First Toxic Asset Deal Goes to Texas Investor

Nearly a year after policymakers first started talking about ways to get toxic assets off bank balance sheets, the Federal Deposit Insurance Corp. said last week that it has sealed a deal with a Texas mortgage investment firm.

Receiving a big chunk of financing from the agency, Residential Credit Solutions of Fort Worth will purchase a piece of a $1.3 billion loan portfolio from the $4.9-billion-asset Franklin Bank in Houston.

The deal for Franklin, which failed in November, is the first transaction in the government's effort to help sell toxic loans, which was the initial idea for the $700 billion Troubled Asset Relief Program enacted in October 2008. The deal is substantially different from what regulators envisioned. Under the Legacy Loans Program, a revamped toxic-asset plan launched in March, the FDIC was to hold auctions to help finance the sale of bad loans from open banks.

Instead, the plan appears to be primarily a way to help the FDIC purge assets inherited from failed banks.

RCS would pay roughly $64 million to own roughly half of the portfolio. The firm and the FDIC would share control of a new limited liability company, to which the FDIC would lend nearly $730 million. The deal is designed to reward both parties over time, as the assets recover value and RCS helps pay off the agency's note.

Overall, the FDIC said it thinks these assets are worth just over $900 million, or roughly 70% of the face value. Officials deemed the deal a success, saying it will be followed by similar deals for failed-bank assets and could serve as a model for open-bank deals.

"We plan on having some" failed-bank "sales scheduled for this fall, and there might be actually one other type of transaction out of a failed bank with a similar-type structure relatively soon," said an FDIC official, briefing reporters on the plan. "What we were doing here was looking at a mechanism that is contemplated to be used in the LLP to both test the operational issues as well as the effectiveness of it and we believe we accomplished those objectives and would be ready to apply it either for failed bank assets or open banks."

But observers continued to raise doubts about whether the structure could ultimately be adapted for open institutions.

Since the program was originally proposed, institutions have expressed concern about the available prices, and said keeping hold of their assets for a market recovery made more sense.

Ralph "Chip" MacDonald, a partner in the law firm Jones Day, said that, though the agency "expanded the market" with the deal and "got a pretty good price" for the assets, "it's going to be harder" when an open bank is the seller.

"It's much easier to do when the FDIC owns the loans that are being sold," Mr. MacDonald said.

Still, he said, "the concept is useful in disposing of loans, especially from failed banks."

The FDIC announced the bidding process for the portfolio on July 31, saying it wanted to test the effectiveness of using government leverage.

Bidders vying for the Franklin loans could either propose buying 20% of the LLC without government financing, though their ownership stake could rise as high as 60% if the assets improved.

If a bidder opted for government financing, it would share control 50-50 with the FDIC, and the agency would lend $4 or $6 for every $1 of equity.

RCS opted for a 6-to-1 leverage, and the FDIC would match RCS's $64 million contribution. That total of $128 million - in addition to the FDIC financing - would be used to purchase the $1.3 billion of assets at a discount.

The FDIC financing would come in the form of a bond issued by the LLC that the agency will guarantee. Officials said the FDIC would likely sell the note at a future date.

The FDIC official said the agency was still examining whether the model can work for open institutions.

"We are continuing with looking at using the LLP," the official said. "Should market conditions dictate, we will assent to obtain the full parties that would be interested in participating in an LLP process, and move forward."

As for failed banks, the pilot program proved other receiverships could be dealt with using the FDIC financing.

"With the results indicated here, we are likely to use a similar type of structure for the sale of assets, particularly distressed assets, out of failed institutions," the official said.

The deal is expected to close this month.

Joe Adler is a reporter at American Banker.