Viewpoint: Five Key Tasks to Make FDIC Loss-Sharing Work

Why? Every day a court in the USA stops a bank from wrongfully foreclosing. Failed Bank executives walk away keeping bonuses based on bad loans. Then …

Why? Every day a court in the USA stops a bank from wrongfully foreclosing. Failed Bank executives walk away keeping bonuses based on bad loans. “After all, there is a reason why these banks failed. Oftentimes, financial statements are old,
appraisals are out of date, and file memos chronicling the loan’s current status are missing.” Then the government insures the buyer of a failed Bank against losses. The thinking seems to be if the government keeps hiding theft and charging it to our children and their children, maybe they (the bankers and the politicians that received “contributions) can continue to get away with skimming.

This article is written by an expert recommending that expert investors who intend to acquire a failed bank with an guarantee against loss should get more experts to counsel on the loss sharing agreement.

So, if the experts have to get experts, how are decent Americans, whether a cook, fireman, truck driver, doctor, or Ph.D. going to understand what is taking place behind closed doors. Yes, closed doors.

A county recorder in Utah said of MERS, “… if looked like a scam from hell.” You will be hearing more about Loss Sharing Agreements. What you won’t hear or read is how by starting a new bank, it might be possible to actually end up with profit by foreclosure on a American. This looks like another “scam from hell” to me.

Viewpoint: Five Key Tasks to Make FDIC Loss-Sharing Work

American Banker | Tuesday, January 12, 2010

By Charles B. Wendel

Entering into shared-loss transactions appears to be the Federal Deposit Insurance Corp.’s preferred approach for
dealing with failed banks. More than 60% of last year’s 140 bank failures were resolved using this approach.

Shared-loss transactions let banks build market share or move into new markets with minimal risk. They also let

private-equity players (led by a team of bankers) take advantage of current industry discontinuities.

Much of the attractiveness of these transactions centers on the “guarantee” the FDIC offers buyers. Typically, the
agency remits 80% of “dollar one” loan losses to buyers and increases its payments to 95% for losses beyond an
agreed upon threshold. In turn, the FDIC benefits from recoveries during the 10-year life of these deals.

Though these deals are attractive strategically and economically, they are also complex.

My company’s work with banks and private-equity players points to five key elements that should be addressed in
order to structure and manage a transaction appropriately.

Conducting a focused due diligence process and negotiating the FDIC shared-loss deal. Though many players

are experienced in due diligence, the FDIC window is short, with no more than two weeks between reviewing an offer
package to bidding. Time with the target is also limited (two to three days), requiring a focused approach. Buyers
should assemble a team of internal and external resources and set clear priorities for their review process.

As for negotiating an agreement, the FDIC has standardized the general structure of its purchase-and-assumption
and shared-loss agreements. However, no two agreements are alike, given evolving requirements by the FDIC (for
example, a “true-up” provision added in the fourth quarter) and buyer-negotiated amendments. Management should
view these agreements as a bible that will be revisited many times. Bank buyers should consult the handful of legal,
valuation and related advisers with expertise in the shared-loss world, leveraging their knowledge rather than relying
solely on internal controllers, general counsels or other internal resources.

Addressing key accounting-related priorities. Accounting regulations to be addressed include FAS 141R, SOP

03-3 and IRC Section 593. Many tax and accounting issues stem from the need to determine the tax basis of assets
subject to the shared-loss agreement and the rules related to deferred tax gains. A bank’s auditor is conflicted out
from offering these services, since it would be reviewing and passing judgment on its own work. This requires bank
buyers to obtain the services of an independent firm with appropriate accounting and valuation capabilities.

Ensuring strong portfolio support. The FDIC expects buyers to make regular claim submissions related to loan

losses, usually monthly for residential loans and quarterly for commercial and consumer loans.

Residential submissions are relatively straightforward because of the objective loss criteria outlined by the FDIC,
namely, “actual losses incurred due to modifications, foreclosures, short sales, deeds-in-lieu or bulk sales.” However,
commercial submissions are more subjective and require greater evaluation.

The state of commercial loan files in failed banks is often inadequate for portfolio management or for making “audit-
proof” submissions. (After all, there is a reason why these banks failed.) Oftentimes, financial statements are old,
appraisals are out of date, and file memos chronicling the loan’s current status are missing.

Owners should select a team of internal and/or external resources to triage, in effect, the portfolio, uncovering the
low-hanging fruit that can be submitted earliest while establishing a process to assess the entire portfolio. Every loan
in the portfolio must be reviewed against the acquirer’s risk rating system and managed within policy guidelines.

Commercial bankers at the acquired bank should undergo a sea change in how they look at their loans. Before

failure, many banks avoided taking losses because their reserves could not support a realistic view of a borrower’s
position. Under shared-loss agreements, management wants bankers to accurately assess transaction risk as quickly
as possible in order to identify loans subject to FDIC claims.

Making accurate and complete certificate submissions. The FDIC has developed a three-page certificate that

requires buyers to tap multiple internal databases and in some cases provide manual inputs as well. Systematizing
this process is crucial to increased accuracy and productivity.

Using technology to track and monitor loan submissions and recoveries during the life of the FDIC agreement.

While residential mortgage loans usually involve one submission, both CRE and C&I loans may require multiple
submissions based upon declining values and continuing expenses related to asset preservation, legal and appraisal
costs.

In addition, recoveries occur across the portfolio. Buyers need to develop an inclusive information management

system or “portal” to track these ins-and-outs. Tying the portal to the bank’s core systems allows for the “automatic”
generation of certificates, eliminating much of the manual activity that dominates bank staffers’ time in the early
stages of integrating an acquisition.

Shared-loss transactions can be very attractive and beneficial to all stakeholders, including the customer and the

FDIC. However, making them work requires senior management focus, clear priorities, and a bankwide

understanding of the unique opportunity these transactions offer.

Charles B. Wendel is the president of Financial Institutions Consulting Inc.