Legacy Loans Program

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Overview

Source: FDIC

In order to cleanse bank balance sheets of distressed loans and other assets and reduce the associated market overhang, the FDIC and Treasury are launching the Legacy Loans Program.

The FDIC will provide oversight for the formation, funding, and operation of new public-private investment funds ("PPIFs") that will purchase loans and other assets from depository institutions. The Legacy Loans Program will attract private capital through an FDIC debt guarantee and Treasury equity co-investment.

Private market equity investors ("Private Investors') are expected to include but are not limited to financial institutions, individuals, insurance companies, mutual funds, publicly managed investment funds, pension funds, foreign investors with a headquarters in the United States, private equity funds, and hedge funds. The participation of mutual funds, pension plans, insurance companies, and other long term investors is particularly encouraged.

The FDIC will staff operations relating to the formation, funding, and operation of PPIFs and will work with participant banks, the Treasury, Private Investors and contractors to administer the asset pool auctions. The Treasury will be responsible for overseeing and managing its equity contribution in the PPIFs, while the FDIC will be responsible for overseeing and managing its debt guarantees to the PPIFs.

FDIC conducts pilot sale of receivership assets under LLP

Yesterday, the FDIC announced that Residential Credit Solutions (RCS) was the winning bidder (out of 12 consortiums that placed bids) in a "pilot sale" of receivership assets that the FDIC conducted to test the funding mechanism for the Legacy Loans Program.

RCS will pay $64.2 million in cash for a 50 percent equity stake in a limited liability company, which will hold a portfolio of residential mortgage loans with an unpaid principal balance of approximately $1.3 billion conveyed by the FDIC as Receiver of Franklin Bank, SSB, Houston, Texas, and the limited liability company, based on a 6-1 leverage ratio, will issue an approximately $727.8 million note (guaranteed by the FDIC and which the FDIC "anticipates selling at a future date") to the FDIC as Receiver.

According to the FDIC, "the present value of this bid equals 70.63% of the outstanding principal balance of this portfolio." After the closing, which is expected to occur later this month, RCS will manage the portfolio and service the loans under the Home Affordable Modification Program guidelines.

LLP launches

Today, the FDIC announced the next steps in further developing the government's Legacy Loan Program (LLP), by testing the LLP program's funding mechanism through the sale of a portfolio of residential mortgage loan receivership assets to a limited liability company (LLC) in exchange for an ownership interest in the LLC. The LLC will also sell an equity interest to an accredited investor, who will be responsible for managing the portfolio of mortgage loans, under the following two options:

  • All cash basis with an equity split of 80 percent (FDIC) and 20 percent (accredited investor); or
  • Sale of loan portfolio involving partial leverage under which the remaining equity split will be 50 percent (FDIC) and 50 percent (accredited investor).

Under the second scenario, the receivership will offer financing to the LLC in the form of an amortizable note guaranteed by the FDIC at a leverage ratio of either 4-to-1 or 6-to-1 (debt to equity), depending on certain elections (to be determined) made in the bid submitted by the accredited investor for the mortgage assets. If the bid incorporates the 6-to-1 leverage alternative, then performance of the underlying assets will be subject to certain performance thresholds including delinquency status, loss severities, and principal repayments. If any one of the performance thresholds is triggered over the life of the note, then all of the principal cash flows that would have been distributed to the equity investors would be applied instead to the reduction of the note until the balance is zero. The performance thresholds will not apply if the bid is based on the 4-to-1 leverage option. The FDIC will be protected against losses on the note guarantee by the limits on the amount of leverage (both in terms of a maximum ratio and dollar amount), the mortgage loans collateralizing the guarantee, and any guarantee fee assessed.

The LLP was initially launched this past March to reduce the “overhang of troubled legacy loans stuck on bank balance sheets," and had been subsequently postponed in June in order to "assess the magnitude and timing of troubled assets sales" and prepare to test the LLP funding mechanism through the a sale of receivership assets in order to be "ready to offer the LLP to open banks as needed."


"The FDIC started its Legacy Loans Program this Friday, launching its first test deal in its effort to help banks shed their toxic assets.

Here are some details, from the FDIC’s press release:

The first test using the LLP funding mechanism commenced this week. In the transaction to be offered, the receivership will transfer a portfolio of residential mortgage loans on a servicing released basis to a limited liability company (LLC) in exchange for an ownership interest in the LLC.

The LLC also will sell an equity interest to an accredited investor, who will be responsible for managing the portfolio of mortgage loans. Loan servicing must conform to either the Home Affordable Modification Program (HAMP) guidelines or FDIC’s loan modification program. Accredited investors will be offered an equity interest in the LLC under two different options.

The first option is on an all cash basis, which is how the FDIC has recently sold receivership assets, with an equity split of 80 percent (FDIC) and 20 percent (accredited investor). The second option is a sale with leverage, under which the equity split will be 50 percent (FDIC) and 50 percent (accredited investor). The funding mechanism is financing offered by the receivership to the LLC using an amortizing note that is guaranteed by the FDIC.

Financing will be offered with leverage of either 4-to-1 or 6-to-1, depending upon certain elections made in the bid submitted by the private investor. If the bid incorporates the 6-to-1 leverage alternative, then performance of the underlying assets will be subject to certain performance thresholds including delinquency status, loss severities, and principal repayments. If any one of the performance thresholds is triggered over the life of the note, then all of the principal cash flows that would have been distributed to the equity investors would be applied instead to the reduction of the note until the balance is zero.

The performance thresholds will not apply if the bid is based on the lower leverage option. The FDIC will be protected against losses on the note guarantee by the limits on the amount of leverage (both in terms of a maximum ratio and dollar amount), the mortgage loans collateralizing the guarantee, and the guarantee fee.

The FDIC will analyze the results of this sale to see how the LLP can best further the removal of troubled assets from bank balance sheets, and in turn spur lending to further support the credit needs of the economy. This announcement is for informational purposes only and is not an offer for the sale of securities. An offering to accredited investors, containing additional technical details of the offering, including an offering memorandum describing fully the details of such offering, will be made available to these investors in accordance with securities laws applicable to sale of securities to accredited investors.

The LLP was, of course, designed to boost private demand for distressed assets and eventually help revive appetite for the ‘legacy’ issues of non-failed banks. That, it is hoped, should facilitate the price discovery process in the market and eventually restart a market for ABS assets, which currently does not exist.

The big question is will the 6-to-1 leveraged financing conditioning on the assets be enough to entice banks to participate?

Potential restrictions on private investors taking part, meanwhile, were always the other big concern.

It now appears, in the case of bids incorporating the 6-to-1 financing , private investors will be subject to performance thresholds including delinquency status, loss severities, and principal repayments."

Program links

Many Legacy Loans Program links available here.

References

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