* Investors offered two options for participation
* FDIC says protected against losses by collateral, fee
* FDIC will take final bids late August, early September
* RBS, Deutsche Bank are advisors
(Adds Wilson comment, byline)
By John Poirier
WASHINGTON, July 31 The U.S. Federal Deposit
Insurance Corp launched the first test of its Legacy Loans
Program that could eventually help banks rid their balance
sheets of toxic assets so they can raise new capital and
increase lending, the agency said on Friday.
Officials at the FDIC, which insures the deposits of U.S.
banks and acts as the receiver for failed institutions, said
they will take final bids in late August or early September and
declined to say which bank's toxic assets were involved in the
In the test transaction, a receivership will transfer a
portfolio of residential mortgage loans to a limited liability
company in exchange for an ownership interest in that entity,
the agency said in a statement.
FDIC spokesman Andrew Gray declined to comment on the size
of the asset pool. He said bidders must sign a confidentiality
agreement in order to participate.
Royal Bank of Scotland (RBS.L) and Deutsche Bank AG
(DBKGn.DE) are the advisers to the FDIC on the program.
In its early stages, the pilot program is soliciting
interest for the transaction and potential bidders are going
through a qualification process, officials said.
No open and operating institutions are currently
participating, FDIC officials said.
Accredited investors will be offered an equity interest in
the limited liability company under two options.
The first is an all-cash basis, which is how the FDIC has
recently sold receivership assets, with an equity split of 20
percent to the investor and 80 percent to the FDIC. The other
option is a sale with leverage, under which the equity split
will be 50-50 between the investor and the FDIC.
The FDIC said it will be protected against losses by the
limits on leverage amount, the mortgage loans collateralizing
the guarantee, and the guarantee fee.
"The FDIC will analyze the results of this sale to see how
the Legacy Loans Program 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,"
the agency said.
FDIC officials did not rule out additional sales.
The test pilot differs from previous receiverships sales
due to the inclusion of a leverage aspect that hasn't been
utilized since the era of the Resolution Trust Corporation, a
government trust that liquidated assets in the 1980s and 1990s
during the savings and loans crisis.
The FDIC is also offering two leverage ratios for investors
-- 6-1, which comes with certain performance strings attached,
and 4-1, which has no strings attached.
For example with a 6-1 leverage, if the transaction price
is $700 million, a note will be issued for $600 million and the
remaining $100 million will be split evenly between the
investor and the FDIC.
An investor who opts into the 6-1 leverage ratio will be
required to meet certain performance thresholds and redirect
some cash flows to lower the note in order to protect the
lender, which is the FDIC.
For an all cash transaction, the investor would be liable
for 20 percent, or $140 million, based on a $700 million
Investors might find the 6-1 leverage option too onerous,
said University of Louisiana finance professor Linus Wilson,
who questioned why investors would want to partner up with the
government and put up a 20 percent stake equity without cheap
"Thus, 4 to 1 leverage may be the more popular choice,"
Officials said the note could be structured so that it is
marketable instrument, similar to a mortgage-based security.
If the test proves successful, open and operating
institutions will be able to shed troubled loans as long as the
manager follows certain loan-servicing requirements under
either the Home Affordable Modification Program guidelines or
FDIC's loan modification program.
The Legacy Loans Program is part of the government
framework called the Public-Private Investment Program, which
also includes a separate program under the Treasury Department
to sop up troubled securities.
The Treasury unveiled PPIP last year with the goal of
enticing private equity firms who were sitting on the sidelines
awaiting rules on when and how they could participate.
(Reporting by John Poirier and Julie Vorman; editing by John
Wallace, Leslie Gevirtz and Bernard Orr)