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cutH/ STATEMENT ON THE FINANCIAL RESOURCES AND CONDITION OF THE FEDERAL DEPOSIT INSURANCE CORPORATION BEFORE THE SUBCOMMITTEE ON FINANCIAL INSTITUTIONS SUPERVISION, REGULATION AND INSURANCE OF THE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS U.S. HOUSE OF REPRESENTATIVES BY STANLEY J. POLING DIRECTOR DIVISION OF ACCOUNTING AND CORPORATE SERVICES FEDERAL DEPOSIT INSURANCE CORPORATION Room 2128, Rayburn House Office Building September 12, 1985 10:00 a.m. Mr. Chairman, members of the Subcommittee, we are pleased to have this opportunity to provide testimony on the financial resources and condition of the FDIC as the Subcommittee continues its evaluation of the need for modifications to our system of Federal deposit insurance. As you are aware, the FDIC has over the past five years, dealt with a post-World War II record number of bank failures throughout the United States. We have responded to 11 bank failures in 1981, 42 in 1982, 48 in 1983, 79 in 1984 and 78 so far in 1985. This period has been difficult for the Corporation and its employees and we see no letup in the immediate future. Although failures since 1981 involved over $30 billion in bank assets, exclusive of Continental Illinois, the resources of the FDIC have been strengthened rather than diminished over the period. The deposit insurance fund, which is defined as the FDIC’s net worth, has increased from $11.1 billion at the beginning of 1981 to its current level at $18.8 billion more than a 70% growth rate. Moreover, the Fund as a percentage of insured deposits during this period increased from 1.21% to approximately 1.26%, continuing a trend started in the mid-1970's. The ability of the insurance fund to grow during a period of frequent bank failures is a tribute to the inherent strength of the Federal deposit insurance system. fund has been achieved through: The growth of the (1) a broad assessment base and system that appears actuarily sound in terms of the volume of failures in the insured system; (2) a large and growing investment portfolio of U.S. Treasury securities; and (3) a range of flexibility which allows the FDIC to respond to failing and failed bank situations in ways which are designed to minimize insurance losses. We submit that the FDIC has functioned exactly as it was designed in 1933...a self-help safety net supported by a broad-based industry’s insurance premiums. With a current income stream in excess of $3 billion annually, the FDIC does not use a single dollar of taxpayer funds. We at the FDIC are fully confident of the ability to maintain this tradition. In response to the specific areas requested in the invitation to this hearing, we have presented in an appendix, summary financial statements of condition and income of the FDIC for the last five years. provided a financial statement as of July 31, 1985. We also have The statements present the major asset, liability, revenue and expense components of our financial position. Further and more detailed presentations are contained in our annual reports which are available to the Subcommittee. Review of our current financial statements quickly reveals the financial resources available for the Corporation's insurance responsibilities. The major components can be aggregated as the $18.8 billion deposit insurance fund, annual gross income (largely from investments and insurance premiums) now in excess of $3.0 billion, and additionally, the Corporation's statutory authority...never used...to borrow up to $3 billion from the United States Treasury. The bulk of the $18.8 billion deposit insurance fund consists of $15.6 billion invested by law in U.S. Treasury securities. That portfolio is highly liquid with an average maturity of approximately two years and one month. The portfolio presently contains total market appreciation of some $430 million in excess of its $15.6 billion book value. - 2- With regard to the major elements of the Corporation’s income, 1984 insurance premium assessments amounted to $1,254 billion, income from the investment portfolio amounted to $1,495 billion and $283 million represented earnings on advances and assets related to our liquidation activities and assistance transactions. In the area of availability of funds for the Corporation’s operations, we have built exceptional liquidity into our resources. We have provided in the appendix a schedule of our operating cash flows projected for the twelve-month period beginning July 1, 1985, which reveals a residual funds* flow of $7.1 billion. We should also note that over the years we have been able to utilize the credit facilities of the Federal Reserve System in a number of failing and failed bank situations, such as Franklin National and Continental Illinois, in scheduling over time, the repayment of debt extended those institutions through the Fed’s discount window. This facility enables the FDIC to further refine our funds’ flows by coordinating repayment schedules with asset collections from liquidation efforts at those institutions. As is apparent from the data presented, the combination of resources, income, and funds' flows has enabled the Corporation to absorb without strain, the adverse impact of closed bank activity while strengthening our reserves, even over this very difficult five-year period. The Subcommittee has also requested the nature and amount of contingent liabilities of the FDIC arising from assistance provided failing banks in previous years. The ready answer is that the FDIC has no contingent liabilities other than those related to banks which will fail in the future••.on which estimates are impossible to make. -3- By policy, the Corporation establishes estimated allowances for losses shortly after a bank falls. These allowances are also established for those banks involved in assisted merger transactions. Thus, the balance sheet presentation of "assets acquired from failures of insured banks" is net of estimated allowance for losses. These loss reserves, including estimated future cash outlays at present value, are reflected on the year-end 1984 balance sheet at a total of $2,430 billion. We should also note that the Continental Illinois transaction has been booked (according to generally accepted accounting principles) with a separate line presentation on our balance sheet (Assets Acquired/Liabilities Incurred In Assistance to Insured Banks). At the time of the transaction, an estimate of the ultimate collectibility of booked assets was not possible. The Corporation’s Liquidation Division is completing its initial determination of the net realization value of the transferred loan portfolio at the present time and an appropriate allowance for losses will be established by year-end 1985 against 1985 revenues. We continue to view this assistance transaction favorably and are confident that the ultimate overall cost, if any, to the insurance fund will not be material. For your convenience, we have attached a copy of the disclosure on this transaction contained in our 1984 Annual Report (Exhibit I). The Subcommittee has also requested comment on the kinds and amounts of financial obligations we anticipate during the next twelve to eighteen months. AS FDIC Director of Bank Supervision Shumway testified yesterday, the number and deposits of problem institutions appear not yet to have peaked. Based on the level of bank failures this year and the size of our problem -4- list, we are currently projecting at least 100 bank failures in 1986, We are, therefore, planning for a continued level of activity which will present the same kinds and amounts of financial obligations as we have experienced over the past eighteen months. Under these conditions, we will continue our present posture of maintaining a high degree of liquidity in our balance sheet and concentrating on the sale at the time of failure of more bank assets to purchasing organizations• We believe that the trend of our financial strength and resources over the past five years has demonstrated beyond question our ability to cope with any foreseeable contingencies without financial strain.•.thereby assuring the safety of depositors in insured institutions. We, likewise, will continue to move aggesslvely in the areas of supervision, enforcement and disclosure. We are, of course, additionally devoting considerable resources to planning efforts for contingencies involving individual banks and large numbers of failed banks. The environment clearly mandates that we be imaginative and responsive to particular situations as they arise if we are to remain a symbol of confidence to the banking public. I would be remiss if I did not press our case against the insurance of brokered deposits. Chairman Isaac has frequently testified on and documented this massive abuse which we see as the primary threat against the soundness of the Federal deposit insurance system. The issue is basic...the deposit insurance system was never designed to enable banks which would otherwise be unable to do so, to attract brokered deposits solely through the Federal guarantee. Without the Federal guarantee, the flow of -5- funds to weak institutions would cease in a competitive free market. We need your help in containing this most serious threat to the deposit insurance system. « Thank you, Mr. Chairman. 9 I will be pleased to respond to any questions you or members of the Subcommittee may have. XXXXX - 6- FOOTNOTE ON CONTINENTAL ILLINOIS TRANSACTION FROM 1984 ANNUAL REPORT OF FDIC EXHIBIT 4. Assets Acquired in Assistance to an Insured Bank: On July 26, 1984, the FDIC, the Federal Reserve Board, the Comptroller of the Currency and a group of major U.S. banks agreed to provide a “permanent assistance program” to the Continental Illinois National Bank and Trust Company of Chicago (“CIN B”) and its parent, Continental Illinois Corporation. This pro-: gram, which became effective on September 26, 198< after Continental Illinois Corporation shareholder approval, replaced a temporary, emergency assistance package among the same parties that had been in effect since May 1984. Major elements of the new package included a financial assistance plan to remove problem loans from CINB and infuse new capital resources into CINB, the continuation of on going lines of credit from the Federal Reserve Board and a group of major U.S. banks to alleviate liquid ity pressures and the installation of a new management team. Additionally, the FDIC agreed to commit more capital or other forms of assistance if the permanent assistance program proves to be insufficient for any reason. The key aspects of the permanent assistance program applicable to the FDIC are embodied in an Im plementation Agreement and an Assistance Agreement between the FDIC and CINB, Continental Illinois Corporation, and Continental Illinois Holding Corporation, a new holding company formed to own all Con tinental Illinois Corporation stock as of the effective date for the purpose of implementing the FDIC Option (described below). Discussed below are the major aspects of the FD IC’s participation in the permanent assistance program and their effect on the FDIC financial statements. The assets acquired by the FDIC in assistance to CINB on the commencement date and as of year end are as follows (in thousands): (Commencement Date) September 26,1984 Loans and related assets purchased Promissory note Preferred stock investment \ 1 December 31,1984 $2,000,000 t , 500,000 1,000,000 $2,010,313 1,447,116 $4,500,000 $4,457,429 1,000,000 Loans acquired were selected by CINB with the restrictions that such loans were nonperforming, classi fied or otherwise of poor quality (i.e., "troubled loans”). Certain foreign loans were excluded from selec tion. On September 26, 1984, after consummation of the permanent assistance program, CINB trans ferred $2.0 billion of troubled loans to the FDIC. The unpaid legal principal value of these loans was approximately $3.7 billion. Also, on September 26, 1984, the FDIC received a promissory note from CINB for $1.5 billion. At CIN B’s option, the promissory note can be paid anytime within three years by transfer of additional troubled loans (subject to the above restrictions) at CIN B’s book value as of the date of transfer. Until such time as the promissory note is paid, interest will be charged. As of December 31, 1984, CINB transferred $52,844,000 of additional troubled loans to the FDIC as partial repayment on the original promissory note. As a result, the remaining unpaid principal balance on the note is $1,447,116,000. The purchase of these assets was, in part, funded by the assumption of $3.5 billion of indebtedness to the Federal Reserve Bank of Chicago (FRB) on behalf of CINB. These borrowings will bear interest at specified rates established by the FRB and the U.S. Treasury. The FDIC will repay these borrowings by making quarterly remittances of its collections, less expenses, on the troubled loans. If there is a shortfall at September 26, 1989, the FDIC will make up such deficiency with its own funds. E-l 28 Assets Acquired in Assistance to an Insured Bank (continued): f l Implementation Agreement provides for the FDIC to be reimbursed each quarter for its expenses listed to administering the transferred loan portfolio and for interest paid on the indebtedness to the ¡18 which it assumed. Thus, such costs arp recorded as assets. The FDIC and CINB have'entered into service agreement whereby CINB will administer the transferred loan portfolio on behalf of the FDIC. te FDIC is also permitted to establish a special reserve account from troubled loan collections. The ^ance in this account, if any, reverts to the FDIC in those quarters when loan collections have been Sufficient to cover interest owing on the indebtedness which it assumed. For financial accounting pur ges, cash collections received on the transferred loan portfolio (plus certain other amounts) are applied Larterly in accordance with the Implementation Agreement terms, as follows: 1) to the administrative tpenses paid by the FDIC; 2) to the interest owing on the assumed indebtedness; 3) to fund the special serve account such that this account plus accrued interest thereon is at least $75 million; and 4) to [incipal owing under the FRB Agreement. The FDIC is entitled to receive interest on the cumulative piciencies between cash collections and the costs incurred in administering the troubled loans and the ierest on the assumed debt. Further, CINB has assigned to the FDIC all its existing and future claims painst any party which may be related to any loss incurred in connection with any transferred loan. ptal cash flow consists of the above collections of principal and interest on the transferred loan portfolio, ierest payments on the CINB promissory note and interest earned on daily collections. As of jecember 31, 1984, the FDIC received cash flow totaling $147,044,000. Cash flow was applied to pministrative costs and interest expense of $3,224,000 and $94,564,000 respectively, and to establish a fecial reserve account balance of $49,256,000. Accordingly, total FDIC obligations for purposes of ¡©rcising the FDIC option (discussed below) are $3,457 billion. The collection results during this period lould not necessarily be considered indicative of the ultimate loan portfolio collectibility. ¡timate collection results on the transferred loan portfolio are subject to significant uncertainties because Hjhe financially troubled nature of the borrowers and the effects of general economic conditions on their dustries. Due to the number and complexity of the loans within the transferred loan portfolio, an estiof the ultimate collectibility has not been completed by the FDIC. Accordingly, no determination has made as to whether or not any allowance for loss related to the CINB permanent assistance proIm is necessary. Consequently, none has been recorded in the financial statements for the year ended ecember 31, 1984. The Corporation expects to complete its initial determination of the estimated net salization on the transferred loan portfolio during 1985. « te FDIC holds an option to acquire up to 40.3 million shares of Continental Illinois Corporation common lock. The shares subject to the option are owned by Continental Illinois Holding Corporation, which is ped by the former stockholders of Continental Illinois Corporation. The option cannot be exercised porto the fifth anniversary of the commencement date, September 26, 1989. Further, the option is [erasable only if the FDIC suffers a loss (disregarding any profit or loss from the FD IC’sJnterest in bntinental Illinois Corporation preferred or common stock) on the transferred loan portfolio, including recovered administrative costs and interest expense. If the FDIC suffers a loss, the FDIC will be enM to retain any remaining transferred loans and to exercise the FDIC Option for one share of Con sta i Illinois Corporation common stock for every $20 of loss, at the exercise price of $0.00001 per F re of common stock. No value has been assigned to the FD IC’s right to exercise this option as of pcember 31, 1984. If the FDIC does not suffer any loss under the permanent assistance program, all pining loans and other assets acquired will be returned to CINB and the option would not be erasable. ^ FDIC also purchased $1 billion of two non-voting, Continental Illinois Corporation, preferred stock p s . The proceeds of these issues were transferred to CINB in the form of a capital contribution. The r or Perpetual Convertible Preference Stock, in the amount of $720 million, is convertible into 160 mil■shares of Continental Illinois Corporation common stock upon sale or transfer by the FDIC. Dividends ■to be received on this preferred stock only to the extent that dividends are paid on the Continental |ois Corporation common stock and are equivalent to that which would be paid on 160 million shares lommon stock. The Adjustable Rate Preferred Stock, Class A, in the amount of $280 million, is a pulative issue that is callable at the option of Continental Illinois Corporation. The issuer also has the n to pay dividends on this issue in the form of additional shares of this issue or cash until the third 'ersary of their original issue date. * E-2 FEDERAL DEPOSIT INSURANCE CORPORATION FEDERAL DEPOSIT INSURANCE CORPORATION STATENENT OF FINANCIAL POSITION FEDERAL DEPOSIT INSURANCE CORPORATION STATENENT OF FINANCIAL POSITION Juif 31, 1985 (In Millions) July 31, (985 (In Millions) STATENENT OF INCOME AND THE DEPOSIT INSURANCE FUND FOR THE SEVEN MONTHS ENDED JULY 31, 1985 (In Millions) ASSETS LIABILITIES AND THE OEPOSIT INSURANCE FUND INCOME CASH t II ACCOUNTS PAYABLE, ACCRUED LIABILITIES AND ESCROW FUNDS I 76 Gross assessients earned Provision for assessment credits Net assessients earned INVESTMENT IN U. S. TREASURY OBLIGATIONS OTHER ASSETS, principally accrued interest receivable on investments IS,583 NET ASSESSMENT INCOME CREDITS BUE TO INSUREO BANKS Available July I, 1986 (Estiiated) Available July 1, 1985 98 54 AM Interest on II. S. Treasury obligations Interest on notes receivable Interest on assets ii liquidation Other incoie TOTAL INCOME CERTIFICATES AND NOTES RECEIVABLE FROM INSURED DAW(S 62b UNEARNED ASSESSMENTS: To be apportionedto fund (Estiiated) To be apportioned to banks (Estiiated) ^ I 748 98 650 918 22 ISO 31 1,771 86 129 EXPENSES AND LOSSES ASSETS ACOUIREB IN ASSISTANCE TO AN INSURED BANK 4,274 LIABILITIES INCURREB IN ASSISTANCE TO INSURED BANKS ASSETS ACOUIREB FROM FAILURES OF INSURED BANKS 2,743 LIABILITIES INCURRED FROM FAILURES OF INSURED BANKS „ 3,758 Adiinistrative operating expenses Merger assistance losses and expenses Provision for insurance losses Nonrecoverable insurance expenses 793 TOTAL EXPENSES AND LOSSES TOTAL LIABILITIES TOTAL ASSETS 42 I 23,813 114 4,994 NET INCOME PROPERTY AND BUILDINGS 91 17 0 6 DEPOSIT INSURANCE FUND 1,657 18,819 DEPOSIT INSURANCE FUND - January 1 TOTAL LIABILITIES AND THE DEPOSIT INSURANCE FUND « 23,813 333333338 SS333SSS8 A-l DEPOSIT INSURANCE FUND < July 31 17,162 118,819 FEDERAL DEPOSIT INSURANCE CORPORATION STATEMENTS OF FINANCIAL POSITION FOR THE TEARS ENDED Beceeber 31, 1984, I9B3, 1982, 1981, I 1980 (in aillions) 1984 19B3 1982 FEDERAL OEPOSIT STATEMENTS OF FOR THE Deceaber 31, 1984, (in 1981 1980 1984 assets : CASH INVESTMENT IN U. S. TREASURY OBLIGATIONS 1 4 14,436 « 89 13,992 t 1 13,252 t 0 12,005 • 2 393 350 239 235 CERTIFICATES AND NOTES RECEIVABLE FROM INSURED BANKS 561 424 705 428 472 ACCOUNTS PAYABLE, ACCRUED LIABILITIES AND ESCRON FUNDS NET ASSESSMENT INCOME INSURED BANKS Available July 1, Available July I, Available July 1, Available July 1, Available July 1, 1981 I960 t 100 t 80 t 98 1 47 1 33 CREDITS DUE TO 1985 1984 1983 1982 1981 LIABILITIES INCURRED IN ASSISTANCE TO INSURED BANKS ASSETS ACQUIRED IN ASSISTANCE TO AN INSURED BANK 4,457 0 0 0 0 ASSETS ACQUIRED FROM FAILURES OF INSURED BANKS 2,144 1,992 714 547 410 LIABILITIES INCURRED FROM FAILURES OF INSURED BANKS TOTAL LIABILITIES 1982 10,494 394 TOTAL ASSETS 1983 LIABILITIES AND THE DEPOSIT INSURANCE FUND: OTHER ASSETS, principally accrued interest receivable on investaents PROPERTY AND BUILDIN6S INSURANCE CORPORATION FINANCIAL POSITION YEARS ENDED 1983, 1982, 1981, t 1980 aillions) 42 37 34 23 23 1 22,038 < 16,927 < 15,056 1 13,242 t 11,636 DEPOSIT INSURANCE FUND TOTAL LIABILITIES AND THE DEPOSIT INSURANCE FUND A -2 68 0 0 0 0 0 164 0 0 0 0 0 96 0 0 0 0 0 129 0 0 0 0 0 569 3,848 0 0 0 0 860 1,254 1,091 820 14 4,876 1,498 1,285 996 616 17,162 15,429 13,771 12,246 11,020 t 22,038 1 16,927 « 15,056 t 13,242 f 11,636 FEDERAL DEPOSIT INSURANCE CORPORATION STATEMENTS OF INCOME AND THE DEPOSIT INSURANCE FUND FOR THE YEARS ENDED December 31, 1984, 1983, 1982, 1981, t 1980 (in Billions) 1984 1983 1982 1981 1980 income : Gross assessaents earned Provision for assessment credits $ Net assessments earned Interest on U. S. Treasury oblibations Interest on notes receivable Interest on assets in liquidation Other income TOTAL INCOME EXPENSES AND LOSSES: Administrative operating expenses Merger assistance losses and expenses Provision for insurance losses Nonrecoverable insurance expenses TOTAL EXPENSES AND LOSSES NET INCOME DEPOSIT INSURANCE FUND - January 1 DEPOSIT INSURANCE FUND * December 31 % 1,323 69 $ 1,216 165 1,109 96 i 1,041 119 % 953 522 1,254 1,051 1,013 922 431 1,495 112 169 2 1,404 65 91 17 1,370 79 54 8 1,115 32 2 3 863 13 2 1 3,032 2,628 2,524 2,074 1,310 151 198 933 17 136 128 675 31 130 681 126 62 127 388 320 13 118 0 (38) 3 1,299 970 999 848 83 1,733 1,658 1,525 1,226 1,227 15,429 13,771 12,246 11,020 9,793 17,162 1 15,429 1 13,771 12,246 1 11,020 Reclassifications have been eade to the 1983, 1982, 1981, and 1980 financial statements to confora to the presentation used in 1984. 4 A -3 % F e d e r a l Deposit In s u r a n c e C o r p o r a t i o n Residual Funds & Cash Flow P ro je ctio n J u ly 1, 1985 through June 30, 1986 (In M illio n s of D o llars) 07/85 08/85 884 09/85 10/85 11/85 12/85 509 283 300 300 82 300 43 59 Bank Assessments 250 407 0 Notes Receivable 12 3 01/86 02/86 250 0 300 300 0 253 103 81 284 23 0 0 0 268 437 0 8 0 1 10 125 125 125 125 125 1353 1344 451 492 678 14 14 14 14 14 20 20 20 20 2 0 76 19 1 55 1298 03/86 04/86 05/86 06/86 TOTAL 296 400 3822 46 248 85 1607 0 0 0 0 1362 2 0 8 0 0 44 125 125 125 125 125 125 1500 479 484 1148 448 179 669 610 8335 14 15 15 15 15 15 15 174 20 20 20 20 20 20 20 20 240 275 0 76 17 2 95 86 0 76 705 1 15 1 2 18 2 2 20 2 2 85 35 111 324 35 112 70 39 132 141 37 113 1204 1309 340 168 643 367 414 1109 316 38 632 497 7131 Receipts Maturing Gov't. S e c u ritie s Int.on Gov't. S e c u ritie s C o llection on Assets & Mise. Income 125 Total y |Di sbursements: Expenses: (Admin, Non Recov.lns. & Li q .) Notes Payable.& Indebtedness Income Maintenance Agreements Total Total Residual Funds •S* A-4
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