Banking Law

An excellent example of what happens to other participants in real estate loans (and in the projects that secure the loans) when the FDIC assumes the lead participant or sole lender role after it seizes a failed bank's assets has been unfolding in Georgia and in Illinois. According to a recent article in the Atlanta Business Chronicle by J. Scott Trubey and Douglas Sams, the "collateral damage" caused by the FDIC doing the only thing it really does well--liquidating assets at firesale prices--will be extensive.

The largest banking failure in Georgia history may not be done causing damage.

The implosion of Silverton Bank N.A. could propel the downtown W Hotel toward foreclosure and put added pressure on scores of community banks nationwide, according to real estate and banking sources.

The Federal Deposit Insurance Corp. enlisted Deutsche Bank to auction loans and lead positions on more than $400 million in hotel and residential development notes. The portfolio likely will include the note for Barry Real Estate Companies Inc.?s glitzy W Atlanta-Downtown and Residences.

[...]

The auction appears to be laid out in two divisions: The sale of $162 million in whole loans held by Silverton, and the sale of a controlling interest in $253 million in separate loan participations, such as the W hotel.

The "ripple effects" that the articles authors detail could spread across scores of banks who are participants in the $253 million in loan participations.

An auction would put a new lead lender in control of the portfolio in partnership with the FDIC. The new lender, which could buy the portfolio at less than 40 cents on the dollar, would have little incentive to work out underperforming loans.

The sale would force banks tied to the portfolio to slash the value of the real estate, a move that could prove fatal for more than one community bank if they do not have the reserves to offset the losses, Chris Marinac, bank analyst with FIG Partners LLC, wrote in a Feb. 1 letter to investors. Dozens more also could take massive capital hits.

And potential failures triggered by the capital hits would likely be more costly to the FDIC than the funds it would recoup from the auction, Marinac predicted.

Good luck with the "more costly" argument, Chris. It certainly rings true to those of us who've been through the massive loan participation workout wars of the 1980s, but we're smart enough to know that when the FDIC puts whatever assumptions it wants to put into "its little black box" that spits out cost calculations (as I once heard a former Federal Home Loan Bank Board general counsel describe it), the "costs" of any course of action the FDIC decides to take will turn out to be--Voila!--the "least cost" alternative. If that sounds a tad bit cynical, then I'm not communicating effectively, because I'm completely cynical.

Silverton's aftermath is not the only evidence of the FDIC's love of liquidation, either. Illinois-based Corus Bank, another spectacular failure from last year, and another bank that was heavily invested in real estate, provides an example that not only loan participants, but borrowers, are also feeling Sheila's Silver Hammer come down on their heads.

In recent months, the FDIC has been more aggressive in disposing of troubled assets, including the failed Corus Bank portfolio of high-rise condos in Atlanta and other major cities.

That aggressive stance has frustrated some developers, who say the FDIC is failing to consider the long-term outlook on many of the projects and their importance for economic development.

I have news for you folks: the FDIC laughs in the face of your weak-kneed "long term outlook." Put it up for auction and liquidate it ASAP, that's its game plan, and it's no different today than it was twenty years ago, when the FDIC staffed the RTC. The people who make money on the real estate loans of failed banks are the folks who buy them from the FDIC, because in the vast majority of the cases, the buyers can see farther down the road than can the FDIC and they've got the expertise to work the assets out over time. In other words, the FDIC views its job as harvesting and marketing lemons. Let private enterprise make lemonade.

Unfortunately, as a reader of this blog who's an experienced banking attorney in another state e-mailed me recently, what the federal regulators don't seem to understand is the concept of a "self-fulfilling prophecy." Fire sales today lower prices tomorrow, so that the next fire sale is at even lower prices.