The Obama Administration and Treasury officials will today announce details of another plan to help rescue the US banking system. The Toxic Asset Repurchase Program aims to help finance the purchase of $1 Trillion of toxic assets from banks. The new program, under a new Public-Private Investment Program government organization, has three key components:
- Federal Deposit Insurance Corp.: The agency that insures deposits at the nation’s banks would operate auctions of troubled mortgage loans and then provide financing to the winning bidders. The FDIC would also share the risks if the mortgages fell further in value.
- Term Asset-Backed Securities Loan Facility: A Federal Reserve-operated loan facility will receive $200 billion from the government’s $700 billion bailout program. That money will enable the Fed to support as much as $1 trillion in loans to investors who want to buy securities backed by various types of consumer loans in an effort to make auto loans, credit card debt and student loans more available. The TALF will be expanded to allow the Fed to provide loans to investors buying securities backed by residential and commercial mortgages.
- Public-Private Investment Funds: The Treasury would launch these partnerships between the government and the private sector, with the government matching dollar-for-dollar money put up by private investors to buy toxic assets.
Unfortunately, it is unclear that this plan has any hope of success. Specifically, the “Public-Private Investment Funds” (PPIF) concept that is intended to remove toxic asset from banks balance sheets seem fraught with problems.
PRICING - Let’s take a look at this specific component of the plan from a real estate practitioners perspective. To begin with I, and most other real estate professionals, are bombarded daily with a barrage of emails announcing new “distressed asset” funds that have been created. I wish I had been keeping track since 2007, but I know that the total is well into the billions of dollars that have been raised. These funds are specifically targeting the very same distressed assets that the PPIF program is targeting. What is noticeably absent, however, are the emails that announce that any deals have actually been completed.
From my own experience trying to buy troubled assets, and those of the fund managers I have spoken with, I can tell you that capital is not the problem. The problem, I have found, is that the banks are not willing to let the assets go at a price that makes the risk worthwhile to an investor. Most of these assets are REO for a reason, and that reason has to be addressed before the asset will be successful. If these were such great and performing assets the bank wouldn’t own them – they would still be in investors hands. So, the PPIF has to address what price these assets will be purchased for.
Today, without the government plan, if banks were willing to sell for a “market” price, which adequately prices the risk involved, there is a ready and willing pool of investors. Tomorrow, with the government plan, the banks will still need to be willing to sell at a market price, even if the investors are getting a loan from the government. That market value will most likely be less than where the bank has the asset on the books. Until they actually sell, they can keep the assets on their books at a higher value (although still written down significantly). Once the asset is actually sold, the market value is the market value and the “pain” is realized. I know on all of the projects I have looked at, the value I underwrote to was +/- 70% of the “written down” bank book value. This discrepancy could mean much more future pain for the banking system.
Low Leverage Amounts - As I read the announcement, the PPIF program will basically amount to 50% leverage. It is unclear whether the government piece will be a loan, in which case any additional debt would be classified as a second mortgage. If it is a loan, will the government subordinate their position to a traditional lender? The other option would be that the government piece would be equity and the public-private partnership could then go put additional debt on the assets. That would obviously be the better scenario. Even in today’s difficult market, experienced real estate operators can get much better than 50% financing. However, they wouldn’t be able to even come close to the low interest rate the government would (most likely) offer. Does that low rate offset the low leverage ratio? I doubt it. Equity is always the most expensive piece of the capital stack. Add more equity to a deal and the required rate of return goes up dramatically.
I recently had the opportunity to hear the Honorable John E. Sununu (Member of the Troubled Asset Relief Program Oversight Board) speak on the TARP program. He indicated that the Public-Private program was going to take the form of a 90% government loan, matched with 10% investor equity. Somewhere between last weeks speech and today’s roll-out, the plan changed. However, given that the previous discussions had centered around a “loan” program, my guess is that today’s PPIF program will be a loan as well.
Lack of Trust - The lack of trust in the government is a big issue, and is one that John E. Sununu brought up as a reason for a lack of participation in TARP. Our government has already shown a willingness and ability to re-trade the terms of the agreement under which banks accepted Stimulus Funds. Under TARP they went back and placed tighter restrictions on executive compensation, dividend policies, acquisition programs, and share repurchase programs. More recently, Congress voted to tax bonuses at a 90% level for those companies that accepted bailout funds. All of these meaningfully influence the way the private sector operates their businesses. And, they were all implemented after the initial agreement. Anyone in real estate knows that the key to any partnership arrangement is trust. If you don’t trust your partner, you are in for a miserable journey. The fear is that the government isn’t a trustworthy partner. The fear is that the government will, after the fact, impose significant limitations on how we operate our businesses.
Overall, I think this program has some very significant flaws. Maybe it buys the administration a few points on the Dow today, but I doubt even that. I think that the real estate professional has other, less restrictive, sources of capital available to them. And that is assuming you can get a bank to agree to a market price. In this economy, I’m not sure they are there yet and I don’t see anything in this program that will help incentivize them to sell at market.
The banks are like the neighbor who wants to sell their house for $X when the market keeps telling them it’s worth $Y. Yet, they just won’t sell. As long as grandma keeps bailing them out and paying their mortgage, there’s no real incentive for them to let it go at a market price. Until there is an incentive, all of the other neighbors point to that one house and say, “he’s selling his for $X, mine must be worth $X too”. The buyers just roll their eyes and go find another neighborhood.