The Federal Deposit Insurance Corp. is considering giving banks the chance to share in future profits on loans sold into a U.S. government-financed program to remove distressed assets.
The FDIC may allow the sellers of a loan to get an equity interest in the vehicle that buys it, meaning they would gain from any future increase in the asset’s value. The aim is to give healthier banks an incentive to sell loans at a cheaper price, encouraging more investors to make bids.
“One option is for the seller to retain an equity interest as a part of the consideration for the sale,” Jim Wigand, the FDIC’s deputy director for resolutions and receiverships, said in an interview.
The agency’s plan is part of an effort by U.S. policy makers to remove as much as $1 trillion of illiquid mortgage loans and securities from banks’ balance sheets, giving them the capacity to offer new credit to consumers and businesses. Bank of America Corp. and other lenders have said they will wait to see the prices offered before deciding to participate.
Private investors stand to gain from Treasury Secretary Timothy Geithner’s Public-Private Investment Program should it get up and running, analysts say.
Under the FDIC-run Legacy Loans Program, the agency will extend financing of as much as six times the capital contributed by investors and the Treasury Department to buy assets in auctions of distressed-loan pools.
The FDIC is considering a change in the original outline of how to finance the purchases, according to documents posted on its Web site.
Rather than guarantee debt issued by the buyers as previously envisaged, the program could issue FDIC-backed notes directly to the banks that are selling loans. That would avoid underwriting fees and accelerate the process. It might be a simpler way to run the program, Wigand said.
The FDIC is seeking public comment on a variety of options for implementing the Legacy Loans Program; responses are due April 10. The Treasury is separately seeking private asset managers to set up its Legacy Securities Program, designed to buy mortgage-backed debt and other securities.
By effectively trading illiquid loans in exchange for FDIC- guaranteed notes, 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.
At the same time, banks might be reluctant to accept notes instead of cash, said Chip MacDonald, a partner specializing in financial services at law firm Jones Day in Atlanta.
“They 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, MacDonald said.
No final decision has been made and the FDIC is still considering whether the program should include publicly issued debt. The regulator plans to hire financial advisers to help assemble and assess the asset pools, according to its Web site.
Wigand said letting banks take an equity stake in the vehicles buying the loans wouldn’t violate conflict-of-interest policies designed to ensure banks don’t take unfair positions on both sides of a transaction.
Officials aim to have the first purchases under the PPIP begin within weeks of the conclusion of stress tests this month on the nation’s biggest banks to assess the vulnerabilities of their balance sheets.
The plan may reward investors with 20 percent annual returns on “really toxic” mortgages bought at 45 cents on the dollar by allowing them to borrow six times their money, New York-based Credit Suisse Group AG analysts Carl Lantz and Dominic Konstam wrote in a March 27 report.
The Treasury aims to provide $75 billion to $100 billion from its $700 billion financial-rescue fund for the PPIP.
Details of the FDIC program could change before the program starts. Since the financial crisis began, the agency has made significant changes to some of its initiatives, said Louis Crandall, chief economist of Wrightson ICAP in Jersey City, New Jersey.
“This has been a recurring pattern for months: the economists propose, but the lawyers and accountants dispose,” Crandall said.