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PPIP and PPIF: Info on Legacy Loan Program

 

Public Private Investment Program (PPIP) Announced
 
            The U.S. Treasury Department has announced the government's latest plan for removing the 'toxic' assets off of the balance sheets of the nation's financial institutions. 
These assets have continually been referred to as “toxic assets”, by media analysts and others to describe asset-backed securities consisting of sub-prime mortgage and other kinds of loans. The plan refers to these assets as “Legacy Assets.” 
The PPIP plan consists of three major elements: 
 
1.      Legacy Loan Program that will buy up residential and commercial real estate loans from banks and other financial intermediaries;
 
2.      Legacy Securities Program, which will create Public and Private Investment Funds (PPIF) that will buy up bad asset-backed securities which are tied to “legacy loan” portfolios; and
 
3.      Expansion of the TALF (Term Asset –Backed Securities Loan Facility) which will further encourage highly leveraged purchases of “Legacy Securities”.  
 

Note: This memo talks only about the Legacy Loan Program.  The big question for most OBA-member banks is the extent to which smaller, community banks will be able to participate in this program. Based on our initial review and the materials we've received from outside counsel, it looks like they will be able to do so, but only through a pooling arrangement with other smaller community banks.  What's not clear are issues relating to pricing, due diligence and how leverage determinations will be handled among the participating entities.

 

Legacy Loan Program: Public and Private Investment Funds (PPIFs) will be created to buy up various loan pools consisting of the bad (formerly “toxic”, now called “legacy”) assets from banks and other financial intermediaries. The purchases will come from money raised by private investors and the U.S. Treasury using leveraged debt financing issued by each PPIF and guaranteed by the FDIC. It's a seller-financing arrangement with the FDIC providing a guarantee on the back end. Here's how it's supposed to work:

 

1.      FDIC-insured banks (and thrifts) will identify loans to be sold. The bank will coordinate with their banking regulatory agency in identifying its pools of such “legacy loans”;
2.      FDIC will select an outside valuation firm to place a value on these loans, and the FDIC will determine what debt-to-equity ratios are permissible for the PPIF in question (up to a maximum of 6 – 1);
3.      Prequalified investors will bid on the pools created through and FDIC-conducted auction (no details yet on the process) and the highest bid will set the price for the given pool;
4.      The FDIC will guarantee the debt issued by the PPIF to the selling bank. (Note: FDIC will charge annual guarantee fee and will also receive ongoing administrative fees for oversight functions.) The amount of the debt will be set by the approved debt-to-equity ratio. The balance of the amount due will be paid by the highest bidder and the Treasury Department;
5.      The selling bank must decide whether to accept the purchase price that's offered, consisting of the cash plus the debt issued by the PPIF.
 
             The PPFI will manage the Legacy Loan Pool through to liquidation or payment, whichever comes first. FDIC is to oversee the process closely.   Investors will share equally in the profits and losses. It's not clear whether the recent uproar over executive compensation will spill over to this new plan, but that's an issue for another discussion.
 
               Importantly, and what's not clear yet, are the details of the plan. As has been the practice of the Administration, these details are going to be released shortly, and bankers are asked to comment specifically on what's been proposed so far.
 
               What is obvious is that questions abound about specific terms of the debt instruments themselves, i.e., the allocation among debt holders, for what term or terms will the debt be issued, at what interest rate or rates, with what restrictions. Other questions that are as yet unanswered include how loan pool servicing is to be conducted on a day-to-day basis, or what limitations may be included on foreclosure and related items.
 
               A final, but major point is what happens if the FDIC issues the debt instrument, charges a guarantee fee, the debt instrument isn't paid off, and the guarantee fees aren't enough to cover the losses?  Do insured banks pick up the tab?  It's not at all clear at this early juncture.
 
               Stay tuned.  We'll have more for you to digest as it becomes available.
 
 
 

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