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Large Bank Pricing Risk-Based Assessment System for Large Insured Depository Institutions

Large Bank Pricing Risk-Based Assessment System for Large Insured Depository Institutions 2011 Final Rule Marc Steckel Associate Director – Division of Insurance and Research Federal Deposit Insurance Corporation. Changes to Assessment System. Assessment Base

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Large Bank Pricing Risk-Based Assessment System for Large Insured Depository Institutions

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  1. Large Bank Pricing Risk-Based Assessment System for Large Insured Depository Institutions 2011 Final Rule Marc Steckel Associate Director – Division of Insurance and Research Federal Deposit Insurance Corporation

  2. Changes to Assessment System • Assessment Base • Average assets less Tangible Equity (Tier 1) • Rate Schedule • Risk categories removed for large institutions (generally TA > $10B) • Replaced with a scorecard system

  3. Dodd-Frank Assessment Base Changes Assessment Base by Asset Size Group ($ billions) Assessments by Asset Size Group ($ millions) Percentages represent the share of total assessments. Percentages represent the share of the total assessment base. 1st Quarter, 2011 2nd Quarter, 2011 78% 71% 70% 79% 30% 21% 29% 22% Less than $10 Billion Greater than $10 Billion Less than $10 Billion Greater than $10 Billion

  4. Why the Change? • Mitigate Pro-cyclicality - price for risks when a bank assumes the risk rather than after problems have developed. • Better differentiation of risk - differentiate banks during good economic times based on how they would fare during stressful times. • Consider losses FDIC may incur at failure (loss severity). 3

  5. Details of Changes • Eliminates risk categories for large institutions (Generally TA > $10B) • Allows for better differentiation of risk • Eliminates long-term debt issuer ratings • Required by Dodd-Frank • Uses Scorecards combining CAMELS and financial ratios that predict long-term performance • Better predictor of risk than previous system • Incorporates loss severity directly into the pricing model • Adds the depository institution debt adjustment (DIDA) for determining the total base assessment rate 4

  6. Pricing Methodology Performance Score x Loss Severity Score produces a Total Score Large bank adjustment applied (if any) (+/- 15 points) Total Score determined Total Score converted to Initial Base Assessment Rate Assessment rate adjustments applied Total Base Assessment Rate determined 5

  7. Scorecard Overview A scorecard will determine an IDI’s Initial Base Assessment Rate Large Institution Scorecard Highly Complex Institution Scorecard The scorecard is comprised of two scores: Performance Score based on: - (1) Weighted average CAMELS rating (30%) - (2) Ability to withstand asset-related stress measures (50%) - (3) Ability to withstand funding-related stress measures (20%) Loss Severity Score based on potential losses to total domestic deposits The loss severity score is converted into a factor between 0.8 – 1.2. In selecting scorecard measures and assigning respective weights, the FDIC relied on statistical analysis that identified how well each measure predicts a large institution’s long-term performance, including performance during a period of stress. 6

  8. Performance Score • The weighted average CAMELS rating comprises 30 percent of the total performance score.

  9. Performance Score • The ability to withstand asset-related stress comprises 50 percent of the total score. • Measures determining asset-related stress include: • Tier 1 Leverage Ratio (10%) • Concentration Measure – represents the higher of the higher-risk concentration measures or growth-adjusted portfolio concentration measures (35%) • The higher-risk concentration measures analyzes construction and development loans, leveraged loans, non-traditional mortgages, and subprime consumer loans. • The growth adjusted portfolio concentration measures growth in various loan portfolios. • Core Earnings / Average Quarter-End Total Assets (20%) • Credit Quality Measure – represents the higher of the criticized and classified items or underperforming assets (35%)

  10. Performance Score • The ability to withstand funding-related stress comprises of 20 percent of the total score. • For large institutions, the measures for determining funding-related stress include: • Core Deposits / Total Liabilities (60%) • Balance Sheet Liquidity Ratio (40%) – measures the amount of highly liquid assets needed to cover potential cash outflows in the event of stress • Highly liquid assets include cash, federal funds sold, repurchase agreements, and the market value of available for sale securities. • The balance sheet liquidity ratio is equal to liquid assets divided by the sum of borrowings, 5 percent of domestic deposits, and 10 percent of uninsured domestic and foreign deposits.

  11. Loss Severity Score • The loss severity measure equals the estimated losses to the DIF in the event of failure divided by total domestic deposits. • The loss severity score is converted into a loss severity factor that ranges between 0.8 and 1.2. • Multiplying the performance score by the loss severity factor produces a combined score (total score) that can be up to 20 percent higher or lower than the performance score.

  12. Large Institution Scorecard Higher Risk Concentrations: -Construction and land development loans -Leveraged loans -Non-traditional Mortgages -Subprime consumer loans Higher of Growth-Adjusted Portfolio Concentrations: Captures growth in various loan portfolios Credit Quality Measure: Higher of criticized and classified items or underperforming assets Estimated Losses/ Domestic Deposits * Average of most recent and four prior quarters 11

  13. Derivation of Total Performance Score • Performance Score is comprised of 3 components: • Weighted Average CAMELS • Ability to withstand asset-related stress • Ability to withstand funding-related stress • Each component is converted to a score ranging from 0-100 points* • Higher scores indicate higher risk • Component scores are then weighted as shown in the table on slide 11 and added together to derive a total performance score. * The weighted average CAMELS score ranges from 25-100 points. 12

  14. Potential Loss Severity • Estimates the relative magnitude of estimated losses to the FDIC in the event of failure (Estimated Losses/Total Domestic Deposits) • Loss Severity Model: • Adjusts the balance sheet to a failure state • Applies “haircuts” to remaining assets • Deducts pledged assets • Determines shortfall, if any, relative to projected insured deposits 13

  15. Derivation of Total Score • The loss severity model produces a value which is scored and converted into a factor (0.8 to 1.2) and then multiplied by the performance score to produce a total score. Performance Score x Loss Severity Factor = Total Score • The total score can be up to 20 percent greater than or less than the performance score, but cannot be less than 30 or greater than 90. Example: • Performance Score = 55.375 • Loss Severity Factor = 1.083 Total Score: 55.375 x 1.083 = 59.971 (The total score is 8.3 percent greater than the performance score.) 14

  16. Conversion to Initial Base Assessment Rate The total score is nonlinearly converted to an initial base assessment rate. The initial base assessment rate ranges between 5 and 35 basis points. A score of 30 results in the minimum initial base assessment rate and a score of 90 results in the maximum initial base assessment rate. Total score of 59.97 results in the initial assessment rate of 13.06 15

  17. Example – Large Bank Scorecard 16

  18. Highly Complex Institution A highly complex institution is an IDI (excluding a credit card bank) that: • Has had $50 billion or more in total assets for at least 4 consecutive quarters, AND • Is controlled by a U.S. parent holding company that has had $500 billion or more in total assets for 4 consecutive quarters, or is controlled by one or more intermediate U.S. parent holding companies that are controlled by a U.S. holding company that has had $500 billion or more in assets for 4 consecutive quarters, OR • Is a processing bank or trust company A processing bank or trust company is an IDI whose: • Last 3 years’ non-lending interest income, fiduciary revenues, and investment banking fees, combined, exceed 50% of total revenues (and its last 3 years fiduciary revenues are non-zero), and • Total fiduciary assets total $500 billion or more, and • Whose total assets for at least four consecutive quarters have been $10 billion or more. 17

  19. Differences between Large and Highly Complex Institutions Scorecards • The highly complex scorecard differs from the large institution scorecard in three ways: • For highly complex institutions, the concentration measure is defined as the greatest of the higher-risk assets to the sum of Tier 1 capital and reserves score, the top 20 counterparty exposure to the sum of Tier 1 capital and reserves score, or the largest counterparty exposure to the sum of Tier 1 capital and reserves score. • In addition to the credit quality measure, highly complex institutions also have a market risk measure, which analyzes the trading revenue volatility, level 3 trading assets, and market risk capital. • For measuring the ability to withstand funding-related stress, highly complex institutions have one additional measure: the average short-term funding / average total assets. Heavy reliance on short-term funding increases a highly complex IDI’s vulnerability to unexpected adverse funding market developments.

  20. Highly Complex Institution Scorecard The flagged measures below are unique to the Highly Complex Scorecard 19

  21. Large Bank Adjustment • An institution’s total score can be adjusted by a maximum of 15 points up or down based on risk factors that are not adequately captured in the Scorecard. • The total score, after the adjustment, cannot be less than 30 or greater than 90. • The FDIC has issued an updated guidelines on the adjustment process for comments. 20

  22. Unsecured Debt Adjustment • All banks: Assessment rates would be reduced for long-term unsecured debt issued by the bank, including subordinated debt because such debt absorbs losses before the FDIC in a failure. • Small banks: Certain amount of Tier 1 capital would also be treated as unsecured debt for purposes of this adjustment.

  23. DIDA Adjustment • The depository institution debt adjustment (DIDA) is for institutions that hold the long-term unsecured debt of other insured depository institutions, which reflect the risk that these funding sources pose to the DIF. • Under the rule, however, the FDIC will exclude the first 3 percent of an institution’s Tier 1 capital from the amount of debt reported when calculating the adjustment.

  24. Brokered Deposit Adjustment • Increases assessment rates for significant amounts of brokered deposits • This adjustment is limited to those institutions whose ratio of brokered deposits to domestic deposits is greater than 10%. • Heavy reliance on brokered deposits is associated with a higher likelihood of failure and higher losses to the FDIC.

  25. Total Base Assessment Rate • After the Initial Base Assessment Rate is adjusted, the Total Base Assessment Rate is determined. • The Total Base Assessment Rate (basis points) is multiplied by the IDI’s assessment base (Average Assets less Tier 1 Capital) to determine the annual deposit insurance premium. • If the assessment base is $20B, then the annual premium is: • 14.35 / 10,000 x $20,000,000 = $28.70 million per year. 24

  26. Assessment Rate Schedule Prior Rate Schedule (effective Q2-09 to Q1-11) 25

  27. Assessment Rate Schedule Rate Schedule (effective Q2-2011)

  28. ScorecardEffectiveness • Scorecard measures predicted the performance of large institutions in 2009 significantly better than weighted-average CAMELS alone or risk measures in financial ratios method. 27

  29. Other Information • FIL 8-2011 addresses the new assessment base and risk-based assessment system. • Link to FIL 8-2011 (PDF) • There is no change to the pricing system for small IDIs other than the assessment base and assessment rate schedule change. Final Rule: http://www.fdic.gov/regulations/laws/federal/2011/11FinalFeb25.pdf Scorecards: http://www.fdic.gov/deposit/insurance/calculator.html 28

  30. Questions? Contacts:Associate Director – Marc Steckelmsteckel@fdic.gov202-898-3618Chief – Pat Mitchellpamitchell@fdic.gov202-898-3943 29

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