Loss Sharing Explained

Uploaded by FDICchannel on 28.06.2010

For more than 75 years the Federal Deposit Insurance
Corporation has kept money in America's bank deposit
accounts safe and sound.
But, what happens when a bank fails?
The FDIC has two jobs.
One: protect all insured deposits.
And Two: dispose of the bank's assets,
which are mostly loans.
They come in many shapes and sizes.
If the FDIC doesn't sell these assets at the time of
failure, it must take them over and manage them until
they can be sold at a later time.
And because of uncertainties about future losses on those
loans, buyers are unwilling to pay much for them.
So, the FDIC has a less costly way to move them at
the time a bank fails.
It's called loss-sharing.
Here's how it works.
Let's say Orchid Bank wants to acquire the failed Beige Bank,
but it is hesitant about the risk in certain
loans in the portfolio.
The FDIC enters into a loss-sharing agreement with
Orchid Bank to cover a portion of the losses on
those loans.
Orchid will assume all of the deposits of
Beige Bank, $100 million, and all of the loans,
valued on the books at $100 million.
The Book Value is what Beige Bank invested in these
assets, but they are not worth that now.
After all, the bank did fail.
With loss-share, Orchid Bank will pay more for the assets
than the FDIC could get by selling everything
on the open market.
And by buying all the assets, Orchid Bank is minimizing the
FDIC's losses.
Loss-sharing benefits Orchid Bank by protecting it from
the trouble that caused Beige Bank to fail.
And it benefits the FDIC which gets a higher price for
the assets by providing some certainty to Orchid bank
about what its maximum losses will be..
An added benefit to the FDIC is that loss share reduces
the amount of cash the FDIC must expend to make
depositors whole..
If the FDIC couldn't find a buyer for Beige Bank,
it would have to take $100 million out of its Fund to
pay Beige Bank depositors.
But with Orchid Bank acquiring all deposits and
assets, the FDIC's outlay is significantly lower.
And because Orchid Bank is doing all of the customer
service on the loans and bank accounts,
the FDIC saves again on the costs it would otherwise
incur in collecting loan payments and other costs of
carrying the loans.
Bank customers also benefit from loss-sharing.
Their deposits and loans stay in the same place.
So, the customer-banking relationship is preserved.
As for making big profits on reselling assets,
the loss-sharing agreement stipulates what Orchid Bank
can and cannot do with those acquired loans.
For example, Orchid can only sell them after a certain
period of time, and even then,
only with the FDIC's approval.
And if the bank incurs no losses on the assets,
the FDIC makes no loss-share payments.
Orchid Bank is also required to implement a
government-approved mortgage loan modification program
with the goal of keeping people in their homes.
If Orchid takes a loss on the modified loan,
the FDIC will make a loss-share
payment to cover it.
But, if modification isn't possible,
and Orchid forecloses on the loan,
the bank gets no loss-share payment until the home is sold,
and even then, only if there is a loss.
The FDIC also carefully audits
every loss-share agreement.
Loss-sharing helps the FDIC minimize outlays and maximize
returns to its Fund.
It keeps assets in the private sector instead of
under government management.
It protects acquiring banks from losses.
Most importantly, it helps local consumers and
businesses, by keeping the assets of the failed bank in
the community; preserving banking relationships for
customers who had both deposits and loans in the
failed bank, and keeping people in their homes
wherever possible.
By sharing the loss, many gain.