Recovery Puts FDIC 'Loss-Sharing' on Endangered List

WASHINGTON — It was once nearly a given that buyers of failed banks would get a partner in the Federal Deposit Insurance Corp. to help shoulder losses from a noxious portfolio. But such deals now have become the exception instead of the rule.

The FDIC has gradually backed away from loss sharing since the crisis began to ease, making it now increasingly rare. Even though many bidders still covet it, no buyer of the year's initial string of five failed banks — ending with the April 5 seizure of the $45 million-asset Gold Canyon Bank in Arizona — received it. Only one in the last 10 deals included protection, marking the lowest frequency of loss-sharing deals since the crisis began in 2008.

"In 2011, loss share agreements were as valuable as silver. Last year, they probably became gold. This year, they're probably diamonds," said Lorraine "Lori" Buerger, a partner at Schiff Hardin LLP.

Some experienced loss share bidders say they still will not vie for an institution without such special arrangements on the table. But the FDIC has consistently found successful buyers that can live without the extra support for a variety of reasons, including continued optimism about a real estate recovery, the relative simplicity of the portfolios of recently failed banks, as well as bidders wary of the monitoring and reporting required by loss-sharing deals.

"There is a lot more confidence that the bottom has been reached in a lot of these markets. … Prices may not rise rapidly, but if you're not seeing a lot of downside, you're going to demand less loss protection as an acquirer," said Richard Brown, the FDIC's chief economist.

With healthy banks still uncertain about buying from the FDIC in the depths of the 2008 crisis, the agency reinstated loss-sharing — a device used in the thrift crisis — to attract private sector help for the oncoming failure wave. Through last year, the agency has used loss-sharing in resolutions of 301 failed banks since the start of the crisis — about 65% of the time — with such agreements covering over $214 billion in assets, according to data published by the Government Accountability Office.

But as early as 2010, when the percentage of annual failures including loss share deals reached a peak of 83%, the FDIC began to clip back some terms of the generous backing. First, the FDIC said it would stop offering 95% protection on loan pools subject to a loss share agreement. Typical deals involve 80% protection, but the FDIC began signaling interest in even lower coverage; in April of that year TD Bank successfully bid on three Florida banks with 50% loss coverage by the FDIC. More recently, the FDIC started limiting its offers of loss share for residential portfolios. (Loss protection for commercial portfolios is more common with analysts still cautious about a turnaround in commercial real estate.)

In 2011, the proportion of failures with loss share dipped to 63%, followed by 39% last year. The last FDIC deal with loss share was the Dec. 14 acquisition of the failed Community Bank of the Ozarks, in Missouri, by Bank of Sullivan.

"Because there are fewer failures, people who haven't been in the business of loss sharing before aren't going to develop the processes and systems to administer loss share deals," said Ralph "Chip" MacDonald, a partner at Jones Day. "There won't be enough loss sharing to start now in developing those processes and systems."

Since May 2012, the agency ceased allowing loss sharing for single-family portfolios under $20 million. Officials say that threshold has since risen to $100 million.

"What we have been hearing … is that they don't really need that comfort on a single family portfolio," said Pamela Farwig, a deputy director in the FDIC's division of resolutions and receiverships.

Farwig and others added that individual failures have also become significantly smaller than earlier in the cycle, allowing bidders that lack experience in loss share management to handle a portfolio without extra FDIC assistance. She noted that the reporting and infrastructure needed to manage loss-sharing is "a little burdensome" for buyers, and "are you really going to want to put all of that machine into place for a $50 million or $100 million institution?"

R. Clark Locke, a managing director for the Hovde Group, said the bigger institutions that failed in the thick of the crisis often had more opaque problems that were difficult to assess in the two-and-a-half-day onsite due diligence the agency allows before the transaction for potential buyers.

"With a limited number of people allowed to be on site for credit file due diligence during the allotted two-and-a-half-day time slot, you couldn't get through and assess enough of a $1 billion plus portfolio to bid without the added protection of a loss share," he said. "With a $100 million portfolio, a five person team during two and a half days can typically get through enough of the portfolio to feel confident enough to bid on a no-loss-share basis."

Yet some bidders continue to make offers that include special FDIC protection, even if they end up losing to another institution, and agency officials say there will continue to be failed-back transactions with such assistance.

"They still have the ability to bid with" loss share, and "we still have staff to monitor the loss share agreements," Farwig said.

Some say they will not bid without it.

"I have learned to never say never. However, it's hard to believe that you can do two days of on-site, watered-down due diligence and get comfortable enough with the financial condition of the bank to go without a loss share," said Edward J. Wehmer, president and chief executive officer of the Chicago-area Wintrust Financial Corp., which has completed nine deals for failed banks.

"We have done a lot of these transactions and I cannot begin to tell you the surprises we have found. There is a reason these banks fail. Given the fact that the current batch of expected failures have been allowed to languish on their death beds longer than ever, one would have to think that there will be more issues than in previous deals."

Buerger said loss sharing has "nowhere near been wiped off the face of the planet."

"Judging from the formal enforcement actions that are out there, we certainly can make the presumption that many of the banks that are still on the problem list have been on that list longer than they would have been in the past," she said. "The longer a bank has been troubled, the more distressed that portfolio is and the more likely it is that the bidding community is going to insist upon loss share coverage of some sort."

Robert Barba contributed to this article.