The proposed merger between CIT Group and OneWest Bank would be one of the first times that bank regulators enable a deal that results in a systemically important financial institution. Given the recent focus on the government support provided to AIG and other institutions during the financial crisis, concerns about the adequacy of big banks' living wills, and ongoing questions about regulators including the New York Fed failing to stand up to banks, the stakes of this deal are high. The public would be well-served by increased transparency and scrutiny of this merger, especially with regard to a controversial shared-loss agreement between the Federal Deposit Insurance Corp. and OneWest.
In 2009, OneWest a holding company formed by billionaire investors including George Soros, John Paulson and Dell founder Michael Dell purchased the failed IndyMac Bank, which had originated thousands of distressed mortgages. As part of the sale, the FDIC entered into a shared-loss agreement with OneWest whereby the government agency agreed to cover the costs of certain IndyMac loan losses.
Under the agreement, OneWest committed to use federal mortgage modification programs to keep struggling borrowers in their homes when possible. If loan modifications didn't work, the FDIC agreed to share in the cost of failed loans, with OneWest absorbing the first 20% of loan losses (approximately $2.5 billion). Once that threshold was met, the FDIC would pay 80% of the cost for the next 10% of losses, and 95% of the cost for losses beyond that amount.
However, it is unclear if OneWest actually met its obligation to modify loans rather than simply foreclosing. According to data from ForeclosureRadar.com, OneWest foreclosed on over 35,000 homeowners in California, including seniors and their surviving spouses who had reverse mortgages from a subsidiary of OneWest the disarmingly named Financial Freedom. The high number of foreclosures is worrisome, but perhaps not surprising, since nonprofit housing counselors consistently ranked OneWest as one of the most difficult servicers to work with in helping homeowners avoid foreclosure.
While the FDIC had 22 opportunities once a quarter since the bank was sold to audit OneWest's compliance with the modification aspect of the loss-share agreements, it is also unclear if it actually did so more than once, in 2011. The results of that audit were not shared publicly. Given the large number of foreclosures and troubling accounts from housing counselors, we believe the public has a right to know if the FDIC ever audited OneWest's compliance with the loss-share agreement, how much money the FDIC has paid OneWest and how much more money the FDIC may yet pay if the merger is approved and the loss share is transferred to CIT and continued.
The FDIC should also share its rationale for continuing the loss-share at a new bank. In 2009, the FDIC could justify this controversial agreement as necessary to preserve confidence in the financial system, unload failed-bank assets and promote loan modifications for struggling homeowners. But in 2014, the FDIC is no longer looking to unload Indymac assets, and investors in OneWest have reportedly more than recouped their initial investment (with billions more to come if the merger goes through). Loan modification programs like HAMP are in place, yet reports from housing counselors and homeowners have raised questions about OneWest's compliance with its loan modification obligations.
The $2.3 billion that CIT Group received from the U.S. Treasury's Troubled Asset Relief Program, which remains unpaid due to CIT's subsequent bankruptcy filing, serves as an all-too-relevant reminder to regulators about the dangers in subsidizing banks without proper oversight. Before regulators give the green light to this merger, public hearings need to be held that thoroughly consider the risks posed by the creation of a SIFI bank that is still dependent on a subsidy from the FDIC. Regulators must weigh the public benefit of this merger something that's hard for us to see against the obvious costs and risks associated with a SIFI.