On March 23, 2009, the United States Department of the Treasury ("Treasury") announced details of its Public-Private Investment Program. Similar to the previously announced Term Asset-Backed Securities Loan Facility ("TALF"), also discussed below, the Public-Private Investment Program is intended to increase the availability of credit in the U.S. economy by facilitating purchases of troubled assets from eligible U.S. financial institutions.
The Public-Private Investment Program is comprised of two main elements:
- the Legacy Loans Program, to purchase troubled residential and commercial real estate loans ("legacy loans"); and
- the Legacy Securities Program, to purchase mortgage-backed and consumer credit-backed securities issued prior to 2009 ("legacy securities").
The program may include additional asset classes in the future depending on market demand.
A critical component of the Public-Private Investment Program is the use of public funding, in the form of both debt and equity investments, to help bridge the gap between the price expectations of buyers and sellers. Treasury anticipates generating US$500 billion in purchasing power (with the possibility of increasing to US$1 trillion) to acquire legacy assets by using private capital and US$75 billion to US$100 billion in previously announced Troubled Assets Relief Program ("TARP") capital (to come from the US$700 billion allocated to TARP under the Emergency Economic Stabilization Act (the "EESA")).
It is expected that Treasury will elaborate on many additional details of the Public-Private Investment Program in due course.
Legacy Loans Program
Under the Legacy Loans Program, newly formed public-private investment funds ("Legacy Loan PPIFs") are to purchase legacy loans from FDIC-insured depositary institutions ("Participating Banks") in auctions overseen by the U.S. Federal Deposit Insurance Corporation (the "FDIC"). Participating Banks may not be foreign owned or controlled. While private investors will control Legacy Loan PPIFs, the FDIC will oversee the formation, funding and operation of these entities.
Treasury will provide up to 50% of the equity capital for each Legacy Loan PPIF (subject to yet-to-be-determined minimums) and private investors will bid for the opportunity to contribute the remaining equity capital. As required by the EESA, Treasury will receive an unspecified amount of warrants to acquire additional equity in each Legacy Loan PPIF.
Eligible private investors are expected to include financial institutions, individuals, insurance companies, mutual funds, publicly managed investment funds, pension funds, foreign investors with headquarters in the United States, private equity funds, hedge funds and other long-term investors. Treasury has yet to provide more detailed guidance as to the eligibility of foreign private investors. Private investors may, subject to FDIC approval, form groups prior to the beginning of the auction process. Legacy Loan PPIFs are likely to be structured as partnerships and treated as flow-through entities for U.S. Federal income tax purposes. Foreign investors may want to consider the use of corporate blockers to avoid U.S. return filing requirements.
Private investors are not permitted to participate in any Legacy Loan PPIF that purchases assets from any Participating Bank that either (i) is an affiliate of the investors or (ii) holds 10% or more of the aggregate private capital in such Legacy Loan PPIF. Legacy Loan PPIFs are to have a buy-and-hold investment strategy.
To supplement the private and Treasury equity investment, Legacy Loan PPIFs will issue non-recourse debt, guaranteed by the FDIC, to third-party private investors. FDIC-selected third-party valuation firms ("Valuation Firms") will analyze the legacy loan pools to determine the level of debt that the FDIC will guarantee, up to a maximum 6-to-1 debt-to-equity ratio, and the proposed financing terms and leverage ratios will be disclosed to potential bidders prior to bid submission. Consideration for legacy loans will consist of cash or a combination of cash and debt issued by Legacy Loan PPIFs to Participating Banks and guaranteed by the FDIC. Legacy loans purchased by Legacy Loan PPIFs will collateralize the FDIC guarantees. In consideration for FDIC guarantees, the FDIC will charge yet-to-be-determined annual guarantee fees based on the outstanding Legacy Loan PPIF debt balances. Legacy Loan PPIFs will be required to have committed financing in order to submit bids.
Participating Banks, working with their primary bank regulators, are to identify to the FDIC pools of eligible legacy loans to be auctioned. Eligible legacy loans (and the collateral supporting such loans) must be situated predominantly in the United States. Participating Banks must satisfy Treasury and the FDIC that the pools of legacy loans meet Treasury's and the FDIC's unspecified, agreed upon minimum requirements. Among other services, Valuation Firms will provide asset pool valuation advice to the FDIC. The FDIC will conduct the auctions for the private investor equity component of PPIFs, with bidders paying a refundable cash deposit of 5% of their bid value to participate in the auction. Bidders will reimburse the FDIC for expenses incurred in conducting the auctions as well as oversight expenses. Upon the FDIC's selection of a winning bid, the Participating Bank may accept or reject the bid. Debt and equity financing for each Legacy Loan PPIF will occur at the closing of each purchase.
Under both the Legacy Loan Program and the Legacy Securities Program (discussed below) each Legacy Loan PPIF and Legacy Securities PPIF, among other things, must agree to waste, fraud and abuse protections to be specified by Treasury and the FDIC. Executive compensation restrictions, however, will not apply to passive private investors in Legacy Loan PPIFs and Legacy Securities PPIFs, although it is unclear whether executive compensation restrictions will apply to non-passive private investors.
Legacy Securities Program
Under the Legacy Securities Program, Treasury will select approximately five potential private sector asset managers ("Fund Managers") to manage legacy securities PPIFs ("Legacy Securities PPIFs"). Treasury requirements for such Fund Managers include headquarters in the United States, a minimum of US$10 billion in market value of legacy securities under management, demonstrated capacity to raise at least US$500 million in private capital, demonstrated legacy securities investment experience and demonstrated operational capacity to manage PPIFs consistent with Treasury's investment objectives. Fund Manager applications are due April 10, 2009, and preliminary Treasury approval of Fund Managers is expected by May 1, 2009. Final Treasury approval of a Fund Manager will be dependent on the applicant obtaining at least US$500 million in private capital commitments in a limited period of time after receiving preliminary approval. The criteria for Fund Managers are such as to exclude all but a very limited number of market participants.
Private investors will form a private investment vehicle (the "Private Vehicle") to be managed by the Fund Manager and will invest in a Legacy Securities PPIF side-by-side with Treasury. As required by the EESA, Treasury will receive an unspecified amount of warrants in the Legacy Securities PPIFs (although the amount of Treasury senior debt financing will in part determine the terms and amounts of such warrants). Although Treasury has not yet provided eligibility criteria for private investors, it has indicated the importance of including retail investors.
As with Legacy Loan PPIFs, Legacy Securities PPIFs are likely to be structured as partnerships and treated as flow-through entities for U.S. Federal tax purposes, and foreign investors may want to consider the use of corporate blockers to avoid U.S. return filing requirements.
Treasury has identified a long-term buy-and-hold strategy as the Legacy Securities PPIF investment strategy, although Treasury will consider other limited trading investment strategies. The term of a Legacy Securities PPIF may not exceed 10 years without Treasury consent. However, Treasury may cease funding its undrawn equity and debt capital commitments to any Legacy Securities PPIF at any time without further obligation.
Private investors may receive voluntary withdrawal rights in the Private Vehicle, subject to certain Treasury restrictions, including a prohibition on withdrawals prior to the third anniversary of the first investment by the Private Vehicle. However, Treasury will not provide debt financing to any Legacy Securities PPIF that has a Private Vehicle that gives private investors the right to withdraw.
So long as private investors do not have withdrawal rights, Fund Managers may obtain non-recourse Treasury senior debt secured by legacy securities in an aggregate amount not to exceed 50% of total Legacy Securities PPIF equity capital, although requests for debt financing up to 100% will be considered. Purchases of legacy securities may also be financed through the TALF, other Treasury programs or private sources so long as Treasury equity capital and Private Vehicle capital are leveraged proportionately with private debt financing. Senior debt financing will accrue interest at a yet-to-be-determined annual rate and will be payable in full on the termination date of the Treasury capital term. The TALF will be expanded to permit non-recourse loans to be made to Legacy Securities PPIFs to fund legacy security purchases. The criteria and terms of such TALF loans have not been specified. Senior debt will be structurally subordinated to any TALF loans extended by the Federal Reserve Bank of New York ("New York Fed").
Fund Managers may charge management fees, and such fees will be considered by Treasury in Fund Manager applications. Fixed management fees equal to a percentage of equity capital contributions for invested equity capital will be acceptable to Treasury and will be paid, together with Treasury's share of Legacy Securities PPIF expenses, solely out of Legacy Securities PPIF distributions. Treasury will consider, and has requested suggestions regarding, various structuring matters, including recycling realized capital.
Legacy Security PPIFs will be permitted to purchase eligible legacy securities. Eligible legacy securities are expected to include non-agency residential mortgage-backed securities that were originally rated AAA and commercial mortgage-backed securities and consumer credit asset-backed securities that are rated AAA. Legacy Securities PPIFs may only purchase legacy securities from financial institutions that Treasury is permitted to purchase assets from under the EESA. A Legacy Securities PPIF is not permitted to purchase legacy securities from any seller that is (i) an affiliate of its Fund Manager, (ii) another Fund Manager or its affiliate or (iii) a private investor that has made 10% or more of the aggregate private capital commitments obtained by such Fund Manager. Additional terms of the legacy securities program will be informed by Treasury discussions with Fund Managers. Treasury did not announce how eligible legacy securities will be identified or purchased under the Legacy Securities Program.
Several weeks prior to Treasury's announcement of the Public-Private Investment Program, Treasury and the Federal Reserve Board announced the launch of TALF, which began operations on March 17, 2009. TALF is intended to increase the availability of credit in the U.S. economy by unfreezing markets for asset-backed securities. The Federal Reserve has authorized the Federal Reserve Bank of New York (New York Fed) to lend up to $200 billion (subject to an increase to up to $1 trillion) under TALF.
The New York Fed will provide non-recourse loans to "eligible borrowers" who own "eligible collateral". Eligible borrowers include any (i) business entity organized in the United States that conducts significant activities or operations in the United States (or a U.S.-organized subsidiary of such entity), (ii) a U.S. branch or agency of a foreign bank (other than a foreign central bank) that maintains reserves with a Federal Reserve Bank, (iii) a U.S insured depository institution or (iv) an investment fund (which includes pooled investment vehicles such as hedge funds and private equity funds, and any vehicle that primarily or exclusively invests in eligible collateral and borrows from TALF) that is organized in the United States and managed by an investment manager with a principal place of business in the United States. However, a borrower may not be controlled by a foreign government or managed by an investment manager controlled by a foreign government.
Eligible collateral includes U.S. dollar-denominated cash (i.e., non-synthetic) asset-backed securities that have the highest long-term or short-term investment-grade rating from at least two major nationally recognized statistical rating organizations ("NRSROs") (i.e., Fitch, Moody's and Standard & Poor's) and do not have a credit rating below the highest investment-grade rating from a major NRSRO. U.S. dollar-denominated cash asset-backed securities that are, or for which all of the underlying credit exposures are, fully guaranteed as to principal and interest by the U.S. government are also eligible collateral. The underlying credit exposures must be auto loans, student loans, credit card loans, equipment loans or leases, floorplan loans, small business loans guaranteed by the U.S. Small Business Administration or receivables related to residential mortgage servicing advances, although the classes of acceptable credit exposures may be expanded over time. The underlying credit exposures must not include exposures that are themselves cash or synthetic asset-backed securities, and the expected life for credit card, auto, equipment, floorplan or servicing advance receivables loan asset-backed securities cannot exceed five years. Eligible asset-backed securities must be issued on or after January 1, 2009, with limited exceptions for certain asset classes, and at least 95% of the credit exposures underlying eligible securities must be to U.S.-domiciled obligors.
TALF loans will equal the lesser of par or market value of the eligible collateral, less a haircut of from 5% to 16% depending on the type and expected life of the security. However, if the pledged security has a market value above par, the New York Fed will lend an amount equal to market value – subject to a cap of 110% of par value – minus the haircut. The minimum TALF loan amount is $10 million, and there is no maximum loan amount nor any limit on the number of loans an eligible borrower may request. Borrowers may choose either a fixed interest rate (generally 100 basis points over the three-year LIBOR swap rate) or a floating interest rate (generally 100 basis points over 1-month LIBOR) on each TALF loan, but fixed rate collateral must be pledged against a fixed rate loan and floating rate collateral against a floating rate loan. Interest rates on TALF loans benefiting from a government guarantee will be lower. TALF loans will be secured by a pledge of the eligible collateral and will have three-year terms.
Borrowers may participate in TALF only through primary dealers approved by the New York Fed. Executive compensation restrictions will not apply to TALF participants. TALF loan funds will be disbursed on one day each month through the end of 2009, unless the program is extended by the Federal Reserve. The first TALF loan funds were disbursed in March.
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