Making the Most of a Failed Bank: FDIC Loss-Sharing and Purchasing Loan Portfolios

One potentially lucrative by-product of the recent economic downturn and corresponding bank failures is the opportunity to acquire banks or loan portfolios at a substantial discount and on favorable terms. An FDIC receivership of a failed bank presents other healthy lenders with an opportunity to obtain receivables at a discount, and possibly corresponding deposits as well. Bank failures also offer options to investors with capital who may be considering non-traditional investment options given the current economic climate and real property market.

These opportunities usually present themselves in one of two ways. First, the FDIC may sell all of the assets of a failed bank, including receivables and deposits, to a third party, which generally is another lender. Second, the FDIC can pool individual loans together and essentially auction a pooled loan portfolio to a third party without corresponding deposits. Both scenarios require scrutiny of certain issues for the acquiring lender or investor in order to maximize the investment revenue from the purchase and ensure compliance with the terms of the agreement with the FDIC.

Loss-Sharing with the FDIC

A purchaser of a failed bank will generally enter into a Loss-Share Agreement with the FDIC. Loss-Share Agreements have developed in the past two decades, and give a purchaser the benefit of the FDIC’s agreement to absorb a percentage of a loss realized on the acquired receivables. Under a Loss-Share Agreement, the purchasing lender incurs the remaining portion of a loss on a loan, generally around 20%, while the FDIC incurs the greater share.

Loss-Share Agreements are intended to facilitate the FDIC’s sale of a greater number of assets to a purchasing lender while also burdening the acquiring lender with the obligation to manage and collect non-performing loans sold from a failed bank. In effect, loss-sharing results in the alignment of interests between an acquiring lender and the FDIC, which both now face risk associated with the workout of the bad debt acquired.

It is essential to understand the potential effects of a Loss-Share Agreement when bidding on a failed bank. The obvious benefit to the acquiring lender is the reduced risk associated with the purchase of a bank or loan portfolio. However, the benefit to the FDIC is that the loss-share, and the reduced risk to the purchaser, will likely create greater interest in acquiring a failed bank, and therefore increased bids for the purchase.

Dealing with Collateral

Evaluation of collateral packages for loans subject to sale by the FDIC is essential in evaluating the transaction and should be undertaken at the earliest possible opportunity. It is not only important to evaluate the collateral, but to take steps to further protect the collateral, even if a particular loan is not in default.

Collateral that is perfected or identified as secured in public records, such as land records or UCC filings, should be identified so that steps can be taken to identify the purchaser as the new secured party. While this is essential in anticipation of a loan workout or collateral liquidation, it is often advisable to reflect the current secured party for certain notice purposes, even when a workout or liquidation is not expected. The purchaser of the loan must be mindful of the particular requirements of the state law where the collateral is located in order to properly demonstrate a transfer of the interest. The FDIC sale or assignment documents often contain provisions allowing the new secured party to execute certain documents, including assignments of collateral, as an attorney in fact for the FDIC and/or the failed bank. Provisions such as these allow the purchaser to transfer interest in collateral and reflect those transfers in the public records without the ongoing need for the FDIC’s involvement.

Workouts and Settlements

The commencement of litigation and the settlement of litigation are also crucial times to refer back to the FDIC transfer documents to ensure that the acquiring lender or purchaser is fully compliant. Allegations concerning the sale or assignment of the loan documents and collateral should be incorporated into a lawsuit in order to foreclose on collateral or recover on a deficiency or guaranty. While this will generally include attaching the transfer documents to the suit, these documents are often public record and are available from the FDIC on the Internet in any event.

Particular scrutiny should be paid to settling workouts of acquired debt and compliance with the terms of the purchase of the loans from the FDIC. Many sale, transfer or assignment agreements from the FDIC to a purchaser include provisions requiring specific terms in any settlement or release of transferred loans. Often, this will require that, whenever a transferred loan is settled or compromised for less than the full value, the purchaser obtain releases of the FDIC and/or the failed bank as part of the settlement.

Posted by Attorney Jeffrey R. Schmitt. Schmitt practices in commercial litigation including banking, real estate, construction, and other matters for individuals and businesses.