As the distressed-asset market begins to stabilize, the Federal Deposit Insurance Corp. (FDIC) is shaking up the way it handles failed banks and their assets.
The vast majority of failed-bank resolutions to date have followed a pattern in which the FDIC sells the bank's assets and deposits to another bank and pledges to cover the bulk of the buyer's losses.
But as the economy stabilizes and a growing pool of investors compete with banks for failed assets, observers said the agency is trying new tactics to reduce its losses.
"What you're seeing is the whole process opening up away from plain-vanilla transactions," said Kip Weissman, a partner in Luse Gorman Pomerenk & Schick. "The FDIC feels more comfortable experimenting and trying to get better pricing."
The FDIC has formed partnerships with investors to sell assets well after a failure, embraced limited involvement from private-equity buyers and boosted liquidity by selling bonds backed by failed-bank assets. Ten days ago, the agency also removed a bonus layer of protection from loss-sharing deals.
But with both the FDIC and investors showing more confidence about what had been a dead market for toxic loans, observers say even bigger changes may be in store.
They sense more openness from FDIC officials toward private equity and cite buzz about possible bid packages that would include multiple failed banks. The FDIC is also discussing plans to securitize receivership assets.
As "they did in the savings and loan crisis, they're experimenting as they go along to see what works best, and with a continuing effort to reduce the cost to the" Deposit Insurance Fund, said Ralph "Chip" MacDonald, a partner in the Jones Day law firm in Atlanta."They obviously have a lot more experience now in the current markets, and they continue to evolve and try to figure out where the demand is."
Since the early '90s, the FDIC has routinely agreed to share losses with buyers as a way to attract better prices on the hard-to-value assets of failed banks.
The agreements — totaling 126 since the start of 2009 or 70% of the failures in that period — have typically forced the FDIC to cover 80% of a buyer's losses up to a stated threshold, and 95% of losses beyond the threshold.
On March 26, the FDIC said that, in light of the improving economy, it was dropping the option of 95% coverage.
The move was seen as having relatively little impact — no buyer has yet had to tap the second layer of protection — but observers cited it as another sign the agency may feel it has more leeway with buyers.
"They have a pulse on the market, and when they feel they can make an adjustment within the constraints they have to work under, they have shown willingness to do that," said Robert Hartheimer, a former director of resolutions at the FDIC, and now a private consultant in Washington. "They clearly feel comfortable with their process today to adjust the loss-sharing formula."
Weissman said the typical whole-bank deal with loss-sharing allows the FDIC to "act quickly" when a bank fails. However, he added, "the pricing wasn't optimal" for the agency "because bidders weren't going to pay as much when they had less time to consider a transaction and because of concerns about the general economy."
The removal of the 95% protection is, "to me, part of a general trend away from one-size-fits-all toward more customized, individually negotiated transactions," Weissman said.
Some observers said the FDIC may simply feel less pressure to unload institutions than when the crisis began. "Certainly, the FDIC does not have the same systemic risk pressures it had a year and a half ago, so it has a little bit more time to think through how it markets community and regional banks that fail," said V. Gerard Comizio, a partner in Paul, Hastings, Janofsky & Walker.
Others said the agency and investors may feel confident enough about other types of deal structures to pursue transactions without loss-sharing, which could increase revenue to the DIF.
For example, since September the FDIC has done five deals with private investors, buying assets left over from failed banks. The FDIC shares in any upside once the assets are resold. On Thursday, it announced its latest deal involving $490.7 million worth of assets from 19 failed banks.
Those structured loan deals give the FDIC "additional reason to believe they can dispose of nonperforming loans … outside the P & A [purchase and assumption] process," said MacDonald.
"That allows them to narrow the spreads and gains they're giving to buyers in whole-bank transactions. As a result, we may see more whole-bank transactions without loss-sharing because they can transfer the assets to the private sector via the structured loan sales."
Michael Krimminger, deputy to the chairman for policy at the FDIC, said the agency is committed to "exploring all the different transaction structures."
"We want to make sure we have all the different tools on the table and are ready to go to get us the best value for a particular pool of assets," he said. "Certainly, a year ago, the market was much less inclined to buy assets separate from the bank franchise itself. There is more interest in that now."
One trend picking up steam is private-equity investors' teaming up with healthy banks to bid. "The banks can use the acquired assets and liabilities more efficiently than private equity. At the same time the banks are capital-constrained," Weissman said.
Observers also expect the FDIC to package multiple failed banks.
The most notable past example of this was in 1991 when seven banks in New Hampshire failed, holding $4.4 billion in assets, or about 25% of the state's total.
The FDIC packaged them into two new entities for sale and combined the unsold assets into one pool.
"Similar to the savings and loan crisis, it's likely that the FDIC will consider offering multiple institutions, especially in the same geographic area, in one bid package or hold them in conservatorship with the possibility of a further bid as a group," Comizio said.
Such transactions would probably give prospective bidders a longer time to conduct due diligence.
"There has been discussion of cluster bids of up to five banks, and with extended marketing and diligence periods of perhaps 60, instead of 30, days," MacDonald said. "If you cluster a bid you can get a package that might interest people with more money to deploy. It makes sense in selected situations and selected markets."
The FDIC has also been signaling plans to make assets in receivership available to investors through the securitization market. "Hopefully, we will be going to the market with a pilot securitization in the not-too-distant future," Krimminger said.