|May 5, 2004|
||The Board of Directors
||Arthur J. Murton, Director
Division of Insurance and Research
||BIF Assessment Rates for the second
Semiannual Assessment Period of 2004
The staff recommends that the Board maintain the existing Bank Insurance Fund (BIF) assessment rate schedule of 0 to 27 basis points
(bp)1 per year. This rate schedule complies with the statutory requirements of the Federal Deposit Insurance Act for the Board to establish a risk-based assessment system and set assessments only to the extent necessary to maintain the BIF at the Designated Reserve Ratio (DRR) of 1.25 percent.
Staff believes that the BIF reserve ratio will remain above the DRR
throughout the assessment period. Therefore, staff recommends maintaining the
existing assessment rate schedule. Based on December 31, 2003 data and projected
ranges for the relevant variables at December 30, 2004, this rate schedule would
result in an average annual assessment rate of approximately 0.19 basis points (bp).
Staff has considered a range of plausible events that could produce
significant movements in the BIF reserve ratio. We have continued to refine the
methodology introduced in the previous assessment rate case. Our methodology
provides ranges for estimated insurance losses that are primarily based on
estimated changes to the contingent liability for anticipated failures
(contingent loss reserve); estimated changes in interest income and the market
value of available-for-sale (AFS) securities due to changes in interest rates;
and estimated growth in insured deposits.
In setting assessment rates since the recapitalization of the BIF, the Board has considered: (1) the probability and likely amount of loss to the fund posed by individual insured institutions; (2) the statutory requirement to maintain the fund at the DRR, currently 1.25 percent, and (3) all other relevant statutory provisions.
Projections for the BIF Reserve Ratio over the Next Assessment Period
Staff's best estimate for the BIF reserve ratio as of June 30, 2004 is 1.27
percent. The lower and upper bounds of the likely range for the BIF reserve
ratio as of June 30, 2004 are 1.16 percent to 1.35 percent, respectively.
Although the lower bound of the estimated range is well below the statutory
requirement of 1.25 percent, staff believes the ratio most likely will be closer
to the best estimate of 1.27 percent.
The following is an analysis of the anticipated effect of changes in the fund
balance and the rate of insured deposit growth on the reserve ratio as of June
1. Fund Balance
Staff evaluates three significant inputs in estimating potential changes to
the fund balance. First, staff estimates the impact of probable insurance
losses, which are primarily losses from failed institutions. Second, staff
estimates the amount of interest income that the fund will receive during the
year. Third, staff projects the level of unrealized gains and losses on
available-for-sale (AFS) securities that will be present at the end of the
A. Insurance Losses
IInsurance losses primarily consist of two components: a contingent liability
for anticipated failures (contingent loss reserve) and an allowance for losses
on banks that have already failed. The Financial Risk Committee (FRC) recommends
the amount of the contingent loss reserve each quarter, and this recommendation
represents the FRC's best estimate of BIF losses from potential bank failures.
It reflects the staff's view of those potential losses that are "probable
and estimable," as required by generally accepted accounting principles.
Actual results could differ from these estimates. As of June 30, 2003 the BIF
loss reserve stood at $785 million. The BIF loss reserve declined to $416
million as of September 30, 2003.
Staff estimates a likely range of insurance losses based on projected changes
in the contingent loss reserve. Several factors drive changes in the contingent
loss reserve for the twelve months ending June 30, 2004. These factors include:
(1) the shifting of problem banks among different risk categories within the
reserve, (2) the movement of banks out of the reserve due to improved financial
conditions, mergers, or failures, and (3) the addition of new problem bank
assets to the reserve. To capture the effects of these changes, staff estimates
the probabilities of banks moving within categories, entering, or leaving the
contingent loss reserve. These probabilities are based on the recent history of
changes to the reserve. Other factors driving changes in the contingent loss
reserve are changes in expected failure rates and changes in rates of loss given
failure. For purposes of this nine-month estimation of the contingent loss
reserve, staff assumes that failure and loss rates remain constant through the
Table 1 shows the range of potential loss provisions based on changes in the
contingent loss reserve, adjustments for net losses/recoveries due to the
resolution of closed banks, adjustments for litigation losses, and adjustments
for other contingencies.
Potential Provisions and Adjustments for Loss Allowances
For the Twelve Months Ending December 31, 2004
|Provision Related to Future Failures (1)
|Adjustment for Closed Banks’
Net Recoveries (2)
|Adjustment for Litigation Losses (3)
|Adjustment for Other Contingencies (4)
|Potential Provision for Losses
(1) Includes provisions required to account for the differences between the
actual balance of the contingent loss reserve on June 30, 2003 ($785 million)
and the June 30, 2004, balance estimated by statistical analysis. Changes in the
contingent loss reserve occur from reductions in reserves after failures,
reductions in reserves from improvement in problem institutions’ conditions,
and additions of reserves due to problem institutions’ deterioration.
(2) Assumes a range of -5% to +5% (-$25 million to +$25 million) of the
estimated net recovery value of bank resolutions, $505 million as of December
31, 2002. This line also includes actual third quarter 2003 adjustments of $143
million for reductions in estimated losses on prior failures.
(3) Based on the standard deviation of changes in the contingent liability
for litigation losses for the period 1998 to 2002.
(4) Based on the standard deviation of changes in the contingent liability
for representations, warranties, asset securitization guarantees, and assistance
agreements for the period 1998 to 2002.
Staff believes that the range provided by the statistical analysis adequately
represents the most likely range of additional provisions needed to cover
insurance losses from future failures. However, the bounds of this range do not
represent "best case" and "worst case" scenarios, and larger
or smaller provisions could occur.
Staff believes that subprime lending continues to be the most likely source
of near-term losses to the insurance funds. Subprime lending has been a
significant factor in 28 percent of failures since 1997. While the number of
subprime lenders and dollar volume of subprime loans have declined from 2000
levels, the percentage of "problem" subprime lenders to total subprime
lenders has increased during the same period.
Staff continues to monitor the potential effects of higher interest rates on
the bank and thrift industries. Rising interest rates have the potential to
adversely affect some insured institutions through net interest margin
compression, a substantial decline in the mortgage origination volume, and
unrealized and realized losses on their security holdings. Institutions most
sensitive to an upward movement in interest rates include mortgage lenders and
other institutions with a high percentage of fixed-income assets in their
portfolio. However, these institutions generally appear to have adequate capital
to sustain a substantial decline in net interest margins that is comparable to
Commercial real estate loan loss rates remain at historical lows. However,
insured institutions with high exposure to commercial real estate loans may
experience an increase in credit risk associated with persistent weak
fundamentals in the commercial real estate and the rising debt service burden
and lower property values that may result from rising interest rates. Newer
banks and those in certain geographic areas are more vulnerable to deterioration
in the commercial real estate loans than other insured institutions; however,
insured institutions in general appear to be well positioned to withstand a
significant stress in their commercial real estate portfolio.
Based on these findings, combined with signs of improving overall economic
conditions, staff believes that current industry trends do not foreshadow
widespread deterioration in the banking industry.
B. Interest Income and Unrealized Gains and Losses on AFS Securities
Staff relied upon expert forecasts as detailed in the Blue Chip Financial
Forecasts to develop interest rate projections and analyze the potential
effect of changes in interest rates on interest income and unrealized gains and
losses on AFS securities. The forecasts defined as our "best estimate"
were the consensus forecasts through the second quarter of 2004 as detailed in
the September issue of the Blue Chip Financial Forecasts. Adopting the
experts' consensus forecasts also allows for forecasted yield curves that change
in shape over time.
Along with forecasting yield curves based upon the experts' forecasts, staff
also calculated bounds within which interest rates are likely to fall using the
historical differences between the experts' forecasts and the actual interest
rates. These bounds vary over the assessment period and change in shape over
time, as opposed to being parallel shifts in rates. The bounds are consistent
with the notion that the projections represent the most likely scenarios and
that the actual rates may be above or below the projections. In general, the
projections indicate stable or slightly rising rates for the period under
consideration. The lower (upper) bound generally reflects rates that are as much
as one percentage point lower (higher) than current rates, with the range
increasing over time. Charts showing the projected rates, upper bound, and lower
bound are included as an appendix to this case.
Table 2 shows projections for low, best, and high estimates for interest
income and unrealized gains and losses on AFS securities using the forecast
rates and the bounds. Because of the significant percentage of AFS securities
held in the insurance fund portfolio at this time, when interest rates change,
the magnitude of the resulting change in market value of these securities
dominates the effect of changes in interest income.
Potential Changes in Interest Income and
Unrealized Gains (Losses) on AFS Securities
June 30, 2003 to June 30,
2004 ($ in millions)
||Low Estimate (1)
||Best Estimate (1)
||High Estimate (1)
|Unrealized Gain (Loss) on AFS Securities (2)
(1) The Low Estimate is calculated using upper
bound interest rates, the Best Estimate is calculated using the projected
rates, and the High Estimate is calculated using the lower bound rates Net
estimated failure resolution outlays equal $25 billion for the Low Estimate
and $89 million for both the Best Estimate and High Estimate Although the
level of interest rates is assumed to be generally higher in the Low Estimate
scenario than in the other two, overall interest revenue is actually lower in
the Low Estimate due to a significantly smaller balance invested during the
period (The Low Estimate assumes greater resolution activity requiring cash
outlays that lower the investable amount during the period)
(2) Includes actual unrealized gains on AFS
securities for the period July 1, 2003 through August 31, 2003 and projected
gains/losses for the remaining period through June 30, 2004
Staff does not anticipate dramatic changes in interest rates. Nevertheless,
as the remaining maturity of the existing AFS portfolio shortens, previously
identified unrealized gains will dissipate. In addition, falling interest rates
would be detrimental to interest income in the long term.
C. Projected Fund Balance
Table 3 summarizes the effects on the fund balance of the low, best, and high
estimates assumed for insurance losses, interest income, and unrealized gains
and losses on AFS securities. The projection also assumes that the current
assessment rate schedule will remain in effect through June 30, 2004.
Projected Fund Balance (1)
($ in millions)
|Interest Income (3)
|Operating Expenses (4)
|Provision for Losses
|Total Expenses & Losses
|Unrealized Gain (Loss) on AFS Securities (3)
|Comprehensive Income (Loss) (5)
|Projected Fund Balance –
(1) Projected income and expense figures are for
the twelve months ending June 30, 2004.
(2) Assumes that the current assessment rate
schedule remains in effect through June 30, 2004.
(3) See also Table 2 for an explanation regarding
changes in interest revenue and unrealized gain (loss) on AFS securities under
(4) Operating expenses for 2003 allocated to the
BIF are estimated based on the FDIC’s 2003 budget.
(5) Comprehensive Income is used instead of Net
Income due to the magnitude of the change in market value of AFS securities
that occurs with fluctuations in interest rates See note (3) above.
2. Insured Deposits
Since June of 1990, annual growth rate for BIF-insured deposits has been as
high as 6.3 percent and as low as an annual shrinkage of 1.8 percent (Figure 1).
After declining June of 1992 through June of 1994, insured deposits grew between
1.5 percent and 3.3 percent annually from June of 1995 to June of 1999. Insured
deposits grew by 5.1 percent, 6.3 percent, and 4.6 percent for the twelve months
ending June 30, 2000, June 30, 2001, and June 30, 2002, respectively. Such
growth slowed to a rate of 2.0 percent for the twelve months ending June 30,
2003. Staff projects that insured deposits will grow at a rate of 3.5 percent
for the twelve months ending June 30, 2004. The projected growth rate, which is
below the five-year average growth rate of 4.2 percent, is consistent with the
recent slowdown in insured deposit growth.
It takes approximately $20 billion in insured deposit growth to create a 1
basis point decline in the BIF reserve ratio, all other things held constant.
Based upon the June 30, 2003, fund balance, it would take about $81.3 billion in
insured deposit growth (3.2 percent) to reduce the reserve ratio to the DRR at
June 30, 2004, all else being equal. Our preliminary estimate indicates that
deposit growth over the next year will be greater than this figure. However, the
net worth of the BIF is likely to grow and the ultimate level of the reserve
ratio will depend on how fast the net worth of the fund grows relative to the
growth of BIF-insured deposits.
Staff developed a statistical model that projects insured deposit growth
based upon previous growth in insured deposits and previous and current growth
in total deposits. After analyzing the results of this model, the best judgment
of the staff is that BIF-insured deposits are likely to experience a growth rate
in the range of +0.2 percent to +6.7 percent between June 2003 and June 2004.
This range represents the statistical margin of error in the estimate provided
by the model3.
The staff believes the most likely scenario is that insured deposits will grow
at the midpoint of this range (3.5 percent), which will bring the total for BIF
insured deposits to $2.6 trillion. The model estimates future growth rates in
insured deposits through historical growth rates in insured and total deposits
and, as such, does not explicitly incorporate economic shocks into the model.
However, some events that could force insured deposits into the high range of
our forecast are a depressed stock market with high volatility as well as
monetary expansion. Some events that could force insured deposits into the low
range of our forecast are an upturn in the stock market and in the U.S. economy
as a whole.
3. BIF Reserve Ratio
Based on the projected BIF balance and the growth of the insured deposit
base, the best estimate of the BIF reserve ratio at June 30, 2004, is 1.27
percent (Table 4, next page). The best estimate assumes a baseline of a moderate
reversal of loss provisions, stable or slightly increasing interest rates, and
an insured deposit growth rate of 3.5 percent.
The staff projects the lower bound and upper bound of the likely range to be
1.16 percent and 1.35 percent, respectively (Table 4, next page). The lower
bound, which reflects a 13 bp decrease from the June 30, 2003, ratio, assumes a
strong increase in the insured deposit base (6.7 percent growth) and a higher
interest rate scenario, resulting in a downward adjustment to the fund balance
due to a reduction in the aggregate amount of unrealized gains on AFS securities
(Table 3). The lower bound also incorporates the high loss estimate for
insurance losses from possible near-term failures as projected by staff. The
estimate reflects the staff's view of a reasonably possible adverse scenario. It
is not intended to represent a "worst case" scenario.
The upper bound produces a 6 bp increase in the reserve ratio at June 30,
2004. This estimate assumes slower growth (0.2 percent) in the BIF-insured
deposit base, the low loss estimate for the provision for losses, and lower
interest rates, resulting in an upward adjustment to the aggregate amount of
unrealized gains on AFS securities.
Projected BIF Reserve Ratios
($ in millions)
June 30, 2003
|Estimated Insured Deposits
||Lower Bound (1)
|Best Estimate (2)
|Upper Bound (3)
|Projected Fund Balance
|Estimated Insured Deposits
|Estimated BIF Ratio
(1) The Lower Bound refers to the scenario of
higher loss provisions (Low Estimate in Table 1), higher interest rates (Low
Estimate in Table 2), and a higher insured deposit growth rate (+67 percent).
(2) The Best Estimate refers to a baseline scenario
of moderate loss provisions (Best Estimate in Table 1), stable or moderately
rising interest rates (Best Estimate in Table 2), and the insured deposit
growth rate projected by staff (+35 percent).
(3) The Upper Bound refers to the scenario of lower
loss provisions (High Estimate in Table 1), moderately declining interest
rates (High Estimate in Table 2), and a lower insured deposit growth rate (+02
As indicated above, staff's best estimate of the reserve ratio for June 30,
2004 is slightly higher than the DRR, represents a 2 bp decline from the June
30, 2003 ratio and a 5 bp decline from the preliminary September 30, 2003 ratio.
Although this appears inconsistent with recent history, where the ratio has
increased for four straight quarters, staff believes several factors indicate
that a decline in the reserve ratio between now and June 30, 2004 is most
- Nearly one-half ($682 million) of comprehensive income in the first nine
months of 2003 is represented by a reversal of the provisions for insurance
losses due to reductions in estimated losses on prior failures and due to
significant reductions in the contingent loss reserve. Although staff
remains cautiously optimistic about the condition of the banking industry,
it is not reasonable to expect such substantial reversal to the loss
provisions to continue through next June.
- Interest rates have remained at very low levels throughout 2003, but staff
believes rates are unlikely to decline further during the upcoming nine
months. The BIF's unrealized gains on available-for-sale securities will be
reduced even in a stable interest rate environment, because such unrealized
gains disappear as securities move closer to their maturity dates. In a
rising rate environment, reductions in unrealized gains would accelerate.
- BIF insured deposit growth was low through the first three quarters of
2003. Although staff does not believe that insured deposit growth will
approach growth rates seen from 2000 through 2002, staff believes that
growth closer to the five-year average rate is not unreasonable.
As a result of these factors, staff believes that a decline in the BIF
reserve ratio is both reasonable and likely. However, given that the BIF reserve
ratio is currently greater than 1.25 percent and that staff's best estimate of
the ratio for June 30, 2004 is above 1.25, staff believes that it is reasonable
to maintain the existing BIF rate schedule. Even if the BIF reserve ratio
declines below the statutory DRR of 1.25 percent, the Board would have two
semiannual assessment periods to bring the ratio back to the target.
Risk-Based Assessment System
Staff recommends retaining the current spread of 27 bp between the
assessments paid by the best- and worst-rated institutions as well as the rate
spreads between adjacent cells in the assessment rate matrix. The proposed
assessment rate schedule appears in Table 5. The Board previously determined
that the current rate spreads provide appropriate incentives for weaker
institutions to improve their condition and for all institutions to avoid
excessive risk-taking, consistent with the goals of risk-based assessments and
existing statutory provisions. The current rate spreads also generally are
consistent with the historical variation in bank failure rates across cells of
the assessment rate matrix.
Proposed Assessment Rate Schedule
First Semiannual Assessment Period of 2005
In setting assessment rates to achieve and maintain the reserve ratio at the
target DRR, the Board is required to consider the effects of assessments on
members' earnings and capital. The estimated annual revenue from the existing
rate schedule is $82 million, which is $5 million more than the annual amount
that was projected six months ago. In recommending that the Board maintain this
schedule, the staff has considered the impact on bank earnings and capital and
found no unwarranted adverse effects.
The Assessment Base Distribution and Matrix Migration
Table 6 summarizes the current distribution of institutions across the
BIF Assessment Base Distribution (1)
Assessable Deposits as of June 30, 2004
Supervisory Subgroup and Capital Groups in Effect July 1, 2004
annual assessment revenue $82 million
Assessment Base $4,081
Average annual assessment rate (bp) 0.20
(1) “Number” reflects the number of BIF
members, including BIF-Oakar institutions; “Base” reflects all BIF-assessable
With 98.5 percent of the number of institutions and 99.4 percent of the
assessment base in the three lowest assessment risk classifications of
"1A," "1B," and "2A," as of July 1, 2003, the
current distribution in the rate matrix reflects little fundamental difference
from the previous semiannual assessment period. The current distribution
reflects slight shrinkage in the best-rated premium category. Since the previous
assessment period, 164 institutions migrated into the "1A" risk
classification (Table 7), and 174 institutions migrated out of the
"1A" risk classification. Only 667 institutions are classified outside
of the best risk classification.
BIF Migration To and From Assessment Risk Classification 1A
|Institutions entering 1A
|Due to capital group reclassification only
|Due to supervisory subgroup reclassification only
|Due to both
|Institutions entering 1A
|Due to capital group reclassification only
|Due to supervisory subgroup reclassification only
|Due to both
The table reflects BIF-insured institutions that moved in and out of
assessment risk classification 1A from the first semiannual assessment period of
2003 to the second semiannual assessment period of 2003 The numbers only include
institutions that were rated in both periods The table does not reflect other
assessment risk classification migrations that are not either to or from
Overall, the supervisory subgroup component of the risk classification was
upgraded since the previous period for 120 institutions with an assessment base
of $12.9 billion and was downgraded for 149 institutions with an assessment base
of $68.9 billion.
Refunds for second semiannual period of 2003. Since BIF-insured institutions
classified as "1A" currently pay no assessments to the BIF under the
proposed rate schedule they are ineligible to receive any refund for the First
semiannual period of 2003.
FICO Assessment. The Funds Act separates the Financing
Corporation (FICO) assessment from the FDIC assessment, so that the amount
assessed on individual institutions by the FICO is in addition to the amount
paid according to the BIF rate schedule. All institutions are assessed the same
rate by FICO, as provided for in the Funds Act, and the FICO rate is updated
quarterly. The FICO rate for the first quarterly payment in first semiannual
assessment period of 2004 will be determined using September 30, 2003 Call
Report and Thrift Financial Report data.
For information about deposit insurance assessments, please contact
Christopher Newbury, Chief, Fund Analysis Section, Division of Insurance and
Research, at (202) 898-3504, or Joe DiNuzzo, Counsel, Legal Division (202)
898-7349. For FICO assessment information, please contact Richard Jones, Chief,
Deposit Insurance Pricing Section, Division of Insurance and Research, at (202)
1 Although the current effective rate schedule
is 0 to 27 basis points, the base rate schedule, established in 1995, is still 4
to 31 basis points. The FDIC may alter the existing rate structure and may
change the base BIF rates by rulemaking with notice and comment. Without a
notice-and-comment rulemaking, the Board has authority to increase or decrease
the effective rate schedule uniformly up to a maximum of 5 basis points, as
deemed necessary to maintain the target DRR.
2 The Board reviews and weighs the following
factors when establishing an assessment schedule: a) the probability and likely
amount of loss to the fund posed by individual institutions; b) case resolution
expenditures and income; c) expected operating expenses; d) the revenue needs of
the fund; e) the effect of assessments on the earnings and capital of fund
members; and f) any other factors that the Board may deem appropriate. These
factors directly affect the reserve ratio prospectively and thus are considered
as elements of the requirement to set rates to maintain the reserve ratio at the
3 The model is a regression model where the
current growth rate in insured deposits is estimated as a linear function of the
previous growth rate in insured deposits as well as the current and previous
growth rates of total (insured and uninsured) deposits. The range (+0.2%, +6.7%)
corresponds to a 95% confidence level. In other words, we can be sure with 95%
confidence that the actual growth rate in insured deposits, from June 2003 to
June 2004, will lie within this range. The growth rate predicted by the model
(thus, the most likely rate) is the midpoint of this range (3.5% annual growth).
Appendix - Interest Rate Assumptions