Avoiding the Abyss

CRE Finance World, Winter 2014

Avoiding the Abyss Five years after the economic collapse, the health of many banks is tied to both managing expiring LSAs and developing increasingly rigorous stress testing A publication of Winter issue 2014 sponsored by CRE Finance World Winter 2014 69 “Bank failures are caused by depositors who don’t deposit enough money to cover losses due to mismanagement.” —Dan Quayle ccording to the Federal Deposit Insurance Corporation (FDIC), 475 banks have failed since Sept. 13, 2008. For many of these failures, the FDIC entered into loss share agreements (LSAs) for the sale of failed bank assets to a healthier bank in order to reduce the impact on the organization’s deposit insurance fund, and to make these failing institutions more attractive to purchasers. The FDIC defines LSAs as an agreement in which the FDIC agrees to absorb a portion of the losses resulting from resolution of the loan portfolio. Typically, the LSAs had terms of five years for commercial assets and 10 years for consumer assets. As we have passed the five-year anniversary of the Lehman Brothers’ collapse earlier this year, banks will need to address the lingering impact of these LSAs. More than $100 billion from LSAs is estimated to be expiring in 2014, and more than $60 billion in 2015. Banks will face a generational challenge as these loss share safety nets eventually disappear. Firms will need to assess independently obtained values of these individual exposures, and report to stakeholders whether these exposures should be retained or sold, as optimal strategies must be determined and quantified. It is clear that the banking industry is continually working to recover from the devastating global economic event, but the Lehman Brothers’ collapse has left a very deep wound that has yet to fully heal, as more than 600 banks remain on its list of “problem” institutions on the most recent iteration of the FDIC Quarterly Banking Profile. Furthermore, these banks comprise nine percent of all FDIC insured banks and more than $200 billion in assets. While the industry continues to show quarterly improvement, the magnitude of these figures remains a concern to many organizations and regulators. Simply put, since the 2008 crash, nearly one in ten banks remains incapable of returning to health via acquisition or capital infusion. The looming impact of the LSA expirations from the Lehman crash is not the only concern. Lehman Brothers’ stress test reporting reveals that the quality and quantity of the underlying data was lacking. Per Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner Report, “When Lehman first adopted stress testing in about 2005, it applied the testing only to its tradable instruments such as stocks, bonds, and other securities; it did not include its untraded assets such as its commercial real estate or private equity investments…. Because Lehman’s stress testing did not include its real estate investments, its private equity investments or, during a crucial time period, its leveraged loan commitments, Lehman’s management pursued its transition from the moving business to the storage business without the benefit of regular stress testing on the primary business lines that were the subject of this strategic change.” Still, a significant question remains: has our revitalized sector learned from these prior missteps? In its August 2013 report, Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice August 2013, the Board of Governors of the Federal Reserve System asserted, “A key lesson from the recent financial crisis is that many financial companies simply failed to adequately identify the potential exposures and risks stemming from their firm-wide activities…. But more importantly, many companies failed to consider the full scale and scope of exposures, and to analyze how the size and risk characteristics of their exposures and business activities might evolve as economic and market conditions changed…. While many of the large BHCs subject to the Capital Plan Rule have made substantial improvements in capital planning, there is still considerable room for advancement across a number of dimensions.” Among the areas for improvement still include enhanced identification and quantification of risks, the need for enhanced support for goals and targets, and the necessity to aggregate and report data with the highest level of accuracy. As we look back at the Lehman Bank collapse and its ripple effect throughout the sector, we must continually reassess whether we have learned from our mistakes or whether today’s banking recovery is merely a precursor for the next down town that seems to occur each decade. The banking sector appears to be on the road to recovery, however, it must be vigilant in identifying and managing systematic risks associated with weaker institutions, the waterfall of loans expiring under LSAs and the ongoing requirement for accurate and meaningful stress test reporting. A Kenneth Segal Managing Director, Bank and Loan Advisory Group Situs “Since the 2008 crash, nearly one in ten banks remains incapable of returning to health via acquisition or capital infusion.”


CRE Finance World, Winter 2014
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