The U.S. Treasury Department has announced plans for an initiative designed to free up depository institutions’ balance sheets from so-called “legacy assets” – troubled real estate loans or mortgage-backed securities that cannot be disposed of by the institutions holding them and inhibit their ability to raise capital and increase lending. According to Treasury, “[t]hese assets create uncertainty around the balance sheets of those financial institutions, compromising their ability to raise capital and their willingness to increase lending.” Although further details will be forthcoming, including through notice and comment rulemaking, Treasury did provide information about the initiative’s basic structure.
The Treasury initiative has been designed in conjunction with the Federal Deposit Insurance Corporation (“FDIC”) and the Federal Reserve Board (“FRB”). Its thrust is to attract private capital to purchase legacy assets from participating institutions with government assistance. The involvement of private investors is intended to establish a market mechanism for valuing the legacy assets. Treasury has indicated that there will actually be two programs, a “Legacy Loans Program,” designed to remove troubled real estate loans, and a “Legacy Securities Program,” intended to facilitate the cleansing of mortgage-backed securities from institutions’ balance sheets.
The Legacy Loans Program involves the creation by Treasury and the FDIC of multiple Public-Private Investment Funds (“PPIFs”), which will be established to purchase loan pools from participating institutions under criteria established by the FDIC. Equity for each of the PPIFs will come from private investors and Treasury based on a 50/50 split. The FDIC will oversee the PPIFs.
The PPIF’s will finance the purchase of eligible loan pools from participating institutions by issuing debt guaranteed by the FDIC. The FDIC guarantee will be secured by assets purchased by the PPIF. PPIF leverage will not exceed a six (6) to one (1) debt to equity ratio and will vary from pool to pool as determined by the FDIC. Loan pools will be subject to due diligence, valuation and an auction process conducted by the FDIC. Once a bid is selected, the participating institution will have the option to accept or reject the bid. For their loan pools, institutions will either receive cash or a combination of cash and debt issued by the PPIF as consideration. Once assets are sold, the private investor would manage the assets subject to FDIC oversight. The selling institution will service the loans, unless other arrangements are made.
The Legacy Securities Program is intended to liquefy the market for these securities, stimulating the extension of new credit. It consists of two parts. First, the FRB’s existing Term Asset-Backed Securities Facility (“TALF”) will be expanded to include a lending program by which non-recourse loans will be available to investors to fund purchases of legacy securitization assets. Eligible securities are expected to include non-agency residential mortgage-backed securities, that were originally rated AAA, and outstanding commercial mortgage-backed securities and asset-backed securities that are rated AAA. Eligibility criteria for borrowers and loan terms have yet to be finalized.
Second, Treasury intends to create a program by which private investment managers may apply for qualification as Fund Manager (“FM”) for PPIFs. Approved FMs, expected to number about five, will have a specified period to raise at least $500 million in private capital and receive matching equity from Treasury. Additional senior debt will be available to FMs from Treasury. The PPIFs will initially invest in commercial and residential mortgage-backed securities issued before 2009 that were initially rated AAA and that are secured directly by the actual mortgage loans, leases or other assets. The FMs will control the process of asset selection and pricing.
All insured U.S. banks and savings associations are eligible to participate in the Legacy Loan Program so long as they are not owned or controlled by a foreign bank or company. Eligible loan pools must be collateralized by properties located predominantly in the United States. Treasury has instructed interested banks and savings associations to work with their primary federal regulators to identify and evaluate possible loan pools to be sold to PPIFs and the related impact of the sale[s] on the institution. Regulators and interested institutions are directed to seek to “identify and sell assets with a view to restoring maximum confidence for depositors, creditors, investors and other counter parties.” According to Treasury, after identifying a potential pool to sell, an institution and its regulator should contact the FDIC to express the institution’s interest in participating in the program.