Unmined gold – investment opportunities created by FDIC bank closures

By Paul Fisher and William Frech

Fisher Cohen Waldman Shapiro LLP

Both the economy generally, and the real estate market specifically, were extremely hard hit from 2008 through 2012.  Further, while experiencing some resurgence, neither is showing signs of becoming robust.  As a result, banks that focused on the real estate market were particularly hard hit, and many are still in the recovery process.  To provide even more clarity to the issue, banks that focused on commercial real estate were the hardest hit.  One result was that many banks were forced to take a considerable volume of real estate on to their balance sheets for debts previously contracted.  While this process created great pain for both individuals and businesses, there are opportunities for investors to identify and acquire properties from banks at attractive prices.  Other real estate owned (OREO), however, is a topic for another day.  This article focuses on the next, and logically final, step that occurred with severely troubled banks that had significant commercial real estate concentrations.  They failed.

Most peoples’ knowledge of the bank failure process is limited to what they read in the press.  What goes on behind the scenes, however, is much more complex.  Once it is determined that a bank is going to fail, it is made available under the supervision and direction of the FDIC for purchase to prequalified buyers—typically other banks/bank holding companies.  They do, by necessity, a relatively brief due diligence process and if they decide to do so, put in a bid with the FDIC.  Part of the bid structure of the purchase can be what is called a Loss Share Agreement. The typical loss share agreement covers an eight-year period after acquisition of the failed bank and provides the acquiring bank the opportunity to go back to the FDIC for the first five years of that agreement and request 80 percent of whatever shortfall there may have been between what the loan was on the books for (at initial purchase valuation minus any charge-offs) and what the net sales price/payoff was (ergo: loss share).[1]  Please note that this is a broad strokes description and that each accepted bid has its own specifics.  However, this provides a reasonable base from which to move forward.

This brings us to the focus of this article, which is opportunities created when a bank acquires loans secured by commercial real estate, and these loans are, or become, non-performing.  When the bank starts knocking on the door and threatening foreclosure (or the foreclosure process has already started) they create motivated sellers.   The bank is also motivated to cooperate with a purchase/refinancing because of the aforementioned loss share agreement.  While the FDIC may not be thrilled that it may suffer further loss to the Bank Insurance Fund, it is reasonable to assume that participation in a loss share agreement was often instrumental in getting the winning bidder to the table.  It is highly preferable from the FDIC’s standpoint that there be a buyer, versus the FDIC having to go through the process of piecemeal liquidation of the bank’s balance sheet.

For real estate investors or brokers, the next step in the process is finding these potential buying opportunities.  Consider an example where you have multiple properties that fit the profile of an acquisition target for you or a client.  If you take the PIN(s) for the property and check for assignments you should be able to identify who did the assignment(s).  If the assignment was done by mortgage through a granting of power of attorney by the FDIC as a part of the process of the bank acquiring it as collateral, it is highly probable that the loan was purchased as part of a closed bank transaction.  (This will take a little research to verify, as the next step is to see if the prior mortgage holder was a bank closed by the FDIC.  However, that can be determined through a Google search.) If only one of the properties has an assignment that fits the criteria, you have identified a property where you may well have more negotiation leverage.   Now that you have this knowledge, what strategy can be used to take advantage of it?

First, you have to understand that transactions associated with loans covered by the loss share agreement are subject to review by the FDIC.  In order to ensure that review goes smoothly (thus avoiding potentially serious consequences from the regulators) the bank needs to be able to justify the payoff amount it is accepting.  A little homework on the part of the buyer can put the bank in a position where it can justify accepting the payoff amount.  If you can identify current distressed comparable sale prices in your desired price range, and establish a reasonable additional discount relative to holding costs the bank would incur if it had to take the property into OREO, or continue to hold it in OREO, you will have a strong platform to support your offer in a way that may give the seller and the bank the ability to justify the sale in light of the bank’s ability to make a claim under the loss share agreement.

Second, you need to understand that another powerful negotiation factor is time.  Remember, in a typical loss share agreement the bank has a five-year claim window.  Therefore, the value to the bank of the loss share agreement can be viewed much like an option, with time being a heavily weighted variable in the equation.  If the assignments discussed earlier were put in place four years and seven months ago, it is probable that time is running out for the bank to be able to go back to the FDIC and get a loss share payment .  I think that most people would agree that it is better to get 80 percent of a lower number back than zero percent of a somewhat higher number (assuming that both numbers are less than the loan balance on the bank’s books).

In conclusion, if you are willing to do some research you might be able to identify a significant point of leverage next time you enter into a negotiation for a property.  As a good negotiator knows, leverage equals opportunity.  Remember also that the bank you identified as likely having a loss share agreement will have other troubled loans, as well as OREO, that need satisfactory disposition.  As a result, the leverage you identified may lead to further opportunities beyond the transaction at hand.

Paul Fisher is a Founding Partner of Fisher Cohen Waldman, Shapiro LLP—a law firm specializing in troubled debt restructuring.

William Frech is the Senior Financial Analyst of Fisher Cohen Waldman Shapiro LLP.  Prior to holding this position he was a bank regulator for more than 29 years.