Geithner’s Plan is a Start, but…

Treasury Secretary, Timothy Geithner, rolled out some of the details of what insiders are referring to as TALF 2.0.  This program has two componets, the Legacy Loan Program and the Legacy Securities Program. These programs are expected to help the commercial real estate industry based upon the premise that loans and securitiees collateralized by real estate are fundamentally undervalued due to a liquidity discount as opposed to drastically reduced cash flow expectation.

The public/private partnership investment program will create a pool of buyers for a market in which there are currently no buyers. For the securities program, the Treasury will oversee the auction process and for the loan program the FDIC will provide the oversight. Buyers will partner 50%/50% with the FDIC or the Treasury and that partnership will borrow money from the government to create purchasing power of up to $1 trillion in the first phase of this program (I am calling it the first phase because there will undoubtedly be additional capital required to address the massive amount of  toxic assets on the balance sheets of institutions). The newly formed entity will borrow on a non-recourse basis and the private sector component of the partnership has losses limited to their initial investment. The substantial incentives and debt guarantees provided by taxpayers to private asset managers should be enough to drive prices to levels satisfactory to sellers.

The questions, however, are several and the primary question of whether the credit supply resumes depends on the true health of banks. Some of the questions revolve around the appetite hedge funds and private equity investors will have for a program controlled by a government that is prone to changing the rules midstream. The recent furor in Congress over executive compensation has been frightening and with the way the White House has tongue lashed Wall Street at every turn, will the Street want to help? Sure they will. Why? Because it is a tremendous money making opportunity and billions will be made by those who can manuver through the system. Another question is whether this can be accomplished without unduly wasting taxpayer money.

Other questions revolve around whether banks will decide to sell their assets through this program. To what level have the assets been written down? What is the expected sale price via the auction? Can the bank set a reserve? How will these assets be valued? Many of these questions have not been answered yet.

To the extent participants do indeed participate, the result will likely be an easing of credit as the capital ratios at banks should be greatly enhanced by these programs. Banks have more cash than they have ever had but capital levels are stressed due to the mark-to-market accounting rules which force banks to mark assets to “market”. But the fact is, when there is no market, you are only guessing at what market is. A few forced transactions do not make a market.

An enormous issue for the commercial real estate market which these programs do not directly address is the status of CMBS loans and how a borrower can deal with maturing loans in a market where there is no replacement financing available and, moreover, there is no one to speak to at “the lender”. A borrower with a performing loan, who is making their monthly payment, which is approaching maturity, will be in technical default if they cannot refinance. Today, it is unlikely they will be able to and the effects of TALF 2.0 will probably not be tangible enough in the short term to address the massive refinancing needs commercial real estate is facing in 2009. A solution to this dynamic is needed quickly as the first performing loan to be held in technical default because of maturity could be the first of many dominos to fall.

7 Responses to “Geithner’s Plan is a Start, but…”

  1. 1 Bill Cash March 25, 2009 at 1:08 pm

    Bob, I just stopped by your blog and thought I would say hello. I like your perspective and site design. Looking forward to reading more down the road.

  2. 2 Phil Huang March 26, 2009 at 4:57 pm

    Hey Bob,

    I recognize the need to have incentives for Private asset managers to get involved in the PPIP but it seems to me that the non-recourse nature of these loans will ultimately just result in a massive transfer of money from taxpayers to commercial banks. Another blog that I read explains it much better which I copied and pasted below. There was also an article by Jeffrey Sachs in yesterday’s Financial Times about the same exact issue. What are your thoughts on the the Geithner plan? Do we have any alternatives or is this plan absolutely necessary?

    “The greatest bait and switch of this generation in all its visual splendor. As a result of the TALF’s non-recourse/non-margin nature, a hedge fund X can buy Bank X’s MBS Portfolio which is marked on the bank’s books at 80 cents on the dollar (but has a market price of 20 cents) for the marked price with a 3% equity check and TALF filling the balance. A day later, Bank X repurchases the portfolio from hedge fund X at the 20 cent market price, and pays HF X a $5 million fee for the “trouble.” The way this would be effectuated is that at t+1, the Hedge Fund decides to run a loss model via TREPP of what have you, and, lo and behold, realizes the loan will default in 1 day (assumptions and outcomes can be easily fudged) and threatens to default on the entire TALF portion. The key word here is non-recourse: the HF would not be liable for anything over its first-loss equity component. In the case of a declared portfolio default, the TALF portion would have to be marked at pure market value, and taxpayers would get stuck with as close to a donut as possible. So here is Bank X running back to the rescue, offering to buy back the original portfolio at market price (even a 1 cent premium would make it politically palatable), in this case 20 cents. For the sinister minded, it become immediately evident, why hedge funds, once loaded up on these investments, would have an incentive to push down the value of the entire portfolio complex, especially if they, wink wink, bought protection via CMBX or other derivatives. The recent spike in CMBX spreads (massive buying pressure) may be one indication of just how hedge funds might be positioning themselves.

    Once purchased the bank waits for the portfolio to appreciate to 50 cents on the dollar by 2014 (although the appreciation is not necessary and is a best case example of how the bank would fare if the market does pick up). Hedge fund X takes a 75% loss on its nominal equity stake but more than makes up in transaction fees. The TALF portion takes a 75% loss with no recourse and no margin to fall back on.

    As a result Bank X takes no writedown now, and in 5 years may book an equity profit of as much as $25 million (net of transaction fees paid to the Hedge Fund X), while Hedge Fund X books a profit of $3.2 million for one day’s work…

    Lastly the U.S. taxpayer loses $54.3 million on a $77.6 million TALF Investment, or 70% (net of 5 years of interest income).

    Note: the maximum TALF size is $1 trillion. Will U.S. taxpayers suffer $700 billion in losses from the TALF?”

  3. 3 Jim Ciotti March 27, 2009 at 10:10 am

    Thanks for your position on the Legacy programs. Don’t you find it interesting how Washington can move from Toxic/Distressed to Legacy? Our business is located in the Washington Metro market and we stay close to the movements in the Capital. We prepared an analysis of the “legacy Programs” from a opportunistic buyer’s position and heres what we see: If a deal appears to be to good to be true/real then it probably isn’t a good play. There are many questions that require clarity, Why is the FDIC brokering loan transactions for Commercial Banks? Where is it getting the staff, which is already strained to the max, to handle these “Auctions”. What is an “Eligible Asset”, What is the depth and level of oversight by the Feds on the entity, What is meant by “Long Term Investment”,”$75-100B doesn’t equate to half of the remaining TARP Funds”, “How can these transactions be DICRETE when Taxpayer dollars are being used, more importantly, what about EOP Executive Order 108 requiring the Fed to set aside 20% for small businesses”,”What are the guidelines for FDIC or Treasury regulation of these PEE-PIPS”,
    “What triggers the FDIC Guaranty on the assets”, “Who is going to be a Market Maker after the Faniie/Freddie debacle”, “What is meant by RIGOROUS oversight by FDIC”, “How long is it going to take the FDIC to evaluate and negotiate with the BANKS”, It is obvious that the BANKS are the sellers, and please define FACE VALUE by the BANK’s standards. Do you think this can be put into action and completed in less than 6 months? More importantly, what are the “FEES” paid by the Private Investor to the Feds going to be? The best one is the simple example for us simple people, a $100 Face Value loan, investor pays $84! That’s a pipe dream in itself, then as an Investor I have $6 of equity in an instument that must be managed and sold at par for $100. Will I make $6 back after fees?
    Grow a pair and close the Banks then let the RTC model do the rest. The market is efficient enough to absorb and distribute the product as we did in the last crisis. Don’t get started on the “Commercial Asset” side….. Thanks for your Blog….


  4. 4 Mariousc March 27, 2009 at 12:55 pm

    Thank you again Mr. Knakal for your blog, as many of times, you are my favorite author (On GlobeSt of course), editor, broker and all around commander in chief when it comes to disecting and breaking down the particles that make up the cell that we call, Commercial Real Estate. The issue we are facing with lenders, borrowers and assets now reminds me of a time when I was young back in the old country. I use to have a puppy named Bensenhurst, but nobody wanted to play with puppy. So I put some fake bunny ears on puppy and I taught puppy how to hop…Then all of a sudden, everybody wanted to come over and play with puppy bunny….This can be translated today to an apartment operator. You have to dress up the building, lease up the units and then everyone comes over to play. But at least now, you can say “No to pets!” Thank you, I am Mariousc and I sell apartments.

  5. 5 rknakal March 27, 2009 at 1:44 pm

    Hi Phil, I do not think the government will permit that type of scenario to occur. The private sector participant will have to put up substantially more than 3% equity. The equity contribution will range from 10% to 33% depending on the asset type and auction scenario. This would result in a significant loss if the scenario you laid out occurs. Additionally, all sales will occur via auctions. If the assets depicted in your example were really worth 20 cents, bids from the non-colluding parties would be in that range. It would be a red flag to see auction bids of 17 cents, 19 cents, 22 cents and then 70 cents. They say the devil is in the details but I do not think this will be permitted to happen.

  6. 6 rknakal March 27, 2009 at 2:01 pm

    Hi Jim, thanks for your post. You bring up many good questions, most of which have not been addressed yet. The details of TALF 3.0 are still being formulated and it will be interesting to see how they look when finalized. Letting a bank fail is one solution but when the assets of that bank are sold, leverage will not be available to buyers near the extent to which it will be under the TALF program. The better levels of leverage should produce higher prices.

  7. 7 rknakal March 27, 2009 at 2:10 pm

    Hi Mariousc, Thank you for your post. I admire your ability to teach a dog to hop.

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