OCTOBER 2008
Financial Institutions
TARP—the Largest Distressed Asset Fund in History
Signed into law on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “Act”) grants the U.S. Department of the Treasury the authority to implement and operate the Troubled Asset Relief Program (TARP), the largest distressed asset fund in history. Note that Congress is continuing to hold hearings on issues related to TARP and we will continue to update you on those developments.
This GT Alert highlights certain features of TARP and does not provide a detailed description of TARP or the Act. In taking any actions in relation to TARP or the Act, you should carefully read the Act and consult with your legal and financial advisors.
TARP BASICS
$700 Billion — total authorized for outstanding purchases or insurance of troubled
assets from financial institutions, with graduated increments • $250 billion immediately
• $100 billion added upon request by president
• $350 billion added upon request by president, subject to disapproval by Congress
• December 31, 2009, termination for purchases and insurance, but Treasury may extend to October 3, 2010
Troubled Assets
• residential and commercial mortgages
• securities, obligations or other instruments based on or related to such mortgages
• assets originated or issued on or before March 14, 2008 (business day prior to Bear Stearns acquisition by JPMorgan Chase)
• other financial instruments as determined by Treasury and Federal Reserve to promote financial market stability
Financial Institutions are any institution, including, but not limited to
• any bank, savings association, credit union, security broker or dealer, or insurance company,
• established and regulated under the United States or any state, territory or possession, and
• having significant operations in the United States
Market Mechanisms for Purchases
• purchase at lowest price
• maximize efficiency through auctions or reverse auctions
• Treasury discretion to use Direct Purchases or Auction Purchases
ALBANY AMSTERDAM ATLANTA AUSTIN BOSTON CHICAGO DALLAS DELAWARE DENVER FORT LAUDERDALE HOUSTON LAS VEGAS LOS ANGELES MIAMI NEW JERSEY NEW YORK ORANGE COUNTY ORLANDO
PALM BEACH COUNTY PHILADELPHIA PHOENIX SACRAMENTO SHANGHAI SILICON VALLEY TALLAHASSEE TAMPA TYSONS CORNER WASHINGTON, D.C. ZURICH
Strategic Alliances with Independent Law Firms
BERLIN BRUSSELS LONDON MILAN ROME TOKYO
OCTOBER 2008
Financial Institutions
• transparency by publication of description, amounts and pricing of purchases
• price cannot exceed seller’s acquisition cost for asset, except for acquisitions from a merger or a bankruptcy, receivership or conservatorship
Equity or Debt kicker — TARP to share in equity appreciation or receive interest premium
• warrants in public company for non-voting common or preferred • senior debt in private company or when warrants are not feasible • warrant exercise price or debt interest rate set at discretion of Treasury • de minimis exception for purchases aggregating less than $100 million
Direct Purchases
• if auction not feasible because of no bidding or available market prices, use additional measures so that prices are reasonable and reflect asset values
• equity or debt kicker required (see above)
• executive compensation limits for top five highly paid officers limits on incentives if taking unnecessary or excessive risks recovery of bonus or incentives if materially inaccurate financials prohibits golden parachutes
Auction Purchases
• equity or debt kicker required (see above)
• executive compensation limits for top 5 highly paid officers applies only for aggregate purchases exceeding $300 million
limited to prohibition against golden parachutes for any new employment contract upon bankruptcy or insolvency event
Insurance Alternative for Troubled Assets
• guarantee timely payment of principal and interest on troubled assets • premiums set to create reserves at level to satisfy anticipated claims
Foreclosure Mitigation — Treasury must implement a plan that
• maximizes assistance to homeowners and
• minimizes foreclosures by encouraging mortgage servicers (considering net present value to taxpayer) to use of HOPE for Homeowners Program
• additional use of loan guarantees and credit enhancements for loan modifications • under existing contracts to consent upon request to loss mitigation, including
term extensions
interest rate reductions principal write-downs
increase in percent of loans allowed to be modified removal of other limitations on modifications
OCTOBER 2008
Financial Institutions
Administration and Management of TARP — through rulemaking, Treasury has broad authority to determine
program terms and conditions • outsourcing of functions through
use of streamlined contracting procedures designating financial institutions as agents
establishing vehicles to purchase, hold, sell and finance assets • discretion to determine terms and conditions to sell or finance assets
hold assets until market is optimal for selling
sell assets at prices to maximize returns based on available financial analysis • numerous considerations in exercising authority, some with conflicting objectives • robust oversight to review actions and make recommendations
• appointment of Inspector General to audit and investigate purchases, management and sales of assets
Recoupment of Loss — if after five years TARP has a shortfall, then president must submit a legislative proposal
to recoup the shortfall from the financial industry
FDIC Deposit Insurance — temporary increase from $100,000 to $250,000 effective from October 3, 2008 until
December 31, 2009
Suspension of Mark-To-Market Accounting — SEC has authority to suspend mark-to-market accounting under
securities laws
TARP IMPACT AND ISSUES
The following highlights the potential impact and open issues from TARP based solely on the thoughts and impressions of many commentators, including the authors.
Pricing Assets — how will “lowest prices” for illiquid troubled assets be determined?
Unknown and subjective
• quick and efficient purchase execution is counter to fair and accurate pricing • equity kicker from warrants and debt will add complexity and complicate pricing
• problematic to use prior commodity pricing based on quantitative methodology that contributed to market crisis
• distressed asset pricing involves a more labor intensive and qualitative approach1
Mortgage Liquidity Crisis — will TARP resolve problems in the Bid-Ask pricing spread in the secondary mortgage
market? Maybe, in some respects yes, but questions remain
• liquidity depends on whether assets have been marked to market prices • Ask pricing for TARP purchases can be supported by equity kicker warrants • Direct Purchases may facilitate Ask pricing and prompt purchase execution • pricing transparency will improve from publication of pricing for TARP purchases • Bid pricing from investors may improve from liquidity injected by TARP purchases
• Bid-Ask spread may remain wide because of investor uncertainty from housing crisis and uncertainty from broader credit crisis affecting consumers and businesses
OCTOBER 2008
Financial Institutions
Housing Crisis — will TARP provide some relief to the housing market problems and stop the decline in home
values? Many observers believe it is doubtful, but expect some relief
• whole loan purchases will facilitate loan modifications and provide some relief to delinquent and distressed homeowners
• does not resolve fundamental problem of over supply of housing and lack of demand no relief for existing REO and future REO from ongoing defaults
no relief for new mortgage lending, in which underwriting is much stricter highly unlikely to restart private secondary mortgage market
Asset Purchase Allocations — how will allocations be decided for purchasing assets?
May be problematic to leave allocations to the discretion of the Treasury and its agents
• between residential and commercial
• between mortgage-backed securities and whole loans • between financial institutions selling assets
• will REO properties become an eligible asset for purchase
Outsourcing TARP — who will be the agents used to administer and manage TARP?
Unknown, subjective and unclear
• will Treasury outsource purchase and sale functions to Wall Street and hedge fund players that participated in creating the credit crisis?
• how will Treasury address the practical issues in servicing whole loans (and resulting REO), including whether sufficient infrastructure exists to service assets and pursue foreclosure mitigation?
• how will the Treasury fund liquidity reserves to service and resolve distressed mortgage loans and resulting REO?
Amount — will $700 billion be enough? Many observers believe it is not likely
• considering size of the residential and commercial mortgage markets • but, it is a major step in the right direction
• may be the “beginning of the end” to the credit crisis
• pricing discounts will affect impact of program based on asset par values (e.g., average price of 65% can acquire almost $1.1 trillion par value)
Ultimate Cost — how much will TARP cost taxpayers? Estimates vary between $700 billion and zero
• lack of specifics on implementation, including pricing makes it impossible to estimate ultimate impact
• Congressional Budget Office believes that TARP will likely entail some net budget cost, which will be substantially smaller than $700 billion.2
Cure-All — will TARP resolve the credit crisis? Most observers believe it is highly unlikely
• it treats symptoms; it does not cure the disease
• credit cancer has spread throughout credit markets and on a global scale
• suspension of mark-to-market accounting may provide additional relief to institutions
Although pricing issues for troubled assets need to be resolved, TARP should provide direct and immediate relief to lenders and address their liquidity problems attributable to whole loans and mortgage-backed securities.
OCTOBER 2008
Financial Institutions
overall economy by “right sizing” distressed mortgages, and therefore, assisting the mortgagors under their distressed mortgages. Time will tell whether TARP is ultimately the “beginning of the end” to the credit crisis.
Endnotes
1For further discussion of the problems with respect to purchasing ‘troubled assets’, see Buying the Bad Stuff: Implementation Considerations
for the Paulson Plan, prepared by NERA Economic Consulting (See: http://www.nera.com/publication.asp?p_ID=3589). http://www.nera.com/publication.asp?p_ID=3589).
2See letter from the Congressional Budget Office to the Honorable Barney Frank dated as of September 28, 2008.
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This GT Alert was prepared by Michael Thimmig, Carl Fornaris, Jeffrey Rosenthal and Gil Rudolph. Questions about this information can be directed to:
• Michael Thimmig — 214.665.3606 ([email protected]) • Carl Fornaris — 305. 579.0626 ([email protected]) • Jeffrey Rosenthal — 973.360.7930 ([email protected]) • Gil Rudolph — 602.445.8206 ([email protected])
For more information about Congressional action related to the TARP legislation, contact Diane Blagman (202.331.3121; [email protected]) or your Greenberg Traurig attorney.
OCTOBER 2008
Financial Institutions
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This Greenberg Traurig Alert is issued for informational purposes only and is not intended to be construed or used as general legal advice. The content is known to be accurate/current as of the date of distribution; subsequent changes to legislation, regulations, policies, etc., mentioned herein are not reflected. Please contact the author(s) or your Greenberg Traurig contact if you have questions regarding the currency of this information. The hiring of a lawyer is an important decision. Before you decide, ask for written information about the lawyer’s legal qualifications and experience. Greenberg Traurig is a trade name of Greenberg Traurig, LLP and Greenberg Traurig, P.A. ©2008 Greenberg Traurig, LLP. All rights reserved.
