Geithner, Show me the Money!

Over the past few days I have been inundated with several questions regarding the new Government program geared toward allowing the private sector to receive Government financial support for the purchase of so-called toxic assets. I would assume the investment community wants a piece of the action, and is asking how? Below I have written an explanation of how this once in a lifetime Public-Private Investment Program (PPIP) works.

Unfortunately it's not as straight forward as simply identifying a desired asset, having your offer accepted followed by an application to the Government for a highly leveraged guaranteed loan. If it were only that easy, we could all jump in! The assets that will be available for sale will most likely be offered not as a single asset but rather as a package of several mortgage loans (commonly referred to in the market as loan pools) and then auctioned off to the highest bidder. Provided you have sufficient funds to purchase mortgage pools this program is an excellent investment opportunity for you. Read on…

I got excited on Monday on hearing the news that private investors could have access to Government guaranteed loans and equity in order to buy troubled loans from banks, in what is being called the Public-Private Investment Program (PPIP). There are two pieces to this, the Legacy Loans Program and the Legacy Securities Program.

The PPIP has three basic principals;

(1) Maximize the impact of each taxpayer dollar through partnership with private investment;

(2) Share the risk and profit with the private sector;

(3) Private sector price discovery through private investor involvement and competition, that is, reestablishing a market price.

Legacy Loans Program

This represents a very real and feasible opportunity for the private sector to acquire pools of loans from banks seeking liquidity because the Government through the Treasury is willing to provide 50% of the required equity and will also guarantee the financing which can be levered by up to 6 to 1 through the FDIC. This represents an equity requirement of 14.3%, or an LTV of 85.7%. Leverage of this scale is currently near impossible to achieve through the traditional banking channels. Additionally, as the Government will be a 50% equity partner, the private investor only needs to come up with half the equity or 7.15% of the purchase price. Therefore a private investor shares 50% of the upside but only has the burden of 7.15% of the risk.

The Treasury will put up $75 billion to $100 billion out of the Troubled Asset Relief Program (TARP) to start the program, and it is anticipated that this will create $500 billion to $1 trillion in loan purchases. Sellers of loans, usually in pools, will identify these to the FDIC who will asses the amount of leverage they are willing to provide on the pool with a limit of 6 to 1. The pools are then auctioned off to the highest private investor bidder with Treasury providing 50% of the equity required. The private investor is free to manage the asset until its ultimate liquidation, the sale of which will be subject to FDIC oversight.

The PPIP will also be available to buy up securitized loans such as residential mortgage backed securities, commercial mortgage backed securities, and other asset backed securities. The Government will also provide 50% of the equity in these investments and guarantee the financing which can be levered by up to 2 to 1 through the FDIC. Funding for this part of the program is being provided through the Term Asset Backed Securities Facility (TALF).

Seem too good to be true? Maybe!

The terms of this program have only been released this week and the first transaction may not happen until May. How well this program is adopted by the banks who will be the sellers of the loans remains to be seen. President Obama is meeting with a group of chief executives from the top financial institutions this Friday to seek support for his various programs to unlock liquidity in the credit markets. These very banks have the most to gain from the PPIP which may reestablish a market price for securitized loans and free up much needed liquidity to allow new lending, so their reaction and feedback to this program is critical in making it work for everyone.

Banks may fear added Government and public scrutiny along with additional regulation if they participate in the PPIP; getting clear guidance from the Government on this will be crucial for the program's successful adoption.