Blending old and new programs, the Federal Deposit Insurance Corporation (FDIC) will soon launch a new funding program to facilitate the purchase of mortgage loans and, potentially, other assets of failed banks. In short, the FDIC is moving toward policies that favor marketing deposits to traditional banks and the assets to non-banks and private equity firms through a PPIF-like structure.  

The FDIC announced plans earlier this year to help insured banks and thrifts to sell whole mortgage loans and other assets as part of the Department of the Treasury’s Public-Private Investment Program. SeeEnlisting Private Equity to Rescue “Legacy Assets”: Treasury Announces Public-Private Investment Funds Structures, 21st Century Money, Banking & Commerce Alert® (Mar. 25, 2009); FDIC Requests Public Comment on Legacy Loans Program, 21st Century Money, Banking & Commerce Alert® (Mar. 27, 2009). At the time, the program was seen as a return to the original intent of the Troubled Asset Relief Program (TARP) to help restore bank lending by creating a marketplace for the troubled “legacy assets” that were hobbling banks and thrifts. Subsequently, following the release of the results of the Treasury’s “stress test” of the largest US banks and their initial success in raising additional capital, the pressure on banks and thrifts to sell troubled assets at depressed prices was reduced. The FDIC then announced that it would postpone launching the program, but would test the funding mechanism.  

The FDIC, through its agent, RBS Securities Inc., has announced that the Legacy Loans Program funding mechanism will be used to sell approximately $1.4 billion of whole residential mortgage loans. Instead of marketing the assets of open institutions, which presents its own set of complexities, the FDIC as receiver for Franklin Bank, S.S.B, Houston, Texas, will sell receivership assets in a competitive bidding process. Private parties may submit sealed bids to become the managing member of and to acquire a 50% equity interest in a limited liability company (LLC) which will hold the loans. The FDIC as receiver will retain the other 50% equity interest and will provide seller financing to cover the entire equity interest in the LLC on a leverage basis up to 6:1, subject to a total debt ceiling. The winning bidder will be required to participate in the Treasury’s Home Affordability Modification Program and any subsequent loan modification programs adopted by the FDIC. The winning bidder also must provide a guarantee from a “financially responsible source” of the performance of its obligations as managing member. The details of these requirements and additional terms are available to registered parties as part of due diligence materials.

Bidders also may submit an all-cash (i.e., non-leveraged) bid, pursuant to which the winning bidder would acquire a 20% equity interest in the LLC and become the managing member, but would not receive any debt financing from the FDIC. The winning bidder’s equity interest would increase to 40% after the FDIC received a minimum required recovery. Thus, the initial cost to the winning bidder would be higher without leverage, but its subsequent expenses would be lower. This formula reflects the structured financing that the FDIC has used in a small number of one-on-one negotiated transactions, such as its agreement on January 7, 2009 to sell $560 million of mortgage loans to Private National Mortgage Acceptance Company, LLC. See Thomas P. Vartanian and Gordon L. Miller,A Review of the FDIC’s Latest Tools For Resolving Problem Banks, ABA Business Law Section, Banking Law Committee Quarterly Journal (April 2009), available at our website. Alternative bids also may be submitted.  

This modified auction process, if successful, would provide the FDIC with an alternative to its current process of selling portfolios of receivership assets either through traditional auction bids or one-on-one negotiated transactions. It may facilitate sales to private equity fund bidders, whom the FDIC has alternately courted and, more recently, appeared to discourage with regard to whole bank transactions that would convey both deposits and assets. See FDIC Proposes Guidelines for PE Investments in Failed Institutions: The Debate Begins, 21st Century Money, Banking & Commerce Alert® (July 6, 2009).  

By taking an investment vehicle and funding mechanism originally designed for the Treasury to co-invest taxpayer-provided TARP funds in the impaired assets of open banks and adapting it to serve as a vehicle for the Deposit Insurance Fund (DIF) to provide both debt and equity financing for the sale of assets acquired by the FDIC as receiver for failed banks, the FDIC is demonstrating its resourcefulness in a difficult environment. Alongside this innovation, the FDIC also has adapted its structured finance model for negotiated asset sales as the basis for a closed bid auction process.  

It remains to be seen how private investors will respond. Unlike the proposed Legacy Loans Program, the extent to which the debt financing that the FDIC will provide will be non-recourse is not clear. The FDIC also may discourage investor interest if it attempts to impose the extensive managerial requirements and operational controls that raised investor concerns about the Legacy Loans Program. Another issue concerns the cost of the program to the FDIC. If the FDIC provides both debt and equity financing in order to sell receivership assets, and winning bidders provide as little as 8% of the purchase price, how much funding can the DIF provide before the FDIC must tap its credit line with the Treasury?