Timothy Geithner’s plan from the Treasury to get rid of toxic assets from banks and financial institutions’ balance sheets is out. What is certain here in the plan is that there are still many questions which are not addressed. The plan has loosely tried to address concerns on whether or not executive pay would be an issue for those who invest in the plan.
The Treasury has outlined the steps for dealing with legacy assets that banks cannot currently get rid of, compromising their ability to raise capital and their willingness to increase lending. This plan also admits the spiral being exacerbated by a negative cycle has developed where declining asset prices have triggered further deleveraging, which has in turn led to further price declines. The funds will generate $500 billion of purchasing power of legacy assets, but ultimately this could be up to $1 trillion.
The Treasury, the Federal Deposit Insurance Corporation, and the Federal Reserve are all participating in a Public-Private Investment Program to repair balance sheets and to ensure that credit is available to the households and businesses. The crux of this is $75 to $100 billion in TARP capital and capital from private investors. The Public-Private Investment Program will generate $500 billion in purchasing power to buy legacy assets, with a potential to expand to $1 trillion over time.
The Public-Private Investment Program ensures that private sector participants invest alongside the taxpayer. The private sector investors could lose their entire investment in a downside scenario, i.e. non-recourse, and the taxpayer will share in profitable returns. To cut down on the probability of overpaying, private sector investors competing with one another will establish the price of the loans and securities purchased under the program.
The Treasury’s two components of the plan in Legacy assets is for targeting legacy loans which are stuck on books of banks and lenders and targeting legacy securities. These are securitized assets but there is essentially no market or are trading at levels which are far under normalized market conditions. These legacy securities are held by banks, insurance companies, pension funds, mutual funds, and funds held in individual retirement accounts.
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. Treasury currently anticipates that approximately half of the TARP resources for legacy assets will be devoted to the Legacy Loans Program. Individual investors, pension plans, insurance companies and other long-term investors are particularly being encouraged to participate. Buyers will purchase asset pools on a discrete basis under FDIC oversight. FDIC will provide a guarantee for debt financing issued by the Public-Private Investment Funds to fund asset purchases. Treasury intends to provide 50 percent of the equity capital for each fund, but private managers will retain control of asset management subject to rigorous oversight from the FDIC.
The process is meant to be fairly straightforward, and as always, the devil will be in the details. The program will allow banks to identify which assets they wish to sell, FDIC will do an analysis, leverage will not exceed 6-to-1 in debt-to-equity ratio, and it will include eligibility for all sizes of institutions. Pools will then be sold to the highest bidder and financing is provided via an FDIC guarantee. Then the private sector partners will control and manage the assets until final liquidation… subject to strict FDIC oversight.
The Term Asset-Backed Securities Facility (or TALF) is being expanded to bring investors back into the market of these legacy securities. Non-recourse loans will be made available to investors to buy legacy securitization assets, which are expected to include certain non-agency residential mortgage backed securities that were originally rated AAA and outstanding commercial mortgage-backed securities and asset-backed securities that are rated AAA. This does state that borrowers will need to meet eligibility criteria, and haircuts will be determined at a later date and will reflect the riskiness of the assets provided as collateral. It is no surprise, but lending rates, minimum sizes, and the duration of the loans has yet to be determined.
There is a side-by-side plan in this as well. Treasury will approve up to five asset managers with a demonstrated track record of purchasing legacy assets. It may also consider adding more depending on the quality of applications received. These approved managers will receive matching Treasury funds under the Public-Private Investment Program which will be invested one-for-one on a fully side-by-side basis with these investors.
These managers will also have the ability to subscribe for senior debt for the Public-Private Investment Fund from the Treasury in the amount of 50% of total equity capital of the fund. The Treasury will consider requests for senior debt for the fund in the amount of 100% of its total equity capital subject to further restrictions.
There is one important notion here, and that involves the executive compensation witch hunts that have started to spread above and beyond normalcy. There is probably going to be a question from the private sector on whether or not they trust this first assurance on no pay caps. In the QUESTIONS SECTION of this, there is a question about if the Legacy Loans Program be subject to executive compensation restrictions. This states that the executive compensation restrictions will not apply to passive Private Investors. The passive “Private Investors” are defined as: “Private market equity investors are expected to include but are not limited to financial institutions, individuals, insurance companies, mutual funds, publicly managed investment funds, pension funds, foreign investors with a headquarters in the United States, private equity funds, and hedge funds. The participation of mutual funds, pension plans, insurance companies, and other long term investors is particularly encouraged.
There is more than just pay as an issue here. Imagine this for a moment: just because a more liquid market comes available, not all banks and lenders and holders of these will want to sell at the new “fair market price.” Some losses might just be too big to take. There is also the notion of possible changes coming in mark-to-market.
JON C. OGG
March 23, 2009
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