The FDIC's Deposit Insurance Fund: Adequately Capitalized

After falling victim to conventional wisdom last week, and speculating whether the FDIC had weeks or days remaining before it would need a Deposit Insurance Fund restoration bailout, I determined that the prudent course of action was to dig a little deeper into the issue.

Specifically, I wanted to know the basics behind whatever accounting procedures took place at the FDIC in order to generate the headline "balance" of the Deposit Insurance Fund.

In doing so, I came across several dissenting opinions (including an especially well-written article in American Banker) which, through a more precise look at the DIF, determined that the Fund has actually remained relatively stable despite there being nearly 100 bank failures in 2009 alone.

Furthermore, I would argue that the Deposit Insurance Fund is not only far from depletion, but also unlikely to come under any considerable stress throughout the forthcoming year.

Most media representations of the DIF involve the reporting of the final line of the Deposit Insurance Fund's balance sheet, which is labeled "Fund Balance". While this may seem like the logical thing for journalists to do, the truth is that it is an inaccurate measure of the FDIC's funds available to absorb depositor losses.

Basically, the DIF's balance sheet is arranged much like any other corporation's would be, although the underlying "accounting equation" carries one distinct label; Assets = Liabilities + Fund Balance. To assume that the line labeled "Fund Balance" is inclusive of the FDIC's total deposit insurance resources at the moment is to ignore a line in the liabilities section labeled "Contingent Liabilities: future failures".

This line item represents the FDIC's best estimation of the next four quarter's worth of failure related DIF losses, and is adjusted based upon the FDIC's assessment of troubled bank's balance sheets/loan losses/deposits etc. At the end of Q2'09, the FDIC had set aside $31.968B to cover losses it expects to occur over the next year. For the 12 months ended June '09, the DIF's headline "balance" has declined by $34.849B; however, Contingent Liabilities have risen by $21.378B.

In other words, although the Fund's balance has declined 77% year over year, the FDIC's loss absorbing resources have only declined by 24% over the same period of time.

When you consider the substantial rise in Contingent Liabilities, along with the fact that the DIF has guaranteed revenue in the form of FDIC "assessments" on the banking industry, it becomes clear that the Deposit Insurance Fund is in a lot better shape than many give it credit.

InfoNgen was used to research this article.

Disclosure: no positions

Comments

[investmentlb:]

Yes, but as of 6/30/09 $22 billion of the asset side of the balance sheet is in illiquid securities taken from failed banks, mostly assets that buyers of other banks refused to purchase. This is the toxic of toxic. And, since the FDIC has been reticent to actually sell many of these, that line item is growing rapidly as the pace of bank failures has accelerated massively in Q3. Further, because the FDIC is not in a position to manage these assets due to the scope of the FDIC's competencies, the longer the FDIC owns them, the less valuable they become. This $22 billion, until it is sold and converted into cash, cannot be used to fund the costs associated with bank failures. So while it clearly has some value (albeit likely well below the reported number), it is not particularly helpful to paying depositors at failed institutions.

The trend has been that the FDIC has been under-forecasting losses on the average failure and that the FDIC has been assuming very low losses on their loss sharing agreements. I suspect this latter point is also a hidden liability on their balance sheet.

Every bank or insurance company that fails (other than from bank runs) fails not because it actually ran out of assets but because reserving was not adequate or, if reserving was adequate, shows insolvency. To say the FDIC is in better shape than the DIF balance indicates is to say that loss reserves don't matter. There are about 92 bank failures this year that say loss reserves do matter. Finally, because the reserving only covers the next 12 months, we can know with a good deal of certainty it understates reality since the bank failure pipeline is either a) much longer than 12 months or; b) if they choose to do it all in 12 months, at much greater cost than $30 billion.

The FDIC is bankrupt and if they are not already using the equivalent of DIP financing from the US Treasury, they soon will be.

Sep 15 09:51 AM

[Carneades:]

The bank failure pipeline is certainly longer than 12 months, however, the FDIC adds to Contingent Liabilities on a quarterly basis. Also, the DIF isn't a stagnant pool of resources, it receives income from assessments on member banks; in other words, the $31B is the amount set aside at a single point in time, not a budget line item that can't be exceeded during a 12 month period.

Finally, it's incorrect to say that the agency consistently under reserves for losses. For instance, the American Banker article cites the example of the Colonial Bank failure, in which the FDIC set aside more reserves than were actually needed. I'll change my mind if someone can present evidence to the contrary, but thus far everyone in the "FDIC is bankrupt" crowd has only managed to speculate based upon their personal perception of the situation.


On Sep 15 09:51 AM investmentlb wrote:

> Yes, but as of 6/30/09 $22 billion of the asset side of the balance
> sheet is in illiquid securities taken from failed banks, mostly assets
> that buyers of other banks refused to purchase. This is the toxic
> of toxic. And, since the FDIC has been reticent to actually sell
> many of these, that line item is growing rapidly as the pace of bank
> failures has accelerated massively in Q3. Further, because the FDIC
> is not in a position to manage these assets due to the scope of the
> FDIC's competencies, the longer the FDIC owns them, the less valuable
> they become. This $22 billion, until it is sold and converted into
> cash, cannot be used to fund the costs associated with bank failures.
> So while it clearly has some value (albeit likely well below the
> reported number), it is not particularly helpful to paying depositors
> at failed institutions.
>
> The trend has been that the FDIC has been under-forecasting losses
> on the average failure and that the FDIC has been assuming very low
> losses on their loss sharing agreements. I suspect this latter point
> is also a hidden liability on their balance sheet.
>
> Every bank or insurance company that fails (other than from bank
> runs) fails not because it actually ran out of assets but because
> reserving was not adequate or, if reserving was adequate, shows insolvency.
> To say the FDIC is in better shape than the DIF balance indicates
> is to say that loss reserves don't matter. There are about 92 bank
> failures this year that say loss reserves do matter. Finally, because
> the reserving only covers the next 12 months, we can know with a
> good deal of certainty it understates reality since the bank failure
> pipeline is either a) much longer than 12 months or; b) if they choose
> to do it all in 12 months, at much greater cost than $30 billion.
>
>
> The FDIC is bankrupt and if they are not already using the equivalent
> of DIP financing from the US Treasury, they soon will be.

Sep 15 11:56 AM

[surferdude808:]

the $31b at q2 has been by many failures since june 30th. there have been 47 failures at an fdic estiamted cost of $13.2b. thus, the contingent loss reserve is down to $17.8b. when the fdic held it q2 news conference in late august and fdic officials were interviewed for the american banker article they were aware of the subsequent failures yet they touted the $31b figure. if a publicly traded company made those statements one would hope the sec would come calling. also, some observers are are raising serious questions about the fdic loss estimates. if they are understated, then the $17.8b contingent loss reserve is much smaller. this us nothing more than a confidence game being run by the fdic as they are doing everything to prevent the fund falling below zero. since losses are running at 25% of a failed institution's assets (according to fdic); then the fund and contingent loss reserve of ~$27b could only absorb failed bank assets of $108b. based on this, it is hard to conclude the insurance fund is sufficiently capitalized.

Sep 15 12:34 PM

[user396040:]

The Treasury will stand behing the FDIC and lend money to the fund or directly provide money to the fund if necessary. Any other policy would be self-defeating. The decline in the stock market and the depressive effect on the economy which would occur if the Treasury let the FDIC fund go bust would reduce tax receipts by an order of magnitude greater than any amount of money the Treasury would have to put into the fund.

Sep 15 06:26 PM

[sanchezman:]

Contingent liabilities here are those of banks that have failed, but for which the FDIC has not 'closed the books', so to speak. It is not a reserve for future failed banks, as you indicate. The FDIC contingent liabilities therefore exceed its assets. It does however have borrowing power as granted by congress from the treasury, as well as the authority to assess additional premia on its bank members. The first two sentences have to do with liquidity, the latter solvency.

Sep 16 10:41 AM

[Carneades:]

That's an inaccurate statement. The FDIC is required, under GAAP, to set aside the amount it expects to lose in the coming four quarters. The amount of expected loss is set by the Financial Risk Committee, based upon the FDIC's internal calculations regarding each member bank's likelihood of failure. Some banks are given a 100% chance of failure by the FDIC; in that case, you raise a marginally valid point.

Your statement would only be correct in the event that say, the DIF's balance sheet was prepared on June 30th, 2009, and a bank failure occurred on September 7th, 2009. In that instance, yes, you would be looking at old numbers that have already been used to fund depositor losses.


On Sep 16 10:41 AM sanchezman wrote:

> Contingent liabilities here are those of banks that have failed,
> but for which the FDIC has not 'closed the books', so to speak. It
> is not a reserve for future failed banks, as you indicate. The FDIC
> contingent liabilities therefore exceed its assets. It does however
> have borrowing power as granted by congress from the treasury, as
> well as the authority to assess additional premia on its bank members.
> The first two sentences have to do with liquidity, the latter solvency.

Sep 16 05:00 PM