BankUnited's resurrection illustrates everything that went wrong in the housing bubble.

Commentary about business and finance.
Jan. 26 2011 7:22 PM

The Sure Thing

BankUnited's resurrection illustrates everything that went wrong in the housing bubble.

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Why such competition to acquire a failed bank? Because the FDIC agreed to a "loss sharing agreement." "Sharing" is here a euphemism for "covering" because  the FDIC will absorb 80 percent of any losses on BankUnited's entire existing loan portfolio, along with some other BankUnited securities. Should total losses exceed $4 billion, the FDIC will absorb 95 percent of the remainder! BankUnited's IPO prospectus says that even in a worst-case scenario, if all the assets covered by the loss sharing agreement lost 100 percent of their value, the bank "would recover no less than 89.7% of the [unpaid balance on the loans] as of the acquisition date." This, of course, explains why the FDIC expects to lose that $5.7 billion.  (Technically this won't be paid by ordinary taxpayers because the FDIC's deposit insurance fund is funded by fees collected from banks. But the banks typically pass along such costs to consumers. And there have been worries that the fund, whose balance has declined precipitously, could go bust, at which point ordinary taxpayers would be on the hook.)

It's no knock on the highly skilled John Kanas and his new management team, who may yet provide a great deal of value, to observe that the resurrected BankUnited's chief market advantage right now isn't management brilliance but corporate welfare. "[A] majority of BankUnited's revenue is currently derived from assets that are covered by the loss sharing agreements," the IPO prospectus boasts. As a result, BankUnited is "one of the most profitable and well capitalized bank holding companies in the US," with an enviable 17.7 percent return on equity.

You could argue that, amid the current fragile recovery, banks need a lot of money right now so they can revive the economy by making new loans or restructuring old ones. But out of the $630 million that the BankUnited IPO is expected to raise, BankUnited itself will receive a mere $86.2 million. The rest of the money from the IPO will go to the sellers, who include Kanas and some other smaller investors. (Kanas will still have 5.5 million shares projected to be worth more than $100 million, and the private-equity firms will own stock projected to be worth some $1.4 billion, so they aren't bailing out.) The FDIC, which in a way is making the IPO possible in the first place, brings up the rear: It's expected to get a payment of $25 million.

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The FDIC says this is a good deal. Jim Wigand, who oversaw many failed bank dispositions and is now director of the FDIC's Office of Complex Financial Institutions, points out that by statutory mandate the FDIC must limit losses to the deposit insurance fund. At the time the deal was struck, he says, this was the best option to achieve that goal. Indeed, the FDIC says it would have cost the fund an additional $1.5 billion to liquidate BankUnited rather than sell it. And BankUnited is required to participate in a loan modification program that the FDIC deems acceptable. When a homeowner can't meet mortgage payments, the bank is required to look into a modification and choose the "most effective loss mitigation strategy," according to its prospectus and the FDIC agreement. That means the bank must calculate which option would bleed the FDIC fund the least: a foreclosure, a short sale, or a restructuring. If foreclosure is the choice, the homeowner gets nothing—but the private equity firm still gets 80 percent of its losses reimbursed by the FDIC.

The FDIC's Wigand says that quite often foreclosure isn't the least costly option; loan modification is. In those instances, presumably mortgage holders stay in their homes. One person familiar with BankUnited says that in the long run loan modifications are more profitable to the bank than foreclosures. But here's what the IPO prospectus says: "Homeowner protection laws may also delay the initiation or completion of foreclosure proceedings on specified types of residential mortgage loans. Any such limitations are likely to cause delayed or reduced collections from mortgagors. Any restriction on our ability to foreclose on a loan, any requirement that we forgo a portion of the amount otherwise due on a loan or any requirement that we modify any original loan terms could negatively impact our business, financial condition, liquidity and results of operations."

In other words, when the government bailed BankUnited out, it didn't necessarily do homeowners delinquent on their mortgages any favors.

Update, Jan. 27: The FDIC feels three points that add context should have been included in this article. They don't correct anything that appears above, and I'm happy to enumerate them here.