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Early terminations of loss-share agreements continue to mount

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Early terminations of loss-share agreements continue to mount

As loss-shareagreements near their expiration, more and more banks are terminating the contractsearly.

Loss-shareagreements, while an essential tool used to attract buyers of failed banks, havecontinued to fade away as acquirers agree to terms with the FDIC to terminate theagreements early. S&P Global Market Intelligence found that the FDIC has terminatedat least 215 loss-share agreements associated with 102 different failed banks thiscycle. More than a third of those terminations have come in the last six monthsas the loss-sharing portions of many of the agreements neared an end.

The twomost recent banks to terminate their loss-share agreements, BNC Bancorp and GreatSouthern Bancorp Inc., did so in recent weeks and payments from the FDIC. BNC alsodisclosed that it recorded a gainon the transaction.

Thosegains are not that common when terminating the agreements, which often results ina one-time expense for failed-bank buyers. That was the case when loss-share agreementstied to three failed-bank deals in late March, resulting in a $3.0 million paymentto the FDIC. Capital Bank said at the time that the termination would offer greaterfinancial transparency, reduce operating costs and come with a "favorable payback"period of approximately three years.

The rationalebehind early terminations generally follows that thinking. The terminations areoften dilutive to buyers' tangible book values but accretive to earnings becauseit eliminates future costs related to the amortization of acquirers' indemnificationasset, or the receivable that accounts for the value of loss-sharing. Terminationsalso improve earnings clarity by eliminating the volatility associated with loss-shareaccounting.

The FDIChas the right to recover losses for three years after a non-single-family loss-shareagreement expires. That right goes away with a termination, giving failed-bank buyersownership of future recoveries on previously covered assets as well. The loss-sharingportion of the non-single-family agreements spanned for five years, and that protectionhas ended for most agreements given that bank failures peaked in 2010.

In manycases, the assets covered under loss-sharing have performed better than originallyexpected, and terminating the agreements can allow failed-bank buyers to participatein upside associated with the credits. Accordingly, the sell-side community hasgenerally viewed the terminations favorably as was the case when its loss-share agreements in February2016.

"Withthe Florida economy in a relatively improved condition, CenterState's managementhas deemed it an opportune time to exit the agreement and assume sole responsibilityfor credit risk in its acquired portfolio," Raymond James analyst Michael Rosenoted in a report at the time.

The FDIC,for its part, has its own administrative burden that comes with managing loss-shareagreements. The agency has been actively reaching out to past acquirers to see ifthey would like to end loss-sharing early as it looks to reduce tail risk.

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The FDICwill only terminate a loss-share agreement early if it proves less costly than itsanticipated net payment obligations for the remaining term of the agreement. TheFDIC has said that it would consider early termination on a loss-share agreementwhen the unpaid principal balance for each portfolio — both single-family and commercial— covered under the agreement is less than $100 million and the FDIC's total paymentis not greater than $10 million. If an acquirer is willing to pay the FDIC to terminatethe agreement early, however, the agency will consider the transaction regardlessof the size.

The FDICfirst entertained early terminations of loss-share agreements tied to small failed-bankdeals in the fall of 2010. The first termination came not longer after that, whenUnited Valley Bank terminatedthe single-family and non-single-family loss-share agreement associated with itspurchase of Marshall Bank NA.

Earlyterminations began toincrease in the fall of 2014 as many loss-share agreements neared their expirationdate. As the pool of covered assets continued shrinking, the FDIC began not longafter that actively reaching out to banks with an unpaid principal balance of coveredassets that fall below the $100 million level.

Banksinterested in pursuing an early termination provide the FDIC with an estimated valueremaining under the loss-share agreement and the agency then determines if thatvalue seems reasonable. If that reasonable test is met, the FDIC will send an independentcontractor to estimate potential losses and recoveries tied to the assets coveredunder the agreement. If the net value of losses and recoveries puts the FDIC's liabilitybelow $10 million, the agency will pursue an early termination.

Somebanks have recently expressed an interest in terminating their agreements early.Home BancShares Inc., forinstance, recently disclosed that it has begun to look at the possibility of its remaining loss-shareagreements with the FDIC.
More early terminations could come in the future as buyers see loss-sharing as lessvaluable simply because assets covered under the agreements have become much smaller.In other cases, failed-bank buyers might want to shed the burden of loss-share accountingand assume full responsibility for the assets now that the loss-sharing portionof their agreement has expired.

Thereare still plenty of opportunities for early terminations tied to loss-share agreementsfitting that bill. S&P Global Market Intelligence found 226 agreements outstandingtied to failed-bank transactions inked between Jan. 1, 2010, and year-end 2011.The loss-sharing portion of those agreements has either already expired or is nearingexpiration.

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Click here to access a template that presents government-assisted deals.

Click here to access the FDIC's list of failed banks/loss-share agreements