In 2009, the Federal Deposit Insurance Corporation (the FDIC) engaged in more than 1,250 sales of loans, loan participation interests and equity interests in entities set up to hold loans and loan-related assets. Historically, the FDIC has sold these loans and other loan-related assets both to stable financial institutions and to private investors, through one of three models: direct loan sales, structures sales, and bank purchase transactions.¹

Direct loan sales and structured sales provide opportunities for eligible private investors with relatively little regulatory limitation on the capitalization of, and control over, the investment vehicle. The FDIC and various third party financial advisors actively market direct loan sales and structured sales to pre-qualified investors. Barring a broad shift by the FDIC to a securitization model, the volume and variety of these transactions may grow significantly in 2010.

Direct Loan Sales

The FDIC and its financial advisors regularly make public announcements of auctions for the direct sale of, or for participation interests in, groups of loans. In some direct loan sales, the FDIC requires that the purchaser be an insured institution. In many cases, however, direct loan sales are open to private investors, subject to the eligibility criteria discussed below. In direct loan sales the acquiring entity is selected by competitive bidding. In 2009 the FDIC sold loans with a total book value of $5.6 billion through nearly 1,200 direct loan sale transactions.² The composition of those loans by type, total purchase price and average discount to the purchaser is as follows:

Structured Sales

The FDIC has disclosed details of eight structured sale transactions since May, 2008, involving assets of five failed institutions: NetBank; First National Bank of Nevada; ANB Financial, N.A.; IndyMac Bank, FSB and Corus Bank. In general, these transactions involved the FDIC’s forming an LLC (the Company), contributing loans and other assets of a failed institution into the Company, and then selling an equity interest in the Company to the winning bidder. The FDIC retained either an equity interest in the Company or a participation interest in the assets themselves. In some cases the FDIC provided purchase money financing to the Company or credit facilities to finance future obligations (such as the obligation to fund construction loans owned by the Company). The FDIC reports that the book value of assets sold in these eight transactions totaled approximately $10.6 billion. Accordingly, structured sales represented 64% of the total value of loans sold by the FDIC during the same period (May 6, 2008 through October 16, 2009), excluding loans sold to banking organizations through bank purchase transactions.

Structured Sales With 100% Private Ownership

In six of the eight structured sale transactions, the winning bidder acquired a 100% equity interest in the Company, and the FDIC retained a participation interest in the assets ranging from 60% to 80% (the FDIC’s participation interest in each of these transactions decreases after the later of the date as of which the FDIC has received a specified recovery threshold or the end of a set period of time after the assets were acquired by the Company). One or more of the private investor’s affiliates with sufficient credit guaranteed the obligations of the private investor to pay the agreed purchase price for its equity interest in the Company, the obligation of the Company to make payments to the FDIC in respect of the FDIC’s participation interest, and other related obligations.

Structured Sales With Partial FDIC Ownership

As part of the Public-Private Investment Program announced in March, 2009, two of the eight structured sale transactions took a different form, in which the FDIC retained a portion of the equity in the Company, and in which the FDIC provided a portion of the acquisition financing in the form of a purchase money note from the Company to the FDIC. Those two transactions involved assets of Franklin Bank, S.S.B. and Corus Bank, N.A., respectively. In the Franklin Bank transaction the FDIC retained a 50% equity interest in the Company. In the Corus Bank transaction the FDIC retained a 60% equity interest in the Company. The purchase money notes in both transactions are guaranteed by the FDIC in its corporate capacity.

The assets in the Franklin Bank transaction consisted of a pool of residential mortgage loans with an unpaid principal balance of approximately $1.3 billion. The winning bidder paid $64,215,000 for a 50% managing equity interest in the Company, resulting in a total equity value for the Company of $128,430,000. With a purchase money note in the amount of $727,770,000 the Franklin transaction had a total leverage ratio of 5.6:1 (the FDIC indicated at the outset of the PPIP that it would allow a leverage ratio of up to 6:1), and a total purchase price of approximately $856,200,000, representing a discount of approximately 35%.

In comparison, the assets in the Corus Bank transaction consisted primarily of real-estate-owned and construction loans (some performing and some non-performing) with an unpaid principal balance of approximately $4.5 billion. The winning Bidder paid $554,400,000 for a 40% managing equity interest in the Company, resulting in a total equity value for the Company of $1.386 billion. With a purchase money note in the amount of $1.386 billion, the Corus transaction had a leverage ratio of 1:1. The total purchase price was therefore $2.772 billion, for a discount (based on the outstanding principal balance of the loans) of approximately 38%.

In at least one other transaction that has closed since October, 2009, but for which the FDIC has not yet released full details, the FDIC has taken an approach similar to that in the Franklin and Corus transactions.

Eligibility to Participate

Direct loan sales and structured sales are marketed and administered through several third party financial advisors. The FDIC is currently using the following financial advisors for direct loan sales and structured sales: Cushman and Wakefield; CB Richard Ellis; Eastdil Secured; Garnet Capital Advisors; Keefe Bruyette & Woods; Milestone Advisors, LLC; Mission Capital Advisors, LLC; Mortgage Industry Advisory Corporation; DebtX, the Debt Exchange; and First Financial Network. These financial advisors place bids with the FDIC to be selected as the facilitator for particular transactions. The selected financial advisor manages the due diligence and bidding process, offers transaction information and solicits bids directly through its own auction platform.

• Although the FDIC may impose any additional requirements that it deems appropriate regarding an asset sale, participants in all direct loan sales and structured sales must satisfy certain eligibility criteria. Among other things, the prospective purchaser (referred to as the Lead Bidder) must be:

• A business entity with a net worth in excess of $5,000,000;

• a trust that was not formed for the purpose of acquiring assets from the FDIC and that has a net worth in excess of $5,000,000;

• a natural person whose net worth, individually or together with his or her spouse, exceeds $1,000,000;

• a bank, savings and loan association or insurance company as defined in the Securities Act of 1933;

• a broker dealer registered pursuant to the Securities Exchange Act of 1934;

• a business development company as defined in the Investment Company Act of 1940;

• a private business development company as defined in the Investment Advisers Act of 1940; or

• a business entity all of whose equity owners meet one of the foregoing criteria.

In addition, a Lead Bidder may not:

• be an FDIC employee;

• be more than 60 days late in the payment of an obligation to the FDIC in excess of $50,000 or in the performance of a non-monetary contractual obligation to the FDIC;

• be a contractor who has performed services for the FDIC within the last three years in relation to the assets being sold (unless the contractual arrangement pursuant to which the services were performed contemplates the Bidder’s purchase of the assets);

• be a current or former officer or director of any failed financial institution, if the Lead Bidder materially participated in a transaction resulting in a “substantial loss” (generally meaning a loss of more than $50,000) to the FDIC or to the failed financial institution and was found or alleged to have conducted some malfeasance (including the violation of federal or state banking law or a breach of fiduciary duty); or

• have a history of being: (i) removed from or prohibited from participating in the affairs of a failed financial institution by the FDIC or by a federal banking agency; or (ii) convicted of bribery, embezzlement or other criminal acts involving financial institutions.

Some of the disqualifying criteria above also apply to individuals and entities that are related to the Lead Bidder.

• In addition to satisfying these basic eligibility criteria, a Lead Bidder who wishes to bid for a structured sale transaction must demonstrate that it has sufficient capital, sophistication, experience and logistical ability to acquire and manage the assets in question, by completing a Bidder Qualification Request (BQR). The BQR contains questions regarding the Lead Bidder’s credit history, legal record, financial background, asset management and servicing experience, and business plan for the assets. Some of these are binary (yes/no) questions, and some are open questions requiring a narrative response. The FDIC scores responses to each question as “satisfactory” or “unsatisfactory,” and Lead Bidders are ranked according to their overall scores. The BQR solicits information on several related parties (collectively referred to as the Bidder), including (1) the Lead Bidder; (2) members of a group, if any, acting collectively with the Lead Bidder in decisions regarding the bid itself or the management of the assets once they are acquired, (3) any individuals or entities that will provide more than 25% of the funding to the entity that will be formed to acquire or hold the Bidder’s interest in the Bidder’s acquisition entity; and (4) any individual or entity that will guarantee the obligations of the Bidder’s acquisition entity. Certain information is also required regarding the proposed servicer and regarding the executives or management personnel that have or will have control over the operations of the Bidder, and the Bidder’s acquisition vehicle.

• Servicers need not be rated to be eligible for participation, but if the proposed Servicer is rated it must have an average or above-average rating. All Servicers must demonstrate experience in the relevant type of asset and must have sufficient infrastructure to service the assets. For structured sales involving residential loans, a proposed Servicer must also be approved by Fannie Mae, Freddie Mac or GNMA.

Process for Qualification, Due Diligence, and Bidding

Parties interested in participating in structured sales or direct loan sales should contact the FDIC to be included on distributions for future transactions. Because any one of several financial advisors may be selected as the facilitator for a particular transaction, potential participants should also contact all of the financial advisors listed above, to be included in their respective distributions.³

In order to receive asset-specific information, participants must complete a Pre-Qualification Request and a Purchaser Eligibility Certification, in which the participant certifies its eligibility under the criteria summarized above. Participants also must enter into a confidentiality agreement with the FDIC and with the applicable financial advisor. To access due diligence materials for a transaction, the participant must also place a refundable deposit. The amount of the deposit may vary, but previous transactions have required due diligence deposits in the range of $250,000.

Pre-qualification and access to due diligence does not guaranty that a Bidder will be eligible to bid for a structured sale transaction. The FDIC or its advisor will determine which pre-qualified bidders to include in a particular transaction based on the preferences, financial attributes and experience of the bidder, and based on the characteristics of the assets being sold. This determination is made largely on the basis of the BQR. Much of the BQR is transaction-specific, and so potential participants in structured sale transactions would complete the BQR, or would elect to withdraw from the transaction, only after reviewing due diligence materials. During the BQR process, some participants would also be eliminated by the FDIC or the financial advisor. Participants who receive transaction-specific qualification and who elect to bid are required to place an additional deposit as earnest money. Previous earnest money deposits have been as low as $1.9million and as high as $9.1 million.

2010 Preview

It is reasonable to assume that direct loans sales and structured sales involving private participants will continue to play a significant role in the FDIC’s overall disposition of failed institutions’ assets. Many expect that the number of bank failures in 2010 will exceed the number of failures in 2009. The FDIC will likely rely to some degree on one or more structured sale formats to dispose of large portfolios of loans. Direct loan sales are an important means of disposing of relatively small portfolios of loans, and can be tailored to a more specific purchaser type. However, through structured sales the FDIC can sell a much larger bundle of assets in a single transaction. For both types of transactions, the quality of assets is likely to improve in 2010, relative to 2009.

The specific form of structured sale transactions is fluid. Details of additional transactions that have closed since the Corus transaction or that are currently in process (including a recent transaction in which Lennar Corporation acquired a portfolio of loans with an unpaid balance of $3 billion) are not yet available from the FDIC. In future transactions the FDIC may vary the amount of equity it retains, the amount of financing it provides, the timing and recovery threshold for resetting its participation interest (if any) and other transaction details. The FDIC also may vary the characteristics of assets it contributes into a deal. The Lennar transaction, for example, is reported to include assets from 22 failed institutions rather than assets from only one failed institution.

The FDIC has indicated it is considering implementing a securitization program for the disposition of failed institutions’ assets. A securitization model would enable the FDIC to appeal to a wider array of investors, but no definitive plan for securitization of FDIC-held assets exists to date.

For more information regarding FDIC loan sales and related transactions, please contact any of the following:

David Dubrow
dubrow.david@arentfox.com
212.484.3957

Mark Katz
katz.mark@arentfox.com
202.857.6260

Daniel Lopez
lopez.daniel@arentfox.com
202.857.6240

¹ Bank purchase transactions are not discussed below. Those transactions require the participation of an established banking organization, and the direct or indirect participation in acquiring institutions by private investors is subject to requirements and limitations of the FDIC, the Federal Reserve Board and the Office of Thrift Supervision, among others. In addition to pre-existing limitations on private investment in banking organizations, the FDIC recently finalized a statement of policy applicable to private investors who wish to own equity interests in entities that acquire deposit liabilities from the FDIC. See FDIC’s Final Statement of Policy on Qualifications for Failed Bank Acquisitions, issued September 2, 2009.

² http://www2.fdic.gov/closedsales/loansales.asp.

³ Notices regarding direct loan sales are also posted directly on the FDIC’s website, including the total principal amount of loans being sold, the type and status (performing or non-performing) of the loans, the name of the failed institution for which the FDIC is holding the loans, the due diligence dates, the bid date, the closing date for each transaction and the name of the advisor, if any, handling the auction process.