Treasury Secretary Timothy Geithner's announcement of the revamped Financial Stability Plan proved to be a showstopper during the American Securitization Forum's (ASF) annual industry conference held earlier this month in Las Vegas. But reactions were mixed.
While ABS market participants welcomed a plan that could finally bring back investors who have retreated on pricing discrepancies and the lack of regulatory framework, they did not see enough detail to restore confidence.
(In our guest column this month, Bill Berliner of Berliner Consulting offers a hard-edged critique of the plan, p.6)
Among the new Federal initiatives is the formation of a Financial Stability Trust, or public-private investment fund, which would encourage private institutions to purchase up to $1 trillion in distressed or legacy assets from banks' balance sheets with financial assistance from the U.S. government.
One N.Y.-based investor criticized the program, which, he suggested, has already stumbled on the lack of information available to market participants.
"It is a failure of communication. You can't set the market up and tell them that you are going to give them specifics and then not give it to them," the investor said. "You have to know exactly what you want to do and lay it out in very specific terms, and the government did not do that."
Second Time Around
Insufficient details are a valid concern for the ABS market, which saw initial plans for a Troubled Asset Relief Program (TARP) - proposed last September by then Treasury Secretary Henry Paulson - fizzle on the launch pad before they even took off. Instead, the TARP plan was swapped out for the Capital Purchase Program, which was aimed at providing immediate funding to ailing banks, but failed to restart consumer lending.
One new wrinkle this time around is a government backstop, which would provide public financing to help the private sector purchase between $500 billion and $1 trillion in assets from bank balance sheets. Initial talk in the market was that the Federal Reserve could directly provide these loans to the private market, or they could be accessed through government-guaranteed bonds.
The backstop format could limit investors' risk, allowing them to take advantage of the discount between current asset values and real potential losses, said analysts at Citigroup Global Markets in a report last week. The analysts expected that the gap between real losses and recent market levels would allow plenty of room to lure back private capital.
In the longer term, the plan "should help tighten the value gap on these assets, and should indirectly help broad categories of secondary market spreads," Citigroup analysts said.
But many questions about the program remain, such as what the government's role is going to be in terms of guaranteeing losses, or whether there will be some risk-sharing aspect to the program, said John McElravey, director in ABS research at Wachovia Capital Markets.
Market participants are also still wondering what type of private sector buyers would be allowed to participate, and whether the program would be limited to larger financial institutions, or if smaller private firms like hedge funds would be able to use the program to sell off distressed assets as well.
The fund looks less likely to be the clean aggregator bank that was initially discussed several weeks ago, especially since the Fed and the Federal Deposit Insurance Corp. (FDIC) announced that they would be partnering in the program, said Amy Moorhus Baumgardner, counsel at Morrison & Foerster. Moorhus Baumgardner suggested that the fund could, instead, incorporate some of the elements in the programs put in place for Citigroup and Bank of America, where the government would provide financing for these private funds that would hold the assets on their balance sheets, instead of the government holding all of the risk. To encourage private investment, a guarantee or insurance component is possible, she said.
The sooner the government comes out with details the better, market participants agree. However, it makes sense to get it right, said Hays Ellisen, partner and co-chair of the TARP task force at Katten Muchin Rosenman in New York, and not come out too soon with details of a plan that continues to change.
What Price Is Right?
But valuation discrepancies between buyers and sellers still remain a challenge to be addressed before the program is up and running.
The indirect government support for the plan will allow the private sector to set their own prices for distressed assets.
"Instead of having the government come in and value assets themselves, which was originally suggested to be done through Dutch auctions or more objective procedures like expert valuations, the government will provide some element of public financing that will bridge the gap but won't set the price," Ellisen said. "It will come down to what the sellers are willing to accept and buyers are willing to pay."
But that is the conundrum, said the N.Y.-based investor. "The market is stuck between a rock and a hard place in this, and striking the right balance is a problem," the investor said. "Banks are incentivized to sell assets off their books, but not at a price where they have to go back to the government for money because their capital gets depleted. And private investors need, on a risk reward basis, to get an appropriate return on their money over time."
Furthermore, with the Republicans voting against the recent stimulus plan, the market is still not confident in the government's ability to turn the market around, he said.
Good Public Policy
However, allowing the private sector to price these securities is positive from a political perspective, Moorhus Baumgardner said, since it presents policy issues when government prices assets. "Treasury has [received] a significant amount of criticism for how they priced the TARP Capital Purchase Program investments, not necessarily because of the prices themselves but because of a lack of transparency. Private investor pricing would be more likely to succeed."
How to set prices is another challenge, especially without a new-issue market. "You need a couple of deals on the new issue side to anchor spreads," McElravey said. Market participants will have to decide how they are going price these securities. "You have to look at it on a deal-by-deal, class-by-class basis. Once you make assumptions about prepayments, defaults, loss severity and timing, then you need to decide what the right discount rate is."
However, Ellisen suggested that just the announcement itself is a positive step for the market. "The general outlook is that unless something is done about the troubled assets on the books of these banks, there will continue to be problems in the wider economy," he said.
Furthermore, many investors have been waiting on the sidelines to make investment decisions, because they want to see what happens on a governmental level. "Just the fact that you have some certainty will be a good thing for the market," Ellisen said.
Many investors want to get involved in the program, which could kick-start some issuance.
Already in the Term Asset-Backed Securities Loan Facility (TALF), there appears to be growing interest from traditional commercial ABS investors, although most interest is coming from hedge funds and other levered investors, according to a report last week from Bank of America Securities.
"A number of credit card and FFELP lenders appear to be willing to issue TALF-eligible ABS, but at spread levels below current market levels," the bank analysts said.
Once the public-private investment fund is up and running, there will still be barriers to recovery in the structured finance market. Financial institutions will have to demonstrate the health of their balance sheets, said Moorhus Baumgardner.
"It will take a little time before banks and other investors will be willing to purchase these securities in the market," she said. "Banks need a period to say they have removed their toxic assets and that it worked-the balance sheets are stable. The market needs to know that there will not be any more excessive write downs and the appropriate risk management procedures were put in place to assure that banks are prudently purchasing asset-backed securities."
While the market expects to see more details of the plan unveiled in the near term, political pressure on the mortgage foreclosure side, and the stimulus plan which passed last week have made prioritizing an issue, several market participants agreed.
Moorhus Baumgardner predicted that the market might see more information on foreclosure prevention first. Indeed, last week President Barack Obama rolled out a $75 billion program to help struggling homeowners avoid foreclosure. The plan is set to take effect March 4, and could include an alteration to the bankruptcy laws to allow for mortgage cram-downs.
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