RESOLUTION PREPARATION

When a problem bank is dealt with swiftly, asset and franchise values are preserved, generating maximum return. This makes the failing bank more desirable to potential acquirers and lowers the ultimate cost of resolution. Resolution preparation involves:

• Compiling initial information about the bank

• Asset valuation

• Completion of a financial information package (bid package)

• Marketing meeting logistics.

Regardless of whether the bank is operating or closed, experienced and qualified personnel should complete the asset valuation. If the bank is in conservatorship, bank staff can prepare the bid package, under the direction of the conservator.

MARKETING STRATEGY

Once the information mentioned above has been compiled, the marketing specialist can begin determination of the best transaction form to offer potential acquirers. Some factors that affect the marketing strategy are:

• Asset and liability composition of the failing bank

• Competitive and economic conditions of the bank’s market area

• Prior resolution experience in the same market

• Other relevant information (such as potential fraud at the bank).

Some of the questions that must be answered to determine the appropriate form of the transaction are:

• Will the bank be sold whole or in parts?

• What types or categories of assets will be offered?

• How should the assets be packaged?

• How should the assets be priced?

Least-Cost Analysis

Some jurisdictions require that the resolution method be the least costly of any other resolution method. Resolution alternatives are evaluated on a net present value basis, using a reasonable discount rate, to determine the least costly resolution.

The least-cost analysis is generally defined as the calculation to determine the problem bank resolution method that is the least costly to a deposit insurance fund (or government budget) of all possible means of resolving the failed bank. Some factors that can influence the least-cost analysis include the difference between assets and liabilities book values, levels of insured deposits, premium paid by an acquirer, and losses on contingent claims.

A typical formula to calculate least cost is: (Loss on assets – equity capital – unsecured creditors’ loss) × (insured deposits/total deposits).

A P&A is a transaction in which a healthy bank (the acquirer) purchases some or all of the assets of a failed bank and assumes the insured deposits. To gain entry to a new market or to increase market share, an acquirer will often pay a premium for this transaction. When the amount of insured deposits assumed exceeds the value of the premium plus assets purchased, an acquirer may receive assistance. Some benefits of a P&A transaction include:

• Customers suffer no loss in service

• Acquiring bank can increase market share

• Usually less expensive than a payoff

• Depending on transaction, can keep assets in the private sector

• P&A transaction with put options on assets allows acquirer to perform due diligence after transaction (although this “cherry-picking” often leads an acquirer to neglect servicing questionable assets).¹¹

The P&A transaction, whether used to transfer insured deposits and selected assets to an assuming bank or to a “bridge” bank managed by the government until an assuming bank is found, employs the instant use of the failed bank’s assets to offset the liabilities transferred.

Under the P&A concept, certain assets and insured deposits of the failed bank are transferred to an assuming bank at book value. In this way, the assets of the failed bank help offset the deposit liabilities transferred to the assuming bank, thus reducing the impact on the deposit insurance fund (if there are not enough “good” assets to balance the amount of insured deposits, the DIA must advance the cash to balance the transaction—assets must equal liabilities). The real cost of not employing a P&A transaction can be devastating to a deposit insurance reserve fund.

Although there are several variations of the P&A transaction used around the world, the concept is very simple. The objective is to include as many assets as possible in the transaction while ensuring that they are of adequate quality so as to not jeopardize any deal or create a problem bank situation with an acquirer. Table 5.1 illustrates the various forms of assets and liabilities with regard to a P&A.

TABLE 5.1

Summary of a Typical Purchase and Assumption Transaction

¹Depending on the bank insolvency regime, some cash may be needed to fund receivership operations until asset liquidation generates enough working capital. Most bankruptcy regimes (commercial or special) stipulate that receivership operating expenses have the highest claim priority.

²See footnote 2 in this chapter.

TABLE 5.1

Summary of a Typical Purchase and Assumption Transaction

Assets
Cash	Passes to acquirer at book value.1
Due from banks	Passes to acquirer at book value.
Investment securities	Can be sold to acquirer at market value, depending on quality and marketability.
Loans	Can be sold to acquirer, depending on quality. For example, loans completely secured by deposits, performing installment and residential mortgage loans may pass, while commercial and nonperforming loans of any type usually do not pass. Homogenous loans may be pooled and sold as part of the transaction or to other investors. Any accrued interest receivable will either pass or stay with the respective pool.
Fixed assets	The purchase and assumption (P&A) transaction can provide the acquirer an exclusive option to purchase owned or assume leased bank premises. These will pass at appraised value or an assignment of lease terms as applicable.
Other real estate owned	Sometimes the acquirer will have an exclusive option to purchase other real estate owned at appraised value.
Other assets	Some may be offered as an option, others may be excluded entirely.
Liabilities
Deposits	Insured deposits are assumed by the acquirer according to the P&A. Any accrued interest payable on insured deposits passes to the acquirer.2
Borrowings	Usually does not pass to acquirer.
Guaranties	Usually does not pass to acquirer.
Other liabilities	Usually does not pass to acquirer unless it is related to an asset the acquirer has purchased or an obligation the acquirer has assumed.
Capital	Under no circumstances does any capital account pass.
	Additional Stipulations
	The acquirer must usually continue banking business at the location for a specified period of time.
	The acquirer must usually manage the failed bank’s safe deposit business.
	The acquirer must provide notice to claimants (and obligors as applicable).
	The acquirer must usually perform certain specific actions related to assets purchased (e.g., loans in litigation, bankruptcy, participations, etc.).

¹Depending on the bank insolvency regime, some cash may be needed to fund receivership operations until asset liquidation generates enough working capital. Most bankruptcy regimes (commercial or special) stipulate that receivership operating expenses have the highest claim priority.

²See footnote 2 in this chapter.

View Table

TABLE 5.1

Summary of a Typical Purchase and Assumption Transaction

Assets
Cash	Passes to acquirer at book value.1
Due from banks	Passes to acquirer at book value.
Investment securities	Can be sold to acquirer at market value, depending on quality and marketability.
Loans	Can be sold to acquirer, depending on quality. For example, loans completely secured by deposits, performing installment and residential mortgage loans may pass, while commercial and nonperforming loans of any type usually do not pass. Homogenous loans may be pooled and sold as part of the transaction or to other investors. Any accrued interest receivable will either pass or stay with the respective pool.
Fixed assets	The purchase and assumption (P&A) transaction can provide the acquirer an exclusive option to purchase owned or assume leased bank premises. These will pass at appraised value or an assignment of lease terms as applicable.
Other real estate owned	Sometimes the acquirer will have an exclusive option to purchase other real estate owned at appraised value.
Other assets	Some may be offered as an option, others may be excluded entirely.
Liabilities
Deposits	Insured deposits are assumed by the acquirer according to the P&A. Any accrued interest payable on insured deposits passes to the acquirer.2
Borrowings	Usually does not pass to acquirer.
Guaranties	Usually does not pass to acquirer.
Other liabilities	Usually does not pass to acquirer unless it is related to an asset the acquirer has purchased or an obligation the acquirer has assumed.
Capital	Under no circumstances does any capital account pass.
	Additional Stipulations
	The acquirer must usually continue banking business at the location for a specified period of time.
	The acquirer must usually manage the failed bank’s safe deposit business.
	The acquirer must provide notice to claimants (and obligors as applicable).
	The acquirer must usually perform certain specific actions related to assets purchased (e.g., loans in litigation, bankruptcy, participations, etc.).

¹Depending on the bank insolvency regime, some cash may be needed to fund receivership operations until asset liquidation generates enough working capital. Most bankruptcy regimes (commercial or special) stipulate that receivership operating expenses have the highest claim priority.

²See footnote 2 in this chapter.

Some examples of the forms a P&A transaction can take are:

• Whole bank. Where a liquidating supervisory authority or the government pays an acquirer to take virtually all assets and liabilities of a failed bank (negative bid).

• Clean bank. Some good assets are sold to an acquirer that also assumes insured deposit liabilities. There are many variations of the asset sale. It can include put-back rights, exclusive asset purchase options, and representations and warranties. Of these, the exclusive asset purchase option, or “cherry pick,” is probably the simplest. The liquidator, or receiver, may lack funds to pay for assets put back, and asset quality is usually insufficient to justify representations and warranties.

• Deposit transfer. An acquirer assumes insured deposits and acts as paying agent for the DIA. Few assets are transferred other than the cash needed to cover the transferred deposits.

Tables 5.2 and 5.3 are two pro forma illustrations of the impact of a P&A transaction on a problem bank’s balance sheet. Both begin with an original balance sheet, which is then adjusted for loss in the bank’s loan portfolio, and concludes with the split of assets and liabilities. In the first example (Table 5.2), the split is between the assuming bank and the receivership; in the second example (Table 5.3), the split is between a newly created “bridge” bank (temporarily owned and operated by the government) and the receivership.

TABLE 5.2

Assuming Bank Purchase and Assumption Example: Failed Bank—Original Balance Sheet

TABLE 5.2

Assuming Bank Purchase and Assumption Example: Failed Bank—Original Balance Sheet

Assets		Liabilities
Cash and bank deposits	154	Deposits	800
Investments	185	Borrowings	70
Loans	710	Other liabilities	110
Fixed assets	25	Subordinated debt	10
Investment in subsidiaries	5	Capital	110
Other assets	21
Total	1,100		1,100
Failed Bank - Original Balance Sheet - Adjusted for Loss
Assets		Liabilities
Cash and bank deposits	154	Deposits	800
Investments	185	Borrowings	70
Loans*	410	Other liabilities	110
Fixed assets	25	Subordinated debt	10
Investment in subsidiaries	5	Capital**	-190
Other assets	21
Total	800		800
* – Loss of 300 in Loans. ** – Charged loss results in insolvency.
“Split” - Assuming Bank
Assets		Liabilities
Cash and bank deposits	154	Insured deposits	550
“Good” Investments	85	Borrowings
“Good” loans	200	Other liabilities**	20
Other assets*	5
Subtotal	444		570
Cash from deposit insurance agency	126
Total	570		570
* – Accrued interest on “good” loans. ** – Accrued interest on insured deposits.
“Split” - Receivership
Assets		Claims
Investments	100	Uninsured deposits	250
Loans	210	Borrowings	70
Fixed assets	25	Other liabilities	90
Investment in subsidiaries	5	Subordinated debt	10
Other assets	16	Capital	110
Total	356		530

View Table

TABLE 5.2

Assuming Bank Purchase and Assumption Example: Failed Bank—Original Balance Sheet

Assets		Liabilities
Cash and bank deposits	154	Deposits	800
Investments	185	Borrowings	70
Loans	710	Other liabilities	110
Fixed assets	25	Subordinated debt	10
Investment in subsidiaries	5	Capital	110
Other assets	21
Total	1,100		1,100
Failed Bank - Original Balance Sheet - Adjusted for Loss
Assets		Liabilities
Cash and bank deposits	154	Deposits	800
Investments	185	Borrowings	70
Loans*	410	Other liabilities	110
Fixed assets	25	Subordinated debt	10
Investment in subsidiaries	5	Capital**	-190
Other assets	21
Total	800		800
* – Loss of 300 in Loans. ** – Charged loss results in insolvency.
“Split” - Assuming Bank
Assets		Liabilities
Cash and bank deposits	154	Insured deposits	550
“Good” Investments	85	Borrowings
“Good” loans	200	Other liabilities**	20
Other assets*	5
Subtotal	444		570
Cash from deposit insurance agency	126
Total	570		570
* – Accrued interest on “good” loans. ** – Accrued interest on insured deposits.
“Split” - Receivership
Assets		Claims
Investments	100	Uninsured deposits	250
Loans	210	Borrowings	70
Fixed assets	25	Other liabilities	90
Investment in subsidiaries	5	Subordinated debt	10
Other assets	16	Capital	110
Total	356		530

TABLE 5.3

“Bridge” Bank Purchase and Assumption Example: Failed Bank—Original Balance Sheet

TABLE 5.3

“Bridge” Bank Purchase and Assumption Example: Failed Bank—Original Balance Sheet

Assets		Liabilities
Cash and bank deposits	154	Deposits	800
Investments	185	Borrowings	70
Loans	710	Other liabilities	110
Fixed assets	25	Subordinated debt	10
Investment in subsidiaries	5	Capital	110
Other assets	21
Total	1,100		1,100
Failed Bank - Original Balance Sheet - Adjusted for Loss
Assets		Liabilities
Cash and bank deposits	154	Deposits	800
Investments	185	Borrowings	70
Loans*	410	Other liabilities	110
Fixed assets	25	Subordinated debt	10
Investment in subsidiaries	5	Capital**	-190
Other assets	21
Total	800		800
* – Loss of 300 in Loans. ** – Charged loss results in insolvency.
“Split” – “Bridge” Bank
Assets		Liabilities
Cash and bank deposits	154	Deposits	800
“Good” Investments	85
“Good” loans	200	Other liabilities**	20
Other assets*	5
Fixed assets	25
Subtotal	469
Cash from deposit insurance agency or state	351
Total	820		820
* – Accrued interest on “good” loans. ** – Accrued interest on insured deposits.		(Contingent liabilities (e.g., unfunded loan commitments, letters of credit, litigation, etc. left in receivership)).
“Split” - Receivership
Assets		Claims
Investments	100
Loans	210	Borrowings	70
Investment in subsidiaries	5	Other liabilities	90
Other assets	16	Subordinated debt	10
		Capital	110
Total	631		280

View Table

TABLE 5.3

“Bridge” Bank Purchase and Assumption Example: Failed Bank—Original Balance Sheet

Assets		Liabilities
Cash and bank deposits	154	Deposits	800
Investments	185	Borrowings	70
Loans	710	Other liabilities	110
Fixed assets	25	Subordinated debt	10
Investment in subsidiaries	5	Capital	110
Other assets	21
Total	1,100		1,100
Failed Bank - Original Balance Sheet - Adjusted for Loss
Assets		Liabilities
Cash and bank deposits	154	Deposits	800
Investments	185	Borrowings	70
Loans*	410	Other liabilities	110
Fixed assets	25	Subordinated debt	10
Investment in subsidiaries	5	Capital**	-190
Other assets	21
Total	800		800
* – Loss of 300 in Loans. ** – Charged loss results in insolvency.
“Split” – “Bridge” Bank
Assets		Liabilities
Cash and bank deposits	154	Deposits	800
“Good” Investments	85
“Good” loans	200	Other liabilities**	20
Other assets*	5
Fixed assets	25
Subtotal	469
Cash from deposit insurance agency or state	351
Total	820		820
* – Accrued interest on “good” loans. ** – Accrued interest on insured deposits.		(Contingent liabilities (e.g., unfunded loan commitments, letters of credit, litigation, etc. left in receivership)).
“Split” - Receivership
Assets		Claims
Investments	100
Loans	210	Borrowings	70
Investment in subsidiaries	5	Other liabilities	90
Other assets	16	Subordinated debt	10
		Capital	110
Total	631		280

A bridge bank allows greater flexibility in that either insured or all depositors can be protected (Box 5.2). Other creditors may be protected as well, depending on governmental decision. A great benefit of a bridge bank is that the contingent liabilities (e.g., unfunded loan commitments, letters of credit, litigation, unknown liabilities, etc.) can be left behind in the receivership, along with selected other liabilities, and the government will bear none of those liabilities.

There is no “one size fits all” answer when choosing a resolution transaction, but a P&A transaction is a versatile vehicle to fit many situations. The proper vehicle for a failing bank resolution can help avoid disruption of orderly economic activity such as:

• Loss of a bank in an isolated area

• Severe reduction in credit availability for an industry or region

• Considerable government ownership of a failed bank’s assets.

An in-depth analysis of asset quality is the primary factor in the type of transaction planned. It is more cost-effective and less disruptive to sell as many assets as possible through the P&A transaction. Often this fact will justify selling the assets at a discount from book value. An acquirer’s reluctance to pay reasonable value for assets should not lead to a “fire sale” mentality, however.

The basic P&A transaction is adaptable to change. For example, where there is a very large failing bank, it may be advisable to market it branch by branch (or in clusters) in order to maximize potential bidders (Box 5.3). The provisions of the P&A transaction should be accommodating enough to return the greatest value for the failed bank. When liquid assets are sufficient to cover payment of insured deposits, a good strategy may be to offer a P&A transaction with an exclusive option to purchase certain assets. This will give an acquirer enough time for asset review to determine which ones meet its criteria. Purchase of additional assets may fund payment of all or part of uninsured deposits and other creditors, and will quickly return assets to the private sector.

Another alternative is to pass assets at book value initially and then provide for third-party valuation after the fact. The government and the assuming bank can each hire an independent auditing firm to value the assets and negotiate from the two results. If there is more than a 10 percent variation between the two reports, a third can be ordered.

Box 5.2.

“Bridge” Banks and Nationalization

A bridge bank is a temporary financial institution established to receive the deposits and good assets of one or several failed institutions.¹ A bridge bank is a type of purchase and assumption (P&A) agreement where the government (or the restructuring agency) itself temporarily acts as the acquirer until the time that the institution is ready for a sale. The bridge bank may be allowed to undertake all or only some banking business, such as providing new credit and rolling over existing credit. Bad assets are liquidated or transferred to an asset management company. If it is expected that the bridge bank will be sold quickly to a solvent bank, the government may opt not to inject any capital in the bank, which makes the bridge bank arrangement potentially a cheap arrangement for the government.

Nationalization of a failing bank means that the government becomes the (main) owner of the insolvent bank and recapitalizes it. The use of the term here is different from the more traditional nationalization, which refers to a situation wherein the government which takes over a solvent bank. In a systemic crisis, the government’s aim is usually to own the bank temporarily and to seek to privatize it at an early date.²

1

Generally in a P&A agreement, only insured deposits transfer to an assuming bank. In a bridge bank situation, however, insured-only or all deposits may be transferred, depending on potential systemic impact.

2

Edward J. Frydl and Marc Quintyn, “The Benefits and Costs of Intervening in Banking Crises” in Bank Restructuring and Resolution (International Monetary Fund, Washington, 2006), pp. 32–33.

Box 5.3.

Branch Breakups¹

There may be instances where a bank has so many branch offices that it may not be feasible for a single institution to acquire it. If such is the case, the supervisory authority may want to consider a “branch breakup” (i.e., offering branch offices individually, or in clusters, to multiple bidders). Following are some pros and cons of branch breakups:

Pros:

• Provides for more potential bidders (especially smaller banks), which may increase the premiums received

• Increases the resolutions options available to the bidders.

Cons:

• Information technology and conversion costs are usually higher

• A quick and smooth transaction is more difficult

• One acquirer must be the “lead” acquirer (an often onerous role), in processing and allocating transactions and costs.

Some branches may be undesirable, resulting in liquidated payoff.

1

Federal Deposit Insurance Corporation, Resolutions Handbook (Washington, 1998).

Preferred failing bank resolution methods are those that help prevent adverse economic results. Their goals are to:

• Preserve franchise values

• Maximize private ownership of assets

• Minimize government ownership of assets

• Preserve (or help create) competitive markets.

If none of the above options prove feasible, then it will be necessary to perform a liquidated payout to insured depositors. During such a situation, it is critical to avoid public gatherings and lines at the failed bank’s offices, as this may result in contagion and possible systemic risk. One solution to this problem is to mail checks to insured depositors. If this option is selected, then it must be highly publicized in all media sources.

Another viable option is to make insured deposit payment via electronic transfers to another bank (Box 5.4). Upon bank failure, depositors should be clearly instructed that they should open an account at another bank, which will transmit the information to the DIA for verification and payment via electronic transfer. Depositors should be notified via a press release to printed media, public service announcements on television, and flyers distributed at every failed bank location.

Other banks should be notified of the process as soon as possible following the bank closing and requested to waive any bank account opening fees they may normally charge. Electronic depositor transfer forms (Annex 5.2) and nonconfidential depositor information should be provided to the other banks for more efficient processing. DIA personnel will review and verify the deposit information, and make deposit transfers as appropriate.

LEGAL DOCUMENTS

There are several standardized documents for a P&A transaction. Supervisory authority attorneys will need to review them to ensure compliance with applicable legislation. Briefly, the documents include:

• Confidentiality agreement. This must be signed by any bank or investor group that is interested in receiving any information regarding the pending transaction. Confidentiality is paramount in order to maintain public confidence and limit competitive abuse (Annex 5.3).¹²

• P&A agreement. The P&A deposit agreement identifies the deposits, terms, and conditions under which they are to be assumed. It also comprises the terms and conditions of any assets to be sold as part of a problem bank resolution. Additionally, in all these agreements, the acquirer is indemnified for any actions of the failing bank prior to failure, unless expressly assumed. (This is not a monetary indemnification, but a legal redirection of claims to the receiver.)

• Interim asset servicing agreemnent. This agreement requires an acquirer to responsibly service specific assets for a certain period. This can apply in cases where the acquirer has an exclusive purchase option on assets, or when the liquidating supervisory authority lacks personnel to service their assets.

• Escrow agreement. This provides an opportunity to consummate a P&A transaction in advance of the scheduled bank closing. It assures both parties that commitments will be honored (Annex 5.4).

• Bid agreement form. A legal document and form that commits the potential acquirer to abide by the restrictions of the resolution process and pay the amount specified (Annex 5.5).

POTENTIAL ACQUIRERS

A P&A transaction is an excellent opportunity for an acquiring bank to either increase market share or expand into areas where the acquirer does not have a presence. Paying a premium for deposits and options on banking premises is much more cost-effective than obtaining premises and soliciting deposits on a de novo basis. (In the United States, estimates are that the acquirers in these types of transactions retain approximately 70 percent of deposits.)¹³

Additionally, the efficiency of the P&A transaction limits financial disruption to a community, maintaining public confidence and stability in the banking system, which should be a mutual goal of every organization involved in the banking sector.

In many cases, it may be prudent to maintain a database of approved banks and investors that are interested in establishing bank operations in the country. When evaluating investor groups for approval, the supervisory authority must consider, among other factors:

• The length of time required for licensing a new bank

• Whether the investor group can raise sufficient capital

• Whether the investor group can provide competent management.

The supervisory authority must be confident that those parties on the list are strong enough to acquire a failed bank and sustain profitable operations. The supervisory authority should keep track of any seriously interested bank or investor group and provide that information to the marketing specialist.

A marketing specialist should confidentially work with the supervisory authority and contact all strong, healthy banks in the country to solicit their interest in acquiring the failing bank. Additionally, again with the supervisory authority, the specialist should solicit the interest of foreign banks attempting to obtain licenses in the country. Another method to elicit interest is to run general advertisements in international trade journals (especially in the specific region) announcing these opportunities (Annex 5.6); however, confidentiality and the adverse impact on the banking system must be considered in relation to such an act.

MARKETING PRESENTATION

After potential acquirers have been identified they should be contacted and invited to a marketing presentation. Registration forms and confidentiality agreements should be mailed or faxed to the potential acquirer. Neither of these forms should identify the failing bank under consideration. Potential acquirers should return a copy of each of the forms. This will guide the marketing specialist in preparing the appropriate number of information packages. The potential acquirers should retain the original forms and present them as their admission tickets to the marketing presentation.¹⁴

Before the meeting, the marketing specialist should ensure that logistical requirements of the meeting are met. There should be adequate numbers of chairs and tables. Any audiovisual equipment (e.g., microphones, overhead or slide projectors, personal computers for PowerPoint presentation, etc.) should be tested. The marketing specialist should also have a rehearsed, standardized script in order to assure a professional presentation.

A registration table, staffed by adequate supervisory authority personnel, should be set up near the entrance of the meeting room. Supervisory authority personnel should screen persons seeking entry. The confidentiality of the proceedings must continually be stressed. Only approved potential acquirers (with properly completed registration forms and confidentiality agreements) should be allowed in. Members of the press must not be allowed to attend.

At registration, an information package consisting of financial data, legal documents, transaction description, and other material should be provided to each potential acquirer. (More than one representative from a potential acquirer may attend the presentation, but only one package should be provided.)

The marketing specialist should cover the following topics:

• Financial data on the bank. This should consist of applicable portions of the bid package discussed above redacted of any confidential information.

• P&A transaction summary. Provide a sample pro forma balance sheet, clearly marked “for reference purposes only,” that demonstrates the financial effects of the transaction. It should show the effect of the required assets to be purchased and deposits to be assumed. Optional asset purchase opportunities can be on other schedules.

• Legal summary. A supervisory authority attorney should make a short presentation describing the nature of the transactional documents and be available to address legal issues.

• Regulatory requirements. Briefly describe the capital and other requirements of a new or enlarged bank.

• Due diligence scheduling. Potential acquirers should have the opportunity to go on-site and examine the relevant records of the failing bank. Depending on the nature of the proposed transaction and the size of the failing bank, this could range from one day to one week or more. The marketing specialist should provide contact information for due diligence scheduling.

• Bid process. The bid agreement form, provided in the package of materials, spells out the legally binding process for bid acceptance. The marketing specialist should estimate the time needed for due diligence and establish tentative dates for bid acceptance and closing of the transaction.

The marketing specialist should clearly advise potential acquirers that they are not to discuss the bank failure or the impending transaction with any failed bank employee, bank vendors, lessors, attorneys, or accountants prior to the actual closing of the transaction. Any such communication is a violation of the confidentiality agreement. Additionally, the marketing specialist should stress that potential acquirers are strictly prohibited from contacting other potential acquirers regarding any aspect of the process.

DUE DILIGENCE¹⁵

Due diligence is the potential acquirers’ on-site inspection of the premises, records, and operations of the failing bank. Due diligence allows the potential acquirers to assess the franchise value and calculate a knowledgeable bid amount.

Approved potential acquirers will have the opportunity to go on-site and examine the relevant records of the failing bank. The potential acquirer must have completed a confidentiality agreement and should be reminded of the need for confidentiality regarding the transaction. The confidentiality agreement is a legally binding document and violations are subject to criminal penalties.

Maintaining the “level playing field” concept, all potential acquirers conducting due diligence should have access to the same information. The number of members of potential acquirers’ due diligence teams will depend on available space.

Potential acquirers should be granted adequate review time, keeping in mind the urgency of the resolution process. If the failing bank is relatively small and/or the contemplated transaction is a deposit transfer with no asset sales, due diligence may be accomplished in a day or less. On the other hand, a larger bank in a transaction with possible asset sales may require a week or more. In cases of lengthy due diligence, appropriate financial information may be updated and provided to all potential acquirers.

The marketing specialist should create and maintain a schedule of the due diligence calendar. Scheduling should generally be on a first-come, first-served basis. Each potential acquirer performing due diligence must provide the name of the leader of the team (with contact information: telephone number, fax number, e-mail address, etc.) and a list of all the members of their due diligence team. The number and/or names of other due diligence teams should not be disclosed under any circumstances.

Working with the conservator, the marketing specialist must ensure that all necessary information (as of the same date) is available to each due diligence team. The conservator or designee should monitor the due diligence process on-site. Unusual requests should be cleared with the marketing specialist. Sign in/out forms should be developed and use required of the due diligence teams.

Policies regarding record review access must be developed. For example, to prevent customer raiding, due diligence policy may dictate providing depositor information represented only by account numbers, with no names and addresses (if possible). More access should be allowed in asset review, because it is in the best interest of the supervisory authority to divest as many assets as possible.

Copying of the failing bank’s records should be prohibited, although handwritten notes or personal computer-generated information may be permitted. Additionally, the potential acquirers conducting due diligence should not have access to board minutes, supervisory examinations, or personnel or other sensitive records.

BID ACCEPTANCE

After all potential acquirers have finished due diligence, they will submit their bids to the appropriate authority (Annex 5.5). The bid amount (or premium) is the price a potential acquirer puts on the value of the transaction (asset purchase options, deposit base, branch network, etc.).

Unless the level of due diligence scheduling prevents it, the bid date announced at the marketing presentation should be adhered to. Bid submission policy should require personal delivery of an original bid, signed by an authorized officer of the potential acquirer. Faxed bids should not be allowed except in very unusual circumstances (and then the original must be delivered via overnight mail).

Although the bid forms should not be altered, the supervisory authority reserves the right to accept or reject any bid for any reason. After bids are received, the winner is selected. Because the P&A transaction is so simple, usually this is a matter of selecting the highest bid. When priced pools of assets have been offered as an option, however, more complex analysis may be necessary.

The winning bidder should be notified, and a meeting to sign contracts should be scheduled. A reminder of the confidentiality of the process is appropriate at this point. Losing bidders should also be notified; however, again because of confidentiality concerns, the identity of the winning bidder should not be disclosed. The winning bidder is referred to as the “assuming bank” in the P&A transaction because it is assuming deposits as an agent of the supervisory authority.

CONTRACT SIGNING

To provide a comfort level to both parties to the transaction, the P&A contracts are signed several days prior to the actual closing of the bank. This eliminates last-minute conditions or demands by either party. Authorized representatives from the supervisory authority and the agent bank will sign the P&A agreements, and, if applicable, the interim servicing agreement. Both parties will also sign the escrow agreement. The escrow agreement merely states that the aforementioned documents were signed and put into escrow until the stipulated date. The agent bank receives only a copy of the escrow agreement. The other signed agreements will be delivered to the agent bank at the time of the bank closing.

CLOSING THE TRANSACTION

Bank failures can disrupt a community and undermine confidence in a banking system. Because it is critical to provide prompt access of customers to their deposits, a quick resolution to the event is required. The final step in the resolution process is actually closing the bank and transferring the assets purchased and deposits assumed to the assuming bank.

If the bank has been operating under conservatorship, much of the preparation for the final resolution can be done in advance. The final resolution will occur in a similar fashion to the initial intervention and appointment of a conservator. That is, supervisory authority staff will address each functional area, striving for asset control and security as stipulated Chapter 3.

The supervisory authority is responsible for settling the affairs of the closed bank. At the closing, the accounting team will prepare pro forma financial statements. According to the terms of the P&A transaction, the team will:

• Balance the accounts of the bank

• Transfer certain assets and insured deposits to the acquirer

• Prepare a pro forma balance sheet demonstrating the division of assets and deposit liabilities that pass to an acquirer and those that remain with the liquidation

• Calculate any amount necessary to balance the transaction (assets purchased compared to deposits assumed, minus bid amount).

An efficient use of time is to close a bank at the usual time on a Friday, work through the weekend to prepare the pro forma, and allow the assuming bank to re-open the bank as a branch the following Monday morning. The assuming bank will sign official receipts documenting the assets and liabilities transferred to it (Annex 5.7).

On Monday, the assuming bank will have access to the liquid assets purchased in an amount necessary to fund the transferred deposits. This will be based on the pro forma created over the weekend. If the pro forma is not completed, an estimate will be produced, subject to adjustment for errors and omissions.

PUBLIC AWARENESS

When the bank is closed and the supervisory authority appoints a receiver, the supervisory authority issues a press release to inform the public (see Annex 3.14 in Chapter 3).

The press release should stress that the action is being taken to minimize the impact of a bank failure on the local economy by finding an assuming bank to handle deposits and transferring assets into the private sector. The assuming bank may also issue a press release; however, the P&A transaction requires that the supervisory authority approve it in advance.

As mentioned in Chapter 1, goodwill can be created by sharing as much information as possible with the local media. Television, radio, and local newspaper announcements can provide failed bank customers with critical information regarding their accounts (whether loan or deposit). It is critical to publicize information regarding when and where insured deposits will be paid. Another information vehicle to consider is the town meeting, where representatives from the supervisory authority and/or DIA are available to answer questions about the failure, resolution process, closing process, and other general questions. Of course, private, confidential, customer-specific information should not be disclosed or discussed.

The marketing specialist should remain on-site throughout the weekend in case there are any disputes arising from misinterpretations of the transaction. After the bank is reopened on Monday morning, the marketing specialist is finished and the remaining assets and liabilities are subject to the liquidation process.

Of course it will not always be possible to follow all the recommended procedures due to time constraints, confidentiality concerns, or conflicting bankruptcy legislation, to name a just few possible complications. The bank resolution methods described may have to be modified and steps skipped in order to accomplish a successful resolution and pay insured depositors.