WASHINGTON — Though the Federal Deposit Insurance Corp. said it would grant distressed institutions a waiver from a plan forcing all banks to prepay three years' worth of premiums, few are expected to get one, observers said.

Exactly how the FDIC will judge whether an institution needs an exemption is unclear. In its Sept. 29 proposal, the agency said only that it would grant waivers on a case-by-case basis "if the FDIC determines that the prepayment would adversely affect" a bank's safety and soundness.

But observers said that applying for a waiver would be risky and could make an institution's situation worse if the application became known.

"Everyone I talk to feels there will be a taint in applying for an exemption. I just can't believe it will be heavily used," said Kip Weissman, a partner at Luse Gorman Pomerenk & Schick PC.

The proposal would let the agency grant an exemption of its own accord but would also give banks the chance to apply for a waiver if the prepayment "would significantly impair the institution's liquidity or would otherwise create significant hardship." Exempted banks would pay their assessments on the normal schedule.

The FDIC last week said the number and names of institutions with exemptions would not be disclosed. Still, observers said that avoiding disclosure may be a challenge, especially for publicly traded banks subject to Securities and Exchange Commission rules.

"I wouldn't worry so much about the privately held institutions. But for public institutions, it becomes pretty problematic," said John Douglas, a partner at Davis Polk & Wardwell and a former FDIC general counsel. "At least publicly traded institutions are going to think pretty hard about whether you apply for the waiver."

James Barth, a finance professor at Auburn University, compared the availability of waivers to institutions' receipt of capital from the government through the Troubled Asset Relief Program.

"It's like when institutions repaid their Tarp funds. The market looks more favorably on such institutions," said Barth, who is also a fellow at the Milken Institute. If an application to be exempted from the prepayment "became known publicly … , the company's shares might indeed decline in value."

In addition to concerns about public disclosure, some observers said, institutions could be wary of being upfront with the FDIC about their troubles.

There is "also a regulatory taint," said Weissman. "A bank would have to make a case that they're having some financial difficulties. That's not the type of case most banks want to make to regulators."

Moreover, in a climate when banks are constantly wary of rumor mills, some have argued that confidentiality may also be a concern for privately held institutions.

"For private companies in this Tarp era, issues have had a way of becoming public even though they're not supposed to be," Weissman said.

William Isaac, a former FDIC chairman, said a bank with an exemption would be in a difficult position if questioned by the media. "A bank would have two choices: It could lie, or it could say, 'No, we are not prepaying because we obtained an exemption,' " said Isaac, now the chairman of LECG Global Financial Services. "A bank that did prepay would probably be willing to say so. That would be taken as a badge of honor."

The prepayment, meant to bolster the FDIC's declining cash reserves, is expected to bring in $45 billion; the money can be used to deal with the growing number of failures. But the cash transaction will show up gradually on the banks' and FDIC's books, as if premiums were being paid normally every quarter. Institutions prepaying their assessments through 2012 would get an asset that declines in value over time.

Dwight Smith, a partner at Alston & Bird LLP, said the accounting for the prepayment could pose a risk to institutions not wanting to disclose that they received a waiver.

"Another issue, and I don't know the answer to this, is whether somehow in the call report there is something in there that would enable somebody reading it to reverse-engineer and figure out whether you were exempt from the prepayment," Smith said.

An FDIC spokesman declined to comment for this story, saying the agency was still seeking comment on the plan.

Under the proposal, the FDIC said it would consult with an institution's primary regulator while considering a waiver request but would retain the ultimate authority to award an exemption or not. Applications would be due Dec. 1, and the agency would inform institutions of its decision by Dec. 24, six days before the prepayment is due. The proposal said the agency does not expect the number of exemptions to significantly affect the prepaid assessment total.

Despite the disclosure risk, many observers said applying for an exemption would be worthwhile for troubled institutions unable to handle the liquidity obligation of the prepayment.

"If payment of these accelerated fees would precipitate a problem in a bank, the FDIC should grant the exemption," said Frank Bonaventure Jr., a principal of the Ober Kaler law firm in Baltimore.

James Chessen, the chief economist at the American Bankers Association, agreed that the "principle of having exclusions makes a great deal of sense. The FDIC does not want to create a liquidity crisis for any bank that might lead to its failure."

He said the agency may find a way to ensure an institution's status is protected. "I think they are looking into making the call-report item" for an exemption "confidential and are also looking into the SEC reporting," he said.

The FDIC has given no answer on the standards it will use to determine which institutions need a waiver. Possible options include using a bank's capital status or examination ratings as criteria, observers said.

"This is a project where the devil is in the details," said V. Gerard Comizio, a partner in Paul, Hastings, Janofsky & Walker LLP.

Douglas, the Davis Polk partner, said distressed institutions probably want to have a conversation with the FDIC now — before the rule is completed. "There are a fair number of institutions that aren't going to last three years," he said. "For those institutions, they'll probably say, 'OK, Coach. What do you want me to do?' "

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