[Federal Register: February 21, 2007 (Volume 72, Number 34)]
[Notices]
[Page 7878-7888]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr21fe07-35]
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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