If there was one compelling theme at Bank Director’s “FDIC-Assisted Bank Deals: Opportunity Knocks” one-day seminar, which took place on Oct. 22 at the Four Seasons Hotel in Las Vegas, it’s that acquiring a failed bank from the Federal Deposit Insurance Corp. is one of the best growth options available to banks and thrifts today.
Although the actual structure may vary from one transaction to another, the typical FDIC-assisted deal involves a loss sharing arrangement where the agency agrees to reimburse up to 80% of losses incurred by the acquirer on “covered assets” up to a certain amount. The bank acquirer would be responsible for 20% of the losses up to the agreed upon ceiling – and 100% of the losses thereafter.
Non-Traditional Growth Opportunity
While FDIC-assisted deals offer tremendous opportunities for growth in a banking market where traditional M&A volume is at historically low levels, and where organic growth has been limited by a lackluster economy, they are a demanding and extremely complex undertaking. Interested banks are not told how many competitors are bidding for the failed institution, due diligence is limited and all deals are final – which places tremendous pressure on participants not only to submit competitive bids, but also to avoid missing something that could have serious financial ramifications later on. These are high stakes deals that place considerable pressure on the bidding institutions and their financial and legal advisors.
Not just any bank or thrift can bid on a failed bank, either. Qualified bidders must have at least a CAMEL I or II rating for capital adequacy and management. (So-called CAMEL ratings are used by federal banking regulators to assess the condition of a financial institution, with I being the highest.) And according to experts at the seminar, it also helps if the bidder has a proven track record at acquiring and integrating banks.
Future of Bank Earnings
John Duffy, CEO of investment bank Keefe Bruyette & Woods Inc. in New York, kicked off the seminar with an extensive overview of the banking industry. According to Duffy, the industry’s profitability (defined as earnings prior to taxes and loss reserve provisions) bottomed out in the second quarter of 2009, but any growth since then has been modest at best. One important bright spot is that the three-year rise in non-performing assets finally peaked in the second quarter of this year, which holds out hope that a somewhat stronger rebound in bank earnings may be in the offing.
Jeff Brand, a KBW principal who has worked on several FDIC deals in the past year, pointed out that as of Oct. 22 there were 829 banks on the FDIC’s trouble bank list. And with the agency expected to spend an estimated $60 billion over the next four years to clean up after failed banks, the market for FDIC-assisted deals should remain strong for the foreseeable future.
The regions of the country with the most failures (and therefore the greatest opportunities), according to Brand, are the Southeast, upper Midwest and West.
Tips on Making a Bid
Jim McAlpin Jr., a partner at the law firm Bryan Cave in Atlanta, advised the directors in attendance to contact the senior FDIC officials in their region even before making a bid on a failed bank. Although the FDIC is required by law to seek the lowest cost resolution when a failed bank has been placed under its control through receivership, it’s still beneficial for the agency to have had personal contact with the management team at an institution prior to the submission of a bid.
Surprisingly, McAlpin also advised that prospective bidders should attempt to talk with trouble banks in their region before they fail and are placed in receivership. The FDIC’s own watch list, as well as other easily obtained analyses that are based on public data, can help identify troubled banks that are in danger of failing. Because FDIC restrictions make it next to impossible to perform a thorough due diligence prior to submitting a bid, any insight that the bidder can glean by talking to the management team of the troubled bank beforehand can prove to be invaluable.
The bidding process is quite complex, and Rick Bennett, managing partner and leader of the bank integration practice at the New York-based consulting firm PricewaterhouseCoopers, said that bidders will need to build a sophisticated data model that will enable them to consider a variety of economic and deal structure scenarios when developing their bid. And because all FDIC-assisted deals are final, it’s crucial that potential acquirers base their bids on solid analytics.
As the old saying goes, caveat emptor!