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FDIC and Open Bank Assistance

FDIC and Open Bank Assistance

January 12, 2009

Authored by: Robert Klingler

On January 2, 2009, the Wall Street Journal ran a story on the possibility of the FDIC agreeing to assume future losses on the troubled assets of a failed institutions.  The FDIC has used versions of the loss-sharing model several times last year, but with the exception of the initial attempt to rescue Wachovia, only as part of the receivership of a failed institution.

“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.”

This leaves open the question of whether the FDIC will begin using a loss-sharing approach to facilitate open bank transactions.  Some advisers believes that the FDIC will use this approach to effectively entice sound financial institutions to purchase struggling banks, or those which may be in imminent danger of failing.  While there is no existing precedent during this period of economic turmoil, open bank assistance was a well regarded and oft used solution in earlier troubled times.  Where FDIC does provide stop loss or other support, it comes ahead of shareholders in the troubled institution, so it does not help shareholders in most instances; however, it does prevent the extra disruption of a failure.  Traditionally, FDIC officials informally estimated the additional loss upon a failure was at least 15% higher than the loss where the troubled bank is acquired by a healthy bank in an open bank transaction.  As a result, properly structured stop loss or other assistance programs should save the deposit insurance fund real dollars.

For now, the FDIC appears tied to the position that it can only offer loss-sharing following receivership and a full auction of the troubled or failing institution in order to comply with its legal obligation to provide the least-costly solution.  If a tangible proposal for a loss sharing were presented to a regional FDIC office, such a proposal would be have to be structured to assure “least costly” status and would be forwarded to DC for review.

Accordingly, we recommend that neither acquiring banks, nor troubled institutions looking to be acquired, put too many eggs in the basket hoping for FDIC loss-sharing assistance.

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Impact of Latest Tax Rules on Bank M&A Activity

One of the consequences of the TARP Capital program is that some banks will use some of the capital infusion to acquire other banks.  We believe that the “winners” in the TARP race will also attract additional private capital as investors decide who the long-term survivors are.  The Internal Revenue Service recently released two notices intended to provide relief to banks and other financial institutions that are looking to raise capital from the tax rules limiting the use of losses after there has been an ownership change in the stock of a corporation.  We believe that once it is widely understood by banks it will add momentum to the merger activity.

Generally, a corporation that has a taxable loss (i.e., tax deductions in excess of taxable income and gains) for federal income tax purposes during a taxable year generally may carry that loss back to each of the two (2) preceding years (to recoup federal income taxes paid in those years) and then forward to each of the following twenty (20) taxable years.  There are special rules, however, that limit the use of a tax loss (commonly referred to as a net operating loss or “NOL”) carryforward that arose prior to the time when the corporation underwent an ownership change with respect to its stock.

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