Financial Markets in Crisis: Public-Private Investment Funds for Distressed Bank Assets — Open Questions and Opportunity to Comment

March 30, 2009

Last week, the Department of the Treasury and the FDIC announced their Public-Private Investment Fund (PPIF) concept, intended to remove troubled assets from banks.  Significant details of the proposal remain undefined, and public comment is sought.

As announced, private investors and the Treasury will invest side-by-side in PPIFs, and will share in both profits and losses.  Treasury financing also will be available.  Additionally, PPIFs may issue FDIC-guaranteed debt.  Details of the capitalization of PPIFs, the terms of the potential investments and financing, the accounting and regulatory implications for banks that sell assets to PPIFs and related matters have not been finalized.  Similarly, while officials have stated that compensation limits will not apply to "passive" investors in PPIFs, the requirements for "passive" status have not been articulated. 

Although potential investors have expressed interest, their ultimate participation will depend on the final terms of the program.  As a result, the FDIC is soliciting public comment on all aspects of the PPIF concept and the related Legacy Loans Program (LLP), pursuant to which distressed assets will be sold to PPIFs.  The deadline for comments is April 10, 2009. 

Major areas of interest and likely comment include the following:

Eligible Investors

• Criteria for investor eligibility to invest in PPIFs (intended to include individuals, mutual funds, pension plans, insurance companies and other long-term investors);
• Whether investor identities should be publicly available;
• How to encourage broad and diverse investment interest (including potentially among retail investors);

Eligible Assets and Asset Pools

• Whether asset categories that are eligible for sale to a PPIF should be limited to real estate-related assets (initial pools are expected to consist of residential and commercial real estate loans, may include loans in foreclosure or related real estate collateral, and may also include nonperforming loans with little or no cash flow);
• Defining the optimal size and characteristics of a PPIF pool of assets;
• Identifying pools to receive priority to be sold in initial PPIF auctions;
• Whether multiple banks may pool assets for sale, applicable requirements for such pools, how proceeds would be allocated and accommodations that might be made to encourage participation by smaller financial institutions;

Terms of Investments

• Whether interests in a PPIF will be transferable and, if so, the criteria for permissible transferees;
• Potential percentage of government equity participation and impact of government investment percentage on private investor interest;
• Whether the government’s participation in investment returns should increase or otherwise change after returns exceed a threshold level;

FDIC Guarantee of PPIF Debt

• Whether the FDIC guarantee fee to be paid by the PPIF should be adjusted based on risk or other criteria;
• Feasibility of publicly-issued vs. privately-placed debt;

Bank Sale of Assets to PPIF

• Payment of consideration to the selling bank in cash vs. notes vs. participation certificates or similar instruments vs. equity allocation in the PPIF;
• The extent to which representations and warranties are provided by the selling bank, and the PPIF’s remedies for breaches;

Auctions

• Defining the type of auction that would facilitate broadest investor participation;
• Details of the competitive auction process (such as whether investors may bid on partial equity stakes in a PPIF, and whether a reserve price may be set);
• Whether the auction mechanism should be on-line, a sealed bid process, an open outcry or some other procedure;
• Whether the FDIC’s independent valuation consultant’s conclusions and related data should be disclosed to potential bidders;
• Whether the terms of the government debt funding should be disclosed to potential investors before the auction;

Asset Management

• Respective roles of the private sector and government in selecting and overseeing asset managers;
• Whether assets should be sold to the PPIF with servicing released to the PPIF (which currently is the expectation, with the selling bank performing subservicing during a transition period);
• Defining applicable servicing standards, including ability to work-out or restructure loans (single family, residential mortgage loans are expected to be subject to the Treasury’s loan modification guidelines);

Conflicts of Interest

• Whether selling banks could bid on pools that include the selling bank’s assets;
• Safeguards to protect against conflicts of interest that may jeopardize arms-length negotiated terms.

In addition, a number of legal issues will need to be addressed in connection with PPIF transactions.  These issues include:

• Compliance with the Investment Company Act of 1940 and the Securities Act of 1933 in structuring PPIFs and offering related equity and debt interests;
• Finalizing governing documents for the PPIF entity (a limited partnership or limited liability company) that address matters such as:  term of fund (expected not to exceed 10 years); offering period; capital calls/commitments; management of PPIF and management fees; control (including decision-making authority of investors, asset manager and servicer); distributions; leverage; compensation parameters, as applicable; indemnification; transferability of equity and withdrawal rights; conflicts of interest;
• Finalizing ancillary agreements (to include an administrative services agreement providing for reimbursement of auction expenses (including a valuation consultant) and ongoing administrative fees to the FDIC, an asset management agreement, a servicing agreement and an intercreditor agreement addressing the priority of the security interests held by Treasury and FDIC (and potentially the Federal Reserve) in assets of the PPIF). 

The FDIC intends to finalize the PPIF structure and details of the related Legacy Loans Program as soon as possible after the comment period ends on April 10, 2009. 

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 Stephanie Tsacoumis (202-955-8277, [email protected]) or Michael Bopp (202-955-8256, [email protected]) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group:

© 2009 Gibson, Dunn & Crutcher LLP

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