Public-Private Investment Program – Legacy Loans Program
On March 23, 2009, the Treasury – in conjunction with the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve - announced the initial details of its Public-Private Investment Program (PPIP) which is designed to (i) remove toxic real estate loans and securities from the balance sheets of U.S. depositary institutions, both large and small, which are insured by the FDIC (Participant Banks), (ii) rejuvenate real estate credit markets and (iii) restart the real estate loan securitization market. PPIP is divided into two programs, (a) the Legacy Loans Program dealing with residential and commercial real estate loans held by Participant Banks, and (b) the Legacy Securities Program dealing with residential and commercial mortgage backed securities which were originally issued prior to 2009 and are presently held by Participant Banks.
On March 26, 2009, the FDIC held a conference call with market participants to provide an overview of the Legacy Loans Program and to commence a two week comment period (ending April 10) in which market participants’ input is welcome to help structure the program. Troutman Sanders participated on this conference call and will continue to participate in the structuring phase of the Legacy Loans Program.
This advisory addresses the Legacy Loans Program. For more information regarding the Legacy Securities Program, please refer to our advisory that can be found here.
Synopsis of Legacy Loans Program
The Legacy Loans Program will facilitate the creation of new Public-Private Investment Funds (PPIFs) which will purchase eligible loan pools (Eligible Loan Pools) from Participant Banks through auctions conducted by the FDIC. The FDIC will provide oversight for the formation, funding and operation of each PPIF. The Treasury and the private investor in a PPIF will each contribute 50% of the equity in such PPIF, although the private investor may elect to contribute a greater percentage of such equity. The private investors in the PPIFs are anticipated to include financial institutions, individuals, insurance companies, mutual funds, publicly managed investment funds, pension funds, foreign investors with headquarters in the United States, private equity funds and hedge funds.
A PPIF will finance its purchase of an Eligible Loan Pool by issuing debt (of up to a 6:1 debt to equity ratio). The FDIC will establish the debt to equity ratio for each Eligible Loan Pool and will guarantee such purchase money debt issued by the PPIF to the Participant Bank. The FDIC’s debt guarantee will be secured by the assets of the Eligible Loan Pool being purchased by the PPIF. The FDIC will receive a fee for each debt guarantee. Once an Eligible Loan Pool has been purchased, a PPIF will have private managers which will control, manage and service the assets until liquidation within parameters established by the FDIC and the Treasury, subject to rigorous oversight from the FDIC. The Treasury and the private investors in a PPIF will share profits and losses in proportion to the equity invested.
Step-by-Step Process for Purchasing Eligible Loan Pools
1. Identification of Assets & Leverage Ratio - Participant Banks work with their primary bank regulators to identify and evaluate loan pools which they would like to sell to PPIFs. The Participant Banks must identify and demonstrate to the satisfaction of the Treasury and the FDIC that the proposed loan pools meet certain Treasury and FDIC minimum requirements which have not yet been published. If a proposed loan pool meets such Treasury and FDIC requirements, the FDIC conducts analysis with the help of a third party valuation firm to determine the ratio of PPIF debt to equity which it will allow with respect to the acquisition of an Eligible Loan Pool. While the FDIC has not yet published criteria for selecting Eligible Loan Pools, it should be noted that collateral supporting Eligible Loan Pools must be situated predominantly in the United States.
2. Satisfying Private Investor Eligibility Criteria - Private investors must be pre-qualified by the FDIC to participate in the auction, though full eligibility criteria has not yet been published by the FDIC. It should be noted that private investors may not participate in any PPIF that purchases assets from sellers that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF.
3. FDIC Marketing of Eligible Loan Pools – Prior to submission of bids, marketing materials for the Eligible Loan Pool, the financing terms and allowed leverage ratios will be disclosed by the FDIC to private investors. Potential PPIFs will then have a due diligence period to review and analyze due diligence materials that may be posted in either virtual or physical data rooms. It is not anticipated that there will be a post-auction due diligence period.
4. Auction – Following its receipt of independent valuation advice from a third party valuation firm, the FDIC will authorize a financial advisor to conduct an auction process open to eligible private investors for the private capital component of the PPIF. The format of the bid process has yet to be determined. Bids must be accompanied by a refundable cash deposit for 5% of the bid value, which deposits will be refunded if the bid is unsuccessful or is ultimately rejected by the Participant Bank. Once the bid is selected by the FDIC, the Participant Bank will have the option of accepting or rejecting the bid. The FDIC is to be reimbursed out of the proceeds of the sale for all expenses related to conducting the auctions.
5. Financing Structure – The PPIF will purchase the Eligible Loan Pool with equity contributed equally from the private investor and the Treasury, though the private investor can choose to take less equity from the Treasury. The PPIF will issue the FDIC approved debt (expected to be non-recourse) to the Participant Bank which will be guaranteed by the FDIC. Though it has been discussed that Participant Banks will take back notes evidencing the debt, other alternatives are also being considered. The interest rate and terms of the debt will be determined on a case by case basis with respect to each Eligible Loan Pool. The PPIF will be required to maintain a debt service coverage escrow. Initially, servicing will be provided by the Participant Bank, and following the sale, PPIFs will be able to change servicers to an FDIC-approved servicer. Consistent with the Emergency Economic Stabilization Act of 2008, Treasury will also receive warrants in the PPIFs.
6. Governance & Maintenance of Assets – Once an Eligible Loan Pool has been sold to a PPIF, private fund managers will control and manage the assets of the PPIF and Treasury will hold a non-controlling equity position. It should be noted that the FDIC has not yet established parameters for the management or servicing of assets held by PPIFs, such as the ability to do workouts and exercise remedies, though we do know that Eligible Loan Pools collateralized with single family dwellings will be subject to the U.S. government loan modification program.
7. FDIC Fees - PPIF’s will pay the FDIC’s ongoing administrative fees for its PPIF oversight role. In exchange for its debt guarantee, the FDIC will also charge PPIFs an annual debt guarantee fee that is to be based on the outstanding debt balance. The debt guarantee fees will be used by the FDIC to cover any of its losses under the debt guarantees. In the event that the debt guarantee fees do not cover those FDIC losses, a special assessment may be levied against all FDIC depositary institutions, regardless of their participation (or non-participation) in the Legacy Loans Program.
A Sample Legacy Loans Program Investment
The following helpful sample investment for the Legacy Loans Program was provided by the Treasury:
Sample Investment Under the Legacy Loans Program |
Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC. |
Questions Raised by the Legacy Loans Program
While the synopsis above captures the details of the Legacy Loans Program provided by Treasury thus far, many relevant details have yet to be released. We expect many of these questions to be addressed during the two week comment period. The following is a sampling of key issues that current Treasury materials do not address:
1. What eligibility criteria will the FDIC establish for loan pools to become Eligible Loan Pools? When will the FDIC’s additional criteria become available? Currently, we know that the initial phase of the program is limited to commercial and residential loans, without regard to the size of the loan. It should be noted that REO assets, consumer loans and C&I loans are currently ineligible for the initial phase of the program. Eligibility criteria will be discussed during the two week comment period, and further criteria is expected to be made available before the program is implemented.
2. What restrictions will be placed on PPIFs’ handling of Eligible Loan Pools? More specifically, will PPIFs be able to liquidate those assets, or will they be required to hold the loans to maturity? Will there be a lock up period similar to the three year lock up period imposed on loans under the Legacy Securities Program? Can individual loans be restructured, and if so will there be any limitations? While a few fundamental restrictions are known, such as that loans collateralized by single family dwellings will be subject to U.S. government loan modification program, many of the details regarding post-closing restrictions, such as PPIFs’ right to exercise remedies, remain open for discussion.
3. What additional parameters will be set for the servicing of the Eligible Loan Pools? While we know that Participant Banks will be able to change servicers from the Participant Banks to an FDIC-approved servicer following the closing, further details on servicing restrictions have yet to be released.
4. What format will the FDIC use for the auctions?
5. What parameters will be placed on private fund managers of PPIFs? What eligibility criteria will the FDIC establish for private investor participation in the PPIFs?
6. What additional restrictions will be applicable to the Legacy Loans Program, such as additional FDIC oversight restrictions, restrictions derived from the Troubled Asset Relief Program (TARP) and executive compensation restrictions?
7. What will the timeframes be for the various steps of the Legacy Loans Program? For instance, how long will private investors have to review marketing materials for Eligible Loan Pools before an auction is conducted?
8. What is the nature of the warrants in the PPIFs to be issued to Treasury?
Troutman Sanders Role
While FDIC officials have alluded to a time period of 8-10 weeks before the first auction occurs, Troutman Sanders has already assembled an experienced multi-disciplinary team to guide clients through the Legacy Loans Program, as well as other programs established as part of Treasury’s Financial Stability Plan. We look forward to assisting existing clients and new clients with opportunities that will be created through the new Public-Private Investment Program. Specifically, our team can assist Participant Banks and private investors with involvement during the two week comment period and with their future participation in the Legacy Loans Program.
Please continue to check our website, as we will continue to follow developments related to Legacy Loans Program and to update this advisory with additional relevant information as soon as it is released. If you have any questions or would like to contact a member of our Legacy Loans Program team, please feel free to call any of the following Troutman Sanders lawyers:
Michael Leichtling Jacob A. (Jake) Lutz
(212) 704-6257 (804) 697-1490
Miles M. Borden Anthony D. Greene
(212) 704-6161 (212) 704-6194