Banking Law

Ever since one of New Mexico's largest home grown community-focused banks, Charter Bank, was seized by the FDIC last year, the New Mexico Business Weekly has been all over the FDIC. Not in the way Monica Lewinski was all over Bill Clinton while they inhabited the White House, but more like the way B-29s were all over Tokyo in the spring and summer of 1945. Last Friday's target was one that has enraged the easily enrageable for some time now: FDIC loss-sharing agreements with the acquirers of failed banks. Once again, Charter Bank's situation was used as the focal point of some negative commentary about the arrangements, and the acquirer of Charter Bank's assets and deposit liabilities (and owner of the "new, improved" Charter Bank), Texas-based Beal Financial Corp., was also in the cross hairs.

?We are probably the best capitalized bank in the state,? Charter Bank of Albuquerque President and CEO Robert Bonnet said recently.

The reason for Charter?s strong standing, though, is in part due to the financial assistance it received and continues to have access to from the Federal Deposit Insurance Corp., in the form of guarantee on loan losses it might incur.

[...]

The FDIC has agreed to reimburse the new Charter up to 80 percent of its losses on $805 million in loans it acquired from the old bank. If Charter loses more than $274 million on those loans, the FDIC will absorb 95 percent of those additional losses, said Charter CFO Bruno Ienni. Three days after it assumed the assets and liabilities of the original Charter, the new entity was sent $89.1 million by the FDIC in a wire transfer, Ienni said. That $89 million represents differences between the liabilities (deposits) and assets (loans) purchased by the new Charter. The bank?s parent company, Beal Financial Corp. of Plano, Texas, put $97 million in fresh capital into the new bank. The FDIC calls that $89 million ?cash amount due to acquirer.? ?When an open financial institution acquires or assumes the liability for a failing institution?s deposits, the FDIC as insurer reimburses it for the amount of insured deposits,? says the federal agency?s handbook on bank closures. In the first quarter, Charter claimed just under $1 million in loss share money, Ienni added.

Yes, that's the way these deals work. The FDIC first has to "fill the hole" between the amount of liabilities assumed and assets taken, then has to provide some loss protection on the riskier assets taken. Otherwise the acquirer would never take the insured deposits, which the FDIC doesn't want to have to pay off, and the FDIC would have to liquidate the assets itself. It's required by law to enter into a loss sharing arrangement like this one only if it determines that its less than the cost of liquidation. The basic templates for these transactions haven't really changed substantially for decades, although they are tweaked as circumstances change. None of this seems unusual or unexpected to anyone who's been in the banking business for more than ten minutes.

Nevertheless, many members of the public are "outraged" at the very thought these acquirers are receiving a "windfall" of "big money" from the public coffers. For bankers, however, whose assessments fund the FDIC, if these deal structures lower ultimate losses to the FDIC from failed banks, they're all for them. That's especially true for "strategic bidders" that are existing well-capitalized financial institutions that use these deals to enter new markets or enhance existing market share more cheaply than they otherwise could. If, as some of the more extreme anti-FDIC pundits have been warning, the FDIC eventually needs a taxpayer bailout, using loss-sharing to lessen FDIC losses will also be good for the taxpayers.

That said, the newspaper picks up on an angle that steams many bankers who are trying to work through troubled times and save their franchise. That's the fact that "open bank assistance" is not on the FDIC's current menu.

It is financial assistance the FDIC won?t and can?t legally give to troubled banks, except if the bank is deemed too big to fail.

[...]

It?s those loss sharing agreements the FDIC can offer to buyers of closed banks, but not to shareholders of troubled banks, that have riled some banking experts.

New Mexico bank consultant Joe Badal says the loss share agreements basically mean that no, or very few investors, will put money into a bank that is under a federal regulatory order. That?s because any investor who did pour capital into a troubled bank would be in line to lose it to loans gone bad, writedowns and federal regulators who, any day, could close a bank and ?sell? it to another entity.

Investors simply cannot obtain the guarantee on losses that someone who acquires a bank from the FDIC has.

?Why would anybody buy a bank on the open market when you could get one, assuming you could work a deal with the FDIC?? Badal said. ?I?ve talked to some investors in town, and they say there is no way they would buy a bank on the open market when they could wait and get an 80/20 split with the FDIC.

?It?s flabbergasting, it?s unbelievable and it?s an absolute boondoggle,? Badal added.

As I've explained above, I don't think it's flabbergasting at all. Nevertheless, I feel Joe's pain. So does the director of the New Mexico Financial Institutions Division, Bill Verant, a regulator who agrees with Badal that investors won't invest in a troubled bank when they can wait until it fails and get loss-sharing from the FDIC. He also yearns for  open bank assistance.

What bothers Verant, a 45-year veteran of the banking business who went through the savings & loan crisis of the late 1980s and early 1990s, is that the FDIC and other federal regulators aren?t doing what was once called ?open bank assistance.? It offered financial aid to troubled banks, instead of closing and selling them.

?Back in the olden times, when they set up the Resolution Trust Corporation during the S&L crisis, they did entertain open bank assistance. They could allow a new controlling interest or partnership to come in and buy a controlling interest and not close the bank and leave the the shareholders in place,? Verant said.

?I thought that was going to be part of what would be going on in the current situation, and I thought that, with the Troubled Asset Relief Program [TARP], they would take troubled assets out of banks and put them in ?warehouses? and use TARP funds to buy troubled assets, but they used TARP money to buy General Motors.?

That last zinger doesn't hit the FDIC, but it does hit the White House square on the chin. I've never met Mr. Verant, but I think I'd like him.

The article accurately points out that Congress changed the law in the 1990s to prevent the FDIC from granting open bank assistance if the existing shareholders would benefit. In almost every case where they aren't completely wiped out by the transaction, that will be difficult to achieve, and i they are wiped out, why would they approve the deal? There are some exceptions to this requirement, but none likely to occur for "too-small-to-save" community banks, or, for that matter, for even a large regional player like the late Guaranty Bank of Dallas, which went down in flames and was sold to BBVA Compass, notwithstanding the fact that investors like Gerald Ford and Carl Icaan were willing to recapitalize the bank if the FDIC would have  agreed to render open bank assistance.

As a matter of pure bureaucratic backside protecting, what's the upside to the FDIC in letting the bank remain open, giving it assistance, and then still have it fail at a later date?

<sound of crickets chirping>

I doubt that the FDIC will ever again determine that an open bank assistance deal is the least costly alternative. Neither does Verant, although he appears somewhat rueful about that fact.

Verant said there were scores of now-closed banks on the FDIC?s troubled bank list that could have benefited from open bank assistance ?instead of having to have gone through the funeral.

?But the FDIC does not have the time to sort them out,? Verant added, ?It decided to close them all and let God sort them out.?

Folks, that's likely one of the few times, and perhaps the only time, you'll see "FDIC" and "God" mentioned in the same sentence on this blog without the deity's name being taken in vain.