A recent failed-bank deal has handed the Federal Deposit Insurance Corp. an opportunity to play the stock market — something the regulator will probably do more of in the coming year.
The agency took up New York Community Bancorp Inc. on its offer of profit if the $44 billion-asset company's shares rose above $12.33 in the weeks after its purchase of the failed AmTrust Bank in Cleveland. New York Community said last week that it paid the FDIC $23.3 million for AmTrust.
The agreement, the first of its kind, is just one of several new twists on failed-bank deals that observers say could help the FDIC mitigate the cost of resolving failures.
Other examples include the agency's broader use of loss-sharing agreements to entice more bids on failed banks.
Also, to ensure that it does not miss out on the upside, the FDIC has begun including "true-up" clauses in agreements that let it benefit if losses are not as large as anticipated. Finally, the regulator is taking stakes in asset sales and financing pieces of the deals.
Herb Held, the associate director of resolution strategy in the FDIC's division of resolution and receiverships, said the agency is working to include agreements similar to the one with New York Community in future deals.
"If you look at stock prices of banks that have acquired substantial institutions from us, the cost of shares has gone up immediately," he said. "We would like a little bit of that benefit back for us. We are still working out what the exact terms are we want so we can standardize it. That is how most of our transactions work. Do something once and work to modify it to see what is best."
Analysts say the FDIC appears to be making some sophisticated moves.
"I think it is good they are taking pieces," said Dan Bass, the managing director in the Houston office of Carson Medlin Co. "Hopefully, if these turn around, they can take advantage of the upside."
And more innovation is planned for the coming year. For example, next year the FDIC plans to sell loans it has made to help finance deals, thus providing immediate liquidity and helping replenish the Deposit Insurance Fund.
It also plans to use the agreement struck with New York Community in Westbury, N.Y., as a template in future negotiations with buyers.
And if the securitization market shows signs of life, the agency is considering a return to securitizing assets from failed banks, much as it did in the last cycle.
The regulator is trying to save the DIF money and developing a best-practices set of standards as it goes, industry watchers said.
Many times the ideas are presented by acquirers — as was the case with New York Community — and the FDIC then devises a strategy to achieve what it believes will be best for both the banks and the fund.
In New York Community's deal, the FDIC got the opportunity to profit if the company's share price rose above $12.33 between the deal's closing date, Dec. 4, and Dec. 23, and it chose to exercise its option.
"I think it is a great idea," said Mark Fitzgibbon, the director of research at the financial advisory firm Sandler O'Neill & Partners LP. "It took a lot of the risk out of the transaction for New York Community, and it allowed the FDIC to look good, where they can garner some of the upside from the deal."
Joseph Ficalora, the chairman, president and chief executive officer of New York Community, said the deal worked well for both the DIF and the company.
A spokesman for the FDIC said 14 banks bid on the failed AmTrust, and industry watchers said the offer of upside potential from share-value appreciation may have attracted this large pool of bidders.
"It definitely sweetened the pot by a large amount," Bass said. "But then the FDIC had to do some analysis and see that there was some upside. It was gravy on the deal. All else being equal, this put [New York Community] over."
The FDIC has plenty of incentive to find creative ways to preserve funds.
By Dec. 18, there had been 140 failures this year, with $137 billion in deposits. The estimated cost to the DIF was roughly $37 billion, or 27% of deposits. This compares with 280 failures with $45.5 billion in deposits in 1988 at the height of the savings and loan crisis. Those failures had an expected loss of $6.9 billion, or 15% of the deposits.
The New York Community agreement gave the FDIC a chance to profit if the shares traded above $12.33 after the deal and required it to exercise its option before Dec. 23.
The FDIC did, in two parts, for a gain of $23.3 million.
At New York Community's discretion, the amount owed to the FDIC could be paid in cash or in an equivalent value of common shares. Ficalora said the company chose cash because it had recently raised capital.
New York Community sold 30 million shares at $13 apiece after the acquisition. The cash payment to the FDIC reduced the amount of capital on hand, and the payment did not run through earnings.
Fitzgibbon said this deal was the first that let FDIC benefit from a higher market valuation for the stock.
"The premium that gets paid back to the FDIC is interesting because it is how the market perceives the deal in a short amount of time," he said. "Nothing to my knowledge has ever been done where the FDIC is sort of making a stock market bet. So far, they have guessed right. The stock has gone up since the transaction."
Another new element in the FDIC's cash-preservation toolbox is a true-up provision for loss-sharing agreements, which also lets the FDIC participate in the upside. The regulator used a true-up for the first time in BB&T Corp.'s acquisition of Colonial Bank in August and, after a little tweaking, added it to all loss-sharing agreements near the end of October.
Held at the FDIC said many times bids come in low because no one is sure what the assets are worth, or where the bottom is. The true-up agreement protects the FDIC if the economy improves and losses are not as bad as expected.
"If things get better quicker than both of us made assumptions, that the future was worse, and when things turn around, we should both benefit," he said.
The standard true-up provision is a 10-year agreement. It typically works this way: 25% of the asset discount given to the buyer plus 25% of all payments the FDIC makes under the loss-share agreement and 1% of the annual average assets are subtracted from 20% of the cumulative expected losses.
If the net amount is positive, then the acquirer pays the FDIC 50% of the gain.
"Clearly they reduce the gain and upside for banks, which may mean banks reduce their bid a little," said Chip MacDonald, a partner in the Jones Day law firm in Atlanta. "The FDIC thinks they have long-term potential, and the buyers do, too, or they wouldn't be buying them."
Indeed, bankers said the true-up provision, besides making accounting a little trickier, would not limit the upside potential so much that failed-bank deals become unattractive. They said they will just take the true-up into account when making their bid.
Jill York, the chief financial officer of the $14.1 billion-asset MB Financial Inc. in Chicago, said the most recent of four failed-bank deals the company has completed in this down cycle — the purchase of Benchmark Bank in Aurora, Ill. — included a true-up provision.
"Certainly in crafting our bid we took into account what we thought any true-up payment might be in the end," she said.
"The good thing about a true-up is, if losses are less than expected, theoretically we should do better than original estimates, and because the FDIC gets a true-up payment, they do better."
Before the Benchmark deal, MB bought Heritage Community Bank in Glenwood, Ill., in February; the deposits and some of the assets of Corus Bank in Chicago; and InBank in Oak Forest, Ill., in September. York said MB Financial bid using a different structure each time.
Another strategy the FDIC has employed recently is to take ownership in a failed bank's asset sale.
The FDIC initially planned to use the public-private investment program to remove toxic assets from banks' balance sheets, but when the plan didn't work, the FDIC found another use for it. In September the FDIC used the strategy to sell failed bank assets to the private sector.
The FDIC sold a piece of a $1.3 billion loan portfolio from the failed $4.9 billion-asset Franklin Bank in Houston at auction to Residential Credit Solutions of Fort Worth, a mortgage investment firm.
The loans were put on the auction block after Franklin's buyer, Prosperity Bancshares Inc. in Houston, declined to purchase them. As part of the deal the firm and the FDIC will share control of a new limited liability company, to which the FDIC lent $730 million. The deal is designed to reward both parties over time, as the assets recover value and RCS helps pay off the agency's loan.
The FDIC still hopes to someday utilize the program with open banks, too.
Sandler O'Neill's Fitzgibbon said he is pleased the FDIC is keeping more of the assets in the private sector.
"What is amazing is, they have been able to not take all this stuff on their balance sheet," he said. "In the last major recession, in the early 1990s, the [Resolution Trust Corp.] was forced to take them over because they couldn't find buyers. The FDIC has done a reasonable job in finding a home where the buyer is in decent shape."
Held said the FDIC could begin selling the notes this spring; they would have an FDIC guarantee, and could help the FDIC gain liquidity and rebuild the deposit insurance fund.
