Saturday, November 13, 2010

BankUnited IPO and the Value of the Loss Sharing Indemnification Asset

As Felix Salmon asks in his Shedding no tiers blog "When bankers make windfall profits from the FDIC" posted on November 11, 2010:

"How is this (windfall) possible, when banks elsewhere are dropping like flies? 
The simple answer is that Kanas and the other BankUnited investors are taking money straight from US taxpayers*: the FDIC lost $4.9 billion when it sold BankUnited, it’s guaranteeing more than 80% of the bank’s assets, and the future income stream from the FDIC to the bank is worth a whopping $800 million."

Here is how the FDIC reimbursement that Salmon refers to works. As part of the deal cut by the FDIC at the time of the failure of BankUnited, the FDIC is covering future losses associated the BankUnited failure. These losses translate into a $2.9 billion asset on the BankUnited balance sheet called the "Indemnification Asset".

As detailed in the Edgar BankUnited IPO Profile:
"Pursuant to the terms of the Loss Sharing Agreements, the Covered Assets are subject to a stated loss threshold whereby the FDIC will reimburse the Bank for 80% of losses up to the $4.0 billion stated threshold and 95% of losses in excess of the $4.0 billion stated threshold, calculated, in each case, based on UPB (or, for investment securities, unamortized cost basis) plus certain interest and expenses. The carrying value of the FDIC indemnification asset at June 30, 2010 was $2.9 billion. The Bank will reimburse the FDIC for its share of recoveries with respect to losses for which the FDIC paid the Bank a reimbursement under the Loss Sharing Agreements. The FDIC's obligation to reimburse the Company for losses with respect to the Covered Assets began with the first dollar of loss incurred. We have received $863.3 million from the FDIC in reimbursements under the Loss Sharing Agreements for claims filed for losses incurred as of June 30, 2010." 

Our Explainer: 
The FDIC provides coverage or a guaranty to an acquiring bank for possible additional losses on the acquired, failed bank assets. FDIC-assisted banks (or a new bank like BankUnited) carry on their balance sheet the FDIC “indemnification asset”, a receivable or "IOU" from the FDIC for the Loss Sharing Agreement obligation due from the agency over time. The indemnification asset value will adjust over time as the condition or "collectability" of the individual assets is determined and changes due to borrower and market conditions. The individual values are “rolled up” into what become the potential cumulative losses of the Loss Sharing Agreement portfolio.

An FDIC indemnification asset represents the present value of the estimated losses on covered loans to be reimbursed by the FDIC based on the applicable terms of the loss sharing agreement.

Despite the intent of "Loss Sharing" to bring order and calm  to the commercial credit markets via long term asset management, some FDIC-assisted banks have raced to recognize and convert to cash loan impairments, liquidating assets as quickly as possible in order to be reimbursed by the FDIC for Loss Sharing losses. 

In one of the rare instances of transparency into the Loss Sharing process as value proposition, we see that BankUnited "has received $863.3 million from the FDIC in reimbursements under the Loss Sharing Agreements for claims filed for losses incurred as of June 30, 2010" and has at least $2.9 billion (in present value) to go.