FDIC Proposed Rule for Orderly Liquidation Underwhelming for Securitization

Earlier today, the FDIC issued a press release announcing that their Board of Directors had approved a Notice of Proposed Rulemaking (“NPR”) which is intended to further clarify the FDIC’s role and policies in connection with the Orderly Liquidation Authority granted to the FDIC under Title II of the Dodd-Frank Act.

Perhaps the clue provided by the emphasis placed in the press release on the liability of senior executives of a failed firm at the expense of possible good news for the structured finance industry should have been a clue.  Perhaps the FDIC would like issuers and investors to simply rely on the Corporation’s “good intentions” because we come away from our first read of the proposed rule, which is essentially an addendum to an interim rule which was adopted by the FDIC in January 2011 in connection with Title II of Dodd-Frank, with a continued lack of confidence that the FDIC intends to provide clarity to investors in mortgage-backed and other securitized structures.

Today’s NPR, in the FDIC’s own words……..

“This proposed rule (“Proposed Rule”) builds on the interim final rule published by the FDIC on January 25, 2011 (“Interim Final Rule”) to address additional provisions of Title II. The Proposed Rule addresses the following issues: (i) the definition of a “financial company” subject to resolution under Title II by establishing criteria for determining whether a company is “predominantly engaged in activities that are financial in nature or incidental thereto;” (ii) recoupment of compensation from senior executives and directors, in limited circumstances, as provided in section 210(s) of the Dodd-Frank Act; (iii) application of the power to avoid fraudulent or preferential transfers; (iv) the priorities of expenses and unsecured claims; and (v) the administrative process for initial determination of claims and the process for judicial determination of claims disallowed by the receiver.”

It is this last section where we have spent most of our time, considering alternative interpretations for how the FDIC is suggesting they will handle the claims of secured creditors.  If we are correct that this section is intended to include holders of securitized debt of a failed financial institution placed under the FDIC’s stewardship then we see problems.

The proposed rule notes that the receiver must approve all claims and that the value of all pledged collateral “above fair market value” becomes the property of the receiver (we assume to be utilized to settle other claims of the estate).  Other sections define a covered “financial company” to include both on-balance sheet and off-balance sheet transactions.  The rule also seems to make it clear that all claims must go through an administrative claims process and that it will be the FDIC that determines if critical criteria, including the “perfection of security interest” in the related collateral meets all legal criteria.

If we are reading this correctly AND this is exactly the intent of the FDIC, how in the world can a broad investor base take any comfort in their abilities to rely on the market fundamentals of the securitized structure in which they invest?  It seems that the credit analysis moves decidedly away from the collateral and squarely onto the financial condition of the issuer.   We would point out the simple truth that investors, in very many cases, make investment decisions not on the likelihood that they will be paid under the best conditions but that they will likely be paid under poor or even the worst conditions.  We see the continued “lack of clarity” from the FDIC between what they sometimes say and what they put down on paper as a continuing source of frustration for the structured finance industry.

The FDIC Chairman’s pronouncements that this latest rule brings greater certainty to the objective that shareholders and creditors (not US taxpayers) will pay for the failure of  financial institutions makes for good political theater but they continue to avoid the questions that investors, who believe they have purchased assets in the open market from a financial institution and had believed they now own those assets, have about the legitimacy of their rights to those assets.

We await further clarification from the FDIC.

The FDIC release, in its entirety, can be viewed at……

Proposed Rule On Priority Claims Under The Orderly Liquidation Authority of Dodd-Frank Act – PDF

About markferraris
Managing Principal Orchard Street Partners LLC

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