Zero Hedge

After the PPIP seemed like a done deal with its legacy loan and legacy security purchasing aspects already virtually set in stone, the FDIC surreptitiously slipped this Request For Comments (RFC) on its website. Two of the proposed questions submitted by the FDIC bear particular attention:

10. Would it be preferable for the selling bank to take a note from the PPIF in exchange for the pool of loans and other assets that it sells? Alternatively, what would be the advantages and disadvantages of structuring the program so that the PPIF issues debt publicly in order to pay cash to the selling bank? Would a public issuance of debt by the PPIF limit its flexibility compared to the issuance of a note to a selling bank?

and

2. Which asset categories should be eligible for sale through the LLP? Should the program initially focus only on legacy real estate assets or should any asset on bank balance sheets be eligible for sale? Are there specific portfolios where there would be more or less interest in selling through the LLP?

Assuming there is sufficient endorsing response on point 10, the PPIP, as currently structured may end up getting turned around on its head. Instead of providing outright guarantees to the non recourse loans that will be used to purchase legacy loans (thus benefitting "private" investors such as PIMCO), the FDIC may end up issuing FDIC-backed notes directly to the banks that are selling loans. The presumption is that by exchanging illiquid loans into FDIC guarantee debt, the selling banks would "strengthen their balance sheets." The FDIC notes would carry higher ratings and may also be eligible for use as collateral for Federal Reserve loan facilities (thus allowing these toxic assets to be used as leverage). In exchange for this principal risk, the banks would get an equity upside component themselves. According to Jim Wigand, FDIC deputy director for resolutions and receiverships, "One option is for the seller to retain an equity interest as a part of the consideration for the sale."

A logical push back to this proposal was voiced by Jones Day partner Chip MacDonald: “[Banks] may need the liquidity of those notes, and it’s not clear there will be a meaningful secondary market for them so banks could sell them for cash."

Furthermore, the potential abuses arising from conflicts of interest, as the banks would take positions on both sides of the transaction, could be dramatic, although likely to have little impact in the FDIC's ultimate decision which has long since lost any credibility of a fair and equitable arbiter.

Additionally, point 2 opens up the potential for banks to endorse the FDIC's support of virtually any security to be eligible for taxpayer subsidies: if this is not nationalization in anything but name, we would refer to our readers to point out how better to call it.

Of course, the parties most opposed to this would be the PIMROCKs of the world, who will thus be unable to participate via a cheap 12x leveraged equity position in the legacy loans.

Ultimately, this whole argument may be moot thanks to the FASB's earlier conversion of all
"assets" to Level 3 equivalency status, and thus the RFC may just be a way out for the FDIC to jettison the whole legacy loan program after receiving "too many divergent opinions."

Additionally points 14 and 17 (see below) are just amusing in their entirety, so I present them without comment.

The entire RFC is presented in its entirety below, and there is an April 10th deadline for comments. We encourage our non-braindead (yet) readers to submit what they really think about the legacy loan program directly to the FDIC.

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II. Request for Comment

The FDIC is requesting comment from interested parties on all aspects of the proposed LLP. In particular it has formulated the following questions for interested parties to consider:

1. Which asset categories should be eligible for sale through the LLP? Should the program initially focus only on legacy real estate assets or should any asset on bank balance sheets be eligible for sale? Are there specific portfolios where there would be more or less interest in selling through the LLP?

2. Should the initial investors be permitted to pledge, sell or transfer their interests in the PPIF? If so, how should the FDIC ensure that subsequent investors meet the program's criteria for investors?

3. What is the appropriate percentage of government equity participation which will maximize returns for taxpayers while assuring integrity in the pricing by private investors? How would a higher investment percentage on the part of the government impact private investment in PPIFs? Should the amount of the government's investment depend on the type of portfolio?

4. Is there any reason that investors' identities should not be made publicly available?

5. How can the FDIC best encourage a broad and diverse range of investment participation? How can the FDIC best structure the valuation and bidding process to motivate sellers to bring assets to the PPIF?

6. What type of auction process facilitates the broadest investor participation? Should we require investors to bid on the entire equity stake of a PPIF, or should we allow investors to bid on partial stakes in a PPIF? If the latter, would a Dutch auction process or some other structure provide the best mechanism for bridging the potential gap between what investors might bid and recoverable value? If multiple investors are allowed to bid through a Dutch auction, or similar process, how should asset management control be determined?

7. What priorities (i.e., types of assets) should the FDIC consider in deciding which pools to set for the initial PPIF auctions?

8. What are the optimal size and characteristics of a pool for a PPIF?

9. What parameters of the note and its rate structure would be essential for a potential private capital investor to know at the time of the equity auction to provide equity?

10. Would it be preferable for the selling bank to take a note from the PPIF in exchange for the pool of loans and other assets that it sells? Alternatively, what would be the advantages and disadvantages of structuring the program so that the PPIF issues debt publicly in order to pay cash to the selling bank? Would a public issuance of debt by the PPIF limit its flexibility compared to the issuance of a note to a selling bank?

11. In return for its guarantee of the debt of the PPIF, the FDIC will be paid an annual fee based on the amount of debt outstanding. Should the guarantee fee be adjusted based on the risk characteristics of the underlying pool or other criteria?

12. Should the program include provisions under which the government would increase its participation in any investment returns that exceed a specified trigger level? If so, what would be the appropriate level and how should that participation be structured?

13. Should the program permit multiple selling banks to pool assets for sale? If so, what constraints should be applied to such pooling arrangements? How can the PPIF structure equitably accommodate participation by smaller institutions? Under what process would proceeds be allocated to selling banks if they pool assets?

14. What are the potential conflicts which could arise among LLP participants? What structural arrangements and safeguards should the FDIC put into place to address or mitigate those concerns?

15. What should the relative role of the government and private sector be in the selection and oversight of asset managers? How can the FDIC most effectively oversee asset management to protect the government's investment, while providing flexibility for working assets in a way which promotes profitability for both public and private investors?

16. How should on-going servicing requirements of underlying assets be sold to a PPIF and paid for? Should value be separately attributed to control of the servicing rights?

17. Should data used by the independent valuation consultant, as well as results of such consultant's analysis, be made available to potential bidders? Should it be made available to potential sellers prior to their decision to submit assets to bid?

Comments on the LLP may be submitted until April 10, 2009.

You may submit comments by any of the following methods:
E-mail: LLPComments@FDIC.gov. Include "Legacy Loans Program" in the subject line of the message.

Mail: Robert E. Feldman, Executive Secretary, Attention: Comments, Federal Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC 20429.
Hand Delivery/Courier: Guard station at the rear of the 550 17th Street Building (located on F Street) on business days between 7 a.m. and 5 p.m. (EDT). Sphere: Related Content

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