The FDIC first began using loss-sharing arrangements in 1991, as the agency managed its way through the S&L crisis. Community banks benefited from these arrangements. These arrangements are associated with purchase and assumption agreements that transfer a failed bank's assets from the FDIC to a healthy bank. In the aftermath of the 2008 financial crisis, the loss-sharing arrangement has made a dramatic return to the forefront.
Under a simple loss-sharing deal, the FDIC might agree to absorb 80 percent of the losses associated with a specific pool of non-performing loans that the healthy bank acquires in the transaction. The healthy bank would absorb the first 20 percent of losses arising from that loan book. The FDIC's liability to share in these losses would last for a stated time period, such as three, five or seven years. There would be additional terms governing the deal-including maximum aggregate losses incurred by the healthy bank, FDIC reimbursement of net charge-offs of shared loss assets, etc.
A proven strategy
Between September of 1991 and January of 1993, the FDIC made loss-sharing arrangements in connection with 24 bank failures. The aggregate value of assets covered by those arrangements was approximately $18.5 billion. After the fact, the FDIC compared the costs of purchase agreements made with and without loss-share arrangements. The agency concluded that loss-share transactions were less expensive than the conventional purchase and assumption agreements, for both large and small banks. http://www.fdic.gov/bank/historical/managing/history1-07.pdf
Besides reduced resolution costs, there are other advantages associated with loss sharing, including:
Greater incentive for the healthy bank to acquire more than just the failed bank's deposits
- Fewer disruptions for loan customers
- Fewer assets being absorbed and subsequently managed/liquidated by the FDIC
- Fewer assets being removed from the private sector
FDIC loss-share arrangements have been called a win/win, but they are not without risks. The problem assets may be a distraction to the new management team, even if the potential for financial losses is limited. Where there is no loss-share agreement, the healthy bank takes only the deposits, thus beginning operations with a clean slate.
Today's crisis
In the first seven months of 2009, the FDIC has used loss share in at least 36 out of 64 bank failures. The aggregate value of assets covered by these arrangements is roughly $20 billion. Among the largest 2009 transactions are:
BankUnited FSB, $10.7 billion covered by loss-sharing
- Security Bank of Jones, $1.6 billion covered by loss-sharing
- Vineyard Bank, $1.5 billion covered by loss-sharing
- Temecula Valley Bank, $1.5 billion covered by loss-sharing
A complete list of 2009 bank failures, along with links to the associated Purchase and Assumption agreements is available here: http://www.fdic.gov/bank/individual/failed/banklist.html
Bank Regulators Solicit Comments on Proposed Liquidity Risk Managements
The U.S. federal bank regulators (OCC, FRB, FDIC, OTS) along with the National Credit Union Association (NCUA) have collectively produced a set of guidelines regarding liquidity risk management for financial institutions. The agencies are soliciting public comments on these guidelines through September 4.
The proposed guidelines define a framework for the identification, measurement and monitoring of funding and liquidity risk; they include specific recommendations for:
- corporate governance
- risk mitigation
- management of intraday liquidity
The responsibility of board members
Under the proposed guidelines, an institution's board members are ultimately responsible for managing liquidity risk. The board must therefore establish an appropriate level of risk tolerance for the institution, and then communicate that risk tolerance profile to the internal management team. At least annually, the board should revisit the liquidity strategy to ensure that:
- current liquidity risks are understood
- the liquidity policy is still relevant and appropriate
- the policy is being enforced
- it is clear internally which senior managers are responsible for making liquidity risk decisions
Key aspects of an institution's liquidity plan
The institution's liquidity management plan should:
- be appropriate given the complexity of the institution's structure and activities
- identify primary funding sources, both for daily needs and seasonal or cyclical needs
- define acceptable liquidity strategies, both for expected and unexpected business scenarios
- address liquidity management in terms of separate currencies and/or business lines, where appropriate
- address how the liquidity management practices dovetail with broader business strategies and contingency planning
The plan should establish liquidity projection assumptions and a periodic review process, to ensure that those assumptions continue to be valid over time. Qualitative targets and quantitative objectives should be clearly defined. Examples include:
- Unpledged liquid asset reserve targets
- Funding diversification targets
- Contingent liability exposures
- Desired asset concentrations
- Activity exposures
- Targeted level of unencumbered assets to serve as liquidity cushion
The guidelines also recommend that senior managers receive liquidity reports at least monthly, or more often when economic conditions are severe. Board members should be evaluating the institution's liquidity position at least quarterly.
It is also advised that complex institutions make efforts to build liquidity costs into internal product pricing and performance measurement.
Risk measurement and reporting
Institutions are expected to measure ongoing liquidity risk with short- and long-term cash flow projections that consider both on- and off-balance sheet items. As part of this process, the institution should have measures in place to ensure the appropriate valuation of assets. Other key components of an appropriate liquidity monitoring strategy include:
- regular stress testing
- collateral position management
- procedures to monitor liquidity across business lines and legal entities
- procedures to monitor and manage intraday liquidity position
The report also addresses liquidity risk management practices for holding companies. Read the Proposed Interagency Guidance here and (http://www.fdic.gov/news/news/press/2009/pr09107a.pdf ) let us know what you think. Are these recommended procedures detailed enough to head off unexpected liquidity crises when economic conditions sour? Have the agencies overlooked key liquidity management tactics? Or are these guidelines too much?
Given the large number of bank failures over the last 18 months, the FDIC is seeing increased interest from would-be investors interested in purchasing depository assets of the failed institutions. Concern has risen at the regulatory level about whether these new bank owners and investors have the qualifications necessary to keep the acquired assets from returning to the failed assets pool. That concern has led the FDIC to issue a proposed policy statement that would, if adopted, establish a new set of qualifications for investment groups intending to purchase failed bank assets.
The proposed standards address the following topics:
- Ownership structure
- Capital levels
- Cross guarantees
- Affiliate transactions
- Continuity of ownership
- Secrecy law jurisdictions
- Limitations on the existing owners of the failed institution
- Disclosure requirements
Key measures of the proposal
- Silo structures will not be deemed eligible for bidding.
- A Tier 1 leverage ratio of 15 percent is required and must be maintained for three years. After that, the institution must remain "well capitalized."
- The holding company must agree to sell stock or engage in capital qualifying borrowing to support the depository institution.
- Investors with interests in more than one FDIC-insured institution have to pledge to the FDIC their proportionate interests in each institution.
- Loans to investors or investors' affiliates would be prohibited.
- Investors would have to retain ownership in the institution for at least three years. The FDIC can approve exceptions.
- Ownership structures involving entities domiciled in bank secrecy jurisdictions will not be eligible bidders.
- Investors owning 10 percent or more of the failed institution will not be eligible bidders.
- Investors will have to disclose to the FDIC information pertaining to the size and composition of capital funds, the business plan, the management team, etc.
Bidders subject to proposed rules
Under the current proposal, these rules would only be applicable to certain types of bank acquirers, namely:
- Private capital investors attempting to take ownership of deposit liabilities that are currently in receivership
- De novo institutions applying for FDIC insurance in association with "the resolution of failed insurance depository institutions"
Balancing capital needs with prudence
While the FDIC is conscious of the need to qualify bidders, regulators are also concerned about placing too many limitations on the inflow of new capital into the banking system. The banking system needs private investor capital. Are these proposed rules going to inhibit the flow of that new capital? Or will the new standards deliver the right amount of prudence? Feel free to sound off!
Read the full FDIC statement here: http://www.thefederalregister.com/d.p/2009-07-09-E9-16077 The proposal policy statement is open for public comments until early-August.
Last week, we addressed the FFIEC’s 2009 list of distressed and underserved communities in the context of identifying geographies appropriate for bank acquisitions. This week, we’ll look at how the composition of that list has changed between 2005 and 2009, and what that might mean for bank acquirers.
The chart below shows the ten states with the highest number of distressed or underserved counties in 2009, along with the data from 2008 through 2005 for those same states. To clarify, the FFIEC list identifies specific community tracts and the counties in which those tracts are located. The data below represents the number of counties in each state that have one or more distressed or underserved community tracts.
As the chart indicates, several of these states show relatively small changes over the five-year time period. Texas, Georgia, Mississippi, Missouri, Arkansas and Oklahoma show an increased number of counties in 2008 and 2009 compared to prior years. The data from Nebraska, Kentucky and Kansas, however, have remained almost flat.
Obviously, we don’t have the data here to understand why these particular states routinely have distressed or underserved community tracts in more counties than other states. But, since the composition of these “top ten” hasn’t changed much in five years, it’s probably safe to say the banking community hasn’t found an effective and sustainable means of serving many of these communities.
The 2009 data reports that in Texas alone, there are 335 distressed or underserved tracts, spread out among 126 counties. Among those tracts, poverty is the most pervasive problem; 173 tracts are designated as impoverished, while 120 have suffered from population loss. Another 85 tracts are in remote rural locations. Only five of the tracts have a noted unemployment problem. (Some tracts fall into more than one of these categories).
In 2005, Texas had 258 distressed or underserved tracts among 109 counties; 125 of the tracts were designated as impoverished, 120 had experienced population loss, and 85 were in remote locations. Twenty-six tracts had problems with unemployment. The change from 2005 to 2009 in Texas’ data looks to be largely driven by an increase in the number of poverty-stricken communities.
Residents of poor, shrinking and/or remote communities aren’t the ideal “target” for most banks. But the conventional school of thought supports the notion that these customers do offer opportunity for banks. They can be weaned onto starter banking services and eventually converted into more sophisticated banking customers.
A bank acquisition team that addresses these customer segments early in the strategic planning process can devote the resources necessary to gain a foothold in underserved areas. That foothold can then develop into a strong competitive advantage, as residents and businesses benefit from the financial support of a community-oriented bank.
For additional reading on addressed underserved communities, see:
• Dryades Savings Bank Case Study
http://www.cdars.com/_docs/case-study-dryades.pdf• FDIC Advisory Committee on Economic Inclusion
http://www.fdic.gov/about/comein/agendaFeb52009.html• Reaching Underserved Borrower Prospects: A Case Of A Small Rural Bank
http://www.cluteinstitute-onlinejournals.com/PDFs/200632.pdf
In June, the Federal Financial Institutions Examination Council (FFIEC) released its 2009 list of middle-income, non-metropolitan community tracts that are distressed or underserved by the banking community. Banks that serve these communities can receive community development loan credits under the Community Reinvestment Act (CRA).
Prospective bank buyers could use the FFIEC list to identify geographic areas where competition is limited. The industry considers moderate-income and underserved communities to be one of the richest areas of opportunity, but has long struggled to reach those potential customers effectively. A comprehensive community development plan in the right geography could be one method of tapping that potential. Under the right circumstances, the bank has the opportunity to team with community leaders to spearhead economic development that will benefit local residents, businesses and the bank itself.
A strategy to acquire a bank with the intention of serving distressed or underserved markets could involve relocating the acquired institution to the targeted area. In the current regulatory environment, this process could be simpler than attempting to open a new bank. Another option would be to target acquisitions that could be expanded into the distressed/underserved areas with new branches.
Composition of the distressed/underserved list The 2009 list contains about 4400 community tracts spread out across the U.S., including Puerto Rico, U.S. Virgin Islands, Guam, American Samoa and Northern Mariana Islands. The factors influencing the distressed and/or underserved designation include employment trends, poverty, population loss and distance from nearest urban area.
The chart included shows that these tracts are not evenly distributed throughout the country. In fact the state of Texas has more than its relative share, with distressed or underserved tracts located in 126 different counties. Georgia follows, with distressed or underserved tracts in 70 different counties. Mississippi and Kansas have more than 50, while Kentucky, Michigan and Nebraska each have 45 or more.
With the exception of Georgia, these top 12 are concentrated in the central U.S.—which begs some interesting strategic questions. Are these areas currently underserved because existing banks haven’t found a way to serve these communities profitably? Could a forward-thinking organization group create a viable plan to develop a new bank acquisition into a profitable, regional network of branches, with the products and services that would appeal to consumers in these areas? Are these communities underserved because the local economies have been particularly hard hit by the recession, or have they long been overlooked by banking institutions?
Top 12 states with the most underserved or distressed countiesTexas 126
Georgia 70
Mississippi 56
Kansas 55
Kentucky 49
Michigan 48
Nebraska 45
Missouri 44
Arkansas 41
South Dakota 41
Oklahoma 41
Montana 41