FDIC regulators are bracing for a wave of bank failures by considering broader use of loss-sharing, which was part of its bailout of Citigroup and of IndyMac.
Loss-sharing gives healthy banks an incentive to take on troubled assets of failed institutions while the government agrees to assume the majority of future losses.
"It is something that we plan on doing in the future where it's appropriate," Assistant FDIC Director Herb Held told The Wall Street Journal.
"I think it's a good deal for everybody: the FDIC, the acquiring bank and the borrowers. It keeps the assets where they were."
The number of banks on the FDIC’s “problem list” hit 171 in the third quarter, the highest since 1995. There were 117 banks on the list in the second quarter.
The FDIC used loss-sharing as part of federal aid to Citigroup, during the fire sale of two failed California financial institutions and as part of the IndyMac sale.
In the IndyMac deal, buyers agreed to continue a loan-modification plan that may not significantly reduce foreclosures because it doesn’t reduce the amount borrowers owe.
If the FDIC offers loss-sharing options to shaky banks that haven’t yet failed, the mechanism could become very costly. But it would also reduce the amount of bad assets the government would acquire if those banks fail.
“It is unfortunate that many of the banks that failed last year had a heavy reliance on Federal Home Loan Bank advances,” IndyMac CEO and FDIC chief operating officer John Bovenzi told Hedge Week.
“These secured borrowings and the associated prepayment penalties have the effect of increasing the costs to the FDIC and to uninsured depositors.”
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