Yesterday, the U.S. Treasury and FDIC jointly launched the Public Private Investment Program, designed to “facilitate price discovery” and “draw new private capital into the market” in an effort to “improve the health of financial institutions” currently burdened by legacy loans and securities. The lack of clarity about the value of many of these legacy residential and commercial loans and securitizations backed by such loan portfolios, have created “uncertainty around the balance sheets” of the financial institutions which own them, and caused a congestion in the financial system. To address these issues, the government has chosen to align public and private investor interests through a combination of government financing and the use of private capital and private fund managers to “help provide a market mechanism for valuing these troubled assets.” The Program, funded with between $75 and $100 billion of Troubled Asset Relief Program (TARP) capital, has the following two parts:
Legacy Loans Program - This program will attempt to reduce the “overhang of troubled legacy loans stuck on bank balance sheets,” by attracting private capital from investors to purchase eligible loan assets from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment.
Asset Identification - Eligible banks (U.S. banks or savings associations) should contact the FDIC to express interest in participating in the program, and work with their primary bank regulator to identify and evaluate those assets, usually a pool of loans, they would like to sell (Eligible Assets). Eligible Assets and any collateral supporting those assets must be situated predominantly in the U.S. and the contemplated loan pools must further qualify based upon Treasury and FDIC agreed upon minimum requirements. The FDIC will retain a third party valuation firm to analyze the appropriate valuation of the Eligible Assets, inform initial views on appropriate leverage and provide information about the structure and value of bids.
Auctions - The FDIC will conduct auctions for these Eligible Assets, to be purchased by private investors (Private Investors) at the highest bid, and funded through debt issued by public-private investment funds (PPIFs). Private investors must be approved by the FDIC, and are expected to include an array of different investors, including, but not limited to, other financial institutions, invidivuals, insurance companies, mutual funds, publicly managed investment funds and pension funds. Once a bid is selected, the participant bank (Participant Bank) will have the option of accepting or rejecting the bid within a pre-established timeframe.
PPIF Financing/FDIC Guarantee -The FDIC will conduct an analysis to determine the amount of PPIF funding it is willing to guarantee, provided that, leverage will not exceed a 6-to-1 debt- to-equity ratio. The remaining equity capital of each PPIF will be contributed 50% by each of Treasury and the private investors. Private investors may take more or less equity in each PPIF (subject to a minimum government subscription right to be determined). In exchange for the debt guarantee, the FDIC will charge the PPIFs an annual guarantee fee based on outstanding debt balances. The PPIF will be required to maintain a Debt Service Coverage Account to ensure that working capital for each PPIF is sufficient to meet anticipated debt servicing obligations, interest expenses and operating expenses.
Governance/Management - Private fund managers will control and manage the assets of the PPIF until final liquidation, subject to strict FDIC oversight. Each PPIF must make certain representations, warranties and covenants regarding the conduct of their business and further agree to waste, fraud and abuse protections to be defined by Treasury and the FDIC. Private Investors may not participate in any PPIF that purchases assets from sellers that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF.
Warrants/Executive Compensation - Consistent with the requirements under the Emergency Economic Stabilization Act of 2008, Treasury shall receive warrants in the PPIF, however passive Private Investors will not be subject to any executive compensation restrictions.
Legacy Securities Program – This program will attempt to “address the broken markets for securities tied to residential and commercial real estate and consumer credit” and support the secondary market for mortgage- and asset-backed securities by expanding the previously announced Term Asset-Backed Securities Loan Facility (TALF) and developing PPIFs to purchase legacy securities (securities issued prior to January 1, 2009).
Expansion of TALF – Treasury and the Federal Reserve will be expanding the category of eligible collateral for TALF to include legacy securities consisting of certain non-agency residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) that were originally rated AAA at issuance, but may no longer hold those ratings. This represents a significant departure for the TALF program, which currently includes as eligible collateral only newly issued, AAA-rated securities backed by auto loans, student loans, SBA-guaranteed loans (which do not require the AAA rating), mortgage servicing advances, loans and leases of business equipment, leases of vehicle fleets and auto and other floorplan loans. Treasury did not announce when the new categories of collateral would be included for TALF funding (the initial TALF funding is scheduled to close on March 25, with subsequent funding to occur each month through 2009).
Legacy Securities Investment Funds – Treasury will be co-investing with private investors to create PPIFs to purchase legacy securities consisting of mortgage- and asset-backed securities that had AAA ratings at the time of issuance. Treasury will approve up to five (or possibly more depending on the applications received) asset managers with “a demonstrated track record of purchasing legacy assets.” Each asset manager will form a PPIF and have a specified period of time in which to raise capital, which will be matched 1:1 by TARP funds from Treasury. The Treasury funds will be invested on a side-by-side basis with the private investors, ensuring that the investors and the government share equally in profits and losses. In addition, each PPIF will be eligible to subscribe for senior debt from Treasury in an amount up to 50% (and in certain cases 100%) of the total capital of the PPIF. Each PPIF will also be eligible to receive non-recourse financing from the Federal Reserve under TALF in respect of TALF-eligible legacy securities. Each fund manager will have full discretion investment decisions for the PPIF; however, each fund manager will be encouraged to follow a “long-term buy-and-hold strategy” for its PPIF.