Loss sharing is a feature that the Federal Deposit Insurance Corporation (FDIC) first introduced into failed bank purchase and assumption (P&A) transactions in the early 1990s. The FDIC entered into 16 loss sharing agreements to resolve 24 banks that failed between 1991 and 1993. In a follow up study, the FDIC concluded that these loss sharing arrangements were less expensive to the FDIC than conventional P&A transactions. See, www.fdic.gov/bank/historical/managing/history1-07.pdf.

In recent months, as the number of failed banks has increased, so has the FDIC’s use of loss sharing. Of the 39 bank failures since July 2, 2009, the FDIC has employed a loss sharing arrangement in 30 of those situations. A list of all bank failures since October 1, 2000, along with links to the associated P&A agreements, is available at http://www.fdic.gov/bank/individual/failed/banklist.html.

The goals of loss sharing are for the FDIC to sell as many assets as possible to an acquiring bank while having the nonperforming assets managed and collected by the acquiring bank in a manner that aligns the interests and incentives of the acquiring bank with the FDIC.

Under the most recent loss sharing arrangements, the acquiring bank is protected by two separate loss sharing agreements. One covers single family residential mortgage loans and the other covers all other loans. During the term of the loss sharing agreement, the acquiring bank retains 20 percent of the loan losses incurred in the acquired loan portfolio up to an agreed upon threshold. Thereafter, the FDIC assumes 95 percent of any additional loan losses. The most recent loss sharing agreements have a term of eight years for single family loans and 10 years for all other loans. See, e.g., the P&A Agreement dated August 21, 2009, resolving ebank, Atlanta, Georgia. http://www.fdic.gov/bank/individual/failed/ebank.html.

On a monthly basis, the FDIC will reimburse the acquiring bank at the 80 percent or 95 percent rate for the amount of any charge-offs on the covered loans, plus certain reimbursable expenses. Similarly, the acquiring bank will reimburse the FDIC for any recoveries, less recovery expenses, on the covered loans.

While the FDIC, based on its experience in the early 1990s, believes that these loss sharing arrangements will provide the least cost resolution for the FDIC, they also provide a significant opportunity for those healthy banks with sufficient capital and management resources to participate in these transactions.