The Public-Private Investment Program - What's Going On? Is It Still Needed?
Corporate & Finance Alert
August 4, 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 viewed 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 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 somewhat 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. Many commentators question whether the PPIP is still needed. This article sheds light on the developments since March and how the programs that make up the PPIP are shaping up.
The PPIP 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”).
Update – Legacy Loans
In order to help cleanse bank balance sheets of troubled legacy loans and reduce the overhang of uncertainty associated with these assets, the FDIC and Treasury designed the Legacy Loan Program.
The Legacy Loan Program is intended to boost private demand for distressed assets and facilitate market-priced sales of troubled assets. The FDIC would provide oversight for the formation, funding, and operation of a number of vehicles that will purchase these assets from banks or directly from the FDIC. Private investors would invest equity capital and the FDIC will provide a guarantee for debt financing issued by these vehicles to fund asset purchases. The FDIC’s guarantee would be collateralized by the purchased assets. The FDIC would receive a fee in return for its guarantee.
Originally, under the Legacy Loans Program, banks would identify loans they plan to sell. The FDIC would analyze the loans and determine the level of debt to be issued by the purchasing entity that the FDIC will guarantee; however the leverage ratio would not be permitted to exceed a 6-to-1 debt-to-equity ratio. The FDIC would then conduct an auction for the loans; private investors would bid for the loans and the bank would then decide whether to accept an offer. The winning bidder would then form a Public-Private Investment Fund (“PPIF”), to which it would contribute 50% of the required equity in excess of the guaranteed debt with the Treasury contributing the remaining 50% of equity. Private investors would be prequalified by the FDIC to participate in the auctions. The FDIC-guaranteed debt would be collateralized by the purchased assets and the FDIC would receive a fee in return for its guarantee. Once the PPIF purchases the assets, the private fund managers would control and manage the assets until final liquidation, subject to FDIC oversight.
On June 3, 2009, the FDIC appeared to scale back the Legacy Loan Program and recognize that the need for the program had diminished, when it announced that the planned pilot sale of assets by open banks would be postponed. In making the announcement, FDIC Chairman Bair stated, “Banks have been able to raise capital without having to sell bad assets through the [Program], which reflects renewed investor confidence in our banking system. As a consequence, banks and their supervisors will take additional time to assess the magnitude and timing of troubled assets sales as part of our larger efforts to strengthen the banking sector.”
Instead, the FDIC elected to test the funding mechanism contemplated by the Program in a sale of receivership assets. This funding mechanism draws upon concepts employed by the Resolution Trust Corporation in the 1990s, which routinely assisted in the financing of asset sales through use of leverage.
On July 31, 2009, the FDIC announced that it had launched its first test of the funding mechanism contemplated by the Program in the context of a sale of receivership assets. In the test transaction, the receivership will transfer a portfolio of residential mortgage loans to a limited liability company (“LLC”) in exchange for an ownership interest in the LLC. The LLC also will sell an equity interest to an accredited investor, who will be responsible for managing the portfolio of mortgage loans.
Accredited investors will be offered an equity interest in the LLC under two different options. The first option is on an all cash basis, which is how the FDIC has recently sold receivership assets, with an equity split of 80 percent (FDIC) and 20 percent (accredited investor). The second option is a sale with leverage, under which the equity split will be 50 percent (FDIC) and 50 percent (accredited investor).
The funding mechanism is financing offered by the receivership to the LLC using an amortizing note that is guaranteed by the FDIC. Financing will be offered with leverage of either 4-to-1 or 6-to-1, depending upon certain elections made in the bid submitted by the private investor. If the bid incorporates the 6-to-1 leverage alternative, then performance of the underlying assets will be subject to certain performance thresholds. The performance thresholds will not apply if the bid is based on the lower leverage option.
The FDIC stated that it will “…analyze the results of this sale to see how the Program can best further the removal of troubled assets from bank balance sheets, and in turn spur lending to further support the credit needs of the economy.”
According to the UK Guardian newspaper, FDIC spokesman Andrew Gray declined to comment on the size of the asset pool or the trial institution involved but said investors, who must sign a confidentiality agreement, have until September to submit bids.
So, although the Legacy Loan Program still exists, at least in a trial format, the decision to move forward appears more to do with confidence building rather than making any serious dent in removing troubled assets from banks’ books. Back in June, Chairman Bair acknowledged that this element of the PPIP was now being configured more as a safety-net when she stated: “ The FDIC will continue its work on the [Program] and will be prepared to offer it in the future as an important tool to cleanse bank balance sheets and bolster their ability to support the credit needs of the economy.”
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 – Underway
The TALF is a credit facility designed to restore liquidity to the market for asset-backed securities. The TALF began operations in March 2009 in relation to a variety of asset-backed securities (“ABS”) and has been considered a moderate success, helping borrowers raise $65 billion in sales of bonds backed by everything from credit cards to car loans. The Federal Reserve has so far made around $35 billion in TALF loans to investors buying these securities. Federal Reserve Chairman Ben Bernanke told Congress on July 21, 2009 that TALF has “been effective,” in restarting some consumer-lending markets and suggested the Fed is considering expanding TALF to “some alternative assets.”
Under the TALF, the Federal Reserve provides non-recourse loans to investors who hold legacy ABS assets. Borrowers need to meet certain eligibility criteria and will be permitted to borrow an amount equal to the value of the legacy securities (which are pledged as collateral) minus a haircut. TALF is designed to jump-start lending by increasing investor demand for securities tied to all kinds of assets, including consumer and commercial loans. As long as banks can move loans off their books by repackaging and selling them as bonds, they will be able to make more loans.
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. At the time, the eligibility criteria and haircuts were yet to be determined. Similarly, lending rates, minimum loan sizes, and loan durations were not available.
This all changed in May when 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 (“FRBNY”) 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.
There have been no deals so far, but a number of new CMBS deals are designed to take advantage of TALF. For example, shopping center giant Developers Diversified Realty Corp. is reportedly working on raising $600 million and Vornado Realty Trust, one of the U.S.’s largest real-estate investment trusts, is reportedly planning on raising between $550 million and $600 million, both through bond sales that would qualify for TALF financing. Both deals are expected to hit the market in the fall.
However, the FRBNY will cease making loans under the TALF on December 31, 2009, unless the Fed agrees to extend the program. Real-estate industry groups are lobbying for the Fed to extend the TALF program beyond its current sunset date, through the end of next year. Jeffrey DeBoer, president of the Real Estate Roundtable, the chief lobbying group for the industry, was recently quoted in the WSJ: “Approving and securitizing a TALF-eligible commercial real-estate loan takes at least three months, unless the government acts soon this potentially positive program will effectively end in mid-September.”
PPIFs – In the Pipeline
Under this program, private investment managers have the opportunity to apply for qualification as a PPIF fund manager. After a two-month beauty contest, involving a number of extensions to the original April 10th deadline, the Treasury announced on July 9, 2009, that it had pre-qualified nine firms to participate as fund managers in the initial round of the program:
- AllianceBernstein, LP and its sub-advisors Greenfield Partners, LLC and Rialto Capital Management, LLC;
- Angelo, Gordon & Co., L.P. and GE Capital Real Estate;
- BlackRock, Inc.;
- Invesco Ltd.;
- Marathon Asset Management, L.P.;
- Oaktree Capital Management, L.P.;
- RLJ Western Asset Management, LP.;
- The TCW Group, Inc.; and
- Wellington Management Company, LLP.
Applicants needed to satisfy criteria, including: (i) demonstrated capacity to raise at least $500 million of private capital; (ii) demonstrated experience investing in “Eligible Assets,” including through performance track records; (iii) a minimum of $10 billion (market value) of Eligible Assets under management; (iv) demonstrated operational capacity to manage the funds in a manner consistent with Treasury’s stated investment objective while also protecting taxpayers; and (iv) headquartered in the United States.
The fund managers were also noted for having established meaningful partnership roles for small-, veteran-, minority-, and women-owned businesses. These roles include, among others, asset management, capital raising, broker-dealer, investment sourcing, research, advisory, cash management and fund administration services. Ten leading small-, veteran-, minority-, and women-owned financial services businesses were named:
- Advent Capital Management, LLC;
- Altura Capital Group LLC;
- Arctic Slope Regional Corporation;
- Atlanta Life Financial Group, through its subsidiary Jackson Securities LLC;
- Blaylock Robert Van, L.L.C.;
- CastleOak Securities, LP;
- Muriel Siebert & Co., Inc.;
- Park Madison Partners LLC;
- The Williams Capital Group, L.P.; and
- Utendahl Capital Management.
Treasury has negotiated equity and debt term sheets for each pre-qualified fund manager and will continue to negotiate final documentation with the expectation of announcing a first closing of a PPIF in early August.
The fund managers will each establish public private investment funds (“PPIFs”). Under the initial Program, the Treasury will invest up to $30 billion of equity and debt in the PPIFs. The Program will initially target CMBS and non-agency residential mortgage-backed securities. To qualify for purchase, these securities must have been issued prior to 2009 and have originally been rated AAA and must be secured directly by the actual mortgage loans, leases, or other assets (“Eligible Assets”).
Each fund manager will have up to 12 weeks to raise at least $500 million of capital from private investors, up to a total of $10 billion for all. Each fund manager will also invest a minimum of $20 million of firm capital into the PPIFs. The equity capital raised from private investors will be matched by the Treasury up to $10 billion. Any investor may invest in a PPIF, including sovereign-wealth funds and foreign investors. Retail investors may also participate in PPIFs. At least one fund manager (BlackRock Inc.) is planning to offer its PPIF to retail investors. No single investor may hold more than 9.9% of any one PPIF. Upon raising the private capital, fund managers may begin purchasing Eligible Assets. The Treasury will also provide up to $20 billion in debt financing for the PPIFs. In addition, PPIFs will be able to obtain debt financing raised from private sources, and leverage through the TALF, for those assets eligible for that program.
The fund managers will have discretion to manage Eligible Assets; however, the Treasury stated that the PPIP’s general investment orientation should center on long-term buy and hold strategies. The PPIFs must be operated by the fund managers for at least eight years, and the fund managers must provide the Treasury with monthly reports that include the price paid for each Eligible Asset. The Treasury has indicated that it will disclose the top 10 holdings for each PPIF, but has not decided whether to provide any additional information on the investments of the PPIFs. Fund managers will be subject to conflict-of-interest rules. These rules, among other things, prohibit fund managers from purchasing Eligible Assets from their affiliates or from other fund managers.
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.