On March 23, 2009, the U.S. Department of the Treasury (“Treasury”) announced the Public-Private Investment Program (the “Program”). The Program, using $75 to $100 billion in TARP funds and capital from private investors, will initially provide funding for $500 billion of purchases of illiquid loans (“Legacy Loans”) and securities backed by mortgages on residential and commercial properties (“Legacy Securities”). The Program has the potential to expand to $1 trillion in funding. The Program involves the formation of two different types of Public-Private Investment Funds (“PPIFs”) by asset managers to purchase illiquid assets with government assistance, as well as an expansion of the Federal Reserve Bank of New York’s (“FRB-NY”) Term Asset-Backed Securities Loan Facility (“TALF”) program.
Legacy Loans Program
Under the Legacy Loans Program, an unspecified number of PPIFs will be formed by private-sector investors to purchase Legacy Loans from banks and thrifts. The Treasury will provide 50 percent of the equity capital for each PPIF, with individual investors, pension plans, insurance companies, hedge funds and other long-term investors expected to invest alongside the Treasury in each PPIF. A private-sector asset management company will manage the portfolio of each PPIF. However, each PPIF will be subject to oversight by the Federal Deposit Insurance Corporation (“FDIC”), intended to protect against waste, fraud and abuse, and each PPIF will be required to make unspecified representations, warranties and covenants regarding the conduct of business and compliance with applicable law. Each PPIF also will be required to give the FDIC and other regulators access to information, and to grant warrants to the Treasury consistent with the requirements under the Emergency Economic Stabilization Act (“EESA”).
How the Legacy Loans Program Will Work
Participation by a bank or thrift as a seller of loans in this program is voluntary. Any bank or savings association that has FDIC deposit insurance (and is not owned or controlled by a foreign bank or company) may elect to offer a pool of loans for sale under the program. The FDIC has not yet specified the types of loans “and other assets” that will be eligible for sale under the program, except to require that the loans and the collateral supporting the loans must be situated predominantly in the U.S. The FDIC will then determine the financing terms and the amount of financing it is willing to guarantee (which may not exceed a 6:1 debt-to-equity ratio). The FDIC will engage private-sector firms to advise it on the valuation of each loan pool and the appropriate loan terms and leverage for each loan pool. Once the loan terms have been determined, the FDIC will conduct an auction among private investors for the Legacy Loans. The FDIC plans to establish a procedure to “pre-qualify” potential private investors to participate in the auction. Bids must be accompanied by a refundable cash deposit for 5 percent of the bid value. The FDIC will select the highest bidder in the auction, at which point the bank will decide whether it wishes to sell the pool of loans at that price. If the bank accepts the bid, the winning bidder will form a PPIF to purchase the Legacy Loans. The Treasury will provide 50 percent of the equity in the PPIF, and private investors will fund the remaining 50 percent of the equity in the PPIF. The PPIF will purchase the pool of loans from the bank or thrift for a combination of cash and notes of the PPIF guaranteed by the FDIC and collateralized by the pool of loans.
Structure of Legacy Loan Funds
The announcement says very little about the structure and terms of the PPIFs to be formed to purchase Legacy Loans. The Treasury and private investors will invest their capital proportionately and at the same time and will share profits and losses in proportion to equity invested (except that the Treasury will receive additional compensation in the form of warrants). The sponsor of a PPIF may request that the Treasury provide less than 50 percent of the equity (subject to an unspecified minimum equity contribution by the Treasury).
After the PPIF purchases the loan pool, it will be managed by an asset manager which must be approved by the FDIC and which will be subject to “strict oversight” by the FDIC. The selling bank generally will retain the servicing of the assets. The level and types of fees that the asset manager and the servicer may charge are not discussed in the announcement. The PPIF will be required to pay periodic guarantee fees and administrative fees to the FDIC.
The announcement states that “passive” private investors in a PPIF formed to buy Legacy Loans will not be subject to executive compensation limitations.
Timetable for the Legacy Loan Program
Many important terms of the Legacy Loan Program remain to be determined and announced. The FDIC will propose rules for this program for public comment in the next few weeks. However, no date has been announced for the first auction of loans.
Legacy Securities Program
The Legacy Securities Program consists of two parts: (i) establishment of PPIFs to draw private capital into the secondary markets for Legacy Securities by providing matching equity capital under the program, and (ii) expanding the availability of debt financing from the FRB-NY under the TALF program.
Expansion of TALF for Legacy Securities
The TALF program has been limited to the financing of “AAA/Aaa” asset-backed securities issued in 2009. It will now be expanded to provide non-recourse financing from the FRB-NY to investors to fund the purchase of Legacy Securities issued prior to 2009. Eligible Legacy Securities will initially include residential mortgage backed securities (“RMBS”) that were originally rated AAA (or an equivalent rating) by two or more rating agencies and commercial mortgage backed securities (“CMBS”) that are currently rated AAA (or an equivalent rating) by two or more rating agencies. Borrowers will need to meet eligibility criteria, which are not specified in the announcement, but are expected to be similar to those applicable to the existing TALF program. In addition, the haircuts, lending rates, loan sizes and loan durations have not yet been determined, but the announcement states that the Federal Reserve recognizes the need to ensure that the duration of these loans takes into account the duration of the RMBS and CMBS being financed. The loan documentation is expected to be similar to the existing TALF documents.
Legacy Securities PPIFs
Like the Legacy Loans Program, the Legacy Securities Program also seeks to attract private capital by having the Treasury invest in PPIFs side-by-side with private investors. The Treasury announced that it will approve up to five asset managers (“Fund Managers”) to raise private capital to invest in dedicated PPIFs established to purchase Legacy Securities. Private asset managers wishing to participate in the Legacy Securities Program must submit the application found at http://financialstability.gov/ no later than 5 pm ET on April 10, 2009. The Treasury will select the Fund Managers based upon criteria that are anticipated to include, among other things, demonstrated capacity to raise at least $500 million of private capital for a PPIF, a minimum of $10 billion (market value) of eligible assets under management, and demonstrated experience investing in eligible assets, including through performance track records. The Fund Manager must have its headquarters in the United States. The Treasury has indicated that it might increase the number of Fund Managers to more than five.
Once a Fund Manager is designated by the Treasury, it will have an unspecified period of time to raise at least $500 million of private capital commitments for the PPIF. “Retail” investors are required to be included in the fundraising plan “if possible.” The private capital raised by each Fund Manager for a dedicated PPIF will be matched on a dollar-for-dollar basis by the Treasury. Each dedicated PPIF also may obtain debt financing from the Treasury in the amount of up to 50 percent of the PPIF’s equity capital. Debt financing may be increased to a level of up to 100 percent of the PPIF’s equity capital, subject to restrictions on the PPIF’s asset level leverage, investor withdrawal rights, disposition priorities and other factors yet to be determined by the Treasury. This senior debt will be non-recourse financing secured by the PPIF’s portfolio, which will mature at the end of the term of the PPIF. The Treasury’s senior loans will be structurally subordinated to any financing extended by the FRB-NY through TALF, if the PPIF also borrows under the expanded TALF program for Legacy Securities. The Treasury will also receive warrants in each PPIF as required under EESA, but the terms of these warrants were not specified. Once a PPIF has been capitalized, the Fund Manager will have discretion to select and purchase “Eligible Assets” for its portfolio. Initially, only CMBS and RMBS issued prior to 2009 which were originally rated “AAA/Aaa” by at least two rating agencies will be Eligible Assets. The CMBS and RMBS must be secured directly by mortgage loans, leases or other assets and not by other securities (with the exception of certain swap positions). The loans underlying an Eligible Asset must be situated “predominantly” in the U.S. The PPIF must purchase its assets solely from financial institutions from which the Treasury may purchase assets under Section 101(a)(i) of EESA.
Structure of Legacy Security Funds
The announcement contains more information regarding the structure of a PPIF formed to purchase Legacy Securities than the FDIC provided regarding a PPIF formed for the Legacy Loan Program. Each PPIF will have two equity investors, the Treasury and a “vehicle” controlled by the Fund Manager (a “Private Vehicle”) through which private capital will be invested. The Treasury’s equity and debt commitments must be drawn down by the PPIF in tranches as needed for anticipated investments and the draws must be pro rata with draws on the private capital (unless the Treasury agrees to a different schedule). The Treasury will have the right to cease funding its equity and debt commitments in its sole discretion. Each PPIF will have a fixed term of not more than 10 years, subject to extension with the Treasury’s consent. A private investor may not have the right to withdraw capital from the Private Vehicle prior to the third anniversary of the Private Vehicle’s first investment in the PPIF, and cannot have any withdrawal rights if the PPIF borrows from the Treasury. The Fund Manager will have complete discretion over the investment decisions and will control the process of asset selection and pricing, asset liquidation, trading and disposition. A Fund Manager may charge private investors management and incentive fees and may charge a fixed management fee on the Treasury’s invested capital; however, the proposed fees will be considered by the Treasury when evaluating applications by potential Fund Managers. Fund Managers will also be required to comply with requirements similar to those which will be placed on PPIFs under the Legacy Loans Program in order to prevent waste, fraud and abuse and requirements giving the Treasury and regulators access to the PPIF’s books and records. However, these requirements have not been announced.
The announcement states that “passive private investors” in a PPIF formed to buy Legacy Securities will not be subject to any executive compensation limitations.
Timetable for the Legacy Securities Program
The Treasury expects to announce “preliminary” approval of the initial Fund Managers by May 1, 2009. No other information has been provided regarding implementation of the Legacy Securities Program. Important terms of the program will not be known until the Treasury makes a more detailed proposal regarding the PPIFs and the FRB-NY issues proposed terms for the expanded TALF program.
If you would like to review the Treasury’s materials covering the Program, please go to: http://financialstability.gov/.