Interest Rate Roundup

Monday, March 23, 2009

Toxic asset plan gets rolled out

We've been waiting for weeks for the details of the government's plan to buy up toxic assets from banks. Today, those details are being released. The plan is designed to deal with both legacy whole loans and legacy securities, using a combination of Treasury capital, private capital, and debt financing backed by an FDIC guarantee. Here are some excerpts from various sources that contain more details ...

The New York Times:

"The Obama administration said Monday that it hoped to use $75 billion to $100 billion from the government’s bailout program, combined with private capital, to buy up to $500 billion in toxic assets and get them off the books of the banks.

"In a statement released Monday, the administration said the initial effort could grow to $1 trillion in purchases eventually.

"The announcement came as the Treasury Department unveiled the details of the administration’s long-awaited plan to purchase troubled assets, meant to remove them from the balance sheets of banks and, in turn, spur banks to lend more money to consumers and companies.

"The plan relies on private investors to team with the government to relieve banks of assets tied to loans and mortgage-linked securities of unknown value. There have been virtually no buyers of these assets because of their uncertain risk.

"The administration said that it expected participation from pension funds to insurance companies and other long-term investors.

"As part of the program, the government plans to offer subsidies, in the form of low-interest loans, to coax private funds to form partnerships with the government to buy troubled assets from banks.

"But some executives at private equity firms and hedge funds, who were briefed on the plan Sunday afternoon, are anxious about the recent uproar over millions of dollars in bonus payments made to executives of the American International Group.

"Some of them have told administration officials that they would participate only if the government guaranteed that it would not set compensation limits on the firms, according to people briefed on the conversations. The executives also expressed worries about whether disclosure and governance rules could be added retroactively to the program by Congress, these people said."

The Wall Street Journal:

"The Treasury plans to contribute between $75 billion and $100 billion from its $700 billion bailout to the programs to remove troubled real-estate-related assets from bank balance sheets, with the possibility of additional money in the future. The Fed and the Federal Deposit Insurance Corp. will provide other forms of financing, including low-risk loans.

"Targeting mortgages that banks no longer want to hold, the Treasury and the FDIC will provide financing to buyers. The FDIC will auction off pools of loans that a bank wants to sell and will become a co-owner by forming a partnership with the highest bidder.

"The partnership will then raise FDIC-guaranteed debt to finance a portion of the purchase price, with the Treasury willing to kick in between 50% and 80% of the equity needed to buy the assets. The Treasury will be an equal investor in the partnerships.

"To tackle risky securities, such as those backed by mortgages, the Treasury will create several investment funds run by private investors who meet certain criteria, such as experience managing similar assets. Treasury again will act as a co-investor, in most cases contributing $1 for every $1 contributed by the private sector and sharing equally in any gains or losses.

"Lastly, the government will expand the Fed's Term Asset-Backed Securities Loan Facility, or TALF, to help absorb risky assets dating back several years."

You can also get more details straight from the source -- the Treasury's own web site. It provides the following example for how a pool of legacy loans might be purchased and financed:

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 they 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.

As for securities, the process would work somewhat differently. Here is a Treasury example of the process there:

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 pre-qualified 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.


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