FDIC’s Increased Use Of Loss-Share Program Enriches Some At Taxpayers Expense
The FDIC’s use of loss-sharing agreements has grown into a huge multi-billion dollar program that almost guarantees profits for the purchasers of failed banks. Originally introduced in 1991, loss-share agreements have now become a standard tool of the FDIC for moving failed bank assets into the private sector.
Under a loss share agreement, the FDIC agrees to absorb losses on up to 80% of a failed bank’s assets that are purchased by an acquiring bank. The loss protection provides the incentive for private equity investors or other banks to purchase failed banks from the FDIC.
From 2007 to date there have been 254 banking failures with the FDIC taking into receivership $616 billion of failed banking assets. With potentially hundreds of additional banking failures and weak property markets, the FDIC has had to provide generous loss-sharing agreements on the majority of banking failures since 2007. Through the end of June 2010, the FDIC has entered into 167 loss sharing agreements covering $176.7 billion in assets of failed banks acquired by other institutions.
The FDIC insists that loss-sharing agreements save the FDIC’s Deposit Insurance Fund money. From the FDIC’s standpoint, loss share transactions are simpler, reduce cash outflows and allow troubled assets to be sold or restructured in an orderly fashion instead of being sold at steep discounts in a poor market. To investors in failed banks, the program means huge potential upside gain with very limited downside loss.
According to the FDIC, a competitive bidding process is used to ensure that the best sales price is obtained on a failed bank. In addition, a financial analysis of asset values is performed by the FDIC which dictates the terms and conditions of the loss-share agreements. Nonetheless, as Problem Bank has noted in the past, there are examples of buyers of failed banks reaping huge profits due to the loss protection guarantees provided by the FDIC:
The FDIC has been heavily criticized lately by those who question whether OneWest got too good of a deal on its purchase of failed banks. Indy Mac was the most costly banking failure in U.S. history at $10.7 billion and the FDIC could still face billions more in losses under its loss-share transactions with OneWest. The question of whether OneWest received a windfall at taxpayer expense became even more relevant this week when OneWest reported huge profits of $1.6 billion last year.
The private investors who formed OneWest had initially contributed only $1.55 billion. Bert Ely, a well respected banking consultant remarked that “This is one hell of a deal for those owners, but hardly a good deal for the banking industry, which pays the FDIC’s bills. These are just incredibly sweet numbers..The public policy question is, why are they so good? Particularly given the magnitude of the loss estimated at the FDIC.”
This week’s bank closing is certain to raise the level of debate over the FDIC’s competence in resolving banking failures on the best terms for the taxpayers.
Investors also apparently view the purchase of failed Beach First as a huge profit opportunity for BNC Bancorp. The stock of BNC Bancorp skyrocketed 12.5% in after hours trading, up $1.03 to $9.28. Bank management and insiders who hold almost 20% of BNC’s float of 7.34 million shares, have instantly reaped a $1.5 million windfall, courtesy of the US taxpayer who ultimately pays for the cost of failed banks (in this case alone $130 million). Keep in mind that BNC Bancorp “purchased” failed Beach First with no money down and an FDIC guarantee to pick up most of the losses on the failed bank’s assets.
The ultimate gain or loss by the FDIC on their long tailed obligation to absorb losses on the ultimate disposition of failed bank assets is impossible to predict. If property markets eventually recover, the FDIC’s losses should be less than estimated.
It will be some time before the results of the loss share programs can be evaluated, since certain assets are covered by loss share agreements for up to 10 years. The cost of expected losses on a failed bank’s assets covered by a loss share transaction is included in the FDIC’s estimated cost of a banking failure.
The FDIC has used the loss-share program to unload failed banks which has resulted in huge gains for certain investors, while the losses on the failed banks have ultimately been borne by the taxpayers. If property markets continue to weaken and credit losses are more than expected, the FDIC could be liable for billions of dollars in additional payments, exposing the American taxpayer to additional losses. Meanwhile, the Deposit Insurance Fund, which is used to cover banking losses, has been depleted and currently has a negative balance of $20.7 billion.