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Loss-sharing Arrangements Keep Failed Bank Assets in Private Sector

Posted by Wendell Brock on Fri, Jul 31, 2009

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.

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:

Topics: FDIC, Bank Failure, Risk Management, Bank Sales, community banks, Loss

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