Executive Summary: Entering into FDIC-backed Shared-Loss Arrangements provides banks with an opportunity that offers highly attractive economics. However, optimizing returns from a shared-loss arrangement can be complex. Further, the five-ten year time frame of these agreements demands significant process streamlining and automation.

 

 

In recent months, almost every Friday evening features the FDIC announcing its latest round of bank failures. In most cases, these failed banks become subject to Shared-Loss Agreements, whereby, the FDIC partners with an acquiring bank or Private Equity firm to assume most of the assets and liabilities of the failed institution.

 

FIC has worked with several of the acquirers, providing them with the expertise and resources necessary to meet the FDIC’s reporting and claims submission requirements and to maximize the available cash flow from these transactions. At the same time, we emphasize implementing an efficient process that allows current bank resources the ability to handle shared-loss transactions as well as perform their normal duties.

 

Mutually Beneficial
Shared-Loss Agreements allow the government to close failed institutions, while ensuring that banking services continue to be offered to the failed bank’s clients. The Agreements allows acquirers, whether banks or PE firms, to generate substantial returns on their investments while providing the FDIC with the opportunity to recover some or all of its upfront losses on the transaction.

 

Case Example
Potential bidders need to focus on the key elements of the bid process, including:

 

• Covered assets- In many cases bidders can negotiate to exclude certain assets from the Agreements, such as non-performing loans, ORE, acquisition/development/ construction(ADC), or leased properties

 

• Premium for non-brokered deposits- For these deals, the percentage offered usually ranges from zero to one percent

 

• Asset discount bid- This is the amount by which purchasers discount the value of the acquired loan portfolio. For example, in one recent case, a bank offered a discount of 25 percent of the total portfolio, purchasing a $2.5B loan portfolio for approximately $1.9B

 

• Stated threshold- This involves the FDIC’s estimate for total expected losses in the Shared-Loss portfolio. If actual losses exceed the “threshold”, the percentage at which the FDIC reimburses the acquirer increases, generally, from 80 percent to 95 percent

 

• Amendments- As part of the bid process, acquirers may be able to negotiate amendments, increasing their flexibility with regard to handling the disposition of certain assets

 

Shared-Loss Economics
Shared-Loss Agreements offer acquirers/investors significant opportunities to generate high returns and create significant shareholder value while limiting downside risk. Cash flow and revenues sources include:

 

• Cash flow/income from Shared-Loss assets that continue to perform

 

• Cash flow from FDIC reimbursements

 

• Revenue from acquired deposits

 

• No loss reserve requirements for purchased loans

 

Elements of risk protection include credit loss exposure limited by the FDIC, as well as the asset discount limiting exposure to a nominal percentage of the purchased book of business.

 

Lessons Learned
Our Shared-Loss work points to several key principles being followed by the most successful players in this area:

 

• The need for a separate and centralized Shared-Loss effort. Shared-Loss loans are different from most banks’ core portfolio. In many cases, customers are outside the bank’s segmentation focus. In addition, FDIC reporting requirements require that loans meet detailed submission criteria. We have seen banks take actions that, potentially, could eliminate the future claim eligibility of certain assets. Therefore, banks need to form a specialized and “centralized” group that knows the ins-and-outs of the Shared-Loss Agreement and related requirements.

 

• Create a Triage Team. Banks should ensure they quickly identify the low hanging fruit within the portfolio and submit those loans for FDIC payment. As part of this process, banks need to conduct a credit audit of their loan portfolios, whereby, they order updated appraisals, request current financials, and ensure that call memos detailing the status of the credit are current. Our experience is that failed banks have files that are woefully inadequate.

 

• Engage Key Internal Constituencies. The Shared-Loss process requires the involvement of Workout, Finance, Accounting, IT, Audit, and other areas. Creating a knowledgeable and engaged Shared-Loss working team is critical. Management needs to establish this effort as a clear priority for all involved. Operating this process with a “side of the desk” mentality will result in reduced cash flow, slow submissions, and potentially lost opportunities due to non-compliance with the Agreement.

 

• View Shared-Loss as a Line of Business, Not a One-Off Transaction. The significant upfront investment required to manage a Shared-Loss transaction can only be justified if the bank maximizes the related cash flow and, ideally, builds a portfolio of these transactions. An acquirer’s goal should be to create a streamlined factory-like approach to this business, resulting in high efficiency and productivity. Thereby, limiting the upfront investment and ongoing operating costs associated with these transactions.

 

Managing the Shared-Loss Process
While these transactions offer strong economics to a bank, they are also complex and demand that the bank organize itself with the specific requirements of Shared-Loss in mind. Our next newsletter will outline some of the tactics that banks should follow in optimizing their Shared-Loss experience.