After weeks of anticipation, on March 23, 2009, the Treasury Department announced its plan, the Public-Private Investment Program (PPIP), to resolve the troubled asset problem plaguing banks and pulling down the U.S. economy. Treasury's plan is three pronged: (1) a legacy loan purchase program (Legacy Loans Program); (2) an expansion of the Federal Reserve Board's Term Asset-Backed Securities Loan Facility (TALF), and (3) the establishment of public-private investment funds to tackle legacy securities backed by mortgages and other assets (Legacy Securities Program).

The PPIP, involving programs by Treasury, the FDIC and the FRB, is premised on three principles: (1) purchase power is maximized through co-investment by the government and the private sector; (2) risk and return is a shared by the government and the private sector; and (3) the private sector is better suited to price legacy assets.

First Prong: Legacy Loans Program

Under the first prong of the PPIP, Treasury and the FDIC are jointly launching the Legacy Loans Program, designed to facilitate the purchase of legacy loans which currently reside on banks' balance sheets. Under the program, Public-Private Investment Funds (PPIFs) will purchase pools of loans and other assets from banks based on criteria established by the FDIC. Individual PPIFs will be formed to own and oversee individual pools of assets sold from banks. The FDIC will oversee the formation, funding and operation of the PPIFs, and will provide debt guarantees to PPIFs for a significant portion of their asset pool purchases. Treasury will take an equity stake along with private investors in the PPIFs.

Generally, the program involves the following steps:
1. A bank identifies legacy loans it wants to sell as a pool of assets.
2. The FDIC analyzes the pool and determines the amount of funding it is willing to guarantee up to a maximum 6-to-1 debt-to-equity ratio.
3. The FDIC auctions the pool with the highest bid representing the combination of the buyer's equity matched by Treasury's equity (generally, 50%, but could be less at private investor's option) and the FDIC guaranteed debt available to fund the PPIF.
4. If the selling bank accepts the bid price, the buyer will receive financing from the FDIC guaranteed debt and the matching Treasury investment to form the PPIF and purchase the asset pool, with the pool serving as collateral for the FDIC guarantee.
5. The PPIF's private investor managers will control and manage the pool until the underlying assets are liquidated, subject to strict oversight by the FDIC.

Treasury provided the following example of a sample investment in the 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.
Step 2: The FDIC would determine, according to the above process, that it would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private-sector bidders submitting bids. The highest bid from the private sector -in this example, $84-would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis-using asset managers approved and subject to oversight by the FDIC.

Banks interested in participating in the Legacy Loans Program are being advised to work with their primary federal regulator to determine what assets to sell. The regulators role is to ensure that banks are identifying and selling assets that will maximize the program's goal of restoring confidence in the market.  After working with its primary regulator to identify the appropriate assets, an interested bank will follow up with the FDIC to indicate its interest in the program. Generally, a selling bank will continue to service the loans and assets in a pool sold to a PPIF, while the PPIF managers oversee disposition of the assets in the pool.

Second Prong: Expansion of TALF

The second prong of the PPIP involves expanding the Fed's existing TALF program, which is specifically designed to restore liquidity to the struggling credit markets.  By way of background, although the TALF has been in the works since last fall, its first phase was executed on March 19, 2009.  Generally, the TALF provides loans to borrowers who hold asset-backed securities (ABS) that the Fed is willing to accept as eligible collateral for a TALF loan. This first phase of TALF is targeted at ABS backed by consumer and small business loans. However, on the same day it executed the first three transactions of the program, the Fed unveiled additional loan types it will accept as eligible collateral for TALF loans. These include ABS backed by: (1) mortgage servicing advances; (2) loans or leases relating to business equipment; (3) commercial leases of vehicle fleets; and (4) various dealer floor-plan loans. These new securities are eligible collateral for TALF loans beginning this month (April 2009).  

Under Treasury's plan, the Fed will extend the TALF even further to accept certain legacy securities (i.e., mortgage-backed securities) in conjunction with the PPIP's Legacy Securities Program (see below). These eligible securities will include certain residential mortgage-backed securities (RMBS) not issued or backed by a U.S. agency or government-sponsored enterprise and that were originally rated "AAA" and outstanding commercial mortgage-backed securities (CMBS) and ABS that are rated "AAA."

While this latest extension of the TALF is directly related to the final prong of the PPIP's public-private investment strategy, details and terms on funding TALF loans with RMBS and CMBS collateral have not been released.  Of particular note, lending rates, minimum loan sizes and loan durations have yet to be determined for this new extension of the TALF program. Currently, TALF loans have a three-year duration, but that duration is expected to be extended to as long as seven years to facilitate paring down bank holdings of RMBS and CMBS. It is also unclear whether the Fed will hold the line at "AAA" ratings for these new asset classes.

Third Prong: Legacy Securities Program

The third prong of the PPIP is the Legacy Securities Program, which is being structured to permit investments by specialized PPIFs in legacy securities, including CMBS and RMBS. These funds will involve a joint investment by private investors and the Treasury. The funds will be managed by private-sector fund managers who raise funds and are selected to invest in the joint investment programs with Treasury. Generally, fund managers will receive matching equity investments on a one-to-one basis from Treasury. Funds will also be able to obtain additional funding via loans from Treasury in an aggregate amount of up to 50% (and sometimes as high as 100%) of the fund's total equity.

These funds will initially be allowed to purchase RMBS and CMBS issued prior to 2009 that were originally rated "AAA" or an equivalent. Generally, the loans and other assets underlying these securities must be located predominately in the U.S., and the securities must be purchased from institutions that Congress has identified as eligible to participate in the TARP.  The funds are designed around a long-term buy-and-hold strategy, but no fund will have a term of greater than ten years.

Treasury is initially seeking to approve five fund managers to raise private capital and separately establish five specialized PPIFs. Applications to become an approved asset manager are due to Treasury by April 10, 2009, with applicants receiving notice of any preliminary approval on or prior to May 1, 2009.  Fund managers will be expected to:
demonstrate the ability to raise at least $500 million of private capital;
demonstrate experience in investing in RMBS and CMBS;
maintain a minimum of $10 billion of RMBS or CMBS under management;
demonstrate capacity to manage the funds consistent with Treasury's objectives, including protection of the U.S. taxpayer; and
maintain their headquarters in the U.S.

Treasury provided the following example of a sample investment in this aspect of the program:
Step 1: Treasury will launch the application process for managers interested in the Legacy Securities Program.
Step 2: A fund manager submits a proposal and is prequalified to raise private capital to participate in joint investment programs with Treasury.
Step 3: The Government agrees to provide a one-for-one match for every dollar of private capital that the fund manager raises and to provide fund-level leverage for the proposed Public-Private Investment Fund.
Step 4: The fund manager commences the sales process for the investment fund and is able to raise $100 of private capital for the fund. Treasury provides $100 equity co-investment on a side-by-side basis with private capital and will provide a $100 loan to the Public-Private Investment Fund. Treasury will also consider requests from the fund manager for an additional loan of up to $100 to the fund.
Step 5: As a result, the fund manager has $300 (or, in some cases, up to $400) in total capital and commences a purchase program for targeted securities.
Step 6: The fund manager has full discretion in investment decisions, although it will predominately follow a long-term buy-and-hold strategy. The Public-Private Investment Fund, if the fund manager so determines, would also be eligible to take advantage of the expanded TALF program for legacy securities when it is launched.

Treasury is encouraging diverse participation in these specialized PPIFs, including the involvement of small, veteran-, minority- and women-owned private asset managers to apply, or partner with other asset managers.  Approved fund managers will be required to report monthly to Treasury and generally agree to allow the government access to books and records to ensure appropriate oversight for taxpayer protection.

Further Details, and Challenges, to Come

Treasury's announcement provided many details surrounding the PPIP, but given the breadth and complexity of the program, there will be further details and clarification to come. In addition, while the program currently targets real estate-related loans and securities, Treasury has indicated that it is open to the evolution and expansion of PPIP based on demand.  As with any program of this magnitude, there is a certain "learning curve" that will determine expansion of the scope of the PPIP and the refinement and modification of its terms.

While there are many challenges remaining in establishing and proving the effectiveness of the PPIP, perhaps the biggest obstacle remains the ability of Treasury Secretary Geithner and President Obama to overcome the firestorm on executive compensation that has gripped the Hill the past several weeks.  This remains a critical first step for the Obama Administration to be able to get its troubled asset relief program on track and moving forward.

Chris Daniel is chair of the Payment Systems Group and is a partner in the Global  Banking and Financial Institutions Practice at international law firm Paul Hastings. Kevin Petrasic a former counsel of the OTS and is of counsel in the Global Banking and Financial Institutions Group. Erica Berg is a senior associate and Nicole Ibbotson is an associate in the Global Banking and Financial Institutions Group.