FDIC and Open Bank Assistance

January 12, 2009

Authored by: Robert Klingler

On January 2, 2009, the Wall Street Journal ran a story on the possibility of the FDIC agreeing to assume future losses on the troubled assets of a failed institutions.  The FDIC has used versions of the loss-sharing model several times last year, but with the exception of the initial attempt to rescue Wachovia, only as part of the receivership of a failed institution.

“It is something that we plan on doing in the future where it’s appropriate,” says Herb Held, assistant director in the FDIC’s division of resolutions and receiverships. “I think it’s a good deal for everybody: the FDIC, the acquiring bank and the borrowers. It keeps the assets where they were.”

This leaves open the question of whether the FDIC will begin using a loss-sharing approach to facilitate open bank transactions.  Some advisers believes that the FDIC will use this approach to effectively entice sound financial institutions to purchase struggling banks, or those which may be in imminent danger of failing.  While there is no existing precedent during this period of economic turmoil, open bank assistance was a well regarded and oft used solution in earlier troubled times.  Where FDIC does provide stop loss or other support, it comes ahead of shareholders in the troubled institution, so it does not help shareholders in most instances; however, it does prevent the extra disruption of a failure.  Traditionally, FDIC officials informally estimated the additional loss upon a failure was at least 15% higher than the loss where the troubled bank is acquired by a healthy bank in an open bank transaction.  As a result, properly structured stop loss or other assistance programs should save the deposit insurance fund real dollars.

For now, the FDIC appears tied to the position that it can only offer loss-sharing following receivership and a full auction of the troubled or failing institution in order to comply with its legal obligation to provide the least-costly solution.  If a tangible proposal for a loss sharing were presented to a regional FDIC office, such a proposal would be have to be structured to assure “least costly” status and would be forwarded to DC for review.

Accordingly, we recommend that neither acquiring banks, nor troubled institutions looking to be acquired, put too many eggs in the basket hoping for FDIC loss-sharing assistance.