[[Page 57472]]

B. Private Sector Adjustment FactorIn March 2009, the Board requested comment on proposed changes to the methodology for calculating the PSAF.\10\ The Board proposed replacing the current correspondent bank model with a ``publicly traded firm model' in which the key components used to determine the pricedservices balance sheet and the PSAF costs would be based on data for the market of U.S. publicly traded firms. Specifically, these components include the capitalization ratio used to determine financing on the pricedservices balance sheet and the effective tax rate, return on equity rate, and debt financing rates. The proposed changes were prompted by the implementation of the payment of interest on reserve (IOR) balances held by depository institutions (DIs) at the Reserve Banks and the anticipated consequent decline in balances held by DIs at Reserve Banks for clearing pricedservices transactions (clearing balances). \10\ 74 FR 1548115491 (Apr. 6, 2009).

Since the implementation of IOR, clearing balances have not declined as rapidly or significantly as originally anticipated. Between the implementation of IOR in October 2008 and January 2009, the total level of clearing balances held by DIs decreased approximately $2 billion, from $6.5 billion to $4.5 billion. During the first half of 2009, clearing balance levels were fairly flat at approximately $4.5 billion. Recently, clearing balances have begun to moderately decline again, with an average balance of $4.0 billion in September 2009. As a result of the relative stability in clearing balance behavior and the continued significant level of balances, the Board will continue to use the correspondent bank model, with two minor modifications, for the 2010 PSAF. First, given the lower level of clearing balances, the Board will reduce the level of core clearing balances.\11\ Second, in the event that debt is required, the Board will use marketbased rather than bank holding company (BHC)based debt rates. Both of these changes are outlined below.
\11\ Core clearing balances are considered the portion of clearing balances that has remained stable over time and are used to fund longterm priced services assets as needed.

The Board is currently analyzing further the proposed publicly traded firm model and an alternate model suggested by several commenters based on a peer group of publicly traded payments processors.

B. Private Sector Adjustment FactorThe method for calculating the financing and equity costs in the PSAF requires determining the appropriate imputed levels of debt and equity and then applying the applicable financing rates. In this process, a pro forma balance sheet using estimated assets and liabilities associated with the Reserve Banks' priced services is developed, and the remaining elements that would exist if these priced services were provided by a private business firm are imputed. The same generally accepted accounting principles that apply to commercialentity financial statements also apply to the relevant elements in the pricedservices pro forma financial statements.

The portion of Federal Reserve assets that will be used to provide priced services during the coming year is determined using information on actual assets and projected disposals and acquisitions. The priced portion of these assets is determined based on the allocation of the related depreciation expense. The priced portion of actual Federal Reserve liabilities consists of clearing balances and other liabilities such as accounts payable and accrued expenses.

Longterm debt is imputed only when core clearing balances, long term liabilities, and equity are not sufficient to fund longterm assets or if the interest rate risk sensitivity analysis, which measures the interest rate effect of the difference between interest rate sensitive assets and liabilities, indicates that a 200 basis point change in interest rates would change cost recovery by more than two percentage points. Shortterm debt is imputed only when shortterm liabilities and clearing balances not used to finance longterm assets are insufficient to fund shortterm assets. A portion of clearing balances is used as a funding source for shortterm pricedservices assets. Longterm assets are partially funded from core clearing balances.

Because of the notable reduction in clearing balances since the implementation of IOR, the Board will adjust the level of core clearing balances from $4 billion to $1 billion. In addition, the Board will base the imputed debt rate on a marketbased average debt rate for any imputed debt, if necessary, rather than an average BHC debt rate.\12\ As compared to an average BHC rate, a marketbased debt rate is easier to calculate and more transparent. The Board will use the average of the 3month AA and A2/P2 nonfinancial commercial paper rates for short term debt and the Merrill Lynch Corporate and High Yield Bond Index yield for longterm debt. The Board requested comment on this proposed change to the correspondent bank model. No comments were received that addressed this proposal.
\12\ This change will likely have little practical effect on the PSAF because the funding need on the priced services balance sheet historically has been a fraction of the available clearing balances. Given current priced services assets and liabilities, the Board anticipates that even with sizable decreases in clearing balances through 2010, imputed debt will not be necessary.

Imputed equity meets the FDIC requirements for a wellcapitalized institution for insurance premium purposes and represents the market capitalization, or shareholder value, for Reserve Bank priced services.\13\ The equity financing rate is the targeted ROE rate produced by the capital asset pricing model (CAPM). In the CAPM, the required rate of return on a firm's equity is equal to the return on a riskfree asset plus a risk premium. To implement the CAPM, the risk free rate is based on the threemonth Treasury bill; the beta is assumed to equal 1.0, which approximates the risk of the market as a whole; and the monthly returns in excess of the riskfree rate over the most recent 40 years are used as the market risk premium. The resulting ROE influences the dollar level of the PSAF because this is the return a shareholder would require in order to invest in a private business firm.
\13\ The FDIC requirements for a wellcapitalized depository institution are (1) a ratio of total capital to riskweighted assets of 10 percent or greater, (2) a ratio of Tier 1 capital to risk weighted assets of 6 percent or greater, and (3) a leverage ratio of Tier 1 capital to total assets of 5 percent or greater. The priced services balance sheet has no components of Tier 1 or total capital other than equity; therefore, requirements 1 and 2 are essentially the same measurement.

As used in this context, the term ``shareholder'' does not refer to the member banks of the Federal Reserve System, but rather to the implied shareholders that would have an ownership interest if the Reserve Banks' priced services were provided by a private firm.

For simplicity, given that federal corporate income tax rates are graduated, state income tax rates vary, and various credits and deductions can apply, an actual income tax expense is not calculated for Reserve Bank priced services. Instead, the Board targets a pretax ROE that would provide sufficient income to fulfill the priced services' imputed income tax obligations. To the extent that actual performance results are greater or less than the targeted ROE, income taxes are adjusted using an imputed income tax rate that is the median of the rates paid by the top fifty bank holding companies based on deposit balances over the past five years, adjusted to the extent that they invested in taxfree municipal bonds.

The PSAF also includes the estimated pricedservicesrelated expenses of the Board of Governors and imputed sales
[[Page 57473]]
taxes based on Reserve Bank estimated expenditures. An assessment for FDIC insurance is imputed based on current FDIC rates and projected clearing balances held with the Reserve Banks.

1. Net Income on Clearing BalancesThe NICB calculation is performed each year along with the PSAF calculation and is based on the assumption that the Reserve Banks invest clearing balances net of an imputed reserve requirement and balances used to finance priced services assets.\14\ The Reserve Banks impute a constant spread, determined by the return on a portfolio of investments, over the three month Treasury bill rate and apply this investment rate to the net level of clearing balances.\15\
\14\ Reserve requirements are the amount of funds that a DI must hold in reserve against specified deposit liabilities. DIs must hold reserves in the form of vault cash or deposits with Federal Reserve Banks. The dollar amount of a DI's reserve requirement is determined by applying the reserve ratios specified in the Board's Regulation D to the institution's reservable liabilities. The Reserve Banks priced services impute a reserve requirement of ten percent, which is applied to the amount of clearing balances held with the Reserve Banks.
\15\ The investment portfolio is composed of investments comparable to a bank holding company's investment holdings, such as shortterm Treasury securities, government agency securities, commercial paper, longterm corporate bonds, and money market funds. See table 7 for the investments imputed in 2010.

NICB is projected to be $14.5 million for 2010. This result uses an investment rate equal to a constant spread of 29 basis points over the threemonth Treasury bill rate, applied to the clearing balance levels used in the 2010 pricing process. The 2009 NICB estimate is $14.0 million.

The calculation also involves determining the pricedservices cost of earnings credits (amounts available to offset service fees) on contracted clearing balances held, net of expired earnings credits, based on a discounted Treasury bill rate. Rates and clearing balance levels used in the 2010 projected NICB are based on July 2009 rates and clearing balance levels. Because clearing balances are held for clearing pricedservices transactions or offsetting pricedservices fees, they are directly related to priced services. The net earnings or expense attributed to the investments and the cost associated with holding clearing balances, therefore, are considered net income for priced services.

Because the Reserve Banks now pay interest on reserve balances, a return on the imputed reserve requirement based on the level of clearing balances on the pro forma balance sheet is also projected.\16\ Similar to the NICB calculation, the interest income on the imputed reserve requirement calculation is based on July 2009 clearing balance and rate information. In addition, because all excess balances held at the Reserve Banks receive explicit interest following the
implementation of IOR, the priced services no longer impute investment income on any portion of excess balances. Consequently, the clearing balances on the pricedservices pro forma balance sheet do not reflect excess clearing balances and only consist of contracted clearing balances held.
\16\ The imputed interest income on the imputed reserve requirement is projected to be $1.5 million for 2010. The projected 2010 rate for imputed interest income on the reserve requirement is based on the July 2009 rate of 0.25 percent.

2. Calculating Cost RecoveryThe PSAF and NICB are incorporated into the projected and actual annual cost recovery calculations for Reserve Bank priced services. In the fall of each year, the Board projects the PSAF for the following year using July clearing balance and rate data during the process of establishing priced services fees. When calculating actual cost recovery for the priced services at the end of each year, the Board historically has used the projected PSAF derived during the pricesetting process with only minimal adjustments for actual rates or balance levels.\17\ For 2009, in light of the uncertainty about the longterm effect that IOR would have on the level of clearing balances, the Board will adjust the PSAF used in the actual costrecovery calculation to reflect the actual clearing balance levels maintained throughout 2009. NICB is also projected in the fall of each year using July data and is recalculated to reflect actual interest rates and clearing balance levels throughout the year when calculating actual priced services cost recovery.
\17\ The largest portion of the PSAF, the target ROE,
historically has been fixed. Imputed sales tax, income tax, and the FDIC assessment are recalculated at the end of each year to adjust for actual expenditures, net income, and clearing balance levels.

3. Analysis of the 2010 PSAFThe 2010 PSAF for Reserve Bank priced services is $50.2 million. This amount represents a decrease of $2.6 million from the estimated 2009 revised PSAF of $52.8 million and a decrease of $12.0 million from the 2009 budgeted PSAF of $62.2 million. The decrease in the 2010 PSAF is primarily due to a reduction in the level of imputed equity and in the targeted ROE rate provided by the CAPM, partially offset by an increase in the imputed FDIC assessment.

Estimated 2010 Federal Reserve pricedservices assets, reflected in table 3, have decreased $1,780.7 million, mainly due to a decline in imputed investments in marketable securities of $1,634.3 million. This reduction stems from the decline in clearing balances held by DIs at Reserve Banks following the implementation of IOR in October 2008.

The pricedservices balance sheet includes projected clearing balances of $4,831.5 million, which represent a decrease of $2,530.1 million from the amount of clearing balances on the balance sheet for the budgeted 2009 PSAF. Because of the continued uncertainty regarding the level of clearing balances in an IOR environment, the actual PSAF costs used in costrecovery calculations will continue to be based on the actual levels of clearing balances held throughout 2010.\18\ To the extent that clearing balances fall below the current level of core clearing balances, debt would be imputed.
\18\ To the extent that the interest rates on excess balances are higher than the earnings credit rate, clearing balances will likely continue to decline. It is difficult to forecast the rapidity and degree of this shift because it depends on DI behavior and the disparity between the excess reserves rate and the earnings credit rate, which at current rates is negligible. The Board is planning to evaluate DIs' views as to any continued benefit to retaining the clearing balance program.

Credit float, which represents the difference between items in process of collection and deferred credit items, increased from $617.8 million in 2009 to $1,200.0 million in 2010.\19\ The increase is primarily a result of new check products introduced in 2009. \19\ Credit float occurs when the Reserve Banks present items for collection to the paying bank prior to providing credit to the depositing bank.

As previously mentioned, clearing balances are available as a funding source for pricedservices assets. As shown in table 4, in 2010, $10.2 million in clearing balances is used as a funding source for shortterm assets. Because of moderate decreases in several long term assets in 2010 ($154.4 million in pension assets, $86.9 million in Bank premises, and $30.7 million in furniture and equipment), longterm liabilities exceed longterm assets by $46.5 million. Consequently, no core clearing balances are used to fund longterm assets and the excess $46.5 million in equity capital is included in the NICB projection calculation as additional imputed investments. This represents a decrease of $72.3 million in clearing balances used to fund priced services assets in 2010 over the level of clearing balances used to fund assets for the 2009 PSAF. The interest rate sensitivity analysis in table 5 indicates that a 200 basis point decrease in interest rates affects the ratio of ratesensitive assets to ratesensitive liabilities and increases cost recovery by 1.3 percentage points, while an increase of 200 basis points in
[[Page 57474]]
interest rates decreases cost recovery by 1.3 percentage points. The established threshold for a change in cost recovery is two percentage points; therefore, interest rate risk associated with using these balances is within acceptable levels and no longterm debt is imputed.

As shown in table 3, the amount of equity imputed for the 2010 PSAF is $369.4 million, a decrease of $89.0 million from the imputed equity for 2009. In accordance with FAS 158 [ASC 715], this amount includes an accumulated other comprehensive loss of $407.7 million. Both the capital to total assets ratio and the capital to riskweighted assets ratio meet or exceed the regulatory requirements for a wellcapitalized DI. Equity is calculated as 5.0 percent of total assets, and the ratio of capital to riskweighted assets is 10.0 percent.\20\ The Reserve Banks imputed an FDIC assessment for the priced services based on the FDIC's proposed 2010 assessment rates and the level of clearing balances held at Reserve Banks. For 2010, the FDIC assessment is imputed at $9.6 million, compared with a net FDIC assessment of $0.9 million in 2009. The increase is due to the exhaustion of the onetime FDIC credit that was used in prior years to offset a majority of the estimated FDIC assessment.\21\ The imputed FDIC assessment also reflects the increased rates and new assessment calculation methodology from the FDIC's most recent proposed rule, which resulted in a prepaid FDIC asset of $24.6 million on the pricedservices balance sheet.\22\ \20\ In December 2006, the Board, the FDIC, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision announced an interim ruling that excludes FAS 158 [ASC 715]related accumulated other comprehensive income or losses from the
calculation of regulatory capital. The Reserve Banks, however, elected to impute total equity at 5 percent of assets, as indicated above, until the regulators announce a final ruling.
\21\ Previously, per FDIC rules, any remaining portion of the onetime assessment credit could offset up to 90 percent of the assessment amount. For 2009, 90 percent of the total imputed assessment of $9.3 million was offset by the remaining assessment credit, resulting in a net assessment of $0.9 million. No credit remained in 2010 to offset any portion of the $9.6 million assessment.
\22\ For information on the proposed 2009 FDIC assessment rates, see http://www.fdic.gov/news/news/press/2009/pr09178.html. \23\ The 2009 PSAF values in tables 3, 4 and 6 reflect the budgeted 2009 PSAF of $62.2 million approved by the Board in October 2008.
\24\ Represents float that is directly estimated at the service level.
\25\ Includes the allocation of Board of Governors assets to priced services of $0.9 million for 2010 and $1.1 million for 2009. \26\ No debt is imputed because clearing balances are a funding source.
\27\ Includes an accumulated other comprehensive loss of $322.6 million for 2009 and $407.7 million for 2010, which reflect the ongoing amortization of the accumulated loss in accordance with FAS 158 [ASC 715]. Future gains or losses, and their effects on the pro forma balance sheet, cannot be projected.

Table 6 shows the imputed PSAF elements, including the pretax ROE and other required PSAF costs, for 2009 and 2010. The $18.0 million decrease in ROE is caused by the combination of a lower amount of imputed equity and a decrease in the riskfree rate of return. Sales taxes decreased from $7.3 million in 2009 to $5.2 million in 2010. The effective income tax rate used in 2010 increased to 33.1 percent from 32.6 percent in 2009. The pricedservices portion of the Board's expenses decreased $0.6 million from $7.8 million in 2009 to $7.2 million in 2010.
Table 3Comparison of Pro Forma Balance Sheets for Federal Reserve Priced Services \23\ [Millions of dollarsprojected average for year] 2010 2009 Change Shortterm assets:

Imputed reserve requirement on clearing balances............ $603.1 $797.9 $(194.8)

Receivables................................................. 45.9 53.6 (7.7)

Materials and supplies...................................... 0.9 1.9 (1.0)

Prepaid expenses............................................ 23.2 26.3 (3.1)

Items in process of collection \24\......................... 520.0 236.4 283.6 Total shortterm assets................................. 1,193.1 1,116.1 77.0 Imputed investments............................................. $5,464.7 $7,099.0 $(1,634.3) Longterm assets:

Premises \25\............................................... $235.4 $322.3 $(86.9)

Furniture and equipment..................................... 62.1 92.8 (30.7)

Leasehold improvements and longterm prepayments............ 60.3 83.0 (22.7)

Prepaid pension costs....................................... 148.9 303.3 (154.4)

Prepaid FDIC asset.......................................... 24.6 0.0 24.6

Deferred tax asset.......................................... 198.9 152.2 46.7 Total longterm assets.................................. 730.2 953.6 (223.4) Total assets........................................ $7,388.0 $9,168.7 $(1,780.7) =============================================== Shortterm liabilities \26\

Clearing balances........................................... $4,831.5 $7,361.6 $(2,530.1)

Deferred credit items \24\.................................. 1,720.0 854.2 865.8

Shortterm payables......................................... 59.8 84.3 (24.5) Total shortterm liabilities............................ 6,611.3 8,300.1 (1,688.8) Longterm liabilities \26\

Postemployment/postretirement benefits liability............ $407.3 $410.2 $(2.9) Total liabilities....................................... $7,018.6 $8,710.3 $(1,691.7) Equity \27\..................................................... 369.4 458.4 (89.0) Total liabilities and equity............................ $7,388.0 $9,168.7 $(1,780.7) BILLING CODE 621001P
[[Page 57475]]

\28\ Clearing balances shown in table 3 are available for financing pricedservices assets. Using these balances reduces the amount available for investment in the NICB calculation. Longterm assets are financed with longterm liabilities, equity, and core clearing balances; a total of $4 billion and $1 billion in clearing balances is available for this purpose in 2009 and 2010,
respectively. Shortterm assets are financed with shortterm payables and clearing balances not used to finance longterm assets. No short or longterm debt is imputed.
\29\ See table 6 for calculation of required imputed equity amount.
[GRAPHIC] [TIFF OMITTED] TN06NO09.001
[[Page 57476]]
Table 52010 Interest Rate Sensitivity Analysis \30\ [millions of dollars] Rate Rate sensitive insensitive Total Assets:

Imputed reserve requirement on clearing balances............ .............. $603.1 $603.1

Imputed investments......................................... $5,464.7 .............. 5,464.7

Receivables................................................. .............. 45.9 45.9

Materials and supplies...................................... .............. 0.9 0.9

Prepaid expenses............................................ .............. 23.2 23.2

Items in process of collection \31\......................... (1,200.0) 1,720.0 520.0

Longterm assets............................................ .............. 730.2 730.2 Total assets............................................ $4,264.7 $3,123.3 $7,388.0 =============================================== Liabilities:

Clearing balances........................................... $4,831.5 .............. $4,831.5

Deferred credit items....................................... .............. $1,720.0 1,720.0

Shortterm payables......................................... .............. 59.8 59.8

Longterm liabilities....................................... .............. 407.3 407.3 Total liabilities....................................... $4,831.5 $2,187.1 $7,018.6 ¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤=============================================== 200 basis 200 basis point point Rate change results decrease increase in rates in rates Asset yield ($4,264.7 x rate change)............ $(85.3) $85.3 Liability cost ($4,831.5 x rate change)......... (96.6) 96.6
Effect of 200 basis point change........ $11.3 $(11.3) ======================= 2010 budgeted revenue........................... $565.8 $565.8 Effect of change................................ 11.3 (11.3)
Revenue adjusted for effect of interest $577.1 $554.5 rate change............................
======================= 2010 budgeted total expenses.................... $543.7 $543.7 2010 budgeted PSAF (net of $9.3 tax effect) \32\ 40.9 40.9 Tax effect of interest rate change ($ change x 3.8 (3.8) 33.1%).........................................

Total recovery amounts.................. $588.4 $580.8 ======================= Recovery rate before interest rate change....... 96.8% 96.8% Recovery rate after interest rate change........ 98.1% 95.5% Effect of interest rate change on cost recovery 1.3% (1.3)% \33\...........................................
BILLING CODE 621001P

\30\ The interest rate sensitivity analysis evaluates the level of interest rate risk presented by the difference between rate sensitive assets and ratesensitive liabilities. The analysis reviews the ratiosensitive assets to ratesensitive liabilities and the effect on cost recovery of a change in interest rates of up to 200 basis points.
\31\ The amount designated as ratesensitive represents items collected prior to providing credit according to established availability schedules.
\32\ The tax effect is due to the projected underrecovery of total actual costs, imputed costs, and targeted ROE.
\33\ The effect of a potential change in rates is less than a two percentage point change in cost recovery; therefore, no long term debt is imputed for 2010.
[[Page 57477]]
[GRAPHIC] [TIFF OMITTED] TN06NO09.002

\34\ No shortterm is imputed because clearing balances are a fundign source for those assets that are not financed with short term payables.
\35\ No longterm debt is imputed because core clearing balances are a funding source.
\36\ Based on the regulatory requirements for a wellcapitalized institution for the purpose of assessing insurance premiums. \37\ The 2010 ROE is equal to a riskfree rate plus a risk premium (beta * market risk premium). The 2010 aftertax CAPM ROE is calculated as 0.18% + (1 * 4.93%) = 5.11%. Using a tax rate of 33.1%, the aftertax ROE is converted into a pretax ROE, which results in a pretax ROE of (5.11% / (133.1%)) = 7.6%.
\38\ System 2010 budgeted priced services expenses less shipping and float are $521.2 million.
[[Page 57478]]
Table 7Computation of 2010 Capital Adequacy for Federal Reserve Priced Services
[Millions of dollars]
Weighted Assets Risk weight assets Imputed reserve requirement on $603.1 0.0 $0.0 clearing balances...............

Imputed investments:

3month Treasury bills $2,317.5 0.0 $0.0 \39,40\.....................

Commercial paper (1month) 2,746.3 1.0 2,746.3 \39\........................

GNMA mutual fund \41\........ 400.9 0.2 80.2
Total imputed investments 5,464.7 ........... 2,826.5 Receivables...................... $45.9 0.2 $9.2 Materials and supplies........... 0.9 1.0 0.9 Prepaid expenses................. 23.2 1.0 23.2 Items in process of collection... 520.0 0.2 104.0 Premises......................... 235.4 1.0 235.4 Furniture and equipment.......... 62.1 1.0 62.1 Leasehold improvements and long 60.3 1.0 60.3 term prepayments................
Prepaid pension costs............ 148.9 1.0 148.9 Prepaid FDIC asset............... 24.6 1.0 24.6 Deferred tax asset............... 198.9 1.0 198.9
Total.................... $7,388.0 ........... $3,694.0 ====================================== Imputed equity for 2010.......... $369.4
Capital to riskweighted assets.. 10.0%

Capital to total assets.......... 5.0%

C. Earnings Credits on Clearing BalancesThe Reserve Banks will maintain the current rate of 80 percent of the threemonth Treasury bill rate to calculate earnings credits on clearing balances. \39\ The imputed investments are assumed to be similar to those for which rates are available on teh Federal Reserve's H.15 statistical release, which can be located at http:// www.federalreserve.gov/releases/h15/data.htm.
\40\ Includes estimated amounts arising from the collection of items prior to providing credit according to established
availability schedules. These amounts are assumed to be invested in a shortterm Treasury security.
\41\ The imputed mutual fund investment is based on Vanguard's GNMA Fund Investor Shares fund, which was chosen based on the investment strategies articulated in its prospectuses. The fund returns can be located at https://personal.vanguard.com/VGApp/hnw/ FundsByType.

Clearing balances were introduced in 1981, as part of the Board's implementation of the Monetary Control Act, to facilitate access to Federal Reserve priced services by institutions that did not have sufficient reserve balances to support the settlement of their payment transactions. The earnings credit calculation uses a percentage discount on a rolling thirteenweek average of the annualized coupon equivalent yield of threemonth Treasury bills in the secondary market. Earnings credits, which are calculated monthly, can be used only to offset charges for priced services and expire if not used within one year.\42\
\42\ A band is established around the contracted clearing balance to determine the maximum balance on which credits are earned as well as any deficiency charges. The clearing balance allowance is 2 percent of the contracted amount or $25,000, whichever is greater. Earnings credits are based on the periodaverage balance maintained up to a maximum of the contracted amount plus the clearing balance allowance. Deficiency charges apply when the average balance falls below the contracted amount less the allowance, although credits are still earned on the average maintained balance.

D. Check ServiceTable 8 shows the 2008, 2009 estimated, and 2010 budgeted cost recovery performance for the commercial check service. Table 8Check Service Pro Forma Cost and Revenue Performance [$ millions] 5 Recovery 3 Net rate after Year 1 Revenue 2 Total income 4 Targeted targeted expense (ROE) [12] ROE ROE [1/ (2+4)] 2008........................................... 683.6 647.1 36.5 51.9 97.8% 2009 (estimate)................................ 495.8 524.0 28.2 15.1 92.0% 2010 (budget).................................. 345.4 353.7 8.4 11.6 94.5%

1. 2009 EstimateThrough August 2009, the check service has recovered 95.3 percent of total costs, including imputed expenses, and targeted ROE. For the full year, the Reserve Banks do not expect to recover fully their costs of providing check services. Specifically, the Reserve Banks estimate that the check service will recover 92.0 percent of its total costs for the full year compared with the budgeted 2009 recovery rate of 92.3 percent, with an operating loss of $28.2 million (see table 8).\43\ The lowerthanbudgeted recovery rate is driven primarily by lowerthananticipated NICB and higherthan expected pension costs, which are offset largely by higherthan expected product
[[Page 57479]]
revenue and lowerthanexpected operating costs.
\43\ The Reserve Banks expect to recover 95 percent of their actual expenses in 2009.

The general decline in the number of checks written continues to influence the decline in checks collected by the Reserve Banks, although the estimated decline for 2009 is somewhat less than the budgeted assumption. For fullyear 2009, the Reserve Banks estimate that their total forward check collection volume will decline nearly 9 percent compared with a budgeted decline of 12 percent.\44\ The proportion of checks deposited and presented electronically has grown steadily in 2009 (see table 9). The Reserve Banks expect that yearend 2009 FedForward deposit and FedReceipt presentment penetration rates will reach 99 percent and 97 percent, respectively. The Reserve Banks also expect that yearend 2009 FedReturn and FedReceipt Return penetration rates will reach 97 percent and 72 percent, respectively. FedReturn and FedReturn Receipt penetration rates have lagged those of FedForward and FedReceipt because initial efforts by the Reserve Banks and depository institutions to apply electronics to the check clearing process focused on the relatively higher volume forward collection process. Moreover, the recent economic environment has limited depository institutions' backoffice investments to apply electronics to the check return process.
\44\ Total forward Reserve Bank check volumes are expected to drop from roughly 9.5 billion in 2008 to 8.7 billion in 2009. Table 9Check 21 Product Penetration Rates \a\ [Percent] \b\ Forward deposit volume Return Volume
FedForward FedReceipt FedReturn FedReceipt Return
Fullyear Yearend Fullyear Yearend Fullyear Yearend Fullyear Yearend 2007............................................ 43 58 12 23 38 45 1 1 2008............................................ 77 92 42 61 58 72 6 13 2009 (estimate)................................. 97 98 78 90 82 93 28 45 2010 (budget)................................... 99 99 95 97 95 97 60 72 \a\ FedForward is the electronic forward check collection product; FedReceipt is electronic presentment with accompanying images; FedReturn is the electronic check return product; and FedReceipt Return is the electronic delivery of returned checks with accompanying images. \b\ Deposit and presentment statistics are calculated as a percentage of total forward collection volume. Return statistics are calculated as a percentage of total return volume.

As the vast majority of Reserve Bank check deposits are now electronic, paper forwardcollection volume is expected to decline nearly 86 percent for the full year (see table 10). The Reserve Banks also estimate that paper return volume will decline at a slightly faster pace than anticipated, 60 percent for the full year, compared with a budgeted decline of 53 percent.
Table 10Paper Check Product Volume Changes
[Percent]
Budgeted Estimated 2009 2009 change change Forward Collection.............................. 87 86 Returns......................................... 53 60

2. 2010 PricingIn 2010, the Reserve Banks project that the check service will recover 94.5 percent of total expenses and targeted ROE.\45\ Revenue is projected to be $345.4 million, a decline of $150.4 million from 2009. This decline is driven largely by projected reductions in check deposits and an increasing proportion of checks being presented electronically. Total expenses for the check service are projected to be $353.7 million, a decline of $170.3 million from 2009. The reduction of check costs is driven by the continued decline in the number of Reserve Bank checkprocessing sites and associated staff reductions. The Reserve Banks recently announced plans to further accelerate the consolidation of their check processing offices, which began in 2003 when they processed checks at 45 offices nationwide. In early 2010, the Reserve Banks will have a single fullservice paper check processing site located at the Federal Reserve Bank of Cleveland. \45\ The Reserve Banks expect to recover all of their actual and 10 percent of their imputed expenses in 2010.

For 2010, the Reserve Banks estimate that their total forward check volume will decline 9 percent (see table 11). FedForward and traditional paper check volumes are expected to decline 6 percent and 84 percent, respectively. The decline in Reserve Bank check volume can be attributed to increased competition, increased use of direct exchanges, and the continued decline in check use nationwide. The Reserve Banks also expect that return volume will decline 10 percent, as FedReturn volume rises 4 percent and traditional paper returns decline 76 percent.
Table 11Check Volume
2010
Budgeted Growth volume from 2009 (millions estimate of items) (percent) FedForward...................................... 7,821 6 Traditional paper forward....................... 47 84

Total forward............................... 7,868 9 ======================= FedReturn....................................... 77 4 Traditional paper return........................ 4 76

Total return................................ 81 10

The Reserve Banks will increase FedForward fees, on average, 6 percent for checks presented electronically and 17 percent for checks presented as substitute checks (see table 12). The average fee paid by FedForward depositors will decline by 23 percent over the average 2009 fee, as the number of depository institutions that accept their presentments electronically increases. FedReturn fees will also increase, on average, 23 percent and 46 percent for electronic and substitute check endpoints, respectively. The average fee paid by depository institutions using FedReturn will rise 7 percent, as the number of institutions
[[Page 57480]]

that accept their returns electronically increases.

For the traditional paper check products, the Reserve Banks will increase forward paper check collection fees 47 percent and paper return fees 33 percent (see table 12). These increases are designed to encourage the continued adoption of Check 21 services.
Table 122010 Fee Changes
2009 2010
Average fee Average fee Fee change \a\ \a\ (percent) FedForward:

Electronic endpoints......... $0.0205 $0.0218 6

Substitute check endpoints... 0.0809 0.0945 17 Weighted average fee \b\. 0.0314 0.0241 23 FedReturn:

Electronic endpoints......... 0.3066 0.3766 23

Substitute check endpoints... 0.8983 1.3083 46 Weighted average fee \b\. 0.6847 0.7352 7 Paper:

Forward collection........... 0.0860 0.1262 47

Returns...................... 2.1467 2.8528 33 \a\ The average fees in this table represent combined cash letter and peritem fees for each product type.
\b\ The weighted average fees for FedForward and FedReturn products are dependent on electronic receipt penetration rates. In this table, the weighted average fees are based on electronic receipt penetration rates estimated for fullyear 2009 and projected for fullyear 2010.

Risks to the Reserve Banks' ability to achieve budgeted 2010 cost recovery for the check service include greaterthanexpected check volume losses to correspondent banks, aggregators, and direct exchanges, which would result in lowerthananticipated revenue, and significant cost overruns associated with unanticipated problems with the Reserve Banks' Check 21 platform.

E. FedACH ServiceTable 13 shows the 2008, 2009 estimate, and 2010 budgeted costrecovery performance for the commercial FedACH service. Table 13FedACH Service Pro Forma Cost and Revenue Performance [$ millions] 5 Recovery 3 Net rate after Year 1 Revenue 2 Total income 4 Targeted targeted expense (ROE) [12] ROE ROE [1/ (2+4)] 2008........................................... 97.9 88.9 9.0 7.6 101.5% 2009 (estimate)................................ 93.6 98.7 5.1 3.1 92.0% 2010 (budget).................................. 113.2 109.4 3.8 3.8 100.0%

1. 2009 EstimateThe Reserve Banks estimate that the FedACH service will recover 92.0 percent of total expenses and targeted ROE, compared with the budgeted recovery rate of 100.3 percent, for an operating loss of $5.1 million.\46\ The lowerthanbudgeted recovery rate is driven by shortfalls in NICB and product revenue of $5.4 million and $3.5 million, respectively, and higherthanexpected pension costs of $6.5 million. Through August, FedACH average daily commercial origination volume has declined 2 percent relative to the same period in 2008. The Reserve Banks had originally projected a 10.5 percent growth in FedACH commercial origination volume for 2009, which was in line with historical volume growth rates. The FedACH volume decline reflects weakerthanexpected industry ACH volume growth and a slight loss of market share. For the full year, the Reserve Banks estimate that volume will decline 2 percent.
\46\ The Reserve Banks expect to recover 95 percent of their actual expenses in 2009.

2. 2010 PricingThe Reserve Banks project that the FedACH service will recover 100.0 percent of total expenses and targeted ROE in 2010. Total revenue is budgeted to increase $19.6 million from the 2009 estimate, primarily due to increases in monthly fixed fees, changes to volumebased receipt fees, the introduction of new monthly minimum fees, the implementation of new valueadded services, and increasing electronic access revenue. Total expenses are budgeted to increase $10.7 million from 2009 due to an increase in the allocation of electronic access costs.\47\
\47\ Beginning in 2010, the Reserve Banks changed the
methodology for allocating both revenues and costs to the electronic access channels, resulting in both higher revenues and costs allocated to the FedACH service.

The Reserve Banks expect FedACH commercial origination and receipt volume in 2010 to grow 2.9 percent and 2.5 percent, respectively. The growth rates for recurring ACH credits and debits are projected to be slightly lower than their histo

FOR FURTHER INFORMATION CONTACT

For questions regarding the fee schedules: Jeffrey C. Marquardt, Deputy Director, (202/4522360); Jeffrey S.H. Yeganeh, Manager, Retail Payments, (202/7285801); Linda S. Healey, Senior Financial Services Analyst, (202/4525274), Division of Reserve Bank Operations and Payment Systems. For questions regarding the PSAF and earnings credits on clearing balances: Gregory L. Evans, Deputy Associate Director, (202/4523945); Brenda L. Richards, Manager, Financial Accounting, (202/4522753); or Rebekah Ellsworth, Financial Analyst, (202/4523480), Division of Reserve Bank Operations and Payment Systems. For users of Telecommunications Device for the Deaf (TDD) only, please call 202/2634869. Copies of the 2010 fee schedules for the check service are available from the Board, the Federal Reserve Banks, or the Reserve Banks' financial services Web site at http:// www.frbservices.org.