Mr. Nesmith is based in our Washington office.

BACKGROUND

In a continuing effort to encourage financial institutions to increase their lending activities and in order to jump start credit markets throughout the country, the U.S. Treasury Department (Treasury) in conjunction with the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve has announced the Public-Private Investment Program (PPIP).

Set forth below is an overview of PPIP which was rolled out earlier this week. As more details with respect to PPIP become available, Holland & Knight's Financial Recovery Team will provide further information.

THREE BASIC PRINCIPLES

Using $75 to $100 billion in Troubled Assets Relief Program (TARP) funding supplemented by an infusion of capital from private investors, PPIP is intended to generate over $500 billion in purchasing power to buy what are characterized by the Administration as "Legacy Assets" (formerly "toxic assets"). Legacy Assets will include whole loans secured by real estate, additional bank assets and commercial mortgage-backed securities and residential mortgage-backed securities issued prior to 2009, but limited to such securities originally rated AAA or equivalent by at least two nationally recognized rating agencies. PIPP has been designed around three basic principles:

  1. Leveraging the Impact of the Government Funds: By using government financing as well as co-investment by private sector investors, substantial purchasing power will be created, making the most of government resources and incentivizing private investment.
  2. Sharing of Both Risk and Profits With Private Sector Participants: PPIP enables private sector participants to invest alongside the government agencies. Private sector investors' loss is capped at their equity investment and they will share in profits along with the government.
  3. Private Sector Sets Pricing: In order to reduce the likelihood that the government may overpay for these assets, private sector investors will bid against one another in auctions to establish the price of the asset pools and securities purchased under the PPIP.

A TWO-PRONGED APPROACH TO GET LEGACY ASSETS OFF OF BALANCE SHEETS

Two Components For Two Types Of Assets

PIPP has two parts, addressing both legacy loans and legacy securities on the balance sheets of financial firms:

  1. Legacy Loans: The glut of troubled legacy loans remaining on bank balance sheets has made it difficult for banks to access private markets for new capital and, coupled with reserve requirements, has limited their ability to lend.
  2. Legacy Securities: Secondary markets have become highly illiquid, and, to the extent they are trading at all, are trading at prices below those expected in normally functioning markets. These securities are currently held by banks as well as insurance companies, pension funds, mutual funds and funds held in individual retirement accounts.

Part One: The Legacy Loans Program

To assist banks in clearing balance sheets of troubled legacy loans, the FDIC and Treasury are seeking to attract private capital to purchase eligible legacy loans from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment. The criteria for bank loans and assets which constitute "Eligible Assets" will be set by the FDIC. Treasury currently anticipates that approximately half of the TARP resources for legacy assets will be devoted to the Legacy Loans Program, but the bifurcated PPIP permits flexibility in allocating government resources among the Legacy Loans and Legacy Securities portions of the Program to maximize the Program's impact.

  • Private Investors Set Prices: Prospective participants in the Program will be subject to FDIC qualification; however the Administration has stated that executive compensation restrictions will not apply to passive private investors. The participation of individual investors, pension plans, insurance companies and other long-term investors is being encouraged. The Legacy Loans Program will create individual Public-Private Investment Funds which will purchase asset pools on a discrete basis. The aim of the Program is to boost private demand for distressed assets that are currently held by banks and facilitate market-priced sales of the troubled loans and other bank assets. The FDIC will seek public comment concerning the Legacy Loans Program and while no start date has been set, the Administration has indicated that it hopes to launch the Program as quickly as possible.
  • FDIC To Provide Oversight: The FDIC will provide oversight for the formation, funding and operation of these new funds that will purchase pools of Eligible Assets from banks.
  • Joint Financing From Treasury, Private Capital And FDIC: Treasury and private capital will provide matching infusions of equity and the FDIC will provide a guarantee for debt financing issued by the Public-Private Investment Funds to fund the purchase of pools of assets. Treasury intends to provide 50 percent of the equity capital for each fund. Under this Program private managers will retain control of asset management subject to oversight by the FDIC.
  • Purchasing Assets Through The Legacy Loans Program:
    • Banks Identify The Assets They Wish To Sell: To start the process, banks will designate those assets that they would like to sell – usually a pool of loans (and based upon the information released by the Administration this week, such loans are likely to include, in large part, real estate mortgage loans). The FDIC will conduct an analysis to determine the amount of funding it is willing to guarantee. Leverage will not exceed a 6-to-1 debt-to-equity ratio. Assets eligible for purchase will be determined by the participating banks, their primary regulators, the FDIC and Treasury. The Program is intended to include financial institutions of all sizes.
    • Pools Are Auctioned To The Highest Bidder: A third-party valuation firm, selected by the FDIC, will provide independent valuation advice to the FDIC with respect to each pool of Eligible Assets. The FDIC will conduct an auction for these pools of Eligible Assets. The highest bidder will have access to PPIP to fund 50 percent of the equity required for purchase.
    • Financing Is Supported By FDIC Guarantee: If the seller accepts the purchase price, the buyer will receive financing by issuing debt guaranteed by the FDIC. The FDIC-guaranteed debt will be collateralized by the purchased assets. The FDIC will receive a fee for issuing its guarantee.
    • Private Sector Fund Managers Manage The Assets: Once the assets have been sold, private fund managers will control and manage the assets until final liquidation, subject to FDIC oversight.

Part Two: The Legacy Securities Program

The goal of this program is to restart the currently dormant market for legacy securities, allowing banks and other financial institutions to free up capital and stimulate the extension of new credit. The Legacy Securities Program consists of two related parts designed to draw private capital into these markets. Debt financing will be provided by the Federal Reserve under the Term Asset-Backed Securities Loan Facility (TALF) introduced by the Administration earlier this month and through matching private capital raised for dedicated funds targeting Legacy Securities.

  1. Expanding TALF To AAA Rated Securities Issued Prior To 2009: The Legacy Securities Program will focus on the markets for mortgage-backed securities tied to residential and commercial real estate. The intention is to expand the previously announced TALF Program to include Legacy Securities.

    • Encouraging Investors To Have Greater Confidence And To Purchase Legacy Assets: It is expected that the provision of leverage through this program will encourage investors to purchase these assets and as a result will increase market liquidity.
    • Funding Purchase Of Legacy Securities: Through the Legacy Securities Program, non-recourse loans will be made available to investors to fund purchases of legacy securitization assets. These assets are expected to include certain non-agency residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities originated prior to 2009 that were originally rated AAA, or its equivalent, by at least two nationally recognized rating agencies, and outstanding commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) that are rated AAA.
    • Working with Market Participants: Investors will need to meet specific eligibility criteria. Lending rates, minimum loan sizes and loan durations have not been determined. These and other terms of the programs remain to be finalized after agency discussions with market participants.

  2. Treasury To Partner With Private Investors In Legacy Securities Investment Funds: Treasury will make co-investment and non-recourse loans available to partner with private capital providers such as private equity firms, hedge funds and individual investors to immediately support the market for these legacy mortgage-backed securities.

    • Qualified Fund Managers: Treasury will, at the Program's commencement, approve up to five asset managers with a proven track record of purchasing legacy assets (reserving the right to add more managers). Managers whose proposals have been approved will be afforded time to raise private capital to target the designated asset classes and will receive matching Treasury funds under PPIP. Treasury funds will be invested one-for-one on a fully side-by-side basis with these investors. Criteria to qualify as a fund manager will include:
      • capacity to raise at least $500 million of private capital
      • experience in investing in Eligible Assets
      • at least $10 billion of Eligible Assets under management
      • operational capacity to manage the Legacy Securities Public-Private Investment Funds
      • headquarters located in the United States
    • Senior Debt: Asset managers will have the ability, subject to meeting certain guidelines, to subscribe for senior debt from Treasury for the Public-Private Investment Fund.

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