The competitive bidding for failing banks has become fierce. Hundreds of banks vie to acquire failing banks and must get creative to gain an edge in the bidding wars that result in bank takeovers occurring each Friday.
Starting 2010, the FDIC began asking the bidders pursuing failing banks to offer the FDIC the opportunity to profit from the acquiring bank’s stock appreciation. The FDIC is obtaining “value appreciation instruments”. These instruments serve as additional consideration for FDIC-assisted transactions according to the agency.
On May 15th the Wall Street Journal reported: “In the largest of Friday's closures, Illinois regulators closed Midwest Bank & Trust Co. of Elmwood Park. FirstMerit Corp., based in Akron, Ohio, agreed to take over Midwest's 23 branches, $2.42 billion in deposits and essentially all of its $3.17 billion in assets.
Midwest had been warning for months that it was in dire financial straits. On Thursday, the bank said in a securities filing that it would likely be placed into receivership because it had been unable to raise fresh capital after a previous plan had been rejected by the Federal Reserve.
As part of the deal, the FDIC will receive a so-called value appreciation instrument, which will provide the agency with additional money if FirstMerit's share price rises over a certain amount of time.”
In another recent example, as reported by Business Wire, Bank Popular acquired the assets of Westernbank in Puerto Rico, and “the FDIC will receive a value appreciation instrument, which grants the FDIC a one-year right to receive a cash payment equal to 50 million multiplied by the difference between the stock price at the time of exercise of the value appreciation instrument and $3.43, which was Popular's 20-day trailing average stock price on April 27. The FDIC may exercise this right at any time, in whole or in part, during the one year period.”
Will enterprise value appreciation drive FDIC fund costs estimates down? Perhaps. In the case of the strong bank getting stronger, with FDIC assistance, it is easy for investors to forecast that value will be lifted by these transactions. The marginal IRR’s of FDIC assisted transactions are high. FDIC assisted transaction yields are attractive enough for private equity firms to become "patient" banking investors and join the toxic bank clean up process.
Value appreciation instruments are one more weapon in the FDIC’s expanding financial arsenal and one more cost variable we need to keep an eye on.