FDIC Sells Mortgage Backed Bonds – Is A Taxpayer Bailout Next?

July 30, 2010 – The FDIC today raised $400 million by selling  bonds backed by performing residential mortgages.  The mortgages are part of $39 billion in assets acquired by the FDIC from failed banks (see FDIC’s Mountain Of Failed Bank Assets Grow).  The securities are guaranteed by the FDIC and were sold at a coupon rate of 2.184% with an expected maturity date of 3.66 years, according to the FDIC.

The Federal Deposit Insurance Corporation (FDIC) today closed on a sale of securities as part of a securitization backed by approximately $471.3 million of performing single-family mortgages from 16 failed banks. The investors represented a wide variety of organizations and paid par for the senior certificates. This pilot program marks the first time the FDIC has sold assets in a securitization in the current financial crisis.

The pilot program consisted of three tranches of securities. Approximately $400 million senior certificates, which were sold today, represented 85 percent of the capital structure and are guaranteed by the FDIC. The fixed-rate, senior note sold at a coupon of 2.184 percent and is expected to have an average life of 3.66 years.

The subordinated certificates are comprised of a mezzanine and an over collateralization (OC) class representing 15 percent of the capital structure. The subordinated certificates will be retained by the failed bank receiverships, which may sell all or a portion at some point in the future.

The FDIC uses several strategies to sell assets from failed banks. Securitization is one of the ways in which the FDIC intends to maximize the value of these assets for the benefit of creditors of the failed banks.

Although this is the first time that the FDIC has raised cash by asset securitization, it is not the first time that the FDIC has had to raise cash to deal with the large number of bank failures over the past three years.   As reported by Bloomberg:

The FDIC, which has closed more than 250 banks since 2008, began raising cash in the bond market for the first time since the early 1990s in March. The Washington-based agency that month sold $3.8 billion of guaranteed notes in three deals.

As of May 31, the agency held about $32 billion of assets from failed banks excluding about $7.9 billion of interests in limited liability companies that it has also been creating to help offload its holdings, Barr said.

Two of the FDIC’s March bond sales were backed by its loans to such companies, while the other transaction was a repackaging of existing mortgage bonds.

Some analysts see the FDIC cash raising efforts as a prelude to an unlimited taxpayer bailout of the FDIC and also question the legal status of FDIC insured bond sales.  This issue was addressed in a recent Barrons article:

BEFORE THE FINANCIAL CRISIS is unwound, the Federal Deposit Insurance Corp. expects to have taken over some 300 failed banks. The rapid closures have drained the agency’s cash reserves.

The FDIC must sell assets to continue the closings. It has about $37 billion of bad-bank assets to sell, but the stockpile would bring only 10 to 50 cents on the dollar.

Enter the FDIC’s Securitization Pilot Program, the sale of U.S.-guaranteed FDIC senior certificates. This enables the FDIC to push much of the losses off its books, thanks to the U.S. guarantee of principal and interest. The program starts with a $500 million issue.

And who makes up the losses? The notes are backed by loans that are bundled into agency-administered pools. But ultimately, the losses could be absorbed by Uncle Sam.

Some see the FDIC program as a way to avoid going before Congress to seek funds.

“They aren’t really selling the bad assets. They’re selling the equivalent of a Treasury bond without congressional approval,” says William Black, a former thrift regulator. “It hides the economic substance of what’s really happening—an unlimited taxpayer bailout.”

The FDIC contests the characterization, saying it doesn’t expect a claim on the guarantee because of an equity cushion to absorb the losses, and the use of only performing mortgages in the pools. The agency says a lot of resources stand between it and the taxpayer.

The bottom line is that the taxpayers ultimately pay for everything.  The FDIC needs to raise cash in order to fulfill its mission of protecting depositors from losses when banks fail.  Raising cash by selling bonds backed by failed bank assets is one method of raising cash without increasing deposit premiums on banks or directly borrowing from the US Treasury.  How the banking crisis is ultimately resolved is anyone’s guess at this point.  FDIC asset backed bond sales may not be the ideal solution to the banking crisis, but it provides the FDIC with resources to resolve failed banks, prevent a possible banking panic and protect depositors from losses on failed banks.  Does anyone really want to see the FDIC run out of cash?

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