Stocks Soar on Details of Treasury's Public-Private Investment Program

March 23, 2009 11:57 AM EDT

Investors are cheering the details on the Treasury's Public-Private Investment Program, which is designed to take the 'legacy' loans and securities off the balance sheet of the nation's banks with the government investing alongside private investors.

At noon, the Dow was up 309, the Nasdaq up 60, and the S&P 500 up 34.

The plan will use $75-$100 billion in TARP capital and capital from private investor, generating $500 billion in purchasing power to buy legacy assets – with the potential to expand to $1 trillion over time.

The Public-Private Investment Program will be designed around three basic principles:

• Maximizing the Impact of Each Taxpayer Dollar: First, by using government financing in partnership with the FDIC and Federal Reserve and co-investment with private sector investors, substantial purchasing power will be created, making the most of taxpayer resources.
  
• Shared Risk and Profits With Private Sector Participants: Second, the Public-Private Investment Program ensures that private sector participants invest alongside the taxpayer, with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns.
  
• Private Sector Price Discovery: Third, to reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program.

The Public-Private Investment Program will address both the legacy loans and legacy securities clogging the balance sheets of financial firms.

Legacy Loans:

To address the legacy loans, the FDIC and Treasury are launching a program to attract private capital to purchase eligible legacy loans from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment. As part of the program, the FDIC will leverage a pool of loans up to 6-to-1 and the highest bidder will have access to the Public-Private Investment Program to fund 50 percent of the equity requirement of their purchase.

Below is a Sample Investment Under the Legacy Loans Program:

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.


2. The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.


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.


4. Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.


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.


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.

Legacy Securities

To address the legacy securities, the Treasury and the Federal Reserve will expand the TALF to also included legacy securities, not just new securities, and the Treasury will make co-investment/leverage available to partner with private capital providers to immediately support the market for legacy mortgage- and asset-backed securities originated prior to 2009 with a rating of AAA at origination.

Below is a Sample Investment Under the Legacy Securities Program:

1. Treasury will launch the application process for managers interested in the Legacy Securities Program. 


2. A fund manager submits a proposal and is pre-qualified to raise private capital to participate in joint investment programs with Treasury.


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.


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.


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.


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.

The Treasury Has Prepared a White Paper and FAQs at http://www.financialstability.gov

Stocks Mentioned

Related Entities

• UBS
• Standard & Poor's
• FDIC

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