In an attempt to improve bank balance sheets and reduce the cloud of uncertainty associated with certain bank assets, the U.S. Treasury (Treasury) has returned to the once abandoned idea of purchasing troubled assets from insolvent banks with $300 billion from the Troubled Asset Relief Program (TARP). The Treasury is seeking direct involvement from a wide range of private investors (such as hedge funds, mutual funds, pension plans, etc.) and is offering incentives that result in up to 90 percent loan-to-value for a troubled asset purchaser.
The Treasury's recently announced Legacy Loans Program is a public-private venture to purchase asset pools from banks. The Treasury is offering to match private equity investments dollar-for-dollar, and the Federal Deposit Insurance Corporation (FDIC) is willing to guarantee debt incurred in connection with these purchases. The Legacy Loans Program not only offers private investors the opportunity to make sound and potentially lucrative investments, but will also enable banks to improve their balance sheets and stimulate future lending.
Shortly after taking office, President Obama announced his Financial Stability Plan. As part of this plan, on March 23, 2009, Treasury Secretary Geithner outlined the Public-Private Investment Program (PPIP), which returns to the idea, originally conceived by the Bush Administration, of buying up troubled assets with TARP funds. The key to PPIP is the Legacy Loans Program, which seeks to improve bank balance sheets by unloading distressed loans and other assets while reducing the cloud of uncertainty associated with these assets.
The Legacy Loans Program involves the formation, funding and operation of new public-private investment funds (Funds), which will be established to purchase, own and manage pools of assets acquired at portfolio auctions conducted by the FDIC. The asset pools offered by participating banks to the FDIC for divestiture will be made up of loans and other assets that must qualify based upon Treasury and FDIC agreed upon minimum requirements. Private investors (including, but not limited to, financial institutions, individuals, insurance companies, mutual funds, publicly managed investment funds, pension funds, foreign investors with a headquarters in the United States, private equity funds, hedge funds and pension plans) will need to be pre-qualified by the FDIC to be eligible to participate in an asset pool auction and to purchase equity stakes in the Funds. A third-party valuation firm selected by the FDIC will provide independent valuation advice to the FDIC on each asset pool. The valuation firm's analysis will assist the FDIC in discussions with the participating bank to determine the valuation of the asset pools, inform initial views on appropriate leverage and provide information about the structure and value of bids. For a bid to be considered in the auction process, the bid must be accompanied by a refundable cash deposit equal to 5 percent of the bid value. In the event that a bid is unsuccessful, or rejected by the participant bank, the deposit will be refunded to the bidder.
The Legacy Loans Program will be attractive to private investors for two reasons. First, the Treasury will utilize TARP funds to provide co-investment equity to the Fund. The Treasury is initially targeting a 50 percent investment of the equity position in each Fund alongside the private investor in a non-controlling position. Private investors can choose to take less Treasury investment subject to a minimum that has yet to be determined. This investment strategy allows the Treasury to not only potentially seek a limited return of capital but also stretch the remaining TARP funds by including private investors in the initial purchase of troubled assets from participating banks.
Second, the FDIC will guarantee debt issued by a Fund in connection with the purchase of an asset pool. The amount of debt the FDIC guarantees will vary from pool to pool based upon each pool's unique assets; in no event will the debt-to-equity ratio exceed 6-to-1. Once leverage ratios have been established, they will be disclosed to potential investors prior to the submission of a bid as part of the auction process. This, together with the Treasury's equity investment of TARP funds, greatly reduces the capital investment required from a private investor. Furthermore, the FDIC's guarantee is non-recourse and will be collateralized only by Fund assets. A debt-guarantee fee will be charged, a portion of which will be allocated to the Deposit Insurance Fund.
The Legacy Loans Program will also be attractive to the participating bank because not only will troubled assets be taken off its balance sheet, but those assets will be replaced with the Fund's FDIC-guaranteed debt. The bank is then free to sell this debt if it so chooses.
For example, if a hedge fund were to submit a winning bid of $100 million on an asset pool in which the FDIC were willing to leverage at a 5-to-1 debt-to-equity ratio, the hedge fund would put up $10 million of the required equity portion with the Treasury putting up the other $10 million. The new Fund would issue debt for the remaining $80 million of the purchase price, which would be guaranteed by the FDIC. The result is a 90 percent loan-to-value troubled asset purchase for the hedge fund, and the participating bank would hold the $80 million of FDIC-guaranteed debt, or sell it. The hedge fund, having put up only $10 million, would be in a position to control a $100 million asset, and the Federal Government would be at risk for the other $90 million.
Subsequent to the transaction, private investors will control and manage the assets until final liquidation, subject to strict oversight from the FDIC. The Treasury will be responsible for overseeing and managing its equity position in the Funds. The FDIC will be responsible for managing Fund debt guarantees and will play an ongoing reporting, oversight and accounting role on behalf of the FDIC and the Treasury. Ongoing administration fees will be paid to the FDIC by Funds in connection with these oversight functions. Private investors and the Treasury will share profits and losses in proportion to equity invested.
Fox Rothschild has continued to closely examine the Emergency Economic Stabilization Act of 2008 and the various subsequent related programs involving the U.S. Government's attempts to stabilize the economy. Our attorneys have extensive experience in the regulatory representation of financial institutions, and the creation of hedge funds, mutual funds, private equity funds, publicly managed investment funds, pension funds and pension plans. Fox Rothschild also has the experience and knowledge to appropriately examine asset pools that may include real estate loans and other assets and aid in the acquisition and sale of such assets.
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