Bloomberg reported in December 2010 that the FDIC planned to sell about $975 million of securities tied to residential and commercial real estate debt through Barclays Capital. Th e offering took the form of three securitizations, with the largest tied to $679 million of commercial property debt. These differed from CMBS issues marketed by investment banks in that the loans backing the securities were smaller and thus lower risk, according to the Wall Street Journal. An FDIC spokesman told Bloomberg that any such sales would be considered private placements and neither confirmed nor denied that the sales were taking place. Galli tells DAI it's too soon to judge if we'll see many such CMBS issues from the FDIC. A follow-up to that Q4 securitization is rumored to be in the works, he says, but it's not clear how positively the market is receiving these deals.

What is clearly a success among investors that can swing them is the FDIC's portfolio sales of commercial real estate loans. This past December alone, there were four such transactions announced with a total unpaid principal balance of more than $720 million, along with a $603-million portfolio of residential mortgages in which Charlotte, NC-based Round Point Financial Group took a 40% stake.

In each of these, the basic format was the same: the FDIC created a limited liability company to hold the assets from failed bank receiverships, offering 1:1 leverage financing to the LLC and retaining a 60% equity stake. The winning bidder serves as the LLC's manager, managing, servicing and ultimately disposing of the LLC's assets.

The largest of these by unpaid principal balance was a $279-million portfolio of 761 distressed residential and development loans, located primarily in Utah, California, Arizona and Nevada. The winning bidder also was based in Utah: Cache Valley Bank of Logan, UT, which put up approximately 22.22% of the unpaid principal balance.

Two of the transactions involved a partnership of Los Angeles-based Colony Capital and the New York City-based Cogsville Group, with other partners joining in. As DAI reported in October, the two firms had teamed up this past summer for a 40% stake in a $1.85-billion package of assets from 22 failed institutions. December's portfolio buys totaled $341 million, comprising more than 700 commercial real estate loans acquired by the FDIC as receiver of 14 failed financial institutions.

In one of these acquisitions, the portfolio consisted of 557 distressed commercial real estate loans with an unpaid principal balance of $204 million; more than 50% of the loans were nonperforming. Eighty-two percent of the collateral in the portfolio was located in Michigan. In the other structured sale, comprising loans with an unpaid principal balance of approximately $137 million from five failed banks in the West, 70% of the collateral was located in Utah. The Michigan portfolio sold for 27% of the unpaid principal balance, while the Western pool sold for 60.1% of the unpaid balance.

Commenting on the Western portfolio acquisition, Cogsville CEO Donald P. Cogsville said in a statement, "We believe that Utah's young and well-educated workforce, coupled with the state's business-friendly policies, will continue to lead the nation in job creation and dramatically increase the value of this portfolio." As for the Michigan-based portfolio, Cogsville says he and his partners in the deal believe that the state is poised for renewed growth. "Like the investors in the new GM, we are confident that America's auto industry still has its best days ahead of it." Partnering with Colony and Cogsville on both transactions were WL Ross & Co. LLC, Invesco Ltd. and Mount Kellett Capital.

Adds Cogsville: "This is a unique opportunity to purchase the distressed real estate assets of commercial banks holding more than $250 billion of non-performing loans, and of special servicers holding another $70 billion. We expect these numbers to grow over the next two years as more of the $1 trillion of commercial real estate loans originated since 2005 come due in a market that has seen prices fall more than 40%."

Galli, who worked on seven of the past eight FDIC structured sales involving commercial real estate and land loan portfolios, with a combined unpaid principal balance of $4.2 billion, told GlobeSt.com in December that the two most recent Colony/Cogsville deals illustrated the FDIC's efforts to expand its offering of smaller loan pools. Having already made smaller pools available, Galli explained in December, the agency went a step further by making those smaller portfolios available in separate pools within the portfolio. Specifically, he tells DAI, the idea is to bring minority-owned players, which may not have access to the funding necessary for the very largest sales, into the game.

Private equity firm Cogsville is one such minority-owned investor; another is New York City-based Hudson Realty Capital, which in December closed on the purchase of 109 commercial real estate loans with an unpaid principal balance of more than $102 million in partnership with the FDIC. HRC was the successful bidder for the FDIC Multibank Commercial Real Estate Venture Loan and Real Estate Owned Structured Transaction, Southeastern Pool, and claims to be the first certified minority-owned business that has won an FDIC-structured sale.

The portfolio involved loans from seven failed banks, located mainly in Florida and Georgia. "While we have been focused on new, one-off loan originations and purchases, we expect the purchase of distressed pools of assets to become a larger portion of our business," HRC managing director Spencer Garfield said in a release. To facilitate the resolution of the portfolio over the next several years, HRC has opened a branch office in Fort Myers, FL.

The FDIC's structured sales have effectively removed billions of dollars in distressed loans from the agency's books, including a deal that Galli tells DAI is worth $820 million and was set to close as this issue is published. Yet he believes that these transactions serve as "a stepping stone" to what could be a "tsunami" of deals in 2011 and 2012 as private institutions adopt the FDIC template.

As described in DAI this past October, the private-sector version of the FDIC's structured sales would entail a bank that owns a non-performing loan portfolio to create an LLC in which a private equity investor takes a 40% stake. The value of the loans would be enhanced by the skill set of the asset manager; Galli reiterates that the core terms of these deals would be very similar to the FDIC's. Banks will provide financing on these deals at close to 0% interest, similar to the federal agency's terms.

He charts several factors that will give rise to FDIC-like joint ventures between banks and private equity on structured sales. For one thing, banks are now in a position to take a hit on losses from NPL sales, thanks to profits that will off set these losses. At the same time, though, Galli believes that banks will engage in these JVs to realize a loss on a portion of a distressed portfolio, rather than selling the entire portfolio at a loss. For another thing, banks now consider loan originations a greater priority these days, and as they reallocate resources for making loans, they'll look to private equity and special servicers to provide asset management capabilities and other exit strategies on NPL portfolios.

Additionally, Galli says, solutions are under development for accounting and regulating constraints on JVs between banks and private equity firms on bank owned NPL portfolios. Finally, investors' return requirements are evolving over time. "We have been extensively involved in exploring various structures proposed for these JVs as a result of our extensive experience on structured transactions for NPL portfolios in public-private partnerships with the FDIC and on similar JVs between private parties," he tells DAI.

Galli says his firm is gearing up for the coming tidal wave. "We have invested an extraordinary amount of time to position ourselves for providing services on the volume of non-performing loan portfolios that are trading and will trade soon in greater volume," he says. "We have done so by establishing teams in each of the states in which we have offices, with those teams having a balance of talent ranging from paralegals and mid-level associates to senior shareholders and a combination of attorneys in our real estate, bankruptcy, tax, partnership, environmental and related practice groups."

Notwithstanding these preparations and the numbers cited by Cogsville, Galli says it's too early to say how sizable the market created by these private- private partnerships will be; a third wave of public-private partnerships involving public agencies other than the FDIC is still a few years away. However, it should be noted that both the FDIC and the private sector's potential market for structured sales continues to grow. Since DAI covered the FDIC's structured- sales program this past October, the agency has announced nearly three dozen more bank closings. Six have gone into receivership just since the beginning of 2011; there were 157 bank closings for all of 2010, including 29 in Florida alone. Moreover, Galli says, the FDIC's watch list currently runs to 903 banks with a combined $431 billion of assets. Commercial real estate exposure is generally the biggest headache most of these institutions face. Add to this roster the banks that haven't appeared on the watch list yet, he says, "and you can only imagine the opportunities that will arise."

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