INTERNATIONAL ASSOCIATION OF DEPOSIT
INSURERS(IADI)
AFRICAN REGIONAL COMMITTEE WORKSHOP ON
RESOLUTION OF PROBLEM BANKS:
PURCHASE & ASSUMPTION OPTION
MAY 9-13, 2011
ABUJA, NIGERIA
A PAPER ON
OVERVIEW OF PURCHASE AND ASSUMPTION
(P&A) TRANSACTION
BY
AYUBA NICHOLAS IBRAHIM
DEPUTY DIRECTOR
ASSET MANAGEMENT DEPARTMENT
NIGERIA DEPOSIT INSURANCE CORPORATION
OUTLINE
Introduction
objective of the Paper
Definition of Purchase & Assumption (P&A) Transaction
Types of P&A Transactions
Advantages and Disadvantages of P& A Transactions
Implementation Challenges for P&A Transaction
Conclusion
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1.0
INTRODUCTION
Bank failure is inevitable. For everything else to work properly and facilitate
effective bank resolutions, there is need to have:

Strong institutional framework

Operationally independent deposit insurer

Resolution powers aligned with mandate

A legal system capable of dealing with systemically important banks

Intervention powers vary across countries and early intervention can
lower the cost of resolution

The purchase and assumption transaction (P&A) is one of the
resolution methods used by deposit insurers in resolving failed banks.
The others include deposit reimbursement (or payout), Open Bank
Assistance, Asset Purchase and Bridge Bank.
2.0 OBJECTIVE OF THE PAPER

To enable participants have a broad understanding of P&A failure
resolution method

To identify the types of P&A transactions

Identify the advantages and disadvantages of each type of P&A

Identify the strengths and challenges in implementing the P&A
transactions
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3.0 PURCHASE AND ASSUMPTION

A purchase and assumption transaction or resolution is defined as one in which a
healthy bank or group of investors assume some or all of the obligations, and purchase
some or all of the assets of a failed or failing bank

Typically , a healthy bank purchases assets and assumes deposit liabilities of the failed
bank, similar to Mergers and Acquisitions

A failed bank could be split to make it attractive to banks that wish to enhance market
penetration or establish new branches where the failed bank had branches

Acquirer is chosen on the basis of the highest premium offered during biding

Deposit insurer or government would put cash/securities for the difference. Such could
be recovered from bad assets of the failed bank

A standard P&A provision allows the assuming institution to required the deposit insurer
to repurchase any acquired loan that has forged or stolen instruments

The price is based on appraisal that is mutually acceptable to the deposit insurer and
the acquirer

The liabilities assumed by the acquirer include the deposit liabilities covered by
insurance

Critics observed that customers with uninsured deposits rarely suffer losses in P&A
transactions, it is like providing unlimited insurance coverage to depositors, and thus
destroy market discipline. P& A appear to provide inequitable protection for uninsured
depositors in large institutions.
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4.0
WHY ADOPT P&A

The main reasons for adopting the P&A resolution method are:
(a)
Cost: When the cost for adopting P&A is less than the estimated loss arising
from a payout
(b)
Stability of Banking Industry: The P&A is considered to be less disruptive to
depositors, borrowers and the payment system when compared to a
payout;
(C)
Interest of stakeholders: P&A is considered to be in the best interests of
bank’s depositors as they are protected, and would aid the reconstruction
of the bank or the dispositions of its assets in an expeditious manner

Other Merits

Continuity in rendering banking services thereby sustaining public confidence in
the banking system

Other creditors might not be paid, thus providing some form of market discipline

Shareholders are wiped out and inefficient bank closed
The Demerits include:

Large and uninsured depositors are protected, thus eroding market
discipline

It could be costly especially if fund from Central Bank/Government/Deposit
Insurer is used to fill the gap between total deposits and assets purchased is
significant
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5.0 TYPES OF P&A

The P&A structure involved over time to incorporate procedures and
incentives to entice acquirers to take more assets of the failed
institution. Some of the variations of the P&A transactions include:

(a)
Whole Bank P&A
(b)
Partial P&A
(c)
Loss sharing P&A
(d)
Bridge Bank
The assets acquired vary, depending on the type of P&A as some
assets are purchased outright while others may be subject to an
exclusive purchase option by the assuming institutions for varying
periods.

The whole bank P&A with optional asset pools appear to be most
common in countries that adopt the P&A resolution method in handling
failed banks

The loss sharing transitions and bridge banks are considered as two of
the more specialized P&As
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5.1

WHOLE BANK P&A
This is a transaction involving one purchaser of all assets and branches
under one agreement

The whole bank P&A structure emerged as a result of effort to induce
acquirers of failed banks to purchase the maximum amount of a failed
institution’s assets

Bidders were asked to bid for all assets of the failed institution on an “as
is“ discounted basis (with no guarantees)

The highest whole bank bid that was less costly than a pay off was
accepted
5.1.1 ADVANTAGES
The merits of the whole bank P&A include the following

Continuation of banking business with new bank

Acquiring bank has opportunity for new customers

Customers with insured deposits suffer no loss

Lower cost compared to deposit pay-out

Reduced initial cash outlay by deposit insurer

Deposit insurer had no further financial obligation to the acquirer

Allowed time for due diligence after P&A was finalised

Reduces amount of assets held by deposit insurer or liquidator for
liquidation.
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5.1.2
DISADVANTAGES
Some of the disadvantages are

Because a whole bank bid constitutes a one –time payment from the
deposit insurer, bidders tend to bid very conservatively to cover all
potential losses

Conservative whole bank bids could not compete with other
transactions on a least cost basis. With the introduction of the least cost
test by the FDIC for instance, the number of successful whole bank bids
declined.

Many institutions are reluctant to purchase commercial credits without
credit enhancements even if assets are purchased at a discount

Requires much pre-closing work for staff of the deposit insurer

Borrowers may have split lines of credits
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5.2

LOSS SHARING P&A
This was adopted to address problems associated with marketing large
institutions with sizeable loan portfolios

Instead of selling some or all of the assets to the acquirer at a
discounted price, the deposit insurer agrees to share in future loss
experienced by the acquirer on a fixed pool of assets

The deposit insurer absorbs a significant portion of the credit loss
(mostly up to 80%) while the acquirer assumes the remaining. Thus
large portion of the portfolio passed to acquirer.

By absorbing a portion of the loss, the deposit insurer is also attempting
to induce rational and responsible credit management behaviour from
the acquirer

The deposit insurer reimburses acquiring institutions substantial
percentage (about 80%) of expenses incurred in relation to the
collection of the shared loss assets, except overhead and personnel
expenses

Shared recovery period runs concurrently with the loss share period
and last another 1-3 years beyond the expiration of the loss sharing
period.
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5.2.1 ADVANTAGES

The depositor insurer absorbs a significant portion of the credit loss an
commercial loans and commercial real estate loans (typically 80% by
the FDIC) while the acquirer assumes the balance

Most of the failed institutions’ loans are passed to acquirer while
(acquirer) still receives a premium for the institution’s deposit franchise

The method induces rational and responsible credit management
behaviour from the acquirer

Used generally in large transactions, loss sharing P&A has been
successful in keeping most assets in the banking industry which results
in lower costs for the deposit insurer due to reduced risk
5.2.2 DISADVABTAGES

The deposit insurer and acquirer take on additional administrative
duties and costs in managing the shared loss asset throughout the life
of the P&A agreement
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 Added responsibilities cause loss of interest in bidding;
It is more time-consuming as agreements last 5-7 years

Many healthy, small financial institutions may not have appropriate
experience in working out problem assets. They may therefore lose
interest or may not manage them well.

The deposit insurer does not control assets yet retains large portion of
the potential loss
5.3 PARTIAL P&A
The partial P&A is a variation of P& A transactions used under differing
circumstances as appropriate. These include basic P&As, Loan
Purchase P&As; Modified P&As; P&As with Put Options; and P&As
with Asset Pools.

Basic P&A - Assets passed to acquirers generally limited to cash and
cash equivalents

Premises and other fixed assets are often offered to acquirers on
optional basis.

Liabilities assumed generally include only the portion of deposit
liabilities covered by insurance
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 Loan Purchase P&As – Winning bidders assume a small portion of the
loan in addition to cash and cash equivalents;
Assets acquired constitute only between 10-25% total assets

Modified P&As -wining bidder purchases cash and cash equivalents, instatement
loans and all or a portion of mortgage loan portfolio

P&As with Put Options – Acquirers have option to put back assets they did not wish
to keep after a prescribed period (usually 30-60 days), or given a period
within which to cherry-pick assets desired. The FDIC discontinued the
put option in 1991 and replaced it with loss sharing option and
the loan pool structure.

P&As with Asset Pools – potential acquirers submit proposals for the
franchise (deposits) for any or all asset pools

Aimed at maximizing sale of assets and keep them in the banking
industry

The loan portfolio is broken into separate pools of homogenous loans
(pooled on the basis of similarity in characteristics such as same
collaterals, terms, history or location) and are marketed separately

Provides additional flexibility since each acquirer has a different interest
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5.3.1 ADVANTAGES

Large number of small and mortgage loan balances sold

Fewer assets are retained by the deposit insurer

Allows acquires time to complete due diligence after the P&A was
finalized.

Improves marketability of loans
5.3.2 DISADVANTAGES

Many acquirers are reluctant to acquire loans

May require much pre-closing work for the deposit insurer

Cherry-picking allows acquirer to pick assets with values above book
values

Put options could delay transfer of assets to acquirer

Deposit insurer left with mostly bad assets to liquidate.
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5.4 BRIDGE BANK

A bridge bank transaction is a type of P&A in which the deposit insurer
itself acts temporarily as the acquirer

It is a new temporary, full- service bank, designed to “bridge” the gap
between the failure of a bank and time when the deposit insurer can
implement a satisfactory acquisition by a 3rd party.

The original bank is closed by the authority and placed in receivership

Bridge bank is operated for a limited time period, with provision for
limited extensions, after which time it must be sold or otherwise
resolved

Bridge bank is especially useful where failing bank is large or unusually
complex.

Before establishing a bridge bank, a cost analysis must show that the
estimated operating cost of the bridge bank is less costly than a payoff

The use of bridge banks has played a key role in the resolution of bank
failure in Korea and Japan. The USA had used bridge bank 10 times
between 1987 and 1994 by creating 32 bridge banks for 114 separate
institutions.

For the FDIC, the competitive Banking Act of 1987 provides for the
operation of a bridge bank resolution option, while the NDIC Act 2006
(S. 39) gives legal backing for the operation of a bridge in Nigeria
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5.4.1 WHY BRIDGE BANK

The goal of bridge bank is to preserve the franchise value and lessen
any disruption to banking activities

It provides the prospective purchasers time necessary to assess the
bank’s condition in order to submit offers or market the institution. Thus
it provides time needed to arrange a permanent transaction.
5.4.2 BASIC CHARACTERISTICS
Bridge bank has its own structure and governance

Separate legal entity

Has board of directors

Deposit insurer appoints officers

Delegation of authority
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 Legal provisions for its capital

Business strategy

Identify care business

Maximize franchise value

Minimize value at risk

Employee strategy

Identify key employees

Implement retention strategy

Right-size organization (economize for sustainability)

Meets liquidity demands

Daily operating expenses

Retain debt obligations

Corporate funding

Deposit run-off
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5.4.3 ADVANTAGES

Provides uninterrupted service to bank customers

Allows deposit insurer sufficient time to evaluate and market the
institutions, thus providing time to arrange a permanent transaction

Provides prospective acquirer time necessary to assess the bank’s
condition in order to submit reasonable bids

Is an improvement over deposit payout or insured deposit transfer
alternatives
5.4.4 DISADVANTAGES

Duplicates resolution process: original bank and bridge bank

Takes much time and effort

Deposit insurer responsible for operation of bridge bank

Difficult to retain key employees during transition

Could lead to lower premium as economic conditions could deteriorate

Franchise value could reduce as best customers may move to more
stable environment.
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6.0
IMPLEMENTATION CHALLENGES AND SITUATIONS THAT MAKE
FOR OPTIMAL UTILIZATION
(a) A major challenge in implementing P&A transaction revolves around
confidentiality and legal provisions

Poor handling of information could lead to bank run or dissipation of
assets of failing bank

The deposit insurer need adequate legal backing to support the type of
resolution option to be applied

The use of “confidentiality Agreement” (which is standard practice)
could address the challenge of maintaining confidentiality in outsourcing
the analysis of a failing bank to determine the resolution method to
adopt

Deposit insurers are guided by legal provisions in deciding on
resolution options to apply

The USA started using the bridge bank only after the relevant law was
enacted in 1987.
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 Taiwan was able to apply the P&A option only after the establishment of
the Financial Re-structuring Fund Act 2001 to quickly resolve the crises
when its DIF could not cope with the several insured financial institutions
failing simultaneously.
(b)The concept of ”whole Bank P&A” is in real sense, a misnomer. This is
because in reality there is hardly any “whole bank” transactions.
(c)A bridge bank could fail without achieving its objective, and therefore
aggravate the cost of resolution.

There is need for proper incisive analysis of the failing institution to
determine whether or not the bridge bank option is indeed a more
viable resolution program
(d)How would a deposit insurer ensure that in adopting any P&A method,
an acquirer purchases substantial assets of the failed bank and carry
through the resolution at the least cost?
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7.0

CONCLUSION
The P&A transaction failure resolution method has become a popular
option for resolving bank failure across jurisdictions with variations in
types of application or structure.

Although each variant has its merits and demerits, the application of
any method or type depends on the legal provisions, and the peculiar or
particular circumstance of the jurisdiction and the nature of failures that
need to be resolved.
THANK YOU FOR YOUR ATTENTION!
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