The real opportunity to make money over the next few years will be through the FDIC. I see many of the same opportunities developing that I saw when I was a real estate consultant at KPMG from 1989 to 1997. During that time, I worked as a consultant to the RTC, solvent banks and loan acquirers.
There will be differences in this cycle, however, as the FDIC and the banks learned many lessons that they are implementing this cycle. You should consider these “Lessons Learned” when adopting your strategy, whatever it may be. Here is some background that should help you.
Between 1980 and 1994, 2,912 federally insured institutions failed, which was about 4 failures every week for 15 years. At the peak in 1991, the FDIC (and the RTC at the time, which handled the savings and loans) had 23,000 employees to handle the 1,430 financial institutions that were labeled as troubled. Today, there are 8,451 federally insured institutions, and we can easily see that number declining to 4,000 by the time this crisis is over.
There are four primary strategies that the FDIC adopts with troubled financial institutions:
- P&A (Purchase and Assumption) transactions are the preferred method, as they work out to be less costly to the taxpayer than the transactions where the government becomes the receiver. This is why the FDIC is actively pursuing acquirers of troubled banks today and it seems that several P&A transactions occur every weekend. In the last cycle, 74% of all failed institutions resulted in P&A deals. If you would like to stay on top of these transactions, bookmark this website, which gets updated every weekend:http://www.fdic.gov/bank/individual/failed/banklist.html. The government also learned that loss sharing arrangements passed less risk to the buyers, and eventually resulted in better taxpayer recovery, which is why most P&As involve loss sharing today.
- Deposit Payoff transactions occurred about 18% of the time in the last crisis and became the disposition of choice when the institution had little franchise value and was full of toxic loans. These are generally smaller institutions.
- Open Bank Assistance (OBA) occurs mainly in institutions that are “too big to fail,” which means that the institution is so important to the economy that it remains open with assistance from the Federal government. While this typically occurs with only a few institutions, OBA assistance represented 27% of the assets of the banks handled by the FDIC during the last crisis. There are so many large banks in the country today that are deemed “too big to fail,” that the government has resorted to OBA capital infusions to avoid the collapse of institutions that impact millions of people. The list of those transactions, which can be found athttp://www.treasury.gov/initiatives/eesa/transactions.shtml, is now 10 pages long!
- Bridge Bank transactions are when the FDIC takes over an institution and runs it until the problem can be resolved. This is usually the case with large, complicated institutions such as IndyMac.
The RTC was a temporary agency that was formed to deal with the Savings and Loan crisis. Since the RTC was temporary, it acted more quickly than the FDIC to resolve its problems, and tended to hire more private sector contractors to help solve the problem. The RTC hired 91 contractors from 1991 to 1993 to dispose of $48.5 billion of assets. The RTC also adopted RALA (Regional Asset Liquidation Agreement), which was the formula used to compensate and reward private sector firms for disposing of the assets at the highest price possible. The RTC also created 72 partnerships with the private sector, where the RTC contributed the assets and took passive profit participation, and the private sector contributed equity and asset management expertise.
During the last crisis, the taxpayer cost of handling $706 billion of failed institutions was $123 billion, or 17% of the asset total. The FDIC’s handling costs were 12%, while the RTC’s costs were 22%, but it is widely regarded that the RTC had more difficult problems to handle. Including interest and other expenses, total losses were greater than $123 billion.
The banking distress is only in the first or second inning, but the dollars are already very significant. Our advice to potential investors is generally as follows:
- Hold onto your cash until you see the deal of a lifetime, which might come with seller-financing.
- Protect and repair your reputation, which is a significant issue for companies that have given properties back to the bank or stiffed a couple of suppliers.
- Develop relationships with the expertise you don’t have in-house.
Our advice to the FDIC and the banks is generally as follows:
- Your appraisals overstate the value you can get today, and probably overstate the value you can get in 2010 or 2011 too, if for no other reason than the last comparable sales are at higher values than someone would willingly pay today. Please don’t shoot the messenger.
- If you can get a private contractor to manage the asset for you, you are better off unless you hire that expertise in your firm. The reason your phone has been ringing off the hook from potential asset managers is that they know they can add value – and, yes, they are also looking for income until the market recovers.
- Consider seller-financing, which will create a performing loan and result in less of a loss. Selling to an all-cash buyer is definitely distressed selling these days. Profit participation is also a great idea if you are entrepreneurial, willing to take the risk, and you trust the partner.