The Public-Private Investment Program - Gaining Momentum?
Corporate & Finance Alert
November 3, 2009
Back in early April we reported that the Treasury Department, the Federal Reserve Bank, and the FDIC had announced the much-anticipated details of the Public Private Investment Program (“PPIP”). A copy of the April article can be view by clicking here. The PPIP was to focus on the purchase of what were described as “troubled assets.” The initial announcement provided only a general framework, with the detail of the specific elements of the PPIP to be fleshed out quickly in the following months. Much has been written about the PPIP since the announcement in March. However, since March, the financial sector has stabilized and many of the nation’s biggest financial companies have been successful in raising significant amounts of capital and, indeed, a number have returned federal bailout money. This has lead many commentators to question whether the PPIP was still needed.
In August we shed light on the developments since March and reviewed how the programs that make up the PPIP were shaping up. A copy of the August article can be viewed by clicking here. Now three months on a further update is called for. In today’s constantly changing financial environment the PPIP continues to change and adapt. Although not the panacea it was originally envisaged to be, the programs that make up the PPIP remain very much alive and may prove to be more valuable than anticipated should the commercial real estate market suffer in the way that commentators are currently predicting, and seemingly evidenced last week when private equity-backed Capmark Financial Group Inc. filed for a $21 billion bankruptcy.
For those new to the PPIP, basically it consists of two core programs – the legacy loans program (“Legacy Loans Program”) and the legacy securities program (“Legacy Securities Program”). Under both programs, assets are purchased by funds capitalized by equity contributed by Treasury and private investors and leveraged by potentially attractive direct government or FDIC-guaranteed debt financing. Both are built around the same basic concepts of pricing established by private investors and credit support provided by the government. The Legacy Loan Program is designed to create a market for troubled loans still on the balance sheets of US banks (and thrifts). The Legacy Securities Program is designed to remedy the illiquidity in the secondary markets for certain mortgage-backed securities – initially residential mortgage backed securities (known as “RMBS”) and commercial mortgage backed securities (known as “CMBS”).
October Update – Legacy Loans
In our August alert, we reported that on July 31, 2009, the FDIC had announced that it had launched its first test of the funding mechanism contemplated by the Legacy Loans Program in the context of a sale of receivership assets. In the test transaction, the receivership would transfer a portfolio of residential mortgage loans to a limited liability company (“LLC”) in exchange for an ownership interest in the LLC. The LLC would also sell an equity interest to an accredited investor, who would be responsible for managing the portfolio of mortgage loans.
In mid-September, the FDIC announced that it has signed a bid confirmation letter with Residential Credit Solutions (“RCS”), the winning bidder in the pilot sale. The transaction involves loans formerly held by Houston-based Franklin Bank SSB (“Franklin”), which failed in November 2008.
Under the terms of the transaction, the FDIC will set up an LLC and convey to it a portfolio of Franklin’s home loans with an unpaid balance of $1.3 billion. In return, the FDIC will take a note for $727,770,000 from the LLC, which it will guarantee in its corporate capacity. The FDIC anticipated that it will sell the note, which will have a 4.25% coupon funded by the cash flow from the mortgage portfolio, at a future date. The FDIC will keep a 50% equity stake in the LLC, and will sell the other 50% stake to RCS, which will pay just over $64 million in cash. Under the deal, RCS will manage the portfolio and service the loans under the Home Affordable Modification Program guidelines. The FDIC stated that, based on its analysis and assumptions, the present value of this bid equals 70.63% of the outstanding principal balance of this portfolio. The FDIC called the transaction a test case that could be replicated soon, possibly in connection with another bank failure. The FDIC also stated that it will analyze the results of this test sale to determine whether the Legacy Loan Program can be used to remove troubled assets from the balance sheets of banks who have not failed and remain open.
October Update – Legacy Securities
The Legacy Securities Program consists of two separate programs. Both are designed to draw private capital into the markets for legacy securities by providing debt financing. In the first instance from the Federal Reserve by expanding the existing Term Asset-Backed Securities Loan Facility (“TALF”) and, secondly, through Public-Private Investment Funds (“PPIF”), matching private capital raised for dedicated funds targeting legacy securities (“Legacy Securities Program”).
TALF Expansion – Still Going Strong
Back in March 2009, at the time the PPIP was announced, the Treasury and Federal Reserve stated that they would expand the TALF to provide financing to eligible borrowers for the purchase of Legacy Securities. In May the Fed announced that beginning in late June 2009, new-issue CMBS will be eligible collateral under the TALF. At the same time the Federal Reserve Bank of New York released the terms and conditions for this program, including the criteria for TALF-eligible CMBS and underlying assets and the required terms of the TALF loans.
It now appeared that Goldman Sachs could be the first to take advantage of the newly expanded TALF program. A five-year, $400 million loan to Developers Diversified Realty Corp., secured by 28 shopping centers, to be used to repay debt on those properties and others, and to reduce the outstanding amounts of credit facilities, being the likely candidate. Both Developers Diversified and Goldman Sachs are working with the Fed to qualify the loan for the TALF program in an attempt to unfreeze the $700 billion market for securities backed by commercial mortgages.
However, the pipeline of potential issuers under TALF has shrunk as unsecured debt markets opened up to real estate companies, and this deal would mark the first since the Fed program was opened to newly issued commercial-mortgage-backed securities in June. While Simon and Westfield were exploring CMBS transactions, the REIT bond market suddenly thawed out, so both firms rushed to float unsecured debt instead. Simon priced $500 million of bonds on Aug. 6, and Westfield followed with $2 billion of paper on Aug. 26. That enabled the mall REITs to lock in financing at relatively attractive rates, rather than waiting to float untried CMBS deals under the TALF umbrella. However, if the Diversified Properties deal goes well, other issuers could follow. There is evidence to suggest that everyone is sitting on the sidelines to wait for the other guy to go first.
Not surprisingly, the Federal Reserve announced in mid-August that it was extending the TALF program from the December 31, 2009 deadline to March 31, 2010 for newly issued ABS and legacy CMBS and to June 30, 2010 for newly issued CMBS. While the Fed acknowledges that conditions in the financial markets have improved, it still views the markets for asset backed securities and commercial mortgage backed securities as “impaired.” The Fed is also leaving the door open to further extensions should conditions warrant. Another outstanding issue is whether to expand the TALF to include other types of eligible collateral. The Fed said in its announcement that it and Treasury will reconsider the issue “if financial or economic developments indicate that providing TALF financing for investors’ acquisitions of additional types of securities is warranted.”
PPIFs – Getting Closer
Of the nine firms selected to participate as fund managers in the initial round of the program, five – Investco Ltd, The TCW Group, Inc., AllianceBernstein, LP, BlackRock, Inc. and Wellington Management Company, LLP – have now completed initial closings, each with at least $500 million of committed equity capital from private investors.
The five initial closings collectively harness approximately $3.07 billion of private sector capital commitments. These are matched 100 percent by Treasury, representing total equity capital commitments of approximately $6.14 billion. In addition, Treasury will also provide debt financing of up to 100 percent of the total capital commitments of each PPIF, representing approximately $12.28 billion of total equity and debt commitments through October.
Following the initial closings, each of the nine PPIFs will have the opportunity for two more closings over the following six months which will also receive matching Treasury equity and debt financing, with a total Treasury equity and debt investment in all PPIFs envisaged to be $30 billion. Providing up to $40 billion (including private sector capital) for the acquisition of troubled assets.
However, while the Program is moving ahead its success remains very much in the balance. The securities targeted by the Program are no longer considered a huge threat to the banking industry’s stability and a number of the large potential participants have already indicated they no longer need to sell troubled assets in the Program. Also, for those banks that still feel the need to participate, the concern over pricing remains. Analysts predict that the Program’s usefulness will be limited because banks will want far more money for the assets than investors (even with the government subsidy) are willing to pay.
Overall, the various PPIP programs remain on track although smaller than originally anticipated. While they will not be the panacea for the projected billions of dollars of defaulted CMBS loans that are expected to come down the pike in the next 12 – 18 months, they do provide the prospect that some transparency will be injected into distressed asset pricing. However, it remains to be seen whether the valuations are at a level where there is comfort for investors to step in and acquire the troubled assets and sellers are comfortable parting with the assets.