. For large banks (i.e., greater than $10 billion in assets), the premium calculation will also change by adding financial ratios to CAMELS and debt issuer ratings (each counting for one-third) and providing a reduction for unsecured debt. The FDIC notes that these changes will add significantly to premium income, allowing a reduction in premiums for banks with lower risk profiles. The FDIC comments that this effectively transfers the higher premiums to banks that are most likely to cause loss to the insurance fund.
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Proposed Risk-Based Premium Classification System (b.p.) Risk Category Current Assessments Base (from 2009Q2 on) Unsecured debt adjustment Secured liability adjustment Brokered deposit adjustment 2009Q2-on Assessments 8-21 I 5-7 10-14 – 0-2 + 0-7 II 10 20 – 0-2 + 0-10 + 0-10 18-40 III 28 30 – 0-2 + 0-15 + 0-10 28-55 IV 43 45 – 0-2 + 0-22½ + 0-10 43-77½
Brokered Deposits The FDIC is proposing to add use of brokered deposits, in combination with rapid growth, as a factor, along with other financial ratios, in risk classification. The brokered deposits surcharge would only affect banks whose total assets are more than 20 percent greater than four years earlier (adjusting for mergers and acquisitions) and whose brokered deposits are more than ten percent of domestic deposits.4 The maximum brokered deposit adjustment will be ten b.p. For Category I banks that exceed these thresholds, a new ratio will be added to the other financial ratios in calculating premiums.5 For banks in Risk Categories II, III, and IV, there will be an additional adjustment. The added premium is calculated by taking the ratio of brokered deposits to domestic deposits less ten percent multiplied by 25 b.p., limited to ten percent. The FDIC will use Call Report information on brokered deposits and the other financial ratios. Note that there is no distinction in the Call Report between various types of brokered deposits, such as reciprocal deposits (e.g., CDARS) and sweeps from broker/dealers to affiliated banks. The FDIC asks whether sweep accounts that currently meet the brokered deposit definition should be excluded; whether reciprocal brokered deposits should be excluded; and whether high cost deposits (such as from listing services) should be included. ABA has written to FDIC about distinguishing between these types of brokered deposits, arguing that use of reciprocal deposits and sweeps from broker/dealer affiliates have characteristics more typical of core deposits.
The theory is that over-reliance on brokered deposits can cause a liquidity crisis at the very time a bank needs funding the most. This is particularly the case when the FDIC must approve use of brokered deposits for adequately-capitalized banks, and under-capitalized banks are prohibited from using such deposits. Moreover, the FDIC argues that the franchise value of a troubled bank may decrease the greater the reliance on non-core deposit funding, thus making it more difficult for a troubled bank to merge with a healthier bank (or be sold by the FDIC in its role as conservator). 5 This adjusted factor is calculated as follows: Calculate the excess portion of brokered deposits beyond the ten percent threshold. Then calculate the asset growth factor by taking the actual growth rate (from four years prior up to the present quarter) less twenty percent (the two percent growth threshold) multiplied by five. Then multiply the asset and brokered deposit ratios together to give the adjusted deposit ratio. Finally, this adjusted ratio is multiplied by 0.055 to give a new ratio which is considered as part of the other financial ratios in determining the premium rate. If the asset growth factor is greater than forty percent, the weighting for this factor is 100 percent.
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Secured Liabilities The FDIC proposes an add-on charge to the assessment rate for a bank if the ratio of secured liabilities – including Federal Home Loan Bank advances – to domestic deposits exceeds 15 percent of deposits. Secured liabilities also include securities sold under repurchase agreements and secured federal funds. The calculation is made by multiplying the base assessment rate by one plus the ratio of the bank’s secured liabilities to deposits minus 15 percent – but limited to 50 percent over the initial assessment rate. This additive factor may increase the assessment of Category I banks above the ceiling rate of 14 b.p. The FDIC advanced three justifications for higher premiums with secured funding. First, the fact that a Federal Home Loan Bank can refuse to lend, and often does so, to a bank with declining financial ratios can create a liquidity problem for the bank. Second, that the loss-given failure is higher in cases with advances because, as secured liabilities, they stand ahead of FDIC (as a general creditor in place of insured depositor claims) in a receivership. The secured nature of advances leaves fewer, high-quality assets able to cover expected losses, leaving the FDIC with higher failure costs. Third, that there is a pricing disparity between those banks with primarily deposit funding versus those with a high percentage of advances. This, FDIC argues, is a result of the assessment base being only total domestic deposits. Thus, a $100 million bank with 100 percent deposit funding will pay twice as much to the FDIC as an identical bank (size and risk) with 50 percent deposit funding and 50 percent advances. Put another way, the deposit funded bank, FDIC argues, will pay more to cover losses incurred by FDIC than one with a high concentration of advances. ABA has long opposed including Federal Home Loan Bank advances in the risk assessment formula, and industry opposition has helped to keep this factor out of the original risk-based calculation. ABA’s Federal Home Loan Bank Committee met by conference call with FDIC staff and expressed concern with the general outlines of the approach put forward. Many banks believe that funding from advances provides added liquidity (thereby reducing the risk of a failure), allows match funding (of both securities and loans to lock in a return), and provides a lower cost funding option in areas where local interest rates are high. Bankers have also argued that the risk is not in the funding source, but in the assets that the funds are invested in. Credit for High Capital The FDIC is proposing to give banks a discount on premiums for high levels of Tier 1 capital and subordinated debt. This discount can even lower a bank’s assessment below the base rate of 10 b.p. (The adjustment would equal the sum of half of Tier 1 capital and unsecured debt between 10-and-15 percent of adjusted average assets plus all Tier 1 capital and unsecured debt above 15 percent of adjusted average assets, divided by total assets.) Any decrease in the assessment rate would be limited to 2 b.p.
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Classification Scheme for Large Banks The FDIC proposes to add financial ratios to the large bank pricing model, and reduce the assessment rate if there is unsecured debt on the balance sheet. Under the current formula, premiums for banks over $10 billion in assets are determined considering only CAMELS and debt-issuer ratings. The FDIC believes that debt-issuer ratings have not been responsive to market changes and, therefore, the current formula is under-pricing true risk. The FDIC is required under law to prevent disparities between banks of different sizes, yet the percentage of banks under $10 billion paying the lowest assessment rate has declined much faster than for larger banks. The FDIC proposes to add the financial ratios used in the small bank risk assessment system to the large bank system, which would then consider equally financial ratios, CAMELS ratings and debt issuer ratings. Then the actual weighting would be calibrated to keep the distribution of large and small banks across the risk-rate structure similar. The FDIC recognizes that long-term unsecured debt (with maturities over a year) covers losses dollar-for-dollar before FDIC takes losses in the event of a failure. This factor would reduce the premium assessment up to two b.p. Comptroller Dugan noted at an FDIC Board meeting that the reduction in premiums for unsecured debt is far less than the penalty for secured borrowing, and questioned the rationale for this decision. Premium Increase Effective First Quarter 2009 After reviewing the public comments, the FDIC Board must approve and provide public notice for any final change to the assessment schedule. With comments due Nov. 17, the FDIC is likely to make a final decision regarding first quarter assessments by yearend. First quarter assessments will be billed on June 15 and payable June 30. The Board may take more time to consider changes to the risk-based system, but it will make a final decision with notice to the industry before the second quarter. Assessment credits will largely be exhausted by the end of this year. FDIC to Revisit Premium Rates at Least Annually The FDIC is authorized to update the pricing multipliers and uniform amount annually, without notice-and-comment rulemaking. The FDIC proposes having authority to adjust the entire rate schedule by three b.p., up or down, without notice and comment. ABA has urged the FDIC to lower premiums rapidly if the recapitalization is occurring faster than anticipated. This would allow the FDIC to utilize the full five-year recapitalization period and not impose excessive cost on banks just to recapitalize faster than is necessary under law. One-Basis-Point Adjustment upon Further Review Under current rules, the FDIC has authority each quarter to consider additional factors and raise or lower premiums by a half a b.p. Because the range from the base to the ceiling rates for most banks will be four b.p., as proposed, the FDIC is proposing to increase the authority to adjust rates up or down by as much as one b.p. ABA has urged the FDIC to consider such an adjustment for banks with exposure to Freddie Mac and Fannie Mae preferred securities or Fannie/Freddie asset-backed securities.
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