Tough Times for Lenders : Financial Services Lawyer & Attorney : Winstead Law Firm : Finance, Banking, Bankruptcy

Investors recently took down 2.3 billion dollars in TALF loans under the August Federal Reserve's Legacy CMBS Term ABS Loan Facility, representing an impressive increase from the modest July subscriptions of 668 million.

Over the past few months, we have seen CMBS AAA spreads tighten, although at this writing this trend seems to have abated, at least temporarily.  The August Legacy CMBS TALF offerings bear interest rates at 3.03% on fixed-rate 3-year loans and 3.9% on fixed 5-year loans.  That seems relatively cheap money to most of us.  With the only eligible securities being "super senior" AAA's with relatively specific additional underwriting criteria required by the treasury for the securities to be TALF eligible, one wonders why the great interest in this market.  Part of the explanation is that the Treasury and Federal Reserve are offering relatively attractive federal loans and co-investing with the private sector through the Legacy Loan and Legacy Securities Programs.  These programs provide highly leveraged Treasury funds, both as debt and equity.  Therefore, much of the attractiveness is not in the AAA CMBS product itself, but comes by way of government subsidies.

It will be interesting to see how CMBS products will trade after the Treasury Department withdraws its financial support for the product.  But in the meantime, the Treasury Department's programs are serving their intended purpose of decreasing the CMBS "overhang," and at the of rate 2.3 billion dollars for last month, that's not a bad rate for taking Legacy CMBS bonds off the market.

The larger question is how will the new capital being generated by these loan transactions be reinvested?  Will our financial institutions make this capital available in a market place, or will they, as has been done in the recent past, simply hang on to the funds?

Please share questions or comments.

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We've now had a few weeks to review and react to the release by the Board of Governors of the Federal Reserve Systems stress test. See The Supervisory Capital Assessment Program: Overview of Results, dated May 7, 2009.

The Fed goes out of its way to state what the stress test IS, and what it is NOT. Specifically, it is NOT a prediction about the future downward movement in the economy, but simply a measurement device that the Fed will use to determine how much of a buffer certain selected large US bank-holding companies (BHCs) would need under a significantly negative set of economic assumptions about the future. The idea is to ensure that even under a relatively dark set of assumptions, major American banks will have the capital to survive.

To that end, a detailed paper on the Supervisory Capital Assessment Program ("SCAP") was released on April 24. The "SCAP buffer" requires that the BHC's attain by the end of 2010, Tier 1 capital of at least 6% of assets and Tier 1 common capital at least equal to 4% of total assets. Of the 19 BHC's in the study, 9 of them already have capital sufficient to meet this requirement. Of the remaining 11 that must add Tier 1 capital, the vast majority of the 185 billion will be added to Tier 1 common capital to attain the 4% requirement.

The Fed makes a point of noting that these hurdles are not designed to be an ongoing regulatory requirement imposed by either the Federal Reserve System or the FDIC. The most important point is that the Fed is acting decisively and quickly in an effort to have major banking institutions design, within the next 30 days, programs to reach the results called for in the stress test mentioned above by December 31, 2010.

Interestingly, the Treasury has not only put in place requirements for shedding certain assets (home mortgages, second tier commercial mortgages and both commercial and residential mortgage back securities (RMBS and CMBS)). Further, the Treasury through offering to the TARP program (principally TALF loans and the Legacy Loan Program and Legacy Securities Program) is not only setting out the requirements but is also providing the tools, for accomplishing the tasks placed before BHCs over the next 2 years.

In effect, we have a road map for the way out. The FDIC, the Fed and the Treasury have acted decisively and in close coordination in an effort to get capital flowing at what may turn out to be surprisingly increased levels toward the end of this year.

Will it work? Stay tuned.
 

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Is it possible to "discover" a market? We've all had a little more than a week now to digest the recent Treasury announcements regarding the creation of two public-private investment programs which, through Washington, DC wizardry, will magically convert heretofore "toxic" assets into "legacy" assets.

Briefly, here's what the two programs look like:

The Legacy Loan Program ("LLP") will purchase residential mortgage loan pools and other troubled eligible assets from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment with private investors. A wide array of private investors are expected to participate. The program will particularly encourage the participation of individuals, mutual funds, pension plans, insurance companies and other long term investors. The program is intended to boost private demand for distressed assets that are currently held by banks and facilitate market priced sales of troubled assets. The FDIC will provide oversight of the formation, funding and operation of a number of public-private investment funds ("PPIF"), that will purchase assets from banks. U.S. banking institutions of all sizes (including state banks) will be eligible to sell assets under the Legacy Loan Program. To start the process, the banks will identify for the FDIC "troubled assets" setting on the balance sheets; typically pools of mortgage loans they wish to sell. Assets eligible for purchase will be determined by the participating bank organizations, including the primary bank regulators, the FDIC and the Treasury. The FDIC will guarantee the debt issued by the PPIF to the banks to purchase these assets. These loans will not exceed a 6:1 debt to equity ratio. After the banks and FDIC have identified the loan pools and established financing terms, the eligible pool of loans, with committed financing, will be auctioned by the FDIC to qualified bidders. Private investors will bid on a 50% equity basis, with the Treasury contributing the remainder of equity.

See linked diagrams:
Legacy Loan Program
Legacy Securities Program

The Legacy Securities Program ("LSP") creates PPIF's designed to purchase the over-hang of Residential Backed Mortgage Securities ("RMBS"), Commercial Mortgage Backed Securities ("CMBS") and other non-real estate asset backed securities, all originally rated AAA without credit support. The Treasury intends to make this program available under the previously announced TALF Program or through pre-qualified PPIF accounts run by five pre-approved "Fund Managers" who are experienced fund managers and meet specified criteria. The equity for these funds will be 50% from private investors and 50% from Treasury. Additionally, the Federal Reserve will provide supporting loans (on terms yet to be determined) equal to 50% of the fund's total equity. The Treasury will consider requests for senior debt for PPIF's in an amount up to 100% of the fund's total equity. Additionally, it is possible that these funds will be independently funded by TALF senior debt.

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