August 5, 2009

Legacy Loan Program: FDIC to Test a Funding Mechanism

White and Williams Task Force

White and Williams LLP attorneys practicing in real estate finance, securities, workouts and financial restructuring previously formed a Legacy Asset Task Force to inform and assist companies and investors interested in opportunities presented by the federal government's Public-Private Investment Program.

This follow up provides you with the latest information on the federal programs for disposal of toxic financial assets. We invite you to contact us with questions regarding recent developments since these programs are still being developed and additional information is becoming available frequently.

Legacy Loan Program Funding Mechanism

In a press release issued on July 31, 2009, the FDIC announced that it was taking the next step in the development of the Legacy Loan Program. The Legacy Loan Program is one of the two federal programs intended to enable financial institutions to dispose of certain toxic (now legacy) assets. Although the FDIC has indicated that the Legacy Loan Program is under review for renewal in a different form due to the reluctance of the banking community to participate in this program as currently structured, the FDIC is continuing to develop this program by testing the funding mechanism.

The test of the funding mechanism will involve the transfer of a group of residential mortgage loans currently held in receivership by the FDIC to a newly formed limited liability company (the LLC). In return for the transferred mortgage loans, the FDIC will receive an ownership interest in the LLC. The LLC will also sell an equity ownership interest to an accredited private sector investor. This investor will also be responsible for managing the residential mortgage loans owned by the LLC. The FDIC has posted a survey for potential investors that is a way for interested investors to demonstrate their interest in the program.

If the private sector investor purchases its interest in the LLC on an all cash basis, the FDIC will hold an 80 percent interest and the private sector investor will hold a 20 percent interest. If the private investor purchases its interest using FDIC guaranteed financing, the FDIC interest would be 50 percent and the private sector investor's interest would be 50 percent.

The FDIC guaranteed financing would permit leverage of either 4 to 1 or 6 to 1, based on certain elections made by the private sector investor. If the higher leverage option is applicable, then the residential mortgage loans acquired by the LLC will be subject to certain performance standards. If the loans do not meet these standards, then the principal payments received by the LLC with respect to the residential mortgage loans would be applied to pay down the FDIC guaranteed financing before any distributions would be made to the investors in the LLC.

The FDIC has indicated that it will review this sale of residential mortgage loans held by the FDIC in receivership in order to determine how the Legacy Loan Program can best be utilized to accomplish its goal of enabling financial institutions to dispose of certain toxic assets. Based on this action by the FDIC, it appears that the Legacy Loan Program may not be abandoned due to lack of interest by the banking community, but may be re-tooled to make it more attractive to that community.

For more information, please contact our Legacy Asset Task Force representatives, Anthony Krol and Joan Rosoff.