The Opportunity: Failed Bank Purchases

Many believe that the current pace of bank failures has created a once-in-a-generation buying opportunity. At year-end 2009, financial institutions with assets below a billion dollars and between one billion and ten billion were experiencing higher percentages of asset quality issues than larger banks. FDIC-facilitated acquisitions of failed whole banks provide an attractive opportunity for healthy banks to expand by acquiring failed bank deposits and assets whose risk is mitigated by the FDIC’s loss-sharing agreement.

The Problem for Community Banks

If there is so much opportunity to expand by acquiring failed banks from the FDIC, why have community banks not been more active acquirers? Two reasons:

First, only healthy banks can meet the FDIC's eligibility criteria for acquiring banks. Generally, in order to participate in an FDIC-assisted transaction an institution must meet all of the following criteria:

• Total risk-based capital ratio of 10 percent or greater
• Tier 1 risk-based capital ratio of 6 percent or greater
• Tier 1 leverage capital ratio of 4 percent or greater
• CAMELS composite rating of 1 or 2
• CAMELS management rating of 1 or 2
• Compliance rating of 1 or 2
• Bank holding company composite (RFI/C) rating of 1 or 2
• Community Reinvestment Act rating of at least satisfactory
• Satisfactory anti-money laundering record

Second, many community banks that could qualify as bidders want to purchase only the failed bank's deposits and branches, but do not want to be required to also assume the bank's loan portfolio as well. Doing so would put the acquiring bank into a new line of business-- working out troubled loans-- which for most community banks would require additional capital, experienced personnel and management supervision. Most community banks are not well positioned to assume those responsibilities.

At the same time, there are many experienced and well capitalized real estate investors that would like to purchase real estate loans from the FDIC in negotiated transactions, but are only permitted to purchase assets via the expensive, highly competitive bid process, established by the FDIC. In this process, the investor must commit to investing large sums to perform due diligence satisfactory to support a competitive bid, which has only a relatively small chance of success. Not an attractive option for any but the very largest real estate companies.

The JV Plan

The JV Plan pairs the acquiring bank with one or more real estate investment companies to acquire from the FDIC failed bank deposits, and some or all of the failed bank's real estate assets pursuant to an FDIC loss–sharing agreement ("LSA"). The bank acquires the deposits, and a new joint venture company, with the bank as minority owner (the "JV"), acquires some or all of the selected assets. The JV then manages and subsequently disposes of the assets, sharing the profits according to the bank's JV percentage ownership.

The JV Plan thus creates a "combination bidder" for failed banks in a whole bank acquisition from the FDIC. A successful acquisition provides the bank with the failed bank's deposits and as many of the loans as it wants to keep, and the real estate investor/manager with the distressed loans it selected to include in the failed bank bid, at deeply discounted prices (because of the negotiated whole bank acquisition), and at greatly reduced risk because of the LSA.

In a failed bank transaction, the FDIC provides a “stated threshold” for bids. Bidders are provided with the specific amount of the stated threshold a week to 10 days before bids are due. Pursuant to the LSA, up to the amount of the stated threshold, all losses, net of recoveries and reimbursable expenses, are shared 80 percent to the FDIC and 20 percent to the assuming bank. Beyond the stated threshold, the FDIC absorbs 95 percent of such losses and expenses.

Currently, it is typical that a winning bidder will bid a "discount" on the transaction. The discount can be expected to cover anticipated loan losses, as well as other costs to the assuming bank. In most transactions, the winning bidder has booked a one-time gain on a bargain sale, which is a taxable one-time profit from engaging in the transaction.

The JV Plan Timetable

1. Bank becomes a qualified bidder.
2. Bank identifies potential target failed bank acquisitions from “triage list” supplied by FDIC and principal regulator.
3. Based on location of potential failed bank target, Bank selects real estate partner(s) (from pre-qualified list) with interest in assets in those locations.
4. Bank and real estate partner negotiate and formalize terms of relationship and begin preliminary due diligence on target.
5. Bank receives (2-3 week) advance notice of the failure of its target bank. Bank notifies FDIC of its interest in bidding on the bank.
6. Bank and real estate partner coordinate due diligence.
7. Bank and real estate partner agree upon, prepare and submit a bid.
8. If bid is successful, Bank and real estate partner form an LLC in accordance with prior agreement reflecting respective equity percentages.
9. Bank and real estate partner negotiate final terms of acquisition with FDIC.
10. Bank closes failed bank acquisition. Simultaneously, Bank sells selected assets to JV. Real estate partner funds its portion of the equity of the JV (its pro rata share of the purchase price). Bank contributes a portion of the acquired assets as its pro rata share of equity to the JV.
11. JV manages and disposes of assets and takes responsibility for managing the FDIC oversight relationship under the LSA.
12. Bank and real estate partner share in JV profits per equity percentages.

This JV plan appears to provide a viable opportunity for healthy community banks to expand their franchises by acquiring failed bank competitors with very little or no asset quality risk.