The Clearing House Letter to the FDIC


1 The members ofThe Clearing House are: ABN AMRO Bank N.V.; Bank of America, NationalAssociation; The Bank of New York Mellon; Citibank, N.A.; Deutsche Bank Trust

Company Americas; HSBC Bank USA, National Association; JPMorgan Chase Bank,

National Association; UBS AG; U.S. Bank National Association; Wachovia Bank,

National Association; and Wells Fargo Bank, National Association.

 Norman R.

Nelson

General Counsel

450 West 33rd Street

New York, NY 10001

tele 212.612.9205

norm.nelson@theclearinghouse.org

December 17, 2008

Mr. Robert E. Feldman

Executive Secretary

Federal Deposit Insurance Corporation

550 17th Street, NW

Washington, D.C. 20429

Attn: Comments

Re: RIN 3064-AD35:

Notice of Proposed Rule Making–Assessments

Dear Mr. Feldman:

The Clearing House Association L.L.C. (“The Clearing House”), an association of

major commercial banks,1 appreciates the opportunity to comment on the Federal Deposit

Insurance Corporation (the “FDIC”) notice of proposed rulemaking on risk-based

deposit insurance assessments and the FDIC’s proposed restoration plan (the

“Proposal”). 73 Fed. Reg. 61560 (Oct. 16, 2006). The Clearing House understands

the FDIC’s need to increase its deposit-insurance assessments in light of the

extraordinarily high deposit-insurance losses in the current year. As we

discuss below, however, we are concerned that certain aspects of the Proposal

are excessive and would produce unintended negative effects on our members and

their customers.

I. Recapitalization of the Deposit Insurance Fund (“DIF”)

Our member banks are prepared to do their part to

maintain a strong and well-capitalized deposit-insurance system. We strongly

agree that a financially sound DIF is essential to support the country’s

financial system, and our member banks recognize that bank premiums have funded

all this support since the FDIC’s creation. Nonetheless, the FDIC must balance

its efforts to rebuild the DIF quickly against the consequences that would

occur from unnecessarily diverting resources from financial institutions that

could use them to meet customer credit needs.

Our nation is faced with the most severe economic

crisis it has experienced in many decades. Central to the current economic

crisis is a severe disruption in the credit markets that has included the

collapse of banks, thrifts, investment banks, insurance companies and other

financial-services companies. We appreciate that the FDIC considered these

circumstances and the current strength of the financial-services industry when

incorporating in its restoration plan the full five-year range for rebuilding

the DIF authorized by Congress.

We respectfully submit, however, that, given the

circumstances, the five-year period should be extended as contemplated by

Congress. In the Federal Deposit Insurance Act, Congress expressly provided the

FDIC with flexibility to extend the period in which the DIF must be restored to

1.15 percent beyond five years on account of “extraordinary circumstances.”2 The current

economic crisis is presumably what Congress considered as it is without

question extraordinary. In fact, the FDIC has invoked its systemic-risk

authority, which prior to September had never previously been used, to provide

guaranties on transaction deposits and senior unsecured debt.3 In addition,

the Secretary of the Treasury (after consultation with the President) and the

Board of Governors of the Federal Reserve System (the “Federal Reserve”) each

made comparable systemic-risk determinations for these guaranties.

Accordingly, The Clearing House agrees with

several other observers and strongly urges the FDIC to extend the period for

restoration of the DIF to at least seven years(which may need to be further extended in the

event of a protracted economic crisis) and, as discussed below, to delay any

increase in assessments beyond the first quarter of 2009 until the effect on

the DIF of recent government intervention programs can be analyzed. If the FDIC

decides to go forward with immediate increases in the assessment rate, The

Clearing House strongly recommends that the FDIC adopt more modest increases

commensurate with a longer restoration period.

The Clearing House appreciates that a strong DIF

is essential to maintaining depositor confidence and supports changes to the

premium calculation that truly reflect the risk of loss to the FDIC. Our member

banks are, however, deeply concerned that the aggressive recapitalization

proposed by the FDIC, although well intentioned, would unnecessarily restrict

their ability to lend in the context of the current extraordinary disruption of

the financial markets. In addition, we believe that the assessment rates

contemplated by the Proposal fail to consider, and thereby potentially

undermine, efforts by Congress and the Department of the Treasury (the “Treasury”)

to support bank liquidity and stimulate lending in the economy.

Congress instructed the FDIC, when setting

assessment rates, to take “into account economic conditions generally affecting

insured depository institutions so as to allow the designated reserve ratio to

increase during more favorable economic conditions and to decrease during less

favorable economic conditions, notwithstanding the increased risks of loss that

may exist during such less favorable conditions.”4 The deeply

troubled economic conditions prevalent today clearly are in line with this

Congressional intent.

Despite this, just yesterday the FDIC approved

raising the existing assessment schedule uniformly by 7 basis points for the

first quarter of 2009. As a result, Category I banks (considered to be the

healthiest) that are well-capitalized and have CAMELS ratings of 1 or 2 will

pay between 12 and 14 basis points for this period. Even at the minimum base

assessment rate, such a large increase will have a significant effect on earnings

and capital, and therefore lending capacity, at the most financially sound

institutions. By way of example, if a large bank,

“Bank  X”, has $750 billion in assessable deposits, applying the FDIC’s proposed

minimum assessment rate (12 basis points), it is paying at least $900 million a

year in assessments. Each basis point increase in the deposit assessment would

cost Bank X $75 million. When the FDIC applies the proposed risk-based

assessments, in the best case scenario Bank X is paying at least 8 basis

points, which would total $600 million per year. The Proposal allows the FDIC

to charge up to 21 basis points, which would cost Bank X over $1.5 billion per

year.

Other metrics further demonstrate the effect of this increase. For example, if Bank X were able to earn 1.20% pre tax on this deposit base, the Proposal would reduce Bank X’s earnings, at the 12 basis point rate, by 10%. For many banks that arestruggling to produce earnings in the current environment, the percentage loss
of earnings would considerably higher. In addition, Bank X’s lending capacity

would be reduced by approximately $6 billion annually assuming a 10x multiplier

and a 33 1/3% effective tax rate. the effect is comparably significant even at smaller institutions. For instance, at a bank, “Bank Y”, with $50 billion in assessable deposits, applying the minimum
assessment rate for Category I institutions, Bank Y will pay $15 million in
deposit assessments for the first quarter of 2009. Each basis point increase in
assessments would cost Bank Y $5 million a year. Under the Proposal, beginning
in April 2009, Bank Y could pay between $40 million to $105 million per year in
assessments.

Sucha large increase in deposit-insurance assessments more than doubles current

premiums and is anticipated to rebuild the reserve ratio to 1.15 percent in

four years, not five. Indeed, the FDIC expects the assessment income to be so

large that the reserve ratio will reach 1.21 percent in five years. This dramatic

increase in assessment rates would run counter to current government policy

objectives, including programs involving the DIF itself.

TheEmergency Economic Stabilization Act (“EESA”) signed into law on October 3,

2008 raised deposit insurance levels to $250,000. Congress, while authorizing

this coverage, specifically excluded the increase in coverage from the

calculation of the DIF ratio. Furthermore, on October 14, the FDIC created the

Temporary Liquidity Guarantee Program (the “Guarantee

Program”), which extended deposit insurance coverage to all non-interest

bearing transaction deposit accounts while also leaving this increased coverage

out of the DIF ratio. These actions strongly support a policy objective to

avoid an unduly onerous insurance premium increase.

Moreover,

under the Guarantee Program, the FDIC established a 10 basis-point surcharge

that applies to non-interest bearing transaction deposit accounts not otherwise

covered by the $250,000 deposit insurance limit. The amount collected by this

surcharge is added to each participant’s deposit-insurance premium.

Inlight of these new programs and the worsening economic climate, The Clearing

House respectfully submits that the analysis on which the FDIC based the

assessments in the Proposal is out of date and that the Proposal has

effectively been overtaken by these developments. Both the transaction deposit

guaranty and $250,000 coverage limit are set to expire on December 31, 2009,

suggesting that a comprehensive review of the nation’s deposit-insurance system

will occur next year in the context of the then-current economy. Accordingly,

The Clearing House strongly urges the FDIC to remove any increase in

assessments from the final rule and to make any significant change to the

assessment system only after a full review of these issues within the context

of this comprehensive review.

Ifthe FDIC decides to move forward with increases in the assessment rates, we

urge the FDIC to take full advantage of the discretion afforded to it by

Congress to design and administer the deposit-insurance system to avoid

pro-cyclical deposit-insurance assessment increases. A gradual increase in the

assessment schedule over the next few years would be more appropriate,

considering the present economic recession and financial turmoil will likely

ebb over time. By contrast, the significant increase contemplated by the

Proposal is inconsistent with government efforts to shore up bank capital and

bank liquidity under the Guarantee Program and the Capital Purchase Program

(“CPP”) under the Troubled Asset Relief Program, established pursuant to the

EESA. Our member banks strongly support their obligation to strengthen FDIC

resources, but propose doing so in a way that is less pro-cyclical and that

keeps more resources available for credit extensions.

Mr. Robert E. Feldman -6- December 17, 2008

II. Calculation of AssessmentsOurmember banks support the FDIC’s

objective to charge riskier banks a higher

assessment for deposit insurance, fostering market discipline through the

deposit insurance cost that a bank pays. However, we believe that the Proposal

falls short of achieving this objective because the measures of risk

contemplated by the Proposal are misdirected and do not adequately evaluate

risk in the event of a failure. The FDIC’s risk of loss in the event of the

failure of a depository institution is a function of two principal factors. The

first is the amount of recoveries on the unencumbered assets, i.e., assets that

are not pledged and are therefore available to the FDIC to pay deposit

liabilities. The second is the aggregate amount of equity and liabilities that

are subordinate to the claims of depositors.

For

the reasons discussed more fully below, The Clearing House has several concerns

with the Proposal’s approach for calculating assessments, including reducing

the assessment rate based on amounts of unsecured debt and increasing the rate

based on amounts of secured debt. A fundamental flaw to this approach is that

it ignores the value of a wide-range of unencumbered assets in the

determination of loss, while disproportionately penalizing institutions for

holding what is arguably one of the few viable sources of funding and liquidity

in today’s difficult markets. Accordingly, The Clearing House recommends that

the FDIC abandon the adjustments for assessment rates for unsecured and secured

liabilities. Instead, we urge the FDIC to adopt a simpler approach that bases

assessments on (1) the amount of insured deposits (as opposed to assessable

deposits) and (2) the unencumbered assets available to pay insured deposits in

the event of a liquidation (as opposed to the adjustments based on

secured/unsecured liabilities). The Proposal uses substitutes for unencumbered

assets—secured liabilities and unsecured liabilities—that we believe are

significantly flawed for several reasons that we outline below. If the FDIC

decides to move forward with the Proposal’s changes to the assessment system

based on secured and unsecured assets, we strongly urge the FDIC to consider

the following recommendations in the final rule.

Unsecured

Liabilities. The Clearing House recognizes the FDIC’s preference that a

bank be funded with unsecured liabilities that would be subordinated to claims

of  depositors in receivership, thereby providing a cushion that can reduce the FDIC’s loss in the event of a failure. In addition, our member banks agree in principle that

the presence of unsecured debt obligations reduces risks to the DIF and

therefore justifies a reduced assessment rate. However, we believe that the

Proposal is too limited and undervalues the risk mitigation of other unsecured

obligations.

As an initial matter, the FDIC’s multiplier (20 basis points) that it proposes to

apply to the ratio of long-term unsecured debt to total deposits at a large

institution discounts the risk mitigation effect of the unsecured debt by 80

percent. We believe that this multiplier is excessively low. The benefit of

unsecured debt is further underestimated in the Proposal because the FDIC

measures it against total deposits, and not only insured deposits, which are the

true proxy for the FDIC’s risk. Therefore, The Clearing House recommends that

the FDIC adjust upward the multiplier for unsecured debt and measure that

amount against only an institution’s insured deposits, not full deposit base.

In

addition, we suggest raising the proposed cap on assessment-rate reductions for

unsecured liabilities. The FDIC sets in the Proposal an arbitrary limit of 2

basis points with no stated legal or economic rationale. Meanwhile, the FDIC

itself recognizes that the greater the amount of unsecured liabilities, the

lower its risk of loss. Indeed, it is not inconceivable that a bank could

present essentially zero risk to the FDIC. The FDIC exacerbates this issue by

applying a significantly disproportionate cap on rate increases for secured

obligations. Consequently, the Proposal can lead to the result of increased

rates based on secured debt, even though there may in fact be unsecured debt to

offset the secured debt attracting no benefit. This could result in

institutions paying significantly higher assessment rates, regardless of their

relative risk.

Finally,

as we mentioned above, The Clearing House suggests that the FDIC use all

unencumbered assets of an institution as a measure of risk in calculating

premiums and not, as the Proposal currently contemplates, merely provide for a

downward adjustment for only for long-term unsecured debt instruments. Indeed,

at many institutions, including our member banks, there are substantial

unencumbered assets that afford the FDIC protection in the event of a

Mr. Robert E. Feldman -8- December 17, 2008

receivership.

The same factors that the FDIC cites as support for reducing deposit-insurance

premiums for unsecured liabilities operate for a wider range of unencumbered

assets as well. Consequently, we recommend that the FDIC abandon the

adjustments for secured and unsecured debt and instead adopt an approach that

bases assessments on an evaluation of an institution’s unencumbered assets. Our

member banks would welcome the opportunity to discuss with staff at the FDIC

alternatives for how such calculations and reporting could be performed.

Nonetheless,

if the FDIC retains the downward adjustment, we believe that all unsecured debt

should be included in determining the adjustment. In fact, short-term debt

absorbs loss upon failure just as well as long-term debt. In addition, we

strongly urge the FDIC to factor into account additional unsecured obligations

that serve as a cushion to FDIC losses in the event of default. We believe

there is no reason for excluding additional types of junior unsecured

obligations (regardless of term or structure) when they will in fact reduce a

deposit holder’s loss in the event of default. Applying a small credit only to

a narrow set of unsecured liabilities while significantly penalizing a wide

range of secured liabilities often used as prudent funding sources creates a

serious disparity in the assessments paid by financial institutions.

Secured

Liabilities.The Clearing House strongly opposes the upward adjustment in

the assessment rate based on the ratio of secured liabilities to domestic

deposits contemplated by the Proposal. This adjustment, unlike the one for

unsecured debt, is not discounted. In addition, it is capped at 50% of the

adjusted base assessment rate. For healthy Category I institutions with the

highest assessment rate, this would result in a penalty of seven basis points

on account of holding secured liabilities. This amount is unreasonably

disproportionate to the risk reduction afforded for unsecured debt. If the FDIC

decides to push forward with these adjustments, as opposed to adopting a

simpler approach like we recommend above, we strongly recommend that the FDIC

equally and fully include the effect of both forms of debt in the calculation.

The

Proposal also ignores the fact that a bank that uses assets to obtain stable,

secured funding may increase its loss given default but it also diminishes its

probability of default. Punishing a financially healthy bank that has little

probability of default with as much as

Mr. Robert E. Feldman -9- December 17, 2008

a  seven basis-point upward adjustment to its assessment is entirely contrary to

the notion of risk-based assessment.

In  addition, including secured lending as a risk factor is contrary to many well-established

programs that have implied government support. Banks routinely borrow secured

funds from the Federal Home Loan Banks (“FHLBs”), and this funding is an

important part of their liability structure. More recently, banks have become

regular borrowers from the Federal Reserve Banks through programs like the Term

Auction Facility. The Proposal specifically mentions both of these types of

secured borrowing as raising the risk to the DIF. It also lists repurchase

agreements that are routinely used by our member banks to obtain low-cost

funding by using excess securities.

The  Proposal thereby threatens to contract substantially this crucial source of

liquidity at a time when it is most needed. The FHLBs and the Federal Reserve

Banks have been important sources of funding for banks since the freeze in the

capital markets. Penalizing banks for accessing these important funding sources

seems imprudent and inconsistent with market realities. Higher assessments for

holding secured liabilities will encourage financial institutions either to

decrease their lending activities or to seek out less reliable, more expensive

sources of alternative funding. In either scenario, the cost of funding for

borrowers will increase. Such unintended consequences are in direct tension

with mandates by Congress, and indeed the FDIC itself, for banks to make more

credit available at a reasonable cost in order to mitigate the current

recessionary trends.

In

fact, on November 10, 2008, the FDIC, Treasury and the Federal Reserve issued

an Interagency Statement on Meeting Needs of Creditworthy Borrowers stating

that, “[a]t this critical time, it is imperative that all banking organizations

and their regulators work together to ensure that the needs of creditworthy

borrowers are met.” Surely banks could continue to use these funding sources,

but they would be more expensive because of the increased assessment costs. As

a result, the cost of credit would increase at this critical time when credit

needs to be more reasonable.

Mr. Robert E. Feldman -10- December 17, 2008

The

treatment of secured debt in the Proposal also would render covered bonds less

attractive at a time when the FDIC itself has been fostering covered bonds as

an alternative funding vehicle. Given the virtual closing of the securitized

asset finance market, it is highly undesirable to adopt an assessment scheme

that will penalize the use of the covered bond alternative.

Finally,

our member banks are seriously concerned that the treatment of secured debt in

the Proposal will result in sharp increases in assessments when amendments take

effect to Statement of Financial Accounting Standards No. 140, Accounting for

Transfers and Servicing of Financial Assets and Extinguishments of Liabilities

(FAS 140). Beginning in 2010, FAS 140 will require banks to report on their

balance sheets assets in their off-balance sheet special-purpose vehicles and

variable-interest entities, which often include securitized assets. As a

result, the associated secured liabilities will come onto banks’ balance

sheets. Under the Proposal, including these secured liabilities when

determining the adjustment to assessment rates, in addition to the secured

funding discussed above, will cause several of our member banks to cross the

10% threshold for secured liabilities that triggers an upward adjustment to

assessments.

Brokered

Deposits.The FDIC requested comments on whether deposits resulting

from balances swept into an insured depository institution from customer

brokerage accounts at an affiliated broker-dealer should be excluded from the

definition of “brokered deposits” for purposes of the assessment calculation.

73 Fed. Reg. at 61,566. Our member banks strongly encourage the FDIC to exclude

these deposits from its brokered deposit assessment calculation because they do

not involve the risk that the FDIC perceives accompanies brokered deposits in

general. Under these sweep programs, a broker-dealer affiliated with one or

more insured depository institutions offers its clients a brokerage account

where the client can elect to have excess funds in the account automatically

invested, or swept, into deposit accounts at the affiliated depository

institution. These deposits are generally reported as “brokered deposits” on

the depository institution’s Call Report or Thrift Financial Report.

Mr. Robert E. Feldman -11- December 17, 2008

The

broker-dealer establishes the deposit account on the books of the affiliated

depository institution in its name, as agent and custodian for the customer,

with “pass-through” deposit insurance. The broker-dealer maintains records of

the deposit accounts held by each of its customers consistent with FDIC

requirements and sends the customer periodic account statements, including with

respect to the deposit accounts and year-end tax-reporting statements. Although

the customer of the broker-dealer is legally not a customer of the affiliated

depository institution, the customer has a long-term relationship with the

financial group of which the broker-dealer and the depository institutions are

part.

The

excess cash in a customer’s brokerage account is automatically swept daily into

the affiliated depository institution, resulting in a continual flow of funds.

Even though withdrawals are made by customers on a daily basis, the flow of

deposits into the depository institution tends to keep the level of total

deposits fairly constant. As a result, this deposit base tends to be stable,

behaving like core deposits. Deposits obtained under these programs generally

pay interest at rates that are at or below prevailing money-market mutual fund

rates. Thus, the deposits are not high rate or rate sensitive. These attributes

make them less like brokered deposits and more like core deposits. These funds

are not “hot money,” which the FDIC considers exceptionally risky. They represent

a product choice of an established customer relationship. Accordingly, The

Clearing House strongly urges the FDIC to exclude these deposits from the

definition of “brokered deposits” for purposes of the brokered deposit

adjustment in the Proposal.

In

addition, our member banks urge the FDIC to consider excluding from the

“brokered deposits” definition balances swept into an insured depository

institution from customer brokerage accounts at unaffiliated broker-dealers.

Financial institutions, including some of our member banks, operate sweep

programs under which cash balances are swept from an account at an unaffiliated

broker-dealer into deposit accounts at one or more third-party depository

institutions, with “pass through” deposit insurance. There is no price

competition among participating banks. Thus, as in the sweep program described

above, deposits that are placed in these programs generally pay interest at

rates that are at or below prevailing rates so

Mr. Robert E. Feldman -12- December 17, 2008

these

deposits also are not high rate or rate sensitive. In addition, these programs

provide a stable source of deposits for well-capitalized banks and do not

present the moral hazards typically associated with brokered deposits.

Consequently, The Clearing House recommends the FDIC exclude these deposits as

well when determining the brokered deposit adjustment.

Inequitable

Treatment of Large Institutions.The Proposal indicates

that, as of June 30, 2008, 45 percent of large banks would have been charged

the minimum assessment rate under the current system of risk calculation

methodology, versus 28 percent of small banks. The Proposal also states that

the anticipated impact of the new risk measurements will be that only 25

percent of large banks may qualify for the minimum rate, consistent with the

same percentage for smaller banks. As a result, the Proposal clearly makes it

more difficult for a large bank to be eligible for the lowest assessment rates.

We urge the FDIC to recognize that the largest institutions should not be

penalized solely on the basis of size with no relation to risk.

* * *

Thank

you for considering the views expressed in this letter. If you would like

additional information regarding this letter, or if it would be helpful to meet

with representatives of our member banks, please contact me at (212) 612-9205.

Sincerely,

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