How the FDIC Hurts Community Banks
In 2006 Developer Dan approaches Elm Street Bank for a $2 million loan for a
subdivision. Its this great idea that had never been done before: the
subdivision has a central courtyard with pigs and a compost pile. He calls
it "The Pig Farm". Elm Street Bank has capital of $5 million so their
lending limit for any one loan is 20% of that, or $1 million. So the Elm
Street banker calls his buddies at The Neighborhood Bank and The Community
Bank and asked them to participate in the loan. After all, Developer Dan is
this great guy and land values never go down! So the Neighborhood Bank and
the Community Bank each chip in ½ million dollar loans for The Pig Farm with
this caveat: a "first out agreement". If the loan goes south and the land is
sold at a loss, these 2 participating banks get paid first, then Elm Street
Bank gets the rest.
Elm Street was so excited about The Pig Farm concept. When Developer Dan
bought 4 more parcels of land in different locations Elm Street Bank signed
on and went to various other community banks. During this time Minnesota led
the nation at new bank creation so there was no shortage of banks to
participate in The Pig Farm loans. And with the "first out agreements" these
loans were perceived as very low risk. And land values never went down.
How to appraise a concept that had never been done? Elm Street Bank just
called his buddy Mike at "Magic Appraisal Services", and, like Magic, the
appraisals supported the development loans.
Fast forward to 2009 and The Pig Farms, all 5 of them, were a tremendous
flop and Elm Street Bank foreclosed. FDIC comes in the middle of the night
and shuts down Elm Street Bank. Elm Street's loan portfolio was such a mess
that the FDIC had to pay SuperSaver Bank $15 million to buy Elm Street Bank
which included an escrow account to fund a "90% loss share agreement" on bad
So The Pig Farms were liquidated with a pig roast that just breaks my
vegetarian heart-those piggies are my favorite at The State Fair. So from a
$2 million loan, they were each liquidated at $800,000, or a loss of $1.2
million. Under the "first out agreement" SuperSaver, assuming Elm Street
Bank's position, would absorb the first million loss for a 100% loss and The
Community Bank and The Neighborhood Bank would each absorb $100,000 on their
$500,000 loans and receive $400,000 or 80% each, recognizing a 20% loss.
"Hold on", said the FDIC. When SuperSaver took over Elm Street Bank all
prior agreements for letters of credit and "first out agreements". The $1.2
million loan loss will be shared equally: $300,000 each to The Neighborhood
Bank and The Community Bank. SuperSaver's share of the loss is $600,000. But
as part of the deal to entice SuperSaver to buy Elm Street the FDIC will
participate 90% in the SuperSaver's share of this loss. So instead of
recognizing a $600,000 loss on each Pig Farm loan, SuperSaver's loss is only
$60,000. And since SuperSaver was paid $15 million to buy Elm Street Bank
they don't care about the $60,000 loss.
The FDIC cares about preserving the integrity of the banking system and
protecting the assets of Joe Voter's deposits. Protecting the healthier
community banks is not their first priority.
Meanwhile, back in Tax Appeal land, the assessor typically tosses out these
deeply discounted sales, like The Pig Farm, because they are "forced sales".
However, with the swirling mess encompassing Community Banks most are either
unwilling or unable to do new land loans, even though some projects make
sense. These "first loss participating agreements", aided by Magic Appraisal
Services, were large contributors to our current real estate economy by
creating the excess supply, often with questionable projects like The Pig
Farm. So when county assessors and fee appraisers take a 2006 land sale and
adjust downward for today-I don't buy it. Adjusting old sales from this era
ignores that fact the today's financial world has completely changed for