Recently, St. George, UT bank, SunFirst was officially closed by the FDIC. It seemed only yesterday that the Regulators had stepped in to take a closer look, which is usually the precursor to Receivership. In short order, Cache Valley Bank, from Logan UT was awarded a Loss Share Agreement to manage the deposits, as well as the majority of the remaining assets. This transaction became the third deal involving Cache Valley who had recently purchased (via structure sale w/FDIC) a selection of performing assets from several banks including, Utah’s Barnes and Centennial Banks.
Loss-Share Agreements have become a common structure by which the FDIC allocates the assets of a failed bank, to another more stable bank. In an attempt to better understand these agreements, I looked first to the FDIC Website.
According to the FDIC website (www.fdic.gov) a Loss-Share Agreement (LSA) is:
1. Loss share is a feature that the Federal Deposit Insurance Corporation (FDIC) first introduced into selected purchase and assumption transactions in 1991. Under loss share, the FDIC absorbs a portion of the loss on a specified pool of assets which maximizes asset recoveries and minimizes FDIC losses. Loss share also reduces the FDIC’s immediate cash needs, is operationally simpler and more seamless to failed bank customers and moves assets quickly into the private sector. (Emphasis added)
2. The FDIC uses two forms of loss share.
- For commercial assets, the SLAs cover an eight-year period with the first five years for losses and recoveries and the final three years for recoveries only. The FDIC typically will reimburse 80 percent of losses incurred by the acquirer on covered assets up to a stated threshold amount (generally the FDIC’s dollar estimate of the total projected losses on loss share assets), with the assuming bank absorbing 20 percent.
- For single-family mortgages, the SLAs are for ten years and have the same 80/20 split as the commercial assets. The FDIC provides coverage on three basic single-family first lien mortgage loss events: modification, short sale, and when the property is sold after foreclosure.
3. To address the question, “How do you know that the FDIC is getting the best deal with loss share?” The FDIC site says:
- When the FDIC is preparing the sale of a failing bank or thrift, the FDIC reaches out to numerous potential bidders to bid for the customer deposits and the failing bank’s assets. The sale relies on a competitive bidding process.
- After the bids are received, the FDIC selects the least costly option
So, to summarize, the FDIC engages in loss share agreements to save money, get the assets back into the private sector faster, and to protect the tax payers with mitigated risk and a quick recovery. Then, to ensure that this system is fair and equitable, the FDIC reaches out to numerous bidders in a competitive bidding process, and selects the least costly option.
However, Loss-Share agreements are draw mixed opinions and reactions. To this point, I recently discovered a Huffington Post article entitled, “ ‘Loss Share’: FDIC Offers Billions in Guarantees For Buyers of Failed Banks” http://www.huffingtonpost.com/2009/08/31/loss-share-fdic-offers-bi_n_272518.html.
One of the main points of the article suggested, “buyers of failed banks are getting billions of dollars in government guarantees to snatch up the bank’s bad assets” and rehearsed some interesting perspectives offered by the WSJ including:
“The result, the WSJ points out, is a massive subsidy to the private equity industry, and a huge risk to the American taxpayer.”
“Though the WSJ doesn’t go so far as to say the enormous guarantees are, in fact, sweetheart deals, it’s hard to imagine a better scenario for bank buyer.”
“To wit, this testimonial from Wilshire State Bank CEO Joanne Kim: ‘After we understood how [the loss-share] works, we were literally overjoyed.’”
Why is it a risk to the American Taxpayer? Well first of all, these agreements are based on specific asset values. Who determines these values? Typically, assets will be valued first by an Appraiser or a 3rd party auditor. However, the appraisal process can be a very subjective evaluation. It wouldn’t be uncommon to see 2 appraisals for the same property with variances up to 50%. The truth in an evaluation can only be found through multiple sources. Therefore, the most important requirement for an accurate assessment is an abundance of comparable data. The same is true for the sale of failed banks, which would likely explain why the FDIC has made a commitment to obtain and consider multiple offers.
Another potential risk lies in the fact that Banks are in the business of making money, not necessarily rescuing the American Tax Payer. Sometimes, offers received for assets under an LSA are too costly to sell. As you’ve read above, the Bank will be required to share in any losses below “book value” which could be very costly. While the FDIC often includes significant cash payments to assuming banks (known as Asset Discounts), it is not entirely clear how those funds affect decisions towards selling properties at a loss. Some LSA’s allow Banks to hold assets for several years. Therefore, one need’s to carefully read the published LSA to determine what obligations the bank might have in regards to the cash received and/or their strategy to settle or modify a borrowers loan.
Are enough Banks bidding on failed Banks?
Consider the following, “The FDIC reaches out to numerous potential bidders . . .The sale relies on a competitive bidding process.” A closer look at 3 recent transactions indicates a “none” in the “other bidders” section (see below). In other words, 3 banks, each with over $200 Million in assets were sold without a competing offer. The commitment to reach out to several bidders is the crux by which this whole system operates properly. A single bidder, in any situation, like a single comparable property, opens the door to subjective (and often incomplete) analysis. I can only assume that the closure and assignment of an entire bank, is as time sensitive as it is complex. Perhaps in certain cases, there isn’t enough time to obtain bids. So, what is the potential risk of not obtaining additional bids? It could be huge if the acquiring bank is deriving a benefit based on being the sole bidder. Hopefully these 3 recent sales represent the exception rather than the majority.
Are Loss-Share Agreements saving money?
Consider: “Loss share also reduces the FDIC’s immediate cash needs” and “the FDIC selects the least costly option”.
The FDIC lists a total of 439 Banks that have gone into receivership since 2000 (the majority being after 2008). Using 12 recent closures (see chart below), 8 were Loss-Share Agreements and 4 were not (regular bank assumption of other bank).
At closing, the FDIC paid each of these 12 banks between $8,500,000 and $78,000,000 (see chart “asset discount paid by FDIC”). The total paid for these 12 banks by the FDIC was $447,282,000. The average Loss Share transaction cost (using the recent twelve (12) as the sample) is $28 Million whereas the average Non-Loss Share cost is $54 Million. It is clear that Loss-Share agreements are, in fact, cheaper to the FDIC, at least initially.
When you look a little closer into the 4 non-Loss Share agreements, 2 of them had Loss Share offers that were rejected. The savings to the FDIC in those 2 cases alone would have been just shy of $70,000,000. In other words, a LSA’s seem to require less cash and allow the FDIC to mitigate some of the potential losses by allocating a percentage to the assuming institution. So why not do them more often, and more importantly, why reject a loss-share offer altogether?
Unanswered questions . . .
Amidst some major uncertainty, one thing is for sure. The FDIC and the general market are overwhelmed with toxic debt. Since 2008, the FDIC has explored a host of deal structures to determine the most efficient and cost effective method to transfer/sell assets. Each structure (LSA, Structured Sales, Brokers) evolves as each deal closes. More concerning, however, is the fact that countless more banks are on the brink of collapse and, consequently, subject to one of these arrangements.
Realizing that the effects of the FDIC’s response will not be entirely evident until each of these deal’s expire in 5-10 years, it is anyone’s guess how this will all turn out. For me, the “jury” is still out on LSA agreements, although my concerns have more to do with the intentions and strategies of banks than the FDIC.