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Wednesday, July 22, 2015 10:51:04 PM
Understanding the Components Bank Failure Resolution Costs
https://www.fdic.gov/bank/analytical/cfr/2014/wp2014/WP_2014_04.pdf
page 3
The standard definition of resolution cost is the difference between the liabilities of the failed bank and the market value of its assets net of expenses incurred by the receivership........In this framework, the gain or losses on the disposition of assets and liabilities and receivership expenses adjust the book value of equity to its market value.
page 4
The FDIC uses a number of methods to resolve failed banks including deposit payoffs, insured-deposit transfers, purchase and assumption (P&A) agreements, whole bank transactions, and open-bank assistance. The primary difference between the methods is whether the FDIC assumes and liquidates the failed-bank assets (deposit payoffs) or leaves most or all of the failed-bank assets in the private sector (P&A agreements, whole bank transactions, and open-bank assistance).
page 6
The FDIC can resolve a failed bank primarily in two ways—deposit payoffs and purchase-and-assumption (P&A). The FDIC also has the option of providing open-bank assistance, but this alternative has not been used since 1992.
page 7
In a P&A transaction, an approved acquiring bank purchases all or part of the failed-bank's assets and simultaneously assumes all or part of the failed bank’s liabilities. The acquirer generally bids separately for assets and deposits. Because the deposit gathering function of the failed bank is transferred to the acquirer, the acquirer’s bid for the liabilities may reflect the franchise value of the failed institution. In some cases the acquirer receives most or all of a failed bank’s assets and deposits in return for a one-time payment from the FDIC. These transactions are termed as Whole Bank P&A transactions. The acquirer’s bid reflects the value of the deposit franchise less expected loss in value on the book value of the assets.
page 8
P&A agreements are closer to Chapter 11 bankruptcy process where all or part of the going concern value of the firm is preserved by reorganization.
page 14
The premium paid to the acquirer can reflect two types of payments. The receiver may pay a financial institution to administer depositor payoff in an insured deposit transfer transaction. This does not frequently occur—in our sample the receivership paid a premium in only seven out of the 155 IDT transactions. In the remainder of the IDTs the receivership received a premium. The bulk of the premium paid comes from the whole bank transactions. In these cases the bidder typically requires a one-time payment to assume the assets and deposits of the failed bank. Hence the premium paid by the receivership in whole bank transactions can reflect the loss on assets net of franchise value. Next, we account for the value of the income from assets, which reflects the interest and fees that are earned on the assets in liquidation during the resolution process and other miscellaneous income. Finally, we include the value of the interest expense paid to the FDIC before we arrive at the loss on assets.
page 14-15
we account for two items to arrive at the resolution
cost. The first one is the premium received from the acquirer. This item reflects the amount that the acquirer pays to the receivership to assume the deposits of the failed bank. The premium received can be used as an imperfect proxy for the franchise value of the failed bank. The proxy is imperfect because in P&A transactions the cash or the liabilities can be confounded by the bid for the assets. An acquirer can adjust upward or downward the premium paid for deposits depending on the estimated market value of assets, which is revealed by the FDIC to the prospective bidders. The last item is the receivership expenses. These expense items are akin to the bankruptcy costs of corporate failures.
Abstract was updated in July 2014......
https://www.fdic.gov/bank/analytical/cfr/2014/wp2014/WP_2014_04.pdf
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