Raft of Deals for Failed Banks Puts U.S. on Hook for Billions

By DAMIAN PALETTA

WASHINGTON -- The biggest spur to deal-making among banks isn't private-equity cash or foreign investors. It is the federal government. bailout

To encourage banks to pick through the wreckage of their collapsed competitors, the Federal Deposit Insurance Corp. has agreed to assume most of the risk on $80 billion in loans and other assets. The agency expects it will eventually have to cover $14 billion in future losses on deals cut so far. The initiative amounts to a subsidy for the banking industry.

Tracking the Nation's Bank Failures

See banks, savings banks and thrifts that have failed since the beginning of 2008.

Through more than 50 deals known as "loss shares," the FDIC has agreed to absorb losses on the detritus of the financial crisis -- from loans on two log cabins in the woods of northwestern Illinois to hundreds of millions of dollars in busted condominium loans in Florida. The agency's total exposure is about six times the amount remaining in its fund that guarantees consumers' deposits, exposing taxpayers to a big, new risk.

As financial markets heal and the economy appears to be pulling out of recession, the federal government is shifting from crisis to cleanup mode. But as the loss-share deals show, its potential financial burden isn't receding. So far, the FDIC has paid out $300 million to a handful of banks under the loss-share agreements.

The practice is largely a response to the number of bank failures of the past 18 months, which has stretched the FDIC's financial and logistical resources. The FDIC had just $10.4 billion in its deposit-insurance fund at the end of June, down from more than $50 billion last year. The agency said Thursday it had 416 banks on its "problem" list at the end of the second quarter, which means the list of banks at a higher risk of insolvency has been growing.

Many of the government programs aimed at attacking the financial crisis have carried high price tags, including the Treasury Department's $700 billion Troubled Asset Relief Program, which includes major government investments in American International Group Inc., Citigroup Inc., Bank of America Corp., and the U.S. auto industry. But federal money isn't just going one way. Some of the emergency programs put in place last year, including TARP, have brought in billions of dollars for the government.

On a range of rescue programs run by the Federal Reserve, such as loans to investment banks and purchases of mortgage-backed securities, the Fed earned $16.4 billion through the first six months of 2009. The FDIC said earlier this year that it earned more than $7 billion on the fees it charged through a program that guaranteed debt issued by banks.

On Aug. 14, Alabama's Colonial Bank collapsed, felled by bad commercial-real-estate lending. The FDIC, assuming its traditional role, brokered a sale of the bank's deposits to BB&T Corp., ensuring that customers wouldn't see any interruption. It also agreed to help BB&T buy a $15 billion portfolio of Colonial's loans and other assets by agreeing to absorb more than 80% of future losses. Under the deal, the most BB&T can lose is $500 million, the bank says, and that is only in the unlikely event that the entire portfolio becomes worthless. The FDIC is on the hook to cover the rest.

In June, Wilshire State Bank, a division of Wilshire Bancorp Inc. in Los Angeles, agreed to buy $362 million in deposits and $449 million of assets from failed Mirae Bank, also of Los Angeles. The FDIC agreed to assume most future losses on roughly $341 million of those assets, largely commercial real estate and construction loans in Southern California.

"After we understood how [the loss-share] works, we were literally overjoyed," says Joanne Kim, chief executive of Wilshire State Bank.

Loss-share agreements made a brief appearance in the early 1990s during the savings-and-loan crisis, but haven't been used this extensively before. The FDIC sees the deals as a way to keep bank loans and other assets in the private sector. More importantly, it believes such deals mitigate the cost of cleaning up the industry.

The FDIC contends it would cost the agency considerably more to simply liquidate the assets of failed banks, especially with the current crop of troubled institutions and their portfolios of loans on misbegotten real estate.

The FDIC's premise is that banks that take on the troubled assets will work to improve their value over time. The agency estimates the loss-share deals cut will cost it $11 billion less than if the agency seized the assets and sold them at fair-market value.

"This is an issue the FDIC is grappling with because the loss rates they are estimating on these failed banks are pretty amazing," says Frederick Cannon, chief equity strategist at Keefe, Bruyette & Woods Inc.

By potentially mitigating losses -- or at least stretching them out over time -- the deals provide some protection for the agency's insurance fund. "It's a great opportunity for banks," says James Wigand, deputy director of the FDIC's division of resolutions and receiverships. "It's a great opportunity for us."