Obligations Limitation: Resolution Trust Corporation's Compliance as of June 30, 1990

Published by the Government Accountability Office on 1990-12-21.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                    United   States   General   Accounting   Office
                    Report to the Chairman, Committee on
                    Banking, Finance and Urban Affairs,
                    House of Representatives

December    1990
                    Resolution Trust
                    Compliance as of
                    June 30,199O


      [Jnited States
GAO   General Accounting Office
      Washington, D.C. 20548
      Accounting and Financial
      Management Division


      December 21,199O

      The Honorable Henry B. Gonzalez
      Chairman, Committee on Banking, Finance
        and Urban Affairs
      House of Representatives

      Dear Mr. Chairman:

      In your December 19, 1989, letter, you requested that we report quar-
      terly on the Resolution Trust Corporation’s compliance with the max-
      imum obligation limit set forth in the Financial Institutions Reform,
      Recovery, and Enforcement Act of 1989 (FIRREX). The act provides the
      formula for calculating the limit and provides $50 billion in financing to
      resolve troubled savings and loan institutions placed into conservator-
      ship or receivership from January 1, 1989, through August 9, 1992. In
      .July 1990, we issued our report on the Corporation’s first quarter

      On September 28, 1990, the Corporation issued to you its second quar-
      terly report of the estimated values of its obligations, assets, and contri-
      butions received as of June 30, 1990. The Corporation reported that the
      financing it has received from the Resolution Funding Corporation
      (RWCORP) and the Department of the Treasury, plus its outstanding obli-
      gations, exceeded its assets by $29.5 billion and that its “adjusted obli-
      gation level” was therefore $20.5 billion below the $50 billion limitation
      on outstanding obligations.

      The Corporation included $18.8 billion received from Treasury in both
      its first and second quarter calculations, even though it was not required
      to do so by FIRRFA. As we stated in our first quarter report, if this
      amount were excluded, the Corporation would be able to incur an addi-
      tional $18.8 billion in net obligations without violating the section
      501(a) limitation. However, FIRREAdoes not provide funds to pay any
      additional obligations incurred. The Corporation’s first and second
      quarter treatment of the Treasury payment is consistent with the views
      of the Chairman and Ranking Minority Member, Senate Committee on
      Banking, Housing and [h-ban Affairs, as expressed in a September 26,
       1989, letter to the Secretary of the Treasury. The letter stated that

      ‘Obligations Limitation: Resolution Trust Ckpur’ation’s   &mpJiance   as of March 31, 1990
      (GAOIAFMD-~-101,        July 27, 1990)

      Page I                                              GAO/AFMB9141        Resolution   Trust Carporation

             end of the calendar year. The Oversight Board2 has taken some short-
             t,erm steps to address the Corporation’s funding needs through early
             next year. However, only quick action to identify a long-term solution
             will ensure the Corporation’s continued ability to respond to the nation’s
             thrift crisis.

             As part of our review work, we also followed up on the implementation
             status of recommendations we made to the Corporation’s Executive
             Director in our first quarter report. These recommendations addressed
             factors that could affect the cost of resolutions and the point at which
             the obligations limitation is reached. We found that Corporation man-
             agement is, in all instances, making progress on the recommendations
             but that. none have been fully implemented.

             In response to the savings and loan crisis and the Federal Savings and
Background   Loan Insurance Corporation’s (FSLIC) mounting losses, FIRREA (Public
             Law 101-73) was enacted into law on August 9, 1989. The act abolished
             FXLIC and transferred its insurance function to the Federal Deposit Insur-
             ance Corporation. FIRREA established the Resolution Trust Corporation
             to resolve the problems of instit,utions placed into conservatorship or
             receivership from January 1, 1989, until August 9, 1992. The act pro-
             vided the Corporation $50 billion to resolve the problems of those insti-
             tutions and to pay administrative expenses.”FIRREA also transferred
             EX.IC“Sassets and liabilities, except for those assumed by the Corpora-
             tion, to a newly established fund, the E’SI,ICResolution Fund.

             FIHREA gave the Corporation certain powers with which to accomplish its
             task, including the power to issue obligations and guarantees when
             acquiring an institution within its jurisdiction. The full faith and credit
             of the United States is pledged to the payment of such obligations if the
             principal amounts and maturity dates are stated in the obligations.

             ‘Thu ResolutionTrust CorporatamOversightBoard was createdby FIRREAto review and have
             overall responsibility for the Cwpwatwn’s actwities. The Secretaryof t.heTreasury SWVPS
                                                                                                   a the
             tlrw-d’s Chairman.
             “As of June 30, 1990,the Corporationhad receivedapproximately$33 billam in funds. The Corpora-
             tion w&sprovided $18.8billion by Treasury and $1.2 billion of cmtributions from the FederalHome
             Loan fJanks.The FederalHomr Loan Bank contributionswere transferred to the Corporationthrough
             RWCORP.Additionally, the Cwporation receivesproceedsfrom the $30 bilbon of bondsthat
             FIKKEA authorizedREFCORPto issue.As of June 30. 1990,REFCOKPhad transfwred $13 bdtion m
             bond proweds to the Corporation.

             Pagr 3                                         GAO/AFMD-HI-41Resolution Trust Corporation

                         As agreed with your staff, we performed a limited review of the Corpo-
Objectives, Scope, and   ration’s second quarter report to test its reasonableness. Specifically,
Methodology              our objectives were to determine if (1) all categories for the formula
                         required by FIRREA were included in the Corporation’s calculation and
                         (2) the values reported appeared reasonable for select components of
                         the calculation.

                         In order to determine the reasonableness of the values of selected com-
                         ponents included in the Corporation’s calculation, we confirmed that the
                         Corporation received contributions from REFCORP,funding from Trea-
                         sury, and Federal Financing Bank loans for working capital in the
                         amounts reported. For significant outstanding obligations other than
                         notes payable, we requested listings of Corporation legal liabilities and
                         contractual obligations. We reviewed the lists for reasonableness, recom-
                         puted the recommended reserve for probable litigation losses, and tested
                         lease obligations calculations which comprised most of the Corporation’s
                         contractual commitments. To ensure the reasonableness of reported
                         receivables from receiverships and conservatorships, we judgmentally
                         sampled from 46 percent to 100 percent of material receivable account
                         balances. We then traced selected transactions to supporting documenta-
                         tion, reconciled general ledger accounts with subsidiary ledgers, and/or
                         recalculated interest accruals.

                         We also evaluated thta reasonableness of the allowances for loss on
                         receivership claims as included in the Corporation’s second quarter
                         report. Our first quarter review of the allowance for loss on receivership
                         claims indicated that the Corporation was using a reasonable method-
                         ology to calculate the allowance. For this review, we selected a sample
                         equal to 75 percent of the total allowance and recalculated the estimated
                         loss for the individual rcbceiverships to ensure that the methodology was
                         being applied consistently and accurately. However, we were unable to
                         test the accuracy of the mark-to-market adjustment for the receiver-
                         ships’ assets because of the large volume and wide geographic disper-
                         sion of the assets as well as the Corporation’s lack of historical
                         experience in asset sales.

                         As discussed earlier. the Corporation eliminated its allowance for loss on
                         conservatorship advames based on (1) legal decisions indicating these
                         advances are priority claims and (2) calculations indicating that suffi-
                         cient assets exist to repay the advances. As part of our review proce-
                         dures, we evaluated t,he Corporation’s assumptions regarding the
                         collectibility of adwnws   and tested a sample of its calculations.

                         Page 5                               GAO/AFMD.Sl-41 Resolution Trust Corporation

In our September 1990 testimony before the House Committee on Ways
and Means,” we reiterated the Corporation’s need for at least another
$50 billion to complete its task of closing failed institutions in an orderly
and expeditious manner. We warned that the Corporation must be given
the funds to continue resolutions since prolonging the operations of
insolvent thrifts could add significantly to their ultimate cost.

On October 10, 1990, the Chairman of the Corporation’s Oversight
Board reported to the Congress that without additional funding, the
Corporation’s resolution activity would cease before the end of the cal-
endar year due to either insufficient loss funds or limits on working cap-
ital borrowings. Loss funds refer to monies that are not expected to be
recovered because they are paid to an acquirer of a failed institution to
cover that institution’s estimated negative net worth after its assets are
written down to fair market value. In contrast, working capital refers to
borrowed funds that are not intended to contribute to losses because the
borrowings (and interest) will be repaid. The working capital borrow-
ings provide temporary funding for the Corporation to purchase the
assets of failed institutions at their fair market value. When the assets
are sold, the Corporation will use the proceeds to repay the working
capital it borrowed.

FIRREA provided the Corporation with $50 billion to cover losses. How-
ever, the section 501(a) formula for calculating the Corporation’s limita-
tion on outstanding obligations accounts for only 85 percent of the fair
market value of noncash assets held by the Corporation. Because 15 per-
cent of the Corporation’s assets are not included in the formula, the Cor-
poration will reach the obligation limit before it utilizes the $50 billion in
loss funds.

In its operating plan for October 1990 through March 1991, the Corpora-
tion projected that it would reach the obligation limit and therefore be
prevented from borrowing the working capital funds required to
purchase the assets of failed thrifts as part of the resolution process.
This would occur as a result of following the obligation limit formula as
required, even though over $10 billion of the $50 billion in loss funds
provided by FIRREA would remain unused. The difference between the
value of the assets held by the Corporation and the 85 percent included

page7                                  GAO/AFMD-91-41Resolution Trust Corporation

                            we followed up with Corporation management to determine the imple-
                            mentation status of those recommendations and found that the Corpora-
                            tion is making progress in all three areas.

Receivership Tracking       Because the market value of assets is a key component in the obligation
System Is Being Developed   limit calculation, overestimation of these values could result in the Cor-
                            poration incurring liabilities it will be unable to repay from sales pro-
                            ceeds. This concern becomes significant as the Corporation approaches
                            the obligation limit. Therefore, we recommended that the Corporation
                            track and report the actual results of asset sales to provide the informa-
                            tion necessary for evaluating the accuracy of estimated fair market
                            values. In particular, we noted that collecting data on initial estimated
                            fair market value assigned, date available for sale and date sold, sales
                            price, and gain or loss would provide historical information against
                            which to compare future estimates.

                            In response to our recommendation, the Corporation stated that it is
                            developing a Receivership Asset Inventory System to report in detail the
                            sales status of individual assets. The system will report and analyze
                            such data as date available for sale, date sold, sales price, gain/loss on
                            disposal, and appraised values. The asset inventory system has an esti-
                            mated completion date of February 28, 1991.

Advances Are Being          Noncompliance with Corporation policies concerning the collateraliza-
Secured but Not Perfected   tion of advances made to conservatorships could lessen the Corpora-
                            tion’s return on asset recoveries, thereby increasing its resolution costs.
                            In our first quarter review, we found that conservatorship managing
                            agents were not following written Corporation procedures that required
                            all institutions to exc’cute a promissory note for each advance, pledge
                            collateral to secure those advances, and perfect the Corporation’s
                            security interest in t hc collateral. Therefore, we recommended that the
                            Corporation clarify and enforce its policies and guidelines regarding
                            conservatorship advances.

                            In response to our recommendation, the Corporation stated that an
                            internal review of conscrvat,orship advances had been conducted and all
                            instances of procedural noncompliance had been corrected. In partic-
                            ular, signed promissory notes for all advances were obtained from the
                            conservatorships. Additionally, certain procedural and reporting
                            changes have been implemented to enhance internal controls in this
                            arca. A new directive, issued on September 14. 1990, made the Deputy

                            Page 9                               GAO/AFMLS91-41Resolution Trust Corporation

              value of receivership assets and thereby affect the asset component of
              the limitation on outstanding obligations calculation.

              As evidenced by the cost of resolutions through October 1, 1990, and by
Conclusions   projections of costs to be incurred over the following g-month period,
              the Corporation requires additional funding to continue its operations in
              an orderly and expeditious manner. The Oversight Board’s decision to
              exclude the $18.8 billion of Treasury funding from the Corporation’s
              obligation limit calculation offers only a limited reprieve. A funding
              decision must be made soon or the Corporation will face higher resolu-
              tion costs due to cant inued operating losses in failed but unresolved

              The Corporation has made some progress in implementing the recom-
              mendations we made in our first quarter report. However, in all
              instances, implementation needs to be completed, additional actions
              taken, or subsequent events evaluated. As a result, we will continue to
              monitor the status of the Corporation’s actions as part of our third
              quarter report revic,w

              As agreed with your office, unless you publicly announce its contents
              earlier, we plan no further distribution of this report until 30 days from
              the date of this letter. At that time, we will send copies to interested
              parties and make copic,s available to others upon request.

              This report was prepared under the direction of Robert W. Gramling,
              Director, Corporatcs Financial Audits, who may be reached on (202)
              275-9406 if you or your staff have any questions. Major contributors are
              listed in appendix 111.

              Sincerely yours,

              Donald H. Chapin
              Assistant Comptroller General

              Page 11                              GAO/AF’MJh91-41Resolution Trust Corporation
Page 13   GAO/AF’MD-9141   Resolution   Trust Chporation
                              Appendix I
                              Resolution Trust Corporation Obligations and
                              Assetsas ofJune30,1999

1.   gutstandina           obliaatio3lB                                  I   30.2    bilUea

     Includes         $26.5 billion             in notes      issued      to the Federal
     Financing           Bank (FFB),          plus accrued         interest:       a 53.4    billion
     payable        for June          resolution        transactions         for which funds
     vere disbursed                in July;       and SO.2 billion           in current
     liabilities,             contractual           commitments        (leases),      and
     contingent           liabilities            (legal    exposure).          Contingent
     liabilities            already        applied      to the value         of RTC's claims           on
     failed       thrift        assets      are not included.               The estimated         future
     costs of resolving                  RTC conservatorships               and other     troubled
     thrifts        are also excluded.
                                                                         B 30.0      billion

     Includes  accounts                payable,   other      current    liabilities,             and
     notes issued    to          the      FFB, including        accrued     interest.
3.   Total   Fair harket Value                 of   won-cash1
        &osetcr Reid bv RTC                                              $ 34.6      bill&l
     Includes         $11.3 billion           in principal       value     of advances,
     accrued        interest,        and reimbursable           expenses       due from
     conservatorships.                 RTC advances        have a claims          priority        ahead
     of general          creditors         and are estimated          to be fully
     collectible.             Also includes           $23.5 billion         for the net
     realizable          value      of RTC claims         on receiverships.               The net
     realizable          value      accounts       for estimated        total     losses       to RTC
     for resolved            cases,      including       expenses     incurred        to manage
     and dispose           of assets,         as well     as estimated         losses      on assets
     covered        under      "put"     agreements.         The obligation           limitation
     counts       the total         of all non-cash          assets     at 95 percent            of the
     fair    market        value      shovn above.
4.   Cash      Held   bv     RTC                                         d 4.0      bilm
I.   Obliaationa            reondsl       Issued    bv REFCORP           S 13.0      billion
     Includes     $4.5 billion       issued    in October   1989, $5.0 billion
     issued    in January      1990, and $3.5 billion        issued    in April
     1990.     RTC also received         $19.9 billion    in Treasury     funds and
     a $1.2 billion       contribution       from the Federal      Home Loan Banks
      (through   REFCOIW).

                              Page 15                                          GAO/AFMD-91.IIResolution Trust Corporation
                                                ResolutionT~st Corporation Maximum
                                                Outstanding Obligations




           1)      CASH       AND EQUIVALENTS                                                                          4,043

0)       ESTIHATED             FMV OF OTHER ASSETS

           1)       CLAIHS         AGAINST RECEIVERSHIPS                                     20,016
                                   23,548 @ 85%

           2)       RECEIVABLES               FROM OPEN INSTITUTIONS                           9,574
                                    11,263       @ 858

           J)       MISC.        RECEIVABLES AND OTHER ASSETS                                          3
                                       4 @ 85%

                               TOTAL OTHER ASSETS                                                                    29,593

ADJUSTED OBLIGATION                          LEVEL (At&C-D)                                                         29,547
NAXIHlJ't4 LEVEL                                                                                                     50,000
           EXCESS OF HAXIMUH LEVEL OVER ADJUSTED                                                                     20,453
           OBLIGATION LEVEL AT 6/10/90  l *                                                                      ======iiE=

 t        Includes  $3,402                   million payable    for  June    resolution           transactions
          for which  funds                   were not disbursed     until    July.
 l   *    A positive  amount indicates    compliance    with                      the    obligation    limitation.
          It does not represent    the limit   on additional                          borrowings.      Additional
          bcrroving  authority  depends on the estimated                             value    of RTC assets      and
          the volume of REFCORP funds raised.

                                                Page17                                     GAO/AF'MD-9l-4I8esolution Trust Corporation
                                     Resolution    Trust     cOrj10ration     Maximum
                                     Amount     Limitation      on
                                     Outstanding      Obligations

          c. Continaent       Liabilities    Related  to the Resolution                                   Qf
          Conservatorshius         and Other Troubled   Thrrftq:    Not                                included     as
          outstanding      obligations.
     C.    Cash      and    Cash   Eauivalents

          Includes         cash,   cash     equivalents               (as     defined      in     FAS 195).
     D.        timated        Fair Market Value                 of    Other      A ssets        Held   bv the
           cO,FD  oration        (852 thereof1

          1. Claims      Aaainst     Receivershios:          Included     at 05% of the Net
          Realizable        Value of such claims.            Loss allowances       against     these
          claims     are estimates       made at the time of resolution.                 RTC
          currently       is implementing        policies      similar    to FDIC policies        for
          valuing     claims     against    receiverships,          which consider
          nondiscounted         cash inflows,       net of liquidation        expenses,      in
          determining        the cash available           to repay the Corporation.
          2. Receivables          from Ooen Institutions:         Included     at 95% of fair
          market     value.       These receivables       have a claims     priority      ahead of
          general     creditors       and are estimated       to be fully    collectible.
          Includes      principal      on advances,     accrued    interest    and other
          receivables        from conservatorships.
          3. Miscellaneous       Receivables    and Other Assets:                                  Includes       current
          assets,    all   at 952.    Also includes    claims from                                depositors       pending
          or unpaid      at 952.

Requests      for copies of GAO reports   should be sent to:

U.S. General Accounting       Office
Post Office Box 6015
Gaithersbug,   Maryland       20877

Telephone      202-275-6241

The first   five copies of each report    are free. Additional   copies are
$2.00 each.

There is a 25% discount       on orders for 100 or more copies mailed to a
single address.
Appendix    III

Major Contributors to This Report

                                Molly Boyle, Assistant Director
Accounting and                  Louise DiBenedetto, Audit Manager
Financial Management            Barbara E. Billingsley, Accountant
Division,         Washington,   Timothy P. Gonzales, Evaluator
                                Dawn A. Holmes, Accountant
DC.                             Kent L. Eby, Accountant

                                Jerry W. Pennington, Regional Assignment      Manager
Kansas City Regional            Marshall S. Picow, Site Senior
Office                          Rose M. Dorlac, Evaluator

                                Patricia E. Cheeseboro, Regional Assignment    Manager
Denver Regional                 Rudolph0 G. Payan, Site Senior
Office                          Diane S. Lund, Evaluator

(917671)                        Page 20                              GAO/AFXD9141   Resolution   Trust Corporation
                                       Appendix II
                                       Resolution Trust Corporation    Maximum
                                       Amount Limitation    on
                                       Oul.hmding   Obligations

                                           FIRREA    Section       501(a)      (j)
                Maximum           Amount    Limitation      on Outstandinq            Obliqations
                                                Explanatory     Notes

A.          ntributions             Received
     Includes         the $18.8 billion               of initial         Treasury  funding, the S1.2
     billion         FHLB contribution               (through         REFCORP), and REFCORP bond

8.        OutstandLDg             Obliaations
     1. Leaal     Exvosurr:        The expected       cost   of those                  pending     or
     threatened       litigations,      claims,      or assessments                    vhere     an estimated
     loss    to RTC (in its Corporate            and Receivership                      capacities)       is
     both    probable       and reasonably      estimable.      These                  are over and above
     any legal      costs already included             in the resolution                       loss
     3. Contractual           Obliaations:             The non-cancellable   portion      of
     outstanding        contractual          obligations.         As of June 30,    1990,    these
     included       primarily      multi-year             leases for space in Washington        and
     other     locations.
     3.     Accounts        Pavable       and Other    Liabilitiu:          Full    face value     of
     routine,          current      liabilities       such as accounts         payable   and accrued
     liabilities.              As of June 30, includes              payable    for those June
     resolutions            where cash disbursements               vere not made until        July.
     Also,        includes      the face value         of the liability          related   to pending
     claims         of depositors            (insured  deposits       owed but not yet paid).
      4.    Notes          Pavable and Other     Debt:     Full    face              value  of all        Federal
      Financing            Bank borrowings   and   accrued      interest                due thereon.
      Additional             Notes      on Outstandina          Obliaations:
      a. Guarantees:        Any expected    cost to the Corporation   of any
      guarantee      issued or assumed from FSLIC (i.e.,       FHLE advances
      guaranteed       by FSLIC).   No expected    cost to RTC since  there  are
      no deficiencies       in the underlying    collateral  on any of these
      guarantees       at June 30, 1990. There vere no other guarantees         as
      of that date.
      b,     Asset        Puts:        Included     in the allowance       for losses       on          resolved
      institutions               iS an estimate          of losses    on assets     likely            to be
      returned            to the RTC under a put aqreement.                   Therefore,              the
      receivables              for resolved        cases    have   already    been adjusted                for the
      contingent             liabilities        relating      to put agreements.           No         additional
      calculation              is necessary.

                                        Page 18                                        GAO/AFMD-91.41      Resolution   Trust Colporalioll
Appendix   II

Resolution Trust Corporation Maximum
Amount Limitation on Outs~ding Obligations

                                                       (5 in    millions)

           A)    CONTRIBUTIONS            RECEIVED

                   1)     TREASURY:                                                        16,600

                   2)     REFCORP:                                                          14,221
                                    TOTAL CONTRIBUTIONS                                                         13,021


                   1)      LEGAL EXPOSURE - ESTIMATED COSTS                                         95

                   7)      CONTRACTUAL OBLIGATIONS             (LEASES,     ETC.)                   95

                   3)      ACCOUNTS PAYABLE AND OTHER LIABILITIES                   l        3,429

                    4)     NOTES PAYABLE AND OTHER DEBT                                     26,543
                                    TOTAL OUTSTAJJDING OBLIGATIONS                                               30,162

                                              Page16                                    GA0/AF’MLM1-41   Resolution   Trust Corporation

Resolution Trust Corporation Obligations and -
Assets as of June 30,199O

                                          Resolution kust Corporation

                                                               September      28, 1990

            Honorable   Henry 8. Gonzalez
            Committee   on Banking,  Finance
              and Urban   Affairs
            House of Representatives
            Washington,   D.C. 20515
            Dear   Mr.   chairman:
            We are pleased            to submit       the second quarterly          report   which you
            requested     in your letter           of March 9, 1990, relating           to the working
            capital    needs of the Resolution               Trust Corporation.         This quarterly
            report    provides          estimated       values    of the RTC's obligations             and
            assets as of June 30, 1990, which are used to determine                         whether the
            RTC remains within            the limitation        on obligations     as mandated by the
            Financial      Institutions           Reform,      Recovery,     and Enforcement      Act of
             1989.    We have also included              a table    presenting    the computation       of
            the obligation          limitation       as of June 30.
            Oversight        Board    staff    are    currently          reviewing     our  June   30
            estimates;       we have not yet received           their     comments.     As you know,
            the     Oversight      Board    considers      the     effects       on the obligation
            limitation       when evaluating      RTC funding         requests.
            We hope that this         information         will  be of   assistance        to you.      If   you
            have any questions,           please    let      me know.

                                                                 David C. Cooke
                                                                 Executive Director
                                        Page 14                                      GAO/AFMD-91.41   Resolution   Trust Corporation

Appendix I
Resolution Trust
Obligations and Assets
as of June 30,199O
Appendix II                                                                                              16
Resolution Trust
Corporation Maximum
Amount Limitation on
Appendix III
Major Contributors to
This Report


                         FIKKEA    Financial Institutions Reform, Recovery, and Enforcement Act
                         E’SLIC    Federal Savings and Loan Insurance Corporation
                         KEFCOW    Resolution Funding Corporation

                         page 12                            GAO/AFMLb91-41   Resolution   Trust Corporation

                      Regional Directors for Resolutions and Operations responsible for the
                      collection and custody of all executed documents associated with the
                      secured advances. Promissory notes are to be executed by managing
                      agents and approved by the Deputy Regional Directors prior to receiving
                      Corporation funds. The original notes are then to be sent to headquar-
                      ters as verification of the conservatorship’s receipt of advance funds.
                      The Deputy Regional Directors for Resolutions are to submit weekly
                      reports to headquarters to track compliance with the documentation
                      requirements. For any institution reported as not complying with the
                      requirements, the report must indicate action taken to remedy the

                      The Corporation’s response also stated that it is currently conducting a
                      cost-benefit analysis of its perfection requirement. The Legal Division
                      has been asked to provide a legal analysis of the risks associated with
                      not perfecting the Corporation’s security interest, a legal definition of
                      perfection, and guidance on the minimum legal requirements to perfect
                      and the means of effective perfection. While this study is being per-
                      formed, Regional Directors have been advised to suspend efforts to per-
                      fect the Corporation’s interest in collateral pledged to secure advances.

Losses Inherent in    Sellers of asset-backed receivables to the secondary market are gener-
Representations and   ally expected to make certain representations and warranties, in the
                      form of factual disclosures, about the assets being sold and are expected
Warranties Will Be    to certify the accuracy of those statements. Without these representa-
Recognized            tions and warranties, the mortgage assets under the Corporation’s con-
                      trol would likely be subject to a substantial discount above and beyond
                      the cost of making such representations and warranties, and certain
                      assets might not be marketable at all. Warranties and representations,
                      however, create contingent liabilities and, if offered, would increase the
                      Corporation’s outstanding obligations and decrease the additional
                      amount of obligations the Corporation could incur. Given the apparent
                      need for representations and warranties, we recommended that when
                      given, an appropriate estimate of the resulting contingent liabilities be
                      made and reflected in the Corporation’s obligations limitation

                       The Corporation responded that its experience with representations and
                       warranties has been quite limited. However! Corporation receiverships
                       will establish reserves for those representations and warranties that are
                       made to facilitate asset sales. These reserves will reduce the fair market

                       Page 10                             GAO/AFMD-91-41   Resolution   Trust Corporation

                        in the formula is to help ensure that the Corporation could pay its obli-
                        gations if the fair market value of the assets which support those pay-
                        ments is not overstated by more than 15 percent. The 15 percent
                        differential is an important safeguard because the Corporation does not
                        have historical sales price data to support estimated fair market value
                        calculations for receivership assets.

                        According to the Chairman of the Oversight Board, even if the 15 per-
                        cent differential could be eliminated or circumvented so that working
                        capital could be borrowed, the Corporation would use virtually all of the
                        $50 billion in loss funds before December 31, 1990. At that time, the
                        Corporation would not be able to incur additional obligations and con-
                        tinue resolving troubled thrifts. To avoid this situation, the Oversight
                        Board requested that the Congress provide the Corporation with an
                        additional $40 billion in loss funds and $17 billion to serve as the
                        required reserve for obligations. This reserve would not be spent but
                        would allow the Corporation access to all loss funds. The Congress, how-
                        ever, did not provide the additional funding before it recessed on
                        October 28, 1990.

                        In the absence of additional funding, the Oversight Board directed the
                        Corporation on November 2, 1990, to exclude the $18.8 billion of Trea-
                        sury funding from the contribution component of the formula when
                        computing future compliance with the obligations limitation. The Corpo-
                        ration is using the Treasury funding to represent the required 15 per-
                        cent differential. This will protect against government losses while
                        allowing the Corporation to utilize unspent loss funds and additional
                        working capital borrowings without exceeding the limitation on out-
                        standing obligations. This short-term solution will allow resolutions
                        through early 199 I.

                        Our first quarter report identified three important factors that could
Implementation Status   affect the cost of resolutions and the point at which the obligations limi-
of First Quarter        tation is reached. These factors included the overestimation of the fair
Review                  market value of assets; noncompliance with Corporation policy gov-
                        erning pledging collateral for advances to conservatorships; and failure
Recommendations         to estimate and disclose the resulting contingent liability for representa-
                        tions and warranties given in connection with the sale of assets. To
                        address these factors, we made specific recommendations to the Corpo-
                        ration’s Executivcb Director. As part of our second quarter review work,

                        Page 8                               GAO/AFMD91-41   Resolution   Trust Ckwporation

                  During our review of the Corporation’s second quarter compliance, we
                  performed our work at the Corporation’s headquarters and, in some
                  instances, in its Central and Western Regions. In three Western Region
                  conservatorships, we made inquiries of management and other per-
                  sonnel related to high cost funds and liquidity advances and performed
                  selected procedures where necessary. Our procedures for conservator-
                  ships primarily consisted of interviews with their personnel, examina-
                  tions of supporting documentation regarding the receipt and recording
                  of advances, and tests of compliance with Corporation policies and pro-
                  cedures for securing and collateralizing advances. We also interviewed
                  Corporation officials at headquarters to determine the status of the rec-
                  ommendations we made in our first quarterly report.

                  We performed our work in accordance with generally accepted govern-
                  ment auditing standards. The scope of our work, however, did not
                  include a review of the internal control environment. Also, we did not
                  test or verify the books and records of the Corporation or the data con-
                  tained in appendixes I and II, except for the procedures detailed in this
                  section. Our review of compliance with laws and regulations was limited
                  to the Corporation’s compliance with the obligations limitation.

                  While we did not obtain written comments on this report, we discussed
                  its contents with cognizant Corporation officials, who agreed with the
                  report’s findings and conclusions. We have incorporated their comments
                  where appropriate.

                  In the following sections, we discuss the current status of Corporation
                  funding and the implementation status of the recommendations we
                  made to the Corporation in our first quarter report.

                  In our April 1990 testimony before the Senate Committee on Banking,
-,      Funding   Housing and Urban Affairs,4 we estimated that the Corporation would
Status            need at least $100 billion, $50 billion more than FIRREA already provides,
                  to cover resolution costs. To address this shortfall, we recommended
                  that the Corporation’s Oversight Board develop funding proposals for
                  congressional consideration. Since that time the administration has pro-
                  posed various general funding mechanisms, any of which would have
                  resolved the Corporation’s immediate cash flow needs. However, the
                  Congress has not yet act,ed on any of the proposals.

                   4Resolvingthe Savingsand Imm (‘rise Billions More and Additional ReformsNeeded
                   (GAO/T-AFMD-90.15, Apnl 6. 1990)

                   Page 6                                       GAO/AFMD-91-41Resolution Trust Corporation

However, section 501(a) of FIRREA limits the outstanding obligations of
the Corporation and provides a formula for calculating the limitation on
such obligations. FIRREA states that the sum of contributions received
from REFCORPplus outstanding obligations may not exceed the Corpora-
tion’s available rash plus 85 percent of the fair market value of its other
assets by more than 850 billion.

Obligations are defined as including (1) any obligation or other liability
assumed by the Corporation from FSLIC, (2) any guarantee issued by the
Corporation, (3) the total of outstanding amounts borrowed from the
Treasury as authorized by FIKREA, and (4) any other obligation, direct or
contingent, for which the Corporation is liable.

FIRREA provided fc)r the Corporation to receive $18.8 billion from Trea-
sury in fiscal year 1989, which the Corporation included in the formula
for calculating the limit on outstanding obligations for its first and
second quarter reports. However, the formula in section 501(a) does not
explicitly contain the Treasury funding and there is no basis in the law
for concluding that it is encompassed either by the REFCOKPcontribu-
tions or the obligations components in the formula. Therefore, as a
matter of law, the Corporation is not required t.o include the Treasury
funding in its calculation of whether the FIKREA limitation on out-
standing obligations has been reached.

The Corporation imlrtded an allowance for loss on advances made to
conservatorships cbqualto approximately 33 percent of the receivable in
its first quarter report because the collectibility of these advances was
questionable. However, recent decisions of the Corporation’s Legal Divi-
sion have indicated that the advances are priority claims and, if secured,
should be fully collectible. To ensure sufficient resources exist to repay
the advances, the Corporation calculated the liquidation value of conser-
vatorship assets and subt ratted from that amount the total conservator-
ship advances and ot,her secured liabilities. If the liquidation value of
the assets equaled or exceeded the priority claims, no loss was recog-
nized. In only one conservatorship did the value of advances and other
secured liabilities c)xctredthe asset liquidation value and the excess was
less than $1 million. As a result, the Corporation eliminated its allow-
ance for loss on advances to conservatorships in its second quarter

 page4                                GAO/APMD-91-41ResolutionTrust Corporation

                   nothing in FIRREA should be viewed as permanently expanding the Cor-
                   poration’s $50 billion limitation. The Corporation’s report and an accom-
                   panying table providing details on the computation are included as
                   appendixes 1 and 11,respectively.

                   During our review period, the Corporation issued its operating plan for
                   the 6 months beginning October 1, 1990. This plan indicated that the
                   Corporation would soon reach the obligation limit and would then be
                   unable to continut, resolving failed institutions. To provide you with
                   information that may impact future compliance with the obligation
                   limit, we have included a discussion of the Corporation’s funding status
                   in this report.

                   Based on our reviclw of the Corporation’s September 28, 1990, report
Results in Brief   and schedule and its financial records, we determined that none of the
                   categories for the formula required by AKKEA were omitted from the
                   Corporation’s calculation. While our work did identify several errors
                   and misclassifications in the Corporation’s financial accounts, none of
                   them would have a material effect on the calculation of the limitation.
                   We reported our findings to Corporation management and are currently
                   working with them t,o correct the problems. WC did not attempt to deter-
                   mine the amount of any undisclosed obligation or overvalued assets of
                   the Corporation which, if disclosed, would have affected its calculation.
                   However, considering the results of our review and the size of the
                   reported excess balance available as of June 30, 1990, we believe there
                   is little risk that the Corporation exceeded the limitation.

                   The Corporation’s operating plan for October 1990 through March 1991
                   indicates that it will face a funding crisis. Without sufficient funds to
                   absorb the losses and to purchase the assets of failed institutions, the
                   Corporation will have to slow down its resolution activity. There may be
                   disagreement concerning the ultimate cost, of such a slowdown, but all
                   agree that allowing failed institutions to continue to incur operating
                   losses will increase rfasohltion costs.

                   Although the administration has not recently appeared before your
                   Committee to discuss funding options, the Secretary of the Treasury’s
                   October 10, 1990, letter to the Congress stated that without additional
                   funding, the Corporation’s resolution activity would cease before the