Last week, close readers of the New York Times might have discovered what appeared to be a bombshell: the Federal Deposit Insurance Corporation, cleaning up the bad loans of one failed bank, sold a small business loan for half of what the borrowers had themselves offered to pay to settle the debt. If true, it wouldn't likely be the only case -- small banks are dropping like flies. So far this year, 25 institutions have failed, as many as failed in all of last year -- and closing in on the total bank failures of the previous eight years combined. It's likely that a couple more banks will be added to the list tonight.
What happens when a lender fails is this: the FDIC tries to work out new terms with borrowers in bad loans, who are very often small businesses. If this fails, the agency pools the loans and sells them for pennies on the dollar to investors, who are usually relentless in trying to collect. (The proceeds of the sale are used to pay back depositors.) In this case, according to the Times, the borrowers, husband-and-wife owners of a fitness studio in Arkansas who were $10 million in arrears, had offered to pay the FDIC $6 million upfront and another $1 million when the business was sold. The FDIC rejected the proposal, and instead sold the loan, according to the Times, "for 34 cents on the dollar, an outcome that left the gym owners furious, because the auction produced a price that was far lower than they had offered to pay the F.D.I.C." The investor is now trying to foreclose on the gym.
On the face of it, that's pretty shocking, and it no doubt left more than a few readers wondering, is the FDIC is making a practice of selling loans to vulture investors for less than the borrowers are willing to offer? That would seem to short-change both depositors and small businesses. Regrettably, the Times doesn't answer the question. In fact, the claim appears near the end of the story, which is itself surprising. In this business we call that "burying the lead." But now I know why it's there: because it's not really true.
The FDIC's public affairs director, Andrew Gray, explains that 34 cents on the dollar is the aggregate price for the pool of loans, not the price of the debt owed by the fitness club. The pools often a mix (relatively) good and bad loans in order to move the bad ones. "While the pool price may be lower than the borrower offered," he says, "it's likely that the contributory value of the loan raised the price of the overall pool." Indeed, Rick Williamson, the buyer of the loans in question, says that the fitness club "relationship" "had the highest percentage of collateral value against the principal." (Williamson bought several loans that comprised three bank-borrower relationships.) And he adds that these debtors, who "haven't paid for a long time," made an offer that was well below the FDIC's appraised value of the collateral. More generally, Williamson fairly points out that if the FDIC had simply accepted the offer, "every debtor of a failed bank would stop paying their loan, knowing they could get a discount."
In any case, both the FDIC and Williamson suggest that what's happening to the Arkansas fitness club owners is the exception rather than the rule. Gray says that when the government negotiates with debtors, "in the vast majority of cases we're able to come up with an equitable solution." Williamson adds that of the three debtors in this particular pool, "one settled almost immediately and bought out their loan. The second one was a little more difficult, because he didn't have the resources to do it himself, so he went to a bank, and we now have that under contract, too."
Other small business watchdogs don't seem particularly concerned. I asked both Congressional small business committees whether they had inquired about the FDIC's workout practices for small business loans. Only Rep. Nydia Velazquez, chair of the House committee, responded, and she said only this: "It is my hope that the FDIC is making good faith efforts to provide workouts and accommodations for struggling small businesses, just as they are working to keep major financial institutions solvent. Small businesses are our nation's most reliable job creators and will be central to our economic recovery."