Beginning next year, the Federal Deposit Insurance Corp. (FDIC) will request bidders for some seized banks to give the agency an opportunity to profit if the deal is well-received by the buyer's shareholders.
The strategy comes after the FDIC collected $23.3 million this month from New York Community Bancorp Inc. as part of the regional bank's recent acquisition of AmTrust Bank, a Cleveland thrift that failed. The purchase included an unusual financial provision ; INSERTed by New York Community to give it an edge over rival bidders.
The provision entitled the FDIC to reap gains from a rally in New York Community's stock price after it announced the AmTrust purchase.
The mechanism paid off for the government when New York Community's stock price rallied more than 16% in the two weeks after the deal, which will substantially expand the regional bank's deposit base.
The FDIC is now embracing that provision, which is a variation of a mechanism that it used in the 1980s, because shares of a number of banks recently have rallied after the purchase of a failed institution.
The FDIC's deposit-insurance fund, which had $45.2 billion in its coffers in June 2008, has been wiped out in the banking crisis and is expected to stay in the red until 2012. The agency views the new mechanism as another way to strengthen its financial position.
"We feel that the FDIC should participate in that increase in value," says Herbert Held, an associate director in the agency's division that handles bank failures. The provision will likely be included only in transactions that involve sizable buyers that are publicly traded.
The job of selling failed banks has intensified in recent months as a growing number of small and regional companies have struggled to cope with ballooning losses. The FDIC technically doesn't close the institutions, leaving that job to the regulatory agencies that oversee the banks. It does, however, arrange auctions for the seized banks, selecting a winning bidder for the failed institution's deposits and assets.
The agency plans to include the provision as one of the financial terms that it provides to buyers of failed banks. The FDIC chooses the winning bids in a failed-bank auction based on multiple factors.
Regulators have seized 140 banks so far this year and the flood of closures is expected to continue in 2010. Banks have grown more enthusiastic about bidding on failed banks in recent months, partly due to a strategy where the FDIC shares in losses that are associated with the closed institution.
The FDIC missed out on a rally in the shares of East West Bancorp Inc., which in November acquired the bulk of United Commercial Bank, a San Francisco-based institution with 63 branches and $10.4 billion in assets. East West's stock price jumped 60% in the two weeks after it acquired the failed bank. The two institutions cater to the Chinese community.
"The pop in East West [stock] was pretty spectacular. It would have been nice to participate in that," Held said.
The agency got its chance when New York Community's bid for AmTrust included an "equity-appreciation instrument" that gave the FDIC an opportunity to make money if the Westbury, N.Y., bank's shares rallied after its deal.
After losing out on other auctions for failed banks, "we decided to try to structure something that was definitively positive to all parties," said Joseph Ficalora, New York Community's chairman and chief executive. The bank would be eager to include the provision in future bids for other failed institutions, he said.
The mechanism came in the form of 25 million "units" of New York Community that could be exchanged for cash or stock. The value was based on the difference between New York Community's closing price of $12.33 on the day of the deal and the price at a future point that would be no later than Dec. 23.
Shares of New York Community rallied after the deal, prompting the FDIC to exchange its holdings for cash in two transactions on Dec. 9 and Dec. 17 that yielded $23.3 million, according to a regulatory filing made by the bank. Still, it appears the agency left some money on the table because the stock price continued to rise after it made the exchange.
So far, shareholders have shrugged off dilution caused by the special government units. New York Community also issued 69 million new shares to pay for the AmTrust transaction.
The FDIC still is working out the details of what it will require from future bidders, Held says, but the agency will begin including the provision in documents early next year.
Charles Wendel, founder of Financial Institutions Consulting Inc. in Ridgefield, Conn., says the FDIC will likely have plenty of opportunities to use the new mechanism.
"Some of these early deals have been pretty rich for investors, so if the economy comes back and management teams are competent, there should be real upside," he said.