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Data Integration for FDIC loss share assists


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Data Integration for FDIC loss share assists

  1. 1. June 2011Integrating and Reporting Loss-Sharing Data: A Critical Challengein FDIC-Assisted AcquisitionsBy David W. Keever and Tapan P. Shah, PMPAfter a record-setting 157 bank failures in 2010, the 1Federal Deposit Insurance Corporation (FDIC) reportsa bit of a slowdown in this trend, with 43 bank closuresthrough May 20, 2011. For healthier banks, such closures 2often present an attractive opportunity to expand theirbusiness through a transaction in which the FDICagrees to absorb a significant portion of the risk.Unfortunately, it is easy to underestimatethe data integration challenges involvedin a bank acquisition, even if bothinstitutions are sound. It is even easierto underestimate the accounting andreporting challenges presented by theloss-sharing agreements the FDIC uses toencourage the purchase of troubled banks.The picture is complicated further by thecontinuing evolution of FDIC and otherregulatory requirements, both as a result ofnew legislative actions and as a responseto the changing economic environment.Partly because of these complications, a number of financial institutions are choosingnot to pursue an FDIC loss-sharing agreement when bidding on failed banks. Somehave stated that, in exchange for a more favorable purchase price, they would prefer totake on all of the risk associated with the portfolio rather than undergo the additionalaccounting, reporting, and compliance requirements a loss-sharing agreement imposeson their already overburdened staff.Fortunately, there is a better alternative – an approach that allows acquiring institutionsto take advantage of the risk-mitigation benefits offered by a loss-sharing agreementwithout incurring an unacceptable administrative burden in order to comply withFDIC accounting and reporting requirements. By employing a systematic, methodicalapproach to the data integration and reporting challenges, the complexity of anFDIC-assisted transaction can be greatly 1
  2. 2. Crowe Horwath LLPLoss-Sharing Agreement Dataand Reporting RequirementsWhen one financial institution acquires the assets of another as part of an FDIC-assisted transaction, the FDIC requires regular reports – either monthly or quarterly– on the status of the acquired assets. These reports must be submitted in the formof loss-share certificates, which contain summary data on the acquired assets, andFDIC download files, which contain more details.Typically, a loss-sharing agreement requires:■ Monthly reporting of single-family loan-loss certificates (sometimes called 415a), with details on each loan for which the bank is submitting a loss claim during the month; and■ Quarterly reporting of commercial loan-loss certificates (sometimes called 415b), detail- ing commercial loan charge-offs, recoveries, and net charge-offs during the quarter.After the initial purchase, the FDIC providesthe acquiring bank with an initial listing Loss-Sharing Agreements: Key Factsof all the loans covered under the loss- ■ Under a loss-sharing agreement, the FDIC absorbs a portion of the loss on asharing agreement. In general, the agency specified pool of assets. This arrangement offers healthier banks an incentive torequires the bank to send back a test file to acquire troubled institutions, which minimizes the FDIC’s losses when a bank fails.demonstrate its ability to fulfill the reportingrequirements. The first certificates typically ■ For commercial assets, loss-sharing agreements typically cover a five-yearare due three months after the purchase date. period, during which the FDIC will reimburse 80 percent of losses incurred by the acquirer on covered assets up to a stated threshold amount, with the acquiringLoans acquired as part of an FDIC- bank absorbing 20 percent.assisted transaction are subject to various ■ For single-family mortgages, loss-sharing agreements usually run 10 years andadditional recordkeeping and reporting have the same 80/20 split as the commercial assets. The FDIC also providesrequirements, including: coverage on some second-lien loans for certain types of losses.■ Internal loan accounting. To effectively ■ Since the inception of loss-sharing agreements in 1991, the basis for sharing manage the portfolio, each loan must be losses has undergone some changes. At one time, the FDIC shared losses with accounted for, rated for risk, and tracked an acquirer on an 80/20 basis until the losses exceeded an established threshold, for regular servicing and transactions. after which the loss-sharing basis shifted to a 95/5 basis. This 95/5 split was Although the acquiring institution will eliminated in March 2010. have its own systems for handling these ■ From 2008 through September 2010, the FDIC entered into 200 loss-sharing tasks, the historical loan accounting data agreements, with $159.2 billion in assets under loss sharing.3 must be left intact in order to support ■ As part of its oversight of loss-sharing agreements, the FDIC requires acquiring loss recognition and accurate reporting. banks to provide quarterly reports to verify compliance with the program and to■ GAAP accounting. For regular report- monitor the performance of the assets. It also conducts periodic on-site reviews ing to shareholders and other interested of the records of covered losses and overall compliance. parties, loan data must be structured in accordance with U.S. generally accepted accounting principles (GAAP), as spelled out in the Financial Accounting Standards Board’s Accounting Standards Codification. Verifying the fair valuation of loans and other assets often entails significant data requirements and complex cash flow esti- mates, which might not be included with the original loan contract and documentation.2
  3. 3. Integrating and Reporting Loss- Sharing Data: A Critical Challenge in FDIC-Assisted Acquisitions ■ Tax accounting. There are important differences in the way acquired loans are handled for tax purposes and the way they are handled for GAAP accounting. Examples include accounting for charge-offs, other real estate owned (OREO), appraisals, expenses, and taxes. Despite the differences, however, the two accounting approaches must rely on standardized and consistent data to satisfy auditors’ and regulators’ tracking and accounting requirements. Complicating Factors – What Acquiring Banks Need to Address Institutions also face a number of broader data integration and reporting issues when acquiring a failing bank’s loan portfolio. Following are some of the most common concerns they encounter.The data used for managing ■ As banks have grown, so has the number of information systems they rely on to manage their assets. Even before an acquisition, most institutions already arecustomer interactions must struggling with loan data being stored in several different systems that do not talkbe accurate and timely to to each other adequately. Integrating the systems from the acquired institution onlydemonstrate strong customer adds to the challenge. ■ The acquiring bank also needs to understand the failed bank’s credit and riskservice and establish acquired review rating structure and identify where that information is kept. It then needscustomers’ confidence with to incorporate the acquired loan portfolio into its own internal reporting systemsthe new bank. for credit risk and financial and operational reporting. This step requires gathering data from new systems and transforming the data into a normalized form that the organization can use. ■ If the actual servicing of the loans was handled by an external servicing organization, the acquiring bank also must coordinate its data acquisition efforts with this servicer in order to incorporate into the bank’s reporting systems the information stored by the servicer. ■ In the case of older loans, some important data elements might be stored in paper files and not reflected in any electronic storage systems. Often banks attempt to retrieve this information manually and store it in a spreadsheet format, only to encounter even more demands on their resources as they attempt to integrate this information with the rest of the data. In some instances, data also might be stored on outsourced systems. ■ Loss-sharing agreements generally allow the acquiring bank to expense direct external acquisition and restructuring costs including professional fees for appraisals, legal and accounting services, and real estate maintenance. This creates additional data integration, tracking, and reporting requirements to confirm these costs are aligned with existing accounting systems and allocated to the appropriate loans. ■ Customer retention is always a critical concern since it is one of the factors that drove the acquisition in the first place. As such, the data used for managing customer interactions must be accurate and timely to demonstrate strong customer service and establish acquired customers’ confidence with the new 3
  4. 4. ■ Transparency is a critical requirement in all FDIC-related reporting. After several Contact Information years of controversy, regulators are especially sensitive about verifying they and the Dave Keever is a principal with Crowe institutions they monitor have systems with auditable processes that can aggregate Horwath LLP in the Indianapolis office. data from multiple sources and present reports quickly, cleanly, and on demand. He can be reached at 317.706.2669 or Up to Today’s Challenge –and Anticipating Tomorrow’s Tapan Shah is with Crowe Horwath LLP in the Oak Brook, Ill., office. He canOne of the first criteria for a healthy bank considering FDIC-assisted acquisitions be reached at 630.586.5113 oris to become a great steward of its own and the acquired bank’s data. Doing so the bank to implement projects that will provide satisfactory answers tocritical questions in six strategic information-management areas.1. Inventory and assessment. What information do we have? What is the true 1 Federal Deposit Insurance Corporation website, source of the information? How was it created? How objective or subjective is it? index.html2. Consolidation. What mechanisms will we need to get all of the disparate data 2 Federal Deposit Insurance Corporation website, normalized and consistent? Quality. How will we facilitate accuracy, integrity, and trust in the data? How will 3 Federal Deposit Insurance Corporation website, we improve data quality over time? Speed and responsiveness. How will we deliver required information in a timely fashion? How will we satisfy FDIC requirements and the data needs of our internal users and other stakeholders?5. Integration. Strategically, how will we establish an integration approach that will facilitate smooth and accurate data and system integration for future acquisitions? In the long term, how will we establish smooth integration between legacy systems and new systems in the event of another acquisition? How can we make sure we are well positioned to comply if we become the acquisition target?6. Adaptability. How will we respond to a very dynamic environment in which data reporting requirements are certain to change over the five- or 10-year duration of a typical loss-sharing agreement?A Team EffortThe complex data integration involved in an FDIC-assisted acquisition requires closecoordination of all parties – from the technology team to the finance department tothe loan servicing teams. Although the challenges can be considerable, the potentialupside – including the opportunity to gain a foothold in new markets and establishnew customer relationships – can make the effort worthwhile.Crowe Horwath LLP is an independent member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath International is a separate and independent legal entity.Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath International or any other member of Crowe Horwath International and specificallydisclaim any and all responsibility or liability for acts or omissions of Crowe Horwath International or any other Crowe Horwath International member. Accountancy services in Kansas and NorthCarolina are rendered by Crowe Chizek LLP, which is not a member of Crowe Horwath International. This material is for informational purposes only and should not be construed as financial orlegal advice. Please seek guidance specific to your organization from qualified advisers in your jurisdiction. © 2011 Crowe Horwath LLP 4