POWER OF INTELLIGENCE

Insight Center: Publications

FDIC Loan Sales - What's Old Is New Again

Author: Audrey D. Wisotsky

7/11/2011

© 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 7 edition of the Bloomberg Law Reports—Banking & Finance. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.

The Federal Deposit Insurance Corporation (FDIC), in its role as conservator or receiver, is responsible for maximizing the recovery on the assets of failed financial institutions (FFIs).1 The focus of this article is FDIC’s sale of residential mortgage loans. After FDIC acquires loans from FFIs, it typically engages in the sale of those loans or loan pools to private-sector purchasers, including depository institutions and other eligible investors. FDIC sales take place either through traditional direct secondary market whole loan sales, securitization, or through a recently created mechanism, structured transactions.

Background

Until the recent financial crisis, FDIC sold whole mortgage loans and real estate owned property (REO) in traditional secondary market servicing released sale transactions in which FDIC made no representations or warranties and provided the purchaser with fairly limited recourse to FDIC. In traditional whole loan sale transactions, once the sale occurred, except for any limited recourse obligations, FDIC no longer was involved with the purchaser of the loans nor did it have any ongoing interest in the loans or any cash flows derived therefrom. For the most part, all risk associated with the loans was transferred to the purchaser of the loan.

In a structured transaction, on the other hand, FDIC retains a participation interest in the future cash

flows of the loans while continuing to limit the recourse provided to the purchaser. While FDIC-structured transactions are a relatively new mechanism for selling FFI assets, the utilization of the private/public partnership derives from lessons learned by FDIC from the thrift crisis of the early 1990s. Structured transactions have become the prevalent method by which FDIC sells loans acquired from FFIs.

A form of structured transaction was utilized by the Resolution Trust Corporation (RTC) in the early 1990s when thrifts were closed in large numbers, creating an extraordinary large number of assets held by the RTC.2 In its effort to dispose of assets and maximize recovery, the RTC successfully used and partnered with private-sector asset managers.3 Drawing upon its experience from the thrift crisis, FDIC has once again turned to partnerships with the private sector to maximize recovery during the current financial crisis on the large number of assets held by FFIs.4

The Architecture of FDIC Structured Transactions

A structured transaction is a joint venture or partnership between FDIC as receiver for FFIs and private-sector entities.5 In transactions executed between May 2008 and March 2009, FDIC, as receiver, held a participation interest in the assets.6 Since September 2009, the transactions have been "partnership" arrangements.7 In the participation transactions the assets were contributed to the limited liability company (LLC) and, by agreement, FDIC obtained a participation interest in the underlying assets, while in the partnership transaction FDIC receives an equity interest in the LLC.8

To facilitate either form of structured transaction, FDIC forms an LLC and conveys assets from one or more FFIs to the LLC through either a Loan Contribution and Assignment Agreement (non-leveraged transactions (described below)) or a Loan Contribution and Sale Agreement (leveraged transactions (described below)).9 In the partnership structure, FDIC receives 100 percent of the ownership interest of the LLC in exchange for the assets.10 Through several other agreements, FDIC then sells an interest in the LLC to a private-sector bidder.11 The private-sector bidder receives a membership interest in the LLC (typically 20-40 percent of the equity in the LLC) and is required to act as manager of the LLC and as manager and servicer of the mortgage loans and REO owned by the LLC.12 Private sector bidders, generally, base their bids on an expected rate of return on the recovery of the value of the underlying mortgage loans.

It should be noted that the transaction agreements provide FDIC with certain consent rights with respect to the LLC’s management activities including, among other things, pledging any of the LLC’s assets for the benefit of another person, having the LLC guaranty the debts of another person, or incurring debt not contemplated by the transaction documents.13 In addition, the transaction agreements impose monthly, semiannual, and annual reporting requirements on the private-sector owner. Also, FDIC performs compliance monitoring of the transaction and an annual review of entity operations.

As originally contemplated, the private sector bidder’s purchase of the LLC interest was on a cash basis in non-leveraged transactions.14 However, since September 2009, structured sales have included FDIC financing through both amortizing and non-amortizing purchase money notes.15 In a leveraged transaction, the LLC issues a promissory note, which may be guaranteed by FDIC, as partial payment to FDIC for the assets sold by FDIC to the LLC.16 The remaining consideration paid to FDIC is the cash contributed by the winning private-sector bidder.17 The terms of the promissory notes vary by transaction. The issuance of the promissory notes by the LLC reduces the private sector participant’s cash outlay than would otherwise be required. The level of financing is determined based upon the risk and cash flow characteristics of the underlying pool of loans and the terms of the promissory notes are disclosed as part of the bidding process.18 It should be noted that while FDIC initially holds the notes, it retains the right to sell them.19 In addition, generally the equity owners will not be entitled to receive distributions until the promissory notes are paid.20 As previously indicated, the private sector bidder is basing its investment decision on its ultimate ability to recover a percentage of the value of the underlying collateral. Therefore, the participant is willing to delay its return on its investment as the initial issuance of the promissory notes reduces its initial capital outlay.

Bidder Eligibility Requirements

A private-sector entity must meet certain eligibility requirements to participate in a bid of FDIC structured loan sales.21 A prequalification process is conducted to determine the universe of prospective bidders to whom general information about an upcoming structured transaction may be sent.22 In general, an entity interested in receiving information regarding structured loan sales must complete a Bidder Pre-Qualification Request,23 a Purchaser Eligibility Certification,24 and a Confidentiality Agreement.25

The eligibility criteria to receive information regarding FDIC structured sales, set forth in the Pre-Qualification Request, include minimum net worth requirements which vary depending upon whether the bidder is a natural person or entity. The potential bidder also certifies that it is in the business of buying, originating or selling loans, or, in the ordinary course of business deals with identical or similar loans, and will be responsible for the proper servicing of the loans, whether performed itself, by an affiliate, or a third party.26

The purpose of the Purchaser Eligibility Certification is to identify prospective purchasers who are ineligible to purchase assets from FDIC.27 Subject to certain exceptions, ineligible purchasers include: (1) FDIC employees and their spouses and minor children; (2) any prospective purchaser that has a delinquent debt of more than 60 days and in excess of $50,000.00; (3) contractors (or an affiliated business entity of a contractor) that have performed services with respect to the loans within the past three years unless the contract for services permits such purchases; (4) officers or directors of an FFI who materially participated in a transaction or transactions that caused "substantial loss" to the FFI and have been alleged or adjudicated to have violated any law, regulation, or order issued by a federal or state banking agency, breached a written agreement with such agency, engaged in an unsafe or unsound practice with respect to such financial institution, or breached a fiduciary duty to the FFI; (5) parties who have been removed or prohibited from participating in the affairs of the FFI by a federal banking agency; (6) parties who have borrowed money or guaranteed loans in more than one transaction with the "intent to cause a loss or with reckless disregard for whether such transactions would cause a loss" to an FDIC-insured institution, which caused a "substantial loss" to one or more FFIs; or (7) parties who have been convicted of committing specified crimes affecting an FFI and have defaulted on any debt or obligation to pay money owed to FDIC or an FFI.28 In addition, in a leveraged transaction, a prospective purchaser is ineligible if it has defaulted on any debts or obligations to pay money to FDIC or an FFI in the aggregate excess of $1,000,000.00 and has made fraudulent misrepresentations in connection with those debts or obligations.29

In addition to completion of the Bidder Pre-Qualification Request, the Purchaser Eligibility Certification, and the Confidentiality Agreement, pre-qualified prospective purchasers may be required to meet additional qualification requirements, including a monetary deposit, prior to obtaining access to due diligence materials.30

Prior to the bid date, prospective bidders must complete a Bidder Qualification Application,31 which is used by FDIC to determine if the prospective purchaser, among other things, has the requisite financial and managerial capability to be a successful bidder. The entity must demonstrate management experience relative to mortgage loans, as well as an experienced management team, operational capabilities, and an overall strategy to manage the assets.32 An entity must also demonstrate that it has resources readily available to close a transaction within FDIC’s prescribed timeline and to fund the management of the loans post-closing including, among other things, without limitation, servicing costs and REO property maintenance costs.33 In addition, FDIC will review the circumstances of any fraud or bankruptcy-related issues related to the entity and its key employees, as well as any associations or dealings in the past with FFIs.34 Once an entity meets the qualification requirements, it will be allowed to participate in the bid process. Prospective bidders may also be required to submit a bid deposit, which is in addition to the due diligence deposit.

FDIC encourages minority- and women-owned investors and asset managers to either bid, or partner in bidding, on portfolios of loans through the structured sale process.35 Accordingly, even if a minority- or woman-owned entity does not satisfy all of the eligibility criteria to qualify as a participant, it is possible through collaborations with qualifying entities to participate in the structured sales.

Key Terms of Structured Transactions

Representations and Warranties

Similar to FDIC direct whole loan sales and, as opposed to private-sector secondary market transactions, FDIC makes virtually no loan-level representations or warranties when it conveys the loans to the LLC in structured transactions. FDIC specifically represents in the relevant agreements that the loans are being conveyed on an "as is" basis. This makes it essential that a prospective bidder perform sufficient due diligence to fully understand the value and issues related to the assets held by the LLC, as there is little recourse available if the purchased loans do not satisfy the purchaser’s underwriting/investment standards and/or do not perform as well as anticipated. Typically, prospective bidders will have three weeks to perform the due diligence through access to an electronic data room. While the period of time will vary, generally the structured loan sales are consummated within 15 days after the bid is awarded.

The typical representations contained in an FDIC whole loan sale agreement and in a structured loan sale transaction are more akin to disclosure of what FDIC is not representing. As previously mentioned, FDIC specifically represents that loans are conveyed "‘as is’ and, ‘with all faults,’ without any representation, warranty or guaranty or . . . recourse whatsoever, including as to collectability, enforceability, value of underlying collateral, ability of any obligor to repay, condition, fitness for any particular purpose, merchantability or fitness for a specific purpose."36 The representation clearly demonstrates that FDIC is conveying the loans truly "as is" and makes no representations whatsoever about the likelihood of repayment. FDIC also states that it makes no warranties or representations as to the sufficiency or accuracy of the amount of any monies held in any escrow account. Further, FDIC affirmatively states that it makes no warranties or representations as to the amount of any additional or future advances of principal that the LLC will become obligated to make and that it makes no warranties or representations as to the accuracy of any calculation or adjustment of interest on any loans sold, whether the calculation or adjustment was made by FDIC, the previous owner of the loans, or any agent or contractor of the foregoing.37

FDIC also states that it makes no warranties or representations as to the completeness or accuracy of any information provided with respect to any loan. Further, the purchaser must acknowledge that the mortgage files for some loans might be missing forms or notices, or might contain incomplete or inaccurate forms or notices that might be required by one or more federal or state consumer protection statutes. In addition, the agreements provide that FDIC has no obligation to obtain any assignment missing from a loan file, and that the absence of any intervening assignment, or the existence of any lien on a loan or its underlying collateral, or any defect in the lien or priority of FDIC’s or the FFI’s security interest in the underlying collateral shall not give rise to any claim for repurchase.38

FDIC Repurchase Obligations

While the transaction agreements provide no loan-level representations or warranties, there is limited recourse to FDIC upon the occurrence of certain events. Under certain circumstances that are set forth in the transaction agreements, the LLC may require FDIC to repurchase a loan upon satisfaction of certain procedural requirements if, prior to the date of the agreement, one of the events set forth below has occurred.

(1) A loan borrower was discharged in a no-asset bankruptcy proceeding, no underlying collateral exists out of which the loan may be satisfied and all guarantors or sureties of the loan, if any, or the obligations contained therein, have also been discharged in no-asset bankruptcies.

(2) A court of competent jurisdiction entered a final judgment holding that neither a loan borrower nor any sureties or other obligors owe an enforceable obligation to pay the holder of a loan or its assignees.

(3) The FFI or FDIC executed and delivered a release of liability from all obligations under the loan to the loan borrower.

(4) A title defect exists in connection with a mortgaged property that is the subject of a sale contract, which defect requires a prior order or judgment of a court to enable the loan/REO purchaser to convey title to such property in accordance with the terms and conditions of the sale contract.

(5) FDIC is not the owner of the loan and FDIC cannot cure the defect to allow transfer of the loan to the LLC.

(6) The mortgaged property securing a loan has "Environmental Hazards" that were not disclosed in the loan documents or other material provided by FDIC prior to the submission of a bid.

(7) FDIC, the FFI, or their respective officers, directors, or employees fraudulently caused a borrower to receive less than all of the proceeds and benefits of a loan.

(8) An action is asserted by more than one borrower with respect to more than one loan that includes allegations of fraud on the part of FDIC or FFI in connection with the origination of such loans and names FDIC or FFI as a defendant and asserts liability on the part of FDIC or the FFI for which the LLC is not liable as an assignee.39

In addition, the LLC may require FDIC to repurchase a loan if, after the closing date of the loan sale, a court issues a final order that requires the assignment and transfer of a loan back to FDIC.40 It is also important to note that, except for transaction-specific issues, the forms of transaction agreements are generally not negotiable.

Servicing

As of the date of the sale of the loans to the LLC, all rights, obligations, liabilities, and responsibilities with respect to the servicing of loans are assumed by the LLC and FDIC is discharged from all responsibility and liability related to the management and servicing of the loans.41 As the managing member of the LLC, the private-sector purchaser is required, as part of the transaction, to enter into a servicing agreement with a servicer who is qualified to service the loans and has all necessary licenses to service the loans.42 In order to provide for the orderly transfer of the servicing functions from FDIC or third-party servicers to the new servicer, the transaction agreements provide for an interim servicing period after the sale, during which FDIC, or a third party servicer, if applicable, continues to perform the necessary servicing functions for the loans on behalf of the LLC. The interim servicing period continues until a mutually agreed upon servicing transfer date, at which time the LLC, through the contracted servicer, assumes sole responsibility for servicing the loans. Not surprisingly, the LLC acknowledges and agrees in the transaction agreements that FDIC performs interim servicing functions for the LLC only as an accommodation to the LLC and that FDIC has no liability for any acts or omissions taken in connection with the interim servicing functions (other than to correct calculation, allocation, or distribution errors). Further, note that the LLC, its managing member and the servicer must comply with all applicable state licensing requirements to hold, interact with borrowers, and/or service the mortgage loans. The issue of licensing, however, is beyond the scope of this article.

Conclusion

Given the lack of private-sector secondary market activity and the ability to obtain an interest in such loans with relatively limited cash payments, an FDIC structured loan sale process can be a win-win scenario for all parties involved.

Endnotes

1 12 U.S.C. § 1823(d)(3)(D).

2 See FDIC, FDIC Structured Transaction Fact Sheet, available at http://www.fdic.gov/buying/financial/factsheet.html.

3 See Id.

4 See Id.

5 See FDIC, Structured Transaction FAQs, available at http://www.fdic.gov/bank/individual/failed/lossshare/Structured_Transaction_FAQs.html.

6 See FDIC, FDIC Structured Transaction Fact Sheet, available at http://www.fdic.gov/buying/financial/factsheet.html.

7 See Id.

8 See FDIC, FDIC Structured Transaction Fact Sheet, available at http://www.fdic.gov/buying/financial/factsheet.html.

9 See Id. An example of a Loan Contribution and Assignment Agreement is available at http://www.fdic.gov/buying/historical/structured/ANB-loan_contribution_assignment_agreement.pdf. An example of a Loan Contribution and Sale Agreement is available at http://www.fdic.gov/buying/historical/structured/SFG2010Loan&SaleAgreement.pdf.

10 See FDIC, FDIC Structured Transaction Fact Sheet, available at http://www.fdic.gov/buying/financial/factsheet.html.

11 See Id.

12 See Id.

13 An example of an Amended and Restated Limited Liability Company Operating Agreement is available at http://www.fdic.gov/buying/historical/structured/SFG2010-AmendedRestatedLLCOpAgmt(Redacted).pdf.

14 See FDIC, Structured Transaction FAQs, available at http://www.fdic.gov/bank/individual/failed/lossshare/Structured_Transaction_FAQs.html.

15 See Id.

16 See Id.

17 See Id.

18 See FDIC, FDIC Structured Transaction Fact Sheet, available at http://www.fdic.gov/buying/financial/factsheet.html.

19 See FDIC, Structured Transaction FAQs, available at http://www.fdic.gov/bank/individual/failed/lossshare/Structured_Transaction_FAQs.html.

20 See FDIC, FDIC Structured Transaction Fact Sheet, available at http://www.fdic.gov/buying/financial/factsheet.html.

21 See FDIC, Financial Asset Sales–Qualification Process, available at http://www.fdic.gov/buying/financial/qualification_process.html.

22 See Id.

23 An example of FDIC's Pre-Qualification Request form is available at http://www.fdic.gov/buying/financial/pre_qualif_request.pdf.

24 An example of FDIC's Purchaser Eligibility Certification is available at http://www.fdic.gov/buying/financial/pec.pdf.

25 An example of FDIC's Confidentiality Agreement is available at http://www.fdic.gov/buying/loan/confidentiality/confidentiality.pdf.

26 An example of FDIC's Pre-Qualification Request form is available at http://www.fdic.gov/buying/financial/pre_qualif_request.pdf.

27 See a sample FDIC Purchaser Eligibility Certification, available at http://www.fdic.gov/buying/financial/pec.pdf.

28 See Id.

29 See Id.

30 See FDIC, Financial Asset Sales—Qualifications Process, available at http://www.fdic.gov/buying/financial/qualification_process.html.

31 A sample Bidder Qualification Application form is available at http://www.fdic.gov/buying/financial/BidderQualApp091310Sample.pdf. FDIC provides guidance and instructions at http://www.fdic.gov/buying/financial/BidderQualAppInstructions091310.pdf and answers to frequently asked questions at http://www.fdic.gov/buying/financial/BidderQualAppFAQ091310.pdf.

32 See Bidder Qualification Application form available at http://www.fdic.gov/buying/financial/BidderQualApp062011Sample.pdf.

33 See Id.

34 See Id.

35 See FDIC, Financial Asset Sales—Qualifications Process, available at http://www.fdic.gov/buying/financial/qualification_process.html.

36 See, e.g., Loan Contribution and Assignment Agreement By and Between the Federal Deposit Insurance Corporation as Receiver for First National Bank of Nevada and FNBN-CMLCON I LLC (February 20, 2009), § 5.1, available at http://fdic.gov/buying/historical/structured/FNBN-CMLCON_loan_contribution_assignment_agreement.pdf.

37 See an example of a Loan Contribution and Assignment Agreement, available at http://fdic.gov/buying/historical/structured/FNBN-CMLCON_loan_contribution_assignment_agreement.pdf.

38 See Id.

39 See Id.

40 See Id.

41 See FDIC, Structured Transaction FAQs, available at http://www.fdic.gov/bank/individual/failed/lossshare/Structured_Transaction_FAQs.html.

42 See FDIC, FDIC Structured Transaction Fact Sheet, available at http://www.fdic.gov/buying/financial/factsheet.html.

Audrey D. Wisotsky and Michael J. Callaghan

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.