Executive Summary: Acquiring entities that win shared-loss bids for failed banks need to appreciate and anticipate the FDIC’s expectations while managing the acquired entity to maximize benefits to the banks’ stakeholders. Any possible deviation between the government’s and the acquirer’s desires need to be anticipated and addressed.
We knew that we were working on a non-traditional assignment when, during our first shared-loss engagement, FDIC representatives came into our conference room at the client and began to photograph the pictures on the wall and tag the furniture.
Entering a shared-loss arrangement means that you have the FDIC as a partner. While our experience is that the FDIC is an accommodating and fair partner, it is also, appropriately, rigorous in its reporting and compliance requirements. Acquirers signing on for shared-loss should follow some key operating principles concerning how they work with the FDIC while benefiting from the positive economics these transactions offer.
Raise Data Issues to the FDIC
Several of our shared-loss clients have faced a situation in which the FDIC requests information that is not available in the near term and, in some cases, even in the long term. For example, acquirers need to complete a report with 82 data fields related to commercial submissions (quarterly) and 52 data fields for residential submissions (usually monthly). Residential information required includes items such as loan ID, first payment date, property description, valuation date and amount, household income, current FICO, etc. Commercial data items requested include business type, branch in which housed, FICO score, guarantor details, MSA code, etc.
Some of these items are immediately and easily available; others will require some manual activities or multi-hour programming. Certain data may simply have never been captured by the bank. To address FDIC concerns, banks need to provide the FDIC with dates when data will be available as well as a list of those items not captured and unavailable.
Propose and Explain
The above data issue provides a good example in which a bank went to the FDIC and detailed the data it could provide (now and/or in the future) as well as that data that it did not believe was relevant to the related portfolio. Our experience is that the FDIC accepts that type of well-reasoned approach and that full disclosure of a potentially cumbersome clean-up process can result in a waiver.
Another client faced a “unique” loan that raised issues concerning how to report it and which Certificate to use for submission. Our advice in this and similar cases is to propose a solution to the FDIC, provide support for it, and then move forward with it. The alternative of asking the FDIC to provide a solution can require significant time and, frankly, may result in an undesired answer. Proactivity in this area is particularly important when reconciling loan schedules to the appropriate residential or commercial Certificate.
Segregate, But Do Not Discriminate
In most cases, shared-loss transactions may represent a substantial asset but, certainly, not the majority of the total bank. In those cases shared-loss assets should be managed separately from “traditional” assets. That said, while they may be organizationally separate, the way in which they are managed has to be in synch with how bankers handle core bank assets. For example, the FDIC expects acquirers to put as much effort into the recovery of shared-asset loans as they do traditional loans. Any suggestion that the FDIC’s loans are being handled to its detriment will impact the bank negatively. The FDIC expects you to “do what you would normally do.”
Transparency is King
To ensure that acquirers follow their agreements, the FDIC has selected several independent companies to review acquirers for compliance. These assessments may evaluate specific loan submissions, recovery procedures, expense claims, and other areas. While not employees, the contractors we know of are highly experienced and professional and understand that they are meant to represent the interests of the FDIC while being mindful of the challenges each bank faces in meeting the agreement’s requirements.
Previous writings have discussed the FDIC Portal, software that we developed to generate residential and commercial Certificates and critical supporting material for multiple bank transactions. A capability such as the Portal may become standard as banks need to reconcile one or more Certificates from one period to another for up to ten years. The ongoing audit/compliance process should encourage banks to systematize their data capture and monitoring process. An approach based on spreadsheets increases the likelihood of errors.
Communicate Upwards
As shared-loss activity picks up, more banks are hiring full-time heads of shared-loss. This person becomes the “go to” man or woman on all things shared-loss. However, the FDIC may require that submission Certificates be signed by a banks’ CFO and or CEO; it wants to make sure that the leaders of the bank are on the hook for the veracity of the payment being requested and the completeness of the supporting documentation backing up that request. Further, because of the visibility of these transactions and the involvement of the FDIC, regular reports will be made to the bank’s Board of Directors, detailing the submissions made, expected future submissions and recoveries, and other material information.
Expect Change and Anticipate Hidden Liabilities
Given the newness of this round of shared-loss agreements, the FDIC is still determining some aspects of the transaction. Without going into too much detail, areas such as reconciling to 4.15A/B, issues related to “new” loans representing draws under existing acquired bank commitments, unpaid bills from the acquired banks, and draws under part bought letters of credit can all lead to some heated discussions and disagreement concerning what constitutes acceptable practices. Acquirers need to be on top of these issues and actively manage through them.
Concluding Comment
We think pursuing shared-loss transactions makes sense for multiple reasons, among them, stand-alone transaction profitability, market share growth, geographic expansion, and an earnings boost at a time when organic earnings are hard to generate. Nonetheless, these transactions are complex and some banks have avoided them in part due to their concern about partnering with the government.
Commenting about his bank’s exit from TARP, one bank Chairman stated, “What seemed very good to get into at that time seems even better to get out of today.” Banks want to avoid the same sentiment when they exit their shared-loss agreements. Doing so requires focus, transparency, data integrity, and process skills.