In more than 300 transactions since 2008, the FDIC, acting as the receiver of a failed bank, has entered into agreements for the sale of failed bank assets to a healthier bank or other financial institution, and the sharing of losses of that failed bank between the FDIC and the assuming institution. The aim of such arrangements is to reduce the burden on the FDIC’s Deposit Insurance Fund, and enhance the attractiveness of failed bank assets to potential purchasers.
Typically, a single-family shared-loss agreement has a term of 10 years. A commercial SLA normally covers an eight-year period; in the first five years, losses and recoveries are shared, and in the final three years, recoveries only are shared. Many assuming institutions with commercial SLAs, therefore, are approaching the end of their loss sharing.
If you are an assuming institution, you are familiar with the ongoing compliance issues of loss-sharing arrangements. However, as SLAs mature, it is time to think more strategically about the next steps in managing the assets, both single family and commercial. Because the FDIC used numerous versions of SLAs, it is important to review the individual provisions of each agreement. In particular, assuming institutions should focus on the following:
1. Asset Management Policies – Ensure that your shared-loss assets are being managed comparably to your institution’s non-shared-loss assets. Accelerated charge-offs of shared-loss loans near the end of the loss-sharing period may attract unfavorable attention from the FDIC and may result in denial of loss sharing.
2. Reimbursable Expenses – Pay attention to applicable deadlines for submission of loss-sharing certificates seeking expense reimbursement and, as applicable, distinguish between reimbursable expenses and recovery expenses.
3. Recoveries – Take steps to maximize recoveries of shared-loss loans, recognizing that the sharing proportion under commercial SLAs will flip at the end of the shared-loss period. Continue loan-modification and loss-mitigation programs, within the specified constraints of your particular commercial SLAs, because once the shared-loss period expires, the assuming institution will bear 100 percent of losses on shared-loss assets, with the accompanying impact on capital requirements.
4. Portfolio Sales – Consider the sale of commercial loans. For commercial assets, after the fourth anniversary of the commencement date, with the FDIC’s prior consent, the assuming institution may liquidate the shared-loss assets for cash. Such sales may be individual or portfolio transactions. The FDIC’s evaluation includes an analysis of alternative collection and modification approaches, and a review to determine whether collections would be maximized with individualized asset strategies. Note also that during the 12-month period prior to the termination date of an SLA, the FDIC may require the assuming institution to liquidate for cash single-family and commercial shared-loss loans.
5. Early Termination – Engage in a cost/benefit analysis of your SLAs, and consider if early termination is appropriate. Compliance costs include the increased staffing, infrastructure and accounting expenses related to SLA reporting and FDIC audits. The FDIC considers offers from assuming institutions to terminate their SLAs. Accepted offers must be less costly to the FDIC than the estimated costs of continuing with the SLAs over their full term. Using publicly posted guidance, the assuming institution submits an offer in writing to the FDIC. If the offer passes the initial reasonableness test, a more detailed evaluation is conducted to see if the offer results in savings to the FDIC. An accepted offer must be less than the FDIC’s estimated threshold, or “take-out” price; the FDIC cannot negotiate to a mutually agreeable number. The termination process takes approximately 60 days, depending on a variety of circumstances. Keep in mind that the FDIC incurs significant compliance costs associated with administration of loss-sharing agreements, and the reduction or elimination of such costs may be a factor that the FDIC will consider.
6. Assignment – Consider options regarding assignment of an SLA. Assignment of SLA by an assuming institution may only be done with the prior written consent of the FDIC, which may be granted or withheld by the FDIC in its sole discretion.
True-Up Calculation – Be prepared to settle up with the FDIC. At the end of the shared-loss and recovery periods, the FDIC and the assuming institution settle up by way of the “true-up,” which provides for a possible return to the FDIC of a portion of the initial asset discount (e.g., in cases where actual losses do not reach initially estimated losses). The date on which such calculation is made is the date which occurs after the later to occur of termination of the SLA and disposition of all assets pursuant to both agreements.
Lisa Greer Quateman and Tracy M. Ginn are shareholders in the Los Angeles office of Polsinelli LP, Polsinelli LLP in California. They can be contacted at 310-556-1801 and at lquateman(at)polsinelli.com or tginn(at)polsinelli.com.
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