The Federal Deposit Insurance Corp. has not guaranteed the bad assets of every bank in receivership sold in recent months, but it has offered what some bankers and lawyers say is an incentive for companies considering buying a failed institution.
Using part of a law enacted during the savings and loan crisis of the 1980s, the FDIC is allowing acquiring banks to walk away from leases and contracts they do not want, without financial obligation, once they acquire a failed institution. The FDIC initially gives the buyer 90 days but has shown a willingness to extend that period as companies decide which contracts they want and which they do not want.
"You can be more successful as a bidder because you don't have to incur additional costs," said Paul Reynolds, general counsel for Fifth Third Bancorp of Cincinnati, which on Oct. 31 bought the branches and deposits of Freedom Bank of Bradenton, Fla., through the FDIC. Failed institutions often have "some overpriced contracts," Mr. Reynolds said.
He said Fifth Third is still determining whether it needs to retain certain contracts in order to operate some of the branches it picked up in the deal.
After acquiring the banking business of the failed thrift company Washington Mutual Inc., JPMorgan Chase & Co. had 90 days to decide how much of the Seattle company's office space, branches, and vendor contracts it wanted to shed. A source familiar with the process said that should contribute a "substantial" portion of $1.5 billion in cost savings JPMorgan Chase has projected for the Wamu deal.
JPMorgan Chase reached its 90-day deadline last week but still had so many contracts to pore over that the FDIC extended the $2.25 trillion-asset company's window by 30 days, to Jan. 23.
Robert Schoppe, the FDIC's assistant director for strategic operations and the receiver in charge of the Wamu sale, said the extension was granted mainly to give JPMorgan Chase more time to review Wamu's vendor relationships.
He said the FDIC is using the law to make it easier to buy failed banks. "The opportunity to leave behind overlapping contracts and leases with the receivership is a wonderful tool" for an acquirer seeking "franchise value" and "the good deposits and the good assets," he said.
Mr. Schoppe said JPMorgan Chase has notified the FDIC that it will discard about 770 of Wamu's 2,500 in outstanding leases, the "vast majority" of them on branches in overlapping markets, including Chicago and parts of Texas.
A JPMorgan Chase spokeswoman would not discuss vendor contracts or branches under review, but she said the New York company would use the law to get rid of about 500,000 square feet of office space in downtown Seattle and to close a 1,600-employee call center near San Francisco.
John Douglas, a lawyer who runs the global banking and financial services practice at Paul, Hastings, Janofsky & Walker LLP and is working with JPMorgan Chase on the Wamu contracts, said the process is particularly useful to eliminate properties with "an above-market lease or a bad location." Though he would not discuss Wamu specifically, he said the FDIC option also gives buyers a chance to eliminate redundancies in areas such as data processing and credit card servicing. "There are huge benefits" to severing vendor relationships at no cost, Mr. Douglas said in an interview Monday.
JPMorgan Chase and Fifth Third are not the only banks wading through such contractual obligations. A U.S. Bancorp spokesman said executives of the Minneapolis company are still evaluating contracts for Downey Financial Corp. and PFF Bancorp Inc., a pair of failed California institutions that the $247.1 billion-asset U.S. Bancorp bought on Nov. 21.
The advantages extend well beyond cost cuts, observers said. Since the FDIC is left holding the contracts, a prospective acquirer would not have to negotiate terminations or ride out what can often be lengthy contract periods, as would be the case in a typical acquisition. Mr. Schoppe, the FDIC official, said the leases for Wamu branches for instance range from one year to more than 20 years. "It will take us three years or more before all the work goes away," he said. While Mr. Schoppe and his team continue to plow through leases and other contracts, JPMorgan Chase can proceed with integrating the branches it keeps and working its way through the assets it agreed to take on.
Mr. Reynolds said Fifth Third's arrangement with the FDIC lets his company focus on retaining employees and equipment, which are relatively "minimal" costs. "That's the only ongoing cost we'll have," he said.
There have been exceptions to the rule. A spokesman for SunTrust Banks Inc. of Atlanta said Tuesday that its August deal with the failed First Priority Bank of Brandenton, Fla., excluded the option because all the $174.8 billion-asset SunTrust bought was the bank's deposits.
Though buying a bank in receivership has a number of advantages, several large deals have been made for ailing companies without the FDIC stepping in, including Wells Fargo & Co.'s agreement to buy Wachovia Corp.
Mr. Douglas, the Paul Hastings lawyer, said a would-be acquirer could risk losing out on an acquisition if it lets the seller slip into receivership. "If you are going to go through the receivership process, you are likely to be bidding against others," he said.
