Wednesday, February 24, 2010

An FDIC "Loss Sharing" Industry has Sprung Up


As of the end of 2009, over 700 U.S. Banks were included in the FDIC’s Problem Bank List. There were 140 bank failures in 2009 and 20 as of the first two months in 2010. By the end of 2009 the FDIC entered into 94 loss sharing agreements covering assets totaling $122 billion. The bulk of failed bank assets have been placed into these structures.

"Loss Sharing" is a public/private partnership between the FDIC and a healthy bank where the FDIC covers an amount of the losses incurred by a bank acquiring failed bank assets in exchange for possible upside to be shared with the FDIC that might result from the acquiring bank's expert asset management and improved economic conditions.

In 2010 alone an additional $11.6 billion in loss sharing agreement were entered into with acquiring banking institutions. A loss sharing industry sprung up in 2009 as a response to complicated and sensitive set of procedures regarding the FDIC oversight of bank failures. It is our opinion there may be in excess of 200 additional bank failures in 2010 alone and the market for assets under Loss Sharing agreements will exceed $300 billion, cumulatively. The "Loss Sharing" field is complicated, arcane and exploding.

FDIC Budget Constraints

The New York Times on February 23, 2010 analyzed the financial condition of the FDIC:

"the federal deposit insurance fund has been severely depleted. At the end of 2009, it carried a negative balance of $20.9 billion.

The insurance fund is in better shape than such numbers might suggest, however. Officials estimate that bank failures would drain about $100 billion from the fund from 2009 through 2013. But of that amount, a total of roughly $80 billion in losses were recognized last year or projected for 2010. By that math, the agency is expecting an additional $20 billion of losses over the next three years.

After slipping into the red last fall, the F.D.I.C. moved swiftly to refill its coffers. The agency imposed a special assessment on banks that gave it an immediate $5.6 billion cash infusion. That assessment was in addition to the ordinary payments that banks make to the F.D.I.C. fund.

In September, the F.D.I.C. ordered banks to prepay quarterly assessments that would have otherwise been due through 2012. That provided an additional $46 billion to restore the fund to normal. For accounting purposes, the agency will add that money to the fund in small doses over the next 13 quarters, which explains the current negative balance.

Together, these moves buy time for the agency to determine its next steps in the event its losses worsen. In such a case, banks might be called on to chip in more money, either through new special assessments, prepaid fees or premium increases. F.D.I.C. officials said no such plans were in the works."

Creative Structures are Being Tested

Further from the New York Times today, the agency has been creative in stretching and ultimately raising funds:

"To protect the fund, the F.D.I.C. also has found creative ways to bring in more money. On Tuesday, Ms. Bair said that the agency would soon issue bonds backed by the assets of failed banks and guaranteed by the government. The program aims to attract nontraditional buyers of bank assets, like insurance companies, pension funds and mutual funds"....

The F.D.I.C. has also tried to entice private equity firms and other investment groups to bid for insolvent banks, with mixed success. The agency is betting that more potential buyers will ultimately result in higher prices."

CREFA Conclusions and Questions

The public private marriage in the banking industry is one of necessity. Unless the agency decides to tap its Treasury line of credit, the capital constrained FDIC has no choice but to court private equity to help clean up the bank mess.

Private equity may find the Failed Bank Asset "Trading Rules" contained in Loss Sharing Agreements restrictive. The FDIC, up to now, has not wanted to promote private speculation in problem assets or in failed banking franchises. Also, transparency required by the FDIC may not be transparency private equity is accustomed to or desires.

This we do know: the FDIC is on a budget. A cash strapped FDIC will not let loss sharing reimbursement funds go out the door to acquiring banks unless the acquiring bank reimbursement requests (loss share certificates) are very well documented. The science of this process continues to evolve.