Changes to Loss-Share Agreement Terms Should Be Considered

For those banks considering the acquisition of a failed bank, changes to the terms of a number of FDIC-assisted transactions announced in the second quarter of 2010 should be considered prior to the preparation of bids. Summarized below are a few of the changes in terms that have surfaced in recent transactions:

• Loss-Share Restructuring – As bids for banks become more competitive, the FDIC is attempting to curtail the costs by allowing bidders of failed bank assets and deposits to determine and submit their own custom first loss tranche as part of their bid. The FDIC believes that this will reduce the amount of assets covered with loss-sharing. In loss-share agreements initiated in 2009, the FDIC absorbed 80% of losses on assets covered in the first loss tranche and after a certain threshold was reached, the FDIC absorbed 95% of losses. In March of 2010, the FDIC told SNL Financial that starting in April of 2010, the FDIC would no longer absorb 95% of losses on pools of assets that fall under loss-share agreements in failed bank transactions.¹ In the same article, the FDIC indicated that loss-sharing would continue to be offered on the first loss tranche at 80%/20% for some transactions, but noted that the FDIC would evaluate if further changes to the structures are needed. On April 16, 2010, an example of the FDIC using this new structure emerged in the loss-share agreement for its transaction with TD Bank NA, which acquired three institutions from the FDIC (Riverside National Bank of Florida, AmericanFirst Bank, and First Federal Bank of North Florida). The FDIC agreed to cover 50% of loan losses in the first loss tranche up to a certain threshold and 80% thereafter. The arrangement also allowed the FDIC to record gains on assets if the loan losses are lower than expected, which is also intended to reduce costs to the FDIC. The new structure does appear to be reducing costs to the FDIC, as eight failures resolved on April 16 had an average cost of 14% of the failed institutions assets, compared to an average cost of 26% in the 42 prior failures in 2010.²
• Grouping Failed Banks Together – One other item of note from the TD Bank NA acquisition is that the FDIC grouped the banks together rather than resolving individually, which was the most common practice in resolutions in 2009. By grouping the deals together, the cost to the Deposit Insurance Fund equated to 13% of the failed institutions’ aggregated assets, below the average cost of other deals in Florida in this credit cycle of 33%.³
• Value Appreciation Instruments – Other transactions in the second quarter of 2010 have allowed the FDIC to participate in positive market reaction to the transactions through the use of warrant-like instruments. For example, AmTrust Bank was sold to New York Community Bancorp Inc. in April 2010 with an appreciation instrument that ultimately resulted in the agency receiving approximately $23.3 million (compared to the approximately $2.0 billion cost to the fund).⁴

Several interesting issues have emerged related to these changes and should be considered if your institution is pursuing a failed bank.

• Additional due diligence and analysis of the failed banks will be required to determine the specifics prior to bidding. For example, the new structure requires a bid to include additional items, including the size of the first-loss tranche and the percentage of the losses that would be covered by the loss-share agreement on the first loss tranche. This increased level of due diligence and analysis may be difficult given the relatively tight timeline for resolving problem institutions, and stresses the importance of being prepared should an opportunity arise.
• Scenario analysis with and without a loss-share agreement may need to be performed to determine which structure is most beneficial for the buyer. Some bidders may opt for whole bank transactions without loss-sharing to avoid systems, reporting, and loan modification payments and FDIC exams in a loss-sharing situation.
• One issue to watch will be the extent to which these changes impact investor interest in failed banks. The recent changes signal that investor interest in failed banks has increased to a level where the FDIC is compelled to make the terms more favorable. However, absent the protection that the older loss-share agreements provided, acquirers may reduce bids and the level of interest in failed banks may decline as buyers have difficulty assessing the financial condition of the distressed institution, particularly given the shorter time period to perform due diligence common in a typical failed bank transactions. As a result, lower bids may be offered due to the additional uncertainty of acquiring the institution.

To discuss the key considerations in pre- and post-acquisition or to discuss your institution’s specific situation in greater detail, contact Andy Gibbs (gibbsa@mercercapital.com) or Jay Wilson (wilsonj@mercercapital.com) at 901.685.2120. Complete confidentially is assured.

Endnotes

¹ “FDIC: Changes to Loss-Share Structure Will Take Effect in April,” by Nathan Stovall and Joe Mantone. Published by SNL Financial, LC, March 26, 2010.

² “FDIC Moves Ahead with Creative Thinking, Cheaper Failures” by Nathan Stovall. Published by SNL Financial, LC, April 20, 2010.

³ Ibid.

⁴ Ibid.

Reprinted from Mercer Capital's Bank Watch, June 2010.