Late last week, the Federal Deposit Insurance Corporation (“FDIC”) announced two new programs designed to attract buyers for distressed assets currently held by banks.
Good Bank/Bad Bank Plan
On Thursday, July 30, 2009, two FDIC officials gave public statements regarding a plan to start splitting off troubled assets from many failed banks, as a way of enticing healthy banks to purchase the rest. According to the plan, if the FDIC believes that strategic buyers are unwilling to purchase a failed bank because of the distressed assets on the target’s balance sheet, the agency will break the target into two pieces, with the goal of selling the charter, deposits and performing assets to another, healthier bank and the distressed assets to investment funds and other private capital sources (presumably with a loss-sharing or other similar arrangement serving as an incentive).
The FDIC is still determining how the process will work (e.g., whether it will hold separate auctions for each half of a failed bank or whether it will expect strategic buyers to team up with private capital investors). However, the agency said it expects to release more details soon and to launch the program “in the coming weeks.”
Public-Private Investment Program for Legacy Loans
On Friday, July 31, 2009, the FDIC announced its plan to move forward with a sale of distressed assets designed to test the mechanism of the legacy loan component of the Public-Private Investment Program announced in March by the U.S. Treasury Department, the Federal Reserve and the FDIC. Under the proposed transaction, the FDIC will establish a limited liability company (“LLC”) to hold a portfolio of residential mortgage loans from banks in receivership. The agency will then sell equity interests in the LLC to accredited investors under two options.
The first option will be on an all cash basis, with an equity split of 20% to the investor and 80% to the FDIC. The second option will be a sale with leverage, under which the equity split will be 50-50.
Funding for the transaction will occur via an amortizing note issued by the receivership to the LLC that is guaranteed by the FDIC. Financing will be offered with a leverage ratio of 4-to-1 or 6-to-1, as chosen by the private investor. If 6-to-1 leveraging is chosen, then the underlying assets will be subject to certain performance thresholds including delinquency status, loss severities and principal repayments. If any of these thresholds is not met, then all of the principal cash flows that would have been distributed to the equity investors will, instead, be applied to the reduction of the note until the balance is zero.
Interested investors must sign a confidentiality agreement with the FDIC in order to obtain more information about the assets that will be held by the LLC, and all bids must be received by a September deadline. The FDIC will analyze the results of this sale in order to determine the best way to move forward with the legacy loan program.