Opportunity knocks, but there are drawbacks

The mess in banking isn’t over yet.That means hundreds of banks, most of them small, community organizations, likely will fail in the years to come. The flip side of all that carnage is an opportunity for bankers to buy troubled institutions, grow balance sheets during tough economic times and let the Federal Deposit Insurance Corp. take most of the bad assets of the failed bank.
The investment bankers and attorneys who attended Bank Director’s May 2nd conference in Chicago agreed on one theme: There are still plenty of deals to be had for banks looking to buy failed institutions from the FDIC, as long as they work hard, fast and smart to do the deals right. 
“There is ample opportunity,’’ said Jeffrey Brand, managing director at investment bank Keefe, Bruyette & Woods. “The FDIC will allow you to bid as many times as you like and they will let you be as creative as you like.”
There were more than 523 banks with $318.3 billion in assets at the end of last year that had Texas ratios topping 100 percent, said Brand, using SNL Financial data. The Texas ratio is commonly used to predict bank failure, and is the amount of non-performing assets and loans, plus loans delinquent for more than 90 days, divided by tangible equity capital and loan loss reserves. If it’s more than 100 percent, that’s trouble.
The number of troubled banks also appears to be increasing. The number of banks with Texas ratios above 100 percent increased 4.5 percent from the third quarter.
The FDIC’s “problem” bank list also appears to be growing. It reached a record high for this cycle of 884 banks at the end of last year, more than 10 percent of the total banking system. That number was up from 860 the quarter before.

Louis Dubin, president of Resolution Asset Management Co., said the states with the most number of troubled banks are Georgia, Florida, Illinois and Minnesota.

Troubled Bank Map: 2010 Q4


CRITERIA: Texas ratio > 100%, Leverage ratio <9%

Picking up failed banks from the FDIC offers some benefits: the FDIC can take on as much as 80 percent of the failed bank’s losses, using a tranche system based on the size of the losses. Plus, the acquiring bank can cherry pick the assets, locations and employees it wants. The failed bank’s pre-existing contracts are automatically voided on the sale.

And bankers can get creative in terms of how they structure deals. Brand recommended making several bids, including one that follows traditional FDIC deals and one that doesn’t. For instance, banks can price bids to take into account future risk, instead of using a loss share agreement, avoiding the hassles of regular audits from the FDIC to make sure they comply with the loss-share agreement.

“The FDIC is discovering the costs of auditing all these banks to see what their losses are,’’ Brand said. “Now they’re doing deals without loss share (agreements). You don’t need that expensive accounting system. But they are taking away that safety net, too. If losses are worse than estimated, that’s 100 percent coming out of your pocket.”  

One of the drawbacks of FDIC deals is the possibility that the government could change the rules at any time. The loss share agreement lasts a decade for single-family housing assets; five years for commercial properties.

Buyers also don’t have much time to do due diligence. The entire process, from expressing an interest in acquiring a bank, to closing, can take about 90 days, less if the failed bank’s situation is dire.

“They don’t let you wander around the bank talking to all the lending officers,’’ said James McAlpin, an attorney and partner at Bryan Cave in Atlanta.

Bank employees will have to work quickly to make a bid and conduct due diligence. Plus, they must be able to reopen the bank on the Monday after the bank’s Friday closure, and follow timelines to transition the acquired bank and dispose of its assets.

“It is a tremendous strain on your organization,’’ Brand said.

Teaming Up on FDIC-Assisted Deals

Resolution Asset Management Co. L.P. was formed in 2010 to assist healthy banks acquire failed institutions from the Federal Deposit Insurance Corp. with loss-sharing agreements where the agency provides some measure of protection against losses. A subsidiary of Cantor Fitzgerald, RAM will provide capital to support the transaction, and has a dedicated team of professionals with real estate, asset management, banking and regulatory experience that can help banks bid for failed institutions and manage the acquired assets. Recently, Bank Director talked with Managing Director Rodney A. Montag about the outlook for FDIC-assisted deals, and how the RAM structure works.

What’s the outlook for FDIC assisted deals in 2011?

The outlook is pretty good, or bad, depending how you view it. We’ve had 322 failures since the current crisis began and we are projecting an additional 300 plus failures over the next few years. Looking forward, one of the big differences will be the average size of the bank failures, which we believe will get smaller.

Has the failure rate of banks peaked or do you think the situation will continue to worsen given the industry’s on-going asset quality problems?

I think that’s more of a regulatory policy question than anything else. There is a backlog of troubled banks to deal with and they’re only closing the worst of the worst, which is to say the banks that have diminished liquidity. They seem to be focused on banks with serious liquidity issues as opposed to those banks with operational or other asset problems.

What are the greatest challenges in doing an FDIC assisted deal?

The first is the availability of capital. Even if a healthy bank has sufficient capital, most banks are in a capital preservation mode and don’t want to spend it, including for an acquisition. The second challenge is working out the good and bad assets that are acquired from the failed institution. The third is the bidding process, which is competitive whether in or outside of your marketplace.

How does Resolution Asset Management work with a participating bank?

The bank will form an operating subsidiary of which RAM will be a non-voting minority member. The bank itself will acquire the failed bank’s deposits and liabilities, while the assets of the failed bank that are covered by loss share will be transferred to the operating subsidiary at a value agreed upon by RAM and the bank. A RAM affiliate will use its real estate, valuation and asset management expertise to manage these covered assets. RAM will provide to the operating subsidiary capital necessary to support the acquisition, which is usually a non-dilutive way for the bank to raise capital. The bank will hold a preferred equity ownership position in the op-sub and all of the voting portion of the common equity. In other words, RAM is a passive investor in the operating subsidiary with no interest in the bank or holding company.

What is your exit strategy once the bank’s loss-share agreement with the FDIC has been concluded?

Our equity interest is solely in the operating subsidiary; once all the covered assets have been resolved either through liquidation or modification, the subsidiary itself will be liquidated and RAM will no longer have any equity interest. And of course we never had any ownership interest in the bank parent or the bank holding company, which is a big difference between our structure and a private equity investment in the bank.

Are there steps that a bank should be taking even before they contact RAM?

It’s important to understand that a bank has to have our structure in place before they can bid on a failed bank, though we can also participate with a bank on a transaction they have already closed upon. We spend as much time underwriting the participating bank to confirm its health for our structure as we do reviewing the failed bank. The participating bank also has to submit our structure to its primary regulator for approval, which takes added time.