This is the accessible text file for GAO report number GAO-06-146 entitled 'Financial Audit: Federal Deposit Insurance Corporation Funds' 2005 and 2004 Financial Statements' which was released on March 3, 2006. This text file was formatted by the U.S. Government Accountability Office (GAO) to be accessible to users with visual impairments, as part of a longer term project to improve GAO products' accessibility. Every attempt has been made to maintain the structural and data integrity of the original printed product. Accessibility features, such as text descriptions of tables, consecutively numbered footnotes placed at the end of the file, and the text of agency comment letters, are provided but may not exactly duplicate the presentation or format of the printed version. The portable document format (PDF) file is an exact electronic replica of the printed version. We welcome your feedback. Please E-mail your comments regarding the contents or accessibility features of this document to Webmaster@gao.gov. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. Because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately. Report to the Congress: March 2006: Financial Audit: Federal Deposit Insurance Corporation Funds' 2005 and 2004 Financial Statements: GAO-06-146: GAO Highlights: Highlights of GAO-06-146, a report to the Congress: Why GAO Did This Study: GAO is required to annually audit the financial statements of the Bank Insurance Fund (BIF), Savings Association Insurance Fund (SAIF), and FSLIC Resolution Fund (FRF), which are administered by the Federal Deposit Insurance Corporation (FDIC). GAO is responsible for obtaining reasonable assurance about whether FDIC’s financial statements for BIF, SAIF, and FRF are presented fairly in all material respects, in conformity with U.S. generally accepted accounting principles, and whether FDIC maintained effective internal control over financial reporting and compliance. Also, GAO is responsible for testing FDIC’s compliance with selected laws and regulations. Created in 1933 to insure bank deposits and promote sound banking practices, FDIC plays an important role in maintaining public confidence in the nation’s financial system. In 1989, legislation to reform the federal deposit insurance system created three funds to be administered by FDIC: BIF and SAIF, which protect bank and savings deposits, and FRF, which was created to close out the business of the former Federal Savings and Loan Insurance Corporation. What GAO Found: In GAO’s opinion, FDIC fairly presented the 2005 and 2004 financial statements for the three funds it administers—the Bank Insurance Fund, the Savings Association Insurance Fund, and the FSLIC Resolution Fund. GAO also found that, although certain controls should be improved, FDIC had effective internal control over financial reporting and compliance for each fund. GAO did not find reportable instances of noncompliance with the laws and regulations it tested. On February 8, 2006, the President signed into law the Federal Deposit Insurance Reform Act of 2005. Among its provisions, the Act calls for merging the Bank Insurance and Savings Association Insurance Funds into a single Deposit Insurance Fund no later than July 1, 2006. Last year, GAO reported on progress FDIC made in addressing long- standing issues related to weaknesses in its information system controls, which GAO had been reporting as a reportable condition. Based on the progress FDIC had made, GAO had concluded in its 2004 audit report that the remaining issues related to information system controls no longer constituted a reportable condition. GAO noted in that report, however, that FDIC’s implementation of a new financial system during 2005 would significantly change its information systems environment and the related information systems controls necessary for their effective operation. GAO found that FDIC, in implementing its new financial system during 2005, did not ensure that adequate controls were in place to accommodate its new systems environment. During its review, GAO identified information system control weaknesses that increased the risk of unauthorized modification and disclosure of critical FDIC financial and sensitive personnel information, disruption of critical operations, and loss of assets. These weaknesses, which constitute a reportable condition in 2005, affected FDIC’s ability to ensure that users only had the access needed to perform their assigned duties and that its systems were sufficiently protected from unauthorized users. FDIC acknowledged but did not share GAO’s assessment regarding the severity of the risks or the magnitude of the vulnerability posed by the issues identified during the audit. However, GAO continues to believe the weaknesses represent significant vulnerabilities in FDIC’s information system controls. In addition to the reportable condition related to FDIC’s information systems controls, GAO noted other less significant matters involving FDIC’s internal controls. GAO will be reporting separately to FDIC management on these matters. www.gao.gov/cgi-bin/getrpt?GAO-06-146. To view the full product, including the scope and methodology, click on the link above. For more information, contact Steven J. Sebastian at (202) 512-3406 or sebastians@gao.gov. [End of section] Contents: Transmittal Letter: Auditor's Report: Opinion on BIF's Financial Statements: Opinion on SAIF's Financial Statements: Opinion on FRF's Financial Statements: Opinion on Internal Control: Compliance with Laws and Regulations: Objectives, Scope, and Methodology: Reportable Condition: FDIC Comments and Our Evaluation: Bank Insurance Fund's Financial Statements: Balance Sheet: Statement of Income and Fund Balance: Statement of Cash Flows: Notes to the Financial Statements: Savings Association Insurance Fund's Financial Statements: Balance Sheet: Statement of Income and Fund Balance: Statement of Cash Flows: Notes to the Financial Statements: FSLIC Resolution Fund's Financial Statements: Balance Sheet: Statement of Income and Accumulated Deficit: Statement of Cash Flows: Notes to the Financial Statements: Appendixes: Appendix I: Comments from the Federal Deposit Insurance Corporation: Appendix II: Staff Acknowledgments: Transmittal Letter March 2, 2006: The President of the Senate: The Speaker of the House of Representatives: This report presents our opinions on whether the financial statements of the Bank Insurance Fund (BIF), the Savings Association Insurance Fund (SAIF), and the FSLIC Resolution Fund (FRF) are presented fairly for the years ended December 31, 2005 and 2004. These financial statements are the responsibility of the Federal Deposit Insurance Corporation (FDIC), the administrator of the three funds. This report also presents (1) our opinion on the effectiveness of FDIC's internal control over financial reporting and compliance for each of the funds as of December 31, 2005, and (2) our evaluation of FDIC's compliance with selected laws and regulations during 2005. The provisions of section 17(d) of the Federal Deposit Insurance Act, as amended (12 U.S.C. 1827), require GAO to conduct an annual audit of BIF, SAIF, and FRF in accordance with U.S. generally accepted government auditing standards. These provisions also stipulate that GAO report on the results of its annual audit of the three funds' financial statements no later than July 15 of the year following the year under audit, or 6½ months after the end of the reporting period. However, for the third consecutive year, and at the request of FDIC management, GAO completed its audits of the three funds' financial statements on a significantly accelerated reporting time frame. This would not have been possible without the tremendous cooperation and dedicated efforts of both FDIC management and staff and the GAO team conducting the audits. We are sending copies of this report to the Chairman and Ranking Minority Member of the Senate Committee on Banking, Housing, and Urban Affairs; the Chairman and Ranking Minority Member of the House Committee on Financial Services; the Chairman of the Board of Directors of the Federal Deposit Insurance Corporation; the Chairman of the Board of Governors of the Federal Reserve System; the Comptroller of the Currency; the Director of the Office of Thrift Supervision; the Secretary of the Treasury; the Director of the Office of Management and Budget; and other interested parties. In addition, this report will be available at no charge on GAO's Web site at [Hyperlink, http://www.gao.gov]. This report was prepared under the direction of Steven J. Sebastian, Director, Financial Management and Assurance, who can be reached on (202) 512-3406 or [Hyperlink, sebastians@gao.gov]. If I can be of further assistance, please call me at (202) 512-5500. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix II. Signed by: David M. Walker: Comptroller General of the United States: Auditor's Report To the Board of Directors: The Federal Deposit Insurance Corporation: We have audited the balance sheets as of December 31, 2005 and 2004, for the three funds administered by the Federal Deposit Insurance Corporation (FDIC), the related statements of income and fund balance (accumulated deficit), and the statements of cash flows for the years then ended. In our audits of the Bank Insurance Fund (BIF), the Savings Association Insurance Fund (SAIF), and the FSLIC Resolution Fund (FRF), we found: * the financial statements of each fund are presented fairly, in all material respects, in conformity with U.S. generally accepted accounting principles; * although certain internal controls should be improved, FDIC had effective internal control over financial reporting and compliance with laws and regulations for each fund; and: * no reportable noncompliance with laws and regulations we tested. The following sections discuss our conclusions in more detail. They also present information on the scope of our audits and our evaluation of FDIC management's comments on a draft of this report. Opinion on BIF's Financial Statements: The financial statements, including the accompanying notes, present fairly, in all material respects, in conformity with U.S. generally accepted accounting principles, BIF's financial position as of December 31, 2005 and 2004, and the results of its operations and its cash flows for the years then ended. As discussed in note 1 to BIF's financial statements, on February 8, 2006, the President signed into law the Federal Deposit Insurance Reform Act of 2005. Among its provisions, the Act calls for the merger of BIF and SAIF into a single Deposit Insurance Fund no later than the first day of the first calendar quarter that begins after the end of the 90-day period beginning on the date of enactment, which would be July 1, 2006. Opinion on SAIF's Financial Statements: The financial statements, including the accompanying notes, present fairly, in all material respects, in conformity with U.S. generally accepted accounting principles, SAIF's financial position as of December 31, 2005 and 2004, and the results of its operations and its cash flows for the years then ended. As discussed in note 1 to SAIF's financial statements, on February 8, 2006, the President signed into law the Federal Deposit Insurance Reform Act of 2005. Among its provisions, the Act calls for the merger of SAIF and BIF into a single Deposit Insurance Fund no later than the first day of the first calendar quarter that begins after the end of the 90-day period beginning on the date of enactment, which would be July 1, 2006. Opinion on FRF's Financial Statements: The financial statements, including the accompanying notes, present fairly, in all material respects, in conformity with U.S. generally accepted accounting principles, FRF's financial position as of December 31, 2005 and 2004, and the results of its operations and its cash flows for the years then ended. Opinion on Internal Control: Although certain internal controls should be improved, FDIC management maintained, in all material respects, effective internal control over financial reporting (including safeguarding assets) and compliance as of December 31, 2005, that provided reasonable assurance that misstatements, losses, or noncompliance material in relation to FDIC's financial statements of each fund would be prevented or detected on a timely basis. Our opinion is based on criteria established under 31 U.S.C. 3512 (c), (d) [commonly known as the Federal Managers' Financial Integrity Act (FMFIA)]. Weaknesses that we identified in FDIC's information system controls, which we consider to be a reportable condition, are described in a later section of this report. The reportable condition in information system controls, although not considered material, represents a significant deficiency in the design or operation of internal control that could adversely affect FDIC's ability to meet its internal control objectives. Although the weaknesses did not materially affect the 2005 financial statements of each of the three funds, misstatements may nevertheless occur in other FDIC-reported financial information as a result of the internal control weaknesses. In addition to the reportable condition concerning information system controls, we noted other less significant matters involving FDIC's internal controls. We will be reporting separately to FDIC management on these matters. Compliance with Laws and Regulations: Our tests for compliance with selected provisions of laws and regulations disclosed no instances of noncompliance that would be reportable under U.S. generally accepted government auditing standards. However, the objective of our audits was not to provide an opinion on overall compliance with laws and regulations. Accordingly, we do not express such an opinion. Objectives, Scope, and Methodology: FDIC management is responsible for (1) preparing the annual financial statements in conformity with U.S. generally accepted accounting principles; (2) establishing, maintaining, and assessing internal control to provide reasonable assurance that the broad control objectives of FMFIA are met; and (3) complying with applicable laws and regulations. We are responsible for obtaining reasonable assurance about whether (1) the financial statements are presented fairly, in all material respects, in conformity with U.S. generally accepted accounting principles, and (2) management maintained effective internal control, the objectives of which are the following: * financial reporting--transactions are properly recorded, processed, and summarized to permit the preparation of financial statements in conformity with U.S. generally accepted accounting principles, and assets are safeguarded against loss from unauthorized acquisition, use, or disposition, and: * compliance with laws and regulations--transactions are executed in accordance with laws and regulations that could have a direct and material effect on the financial statements. We are also responsible for testing compliance with selected provisions of laws and regulations that could have a direct and material effect on the financial statements. In order to fulfill these responsibilities, we: * examined, on a test basis, evidence supporting the amounts and disclosures in the financial statements; * assessed the accounting principles used and significant estimates made by management; * evaluated the overall presentation of the financial statements; * obtained an understanding of internal control related to financial reporting (including safeguarding assets) and compliance with laws and regulations; * tested relevant internal controls over financial reporting and compliance, and evaluated the design and operating effectiveness of internal control; * considered FDIC's process for evaluating and reporting on internal control based on criteria established by FMFIA; and: * tested compliance with certain laws and regulations, including selected provisions of the Federal Deposit Insurance Act, as amended, and the Chief Financial Officers Act of 1990. We did not evaluate all internal controls relevant to operating objectives as broadly defined by FMFIA, such as those controls relevant to preparing statistical reports and ensuring efficient operations. We limited our internal control testing to controls over financial reporting and compliance. Because of inherent limitations in internal control, misstatements due to error or fraud, losses, or noncompliance may nevertheless occur and not be detected. We also caution that projecting our evaluation to future periods is subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with controls may deteriorate. We did not test compliance with all laws and regulations applicable to FDIC. We limited our tests of compliance to those laws and regulations that could have a direct and material effect on the financial statements for the year ended December 31, 2005. We caution that noncompliance may occur and not be detected by these tests and that such testing may not be sufficient for other purposes. We performed our work in accordance with U.S. generally accepted government auditing standards. Reportable Condition: In connection with our audits of the financial statements of the three funds administered by FDIC, we reviewed FDIC's information system controls. Effective information system controls are essential to safeguarding financial data, protecting computer application programs, providing for the integrity of system software, and ensuring continued computer operations in case of unexpected interruption. These controls include the corporatewide security management program, access controls, system software, application development and change control, segregation of duties, and service continuity controls. In years prior to our 2004 financial audit, we reported on weaknesses we identified in FDIC's information system controls, which we considered to be a reportable condition. Over a period of years, FDIC made progress in correcting these information system control weaknesses and, in 2004, made substantial progress by correcting most of the weaknesses we had identified in prior years, including taking steps to fully establish a comprehensive information security program. These improvements enabled us to conclude that the remaining issues related to information system controls no longer constituted a reportable condition. However, we noted in our 2004 audit report[Footnote 1] that FDIC's implementation of a new financial system in 2005 would significantly change its information systems environment and the related information system controls necessary for their effective operation and that, consequently, continued commitment to an effective information security program would be essential to ensure that the corporation's financial and sensitive information would be adequately protected in the new environment. FDIC implemented its new financial system in May 2005. However, in doing so, FDIC did not ensure that controls were adequate to accommodate its new systems environment. Our audit identified information system control weaknesses, which we consider to be a reportable condition that increased the risk of unauthorized modification and disclosure of critical FDIC financial and sensitive personnel information, disruption of critical operations, and loss of assets. Specifically, FDIC did not (1) adequately restrict access to critical financial programs and data; (2) ensure incompatible systems- related functions, duties, and capabilities were appropriately segregated; and (3) sufficiently monitor access to system programs and data. Such weaknesses affected FDIC's ability to ensure that users only had the access needed to perform their assigned duties and that its systems were sufficiently protected from unauthorized users. We determined that other management controls mitigated the effect of the information system control weaknesses on the preparation of the funds' financial statements for 2005. However, it is important going forward that FDIC work to address these weaknesses to ensure its information system controls appropriately safeguard the integrity of its financial and other data. Because of their sensitive nature, the details surrounding these weaknesses will be reported separately to FDIC management, along with recommendations for corrective actions. FDIC Comments and Our Evaluation: In commenting on a draft of this report, FDIC's Chief Financial Officer (CFO) was pleased to receive unqualified opinions on BIF's, SAIF's, and FRF's 2005 and 2004 financial statements, and to note that there were no material weaknesses identified during the 2005 audits. With respect to our reporting as a reportable condition in 2005 weaknesses in information system controls, FDIC's CFO acknowledged but did not share our assessment regarding the severity of the risks or the magnitude of the vulnerability posed by the issues identified during the audit. The CFO expressed confidence in the sufficiency of the FDIC's information systems environment and related controls based on the corporation's view that it had a deliberate, comprehensive program designed to integrate not only system controls, but procedural, managerial, and audit controls into a balanced and cost-effective control framework. The CFO nonetheless acknowledged that the corporation would work diligently with us over the next audit cycle to both reconcile the two differing viewpoints and, where it feels changes are appropriate, to augment the corporation's program. We are pleased that FDIC's CFO has pledged his commitment to work with us on these matters during the 2006 audits. However, the issues we identified during our 2005 audits, including (1) lack of adequate restriction of access to critical financial programs and data; (2) inappropriate segregation of incompatible systems-related functions, duties, and capabilities; and (3) lack of an effective process to sufficiently monitor access to systems programs and data, collectively, we believe, create a significant risk that critical financial and sensitive personnel information could be inappropriately disclosed and modified, assets lost, and critical systems operations disrupted. While we acknowledge that certain management controls FDIC had in place were able to mitigate the effect of these weaknesses with respect to preparation of the three funds' 2005 financial statements, the weaknesses nonetheless represent significant vulnerabilities in FDIC's information system controls and thus constitute a reportable condition. The complete text of FDIC's comments is reprinted in appendix I. Signed by: David M. Walker: Comptroller General of the United States: January 31, 2006: [End of section] Bank Insurance Fund's Financial Statements: Balance Sheet: Bank Insurance Fund: Federal Deposit Insurance Corporation: Bank Insurance Fund Balance Sheet at December 31: Dollars in Thousands. [See PDF for image] [End of table] The accompanying notes are an integral part of these financial statements. Bank Insurance Fund's Financial Statements: Statement of Income and Fund Balance: Federal Deposit Insurance Corporation: Bank Insurance Fund Statement of Income and Fund Balance for the Years Ended December 31: Dollars in Thousands: [See PDF for image] [End of table] The accompanying notes are an integral part of these financial statements. Bank Insurance Fund's Financial Statements: Statement of Cash Flows: Bank Insurance Fund: Federal Deposit Insurance Corporation: Bank Insurance Fund Statement of Cash Flows for the Years Ended December 31: Dollars in Thousands. [See PDF for image] [End of table] The accompanying notes are an integral part of these financial statements. Bank Insurance Fund's Financial Statements: Notes to the Financial Statements: Financial Statements and Notes: Bank Insurance Fund: 1. Legislation and Operations of the Bank Insurance Fund: Overview: The Federal Deposit Insurance Corporation (FDIC) is the independent deposit insurance agency created by Congress in 1933 to maintain stability and public confidence in the nation's banking system. Provisions that govern the operations of the FDIC are generally found in the Federal Deposit Insurance (FDI) Act, as amended, (12 U.S.C. 1811, et seq). In carrying out the purposes of the FDI Act, as amended, the FDIC insures the deposits of banks and savings associations, and in cooperation with other federal and state agencies promotes the safety and soundness of insured depository institutions by identifying, monitoring and addressing risks to the deposit insurance funds. The FDIC is the administrator of the Bank Insurance Fund (BIF), the Savings Association Insurance Fund (SAIF), and the FSLIC Resolution Fund (FRF), which are maintained separately to carry out their respective mandates. The BIF and the SAIF are insurance funds responsible for protecting insured bank and thrift depositors from loss due to institution failures. These insurance funds must be maintained at not less than 1.25 percent of estimated insured deposits or a higher percentage as circumstances warrant. The FRF is a resolution fund responsible for the sale of remaining assets and satisfaction of liabilities associated with the former Federal Savings and Loan Insurance Corporation (FSLIC) and the Resolution Trust Corporation. An active institution's insurance fund membership and primary federal supervisor are generally determined by the institution's charter type. Deposits of BIF-member institutions are generally insured by the BIF; BIF members are predominantly commercial and savings banks supervised by the FDIC, the Office of the Comptroller of the Currency, or the Federal Reserve Board. Deposits of SAIF-member institutions are generally insured by the SAIF; SAIF members are predominantly thrifts supervised by the Office of Thrift Supervision. In addition to traditional banks and thrifts, several other categories of institutions exist. A member of one insurance fund may, with the approval of its primary federal supervisor, merge, consolidate with, or acquire the deposit liabilities of an institution that is a member of the other insurance fund without changing insurance fund status for the acquired deposits. These institutions with deposits insured by both insurance funds are referred to as Oakar financial institutions. In addition, SAIF-member thrifts can convert to a bank charter and retain their SAIF membership. These institutions are referred to as Sasser financial institutions. Likewise, BIF-member banks can convert to a thrift charter and retain their BIF membership. Operations of the BIF: The primary purpose of the BIF is to: 1) insure the deposits and protect the depositors of BIF-insured institutions and 2) resolve BIF- insured failed institutions upon appointment of FDIC as receiver in a manner that will result in the least possible cost to the BIF. In addition, the FDIC, acting on behalf of the BIF, examines state- chartered banks that are not members of the Federal Reserve System. The BIF is primarily funded from: 1) interest earned on investments in U.S. Treasury obligations and 2) deposit insurance assessments. Additional funding sources are U.S. Treasury and Federal Financing Bank (FFB) borrowings, if necessary. The FDIC has borrowing authority from the U.S. Treasury up to $30 billion for insurance purposes on behalf of the BIF and the SAIF. A statutory formula, known as the Maximum Obligation Limitation (MOL), limits the amount of obligations the BI F can incur to the sum of its cash, 90 percent of the fair market value of other assets, and the amount authorized to be borrowed from the U.S. Treasury. The MOIL for the BIF was $57.2 billion and $57.0 billion as of December 31, 2005 and 2004, respectively. Receivership Operations: The FDIC is responsible for managing and disposing of the assets of failed institutions in an orderly and efficient manner. The assets held by receivership entities, and the claims against them, are accounted for separately from BI F assets and liabilities to ensure that receivership proceeds are distributed in accordance with applicable laws and regulations. Accordingly, income and expenses attributable to receiverships are accounted for as transactions of those receiverships. Receiverships are billed by the FDIC for services provided on their behalf. Recent Legislative Initiatives: The Deposit Insurance Reform Act of 2005 (Title II of Public Law 109- 171) was enacted on February 8, 2006. The companion legislation, the Federal Deposit Insurance Reform Conforming Amendments Act of 2005 (Public Law 109-173), was enacted on February 15, 2006. The legislation: 1) merges the BIF and the SAIF into a new fund, the Deposit Insurance Fund (DIF); 2) annually permits the designated reserve ratio to vary between 1.15 and 1.50 of estimated insured deposits, thereby eliminating the fixed designated reserve ratio of 1.25; 3) requires the declaration of dividends from the DIF for the full amount of the reserve ratio in excess of 1.50 percent or, if less than 1.50 percent, one-half of the amount between 1.35 and 1.50 percent; 4) grants a one-time assessment credit for each eligible institution or its successor based on an institution's proportionate share of the aggregate assessment base at December 31,1996; and 5) immediately increases coverage for certain retirement accounts to $250,000 and indexes all deposit insurance coverage every five years beginning January 1, 2011. 2. Summary of Significant Accounting Policies: General: These financial statements pertain to the financial position, results of operations, and cash flows of the BIF and are presented in conformity with U.S. generally accepted accounting principles (GAAP. These statements do not include reporting for assets and liabilities of closed banks for which the FDIC acts as receiver. Periodic and final accountability reports of the FDIC's activities as receiver are furnished to courts, supervisory authorities, and others as required. Use of Estimates: Management makes estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates. Where it is reasonably possible that changes in estimates will cause a material change in the financial statements in the near term, the nature and extent of such changes in estimates have been disclosed. The more significant estimates include allowance for loss on receivables from bank resolutions, the estimated losses for anticipated failures and litigation, and the postretirement benefit obligation. Cash Equivalents: Cash equivalents are short-term, highly liquid investments with original maturities of three months or less. Cash equivalents consist primarily of Special U.S. Treasury Certificates. Investment in U.S. Treasury Obligations: BIF funds are required to be invested in obligations of the United States or: in obligations guaranteed as to principal and interest by the United States; the Secretary of the U.S. Treasury must approve all such investments in excess of $100,000. The Secretary has granted approval to invest BI F funds only in U.S. Treasury obligations that are purchased or sold exclusively through the Bureau of the Public Debt's Government Account Series (GAS) program. BIF's investments in U.S. Treasury obligations are either classified as held-to-maturity or available-for-sale. Securities designated as held- to-maturity are shown at amortized cost. Amortized cost is the face value of securities plus the unamortized premium or less the unamortized discount. Amortizations are computed on a daily basis from the date of acquisition to the date of maturity, except for callable U.S. Treasury securities, which are amortized to the first call date. Securities designated as available-for-sale are shown at market value, which approximates fair value. Unrealized gains and losses are included in Comprehensive Income. Realized gains and losses are included in the Statement of Income and Fund Balance as components of Net Income. Income on both types of securities is calculated and recorded on a daily basis using the effective interest method. Cost Allocations Among Funds: Operating expenses not directly charged to the BIF, the SAIF, and the FRF are allocated to all funds using workload-based allocation percentages. These percentages are developed during the annual corporate planning process and through supplemental functional analyses. Capital Assets and Depreciation: The FDIC has designated the BIF as administrator of property and equipment used in its operations. Consequently, the BIF includes the cost of these assets in its financial statements and provides the necessary funding for them. The BI F charges the other funds usage fees representing an allocated share of its annual depreciation expense. These usage fees are recorded as cost recoveries, which reduce operating expenses. The FDIC buildings are depreciated on a straight-line basis over a 35 to 50 year estimated life. Leasehold improvements are capitalized and depreciated over the lesser of the remaining life of the lease or the estimated useful life of the improvements, if determined to be material. Capital assets depreciated on a straight-line basis over a five-year estimated life include mainframe equipment; furniture, fixtures, and general equipment; and internal-use software. Personal computer equipment is depreciated on a straight-line basis over a three- year estimated life. Disclosure about Recent Accounting Pronouncements: Recent accounting pronouncements have been adopted or deemed to be not applicable to the financial statements as presented. Related Parties: The nature of related parties and a description of related party transactions are discussed in Note 1 and disclosed throughout the financial statements and footnotes. Reclassifications: Reclassifications have been made in the 2004 financial statements to conform to the presentation used in 2005. These reclassifications include the reallocation of amounts from "Provision for insurance losses" to "Insurance and other expenses" for assets acquired from assisted banks and terminated receiverships. The reclassifications, which were based on the restructuring of accounts, had no impact on the prior year's net income or fund balance. 3. Investment in U.S.Treasury Obligations, Net: As of December 31, 2005 and 2004, the book value of investments in U.S. Treasury obligations, net, was $32.3 billion and $32.1 billion, respectively. As of December 31, 2005, the BIF held $6.5 billion of Treasury inflation-protected securities (TIPS). These securities are indexed to increases or decreases in the Consumer Price Index for All Urban Consumers (CPI-U). Additionally, the BIF held $5.4 billion of callable U.S. Treasury bonds at December 31, 2005. Callable U.S. Treasury bonds may be called five years prior to the respective bonds' stated maturity on their semi-annual coupon payment dates upon 120 days notice. U.S. Treasury Obligations at December 31, 2005: Dollars in Thousands: [See PDF for image] [1] For purposes of this table, all callable securities are assumed to mature on their first call dates. Their yields at purchase are reported as their yield to first call date. [2] For TIPS, the yields in the above table are stated at their real yields at purchase, not their effective yields. Effective yields on TIPS include a long-term annual inflation assumption as measured by the CPI-U. The long-term CPI-U consensus forecast is 2.2%, based on figures issued by the Congressional Budget Office and Blue Chip Economic Indicators in early 2005. [3] All unrealized losses occurred as a result of changes in market interest rates. FDIC has the ability and intent to hold the related securities until maturity. As a result, all unrealized losses are considered temporary. However, of the $181 million reported as total unrealized losses, $86 million is recognized as unrealized losses occurring over a period of 12 months or longer with a market value of $3.7 billion applied to the affected securities. [End of table] U.S. Treasury Obligations at December 31, 2004: [See PDF for image] [End of table] Bank Insurance Fund's Financial Statements: 4. Receivables from Bank Resolutions, Net: The receivables from bank resolutions include payments made by the BIF to cover obligations to insured depositors, advances to receiverships for working capital, and administrative expenses paid on behalf of receiverships. Any related allowance for loss represents the difference between the funds advanced and/or obligations incurred and the expected repayment. Assets held by BIF receiverships are the main source of repayment of the BIF's receivables from closed banks. As of December 31, 2005, there were 24 active receiverships, with no failures in the current year. As of December 31, 2005 and 2004, BIF receiverships held assets with a book value of $357 million and $504 million, respectively (including cash, investments, and miscellaneous receivables of $251 million and $269 million at December 31, 2005 and 2004, respectively). The estimated cash recoveries from the management and disposition of these assets that are used to derive the allowance for losses are based on a sampling of receivership assets in liquidation. The sampled assets are generally valued by estimating future cash recoveries, net of applicable liquidation cost estimates, and then discounting these net cash recoveries using current market-based risk factors based on a given asset's type and quality. Resultant recovery estimates are extrapolated to the non-sampled assets in order to derive the allowance for loss on the receivable. These estimated recoveries are regularly evaluated, but remain subject to uncertainties because of potential changes in economic and market conditions. Such uncertainties could cause the BIF's actual recoveries to vary from the level currently estimated. Receivables From Bank Resolutions, Net at December 31. Dollars in Thousands. [See PDF for image] [End of table] As of December 31, 2005, an allowance for loss of $4.1 billion, or 93 percent of the gross receivable, was recorded. Of the remaining seven percent of the gross receivable, the amount of credit risk is limited since 71 percent of the receivable will be repaid from receivership cash and investments. 5. Property and Equipment, Net: Property and Equipment, Net at December 31: Dollars in Thousands: [See PDF for image] [End of table] The depreciation expense was $56 million and $54 million for December 31, 2005 and 2004, respectively. 6. Contingent Liabilities for: Anticipated Failure of Insured Institutions: The BIF records a contingent liability and a loss provision for BIF- insured institutions (including Oakar and Sasser financial institutions) that are likely to fail within one year of the reporting date, absent some favorable event such as obtaining additional capital or merging, when the liability becomes probable and reasonably estimable. The contingent liability is derived by applying expected failure rates and loss rates to institutions based on supervisory ratings, balance sheet characteristics, and projected capital levels. In addition, institution-specific analysis is performed on those institutions where failure is imminent absent institution management resolution of existing problems, or where additional information is available that may affect the estimate of losses. As of December 31, 2005 and 2004, the contingent liabilities for anticipated failure of insured institutions were $2 million and $8 million, respectively. In addition to these recorded contingent liabilities, the FDIC has identified additional risk in the financial services industry that could result in an additional loss to the BIF should potentially vulnerable financial institutions ultimately fail. This risk results from the presence of various high-risk banking business activities that are particularly vulnerable to adverse economic and market conditions. Due to the uncertainty surrounding such conditions in the future, there are institutions other than those with losses included in the contingent liability for which the risk of failure is less certain, but still considered reasonably possible. As a result of these risks, the FDIC believes that it is reasonably possible that the BIF could incur additional estimated losses up to approximately $0.3 billion. The accuracy of these estimates will largely depend on future economic and market conditions. The FDIC's Board of Directors has the statutory authority to consider the contingent liability from anticipated failures of insured institutions when setting assessment rates. There remains uncertainty about the effect of the 2005 hurricane season on the deposit insurance fund balances. The economic dislocations as well as the potential adverse effects on collateral values and the repayment capacity of borrowers resulting from the hurricanes may stress the balance sheets of a few, small institutions that are located in the areas of greatest devastation. The FDIC continues to evaluate the risks to affected institutions in light of economic conditions, the amount of insurance proceeds that will protect institution collateral, and the level of government disaster relief. At this point, however, the FDIC cannot estimate the impact of such risks on the insurance funds. Litigation Losses: The BIF records an estimated loss for unresolved legal cases to the extent that those losses are considered probable and reasonably estimable. In addition to the amount recorded as probable, the FDIC has determined that losses from unresolved legal cases totaling $1.2 million are reasonably possible. Other Contingencies: Representations and Warranties: As part of the FDIC's efforts to maximize the return from the sale of assets from bank resolutions, representations and warranties, and guarantees were offered on certain loan sales. In general, the guarantees, representations, and warranties on loans sold relate to the completeness and accuracy of loan documentation, the quality of the underwriting standards used, the accuracy of the delinquency status when sold, and the conformity of the loans with characteristics of the pool in which they were sold. The total amount of loans sold subject to unexpired representations and warranties, and guarantees was $3.4 billion as of December 31, 2005. There were no contingent liabilities from any of the outstanding claims asserted in connection with representations and warranties at December 31, 2005 and 2004, respectively. In addition, future losses on representations and warranties, and guarantees could be incurred over the remaining life of the loans sold, which is generally 20 years or more. Consequently, the FDIC believes it is possible that additional losses may be incurred by the BIF from the universe of outstanding contracts with unasserted representation and warranty claims. However, because of the uncertainties surrounding the timing of when claims may be asserted, the FDIC is unable to reasonably estimate a range of loss to the BIF from outstanding contracts with unasserted representation and warranty claims. 7. Assessments: In compliance with provisions of the FDI Act, as amended, the FDIC uses a risk-based assessment system that charges higher rates to those institutions that pose greater risks to the BIF. To arrive at a risk- based assessment for a particular institution, the FDIC places each institution in one of nine risk categories based on capital ratios and supervisory examination data. Due to the continuing health of the banking industry, the majority of the financial institutions are not assessed. Of those assessed, the assessment rate averaged approximately 11 cents and 22 cents per $100 of assessable deposits for 2005 and 2004, respectively. During 2005 and 2004, $53 million and $95 million were recognized as assessment income from BIF-member institutions, respectively. On November 8, 2005, the Board voted to retain the BIF assessment schedule at the annual rate of 0 to 27 cents per $100 of assessable deposits for the first semiannual period of 2006. The Board reviews assessment rates semiannually to ensure that funds are available to satisfy the BIF's obligations. If necessary, the Board may impose more frequent rate adjustments or emergency special assessments. The FDIC is required to maintain the insurance funds at a designated reserve ratio (DRR) of not less than 1.25 percent of estimated insured deposits (or a higher percentage as circumstances warrant). If the reserve ratio falls below the DRR, the FDIC is required to set semiannual assessment rates that are sufficient to increase the reserve ratio to the DRR not later than one year after such rates are set, or in accordance with a recapitalization schedule of fifteen years or less. As of September 30, 2005, the BIF reserve ratio was 1.25 percent of estimated insured deposits. Assessments are also levied on institutions for payments of the interest on obligations issued by the Financing Corporation (FICO). The FICO was established as a mixed-ownership government corporation to function solely as a financing vehicle for the FSLIC. The annual FICO interest obligation of approximately $790 million is paid on a pro rata basis using the same rate for banks and thrifts. The FICO assessment has no financial impact on the BIF and is separate from the regular deposit insurance assessments. The FDIC, as administrator of the BIF acts solely as a collection agent for the FICO. During 2005 and 2004, $620 million and $631 million, respectively, were collected from BIF- member institutions and remitted to the FICO. Bank Insurance Fund's Financial Statements: 8. Operating Expenses: Operating expenses were $846 million for 2005, compared to $821 million for 2004. The chart below lists the major components of operating expenses. Operating Expenses for the Years Ended December 31. Dollars in Thousands. [See PDF for image] [End of table] 9. Provision for Insurance Losses: Provision for insurance losses was a negative $138 million for 2005 and a negative $281 million for 2004. The following chart lists the major components of the provision for insurance losses. Provision for Insurance Losses for the Years Ended December 31. [See PDF for image] [End of table] 10. Employee Benefits: Pension Benefits, Savings Plans and Postemployment Benefits: Eligible FDIC employees (permanent and term employees with appointments exceeding one year) are covered by the federal government retirement plans, either the Civil Service Retirement System (CSRS) or the Federal Employees Retirement System (FERS). Although the BIF contributes a portion of pension benefits for eligible employees, it does not account for the assets of either retirement system. The BIF also does not have actuarial data for accumulated plan benefits or the unfunded liability relative to eligible employees. These amounts are reported on and accounted for by the U.S. Office of Personnel Management. Eligible FDIC employees also may participate in a FDIC-sponsored tax- deferred 401 (k) savings plan with matching contributions up to five percent. The BIF pays its share of the employer's portion of all related costs. The FDIC offered a voluntary employee buyout program to a majority of its employees during 2004 and conducted a reduction-in-force (RIF) during 2005 in an effort to further reduce identified staffing excesses. Consequently, 578 employees left or will leave the FDIC as a result of the buyout program and an additional 62 employees left due to the RIF. Termination benefits included compensation of fifty percent of the current salary for voluntary departures and severance pay for employees that left due to the RIF. The total cost of the buyout program and the RIF to the FDIC was $32.6 million, with BIF's share totaling $28 million, which is included in the "Operating expenses" line item for 2005 and 2004. Pension Benefits, Savings Plans Expenses and Postemployment Benefits for the Years Ended December 31: Dollars in Thousands: [See PDF for image] [End of table] Postretirement Benefits Other Than Pensions: The FDIC provides certain life and dental insurance coverage for its eligible retirees, the retirees' beneficiaries, and covered dependents. Retirees eligible for life insurance coverage are those who have qualified due to: 1) immediate enrollment upon appointment or five years of participation in the plan and 2) eligibility for an immediate annuity. The life insurance program provides basic coverage at no cost to retirees and allows converting optional coverages to direct-pay plans. Dental coverage is provided to all retirees eligible for an immediate annuity. At December 31, 2005 and 2004, the BIF's net postretirement benefit liability recognized in the "Accounts payable and other liabilities" line item in the Balance Sheet was $110 million and $104 million, respectively. In addition, the BIF's expense for these benefits in 2005 and 2004 was $9.0 million and $9.3 million, respectively, which is included in the current and prior year's operating expenses. Key actuarial assumptions used in the accounting for the plan include the discount rate, the rate of compensation increase, and the dental coverage trend rate. 11. Commitments and Off-Balance-Sheet Exposure: Commitments: Leased Space: The BIF's allocated share of the FDIC's lease commitments totals $78.6 million for future years. The lease agreements contain escalation clauses resulting in adjustments, usually on an annual basis. The allocation to the BIF of the FDIC's future lease commitments is based upon current relationships of the workloads among the BI F and the SAIF. Changes in the relative workloads could cause the amounts allocated to the BIF in the future to vary from the amounts shown below. The BIF recognized leased space expense of $34 million and $36 million for the years ended December 31, 2005 and 2004, respectively. Leased Space Commitments: Dollars in Thousands: [See PDF for image] [End of table] Off-Balance-Sheet Exposure: Deposit Insurance: As of September 30, 2005, the estimated insured deposits for BIF were $2.8 trillion. This would be the accounting loss if all depository institutions were to fail and the acquired assets provided no recoveries. 12. Disclosures About the Fair Value of Financial Instruments: Cash equivalents are short-term, highly liquid investments and are shown at current value. The fair market value of the investment in U.S. Treasury obligations is disclosed in Note 3 and is based on current market prices. The carrying amount of interest receivable on investments, short-term receivables, and accounts payable and other liabilities approximates their fair market value, due to their short maturities and/or comparability with current interest rates. The net receivables from bank resolutions primarily include the BIF's subrogated claim arising from payments to insured depositors. The receivership assets that will ultimately be used to pay the corporate subrogated claim are valued using discount rates that include consideration of market risk. These discounts ultimately affect the BIF's allowance for loss against the net receivables from bank resolutions. Therefore, the corporate subrogated claim indirectly includes the effect of discounting and should not be viewed as being stated in terms of nominal cash flows. Although the value of the corporate subrogated claim is influenced by valuation of receivership assets (see Note 4), such receivership valuation is not equivalent to the valuation of the corporate claim. Since the corporate claim is unique, not intended for sale to the private sector, and has no established market, it is not practicable to estimate its fair market value. The FDIC believes that a sale to the private sector of the corporate claim would require indeterminate, but substantial, discounts for an interested party to profit from these assets because of credit and other risks. In addition, the timing of receivership payments to the BIF on the subrogated claim does not necessarily correspond with the timing of collections on receivership assets. Therefore, the effect of discounting used by receiverships should not necessarily be viewed as producing an estimate of market value for the net receivables from bank resolutions. [End of section] Savings Association Insurance Fund's Financial Statements: Balance Sheet: Savings Association Insurance Fund: Federal Deposit Insurance Corporation: Savings Association Insurance Fund Balance Sheet at December 31: Dollars in Thousands. [See PDF for image] [End of table] The accompanying notes are an integral part of these financial statements. Statement of Income and Fund Balance: Federal Deposit Insurance Corporation: Savings Association Insurance Fund Statement of Income and Fund Balance for the Years Ended December 31: Dollars in Thousands: [See PDF for image] [End of table] The accompanying notes are an integral part of these financial statements. Statement of Cash Flows: Savings Association Insurance Fund: Federal Deposit Insurance Corporation: Savings Association Insurance Fund Statement of Cash Flows for the Years Ended December 31: Dollars in Thousands. [See PDF for image] [End of table] The accompanying notes are an integral part of these financial statements. Notes to the Financial Statements: Financial Statements and Notes: Savings Association Insurance Fund: 1. Legislation and Operations of the Savings Association Insurance Fund: Overview: The Federal Deposit Insurance Corporation (FDIC) is the independent deposit insurance agency created by Congress in 1933 to maintain stability and public confidence in the nation's banking system. Provisions that govern the operations of the FDIC are generally found in the Federal Deposit Insurance (FDI) Act, as amended, (12 U.S.C. 1811, et seq). In carrying out the purposes of the FDI Act, as amended, the FDIC insures the deposits of banks and savings associations, and in cooperation with other federal and state agencies promotes the safety and soundness of insured depository institutions by identifying, monitoring and addressing risks to the deposit insurance funds. FDIC is the administrator of the Savings Association Insurance Fund (SAIF), the Bank Insurance Fund (BIF), and the FSLIC Resolution Fund (FRF), which are maintained separately to carry out their respective mandates. The SAIF and the BIF are insurance funds responsible for protecting insured thrift and bank depositors from loss due to institution failures. These insurance funds must be maintained at not less than 1.25 percent of estimated insured deposits or a higher percentage as circumstances warrant. The FRF is a resolution fund responsible for the sale of remaining assets and satisfaction of liabilities associated with the former Federal Savings and Loan Insurance Corporation (FSLIC) and the Resolution Trust Corporation. An active institution's insurance fund membership and primary federal supervisor are generally determined by the institution's charter type. Deposits of SAIF-member institutions are generally insured by the SAIF; SAIF members are predominantly thrifts supervised by the Office of Thrift Supervision (OTS). Deposits of BIF-member institutions are generally insured by the BIF; BIF members are predominantly commercial and savings banks supervised by the FDIC, the Office of the Comptroller of the Currency, or the Federal Reserve Board. In addition to traditional thrifts and banks, several other categories of institutions exist. A member of one insurance fund may, with the approval of its primary federal supervisor, merge, consolidate with, or acquire the deposit liabilities of an institution that is a member of the other insurance fund without changing insurance fund status for the acquired deposits. These institutions with deposits insured by both insurance funds are referred to as Oakar financial institutions. In addition, SAIF-member thrifts can convert to a bank charter and retain their SAIF membership. These institutions are referred to as Sasser financial institutions. Likewise, BIF-member banks can convert to a thrift charter and retain their BIF membership. Operations of the SAIF: The primary purpose of the SAIF is to: 1) insure the deposits and protect the depositors of SAIF-insured institutions and 2) resolve SAIF- insured failed institutions upon appointment of FDIC as receiver in a manner that will result in the least possible cost to the SAIF. The SAIF is primarily funded from: 1) interest earned on investments in U.S. Treasury obligations and 2) deposit insurance assessments. Additional funding sources are borrowings from the U.S. Treasury, the Federal Financing Bank (FFB), and the Federal Home Loan Banks, if necessary. The FDIC has borrowing authority from the U.S. Treasury up to $30 billion for insurance purposes on behalf of the SAIF and the BI F. A statutory formula, known as the Maximum Obligation Limitation (MOL), limits the amount of obligations the SAIF can incur to the sum of its cash, 90 percent of the fair market value of other assets, and the amount authorized to be borrowed from the U.S. Treasury. The MOIL for the SAIF was $21.0 billion as of December 31, 2005 and 2004, respectively. Receivership Operations: The FDIC is responsible for managing and disposing of the assets of failed institutions in an orderly and efficient manner. The assets held by receivership entities, and the claims against them, are accounted for separately from SAIF assets and liabilities to ensure that receivership proceeds are distributed in accordance with applicable laws and regulations. Accordingly, income and expenses attributable to receiverships are accounted for as transactions of those receiverships. Receiverships are billed by the FDIC for services provided on their behalf. Recent Legislative Initiatives: The Deposit Insurance Reform Act of 2005 (Title II of Public Law 109- 171) was enacted on February 8, 2006. The companion legislation, the Federal Deposit Insurance Reform Conforming Amendments Act of 2005 (Public Law 109-173), was enacted on February 15, 2006. The legislation: 1) merges the BIF and the SAIF into a new fund, the Deposit Insurance Fund (DIF); 2) requires the deposit of funds into the DIF for SAIF-member exit fees that have been restricted and held in escrow; 3) annually permits the designated reserve ratio to vary between 1.15 and 1.50 of estimated insured deposits, thereby eliminating the fixed designated reserve ratio of 1.25; 4) requires the declaration of dividends from the DIF for the full amount of the reserve ratio in excess of 1.50 percent or, if less than 1.50 percent, one-half of the amount between 1.35 and 1.50 percent; 5) grants a one- time assessment credit for each eligible institution or its successor based on an institution's proportionate share of the aggregate assessment base at December 31, 1996; and 6) immediately increases coverage for certain retirement accounts to $250,000 and indexes all deposit insurance coverage every five years beginning January 1, 2011. 2. Summary of Significant Accounting Policies: General: These financial statements pertain to the financial position, results of operations, and cash flows of the SAIF and are presented in conformity with U.S. generally accepted accounting principles (GAAP). These statements do not include reporting for assets and liabilities of closed thrift institutions for which the FDIC acts as receiver. Periodic and final accountability reports of the FDIC's activities as receiver are furnished to courts, supervisory authorities, and others as required. Use of Estimates: Management makes estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates. Where it is reasonably possible that changes in estimates will cause a material change in the financial statements in the near term, the nature and extent of such changes in estimates have been disclosed. The more significant estimates include allowance for loss on receivables from thrift resolutions, the estimated losses for anticipated failures and litigation, and the postretirement benefit obligation. Cash Equivalents: Cash equivalents are short-term, highly liquid investments with original maturities of three months or less. Cash equivalents consist primarily of Special U.S. Treasury Certificates. Investment in U.S. Treasury Obligations: SAIF funds are required to be invested in obligations of the United States: or in obligations guaranteed as to principal and interest by the United States; the Secretary of the U.S. Treasury must approve all such investments in excess of $100,000. The Secretary has granted approval to invest SAIF funds only in U.S. Treasury obligations that are purchased or sold exclusively through the Bureau of the Public Debt's Government Account Series (GAS) program. SAIF's investments in U.S. Treasury obligations are either classified as held-to-maturity or available-for-sale. Securities designated as held-to-maturity are shown at amortized cost. Amortized cost is the face value of securities plus the unamortized premium or less the unamortized discount. Amortizations are computed on a daily basis from the date of acquisition to the date of maturity, except for callable U.S. Treasury securities, which are amortized to the first call date. Securities designated as available-for-sale are shown at market value, which approximates fair value. Unrealized gains and losses are included in Comprehensive Income. Realized gains and losses are included in the Statement of Income and Fund Balance as components of Net Income. Income on both types of securities is calculated and recorded on a daily basis using the effective interest method. Cost Allocations Among Funds: Operating expenses not directly charged to the SAIF, the BIF, and the FRF are allocated to all funds using workload-based allocation percentages. These percentages are developed during the annual corporate planning process and through supplemental functional analyses. Disclosure about Recent Accounting Pronouncements: Recent accounting pronouncements have been adopted or deemed to be not applicable to the financial statements as presented. Related Parties: The nature of related parties and a description of related party transactions are discussed in Note 1 and disclosed throughout the financial statements and footnotes. Reclassifications: Reclassifications have been made in the 2004 financial statements to conform to the presentation used in 2005. These reclassifications include the reallocation of amounts from "Provision for insurance losses" to "Insurance and other expenses" for assets acquired from assisted thrifts and terminated receiverships. Additionally, amounts were reallocated from "Operating expenses" to "Insurance and other expenses" for SAIF's share of the loss on the retirement of capital assets. The reclassifications, which were based on the restructuring of accounts, had no impact on the prior year's net income or fund balance. 3. Cash and Other Assets: Restricted for SAIF-Member Exit Fees: The SAIF collects entrance and exit fees for conversion transactions when an insured depository institution converts from the BIF to the SAIF (resulting in an entrance fee) or from the SAIF to the BIF (resulting in an exit fee). Regulations approved by the FDIC's Board of Directors (Board) and published in the Federal Register on March 21, 1990, directed that exit fees paid to the SAIF be held in escrow. The FDIC and the Secretary of the Treasury will determine when it is no longer necessary to escrow such funds for the payment of interest on obligations previously issued by the Financing Corporation (FICO). These escrowed exit fees are invested in U.S. Treasury securities pending determination of ownership. The interest earned is also held in escrow. There were no conversion transactions during 2005 and 2004 that resulted in an entrance/exit fee to the SAIF. Cash and Other Assets: Restricted for SAIF-Member Exit Fees at December 31: [See PDF for image] [End of table] U.S. Treasury Obligations at December 31, 2005 (Restricted for SAIF- Member Exit Fees): [See PDF for image] [End of table] U.S. Treasury Obligations at December 31, 2004 (Restricted for SAIF- Member Exit Fees): [See PDF for image] [End of table] As of December 31, 2005 and 2004, the unamortized premium, net of the unamortized discount, was $19.9 million and $13.4 million, respectively. 4. Investment in U.S. Treasury Obligations, Net: As of December 31, 2005 and 2004,the book value of investments in U.S.Treasury obligations, net, was $11.9 billion and $11.6 billion, respectively. As of December 31, 2005, the SAIF held $2.2 billion of Treasury inflation-protected securities (TIPS). These securities are indexed to increases or decreases in the Consumer Price Index for All Urban Consumers (CPI-U). Additionally, the SAI F held $2.1 billion of callable U.S. Treasury bonds at December 31, 2005. Callable U.S. Treasury bonds may be called five years prior to the respective bonds' stated maturity on their semi-annual coupon payment dates upon 120 days notice. Page 35 GAO-06-146 FDIC Funds' 2005 and 2004 Financial Statements: Savings Association Insurance Fund's Financial Statements: U.S. Treasury Obligations at December 31, 2005 (Unrestricted): [See PDF for image] [End of table] U.S. Treasury Obligations at December 31, 2004 (Unrestricted): Dollars in Thousands: [See PDF for image] [End of table] 5. Receivables From Thrift Resolutions, Net: The receivables from thrift resolutions include payments made by the SAIF to cover obligations to insured depositors, advances to receiverships for working capital, and administrative expenses paid on behalf of receiverships. Any related allowance for loss represents the difference between the funds advanced and/or obligations incurred and the expected repayment. Assets held by SAIF receiverships are the main source of repayment of the SAIF's receivables from closed thrifts. As of December 31, 2005, there were three active receiverships, with no failures in the current year. As of December 31, 2005 and 2004, SAIF receiverships held assets with a book value of $388 million and $483 million, respectively (including cash, investments, and miscellaneous receivables of $118 million and $182 million at December 31, 2005 and 2004, respectively). The estimated cash recoveries from the management and disposition of these assets that are used to derive the allowance for losses are based on a sampling of receivership assets in liquidation. The sampled assets are generally valued by estimating future cash recoveries, net of applicable liquidation cost estimates, and then discounting these net cash recoveries using current market-based risk factors based on a given asset's type and quality. Resultant recovery estimates are extrapolated to the non-sampled assets in order to derive the allowance for loss on the receivable. These estimated recoveries are regularly evaluated, but remain subject to uncertainties because of potential changes in economic and market conditions. Such uncertainties could cause the SAIF's actual recoveries to vary from the level currently estimated. Receivables From Thrift Resolutions, Net at December 31. Dollars in Thousands. [See PDF for image] [End of table] At December 31, 2005, about 99 percent of the SAIF's $234 million net receivable will be repaid from assets related to the Superior receivership (which failed in July 2001). These assets primarily consist of cash, investments, and a promissory note arising from a settlement with the owners of the failed institution. The credit risk related to the promissory note is limited since half of the outstanding note is secured by a letter of credit and the remaining half is subject to the creditworthiness of the payor of the note. Annual monitoring of the credit-worthiness of the payor is performed and currently indicates a low risk of non-performance. 6. Contingent Liabilities for: Anticipated Failure of Insured Institutions: The SAIF records a contingent liability and a loss provision for SAIF- insured institutions (including Oakar and Sasser financial institutions) that are likely to fail within one year of the reporting date, absent some favorable event such as obtaining additional capital or merging, when the liability becomes probable and reasonably estimable. The contingent liability is derived by applying expected failure rates and loss rates to institutions based on supervisory ratings, balance sheet characteristics, and projected capital levels. In addition, institution-specific analysis is performed on those institutions where failure is imminent absent institution management resolution of existing problems, or where additional information is available that may affect the estimate of losses. As of December 31, 2005 and 2004, the contingent liabilities for anticipated failure of insured institutions were $4 million and $2 million, respectively. In addition to these recorded contingent liabilities, the FDIC has identified additional risk in the financial services industry that could result in an additional loss to the SAIF should potentially vulnerable financial institutions ultimately fail. This risk results from the presence of various high-risk banking business activities that are particularly vulnerable to adverse economic and market conditions. Due to the uncertainty surrounding such conditions in the future, there are institutions other than those with losses included in the contingent liability for which the risk of failure is less certain, but still considered reasonably possible. As a result of these risks, the FDIC believes that it is reasonably possible that the SAIF could incur additional estimated losses up to approximately $0.2 billion. The accuracy of these estimates will largely depend on future economic and market conditions. The FDIC's Board of Directors has the statutory authority to consider the contingent liability from anticipated failures of insured institutions when setting assessment rates. There remains uncertainty about the effect of the 2005 hurricane season on the deposit insurance fund balances. The economic dislocations as well as the potential adverse effects on collateral values and the repayment capacity of borrowers resulting from the hurricanes may stress the balance sheets of a few, small institutions that are located in the areas of greatest devastation. The FDIC continues to evaluate the risks to affected institutions in light of economic conditions, the amount of insurance proceeds that will protect institution collateral, and the level of government disaster relief. At this point, however, the FDIC cannot estimate the impact of such risks on the insurance funds. Litigation Losses: The SAIF records an estimated loss for unresolved legal cases to the extent those losses are considered probable and reasonably estimable. In addition to the amount recorded as probable, the FDIC has determined that losses from unresolved legal cases totaling $140 thousand are reasonably possible. Other Contingencies: Representations and Warranties: As part of the FDIC's efforts to maximize the return from the sale of assets from thrift resolutions, representations and warranties, and guarantees were offered on certain loan sales. In general, the guarantees, representations, and warranties on loans sold relate to the completeness and accuracy of loan documentation, the quality of the underwriting standards used, the accuracy of the delinquency status when sold, and the conformity of the loans with characteristics of the pool in which they were sold. The total amount of loans sold subject to unexpired representations and warranties, and guarantees was $4.7 billion as of December 31, 2005. SAIF did not establish a liability for all outstanding claims asserted in connection with representations and warranties because the receiverships have sufficient funds to pay for such claims. In addition, future losses on representations and warranties, and guarantees could be incurred over the remaining life of the loans sold, which is generally 20 years or more. Consequently, the FDIC believes it is possible that additional losses may be incurred by the SAIF from the universe of outstanding contracts with unasserted representation and warranty claims. However, because of the uncertainties surrounding the timing of when claims may be asserted, the FDIC is unable to reasonably estimate a range of loss to the SAIF from outstanding contracts with unasserted representation and warranty claims. 7. Assessments: In compliance with provisions of the FDI Act, as amended, the FDIC uses a risk-based assessment system that charges higher rates to those institutions that pose greater risks to the SAIF. To arrive at a risk- based assessment for a particular institution, the FDIC places each institution in one of nine risk categories based on capital ratios and supervisory examination data. Due to the continuing health of the thrift industry, the majority of the financial institutions are not assessed. Of those assessed, the assessment rate averaged approximately 7 cents and 8 cents per $100 of assessable deposits for 2005 and 2004, respectively. During 2005 and 2004, $8 million and $9 million were recognized as assessment income from SAIF-member institutions, respectively. On November 8, 2005, the Board voted to retain the SAIF assessment schedule at the annual rate of 0 to 27 cents per $100 of assessable deposits for the first semiannual period of 2006. The Board reviews assessment rates semiannually to ensure that funds are available to satisfy the SAIF's obligations. If necessary, the Board may impose more frequent rate adjustments or emergency special assessments. The FDIC is required to maintain the insurance funds at a designated reserve ratio (DRR) of not less than 1.25 percent of estimated insured deposits (or a higher percentage as circumstances warrant). If the reserve ratio falls below the DRR, the FDIC is required to set semiannual assessment rates that are sufficient to increase the reserve ratio to the DRR not later than one year after such rates are set, or in accordance with a recapitalization schedule of fifteen years or less. As of September 30, 2005, the SAIF reserve ratio was 1.30 percent of estimated insured deposits. Assessments are also levied on institutions for payments of the interest on obligations issued by the FICO. The FICO was established as a mixed-ownership government corporation to function solely as a financing vehicle for the FSLIC. The annual FICO interest obligation of approximately $790 million is paid on a pro rata basis using the same rate for banks and thrifts. The FICO assessment has no financial impact on the SAIF and is separate from the regular deposit insurance assessments. The FDIC, as administrator of the SAIF, acts solely as a collection agent for the FICO. During 2005 and 2004, $160 million and $161 million, respectively, were collected from SAIF-member institutions and remitted to the FICO. 8. Operating Expenses: Operating expenses totaled $119 million for 2005, compared to $120 million for 2004. The chart below lists the major components of operating expenses. Operating Expenses for the Years Ended December 31. Dollars in Thousands. [See PDF for image] [End of table] 9. Provision for Insurance Losses: Provision for insurance losses was a negative $22 million for 2005 and a negative $72 million for 2004. The following chart lists the major components of the provision for insurance losses. Provision for Insurance Losses for the Years Ended December 31. Dollars in Thousands. [See PDF for image] [End of table] 10. Employee Benefits: Pension Benefits, Savings Plans and Postemployment Benefits: Eligible FDIC employees (permanent and term employees with appointments exceeding one year) are covered by the federal government retirement plans, either the Civil Service Retirement System (CSRS) or the Federal Employees Retirement System (FERS). Although the SAIF contributes a portion of pension benefits for eligible employees, it does not account for the assets of either retirement system. The SAIF also does not have actuarial data for accumulated plan benefits or the unfunded liability relative to eligible employees. These amounts are reported on and accounted for by the U.S. Office of Personnel Management. Eligible FDIC employees also may participate in a FDIC-sponsored tax- deferred 401 (k) savings plan with matching contributions up to five percent. The SAI F pays its share of the employer's portion of all related costs. The FDIC offered a voluntary employee buyout program to a majority of its employees during 2004 and conducted a reduction-in-force (RIF) during 2005 in an effort to further reduce identified staffing excesses. Consequently, 578 employees left or will leave the FDIC as a result of the buyout program and an additional 62 employees left due to the RIF. Termination benefits included compensation of fifty percent of the current salary for voluntary departures and severance pay for employees that left due to the RIF. The total cost of the buyout program and the RIF to the FDIC was $32.6 million, with SAIF's share totaling $4.3 million, which is included in the "Operating expenses" line item for 2005 and 2004. Pension Benefits, Savings Plans Expenses and Postemployment Benefits for the Years Ended December 31: Dollars in Thousands. [See PDF for image] [End of table] Postretirement Benefits Other Than Pensions: The FDIC provides certain life and dental insurance coverage for its eligible retirees, the retirees' beneficiaries, and covered dependents. Retirees eligible for life insurance coverage are those who have qualified due to: 1) immediate enrollment upon appointment or five years of participation in the plan and 2) eligibility for an immediate annuity. The life insurance program provides basic coverage at no cost to retirees and allows converting optional coverages to direct-pay plans. Dental coverage is provided to all retirees eligible for an immediate annuity. At December 31, 2005 and 2004, the SAIF's net postretirement benefit liability recognized in the "Accounts payable and other liabilities" line item in the Balance Sheet was $16.7 million and $15.7 million, respectively. In addition, the SAIF's expense for these benefits in 2005 and 2004 was $1.3 million and $1.4 million, respectively, which is included in the current and prior year's operating expenses. Key actuarial assumptions used in the accounting for the plan include the discount rate, the rate of compensation increase, and the dental coverage trend rate. 11. Commitments and Off-Balance-Sheet Exposure: Commitments: Leased Space: The SAIF's allocated share of the FDIC's lease commitments totals $11.7 million for future years. The lease agreements contain escalation clauses resulting in adjustments, usually on an annual basis. The allocation to the SAIF of the FDIC's future lease commitments is based upon current relationships of the workloads among the SAIF and the BIF. Changes in the relative workloads could cause the amounts allocated to the SAIF in the future to vary from the amounts shown below. The SAIF recognized leased space expense of $5.0 million and $6.9 million for the years ended December 31, 2005 and December 31, 2004, respectively. Leased Space Commitments: Dollars in Thousands: [See PDF for image] [End of table] Off-Balance-Sheet Exposure: Deposit Insurance: As of September 30, 2005, the estimated insured deposits for SAIF were $1.0 trillion. This would be the accounting loss if all depository institutions were to fail and the acquired assets provided no recoveries. 12. Disclosures About the Fair Value of Financial Instruments: Cash equivalents are short-term, highly liquid investments and are shown at current value. The fair market value of the investment in U.S.Treasury obligations is disclosed in Notes 3 and 4 and is based on current market prices. The carrying amount of interest receivable on investments, short-term receivables, and accounts payable and other liabilities approximates their fair market value, due to their short maturities and/or comparability with current interest rates. The net receivables from thrift resolutions primarily include the SAIF's subrogated claim arising from payments to insured depositors. The receivership assets that will ultimately be used to pay the corporate subrogated claim are valued using discount rates that include consideration of market risk. These discounts ultimately affect the SAIF's allowance for loss against the net receivables from thrift resolutions. Therefore, the corporate subrogated claim indirectly includes the effect of discounting and should not be viewed as being stated in terms of nominal cash flows. Although the value of the corporate subrogated claim is influenced by valuation of receivership assets (see Note 5), such receivership valuation is not equivalent to the valuation of the corporate claim. Since the corporate claim is unique, not intended for sale to the private sector, and has no established market, it is not practicable to estimate its fair market value. The FDIC believes that a sale to the private sector of the corporate claim would require indeterminate, but substantial, discounts for an interested party to profit from these assets because of credit and other risks. In addition, the timing of receivership payments to the SAIF on the subrogated claim does not necessarily correspond with the timing of collections on receivership assets. Therefore, the effect of discounting used by receiverships should not necessarily be viewed as producing an estimate of market value for the net receivables from thrift resolutions. [End of section] FSLIC Resolution Fund's Financial Statements: Balance Sheet: FSLIC Resolution Fund: Federal Deposit Insurance Corporation. FSLIC Resolution Fund Balance Sheet at December 31. Dollars in Thousands. [See PDF for image] [End of table] Statement of Income and Accumulated Deficit: Federal Deposit Insurance Corporation: FSLIC Resolution Fund Statement of Income and Accumulated Deficit for the Years Ended December 31: Dollars in Thousands. [See PDF for image] [End of table] Statement of Cash Flows: FSLIC Resolution Fund: Federal Deposit Insurance Corporation: FSLIC Resolution Fund Statement of Cash Flows for the Years Ended December 31: Dollars in Thousands. [See PDF for image] [End of table] Notes to the Financial Statements: Financial Statements and Notes: FSLIC Resolution Fund: Notes to the Financial Statements December 31, 2005 and 2004. 1. Legislative History and Operations/Dissolution of the FSLIC Resolution Fund: Legislative History: The Federal Deposit Insurance Corporation (FDIC) is the independent deposit insurance agency created by Congress in 1933 to maintain stability and public confidence in the nation's banking system. Provisions that govern the operations of the FDIC are generally found in the Federal Deposit Insurance (FDI) Act, as amended, (12 U.S.C. 1811, et seq). In carrying out the purposes of the FDI Act, as amended, the FDIC insures the deposits of banks and savings associations, and in cooperation with other federal and state agencies promotes the safety and soundness of insured depository institutions by identifying, monitoring and addressing risks to the deposit insurance funds established in the FDI Act, as amended. In addition, FDIC is charged with responsibility for the sale of remaining assets and satisfaction of liabilities associated with the former Federal Savings and Loan Insurance Corporation (FSLIC) and the Resolution Trust Corporation (RTC). The U.S. Congress created the FSLIC through the enactment of the National Housing Act of 1934. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) abolished the insolvent FSLIC, created the FSLIC Resolution Fund (FRF), and transferred the assets and liabilities of the FSLIC to the FRF-except those assets and liabilities transferred to the RTC-effective on August 9, 1989. The FIRREA was enacted to reform, recapitalize, and consolidate the federal deposit insurance system. In addition to the FRF, FIRREA created the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF). It also designated the FDIC as the administrator of these funds. All three funds are maintained separately to carry out their respective mandates. The FIRREA created the RTC to manage and resolve all thrifts previously insured by the FSLIC for which a conservator or receiver was appointed during the period January 1, 1989, through August 8, 1992. Resolution responsibility was subsequently extended and ultimately transferred from the RTC to the SAIF on July 1, 1995. The FIRREA established the Resolution Funding Corporation (REFCORP) to provide part of the initial funds used by the RTC for thrift resolutions. The RTC Completion Act of 1993 (RTC Completion Act) terminated the RTC as of December 31, 1995. All remaining assets and liabilities of the RTC were transferred to the FRF on January 1, 1996. Today, the FRF consists of two distinct pools of assets and liabilities: one composed of the assets and liabilities of the FSLIC transferred to the FRF upon the dissolution of the FSLIC (FRF-FSLIC), and the other composed of the RTC assets and liabilities (FRF-RTC). The assets of one pool are not available to satisfy obligations of the other. Operations/Dissolution of the FRF: The FRF will continue operations until all of its assets are sold or otherwise liquidated and all of its liabilities are satisfied. Any funds remaining in the FRF-FSLIC will be paid to the U.S.Treasury. Any remaining funds of the FRF-RTC will be distributed to the REFCORP to pay the interest on the REFCORP bonds. In addition, the FRF-FSLIC has available until expended $602.2 million in appropriations to facilitate, if required, efforts to wind up the resolution activity of the FRF-FSLIC. The FDIC has conducted an extensive review and cataloging of FRF's remaining assets and liabilities and is continuing to explore approaches for concluding FRF's activities. An executive-level Steering Committee was established in 2003 to facilitate the FRF dissolution. Some of the issues and items that remain open in FRF are: 1) criminal restitution orders (generally have from five to ten years remaining); 2) litigation claims and judgments obtained against officers and directors and other professionals responsible for causing or contributing to thrift losses (judgments generally vary from five to ten years); 3) numerous assistance agreements entered into by the former FSLIC (FRF could continue to receive tax-sharing benefits through year 2008); 4) Goodwill and Guarini litigation (no final date for resolution has been established; see Note 4); and 5) environmentally impaired owned real estate assets. The FDIC is considering whether enabling legislation or other measures may be needed to accelerate liquidation of the remaining FRF assets and liabilities. The FRF could realize substantial recoveries from the aforementioned tax-sharing benefits ranging from $144 million to $224 million; however, any associated recoveries are not reflected in FRF's financial statements given the significant uncertainties surrounding the ultimate outcome. Receivership Operations: The FDIC is responsible for managing and disposing of the assets of failed institutions in an orderly and efficient manner. The assets held by receivership entities, and the claims against them, are accounted for separately from FRF assets and liabilities to ensure that receivership proceeds are distributed in accordance with applicable laws and regulations. Also, the income and expenses attributable to receiverships are accounted for as transactions of those receiverships. Receiverships are billed by the FDIC for services provided on their behalf. 2. Summary of Significant Accounting Policies: General: These financial statements pertain to the financial position, results of operations, and cash flows of the FRF and are presented in conformity with U.S. generally accepted accounting principles (GAAP). These statements do not include reporting for assets and liabilities of closed thrift institutions for which the FDIC acts as receiver. Periodic and final accountability reports of the FDIC's activities as receiver are furnished to courts, supervisory authorities, and others as required. Use of Estimates: Management makes estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates. Where it is reasonably possible that changes in estimates will cause a material change in the financial statements in the near term, the nature and extent of such changes in estimates have been disclosed. The more significant estimates include allowance for losses on receivables from thrift resolutions and the estimated losses for litigation. Fair Value of Financial Instruments: Cash equivalents, which consist of Special U.S. Treasury Certificates, are short-term, highly liquid investments with original maturities of three months or less and are shown at fair value. The carrying amount of short-term receivables and accounts payable and other liabilities approximates their fair market value, due to their short maturities. The investment in securitization-related assets acquired from receiverships consists of credit enhancement reserves. The credit enhancement reserves, which resulted from swap transactions, are valued by performing projected cash flow analyses using market-based assumptions (see Note 3). The net receivable from thrift resolutions is influenced by the underlying valuation of receivership assets. This corporate receivable is unique and the estimate presented is not necessarily indicative of the amount that could be realized in a sale to the private sector. Such a sale would require indeterminate, but substantial, discounts for an interested party to profit from these assets because of credit and other risks. Consequently, it is not practicable to estimate its fair market value. Cost Allocations Among Funds: Operating expenses not directly charged to the FRF, the BIF and the SAIF are allocated to all funds using workload-based allocation percentages. These percentages are developed during the annual corporate planning process and through supplemental functional analyses. Disclosure about Recent Accounting Pronouncements: Recent accounting pronouncements have been adopted or deemed to be not applicable to the financial statements as presented. Related Parties: The nature of related parties and a description of related party transactions are discussed in Note 1 and disclosed throughout the financial statements and footnotes. Reclassifications: Reclassifications have been made in the 2004 financial statements to conform to the presentation used in 2005. These reclassifications include the reallocation of amounts from "Provision for insurance losses" to "Other expenses" for assets acquired from assisted thrifts and terminated receiverships. The reclassifications had no impact on the prior year's net income or resolution equity. 3. Receivables From Thrift Resolutions and Other Assets, Net: Receivables From Thrift Resolutions: The receivables from thrift resolutions include payments made by the FRF to cover obligations to insured depositors, advances to receiverships for working capital, and administrative expenses paid on behalf of receiverships. Any related allowance for loss represents the difference between the funds advanced and/or obligations incurred and the expected repayment. Assets held by the FDIC in its receivership capacity for the former FSLIC and SAIF-insured institutions are a significant source of repayment of the FRF's receivables from thrift resolutions. As of December 31, 2005, 25 of the 850 FRF receiverships remain active primarily due to unresolved litigation, including Goodwill matters. As of December 31, 2005 and 2004, FRF receiverships held assets with a book value of $139 million and $175 million, respectively (including cash, investments, and miscellaneous receivables of $113 million and $142 million at December 31, 2005 and 2004, respectively). The estimated cash recoveries from the management and disposition of these assets that are used to derive the allowance for losses are based on a sampling of receivership assets in liquidation. The sampled assets are generally valued by estimating future cash recoveries, net of applicable liquidation cost estimates, and then discounting these net cash recoveries using current market-based risk factors based on a given asset's type and quality. Resultant recovery estimates are extrapolated to the non-sampled assets in order to derive the allowance for loss on the receivable. These estimated recoveries are regularly evaluated, but remain subject to uncertainties because of potential changes in economic and market conditions. Such uncertainties could cause the FRF's actual recoveries to vary from the level currently estimated. Investment in Securitization-Related Assets Acquired from Receiverships This investment includes credit enhancement reserves valued at $16.7 million and $15.6 million as of December 31, 2005 and 2004, respectively. The credit enhancement reserves resulted from swap transactions where the former RTC received mortgage-backed securities in exchange for single-family mortgage loans. The former RTC supplied credit enhancement reserves for the mortgage loans in the form of cash collateral to cover future credit losses over the remaining life of the loans. These reserves may cover future credit losses through 2020. Receivables From Thrift Resolutions and Other Assets, Net at December 31: Dollars in Thousands. [See PDF for image] [End of table] Gross receivables from thrift resolutions and the investment in securitization-related assets subject the FRF to credit risk. An allowance for loss of $16.1 billion, or 99.9 percent of the gross receivable, was recorded as of December 31, 2005. Of the remaining 0.1 percent of the gross receivable, 71 percent is expected to be repaid from receivership cash and investments. FSLIC Resolution Fund: 4. Contingent Liabilities for: Litigation Losses: The FRF records an estimated loss for unresolved legal cases to the extent those losses are considered probable and reasonably estimable. In addition to the amount recorded as probable, the FDIC has determined that losses from unresolved legal cases totaling $85.4 million are reasonably possible. Additional Contingency: Goodwill Litigation: In United States v. Winstar Corp., 518 U.S. 839 (1996), the Supreme Court held that when it became impossible following the enactment of FIRREA in 1989 for the federal government to perform certain agreements to count goodwill toward regulatory capital, the plaintiffs were entitled to recover damages from the United States. Approximately 35 remaining cases are pending against the United States based on alleged breaches of these agreements. On July 22, 1998, the Department of Justice's (DOJ's) Office of Legal Counsel (OLC) concluded that the FRF is legally available to satisfy all judgments and settlements in the Goodwill Litigation involving supervisory action or assistance agreements. OLC determined that nonperformance of these agreements was a contingent liability that was transferred to the FRF on August 9, 1989, upon the dissolution of the FSLIC. On July 23, 1998, the U.S. Treasury determined, based on OLC's opinion, that the FRF is the appropriate source of funds for payments of any such judgments and settlements. The FDIC General Counsel concluded that, as liabilities transferred on August 9, 1989, these contingent liabilities for future nonperformance of prior agreements with respect to supervisory goodwill were transferred to the FRF-FSLIC, which is that portion of the FRF encompassing the obligations of the former FSLIC. The FRF-RTC, which encompasses the obligations of the former RTC and was created upon the termination of the RTC on December 31, 1995, is not available to pay any settlements or judgments arising out of the Goodwill Litigation. The Goodwill lawsuits are against the United States and as such are defended by the DOJ. On November 16, 2005, the DOJ again informed the FDIC that it is "unable at this time to provide a reasonable estimate of the likely aggregate contingent liability resulting from the Winstar- related cases." This uncertainty arises, in part, from the existence of significant unresolved issues pending at the appellate or trial court level, as well as the unique circumstances of each case. The FDIC believes that it is probable that additional amounts, possibly substantial, may be paid from the FRF-FSLIC as a result of judgments and settlements in the Goodwill Litigation. Based on the response from the DOJ, the FDIC is unable to estimate a range of loss to the FRF- FSLIC from the Goodwill Litigation. However, the FRF can draw from an appropriation provided by Section 110 of the Department of Justice Appropriations Act, 2000 (Public Law 106- 113, Appendix A, Title I, 113 Stat. 1501A-3, 1501A-20) such sums as may be necessary for the payment of judgments and compromise settlements in the Goodwill Litigation. This appropriation is to remain available until expended. Because an appropriation is available to pay such judgments and settlements, any liabilities for the Goodwill Litigation should have no impact on the financial condition of the FRF-FSLIC. The FRF paid $624.6 million as a result of judgments and settlements in seven Goodwill cases during 2005, compared to $5 million for one Goodwill case for 2004. However, as described above, the FRF received appropriations from the U.S. Treasury to fund these payments. In January 2006, the Department of Justice decided not to appeal the December 30, 2005 U. S. Court of Federal Claims order that FRF pay a $134 million partial judgment in another Goodwill litigation case. As in the previous cases, the FRF will receive an appropriation from the U.S.Treasury to satisfy this judgment. The December 31, 2005 FRF financial statements do not reflect the liability to pay the judgment to the plaintiff or the offsetting receivable for the U.S.Treasury appropriation to fund the judgment. In addition, the FRF-FSLIC pays the goodwill litigation expenses incurred by DOJ based on a Memorandum of Understanding (MOU) dated October 2, 1998, between the FDIC and DOJ. Under the terms of the MOU, the FRF-FSLIC paid $18.3 million and $30.1 million to DOJ for fiscal years 2006 and 2005, respectively. DOJ returns any unused fiscal year funding to the FRF unless special circumstances warrant these funds be carried over and applied against current fiscal year charges. In April 2005, DOJ returned $3 million of unused fiscal year 2005 funds. At September 30, 2005, DOJ had an additional $10.1 million in unused fiscal year 2005 funds that were applied against FY 2006 charges of $28.4 million. Guarini Litigation: Paralleling the Goodwill cases are similar cases alleging that the government breached agreements regarding tax benefits associated with certain FSLIC-assisted acquisitions. These agreements allegedly contained the promise of tax deductions for losses incurred on the sale of certain thrift assets purchased by plaintiffs from the FSLIC, even though the FSLIC provided the plaintiffs with tax-exempt reimbursement. A provision in the Omnibus Budget Reconciliation Act of 1993 (popularly referred to as the °Guarini legislation") eliminated the tax deductions for these losses. Eight °Guarini" cases originally were filed seeking damages. Four "Guarini" cases have now concluded. In the first, no damages were awarded by the trial court and the case was not appealed. A second case was settled for $20,000. In the third and fourth cases, the FRF-FSLIC paid damages of $28.1 million and $48.7 million, respectively. (Certain attorneys' fees and cost issues in these two cases are pending in the trial court.) In a fifth case, the Federal Circuit recently affirmed the trial court's decision to award damages of $70 million. The time has not run yet for the Justice Department to decide whether it will seek further review of this decision. Two other cases are currently pending on appeal before the Federal Circuit; in those cases the trial court awarded plaintiffs damages totaling about $33 million in the aggregate. The eighth case is pending in trial court; in November, the court granted most of plaintiff's motion for partial summary judgment, entitling plaintiff to $149.6 million. However, other issues remain to be resolved before the trial court. The FDIC has established a loss reserve of approximately $257 million for the remaining four Guarini cases because these losses are deemed probable and reasonably estimable. An additional loss of $82.4 million on the Guarini Litigation is considered reasonably possible. Representations and Warranties: As part of the RTC's efforts to maximize the return from the sale of assets from thrift resolutions, representations and warranties, and guarantees were offered on certain loan sales. The majority of loans subject to these agreements have most likely been paid off, refinanced, or the period for filing claims has expired. However, there is no reporting mechanism to determine the aggregate amount of remaining loans. Therefore, the FDIC is unable to provide an estimate of maximum exposure to the FRF. Based on the above and our history of claims processed, the FDIC believes that any future representation and warranty liability to the FRF will likely be minimal. 5. Provision for Losses: The provision for losses was $241.1 million and a negative $13.2 million for 2005 and 2004, respectively. The increased provision in 2005 was primarily due to the recognition of a probable loss on the unresolved Guarini cases. 6. Resolution Equity: As stated in the Legislative History section of Note 1, the FRF is comprised of two distinct pools: the FRF-FSLIC and the FRF-RTC. The FRF- FSLIC consists of the assets and liabilities of the former FSLIC. The FRF-RTC consists of the assets and liabilities of the former RTC. Pursuant to legal restrictions, the two pools are maintained separately and the assets of one pool are not available to satisfy obligations of the other. The following table shows the contributed capital, accumulated deficit, and resulting resolution equity for each pool. Resolution Equity at December 31, 2005: Dollars in Thousands: [See PDF for image] [End of table] Contributed Capital: The FRF-FSLIC and the former RTC received $43.5 billion and $60.1 billion from the U.S. Treasury, respectively, to fund losses from thrift resolutions prior to July 1, 1995. Additionally, the FRF-FSLIC issued $670 million in capital certificates to the Financing Corporation (a mixed-ownership government corporation established to function solely as a financing vehicle for the FSLIC) and the RTC issued $31.3 billion of these instruments to the REFCORP FIRREA prohibited the payment of dividends on any of these capital certificates. Through December 31, 2005, the FRF-RTC has returned $4.556 billion to the U.S. Treasury and made payments of $4.572 billion to the REFCORP. These actions serve to reduce contributed capital. Accumulated Deficit: The accumulated deficit represents the cumulative excess of expenses over revenue for activity related to the FRF-FSLIC and the FRF-RTC. Approximately $29.8 billion and $87.9 billion were brought forward from the former FSLIC and the former RTC on August 9, 1989, and January 1, 1996, respectively. The FRF-FSLIC accumulated deficit has increased by $12.2 billion, whereas the FRF-RTC accumulated deficit has decreased by $6.3 billion, since their dissolution dates. 7. Employee Benefits: Pension Benefits: Eligible FDIC employees (permanent and term employees with appointments exceeding one year) are covered by the federal government retirement plans, either the Civil Service Retirement System (CSRS) or the Federal Employees Retirement System (FERS). Although the FRF contributes a portion of pension benefits for eligible employees, it does not account for the assets of either retirement system. The FRF also does not have actuarial data for accumulated plan benefits or the unfunded liability relative to eligible employees. These amounts are reported on and accounted for by the U.S. Office of Personnel Management. The FRF's pro rata share of pension-related expenses was $2.9 million and $2.8 million, as of December 31, 2005 and 2004, respectively. Postretirement Benefits Other Than Pensions: The FRF no longer records a liability for the postretirement benefits of life and dental insurance as a result of FDIC's change in funding policy for these benefits and elimination of the separate entity formerly used to account for such estimated future costs. In implementing this change, management decided not to allocate either the plan assets or the revised net accumulated postretirement benefit obligation (a long-term liability) to the FRF due to the expected dissolution of the Fund. However, the FRF does continue to pay its proportionate share of the yearly claim expenses associated with these benefits. [End of section] Appendix I: Comments from the Federal Deposit Insurance Corporation: FDIC: Deputy to the Chairman and Chief Financial Officer: Federal Deposit Insurance Corporation: 550 17th Street, NW, Washington, DC 20429: February 22, 2006: Mr. David M. Walker: Comptroller General of the United States: U.S. Government Accountability Office: 441 G Street, NW: Washington, DC 20548: Re: FDIC Management Response on the GAO 2005 Financial Statements Audit Report: Dear Mr. Walker: Thank you for the opportunity to comment on the U.S. Government Accountability Office's (GAO) draft audit report titled, Financial Audit: Federal Deposit Insurance Corporation Funds' 2005 and 2004 Financial Statements, GAO-06-146, The report presents GAO's opinions on the calendar years 2005 and 2004 financial statements of the Bank Insurance Fund (BIF), the Savings Association Insurance Fund (SAIF), and the Federal Savings and Loan Insurance Corporation Resolution Fund (FRF). The report also presents GAO's opinion on the effectiveness of FDIC's internal controls as of December 31, 2005, and GAO's evaluation of FDIC's compliance with applicable laws and regulations. We are pleased to accept GAO's unqualified opinions on the BIF, SAIF, and FRF financial statements and to note that there were no material weaknesses identified during the 2005 audits. The GAO reported that the funds' financial statements were presented fairly, in all material respects, in conformity with U.S. generally accepted accounting principles; FDIC had effective internal control over financial reporting and compliance with laws and regulations; and there were no instances of noncompliance with laws and regulations that were tested. Regarding the reinstated reportable condition on information systems controls, we acknowledge but do not share the GAO's assessment regarding the severity of the risk impact or the magnitude of the collective vulnerability posed by the potential control issues identified by the GAO's audit team. Confidence in the sufficiency of our information systems environment and the related information system controls is grounded in what FDIC believes is a deliberate, comprehensive program designed, in conjunction with the deployment of our new financial system, to integrate not only system controls, but procedural, managerial, and audit controls into a balanced and cost- effective control framework. Nevertheless, the FDIC will work diligently with our GAO audit partners, throughout the 2006 audit cycle, to reconcile our respective views on this matter and to augment our program in those instances where it is determined that changes are appropriate. If you have any questions or concerns, please do not hesitate to contact me. Sincerely, Signed by: Steven O. App: Deputy to the Chairman and Chief Financial Officer: [End of section] Appendix II: Staff Acknowledgments: Acknowledgments: The following individuals made major contributions to this report: Julia Duquette (Assistant Director), Edward R. Alexander Jr., Gerald L. Barnes, Cara L. Bauer, Angela M. Bell, Ronald A. Bergman, Matthew J. Braun, Latasha L. Brown, Sharon O. Byrd, Gloria Cano, Mark J. Canter, Jason A. Carroll, Lon C. Chin, Gary P. Chupka, Dennis L. Clarke, John C. Craig, Nina E. Crocker, Anh Dang, Kristi C. Dorsey, Denise E. Fitzpatrick, Mark R. Fostek, Alberto Garza, Ryan T. Geach, Edward M. Glagola Jr., David B. Hayes, Sairah R. Ijaz, Wing Y. Lam, Richard A. Larsen, Dragan Matic, Kevin C. Metcalfe, Duc M. Ngo, Theresa A. Patrizio, Deborah R. Peay, John W. Smolen, Eugene E. Stevens, Charles M. Vrabel, William F. Wadsworth, Christopher J. Warweg, LaShawnda K. Wilson, and Gregory J. Ziombra. Paul S. Johnston from the FDIC Office of Inspector General also contributed to this report. (196054): FOOTNOTES [1] GAO, Financial Audit: Federal Deposit Insurance Corporation Funds' 2004 and 2003 Financial Statements, GAO-05-281 (Washington, D.C.: Feb. 11, 2005). GAO's Mission: The Government Accountability Office, the investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO's commitment to good government is reflected in its core values of accountability, integrity, and reliability. Obtaining Copies of GAO Reports and Testimony: The fastest and easiest way to obtain copies of GAO documents at no cost is through the Internet. 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