Real Estate Forum

Public/Private Fusion

The FDIC’s recent development of the public/private partnership transaction builds on the traditional direct loan sales program. In this structure, the FDIC as receiver of a failed bank contributes a loan portfolio to a single-purpose limited liability company (“SP LLC”) formed by the FDIC as receiver. The FDIC then sells either a portion (generally 40%) of its membership interest in the SP LLC to a private investor or sells all of its membership interest in the SP LLC to the private investor but retains a participation interest in the cash flows from the loan portfolio. In either case, the FDIC receives cash and retains rights to some portion of future revenues from the loan portfolio.

The FDIC uses several investment advisory firms to market loan portfolios as public/private partnership opportunities to certain parties that have pre-qualified with the FDIC. The pre-qualification process involves demonstrating to the FDIC and its advisors that a private investor has the requisite expertise and experience to manage the proffered loan portfolios. As opportunities arise, pre-qualified parties are notified of the FDIC’s proposed terms for the partnership or participation structure and are provided a limited opportunity to conduct due diligence. Interested parties then submit bids and the FDIC works with the investment advisor to select the winning bid.

The public/private partnership arrangement is generally structured with a seven-year term. The FDIC has the ability to call for liquidation at the end of the seven-year term or earlier if the unpaid principal balance of the pool of assets has been reduced to 10% of the original balance.

Key terms of these deals vary from transaction to transaction. In general, the FDIC has strong approval rights over bulk sales and transfers by the private investor, but the private investor (and any servicer selected by the private investor) has broad discretion over servicing decisions, including dispositions of individual loans or sale of collateral. The agreements with the private investor generally provide for pari passu distributions based on initial capital percentages (usually 60% FDIC/40% private investor), but are often subject to a reverse promote structure where the private owner’s rights to distributions from the SP LLC decline after certain IRR hurdles are achieved (generally at or above 25%). In some cases, private owners have had substantial obligations to contribute additional capital to fund expenses and future advances under the loans, whereas in others the FDIC has agreed to provide advance facilities to fund future advances, especially in the context

of construction loans on unfinished projects. In transactions
with substantial additional capital obligations, guaranties
from creditworthy entities have been required.
Focus on Benefits

In addition to the opportunity to acquire real estate-secured loans in volume at a discount with relatively low transaction costs (because diligence is streamlined and documentation is not highly negotiated), the FDIC has offered optional zero-coupon financing, with repayment generally being subordinate to all transaction costs but senior to distributions to the equity holders in the SP LLC.

Investors have broad discretion over servicing decisions, including terms of workouts and when to exercise remedies such as foreclosure. In general, the investor in a public/ private partnership with the FDIC has three ways to receive a return on its investment and to cover its expenses:

• Due to the insolvency of the originating bank, there are many otherwise performing loans that failed to make payments while the originating bank was having its financial troubles. Once contacted by the servicer, many of these loans purchased at a discount return to performing status.

• Investors with real estate and workout experience can
restructure loans so as to convert nonperforming loans
purchased at a discount to performing loans.

• Investors have the ability to market and sell the loans and collateral assets, subject to limitations on bulk sales imposed by the FDIC. It should be noted, however, that the FDIC must approve of any sales transactions with affiliates of the private investor.

Flex Your Opportunity

The door is open for private investors to partner with the FDIC in a mutually beneficial relationship. For real estate and finance industry participants, acquiring distressed loans and sharing in the upside with the FDIC truly is a more intelligent way of doing things. ■