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Treasury Announces Public-Private Investment Program for Legacy Assets and Expansion of Term Asset-Backed Security Loan Facility

January 1, 0001

 

Overview: Legacy Loans Program and Legacy Securities Program

The United States Department of the Treasury (“Treasury”) announced yesterday another prong of its Financial Stability Plan[1] — the Public-Private Investment Program (“PPIP”) — under which the U.S. Government and private investors will co-invest in Public-Private Investment Funds (“PPIFs”) to purchase toxic, or “legacy”, loans and securities backed by loan portfolios, in each case, initially and primarily focused on residential and commercial real estate mortgages. The PPIP, which is comprised of two programs — the Legacy Loans Program and the Legacy Securities Program — is designed both to cleanse bank balance sheets of troubled legacy loans and to jumpstart the currently highly illiquid secondary markets for legacy securities, in an effort to facilitate access to liquidity by banks and other financial institutions and stimulate the extension of new credit.

Treasury, along with the Federal Deposit Insurance Corporation (the “FDIC”), has established the Legacy Loans Program (“LLP”). The LLP will facilitate the creation of PPIFs by institutional and individual investors, pension funds, insurance companies and other long-term investors, on the one hand, and the U.S. Government, on the other hand, to acquire pools of eligible legacy loans from insured depository institutions (“Participant Banks”). Participant Banks will identify asset pools that they propose to sell to bidding PPIFs in auctions administered by the FDIC. The FDIC will, in consultation with a third party valuation firm, determine the appropriate leverage level for each asset pool (not to exceed a 6-to-1 debt-to-equity ratio). PPIFs will acquire these asset pools through a combination of debt, guaranteed by the FDIC, up to the FDIC-approved leverage amount, and an equity investment (typically funded 50/50 with Treasury funds and private capital).

Treasury has also established the Legacy Securities Program (“LSP”) to provide both equity and debt financing to facilitate the acquisition by PPIFs of legacy securities that will initially include securities backed by mortgages on residential and commercial properties. Pursuant to the LSP, Treasury will approve approximately five private asset managers (“Fund Managers”) to administer separate PPIFs. In order to obtain final approval from Treasury, among other things, each Fund Manager must raise at least $500 million in private equity, which equity investment Treasury will match dollar for dollar. Treasury will also provide senior debt financing of up to 50% of a PPIF’s total equity capital (or up to 100% in certain circumstances). PPIFs participating in the LSP will also be eligible to participate in the Term Asset-Backed Security Loan Facility (click)(“TALF”),[2] which Treasury announced yesterday is expected to be expanded to include, as eligible assets, certain residential mortgage-backed securities that were originally rated AAA and commercial mortgage-backed securities and asset-backed securities that are rated AAA (“Legacy TALF”).

Through both PPIP programs, the U.S. Government expects to use as much as $100 billion in capital from the Troubled Asset Relief Program (“TARP”), combined with capital from private investors, in order to generate $500 billion (with the potential to expand to $1 trillion) in purchasing power to buy legacy assets.

Legacy Loans Program


  • Eligible Assets: Individual pools of legacy loans identified by Participant Banks, in consultation with federal banking regulators, and approved by the FDIC. Eligible assets must be situated predominantly in the United States. Each pool of eligible assets will require a separate PPIF.


  • Eligible Participant Banks: Any insured bank or savings association organized under the laws of the United States or any State, district, territory or possession of the United States. Banks or savings associations owned or controlled by a foreign bank or company are not eligible. Treasury and the FDIC will determine eligibility and allocation for institutions after consultation with the appropriate Federal banking agency.


  • Eligible Private Investor Groups: Private investor groups will be subject to the FDIC’s approval and, once the auction process begins, cooperation among private investor groups will be prohibited. Treasury and the FDIC are encouraging the participation of small, veteran, minority- and women-owned firms.


  • Affiliate Restrictions: A private investor may not participate in a PPIF that purchases assets from a Participant Bank that is an affiliate of such investor or that represents 10% or more of the aggregate private capital in the PPIF.


  • Public Funding: The FDIC will guarantee on a non-recourse basis debt issued by a PPIF to a Participant Bank or the market in exchange for the purchase of an eligible asset pool. The FDIC guarantee will be based on a leverage level that it sets for each asset pool in its sole discretion, not to exceed a 6-to-1 debt-to-equity ratio. The FDIC guarantee will be senior debt of the PPIF, secured by the eligible asset pool purchased by the PPIF. In addition, equity financing from Treasury may account for up to 50% of equity capital of the PPIF. Private investors may choose to take less Treasury equity, subject to a minimum yet to be determined. In addition, alternatives for Treasury’s equity investment may be adopted, as long as they are capital neutral compared with the currently contemplated structure and do not diminish the FDIC’s security package. Treasury will not have control rights with respect to its equity investment.


  • Auction Process:


    • The FDIC will establish the criteria for eligible asset pools, with input from a third party valuation firm selected by the FDIC, advising the FDIC on each eligible asset pool and its appropriate leverage threshold. The FDIC will oversee the formation, funding and operation of PPIFs and will pre-qualify PPIFs to participate in each eligible asset pool auction. In addition, the FDIC will manage the due diligence process and the preparation of marketing materials related to the auction.


    • Each eligible asset pool, together with the committed public funding based on leverage levels determined by the FDIC in its sole discretion, will be auctioned by the FDIC to qualified PPIF bidders. Each eligible bid must be accompanied by a refundable cash deposit of 5% of the bid value. The third party valuation firm will advise the FDIC on the structure and value of bids placed by PPIFs.


    • The FDIC will select the winning bids and the Participant Bank will have the option of accepting or rejecting the bid within a pre-established timeframe. Debt and equity funding for each PPIF will occur at the closing of each eligible asset pool purchase.


  • Debt/Seller Financing: The debt issued by a PPIF is expected to be placed initially at the Participant Bank in exchange for the purchase of an eligible asset pool. Participant Banks will be able to resell the debt into the market.

Click here to view a follow-along graphic on the Legacy Loan Program.


  • Debt Service Coverage Holdback: Each PPIF will be required to holdback a yet-to-be-specified portion of the cash purchase price for the acquisition of eligible asset pools to ensure that the PPIF has adequate working capital to meet anticipated debt servicing obligations, interest expenses and operating expenses. Each PPIF must also maintain a Debt Service Coverage Account in to which cash flows from the purchased asset pool will be deposited until the reserve is fully funded, at which point the excess escrowed holdback will be released to the Participant Bank.


  • Treasury Warrants: Treasury will be entitled to warrants consistent with the requirements of the Emergency Economic Stabilization Act of 2008.


  • PPIF Management and Governance: The FDIC and Treasury will establish parameters by which asset managers will provide asset management and servicing to the PPIFs.[3] PPIFs will be subject to reporting to, and oversight by, the FDIC. Each PPIF must agree to waste, fraud and abuse protections to be determined by Treasury and the FDIC.


  • Access to Books and Records: Each PPIF will be required to provide information to the FDIC so that the FDIC may oversee the PPIF. In addition, each PPIF must agree to provide access to information required by the Special Inspector General of the TARP and the Government Accountability Office (“GAO”).


  • Executive Compensation: The executive compensation restrictions under the TARP will not apply to “passive private investors” in LLP PPIFs.


  • FDIC Fees and Expenses: The FDIC will charge each PPIF an annual guarantee fee based on the outstanding debt balance on each anniversary of the closing date. A portion of the guarantee fee will be allocated to the Deposit Insurance Fund.[4] The FDIC will also receive ongoing administration fees for its oversight function and will be reimbursed for all expenses related to conducting auctions of eligible asset pools.

Legacy Securities Program


  • Eligible Assets: Initially, commercial mortgage-backed securities and residential mortgage-backed securities issued prior to 2009 that were originally rated AAA or an equivalent rating by two or more nationally recognized statistical rating organizations without ratings enhancement and that are secured directly by the actual mortgage loans, leases or other assets and not other securities (other than certain swap positions, as determined by Treasury).


  • Fund Manager Role and Qualifications:


    • Fund Managers will be responsible for raising private capital to invest in joint investment programs with Treasury. In addition, the Fund Manager of each PPIF will control the asset selection, pricing, liquidation, trading and disposition by the PPIF.


    • Treasury expects to approve approximately 5 (or more) Fund Managers, who will be pre-qualified based upon criteria that are expected to include: (i) demonstrated capacity to raise at least $500 million of private capital; (ii) demonstrated experience and track record of investing in LSP-eligible assets; (iii) a minimum of $10 billion (market value) of LSP-eligible assets under management; and (iv) demonstrated operational capacity to manage the PPIFs in a manner consistent with Treasury’s stated investment objective. Fund Managers must also be headquartered in the United States.


    • Applicants will have a limited period of time from preliminary approval to raise at least $500 million of committed private equity capital before receiving final approval from Treasury. Applicants will need to indicate in their applications the amount of time they anticipate needing to raise the minimum private equity capital.


    • To ensure a diversity of participation, Treasury is encouraging small, veteran, minority- and women-owned private asset managers to partner with other private asset managers, if necessary, in order to meet the criteria for Fund Manager eligibility.


    • Private asset managers wishing to participate in this program should submit a pre-qualification application to Treasury by April 10, 2009, with preliminary approval announcements expected by May 1, 2009. A link to the application is included below.


  • Restriction on Affiliate Purchases: Each Fund Manager may only purchase eligible assets from Participant Banks that are not affiliates of such Fund Manager, any other Fund Manager or their respective affiliates or any private investor that has committed at least 10% of the aggregate private capital raised by such Fund Manager.


  • Restriction on Information to Private Investors: Private investors may not be informed of potential acquisitions of specific eligible assets prior to acquisition.


  • Public Funding:


    • Treasury will provide equity financing matching the private capital raised by the Fund Manager on a dollar-for-dollar basis. In addition, each PPIF may obtain secured non-recourse loans from Treasury (“Treasury Debt Financing”) in an amount up to 50% of the PPIF’s total equity capital. Treasury Debt Financing will not be available, however, to any Fund Manager in respect of a PPIF in which the private investors have voluntary withdrawal rights. Treasury will consider requests for Treasury Debt Financing of up to 100% of a PPIF’s total equity capital, subject to restrictions on asset level leverage, withdrawal rights, disposition priorities and other factors that Treasury deems relevant. Fund Managers will have the opportunity to request this additional Treasury leverage and propose additional terms in their applications.


    • PPIFs may also finance the purchase of LSP-eligible assets through the proposed Legacy TALF program, any other Treasury program or debt financing raised from private sources so long as Treasury equity capital and private capital are leveraged proportionately.


    • Loans made by Treasury to a PPIF will accrue interest at an annual rate to be determined by Treasury and will be payable in full at the expiration of the term of the PPIF.

Click here to view a follow-along graphic on the Legacy Securities Program.


  • Equity and Debt Drawdowns: Treasury equity capital will be drawn down in tranches to fund anticipated investments in eligible assets at the same time and in the same proportion as private equity capital is drawn down. Debt financing will be funded concurrently with drawdowns of equity commitments.


  • Termination of Treasury Commitment: Treasury will retain the right to cease funding of committed but undrawn Treasury equity capital and debt financing in its sole discretion.


  • Treasury Warrants: Treasury will be entitled to warrants consistent with the requirements of the Emergency Economic Stabilization Act of 2008.


  • Private Investor Withdrawal Rights: Subject to limitations to be agreed upon with Treasury, private investors may be given voluntary withdrawal rights from the private vehicle through which such investors invest in the PPIF (a “Private Vehicle”). It is expected that no private investor will have the right to voluntarily withdraw from a Private Vehicle prior to the third anniversary of the first investment by such Private Vehicle.


  • PPIF Management and Governance: PPIFs will be managed by Fund Managers according to parameters to be established by Treasury prior to fundraising.


  • Management Fees: Fund Managers may propose to charge Treasury a fixed management fee based on a percentage of equity capital invested and may propose to charge fees to private investors. Treasury will consider the fees proposed to be charged when evaluating applications by prospective Fund Managers. Fees in respect of Treasury equity capital and Treasury’s share of PPIF expenses will be paid solely out of distributions with respect to Treasury equity capital.


  • Access to Books and Records: Each Fund Manager will be required to report monthly to Treasury on eligible assets purchased and disposed, current valuations and profits/losses on eligible assets in its PPIF. Prices of eligible assets for reporting purposes must be tracked using third party sources and annual audited valuations by a nationally recognized accounting firm. Fund Managers must also agree to provide access to books and records of the PPIF to Treasury, the Special Inspector General of the TARP, the GAO and their respective advisors and representatives.


  • Executive Compensation: The executive compensation restrictions under the TARP will not apply to “passive private investors” in LSP PPIFs.


  • PPIF Term: Not to exceed 10 years, subject to extension with Treasury’s consent.

There are a number of areas of the PPIP, certain of which are set forth below, where specifics have yet to be provided by Treasury, the FDIC and the Federal Reserve. Any of these areas may materially impact the structure and mechanics of the LLP and the LSP for prospective private investors.

Legacy Loan Program


  • Eligible Assets: As described above, Participant Banks must demonstrate to the satisfaction of Treasury and the FDIC that proposed loan pools meet certain minimum eligibility requirements; such minimum requirements have not yet been set.


  • Cooperation Among Private Investor Groups: Private investor groups may not “cooperate” among themselves once the auction process begins; Treasury has not, however, provided clear guidelines regarding the ability of private investor groups otherwise to cooperate in connection with their proposed investments in PPIFs. 


  • PPIF Capital Structure: Although the target investment by Treasury is 50%, private investors may choose to structure PPIFs with less Treasury equity capital subject to a yet-to-be-determined minimum.


  • FDIC Guaranteed Secured Debt PPIF Term Sheet: Proposed financing terms and leverage ratios for each PPIF will be established by the FDIC in the FDIC Guaranteed Secured Debt for PPIF Term Sheet and disclosed to potential investors as part of the auction process (prior to bid submission).


  • Auction Minimum Bids: The documents provide that the Participants will have the right to reject or accept the winning bid determined by the FDIC. The documents do not make clear whether this right of the Participant Bank applies to all bids or only those bids which do not meet the minimum purchase price for each eligible asset pool derived from the FDIC's maximum leverage amount and the corresponding minimum equity funding requirements.


  • Treasury Warrants: The mechanics of Treasury’s right to receive warrants in connection with its investments in the LLP remains unclear.


  • Governance/Management: The FDIC and Treasury shall establish certain governance procedures on the management, servicing agreement, financial and operating reporting requirements, exit timing and alternatives for each of the LLP eligible asset pools. Although such procedures are expected to be reflected in standard documentation to the extent practicable, the exact terms are presently unknown. Each PPIF must also agree to unspecified waste, fraud and abuse protections to be defined by Treasury and the FDIC.


  • Reservation of Rights and Proposed Rule-Making: The Proposed Summary of Terms released by Treasury explicitly reserves to Treasury and the FDIC the right to modify the requirements in the Proposed Summary of Proposed Terms or to withdraw it at any time. In addition, Treasury has indicated that the exact structure and requirements of the LLP will be subject to notice and comment rulemaking.


  • Timing: It is not clear when a PPIF could expect to close its first loan or asset pool purchase. The FDIC has indicated that it will be seeking public comment and communicating with stakeholders expeditiously and will launch the LLP as quickly as possible.


  • Executive Compensation: While Treasury has expressly indicated that the executive compensation restrictions under the TARP will not apply to “passive private investors” in LLP PPIFs, the documentation provided by Treasury so far is silent on the application of the TARP’s executive compensation restrictions to private asset managers of the LLP PPIFs. It is also unclear what impact noncompliance by an asset manager with any such restrictions will have on the PPIF and its private investors.

Legacy Securities Program:


  • Eligible Assets: The loans and other assets underlying any LSP Eligible Asset must be situated predominately in the U.S.; this limitation, however, is subject to further clarification by Treasury.


  • Investment Strategy: It is expect that PPIFs will predominantly follow a long-term buy and hold strategy, but Treasury will consider other strategies involving limited trading.


  • Drawdowns: Treasury equity capital will be drawn down in tranches to provide for anticipated investments; this is expected, however, to be subject to limitations to be agreed with Treasury.


  • Termination of Committed Capital: While Treasury reserves the right to terminate committed but undrawn equity and debt financing, it is unclear whether the back-to-back equity commitments provided by private investors to the Private Vehicles and by the Private Vehicles to PPIFs will also be entitled to proportionate reduction or termination.


  • Treasury Warrants: The mechanics of Treasury’s right to receive warrants in connection with its investments in the LSP remains unclear.


  • Governance and Management: Treasury expects to define the final terms and conditions for the PPIFs prior to fundraising. Each PPIF must also agree to unspecified waste, fraud and abuse protections to be defined by Treasury.


  • Debt Financing and Rates: Loans made by Treasury to any PPIF will accrue interest at an annual rate to be determined by Treasury.


  • TALF: PPIFs may finance the purchase of LSP Eligible Assets through the Legacy TALF program, the proposed expansion of the existing TALF program; specifics on the Legacy TALF program have yet to be provided.


  • PPIF Structure Detail: Treasury will request suggestions on PPIF structures from Fund Managers, including with respect to possible recycling of realized capital. In addition, private investors may be given voluntary withdrawal rights, subject to limitations to be agreed with Treasury (including no right to withdraw before the third anniversary of the first investment).


  • Executive Compensation: While Treasury has expressly indicated that the executive compensation restrictions under the TARP will not apply to “passive private investors” in LSP PPIFs, the documentation provided by Treasury so far is silent on the application of the TARP’s executive compensation restrictions to Fund Managers of the LSP PPIFs.


  • Treasury Capital Term: Fund Managers may propose the term of a PPIF consistent with the intention to maximize returns for taxpayers and private investors. Such term may not be greater than 10 years, subject to extension with Treasury’s consent.


Additional information including LSP and LLP term sheets, FAQs and related documents can be obtained at Treasury’s website at: http://www.treas.gov/initiatives/eesa/.


[1] Treasury, along with the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Office of Thrift Supervision, announced on February 10, 2009 a comprehensive Financial Stability Plan designed to restore stability to the U.S. financial system and restore the flow of credit. The Financial Stability Plan includes four core elements: (i) a Capital Assistance Program pursuant to which Treasury would invest in convertible preferred stock of large institutions that undergo comprehensive “stress tests” and smaller institutions that undergo supervisory reviews as a capital buffer and a bridge to private capital; (ii) a Consumer and Business Lending Initiative through a Term Asset-Backed Security Loan Facility using $100 billion of Treasury funding to up to $1 trillion in Federal Reserve lending to fund new consumer loan, small business loan and commercial mortgage asset-backed securities issuances; (iii) a Public-Private Investment Program leveraging public and private capital with public financing to buy “legacy assets” from financial institutions; and (iv) various programs to help homeowners reduce mortgage payments and interest rates and avoid foreclosure through loan modification plans. Additional information on the Financial Stability Plan can be obtained at http://www.financialstability.gov and http://www.treas.gov/initiatives/eesa/.

[2] TALF is presently limited to dollar-denominated, non-synthetic asset-backed securities issued after January 1, 2009 that are AAA-rated with underlying assets that include certain auto loans, credit card receivables, student loans, equipment loans and leases, small business loans and residential mortgage servicing advances. For more information on the existing TALF program, see the attached overview and http://www.newyorkfed.org/markets/talf.html.

[3] Servicing is expected to be provided by the Participant Bank.

[4] The FDIC funds obligations to depositors created under its deposit insurance program first from the Deposit Insurance Fund (“DIF”), then from the Treasury (as FDIC obligations are backed by the full faith and credit of the U.S. Government). Insurance premiums assessed by the FDIC on depository institutions provide funding for the DIF (which premiums are based on the balance of insured deposits at the institution and the degree of risk posed by the institution to the DIF).