Treasury Announces Launch of the Public-Private Investment Program

On Monday, March 23, 2009, Treasury Secretary Timothy Geithner announced the details of the new Public-Private Investment Program (PPIP) previously introduced as an important component of the Financial Stability Plan. The PPIP is specifically intended to target the complex problem of the "legacy assets" that remain on the balance sheets of U.S. financial institutions impeding their ability to raise capital and increase lending. Legacy assets consist primarily of troubled real estate loans and securities backed by real estate loans.

The PPIP is designed around three basic principles:

• Maximizing the impact of taxpayer resources. The use of government financing in partnership with the FDIC and Federal Reserve and co-investment with private sector investors will create substantial purchasing power.
• Public-private risk and profit sharing. Under the PPIP, private sector participants invest alongside the taxpayer. Private sector investors therefore risk losing their entire investment in a downside scenario, while the taxpayer shares in any profits realized in an upside scenario.
• Private sector price discovery. Competition between private sector investors will establish the price of the loans and securities purchased under the PPIP, thereby reducing the likelihood that the government will overpay for these assets.

The PPIP is comprised of two different programs: (1) a Legacy Loans Program intended to address the issue of the real estate loans held directly on the books of U.S. financial institutions, and (2) a Legacy Securities Program intended to combat the problem of securities backed by loan portfolios.

The Legacy Loans Program

Under the Legacy Loans Program, legacy loans will be purchased from U.S. financial institutions through one or more Public-Private Investment Funds (PPIFs). The FDIC will guarantee debt issued to purchase legacy loans and provide oversight for the formation, funding and operation of the various newly-created PPIFs. The individual PPIFs will receive up to 50 percent of equity capital from Treasury (using funds under the Troubled Asset Relief Program, or TARP) and the remaining equity will come from private investors. Private investors are expected to include financial institutions, individuals, insurance companies, mutual funds, pension funds and hedge funds—to name a few.

U.S. financial institutions will identify the specific asset pool they would like to sell. This will be followed by an FDIC analysis to determine the amount of funding that will be FDIC guaranteed. Eligible assets include loans and other assets from depository institutions that meet Treasury and FDIC requirements that have yet to be established. All eligible assets and any collateral supporting those assets must be situated predominantly in the United States.

Once the asset pool has been identified, the FDIC will conduct an auction and the highest bidder will have access to the PPIP to fund 50 percent of the equity requirement. Once the bid is accepted by the seller, the buyer will receive financing by issuing debt guaranteed by the FDIC. The debt will be collateralized by the purchased assets and the FDIC will receive a fee in exchange for its guarantee. The PPIF loan leverage will vary from pool to pool based on joint analyses performed by the FDIC and a third party valuation firm, but in any event will not exceed a 6-to-1 debt-to-equity ratio.

Consistent with the requirements of the Emergency Economic Stabilization Act of 2008 (EESA), Treasury will have warrants in the PPIFs. Passive investors will not be subject to the restrictions on executive compensation. Passive investors must be pre-qualified by the FDIC to participate in this program pursuant to requirements that have yet to be established by the FDIC. Private fund managers will control and manage the assets subject to strict FDIC oversight.

The Legacy Securities Program

Under the Legacy Securities Program, Treasury will partner with private asset fund managers to jointly invest in eligible assets through a PPIF.

Initially, Treasury will select up to five fund managers to participate in the program (although Treasury, at its discretion, may increase the number of approved fund managers). Asset manager applicants must demonstrate the ability to raise at least $500 million in private capital and have demonstrated experience in investing in eligible securities. In addition, asset manager applicants must have a minimum of $10 billion of eligible securities under management and be headquartered in the United States. Interested asset manager applicants should complete the application available at http://www.financialstability.gov. The deadline for submitting the application is April 10, 2009, at 5 p.m. EST.

The approved fund managers will raise capital from private investors to acquire the eligible securities. Treasury will then provide a dollar-for-dollar match for every dollar of private capital raised by the fund manager. Treasury will receive warrants in the PPIFs as required under the EESA. If the investment fund structure meets certain guidelines (yet to be announced), fund managers will have the option to obtain nonrecourse loans from Treasury in an amount of up to 50 percent of the PPIF's total equity capital, or 100 percent of the PPIF's equity capital on a discretionary basis. The loans will be secured by the assets held by the PPIF. The fund manager will have full discretion in the management of the assets but will predominantly pursue a long-term buy-and-hold strategy.

Eligible assets will include commercial and residential mortgage-backed securities originally issued prior to 2009 that were originally AAA-rated or had an equivalent rating by two or more nationally recognized rating organizations. The eligible assets must be secured directly by the actual mortgage loans, leases or other assets and situated predominantly in the United States.

Questions Remain

Additional details of both the Legacy Loan Program and the Legacy Securities Program, to be announced in the coming weeks, will determine whether these programs will be successful in stimulating the market and encouraging private investors. Currently, there are more questions than answers, including:

• Will investors sign on given concerns over rapidly changing terms and rules for other government programs?
• If TARP money is involved, will Congress also have regulatory authority through the Government Accounting Office established under the EESA to oversee the use of TARP funds?
• Will banks be forced to participate based on stress testing?
• What if the PPIP results in losses?
• How is the FDIC's deposit insurance fund impacted?
• Will banks be forced to accept prices/bids they view as too low?
• Will bidders be willing to invest at the prices banks will insist on?
• How quickly can the PPIP be implemented?

Treasury is seeking comments and questions on the proposed PPIP through April 10, 2009. Comments and questions can be submitted to Treasury at:

Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220
Fax: (202) 622-6415