March 23, 2009
The Gibson, Dunn & Crutcher Financial Markets Crisis Group is closely tracking government responses to the turmoil that has catalyzed a dramatic and rapid reshaping of our capital and credit markets.
We are providing updates on key regulatory and legislative issues, as well as information on legal issues that we believe could prove useful as firms and other entities navigate these challenging times.
This update focuses on the Public-Private Investment Program (“PPIP”), the details of which were released by the Treasury on March 23, 2009. The PPIP is the latest in a series of Federal government programs intended to help the economy recover. The program is different, though, in that it attempts to get at the roots of the financial markets crisis – so called “toxic” assets – rather than addressing symptoms. The new, expansive program creates potential opportunities for both banks and investors.
The PPIP in General
A central problem impacting the U.S. financial system is the concern that so-called “legacy assets” are currently being undervalued by the market, requiring asset mark downs that reduce financial institution lending capacity. Such “legacy assets” include both troubled real-estate assets and unmarketable mortgage backed and asset backed securities on the books of financial institutions. Treasury’s announcement today addresses the conviction that using public-private partnerships to remove these assets from financial institution balance sheets will let these institutions resume lending and facilitate the flow of credit through the economy.
The PPIP will use public and private capital, in conjunction with private Fund Managers” expertise to purchase legacy assets from banks and investors. The PPIP proposes to use $75 billion to $100 billion of TARP funding in combination with capital from private investors and FDIC guaranteed debt to generate an initial $500 billion in purchasing power for illiquid loans and securities. Treasury indicates that the program could be expanded to create $1 trillion in buying power over time.
The program has multiple components. The Legacy Loans Program will utilize FDIC-guaranteed debt financing and private equity to purchase troubled loans from FDIC-insured financial institutions. The Legacy Securities Program has two pieces. One is an expansion of the Term Asset-Backed Securities Loan Facility (TALF) that will apply to more and lower-rated assets. The other entails the Treasury Department providing matching equity co-investments to qualified funds purchasing legacy mortgage- and asset-backed securities.
While Treasury, the Federal Reserve, and the FDIC have each expressed the desire to launch the new PPIP programs as soon as possible, it is clear that a substantial period of time will be needed to issue governing guidelines or regulations. Indeed, FDIC Chairman Sheila Bair in a statement today noted that the “FDIC intends to move forward with this program in a methodical and transparent fashion [and] will provide the opportunity for public comment on critical aspects of the program prior to implementation.”
Legacy Loan and Securities Programs
Legacy Loan Program. An insured depository institution interested in participating in the Legacy Loan Program must first identify a pool of eligible assets (defined as “[l]oans and other assets from depository institutions under criteria established by the FDIC”) that it wishes to sell. The selling bank then advises the FDIC, which determines a funding guarantee level that can range as high as a 6-to-1 debt-to-equity ratio. The FDIC then auctions the pooled assets, with the highest bidder gaining access to the public-private investment program in which Treasury may fund up to 50% of the equity requirement of the purchase. This bidding process increases the likelihood that the troubled assets are priced at market value. In practice, this means that for each $1 of private equity, Treasury may match with up to $1 of public equity and the FDIC may guarantee up to $12 in private sector debt. Therefore, private investors could theoretically invest 1/14th — or 7.14% — of the total capital required to make the purchase. The program does not currently address whether Treasury will pay a promotional fee on its investment to the private investor. In addition, while the private investor may elect to take less than the maximum 50% matching Treasury equity investment, it will likely be required to take some Treasury money as language provides for an as-yet-undetermined minimum government subscription right. The private investor will service the asset pool and determine the timing of its disposition on an ongoing basis.
Legacy Securities Program. Under the co-investment piece of the Legacy Securities Program, Treasury expects to initially approve five Fund Managers and may expand the number in the future. Fund Managers must have a demonstrated track record of investing in legacy assets of the types described below. These Fund Managers will then submit proposals to raise private capital and participate in a joint investment program with the Treasury. Once the Fund Manager has raised the target amount of capital, that equity will be matched by the Treasury and the FDIC will guarantee a loan for up to 50% of the equity value of the fund (in certain cases the Fund Manager may apply for a loan of up to 100% of the equity value of the fund and be subject to additional restrictions). In practice, this means that for each $1 of private equity raised, the fund may receive $1 of equity matched by Treasury and borrow up to another $2 (100% of both the private funds and Treasury match). The fund will then commence a purchase program for targeted securities. The Fund Manager will “control” the process of asset selection, pricing, asset liquidation, trading, and disposition and must predominately follow a long-term buy-and-hold strategy. The Fund Manager will also be eligible to take advantage of the expanded TALF program (described in our previous client alert) for legacy securities, when it is launched.
The Legacy Securities Program also includes an expansion of the TALF. Key components of the expansion include the following:
Today’s announcement raises a number of accounting-related questions related to a bank’s participation in the Legacy Loan Program. Among them is whether, if a bank decides to put a pool of loans up for sale and the auction fails or a reserve price is not met, has a market price been established such that the bank must now mark down the assets?
Also, we would note that the program will not necessarily help banks that have not yet marked assets to markets, as a bank would need to mark down the assets when sold through the PPIF and would then need capital to “fill the hole.”
Executive Compensation Restrictions Will Not Apply to Passive Private Investors Participating in PPIP; Fund Managers Also Not Likely to be Subject to Restrictions
The FAQs for each of the Legacy Loans and Legacy Securities Programs both state that passive private investors will not be subject to the executive compensation requirements, but none of the Treasury documents that were released today affirmatively state whether or not the executive compensation requirements will apply to Fund Managers. Journalists have posited that the requirements will not apply and that seems likely, especially given that the executive compensation restrictions do not apply to TALF sponsors, underwriters and borrowers. The goal of PPIP is to encourage talented Fund Managers to invest their own money and time into making these investment vehicles profitable and the government has an interest in recruiting the best talent possible. Nevertheless, this question has not been answered conclusively.
Key Tax Questions Unanswered
No information has been provided as to the government’s views on how investors will be taxed on their investment in the PPIP. In addition to the politically charged issues relating to the amount of compensation that can be earned by individual managers (including amounts attributable to carried interests) and whether such compensation will be taxed as ordinary income or as capital gain, no guidance has been provided with respect to several significant issues, including: (1) whether the government will require the use of a specific form of entity (e.g. corporation, limited liability company, partnership or trust) to acquire the assets, and whether that entity must be a domestic entity; (2) whether gains and losses with respect to the acquired assets will be treated as capital gains and losses or as ordinary income or loss, and (3) assuming pass-through entities are eligible investors, whether a foreign or tax-exempt investor will be treated as being engaged in a trade or business as a result of the activities required to manage the assets.
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We will continue to monitor developments with respect to these issues and will provide clients and friends with further updates on these and other issues as additional information becomes available.
Summary of Terms of Legacy Loans Program
|Summary of Public-Private Investment Funds (“PPIF”)||
|PPIF Capital Structure||Treasury and private capital will invest proportionately at the same time in PPIF|
|Eligible Private Investors||Must be approved by the FDIC, expected to include an array of different investors, including but not limited to, financial institutions, individuals, insurance companies, mutual funds, pension funds and publicly managed investment funds|
|Selling Bank Application Process||
|Asset Purchases & Pricing||
|Governance & Management||PPIFs will be managed within the parameters pre-established by the FDIC and Treasury. Private investors may not participate in any PPIF that purchases assets from an affiliate.|
|Equity Capital||Initially, 50% of equity will come from Treasury but it will have no control rights. Investors can choose to take less Treasury equity subject to certain minimums.|
|Treasury Warrants||Treasury will receive warrants in the PPIF|
|Non-Recourse Debt||The FDIC guarantee is collateralized by assets purchased by each PPIF|
|Servicing||Provided by the bank|
Summary of Terms of Legacy Securities Program
|Summary of Program||
|Investment Objective||To generate attractive returns for taxpayers and private investors|
|Investment Strategy||Predominantly a long-term buy and hold strategy|
|Fund Structure||The fund will be controlled by a private vehicle (in which private investors can invest) and Treasury|
|Pre-Qualification of Fund Managers||
|Eligible Assets||Commercial mortgage backed securities and residential mortgage backed securities issued prior to 2009 that were originally rated AAA|
|Drawdowns||Treasury equity capital will be drawn down in tranches to provide for anticipated investments|
|Asset Purchases / Dispositions||Fund managers will control the process of asset selection, pricing, liquidation, trading and disposition|
|Treasury Capital Term||No greater than 10 years|
|Debt Financing||Fund managers will have the option to obtain secured non-recourse loans in an aggregate amount of up to 50% of the fund”s total equity, provided that private investors have no voluntary withdrawal rights|
|Treasury Warrants||Treasury will take warrants in the fund determined by the amount of debt financing taken|
 The full summary of terms can be found at
 The full summary of terms can be found at
Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above. Please contact Michael Bopp (202-955-8256, firstname.lastname@example.org) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group:
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Mel Levine – Century City (310-557-8098, email@example.com)
John F. Olson – Washington, D.C. (202-955-8522, firstname.lastname@example.org)
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Executive and Incentive Compensation Expertise
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Michael J. Collins – Washington, D.C. (202-887-3551, email@example.com)
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Amber Busuttil Mullen – Los Angeles (213-229-7023, email@example.com)
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