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.

The Recipe for Success at Reliant Bank

recipe.jpgWith the end of 2010 quickly approaching, there’s no doubt that many bankers won’t be sad to see the end of yet another tumultuous year for the financial industry. However, the outlook for this badly bruised industry is beginning to show signs of improvement per a historical trends analysis shared by Ben Plotkin, EVP and vice chairman at the investment banking firm Stifel Nicolaus Weisel, during our recent Bank Executive and Board Compensation event.

Looking Toward the Future

Looking ahead to 2011, I had the opportunity to speak with fellow Nashvillian and CEO of Reliant Bank, DeVan Ard, who coincidentally will be speaking at our upcoming Acquire or Be Acquired conference scheduled for January 29th through February 1st in Scottsdale, Arizona. After briefly catching up, DeVan reiterated to me a theme that I have heard throughout the past few months, that this is most definitely a challenging time for bankers.

But the question on my mind was how did Reliant Bank, a $400-million community bank, manage to achieve over 46% growth in assets from 2008 to 2010 despite one of the worst economic downturns this country as faced since the 1930s? The answer to that question also happens to be the focus of DeVan’s panel next month, as he and Andrew Samuel, the CEO of Tower Bancorp Inc. in Enola, PA, will share their philosophies and methods for profitably growing their institutions during these competitive and challenging times.

Recipe of Success

As a non-TARP bank, DeVan attributes the continuing success of Reliant Bank to a talented team of employees, a strong board of directors invested financially and personally into the bank, and the continued dedication of building solid customer relationships.

Although DeVan ponders if he would even join the board of a bank today with all the regulations and liability piled on already stretched bank directors, he is confident that smart business decisions and good strategic planning goes a long way. Over the next few years, as loan demand continues to decline, Reliant Bank plans to improve interest margins, reduce expenses across the institution and look for non-interest partnerships to stretch profitability rather than focus on growth.

Results vs. Regulation

The trickle down effect of regulations aimed at larger institutions will most certainly hurt many small community banks proving once again that a few bad apples spoil the bunch. But with an engaged and invested group of directors who aid in the business development of the bank and are determined to make a positive impact in their community, hopefully Reliant Bank’s results will speak louder than regulations.

The Return of Darwinian Banking

Listening to Ben Plotkin, EVP and vice chairman at the investment banking firm Stifel Nicolaus Weisel, as he provided a broad industry overview at our Bank Executive & Board Compensation event last week in Chicago, the image that came to mind was a heavy-weight boxer who has been staggered by repeated blows to the head but somehow is still standing.

Looking at the fundamentals, there’s no question that the U.S. banking industry has been bloodied by the worst economic downturn since the Great Depression of the 1930. According to Plotkin, the industry’s profitability plummeted from a high-water mark of $128.2 billion in 2006, to $97.6 billion in 2007 – to just $15.3 billion in 2008. Plotkin illustrated this on a bar chart, and that dramatic 2009 earnings decline resembled a Sears Tower elevator dropping from the top floor to darn near the basement.


“Unreal” Earnings

Of course, we all know that industry’s record profitability from 2002 through 2006 was fueled by the bubble economy and a hyperactive mortgage market. Or as Plotkin put it, “A lot of people say those earnings weren’t real.” And indeed they weren’t considering how much of that money was given back in the form of loan and bond losses, but I think it’s also amazing that the banking industry didn’t sustain even more damage than it did.

The number of banks on the Federal Deposit Insurance Corp.’s troubled institution list rose to 829 in the second quarter of this year, but banks are dropping at a much lower rate than in the early 1990s, when the collapse of the commercial real estate market resulted in many more bank failures than we’re likely to see this time around.

Improving Trends

But there is light at the end of the tunnel for most banks, and it’s not necessarily a freight train hurtling towards them. Based on Plotkin’s numbers, it would seem that the industry’s asset quality problems have finally peaked. After rising sharply from 2006 through 2009, non-performing loans have finally leveled out and even declined slightly to about 3.2% in November. Healthy banks with strong balance sheets (including better than average asset quality) have also been able to raise capital from institutional investors.

The industry’s net interest margin (which is essentially the difference between the interest rate on a loan and all the costs associated with getting that loan) has also shown recent improvement. Through the first two quarters of 2010 the margin was approximately 3.85% — compared to 3.39% in 2006 and 3.35% in 2007, when the industry was (ironically enough) rolling in dough. Those numbers say two things to me.

One, loan pricing is gradually improving as bankers are able to charge higher rates on their loans. And two, the industry compensated for its cut-rate pricing in 2006-2007 with volume – which turned out to be a recipe for disaster.

Why would the big pension and mutual funds be willing to invest capital in a troubled industry? Perhaps because they anticipate a predatory environment in which the strong and the swift will devour the weak and the weary. “Many of the catalysts for renewal of the traditional M&A market are beginning to take shape,” Plotkin told the audience. Asset quality is slowly beginning to improve, signaling potential acquirers that the worst is over. Strong banks have access to capital, so they can afford to acquire. And banks with diminished earnings power and little or no access to institutional sources of capital may find that selling out to a more highly valued competitor is their only viable strategy to reward their long suffering owners.

It’s a Darwinian principal that has helped drive bank consolidation for the past 25 years, and no doubt for a few years more.