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.

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Illinois Considering Substantial Changes to Improve Foreclosure Process

Chicago Tribune reports Illinois considering changes to its foreclosure process, potentially affecting any one of the approximately 70,550 foreclosures pending in the State.

NYSE and Deutsche Boerse (DB) Merge to Survive

Is America’s dominance in capitalism clearly over?

The NYSE merger is one of survival both for the NYSE and for the German securities exchange Deutsche Boerse.

The NYSE is inefficient, i.e. the pit, traders on the floor. Lower fees and better efficiencies created the mess at the NYSE.  The NYSE has too many outdated traditions which created numerous types of inefficiencies, forcing the NYSE into a downward position. Even the NASDAQ was doing better than the NYSE regarding efficiencies via electronic trading.

We live in a global economy. There are trading exchanges all over the world, i.e. China, Tokyo, Brazil , Russia, India, Australia, London, etc. The stock exchanges in China and Brazil are some of the largest in the world. Everybody in the world can access securities exchanges via the Internet.

The dollar is weak right now. Europe has a debt crisis and the Euro is not so stable.

Not long ago, one of Europe’s leading independent forecasters for the Treasury asserted that the Euro could collapse as a result of Europe’s debt crisis. The European Central Bank’s Governing Council Member asserted that it is not up to the bank to save countries where governments run the risk of being insolvent.

Right now, Ireland, Greece, Portugal, Italy, and Spain have a lot of debt problems and plenty of entities are buying more insurance at higher prices to cover potential losses in those countries.

Germany had good growth in 2010 but their economic model is centered around exports, i.e. cars and machines. Asia (China) drove Germany’s growth in 2010. Can Germany sustain their economic model since other European countries (mainly southern Europe) have stagnant economies re: exports and imports? The European debt crisis has pushed the Euro down which has made German exports more competitive.

Right now, US exports are even better than German exports because the US dollar is weak, too.

Since Germany appears to be in the best economic position in Europe more people are putting capital in Germany when investing in Europe. German exporters could take a huge hit if Europe’s debt crisis runs into other European countries.

Who knows what will happen because regulators have to look this over. Also, there are may political issues with this deal starting with a fight over what to name the exchange. Politicians could crush the regulatory process simply because they do not like the proposed name. I suspect it will go through because both exchanges need this for survival.

I think the NYSE deal is a play on a world asset which is undervalued as a result of a weak US dollar.

Ex: InBev could not purchase AB if the US dollar was strong. InBev took advantage of a weak US dollar and is now dealing with a lot of debt and debt service. The strength of the US dollar runs in cycles just like the markets. Will the US dollar stay at its current value forever or remain at lower values when priced against other global currencies? I suspect not.

The World Bank has predicted a global growth of 3.3% for 2011. Europe’s debt crisis is a huge factor which could derail any global recovery.

The European Central Bank has asserted that inflation may be around for months in Europe which would probably require a European interest rate hike which would make borrowing from global banks tougher than it already is.

However, major companies are lean and mean now and sitting on trillions of dollars of cash. In addition to inflation and a debt crisis, the 17 member European nation is still facing 10% unemployment which was after a recent drop. Also, housing prices continue to drop in Europe although it appears that it has bottomed out.

Is America’s dominance in capitalism clearly over? I would say no since nothing is clear right now with global economies, global financial markets and global debts and debt service.

Condominium Assessments and the Recession

Why Bankruptcy and Foreclosure Aren’t Always the End of the Line in Missouri

The past decade saw a surge in condominium, loft, town home, and other multi-unit developments, in both urban and suburban areas. Urban revitalization resulted in renovated commercial and industrial buildings for loft developments, and baby boomers and empty-nesters have been drawn to the convenience of maintenance-free living provided by multi-unit developments in cities and suburbs. The recent recession and ensuing economic climate has impacted the real estate market and construction industry particularly hard, and many unfinished developments suffered as a result. However, the down turn in the economy poses problems for existing, fully occupied, and even well-managed buildings too.

Traditionally, the payment of condo fees or assessments by a unit owner was a priority, just like the payment of a mortgage. As increasing numbers of unit owners face job loss, reduction in pay, or other financial hardship, this tradition is falling fast, and payment of condominium fees and assessments has become less of a priority.

Other than headaches for building management and board members, delinquent condo fees and assessments pose a variety of dilemmas for multi-unit developments. Legal and practical ramifications of increasing delinquencies include the inability to obtain loans for capital improvements, a loss of services for the buildings and grounds, and an obstacle to sales of existing units.

Condominium associations and boards have long relied on collection lawsuits to compel delinquent owners to pay, and, ultimately threaten the sale of the unit by foreclosure of the condominium’s assessment lien. Increasingly, this litigation option is becoming less viable. The recent and continuing onslaught of foreclosure sales and personal bankruptcies strip the building management of the power to collect through litigation. However, all is not lost when a unit is subject to foreclosure or an owner files bankruptcy, and it is important that associations and boards are aware of their rights in these situations.

Foreclosure

In Missouri, and in approximately half of the states, lenders have the right to foreclose on a delinquent borrower through a non-judicial “power of sale.” Power of sale gives the lender the right to provide notice of foreclosure proceedings and sell property on the courthouse steps. Foreclosure sales by lenders threaten to extinguish assessment liens against a condominium unit that are imposed by operation of the building’s governing documents and Missouri law. In most cases, the lender will buy the property back and will become the new owner of the unit. In these cases, the sale price at foreclosure will likely be less than the loan value, and there will be no surplus for other lien claimants, including condo associations.

It is important for the board to know whether the foreclosing lender made a purchase money loan, that is, a loan used by the owner to purchase the property from a previous owner, or rather a refinance loan. The Missouri Condominium Act gives different treatment to condominium assessment liens and their priority over purchase money loans as opposed to refinance loans. In some cases, building associations can assert priority over the lender for all or part of the unpaid assessment lien. This means that the lien may survive the foreclosure and can be enforced against the lender or other subsequent owner. In any event, the subsequent owner is responsible for payment for fees accruing post-foreclosure.

It is also imperative that building management and the board are mindful of the building indenture and bylaws, and ensure that the provisions concerning assessment lien priority are consistent with those protections provided by the Missouri Condominium Act.

Bankruptcy

A unit owner’s bankruptcy, while initially causing collection problems, does not always result in the removal of an assessment lien. Most personal bankruptcies in the United States today are Chapter 7 cases, meaning that the owner’s assets are liquidated in order to pay creditors. As soon as a Chapter 7 case is filed a condominium association must cease collection activities against the property owner for the past debt. However, the assessment lien against the unit may remain as an encumbrance against the property. This means that in the event of a subsequent sale or refinance after the bankruptcy, the delinquent assessments may be paid at closing, even though the association cannot pursue the owner for those delinquent assessments directly.

Depending on the equity in the unit after a mortgage, the assessment lien, and any other liens against the property, the Bankruptcy Court may allow an assessment lien or other liens to be reduced or eliminated all together, in order to provide value to creditors. Of course, many lenders will begin foreclosure proceedings after an owner has filed bankruptcy, with permission from the Court.

It is also important to remember that even when an owner files a Chapter 7 bankruptcy case, monthly fees and assessments payable after the date of the bankruptcy filing may be collected from the unit owner, and may result in an assessment lien which can be enforced through litigation.

Some individuals file Chapter 13 bankruptcies, which are reorganizations of their financial affairs. These owners will propose a plan to the Bankruptcy Court to repay their debt over a period of three to five years. In many Chapter 13 cases, the delinquent assessments will be paid to the building over time.

Bankruptcy cases can vary widely, and building managers must keep abreast with the status of the case, the effect on the unit, and whether or not a claim for assessments should be filed.

Conclusion

Bankruptcies and foreclosures can seem ominous to building managers and boards seeking to recover delinquent assessments from owners. However, these circumstances do not necessarily preclude the recovery of unpaid accounts. Multi-unit developments are not always doomed to the fate of helpless victims in these scenarios and the management should respond to bankruptcy and foreclosure notices with an investigation of the circumstances in order to evaluate the options that remain and how the building’s rights can be enforced both in the immediate and long term future.

Cash-for-Keys Strategy Gaining Momentum in St. Louis

Interesting article in today’s St. Louis Post-Dispatch on the Cash-for-Keys program. The Cash-for-Keys program is designed to entice tenants residing in bank-owned, foreclosed upon properties to willingly vacate the property for a pre-negotiated sum. The tenant receives some amount of money for leaving, the bank saves money by avoiding litigation to remove the tenant. What the article fails to mention is that the bank needs to properly document the Cash-for-Keys transaction to ensure the tenant actually vacates by the agreed upon date.

Stepping Back. US MicroLending with Kiva: Raising Capital + Raising You

When the usual suspects are rounded up to determine the reason for the decrease in start-ups and/or business failures in 2009/2010, in this author’s view, some blame must be placed on the business owner’s own failure to have introduced himself to his “better self” in the words of Napoleon Hill.

Bob Calcaterra recently noted this problem in the August 2010 Missouri Venture Forum Newsletter.

In Ralph Waldo Emerson’s essay “Experience,” he posits that all of us have an iron wire which he calls “Temperament” upon which the seeds of the individual are strung. He further argues in his essay “Compensation” that “strength grows out of our weakness and that indignation which arms itself with secret forces does not awaken until we are pricked and stung and sorely assailed.”

This veto or limitation power of adversity is the theme in the Summer 2010 Wilson Quarterly article “What Next for the Start- Up Nation” where the author speculates as to what attributes Israel start-up founders have that create so many successful start ups (persistence, mission critical focus, etc.) .

In twenty-seven years of counseling small businesses, I have found that the business owners who are the most successful are self disciplined, incredibly focused, hungry and have an iron will.

When one reviews the evidence of successful start-ups, one sees so many first and second generation Americans who will not give up. So, for those of you with the iron will or who want to develop that iron will by apprenticing at the bottom or “start where you are and build”, please check out the Microlending article in the New York Times. You will be introduced to Kiva.org, who has just started a pilot program lending to business owners in the United States. Remember, Microsoft was created in 1975, at the end of the first great recession since the Depression.

Who knows what will happen, you may become a Bill Gates.

The End of LIFO/FIFO Loan Participations between Banks?

Loan participations are invaluable to community and regional banks who want to service their borrowers’ needs beyond its legal lending limits or risk tolerance. Loan participations frequently include “LIFO” (Last-in, First-out) and “FIFO” (First-in, First-out) provisions designed to streamline the lending process, simplify monitoring the legal lending limits, and entice banks to participate in a loan they would not otherwise consider.

LIFO loan participations are effective when the originating bank advances funds to its borrower up to its legal lending limit for that single borrower – subsequently the participating bank purchases that amount of the loan which exceeds the originating bank’s lending limit. For the participating bank’s trouble, or relative bargaining power, the participating bank is repaid its principal before the originating bank. The opposite holds true for FIFO loans. Regardless of the loans LIFO or FIFO status, in the event of default losses are shared between the originating bank and the participating bank on a pro-rata basis.

Effective January 1, 2010, FASB Statement No. 166, Accounting for Transfers of Financial Assets (“FAS 166”) altered what constitutes a transfer of a portion of a financial asset, e.g., a loan participation, to be treated as an actual sale. Per FAS 166, LIFO and FIFO participation loans do not qualify for sale accounting treatment. What this means to bankers is that the originating bank is now obligated to report that portion of the loan “sold” to the participating bank as a loan on its balance sheet. So, rather than account for only what the originating bank has outstanding, less what it sold to the participating bank, the originating bank now must include the aggregate balance of a borrower’s debt, which, in turn, is used to determine compliance with legal lending limits (see generally12 USC § 84; Reg O; RSMo § 362.170; and CSR 140-2.080).

The American Bankers Association has been proactive on this front, authoring a March 3, 2010 letter discussing the regulatory requirements for loan participations effected by FASB Statement No. 166. In its letter to the Federal Reserve and interested parties, the ABA recommends that FAS 166 should not be used to regulate legal lending limits – rather, “[c]ompliance with such limits should apply on the basis of the contractual borrower.”

To be clear, FAS 166 does not apply to loan participations where all cash flows from the entire financial asset are divided proportionately among the participating interest holders in an amount equal to their share of ownership. What is less clear, however, is whether banks must are required to modify accounting methods for loans made pre-2010 but include disbursements post-2009, such as a revolving line of credit.

In sum, until the certain clarifications are made, in order to qualify for sale accounting the originating bank must carefully review its policies and procedures for loan participations, and understand the implications that come with FAS 166.