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Monday, March 23, 2009

Digest Treasury's Toxic Asset Plan

The plan consists of two key components:

Legacy Loans Program: a program to combine an FDIC guarantee of debt financing with
equity capital from the private sector and the Treasury to support the purchase of troubled loans from insured depository institutions.

Legacy Securities Program: a program to combine financing from the Federal Reserve and Treasury through the Term Asset-Backed Securities Loan Facility (“TALF”) with equity capital from the private sector and the Treasury to address the problem of troubled securities.

Example How It Works

For Legacy Loans Program

If a bank has a pool of residential mortgages with $100 face value that they are seeking to divest, the bank would approach the FDIC. 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. The pool would then be auctioned by the FDIC, with several private buyers submitting bids. The highest bid from the private sector – in this example, $84 – would define the total price paid by the private investors and the Treasury for the mortgages. Of this $84 purchase price, the Treasury and the private investors would split the $12 equity portion. The new PPIF would issue debt for the remaining $72 of the price and the debt would be guaranteed by the FDIC. This guarantee would be secured by the purchased assets. 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. Through transactions like this, the Legacy Loans Program is designed to use private sector pricing to cleanse banks’ balance sheets of troubled assets and create a more healthy banking system.


For Legacy Securities Program

Treasury will launch the application process for managers interested in the Legacy Securities Program. An interested FM would submit an application and be pre-qualified to raise private capital to participate in joint investment programs with Treasury. Treasury would agree to provide a one-for-one equity match for every dollar of private capital that the FM raises and provide fund-level leverage for the proposed PPIF. The FM would commence the sales process for the PPIF and raise $100 of private capital for the PPIF. Treasury would provide $100 of equity capital to be invested on side-by-side basis with private capital and would provide up to a $100 loan to the PPIF if the fund met certain guidelines. Treasury would also consider requests from the FM for an additional loan of up to $100 subject to further restrictions. As a result, the FM would have $300 (or, in some cases, up to $400) in total capital and would commence a purchase program for targeted securities. The FM would have full discretion in investment decisions, although the PPIFs will predominately follow a long-term buy and hold strategy. Depending on the amount of loans provided directly from Treasury, the PPIF would also be eligible to take advantage of the expanded TALF program for legacy securities when that program is operational.


Here is a graph from NYT, making the two examples easier to understand:


(click to enlarge)


Reactions to the plan: