US Treasury Secretary Tim Geithner leaked out the details of his bank recovery program over the weekend and had a early morning press conference to discuss the details of the plan. It's complicated, it has a lot of moving parts, it attempts to involve the private sector, and no one is sure whether banks will sell these assets to create the program.
Other than that, the markets are loving it early.
From the US Treasury Department, the details are as follows:
Three Basic Principles:Using $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 the potential to expand to $1 trillion over time.
The Public-Private Investment Program will be designed around three basic principles:
1. 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.
2. 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.
3. 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 devil's in the details on this and there are questions already over the willingness of the private sector to work with the government due to credibility issues over retroactive taxes claw backs on executive pay. Here's another question, why would banks part with these assets now?
To start the process, banks are going to determine which assets they wish to sell and then inform the FDIC. If a bank has written down the value of the "toxic" or legacy asset to a reasonable value (using mark-to-market), then the bank has already taken the loss on the asset. The potential return for that asset is what will drive the bank's decision as to whether they want to sell it now or hold on to it. If it's already written down to 30 cents on the dollar, the recovery rate or the potential return for that asset could be very high. Therefore, the willingness to sell these loans would be low. Remember, a written down loan or asset requires less capital and therefore a higher potential return.
If the bank has not written it down far enough to reflect the loans mark-to-market value or "true" value, then the bank would have an incentive to sell it. Then the question becomes, why would a private investor buy it? The private investor might be willing to absorb another 10-15% loss if the potential recovery rate is two or three times that rate. But wouldn't the banks know this potential better than private investors? It's a question of the recovery model for loans at this stage and whether banks are already seeing the rate improve to a point where they don't want to part with the loans.
The financing aspect of the Geithner/Obama plan may be favorable enough to have private investors overpay for the assets. If the bank accepts the purchase price, the buyer would receive financing by issuing debt guaranteed by the FDIC. The FDIC-guaranteed debt would be collateralized by the purchased assets and the FDIC would receive a fee in return for its guarantee. Of an asset value of 84c on the dollar, the FDIC would provide financing of 72c and the Treasury would provide 6c of equity. This would leave only 6c of equity for the private investor to fund. This seems like an amazing financing structure for the private investor and may actually raise the ire of Congress.
The applications to be part of the program are due by May. This would mean at least four to six weeks of vetting. And then starting the program by September....If, if, if the banks are willing to part with the legacy loans and securities. By then, the recovery models may be projecting even higher at that point and lessen banks interest in the program. If mark to market is suspended, there is almost no incentive for banks to rid themselves of these loans.....but this should encourage capital formation and new lending.
Overall, time is going to continue to be the most important component for improving the balance sheets of banks.
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