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Risk - Based Assessment System
SAIF Assessment Rates for the First Semiannual Assessment Period of 2003
|MEMORANDUM TO:||Board of Directors|
|FROM:||Arthur J. Murton, Director
Division of Insurance
|SUBJECT:||SAIF Assessment Rates for the First Semiannual Assessment Period of 2003|
Some institutions will pay premiums under the schedule even
though the reserve ratio exceeds the target DRR; however, the view of the staff
is that the current schedule is consistent with the statutory requirement to
establish a risk-based assessment system. Based upon June 30, 2002, data and
projected ranges for the relevant variables at June 30, 2003, this rate schedule
would result in an average annual assessment rate of approximately 0.25 bp.
Some institutions will pay premiums under the schedule even though the reserve ratio exceeds the target DRR; however, the view of the staff is that the current schedule is consistent with the statutory requirement to establish a risk-based assessment system. Based upon June 30, 2002, data and projected ranges for the relevant variables at June 30, 2003, this rate schedule would result in an average annual assessment rate of approximately 0.25 bp.
Projections for the SAIF Reserve Ratio Over
the Next Assessment Period
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 through June 30, 2003.
1. Fund Balance
Insurance Losses. Insurance losses consist of two components: a contingent liability for future failures and an allowance for losses on institutions that have already failed. Estimated changes in contingent liabilities for the twelve months ending June 30, 2003, were based upon the Financial Risk Committee’s (FRC) third quarter estimates of possible failed thrift assets using June 30, 2002, asset figures. These estimates were adjusted, where necessary, for: (1) estimated losses on failures that have occurred since June 30, 2002; and (2) potential failures identified subsequent to the FRC’s estimates. The resulting range for changes in contingent liabilities is $200 million to $1.0 billion. Table 1 projects low and high estimates for potential increases in the total provision for losses based on changes in contingent liabilities and adjustments for the net recovery value of closed banks in receivership.
The level of insurance losses will partly depend on the future condition of the economy and its effect on the thrift industry. Staff has considered several future economic scenarios and believes a slow-growth economic recovery is most likely in the coming months. However, there is some risk that a shock to the economy, such as the outbreak of war, another corporate governance scandal, an oil price spike, or another terrorist attack, could lead consumers to stop spending, a mainstay of this recovery so far. Given these possibilities, a double dip recession cannot be ruled out.
The single most likely source of significant insurance losses related to the failure of FDIC-insured institutions in the near-term is subprime consumer lending. Some 128 FDIC-insured institutions with 6.5 percent of industry assets are currently identified as having subprime consumer or mortgage loans greater than 25 percent of Tier 1 capital. This group has a significant number of problem institutions and has contributed disproportionately to recent financial institution failures.
For purposes of determining adequacy of the current contingent liability, staff has conducted financial stress tests that incorporate a variety of economic scenarios on consumer specialty lenders, including subprime consumer lenders. Given the most likely economic scenario of a slow-growth recovery, staff believes the change in total provisions is less likely to resemble the high loss estimate than the low loss estimate in Table 1.
Interest Income and Unrealized Gains and Losses on Available-for-Sale (AFS) Securities. In order to estimate interest income for the year, staff has identified a likely range of potential interest rate movements over the next year. Given current interest rate levels and the economic outlook, scenarios for shifts in the level of interest rates of plus 150 bp or minus 50 bp for new investments appear reasonable. Table 2 projects low and high estimates for interest income and unrealized gains and losses on AFS securities. 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 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 (1)
June 30, 2002 to June 30, 2003 ($ in millions)
With a slow-growth economic recovery likely into the second half of next year, staff does not anticipate dramatic changes in bond market rates. If market rates hold relatively steady, the AFS securities’ accounting treatment will have less of an impact on changes in the fund balance than it has in the recent past.
Projected Fund Balance. Table 3 summarizes the effects on the fund balance of the low 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, 2003.
2. Insured Deposits
It takes approximately $6 billion in estimated insured deposit growth to create a 1 basis point change in the SAIF reserve ratio, all other things held constant. With the reserve ratio at 1.38 percent on June 30, 2002, it would take approximately $89 billion in insured deposit growth to reduce the fund to the Designated Reserve Ratio level, all else being equal. As of June 30, 2002, $89 billion is over 10 percent of estimated insured deposits. It is unlikely that deposit growth alone could drive the reserve ratio below 1.25 percent during the upcoming assessment period. Significant insurance losses in addition to sustained rapid deposit growth would be required to cause the reserve ratio fall below its target in the near term.
In light of recent strong growth in SAIF-insured deposits, staff believes the five-year average growth rate is more indicative of likely future trends than the ten-year average. Also, deposit growth differences between commercial banks and thrifts are unpredictable and diminishing. Thus, the staff projects SAIF-insured deposit growth in the range of +2 percent to +6 percent between June 30, 2002, and June 30, 2003, the same range used to project BIF-insured deposits. Although interest rates remain low, continued stock market volatility and investors’ concerns for safety suggest that insured deposits may remain an attractive investment as we approach the upcoming assessment period. Moderate growth in insured deposits appears likely in the coming year.3. SAIF Reserve Ratio
Based on the projected SAIF balance and the projected growth of the insured-deposit base, the staff expects the SAIF reserve ratio to be within the range of 1.23 percent to 1.39 percent at June 30, 2003 (Table 4). The low estimate, which represents a 15 bp decrease in the reserve ratio from June 30, 2002, assumes a strong increase in the insured deposit base (+6 percent) 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 low estimate incorporates the high loss estimate for insurance fund losses from possible near-term failures as projected by the staff; the estimates are not intended to represent a "worst-case" scenario.
The high estimate represents a 1 bp increase in the reserve ratio from June 30, 2002. It assumes slower growth (+2 percent) in the SAIF-insured deposit base, the low-loss estimate for insurance losses, and lower interest rates, resulting in an upward adjustment to the aggregate amount of unrealized gains on AFS securities.
Staff expects that the actual reserve ratio at June 30, 2003, will exceed 1.25 percent. As indicated in Table 4, if the low estimate were to be realized, the current rate schedule would not be sufficient to maintain the DRR through June 30, 2003. Staff believes that such a scenario is possible, but not likely, because the low estimate requires sustained rapid deposit growth, high insurance losses, and a substantial increase in interest rates to occur during the assessment period. Even if the SAIF reserve ratio falls below the starting target 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. The 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.
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 $23 million, which is $1 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 thrift earnings and capital of the current rate schedule and found no unwarranted adverse effects.
The Assessment Base Distribution
and Matrix Migration
Estimated annual assessment revenue $23 million
With 97.5 percent of the number of institutions and 99.3 percent of the assessment base in the three lowest assessment risk classifications of "1A," "1B," and "2A," as of July 1, 2002, the current distribution in the rate matrix reflects little fundamental difference from the previous semiannual assessment period. The current distribution reflects slight improvement in the best-rated premium category. Since the previous assessment period, 20 institutions migrated into the "1A" risk classification (Table 7), and 17 institutions migrated out of the "1A" risk classification. Only 117 institutions are currently classified outside of the best risk classification.
Overall, for all SAIF-insured institutions, the supervisory subgroup component of the risk classification was upgraded since the previous period for 18 institutions with an assessment base of $30.1 billion and was downgraded for 20 institutions with an assessment base of $18.3 billion.
|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 SAIF 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 is required to review and weigh 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 funds; 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 target DRR.|
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