WASHINGTON — It sounds strange to say, but the Federal Deposit Insurance Corp. is solvent again.
That the FDIC was technically in the red for seven quarters — the result of heavy failures and very strict accounting — was a lesser-known fact of the 2008 crisis, and so news last month that the Deposit Insurance Fund turned positive in the second quarter also drew scant attention.
But the return to black — a much bigger deal in the 1990s when the FDIC similarly went bust and rebounded after the thrift crisis — is still a milestone as banks try to retain some normalcy in still-uncertain times.
"It is a little flash of light and hope in a world of economic and financial darkness," said Kenneth Guenther, the former chief executive of the Independent Community Bankers of America.
The revelation — aired during Acting FDIC Chairman Martin Gruenberg's July 26 testimony on his nomination for the full-time job — validated the agency's 2009 plan to improve finances, which involved borrowing three years of premiums in advance.
But amid continued signs of lower failure projections going forward, the fund's recovery has also led to immediate calls for banks to get some of that prepayment back. (The FDIC will report the exact level of the fund later this month.)
"We would say they need to look at the level of premiums and look to reduce that burden given the current pace of recapitalization," said James Chessen, the chief economist of the American Bankers Association. "There is a long way to go to recapitalize the fund. The question is not should the fund be capitalized at an adequate level, it's a matter of how quickly you get there."
The fund went negative in the third quarter of 2009, and was at its worst at the end of that year, falling past negative-$20.8 billion. The only other stretch in FDIC history when the DIF ran a deficit was at the height of the savings and loan crisis.
The dwindling fund in 2009 initially led to fears about the agency's ability to handle the strain. But officials quickly sought to put those worries to rest, repeating in speeches and interviews that the FDIC — required to withdraw from the DIF any money it may need for projected failures — had ample cash. For example, while the fund had just $10 billion left by the middle of 2009, the FDIC in fact had more than $40 billion in cash reserves.
Needing even more cash but not wanting to overburden banks, the FDIC hatched a novel idea. It asked the industry to prepay premiums through 2012 — totaling about $46 billion — in the form of a loan. Banks did not report the expense in advance, but booked the prepayment as an asset that depreciates according to when fees would otherwise be paid.
"The prepayment plan was a very good idea and far superior to raising premiums at the time," Chessen said.
The tactic sought to prevent a repeat of what occurred after the S&L crisis, when overly conservative failure projections and a quick economic recovery caused a sharp turnaround in funds, and criticism that banks had paid too much to recapitalize it.
"It was a huge deal," said Bill Longbrake, a former FDIC chief financial officer and now an executive-in-residence at the University of Maryland, of the rebound in the 1990s.
Back then, the FDIC was limited in how it managed its resources, leaving the industry essentially vulnerable to heavy across-the-board premiums in the rare event of negative funds, which is exactly what happened. While policymakers said the system was still not refined enough in the latest crisis, the FDIC was still better prepared than in the 1990s. (The Dodd-Frank Act passed a year ago gave the agency even greater authority, raising the baseline ratio for reserves to insured deposits to 1.35%, from 1.15%, and leaving the fund uncapped. The FDIC has recently proposed a target 2% ratio.)
"It was a different world" coming out of the S&L crisis, Longbrake said. "We didn't have at that time target reserve ratios in statute. So there was immediate pressure, since banks had been under this very, very high premium structure, to actually rebate the excess. … The political pressures at that time were, 'Give us relief and rebate us what we've paid in.'
"You won't have that now because it's a very different statutory regime. You won't get the bankers arguing that anymore. You might get them arguing, 'Is 2% too much?' But the principle of building it up, so far as I'm aware, has not been challenged."
Industry representatives said the prepayment, in contrast to the thrift debacle, limited the impact on banks of restoring the DIF.
"It was a smart move. At the time, banks were rich with cash, but [the prepayment] wasn't a big hit to their earnings or balance sheet," said Karen Thomas, the ICBA's senior executive vice president for government relations and public policy. "Each quarter they have expensed it over time. … It was designed to deal with the FDIC's concerns about its liquidity, not necessarily its net worth."
Signs suggest the FDIC may have over-reserved again this time around, but to a lesser extent. In April, it lowered projected failure losses for the five-year period ending in 2014 by 13%, to $45 billion. And the agency gradually shortened the time it expected the fund to turn positive. In September 2009, it projected returning to solvency in 2012. It later cut that to the fourth quarter of 2011, and then simply to sometime this year.
Gruenberg revealed in July that the fund had hit positive territory in the second quarter, but FDIC officials are not expected to detail the ratio until next week, when it releases its Quarterly Banking Profile.
"In addition" to assessment income, "you have positive movement in the fund balance because the FDIC is backing funds out of its expected failure losses," Thomas said. "That means the FDIC … was over-reserving or some institutions they expected to fail improved their condition."
Experts say adjustments in failure projections should be expected. "The estimates the FDIC had to make were contingent on a lot of things — they were within a reasonable confidence interval," said Edward Kane, a finance professor at Boston College.
He said that a positive DIF is "not enough."
"If we want it to be an advanced funding mechanism, it shouldn't run negative in the future," Kane said. "I could understand the industry's point of view that they would rather have their reserves than have the FDIC have them. But it's not unreasonable that the FDIC should build it up more."
But that has not quieted the industry from calling for added relief.
While the prepayment plan calls for the FDIC returning any unused fees — or charging more if the prepaid amount was insufficient — at the end of the three years, Chessen said the agency should consider giving a portion back sooner.
One reason, he said, was other reforms mandated by Dodd-Frank. Under the law, a premium rate is now multiplied by a bank's assets — minus its capital — instead of by its deposits to calculate a bank's fee, meaning an institution's charge is based on all of its liabilities. The change means community banks with deposits making up a greater share of their funding compared with bigger banks now pay a smaller share of FDIC assessments. But even though smaller banks may owe less, they still have to wait until the end of the three-year period to receive liquidity back that the FDIC did not need, Chessen said.
If the FDIC returned it sooner, "you take something that was tied up in knots and you free it up to be used for lending or other investments," he said.
