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FDIC Turns to Loss-Sharing Agreements as Bank Failures Mount

As the number of bank failures continues to climb, with troubled commercial real estate loans increasingly contributing to the failures, the Federal Deposit Insurance Corp. (FDIC) is taking steps to mitigate the costs and the workload associated with the collapse of financial institutions. In particular, the FDIC is using loss-sharing agreements.

"The FDIC's use of loss-sharing agreements allows us to sell failed bank assets when an institution fails and potentially recover prior asset losses when market conditions improve," says Sandra Thompson, director of the division of supervision and consumer protection. "These agreements affect not only the resolution of failing banks, but also the examination process for acquiring banks."

Through June 25, 86 banks have failed this year. The number of failures in 2010 is expected to exceed the 140 bank failures recorded in 2009, according to the FDIC, which frequently is appointed receiver for failed banks. Not only is the number of bank failures growing, the number of insured lenders on FDIC’s problem bank list is also rising, the agency reports.

Loss-sharing agreements allow the FDIC to sell bank assets when an institution fails, and they also help to recover earlier losses when market conditions improve. Over approximately the past year and a half, the FDIC used loss-sharing agreements for about 75% of 212 bank failures.

The agreements also make failed institutions more attractive to potential buyers of the bank’s assets, according to FDIC. The amount of cash required can be lowered through the agreements, and assets also can be more easily transferred to the private sector.

Also, for the buyer of a failed bank, the loss-sharing agreements provide better protection against losses on covered assets, FDIC notes. The program operates like a federal loan guarantee, and the covered assets are far less likely to be subject to negative classification if the purchaser complies with the loss-sharing agreement.

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