Alert April 20, 2010

FDIC Proposes Risk-Sensitive Deposit Insurance Assessment Scheme for Large and Highly Complex Institutions

I. Introduction

The FDIC issued a Notice of Proposed Rulemaking (the “Proposal”) to revise the deposit insurance assessment system for large institutions and for highly complex institutions.  The Proposal is an effort by the FDIC to develop an assessment methodology that is more responsive to risks taken on by insured institutions and is less pro-cyclical than the current assessment system.  Therefore, the Proposal replaces the financial ratios used in the current assessment system with a scorecard consisting of risk-sensitive financial measures and eliminates the use of credit ratings.  The financial measures would be calculated based on inputs taken from institutions’ Call or TFR reports, the FDIC’s Large Insured Depository Institution (“LIDI”) program, and examination results.  The Proposal also would alter the assessment rates applicable to all insured depository institutions to ensure that the revenue collected under the proposed assessment system would approximately equal the revenue collected under the existing assessment system and to maintain parity among large and small institutions.  The Proposal is very detailed, and, if promulgated, would represent a significant increase in the complexity of calculating and managing deposit insurance assessments for large and highly complex institutions, in some respects matching the complexity of calculating risk-based capital measures.  However, the FDIC does not believe that the Proposal, if promulgated, will significantly affect the amount of assessments collected overall.

II.  Large Institution Scorecard and Base Assessment Rate

The Proposal calculates the assessment rate for large institutions using a scorecard which is based on institution performance and financial measures as potentially modified by discretionary and liability-based adjustments available to the FDIC.  A “large institution” would be defined under the Proposal as an insured depository institution with $10 billion or greater in total assets for at least four consecutive quarters.  Insured branches of foreign banks would not be defined as large institutions.  The scorecard would have two components, a performance score (the “Performance Score”) and loss severity score (the “Loss Severity Score”).  Each score is subject to discretionary adjustments by the FDIC.  The two component scores would then be combined, using a mathematical formula, to produce a total score, which would be translated into an initial assessment rate, which would in turn be converted into a total assessment rate based on the FDIC’s liability-based adjustments if applicable.

a.  Performance Score

An institution’s performance score is a weighted average of three inputs, which are described in more detail below.

            (i) Weighted Average CAMELS Score

A weighted average of an institution’s CAMELS score constitutes 30% of such institution’s Performance Score.  Due to a non-linear conversion, the Performance Score would increase at an increasing rate as the weighted average CAMELS rating increases.  The Proposal clarifies that if the FDIC disagrees with the ratings changes to an institution’s risk assignment by its primary federal regulator or, for state-chartered institutions, by the state banking supervisor, the FDIC will notify the institution of its decision and any resulting change to an institution’s risk assessment is effective as of the date of FDIC’s transmittal notice.

            (ii)  Asset-Related Stress Component

The ability of an institution to withstand asset-related stress constitutes 50% of such institution’s Performance Score and is based on a weighted calculation combining the following financial measures:

  • Tier 1 common capital ratio;
  • Concentration measure (the higher, or least favorable, of the higher-risk concentrations measure or growth-adjusted portfolio concentrations measures);
  • Core earnings/average total assets;
  • Credit quality measure (the higher, or least favorable, of the criticized and classified items/Tier 1 capital and reserves or underperforming assets/Tier 1 capital and reserves)

Each of these measures is described in detail in Appendix B to the Proposal.  Each of the measures is also subject to a minimum and a maximum cutoff, meaning that to the extent that such measures produce values that are very low or very high, the effect of such value on the Performance Score is limited.  However, in order to deal with outliers, the FDIC would increase the performance score significantly if either or both of the credit quality measure or the higher risk concentration measure were to exceed certain stated values.  Such adjustment measures are referred to as “outlier add-ons.”

            (iii)  Funding-Related Stress Component

The ability of an institution to withstand funding-related stress constitutes 20% of such institution’s Performance Score and is based on a weighted calculation combining the following financial measures:

  • Core deposits to total liabilities ratio
  • Unfunded commitments to total assets ratio
  • Liquid assets to short-term liabilities (liquidity coverage) ratio

Each of these measures is described in detail in Appendix B to the Proposal.  Each of the measures is also subject to a minimum and a maximum cutoff, meaning that to the extent that such measures produce values that are very low or very high, the effect of such value on the Performance Score is limited.

            (iv) Discretionary Adjustment

The Performance Score could be significantly adjusted, in the discretion of the FDIC, up or down,  based upon significant risk factors that are not adequately captured in the performance scorecard.  The resulting score, however, cannot be lower than a certain minimum nor higher than a certain maximum.  Appendix E to the proposal lists some, but not all, criteria that could be considered in determining whether or not a discretionary adjustment is appropriate.  In general, the proposed adjustments would have a proportionally greater effect on the assessment rate of those institutions with an otherwise higher assessment.  Notifications involving an upward adjustment to an institution’s assessment rate would be made in advance of implementing such an adjustment so that the institution has an opportunity to respond to or address the FDIC’s rationale for proposing an upward adjustment.  Adjustments would be implemented after considering the institution’s response to the notification along with any subsequent changes either to the inputs or other risk factors that relate to the FDIC’s decision.

b. Loss Severity Score

The Loss Severity Score would measure the relative magnitude of potential losses to the FDIC in the event of an institution’s failure, and is based on a calculation that equally weighs two measures: the loss severity measure, and the secured liabilities measure.  (Appendix D to the Proposal describes the calculation of the loss severity measure in detail, while Appendix B defines the component measures and gives the sources of the data used to calculate them.)  The loss severity measure is the ratio of possible losses to the FDIC in the event of an institution’s failure to total domestic deposits, averaged over three quarters.  A standardized set of assumptions, based on recent failures, regarding liability runoffs and the recovery value of asset categories are applied to calculate possible losses to the FDIC.  The second measure is the ratio of secured liabilities to total domestic deposits.  Like the Performance Score, the Loss Severity Score is subject to discretionary adjustment by the FDIC, subject to the same conditions.

c. Liability-Based Adjustments

The Proposal would continue to allow for significant adjustments to an institution’s initial base assessment rate as a result of certain long-term unsecured debt, secured liabilities and brokered deposits.  These adjustments are currently provided for in the assessments rule effective as of April 1, 2009, except that the brokered deposit adjustment currently applies only to institutions in Risk Categories II, III and IV.  The Proposal would extend the brokered deposit adjustment to all large institutions since the adjusted brokered deposit ratio (which took brokered deposits and growth into account for large Risk Category I institutions) would no longer apply.  The unsecured debt adjustment, secured liability adjustment and brokered deposit adjustment would be applicable to both large institutions and highly complex institutions under the proposal.

III.  Highly Complex Institution Scorecard and Base Assessment Rate

Institutions that meet the definition of “highly complex” would be subject to a more complex scorecard than ordinary large institutions.  A highly complex institution would be defined as an insured depository institution with greater than $50 billion in total assets that is fully owned by a parent company with more than $500 billion in total assets.  The designation also would apply to a processing bank and trust company with greater than $10 billion in total assets.  The scorecards for highly complex institutions and relevant adjustments thereto are identical to the scorecard and injunctions for large institutions, with the exception that the following measures will also be included:

  • Senior bond spread
  • Institution’s parent company’s tangible common equity (TCE) ratio
  • 10-day 99 percent Value at Risk (VaR)/Tier 1 Capital
  • Short-term funding to total assets ratio

Each of these measures is described in detail in Appendix B to the Proposal.  The senior bond spread measure and the parent company’s TCE ratio are used to calculate the Market Indicator, which is in turn used as an additional weighted component in the Performance Score.  The weights of the other components to the Performance Score are adjusted accordingly.  The TCE ratio is used as an outlier add-on only, meaning that it is used only if it falls below a certain amount.  The 10-day 99 percent Value at Risk (VaR)/Tier 1 Capital is used as an additional factor in the calculation of the Asset-Related Stress Component of the Performance Score.  The short-term funding to total assets ratio is used as both a component and an outlier add-on in the calculation of the Funding-Related Stress Component of the Performance Score.

IV.  Changes to Small Bank and Branches of Foreign Banks Assessment Rates

To maintain approximately the same total revenue under the Proposal as under the current system, under the Proposal, the range of initial base assessment rates for small institutions and insured branches of foreign banks in Risk Category I would be uniformly 2 basis points lower than under the current assessment system; the initial base assessment rate for institutions in Risk Category II would be unchanged; while the proposed initial base assessment rate for small institutions and insured branches in Risk categories III and IV would be somewhat higher.

V.  Further FDIC Rights

a. FDIC Adjustment

Actual total assessment rates will be set uniformly 3 basis points higher than the proposed rates in accordance with the Amended Restoration Plan that the FDIC adopted on September 29, 2009.  Under current rules, the FDIC has discretion to increase or decrease assessment rates in effect up to 3 basis points above or below total base assessment rates without the need for additional rulemaking.  The proposed rule would not affect this provision.

b. Cutoff Adjustments

The Proposal states that the FDIC shall have the flexibility to update the minimum and maximum cutoff values and weights used in each scorecard annually, without notice-and comment rulemaking.  In particular, the FDIC could add new data from each year to its analysis and could, from time to time, exclude data from some earlier years from its analysis.

VI.  Request for Comments and FDIC Questions About Other Factors

There will be a 60-day public comment period upon publication of the Proposal in the Federal Register.  In addition to comments on the Proposal, the FDIC seeks comment regarding whether, and by what method, additional measures and factors that should be incorporated into the assessment system in future rulemakings.  These measures and factors include credit, liquidity, market, and interest rate stress tests, underwriting quality, counterparty risk, market risk, liquidity risk, systemic risk and capability of risk management.  The FDIC is also seeking comments regarding whether the FDIC should review the assessment system applicable to small institutions to determine whether improvements, including improvements analogous to those being proposed for the large institution assessment system, should be made to the assessment system used for small institutions.  If adopted, the Proposal would go into effect on January 1, 2011.