Description of the Loss Severity Measure

The loss severity measure applies a standardized set of assumptions to an institution's balance sheet to measure possible losses to the FDIC in the event of an institution's failure. To determine an institution's loss severity rate, the FDIC first applies assumptions about uninsured deposit and other unsecured liability runoff, and growth in insured deposits, to adjust the size and composition of the institution's liabilities. Assets are then reduced to match any reduction in liabilities. 1 The institution's asset values are then further reduced so that the Leverage ratio reaches 2 percent. 2 3 In both cases, assets are adjusted pro rata to preserve the institution's asset composition. Assumptions regarding loss rates at failure for a given asset category and the extent of secured liabilities are then applied to estimated assets and liabilities at failure to determine whether the institution has enough unencumbered assets to cover domestic deposits. Any projected shortfall is divided by current domestic deposits to obtain an end-of-period loss severity ratio. The loss severity measure is an average loss severity ratio for the three most recent quarters of data available. 1 In most cases, the model would yield reductions in liabilities and assets prior to failure. Exceptions may occur for institutions primarily funded through insured deposits which the model assumes to grow prior to failure. 2 Of course, in reality, runoff and capital declines occur more or less simultaneously as an institution approaches failure. The loss severity measure assumptions simplify this process for ease of modeling. 3 The applicable portions of the current expected credit loss methodology (CECL) transitional amounts attributable to the allowance for credit losses on loans and leases held for investment and added to retained earnings for regulatory capital purposes pursuant to the regulatory capital regulations, as they may be amended from time to time (12 CFR part 3, 12 CFR part 217, 12 CFR part 324, 85 FR 61577 (Sept. 30, 2020), and 84 FR 4222 (Feb. 14, 2019)), will be removed from the calculation of the loss severity measure. Runoff and Capital Adjustment Assumptions Table D.1 contains run-off assumptions. Table D.1—Runoff Rate Assumptions Liability type Runoff rate * (percent) Insured Deposits (10) Uninsured Deposits 58 Foreign Deposits 80 Federal Funds Purchased 100 Repurchase Agreements 75 Trading Liabilities 50 Unsecured Borrowings ≤ 1 Year 75 Secured Borrowings ≤ 1 Year 25 Subordinated Debt and Limited Liability Preferred Stock 15 * A negative rate implies growth. Given the resulting total liabilities after runoff, assets are then reduced pro rata to preserve the relative amount of assets in each of the following asset categories and to achieve a Leverage ratio of 2 percent: • Cash and Interest Bearing Balances; • Trading Account Assets; • Federal Funds Sold and Repurchase Agreements; • Treasury and Agency Securities; • Municipal Securities; • Other Securities; • Construction and Development Loans; • Nonresidential Real Estate Loans; • Multifamily Real Estate Loans; • 1-4 Family Closed-End First Liens; • 1-4 Family Closed-End Junior Liens; • Revolving Home Equity Loans; and • Agricultural Real Estate Loans. Recovery Value of Assets at Failure Table D.2 shows loss rates applied to each of the asset categories as adjusted above. Table D.2—Asset Loss Rate Assumptions Asset category Loss rate (percent) Cash and Interest Bearing Balances 0.0 Trading Account Assets 0.0 Federal Funds Sold and Repurchase Agreements 0.0 Treasury and Agency Securities 0.0 Municipal Securities 10.0 Other Securities 15.0 Construction and Development Loans 38.2 Nonresidential Real Estate Loans 17.6 Multifamily Real Estate Loans 10.8 1-4 Family Closed-End First Liens 19.4 1-4 Family Closed-End Junior Liens 41.0 Revolving Home Equity Loans 41.0 Agricultural Real Estate Loans 19.7 Agricultural Loans 11.8 Commercial and Industrial Loans 21.5 Credit Card Loans 18.3 Other Consumer Loans 18.3 All Other Loans 51.0 Other Assets 75.0 Secured Liabilities at Failure Federal home loan bank advances, secured federal funds purchased and repurchase agreements are assumed to be fully secured. Foreign deposits are treated as fully secured because of the potential for ring fencing. Loss Severity Ratio Calculation The FDIC's loss given failure (LGD) is calculated as: An end-of-quarter loss severity ratio is LGD divided by total domestic deposits at quarter-end and the loss severity measure for the scorecard is an average of end-of-period loss severity ratios for three most recent quarters. [76 FR 10724, Feb. 25, 2011, as amended at 86 FR 11401, Feb. 25, 2021]