Silver Law Offices Inc. E-Alert

Loss sharing arrangements were first used in the early '90s and now the FDIC is employing them again to entice "healthy" banks to acquire a failing bank's loans in a government assisted transaction. Through August 2009, the FDIC had entered into 53 loss sharing agreements, with $80 billion in assets under loss share. According to the FDIC, the estimated "savings" exceed $11 billion, compared to an outright cash sale of those assets.There were 25 bank failures in 2008 and there have been 125 bank failures so far in 2009, of which the FDIC entered into less than 10 loss sharing agreements as part of a corresponding assisted transaction.

Here's how it works. The FDIC agrees to share in loan losses that may be incurred by the acquiring healthy bank as a direct result of any nonperforming loans that it acquired from the failed bank. The loss sharing agreements also provide that the FDIC will share in any recoveries on nonperforming loans. The FDIC uses two forms of loss sharing. The first is for commercial assets and the other is for residential mortgages. For commercial assets, the agreements typically cover an eight-year period with the first five years for losses and recoveries and the final 3 years for recoveries only. The FDIC will reimburse 80 percent of losses incurred by acquirer on covered assets up to a stated threshold amount (generally FDIC's dollar estimate of the total projected losses on loss share assets), with the assuming bank picking up 20 percent. Any losses above the stated threshold amount will be reimbursed at 95 percent of the losses booked by the acquirer. For single family mortgages, the length of the agreements tend to run for 10 years and have the same 80/20 and 95/5 split as the commercial assets. The FDIC provides coverage for four basic loss events: modification, short sale, foreclosure, and charge-off for some second liens (loss sharing agreements differ on types of acceptable loss events). Loss coverage is also provided for loan sales but such sales require prior approval by the FDIC. Recoveries on loans which experience loss events are shared in the same proportion as the original loss. So If asset losses are lower than anticipated, then the FDIC receives the majority of the benefit.

If you are a borrower on a loan that is purchased by an acquiring bank in a transaction assisted by an FDIC Loss Sharing Agreement then knowing that your lender's losses are "backstopped" will assist you in negotiations. We can obtain and review particular loss sharing agreements which can be found in corporate and governmental filings available to the public. We have worked on at least one loan workout involving a loan wherein the loss sharing agreement prohibited the lender from selling the loan to the borrower at all; in order to qualify for loss sharing, the property had to either go through foreclosure or the lender could sell the note or approve a short sale of the property to an unaffiliated buyer (not affiliated with the borrower), in either case subject to FDIC blessing.