TARP UPDATE: Public-Private Partnership Investment Program

On Monday, March 23, 2009 , the Treasury Department announced details on its Public Private Partnership Investment Program (the “Program”), a plan to provide a market for legacy real-estate related loans and securities (“Legacy Assets”). The Program will initially provide financing for $500 billion in activity, with $75 to $100 billion coming from TARP capital, and the entire Program can expand up to $1 trillion.

The funds established under the Program will have three essential features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors. Second, the Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments. Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.

The Program is divided into two components to address the Legacy Assets: a Legacy Loans Program and a Legacy Securities Program. It is anticipated that each program will receive one-half of the TARP resources for Legacy Assets, but the allocation may change in order to achieve the greatest impact.

The Legacy Loans Program. Together the with the FDIC, the Treasury Department created a Legacy Loans Program to attract private capital to purchase eligible legacy loans (“Legacy Loans”) from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment. Legacy Loans are eligible real estate related loans on the books of participating banks.

Participants. A wide range of investors are expected: individual investors, pension plans, insurance companies and other long-term investors. The Legacy Loans Program will create individual Private-Public Investment Funds (“Funds”) to purchase pools of Legacy Loans.

Financing and Management. The Treasury Department and private capital will provide equity financing and the FDIC will provide a guarantee for debt financing issued by the Funds. The Treasury Department will manage investments on behalf of taxpayers. The Treasury Department will provide 50 percent of equity capital for each Fund and private managers will retain control of asset management with FDIC oversight.

Purchasing Process. First, banks will select assets for sale, most likely a pool of mortgage loans. The FDIC will analyze the asset and determine the amount of funding it will guarantee, with leverage not to exceed a 6-to-1 debt-to-equity ratio. The FDIC will conduct an auction for the asset. The winning bidder can fund 50 percent of the purchase’s equity requirement via the Program. If the seller accepts the purchase price, the buyer can finance its purchase (for a fee paid to the FDIC) by issuing FDIC-guaranteed debt collateralized by the purchased asset. Once the assets have been sold, private fund managers will manage the assets until final liquidation.

The Legacy Securities Program. The Legacy Securities Program has two components, each intended to restart the market for eligible legacy securities (“Legacy Securities”), free capital and extend new credit. The former will address recently-issued securities and the latter will deal with securities issued prior to 2009. Legacy Securities are eligible commercial and residential mortgage backed securities originally issued prior to 2009.

(1) Expanding TALF to Legacy Securities. The Treasury Department and the Federal Reserve intend to expand the Term Asset-Backed Securities Facility (“TALF”) to include residential and commercial real estate asset-backed securities. Through the TALF, nonrecourse loans will be made to investors to purchase Legacy Securities, including non-agency residential mortgage-backed securities, outstanding commercial mortgage-backed securities and asset-backed securities that were originally rated “AAA”. Other terms and conditions for Legacy Securities, including the haircut rate, lending rate, minimum loan sizes and loan durations have not yet been determined.

(2) Partnering with Private Investors in Legacy Securities Investment Funds. For legacy mortgage- and asset-backed securities originated prior to 2009 with a “AAA” rating, the Treasury Department will make co-investment/leverage available to up to five fund managers who provide private capital. Fund managers will apply to the Treasury Department (additional information on application below) and if approved, must raise private capital to target designated asset classes. Fund managers will receive matching Treasury funds under the Program. In addition, should investment fund structures meet certain guidelines, fund managers will be able to subscribe for senior debt for the Fund from the Treasury Department in the amount of 50% of total equity capital of the fund.

The Fact Sheet released by Treasury also indicates that requests for senior debt for the fund in the amount of 100% of the total equity capital will be considered, subject to further restrictions on asset level leverage, redemption rights, disposition priorities and other factors the Treasury Department deems relevant. The senior debt will have the same duration as the underlying fund and will be repaid on a pro rata basis as principal repayments or disposition proceeds are realized by the Fund. Senior debt obligations will be subordinated to any financing extended by the Federal Reserve via the TALF.

Applying to Treasury as Fund Manager. Under the Legacy Securities Program, the Treasury Department will partner with approximately five private fund managers. Each private fund manager applicant will be pre-qualified based upon its demonstrated capacity to raise at least $500 million of private capital, its historical track record investing in Legacy Securities, having $10 billion of Legacy Securities under management, being headquartered in the United States, and the details presented in its structural proposals for the Fund. The applicant fund manager must also have the operational capacity to manage the Fund in a manner consistent with the Treasury Department’s stated investment objective and protect taxpayers’ interests. Fund managers must submit a fundraising plan including retail investors, if possible. If approved, fund managers will raise private capital to target the designated asset classes and will receive matching equity capital from the Treasury Department.

Applications must be submitted to the Treasury Department by 5:00 p.m. EST on April 10, 2009. Applicants are required to provide information about the applicant’s qualifications and performance history, investment strategy, governance and management and its valuation, monitoring and reporting methodologies. The applicants must also provide information about the proposed Fund, the structure, summary of terms, debt financing, proposed fees and tax considerations.

The application can be found at http://www.treas.gov/press/releases/reports/legacy_securities_ppif_app.pdf.

Written by Matthew Kulkin