Insights

FDIC Changes Loss-Sharing on Failed Bank P&As

The FDIC is changing the terms of its whole bank purchase and assumption ("P&A") with loss-sharing transactions. The following is a summary of changes we are seeing as the FDIC seeks to reduce the cost to its Deposit Insurance Fund ("DIF") of loss-sharing. These are based in part on the FDIC’s experience with the pricing realized on structured loan sales using PPIP-type financing, which has encouraged the FDIC to seek better pricing on whole bank, loss-sharing P&As.

 

Current Loss-Sharing

 

Assets in a loss-sharing transaction are valued at the failed bank’s book value plus a premium or minus a discount offered by bidders. Therefore, a bid may be an asset premium bid or an asset discount bid.

 

First Loss Tranche. Loss-sharing starts after losses on loans have exhausted the "first loss tranche." The first loss tranche for loss-sharing transactions has been determined by adding: 
  • The deposit premium or discount;
  • The positive or negative asset premium bid or discount bid; and
  • The equity adjustment (the book value of assets acquired less the book value of liabilities assumed, as of the closing of the failed bank).

 

If this sum is a positive number, the amount represents the amount of loss the bidder is willing to absorb on the purchase of assets and assumption of liabilities of the failed bank before receiving FDIC loss share protection. If it is a negative number, the amount represents the amount of money to be paid to the winning bidder at the end of the first business day following the bank’s closing.

 

Threshold Amount. The loss-sharing percentage determined by the FDIC is 80 percent up to the defined "threshold amount" and has been 95 percent thereafter.

 

Differences Among Loan Types. Loss-sharing depends upon whether the assets are single-family residential loans or other loans. Single-family loans are subject to the FDIC Loan Modification Program or HAMP, as selected by the bidder in its bid. Bidders theoretically can also propose a different loan modification program, provided the FDIC agrees.

 

Single-Family Loan Loss-Sharing. The characteristics of single-family loan loss-sharing are as follows:

 

  • Ten-year agreement;
  • Credit loss coverage is provided for loan modifications, short sales, sales of foreclosed real estate, loans that are sold at the end of a loss-sharing agreement in a liquidation (subject to FDIC concurrence), and bulk loan sales (subject to FDIC concurrence);
  • Credit loss coverage is allowed for up to three months of accrued but unpaid interest;
  • Qualifying expenses included in the loss calculation are limited to amounts paid to third parties. Acquirer’s internal costs of all types are excluded from the loss calculation; and
  • Loss-sharing rights may be transferred to an affiliate of the purchaser.

 

All Other Loans. The characteristics of all other loans are as follows:

 

  • Five-year agreement;
  • Credit loss coverage provided when assets are written down according to examination criteria of the purchaser’s primary regulator and when assets are sold (bulk sales require prior FDIC approval);
  • When assets are initially written down, credit loss coverage is allowed for up to three months of accrued but unpaid interest;
  • Qualifying expenses to third parties are capitalized or treated as covered losses; and
  • Loss-sharing rights may be transferred to an affiliate with FDIC concurrence.

 

New Loss-Sharing Terms. The FDIC’s new loss-sharing contains the following terms:

 

The stated threshold is being eliminated. Loss-sharing will be 80 percent/20 percent for the life of the loss-sharing agreement, with no provision for a step-up to 95 percent loss absorption by the FDIC.

 

The asset premium or discount bid was formerly a fixed dollar bid, and in the future, it will be expressed as a percentage of the book value of the failed bank’s assets. The asset premium or discount bid may be stated as a positive or negative percentage of the book value of assets of the failed bank. Book value is calculated as of the date of failure.

 

On the first loss tranche losses, the buyer will absorb prior to the commencement of loss-sharing. Bidders will now determine and submit their own custom first loss tranche as part of their respective bids. First loss tranche bids cannot be less than zero, and the first loss tranche bid will now be expressed as a percentage of the book value of assets covered by the loss-sharing agreement.

 

The initial payment due to or from the FDIC on the closing of the P&A agreement with the FDIC is the sum of the equity adjustment (assets less liabilities), deposit premium bid in dollars, and the asset premium (discount) bid, in dollars.

 

If the result is a negative amount, the FDIC will wire funds to the buyer at closing. If the result is a positive amount, the acquirer will wire funds to the FDIC at closing.

 

Under this new method, a successful bidder is more likely to make a payment to the FDIC at closing, especially when the amount of acquired assets exceeds the amount of assumed deposit liabilities.

 

Conclusions

 

The new loss-sharing agreements will require more and better asset diligence and analyses of the failed bank by bidders to determine an acceptable first loss tranche. The first loss tranche will now be set competitively by each bidder, which should reduce the amount of assets that the FDIC will have to cover with loss-sharing. These terms are expected to reduce the receivable from the FDIC recognized by the winning bidder and the gain recognized from failed bank acquisitions, assuming a number of interested, FDIC-qualified bidders. The FDIC hopes to reduce resolution costs, which averaged 27.7 percent of failed bank assets in 2009 and 25.9 percent in the current year through March 26, 2010.

 

As a result of the expected reduced benefits of loss-sharing, bidders may not be as interested in failed bank deals and may increase the discount bid on failed bank assets to reflect the additional risks of loss. Since the benefits of loss-sharing are expected to be less with more uncertainty around competitors’ bid terms on the first loss tranche, some bidders may opt for whole bank transactions without loss-sharing to avoid the systems, reporting, loan modification requirements, and FDIC examinations inherent in loss-sharing.

 

Whole bank transactions without loss-sharing may be more successful because they may cost the FDIC less than loss-sharing and may produce favorable financial results for the buyer. Buyers in whole bank P&As will take on more risk than in loss-sharing transactions and will not have the benefit of a 20 percent risk-weighting for risk-based capital purposes that loss-sharing provides, however. Acquisition models should be revised for the new loss-sharing and run on transactions with and without loss-sharing.

 

Lawyer Contacts

 

For further information, please contact your principal Firm representative or one of the lawyers listed below. General email messages may be sent using our "Contact Us" form, which can be found at www.jonesday.com.  

Chip MacDonald
+1.404.581.8622
cmacdonald@jonesday.com

Brett P. Barragate
+1.212.326.3446
bpbarragate@jonesday.com

Ronald S. Gross
+1.212.326.8331
rsgross@jonesday.com

Ning Zhang
+1.404.581.8379
ningzhang@jonesday.com

 

Jones Day publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our "Contact Us" form, which can be found on our web site at www.jonesday.com. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.

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