United States Treasury Department Releases Details of the Public-Private Investment Program

On March 23, 2009, the United States Department of Treasury (Treasury) unveiled the long-awaited details of the Public-Private Partnership Investment Program (PPIP). Targeting illiquid real estate loans held on the books of financial institutions (Legacy Loans) and securities backed by loan portfolios (Legacy Securities), the PPIP is designed to open “lending channels by facilitating a market for distressed assets currently clogging the system.”

The PPIP has been structured to combine $75 to $100 billion in capital from the Troubled Asset Relief Program ¹ with capital from the private sector to generate $500 billion in purchasing power that will used to buy Legacy Loans and Legacy Securities.

The two prongs of the PPIP, the Legacy Loan Program and the Legacy Securities Program, are described in further detail below.

Legacy Loan Program

Under the new Legacy Loan Program, the Federal Deposit Insurance Corporation (FDIC) will provide oversight for the formation, funding and operation of new public-private investment funds (PPIF) that will purchase Legacy Loans. Equity in the PPIFs will come from private investors ² such as financial institutions, individuals, mutual funds, publicly managed investment funds and pension funds. Private investors must be approved by the FDIC. In the Treasury’s Legacy Loan Program Summary of Terms, dated March 23, 2009 (Legacy Loan Term Sheet), it is noted that, “Private Investors may not participate in any PPIF that purchases assets from sellers [of assets] that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF.”

Under the Legacy Loan Program, insured depository institutions (i.e., insured U.S. banks or U.S. savings associations) will decide which pools of loans ³ that they would like to sell. The FDIC will then conduct an analysis of each of the pools to determine the level of debt to be issued by the PPIF that the FDIC is willing to guarantee. Leverage will not exceed a 6:1 debt to equity ratio. Actual leverage ratios will be determined on a pool-by-pool basis by the FDIC, with input from a third party valuation firm. When assessing the supportable leverage of each asset pool, third party valuation firms will be asked to consider, among other factors, “expected cash flows based on type of interest rates, risk of underlying assets, expected lifetime losses, geographic exposures and maturity profiles.”

The FDIC will then conduct auctions for the sale of loan pools. Each bid submitted by a PPIF at the auctions will be accompanied by a refundable cash deposit equal to five percent of the bid value. After the conclusion of each auction, the seller (i.e., the lending institution) will then have a specified period of time to accept or reject the bids. If a PPIF’s bid is accepted, the PPIF would have the option, subject to the maximum leverage ratios determined by the FDIC, of financing a substantial portion of the purchase price through debt financing provided by the seller of the assets. ⁴ For a fee, the FDIC will provide a guarantee of the PPIF’s debt, collateralized by the assets being purchased by the PPIF. Further, the Treasury has committed to fund fifty percent (50%) of the equity requirement for the purchase. Accordingly, the equity requirement for the purchase would be divided evenly, 50%-50%, between the PPIF and the Treasury. ⁵