Nearing the End of the Bank Failure Cycle or New Stage? Trends in Bank Receiverships
As 2012 begins, the banking industry can reflect with relief upon the decreased number of bank failures in 2011. Last year ended with 92 bank failures, a substantial decrease from 2010 when 157 financial institutions were placed into receivership. The smaller number of shuttered banks, and some noteworthy instances of successful bank recapitalizations, is good news for the banking industry. Some see this trend and believe (or hope) it will continue. But, the inventory of distressed banks suggests otherwise.
Multiple data points indicate that the cycle of bank failures is not yet over or even near its end. Factors affecting the failure rate in 2012 and 2013 are:
- More than 800 banks remain on the FDIC's confidential "troubled institution" list. In most instances, these distressed banks require significant recapitalization, from a limited and cautious pool of potential qualified investors. The number of institutions on this distressed list has diminished only very modestly over the last three years. Instead, the distressed banks that have failed have been replaced on the list by other troubled institutions.
- The bank failure hot spots in 2010 and 2011 were Illinois, California, Florida and Georgia. Banks in those markets will continue to be especially vulnerable to receivership risk, especially for smaller institutions for which Texas ratios (a traditional measure of bank health) remain at historically high levels. Real estate valuations in these markets continue to put pressure on bank balance sheets and the number of de novo banks is especially high in Illinois and Georgia. These de novos are particularly vulnerable because many of them have real estate-based credit portfolios created during the height of the real estate bubble.
- On average, the size of troubled institutions is smaller than that of those banks that failed earlier in the cycle. These distressed banks often find attracting recapitalization partners — whether financial or strategic buyers — more challenging than for larger competitors with meaningful core deposit franchises. Many of the smaller bank failures are those in more rural areas with fewer market expansion opportunities, which is another hindrance in attracting "growth" capital. Lack of access to capital sources, core franchise deterioration and the associated liquidity strain, a fragile economy that is causing more and more credits to "tip over," and fatigued and overwhelmed management teams and boards of directors can contribute to a slide towards receivership.
For potential assuming institutions, the result will be continued opportunities for growth through FDIC-assisted transactions in 2012.
Savvy potential assuming institutions remain well informed about current trends in FDIC-assisted transactions, which influence their bidding patterns. Recent examples of material developments include:
- In some instances bidders now have the opportunity to purchase failed bank premises based on 30-day "fixed price" purchase options, rather than through the more typical 90-day post-closing purchase option. This is an opportunity most attractive to local bidders that are well informed about specific bank premises and valuations in the particular real estate market.
- Continuing an ongoing trend towards leaner loss-share portfolios, loans for which government guarantees are available are now excluded from loss-share coverage. This change heightens the need for focused pre-bidding diligence regarding the size and extent of the failed bank's guaranteed loan portfolios, particularly SBA loans.
- Assets that were fully charged-off by the failed bank prior to receivership (other than those secured by collateral that is purchased by the assuming institution) are now being retained by the FDIC as receiver. This is significant as a portion of the potential gains associated with these fully-charged-off assets no longer pass to the buyer.
- Rules for modification of commercial assets covered by loss-share have been revised to allow assuming institutions greater flexibility in workout and credit restructuring efforts. These changes represent increased latitude for loan workout staff, especially during the final years of a loss-share agreement, but also a heightened need for internal discipline to ensure potential losses are not inadvertently being delayed (rather than prevented) such that the assuming institution assumes full financial responsibility for them.
In sum, bank failures are likely to continue in significant numbers during 2012 and will represent excellent strategic opportunities for well-informed potential buyers.