Treasury Releases Details on Public-Private Investment Program Targeted at Troubled Assets
The Treasury announced further details on its Public-Private Investment Program (“PPIP”), which is a component of the Financial Stability Plan. The PPIP directly targets “legacy assets” - loans and mortgage-backed securities originated prior to 2009 which have fallen into distress following the collapse of real estate prices. The Treasury indicated that though the program initially targets real estate-related assets, it may evolve, based on market demand, to include other asset classes.
To fund the PPIP, a series of Public Private Investment Funds (PPIFs) will be formed to invest in both legacy loans and legacy securities. The Treasury has initially devoted $75 to $100 billion of TARP funds to the PPIP, which, when combined with private capital and several leverage mechanisms discussed below, is hoped to generate at least $500 billion in purchasing power that may be expanded to as much as $1 trillion. The Treasury anticipates that its initial investment in the PPIP will be evenly split between the Legacy Loan Program and the Legacy Securities Program. The Treasury stated that passive private investors in the PPIP will not be subject to executive compensation restrictions.
The Legacy Loan Program. The Legacy Loan Program focuses on real estate loans banks currently hold on their balance sheets. It is intended to attract private capital to purchase eligible legacy loans from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment. Eligible banks include any insured U.S. bank or U.S. savings association. Banks or savings associations owned or controlled by a foreign bank or company are not eligible. Private investors may not participate in any PPIF that purchases assets from sellers that are affiliates of the private investor or represent 10% or more of the aggregate private capital in the PPIF. The exact requirements and structure of the Legacy Loans Program will be subject to notice and comment rulemaking.
Sale of Assets. To start the process, interested banks should work with their primary banking regulator to identify and evaluate eligible assets for sale under the PPIP and the corresponding financial impact on the bank from the sale of such assets. After identifying a pool of assets to sell, the bank should contact the FDIC to express an interest in participating in the Legacy Loan Program. Assets eligible for purchase ultimately will be determined by the participating banking organizations, including the primary banking regulators, the FDIC, and the Treasury. The FDIC will employ contractors to analyze the pools and will determine the level of non-recourse debt guaranteed by the FDIC to be issued by the PPIF. This will not exceed, and may be less than, a 6-to-1 debt-to-equity ratio (e.g., the FDIC will guarantee up to $6 of debt issued by the PPIF for every $1 of capital invested in the PPIF by the Treasury and private investors). An eligible pool of loans, with committed financing, will then be auctioned by the FDIC to qualified bidders. Private investors will bid for the opportunity to contribute 50% of the equity for the PPIF with the Treasury contributing the remainder. The winning bid for this equity stake together with the amount of debt the FDIC is willing to guarantee (based on a predetermined debt-to-equity ratio) will define the price offered to the selling bank. The bank would then decide whether to accept the offer price. The price paid to the bank will be in the form of cash or cash and FDIC-guaranteed debt.
Management of Assets. Once the initial transaction has been completed, the private capital partners will control and manage the assets until final liquidation, subject to strict oversight from the FDIC. The FDIC will play an ongoing reporting, oversight and accounting role on behalf of the FDIC and Treasury.
FDIC-Guaranteed Debt. As discussed above, the FDIC will guarantee non-recourse debt issued by the PPIFs. A fee will be assessed on the debt guaranteed by the FDIC under the PPIP, a portion of which will be allocated to the Deposit Insurance Fund. The FDIC has indicated that the non-recourse guaranteed debt will initially be placed with the participating banks, possibly as a portion of the purchase price for the legacy loans, and that the banks will be able to resell such guaranteed debt at their discretion.
Example. The following sample transaction illustrates the PPIP process for legacy loans:
Step 1: A bank with a pool of residential mortgages with $100 face value that it is seeking to divest approaches the FDIC.
Step 2: The FDIC determines, according to the above process, that for this pool the agency is willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool is then auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – for example, $84 – is the winner and forms a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC provides guarantees for $72 of PPIF debt, leaving $12 of equity (and allowing the FDIC to meet its 6-to-1 debt to equity ratio). In this case, some or all of the $72 of FDIC-guaranteed debt may be issued directly to the seller as part of the purchase price.
Step 5: The Treasury then provides 50% of the equity funding required on a side-by-side basis with the investor. In this case, the Treasury invests approximately $6, with the private investor contributing $6.
Step 6: The private investor then manages the servicing of the asset pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC.
The Legacy Securities Program. The Legacy Securities Program consists of two related parts designed to draw private capital into these markets by providing debt financing from the FRB under an expansion of the Term Asset-Backed Securities Loan Facility (“TALF”) and through matching private capital raised for dedicated funds targeting legacy securities.
Expansion of TALF. Through the expansion of the TALF, non-recourse loans will be made available to investors to fund purchases of legacy securitization assets. In addition to the current eligible assets under the TALF (asset backed securities relating to auto loans, student loans, credit card loans, equipment loans, floorplan loans, small business loans fully guaranteed as to principal and interest by the U.S. Small Business Association, or receivables related to residential mortgage servicing advances) eligible assets are expected to expand to include certain non-agency residential mortgage-backed securities (“RMBS”) that were originally rated AAA, and outstanding commercial mortgage-backed securities (“CMBS”) and asset-backed securities that are rated AAA. Borrowers will need to meet certain eligibility criteria. Haircuts will be determined at a later date and will reflect the risk of the assets provided as collateral. Lending rates, minimum loan sizes, and loan durations have not yet been determined.
Legacy Securities PPIFs. The Treasury also announced a program to partner with private fund managers to support the market for legacy securities, initially by targeting non-agency RMBS and CMBS originated prior to 2009 with a AAA rating at origination, which are similar to the asset classes targeted by the expanded TALF program discussed above. The loans and other assets underlying these eligible assets must be situated predominantly in the United States, which limitation is subject to further clarification by the Treasury. Such eligible assets will be purchased solely from financial institutions from which the Treasury may purchase assets under the Emergency Economic Stabilization Act of 2008, which includes U.S. banks, savings associations, credit unions, securities broker-dealers, and insurance companies.
Under this program, private investment managers will have the opportunity to apply for qualification as a PPIF fund manager. Applicants will be pre-qualified based upon criteria that include a demonstrable historical track record in the targeted asset classes, a minimum amount of assets under management in the targeted asset classes, and detailed structural proposals for the proposed Legacy Securities PPIF. The Treasury expects to approve approximately five PPIF fund managers and may consider adding more depending on the quality of applications received. Approved PPIF fund managers will have a period of time to raise private capital to target the designated asset classes and will receive matching equity capital from the Treasury. PPIF fund managers will be required to submit a fundraising plan to include retail investors, if possible.
Investors will participate in the PPIF through an investment vehicle. Private investors may be given voluntary withdrawal rights at the level the private vehicle, subject to limitations to be agreed with the Treasury including that no private investor may have the right to voluntarily withdraw from such an investment vehicle for three years following the first investment by such vehicle. These private investment vehicles will be structured so that benefit plan investors will be eligible to participate as indirect investors in the PPIFs.
The Treasury will invest equity capital on a fully side-by-side basis with the private investors in each PPIF. Furthermore, PPIF fund managers will have the ability, to the extent their PPIF structures meet certain guidelines, to have the PPIF issue to the Treasury non-recourse senior debt in the amount of up to 50% of a PPIF’s total equity capital, and the Treasury will consider requests by the PPIFs to issue non-recourse senior debt in the amount of up to 100% of a PPIF’s total equity capital subject to further restrictions on asset level leverage, redemption rights, disposition priorities, and other factors the Treasury deems relevant. This senior debt will have the same duration as the underlying fund and will be repaid on a pro-rata basis as principal repayments or disposition proceeds are realized by the PPIF. These senior loans will be structurally subordinated to any financing extended by the FRB to these PPIFs via the TALF.
Example: The following sample transaction illustrates the PPIP process for legacy securities:
Step 1: The Treasury will launch the application process for managers interested in the Legacy Securities Program.
Step 2: A fund manager submits a proposal and is pre-qualified to raise private capital to participate in joint investment programs with the Treasury.
Step 3: The Treasury agrees to provide a one-for-one match for every dollar of private capital that the fund manager raises and fund-level leverage for the proposed PPIF.
Step 4: The fund manager commences the sales process for the PPIF and is able to raise $100 of private capital for the PPIF. The Treasury provides $100 equity co-investment on a side-by-side basis with private capital and provides a $100 loan to the PPIF. The Treasury will also consider requests from the fund manager for an additional loan of up to $100 to the PPIF.
Step 5: As a result, the fund manager has $300 (or, in some cases, up to $400) in total capital and commences a purchase program for targeted securities.
Step 6: The fund manager has full discretion in investment decisions, although it will predominately follow a long-term buy-and-hold strategy. The PPIF, if the fund manager so determines, would also be eligible to take advantage of any expansion of the TALF program for legacy securities when such expansion occurs.
