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) -- Though banks have been facing more and more pressure to originate fresh loans to consumers and small businesses, they don't really have to yet - they're growing loan books through Federal Deposit Insurance Corp. auctions instead.

The bidding wars for failed bank assets have heated up over the past few months, a result of the low interest-rate environment and the enormous amount of capital sloshing around the banking industry. This is a great development for banks and for the FDIC, but not such a great thing for economic growth.

It also represents a sharp reversal from the FDIC's initial efforts to market failed banks to their peers.

The regulator has been sweeping up the mess left by nearly 300 bank failures since 2008. It has provided backstops on deals that represent $3.85 trillion in assets and $57.2 billion in losses for its insurance fund so far.

Since the early spring, though, bidding has gotten far more competitive. The new entrants are mainly from the banking arena, and have been offering higher deposit bids and more equitable loss-share agreements on loans. In some cases, the FDIC hasn't had to take any losses on bank failures at all.

"The FDIC has been very successful in not only selling failed banks, but the assets of institutions that have been closed as well," says FDIC spokesman David Barr. "If you look at the statistics, I would venture to say well more than 90% of the banks that have failed, the FDIC has been able to find a buyer."

Former FDIC Chairman Bill Isaac, who now chairs the financial services division of consulting firm LECG, agrees: "Things are beginning to open up. The FDIC is getting more bidders and more attractive bids."

Days before a bank is shuttered by state regulators, the FDIC begins quietly marketing the institution by sending an email blast to a list of private investors and banks. Interested suitors must sign confidentiality agreements and place bids on a secured Web site. The bids are "blind," meaning competitors don't know details of any offers other than their own.

The FDIC assesses which bid is least costly to its insurance fund - usually within the same day - then quickly notifies the winner to prepare for the imminent deal.

The far most costly bank failures involved private-equity. The deals came with relatively generous loss-sharing agreements for the acquirers.

The most expensive bank failure for the FDIC was that of IndyMac, the first major bank to fall victim to the subprime crisis in July 2008. The transaction came after several months of marketing the bank during a difficult period, then wrangling with a consortium of high-profile private-investors on pricing.

The FDIC finally sold IndyMac's $32 billion in assets, at an ultimate loss of $12.8 billion. That compares with an average loss of $347 million for the FDIC's crisis era deals so far.

The second-most expensive bank failure for the FDIC was BankUnited, a $12.8 billion Florida lender that failed in May 2009. The bank was snatched up by another group of P.E. titans, including WL Ross & Co., Carlyle Group, Blackstone and Centerbridge Partners. Though the bidding for BankUnited was more competitive, it eventually cost the FDIC $5.7 billion.

A key investor in the IndyMac deal, former

Goldman Sachs


dealmaker-turned-vulture-investor J. Christopher Flowers, famously said "the government has all the downside and we have all the upside."

He was right.

Losses are typically shared on an 80%-20% basis, with the FDIC taking the bigger hit. Early on, a more munificent provision allowed for 95%-5% arrangement once losses reached a pre-determined threshold. But because bidding has gotten so much more competitive, the FDIC removed the second-tier of loss-sharing on March 26. One winning bid recently came with a 50-50 loss-share agreement and a few others have foregone the loss-share entirely.

"We are seeing improvement on that front," says Barr. "You'll hear some private investors and even some banks out there saying they're going to be doing non-FDIC-assisted private transactions. This is a competitive bidding process."

One such transaction occurred recently, with

First Niagara's


announcement of a non-assisted deal to acquire NewAlliance for $1.5 billion.

Within the FDIC-assisted space, more interest in bank-bank M&A has been percolating in recent months. About 55% more FDIC-assisted transactions have been announced this year than in the comparable period of 2009. The bulk of activity has occurred since late-May.

Small, regional lenders like

Bank of the Ozarks



Umpqua Bank



City National Bank


People's United


, as well as some foreign institutions like



have all made successful bids since the FDIC's 95-5 provision was swept away.

U.S. Bancorp






New York Community Bank

( NYB) and



were among the more opportunistic acquirers last year.

"The vast majority - the overwhelming majority - of banks are sold to pre-existing banks," says Barr.

The reason banks have become more interested in FDIC deals is twofold. They have finally gotten their arms around loan losses on their own balance sheets and others'. Now they're faced with the challenge of offsetting a flood of deposit liabilities with earning assets. And in a low-interest rate environment, the quicker the better.

"There are more stable banks than there were a year ago, and they have been getting a lot of deposits and not a lot of loans," says Lee Kyriacou, a former manager at Fleet Bank and Chase Manhattan, who now advises bidders at the consulting firm Novantas. "More and more of them are saying, 'I'm not getting enough loans in the market, why don't I just acquire a book of loans as opposed to putting it in securities?'"

Kyriacou points out that banks' loan-to-deposit ratio is "well below 100%" - with $7.4 billion in loans and $9.1 billion in deposits at June 30 - a telltale sign that the industry will be pushing further out into the risk spectrum to satisfy stakeholders.

Though the FDIC and the banking industry are faring well, not everyone is thrilled with the outcome.

For one thing, the trend represents a quick-and-dirty way to boost returns. The FDIC deals don't directly stimulate economic growth the way new loan originations to would. Then there's the issue of sour grapes.

Private-equity firms structured investment strategies around the banking sector during the dark days of 2008, sensing rich opportunities. Investors planned to cobble together management teams with strong banking experience, then seed acquisition sprees to build out regional franchises.

Yet their double-digit R.O.I. targets don't allow private-equity players to compete with banks in bidding. While they are seeking supremely discounted deals, the banking industry is simply trying to boost returns from rock-bottom lows under 1%.

"A lot of people have said, 'Why aren't you selling more to private equity? Don't you like private equity?'" says Barr. "Well, it's a bidding process. Everybody has their own certain rate of return that they'd like to see on their investment. We've sold maybe a dozen or so failed banks to private equity, but they've bid on far more than those. They just haven't come out on top of the process."

For instance, after the IndyMac deal was struck, the renamed OneWest Bank moved forward on building a robust West Coast franchise.

The consortium has announced two more FDIC-assisted deals - just before the window closed on the FDIC's more liberal loss-sharing standards. With its acquisitions of First Federal Bank of California and La Jolla Bank, OneWest expanded its footprint 25 miles west and 120 miles south, adding more than 50 branches to its network.

But now there's an unfortunate twist to the investment team's plans for future growth.

At the time of the acquisitions, First Federal and La Jolla both had a loan-to-deposit ratios of 1.2-to-1. Since then, loan balances have declined across the industry -- particularly in troubled markets like California -- meaning OneWest is likely wading through deep liabilities.

But while its backers are just as determined to boost returns as traditional banking rivals, OneWest has less flexibility to offer competitive bids.

"The banks want to grow their books right now; they're going to sop up this supply pretty quickly," says Kyriacou. "I think the P.E. firms are going to go home."

--Written by Lauren Tara LaCapra in New York.

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