Treasury Releases Details On Public-Private Investment Program Targeted At Troubled Assets

Developments Of Note

Treasury Releases Details On Public-Private Investment Program

Targeted At Troubled Assets

FASB Proposals Offer New Guidance On Distressed Sales And

Impaired Assets

Documentation Issues And Risks In Purchasing Residential

Mortgage Loans

FRB Delays Effective Date Of Rule Limiting BHCs' Risk-Based

Capital Calculations

FDIC Extends The Debt Guarantee Component Of The Temporary

Liquidity Guarantee Program

FINRA Identifies 2009 Broker-Dealer Examination Priorities

OCC Issues Interpretive Letter Permitting National Banks To

Engage In Derivative Transactions On Longevity Indices

DEVELOPMENTS OF NOTE

Treasury Releases Details On Public-Private Investment Program

Targeted At Troubled Assets

The Treasury announced further details on its Public-Private

Investment Program ("PPIP"), which is a component of the

Financial Stability Plan. The PPIP directly targets "legacy

assets" - loans and mortgage-backed securities originated

prior to 2009 which have fallen into distress following the

collapse of real estate prices. The Treasury indicated that though

the program initially targets real estate-related assets, it may

evolve, based on market demand, to include other asset classes.

To fund the PPIP, a series of Public Private Investment Funds

(PPIFs) will be formed to invest in both legacy loans and legacy

securities. The Treasury has initially devoted $75 to $100 billion

of TARP funds to the PPIP, which, when combined with private

capital and several leverage mechanisms discussed below, is hoped

to generate at least $500 billion in purchasing power that may be

expanded to as much as $1 trillion. The Treasury anticipates that

its initial investment in the PPIP will be evenly split between the

Legacy Loan Program and the Legacy Securities Program. The Treasury

stated that passive private investors in the PPIP will not be

subject to executive compensation restrictions.

The Legacy Loan Program. The Legacy Loan

Program focuses on real estate loans banks currently hold on their

balance sheets. It is intended to attract private capital to

purchase eligible legacy loans from participating banks through the

provision of FDIC debt guarantees and Treasury equity

co-investment. Eligible banks include any insured U.S. bank or U.S.

savings association. Banks or savings associations owned or

controlled by a foreign bank or company are not eligible. Private

investors may not participate in any PPIF that purchases assets

from sellers that are affiliates of the private investor or

represent 10% or more of the aggregate private capital in the PPIF.

The exact requirements and structure of the Legacy Loans Program

will be subject to notice and comment rulemaking.

Sale of Assets. To start the process, interested banks

should work with their primary banking regulator to identify and

evaluate eligible assets for sale under the PPIP and the

corresponding financial impact on the bank from the sale of such

assets. After identifying a pool of assets to sell, the bank should

contact the FDIC to express an interest in participating in the

Legacy Loan Program. Assets eligible for purchase ultimately will

be determined by the participating banking organizations, including

the primary banking regulators, the FDIC, and the Treasury. The

FDIC will employ contractors to analyze the pools and will

determine the level of non-recourse debt guaranteed by the FDIC to

be issued by the PPIF. This will not exceed, and may be less than,

a 6-to-1 debt-to-equity ratio (e.g., the FDIC will

guarantee up to $6 of debt issued by the PPIF for every $1 of

capital invested in the PPIF by the Treasury and private

investors). An eligible pool of loans, with committed financing,

will then be auctioned by the FDIC to qualified bidders. Private

investors will bid for the opportunity to contribute 50% of the

equity for the PPIF with the Treasury contributing the remainder.

The winning bid for this equity stake together with the amount of

debt the FDIC is willing to guarantee (based on a predetermined

debt-to-equity ratio) will define the price offered to the selling

bank. The bank would then decide whether to accept the offer price.

The price paid to the bank will be in the form of cash or cash and

FDIC-guaranteed debt.

Management of Assets. Once the initial transaction has

been completed, the private capital partners will control and

manage the assets until final liquidation, subject to strict

oversight from the FDIC. The FDIC will play an ongoing reporting,

oversight and accounting role on behalf of the FDIC and

Treasury.

FDIC-Guaranteed Debt. As discussed above, the FDIC will

guarantee non-recourse debt issued by the PPIFs. A fee will be

assessed on the debt guaranteed by the FDIC under the PPIP, a

portion of which will be allocated to the Deposit Insurance Fund.

The FDIC has indicated that the non-recourse guaranteed debt will

initially be placed with the participating banks, possibly as a

portion of the purchase price for the legacy loans, and that the

banks will be able to resell such guaranteed debt at their

discretion.

Example. The following sample transaction illustrates

the PPIP process for legacy loans:

Step 1: A bank with a pool of residential

mortgages with $100 face value that it is seeking to divest

approaches the FDIC.

Step 2: The FDIC determines, according to the

above process, that for this pool the agency is willing to leverage

the pool at a 6-to-1 debt-to-equity ratio.

Step 3: The pool is then auctioned by the FDIC,

with several private sector bidders submitting bids. The highest

bid from the private sector – for example, $84

– is the winner and forms a Public-Private Investment

Fund to purchase the pool of mortgages.

Step 4: Of this $84 purchase price, the FDIC

provides guarantees for $72 of PPIF debt, leaving $12 of equity

(and allowing the FDIC to meet its 6-to-1 debt to equity ratio). In

this case, some or all of the $72 of FDIC-guaranteed debt may be

issued directly to the seller as part of the purchase price.

Step 5: The Treasury then provides 50% of the

equity funding required on a side-by-side basis with the investor.

In this case, the Treasury invests approximately $6, with the

private investor contributing $6.

Step 6: The private investor then manages the

servicing of the asset pool and the timing of its disposition on an

ongoing basis – using asset managers approved and subject

to oversight by the FDIC.

The Legacy Securities Program. The Legacy

Securities Program consists of two related parts designed to draw

private capital into these markets by providing debt financing from

the FRB under an expansion of the Term Asset-Backed Securities Loan

Facility ("TALF") and through matching private capital

raised for dedicated funds targeting legacy securities.

Expansion of TALF. Through the expansion of the TALF,

non-recourse loans will be made available to investors to fund

purchases of legacy securitization assets. In addition to the

current eligible assets under the TALF (asset backed securities

relating to auto loans, student loans, credit card loans, equipment

loans, floorplan loans, small business loans fully guaranteed as to

principal and interest by the U.S. Small Business Association, or

receivables related to residential mortgage servicing advances)

eligible assets are expected to expand to include certain

non-agency residential mortgage-backed securities

("RMBS") that were originally rated AAA, and outstanding

commercial mortgage-backed securities ("CMBS") and

asset-backed securities that are rated AAA. Borrowers will need to

meet certain eligibility criteria. Haircuts will be determined at a

later date and will reflect the risk of the assets provided as

collateral. Lending rates, minimum loan sizes, and loan durations

have not yet been determined

Legacy Securities PPIFs. The Treasury also announced a

program to partner with private fund managers to support the market

for legacy securities, initially by targeting non-agency RMBS and

CMBS originated prior to 2009 with a AAA rating at origination,

which are similar to the asset classes targeted by the expanded

TALF program discussed above. The loans and other assets underlying

these eligible assets must be situated predominantly in the United

States, which limitation is subject to further clarification by the

Treasury. Such eligible assets will be purchased solely from

financial institutions from which the Treasury may purchase assets

under the Emergency Economic Stabilization Act of 2008, which

includes U.S. banks, savings associations, credit unions,

securities broker-dealers, and insurance companies.

Under this program, private investment managers will have the

opportunity to apply for qualification as a PPIF fund manager.

Applicants will be pre-qualified based upon criteria that include a

demonstrable historical track record in the targeted asset classes,

a minimum amount of assets under management in the targeted asset

classes, and detailed structural proposals for the proposed Legacy

Securities PPIF. The Treasury expects to approve approximately five

PPIF fund managers and may consider adding more depending on the

quality of applications received. Approved PPIF fund managers will

have a period of time to raise private capital to target the

designated asset classes and will receive matching equity capital

from the Treasury. PPIF fund managers will be required to submit a

fundraising plan to include retail investors, if possible.

Investors will participate in the PPIF through an investment

vehicle. Private investors may be given voluntary withdrawal rights

at the level the private vehicle, subject to limitations to be

agreed with the Treasury including that no private investor may

have the right to voluntarily withdraw from such an investment

vehicle for three years following the first investment by such

vehicle. These private investment vehicles will be structured so

that benefit plan investors will be eligible to participate as

indirect investors in the PPIFs.

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