FDIC Employs Tool Used for S&L Crisis

By DAMIAN PALETTA and DAVID ENRICH WASHINGTON -- Federal regulators are dusting off a tool used during the savings-and-loan crisis to help deal with an expected wave of bank failures in 2009. The mechanism, known as "loss sharing," gives healthy banks an incentive to take on troubled assets of a failed institution, with the government agreeing to assume the majority of future losses. In most other cases, the buyer takes the failed bank's deposits, leaving most of the assets to be managed and sold by the Federal Deposit Insurance Corp. The FDIC used versions of the loss-sharing model several times last year, including during the initial attempt to rescue Wachovia Corp., as part of federal aid to Citigroup Inc. and during the fire sale of two failed California institutions. Several bankers say the FDIC has been gauging the industry's interest in the approach as the agency prepares to take over more banks. Regulators are discussing using a loss-sharing arrangement in the purchase by private-equity investors of IndyMac Bank, which has been operating under FDIC receivership since it failed last July, according to people familiar with the matter. "It is something that we plan on doing in the future where it's appropriate," says Herb Held, assistant director in the FDIC's division of resolutions and receiverships. "I think it's a good deal for everybody: the FDIC, the acquiring bank and the borrowers. It keeps the assets where they were." A move toward such deals would leave the FDIC on the hook for losses related to the sometimes exotic assets that are fouling the banking system, though the acquirer typically shoulders the first tranche of losses. If the FDIC agrees to extend loss-sharing deals to shaky banks that haven't failed, it could become costly. At the same time, such deals could reduce the pile of bad assets the government would inherit in bank failures, especially from banks heavy with commercial real-estate loans that would be tough for the FDIC to manage. "They don't have the capacity" to handle that kind of portfolio, says Pat Doyle, co-head of the financial-institutions group at law firm Arnold & Porter LLP. The FDIC already is grappling with assets of the 25 banks that failed in 2008. As of Dec. 26, the book value of the FDIC's assets under liquidation was $15.3 billion, compared with $310 million at the end of 2006. That doesn't include IndyMac, which could push the total to levels unseen since the 1990s. When Houston-based Franklin Bank failed Nov. 7, for example, Prosperity Bank of El Campo, Texas, agreed to acquire all of Franklin's deposits. But it took on just $850 million out of $5.1 billion in assets. The rest ended up with the FDIC. As the credit crunch continues, the government is taking more aggressive and creative steps to stabilize the industry. Federal regulators have handed down dozens of enforcement actions, following criticism of oversight. Analysts predict U.S. banks may report an overall loss for the fourth quarter, the first time that has happened since 1990. The number of bank failures is expected to rise. It can take months or years for the government to sell loans or property acquired after failures, and the FDIC has a team of experts who specialize in working out and selling loans. The agency has taken steps to bulk up for 2009; it plans to boost staff to 6,259 from 5,721 in 2008. It also approved a $1 billion budget to fund its receiverships operations, up from $150 million for 2008. During the S&L crisis, the FDIC and Resolution Trust Corp. employed 20,000-plus. Healthy banks have teams of experts in place who specialize in working out bad loans. Loss-sharing agreements help overcome uncertainty about taking on assets that have felled another institution. Some of those commercial real-estate and exotic mortgage loans are hard to value, but they could eventually rise in value. "It's a good idea because the banks will undoubtedly do a good job managing it, because they have an interest," says William Seidman, a former FDIC chairman, now adviser for SecondMarket, which trades illiquid assets. When U.S. Bancorp acquired most assets of Downey Savings & Loan and PFF Bank & Trust on Nov. 21, it agreed to shoulder the first $1.6 billion in losses on certain assets. The FDIC agreed to absorb most future ones.