David McCraw, SVP  Client Solutions Group

 
     There have been so many federal responses to the economic crisis during the past 18 months that it’s difficult to keep track of them. Making it even more confusing, many programs stemming from the Emergency Economic Stabilization Act are inter-related, so not only are there sister programs, new ones are birthed almost monthly. The Emergency Economic Stabilization Act of 2008 (EESA) was aimed at stabilizing the financial system. The Troubled Assets Relief Program (TARP) was established under EESA to prevent a systemic financial collapse. To assist you in keeping track of this plethora of programs, MIAC offers the following primer on the programs of most interest to our clients. The snapshot below provides highlights of each for quick reference, followed by a more detailed discussion of each with our assessments.

• Capital Purchase Program (CPP): Under this voluntary program, Treasury is prepared to purchase up to $250 B of senior preferred shares in financial institutions to help them build capital and increase the flow of financing.  The federal banking regulators are currently evaluating all submitted CPP applications and continue to send qualifying applications to Treasury for final approval.

What this means to the market: The deadline for this kind of support has closed. Those institutions willing to live with the executive compensation requirements can free up capital by paying Treasury a five percent dividend on senior preferred shares for the first five years following the Treasury’s investment and a rate of nine percent per year, thereafter. Not bad, if you need the capital. So far, 633 financial institutions have taken advantage of this program to the tune of nearly $200B. Participants have to be able to show how every dollar of capital received enables them to preserve or generate new lending compared to what would have been generated without Federal assistance.

• Targeted Investment Program (TIP): This has also been referred to as the “Systemically Significant Failing Institutions Program.” The goal is to assist any one financial institution that could, if left unassisted, threaten the well being of other financial institutions and the broader economy. The extent and probability of the troubled institution’s ability to access alternative capital is key in determining whether the government intervenes. There is no application, no deadline, and no specific guidelines on how much or in what capacity the Federal Government will invest in the failing institution. Treasury provided assistance to AIG under this program in November 2008 and April 2009. Citigroup was also a beneficiary.

What this means to the market: The wisdom of maintaining a “too big to fail” program has been questioned. The taxpayer’s investment in institutions too complex to quickly understand and too big to be managed by the government is a legitimate concern. Most of us will never have to worry about being big enough to fall into this category, but self-imposed “stress testing” may be the best way to ensure your institution is up to the current economic challenge. MIAC has the talent and tools to “shock” your portfolios to ensure you know just what to expect in a worsening economy.

• Making Home Affordable: Making Home Affordable includes the Home Affordable Refinance Program and the Home Affordable Modification Program.

• The Refinance Program is designed to assist borrowers current on their payments but unable to refinance at lower interest rates because of plummeting home values. Qualified borrowers must have mortgages held in portfolio, securitized or guaranteed by Fannie Mae or Freddie Mac. First liens up to 105% of the current market value of the home are eligible.

• The Modification Program is designed to assist borrowers avoid foreclosure. Under the program, the government shares the costs of modifying those loans with the lender. Borrower qualifications include the following: the mortgage must cover a primary residence; the current monthly mortgage payment is greater than 31% of the borrower’s gross monthly income; and the mortgage loan amount does not exceed $729,750 for one unit properties.

To incent participants, the Treasury will pay servicers a fee for modifications made to borrowers along with an ongoing performance incentive for loans that stay in the program. Treasury will also pay borrower incentives for those who continue to pay their mortgage on time. An incentive payment is also paid to investors for modifying certain loan types.  For all modified loans, the Treasury will compensate the investor for a portion of the payment reduction from 38% to 31% debt-to-income.

What this means to the market: This is an excellent way to stave off foreclosure and increase your servicing value if you’re holding mortgage portfolios. And, the built in incentives for servicers, borrowers and investors make this a winning strategy all the way around, not to mention that no financial institution really wants to be in the position of displacing a homeowner.  MIAC has recently enhanced its DataRaptor product to assist lenders managing mortgage portfolios to easily assess their opportunity to take advantage of this program and its WinOAS cash flow engine to price the new cash streams associated with the modified loans.For more information, please see the accompanying article in this issue by Lisa Malie, “To Modify or Not to Modify”.

• Capital Assistance Program: This program was implemented in February to ensure the stability of financial institutions with assets in excess of $100 B, which accounted for the 19 largest institutions nationally. Stress testing was implemented on an interagency basis to determine whether these institutions (1) held sufficient capital to absorb any losses expected from the current economic downturn and (2) would still be able to extend credit to their respective markets. The tests compared the level of assets held by these institutions against the level required under two different but possible scenarios depicting just how deep the recession might go. The results were announced May 7th, and it was determined that 10 of the 19 banks needed to raise $75B within six months.  

Those banks requiring additional capital have until November 2009 to raise funds on their own. If unable to raise sufficient capital, each institution will commit to issue a CAP convertible preferred security to the Treasury in an amount equal to the necessary additional capital. These securities can be converted into common stock on an as needed basis.  The downside of this solution is that it makes the government a shareholder in these banks and does not necessarily free up credit.

What this means to the market: The banking organizations included in this exercise comprise the core of the US banking system, representing roughly two-thirds of aggregate U.S. Bank Holding Company assets. Eligible U.S. banking institutions with consolidated assets below $100 billion may also obtain capital through this program. Eligibility is based on criteria established for the program.  MIAC can help you determine if you qualify for the program if interested and ensure your financial house is in order regardless by customizing a ‘portfolio shocking analysis’ combined with other tools based on your profile.

• Asset Guarantee Program (AGP): This program is designed for financial institutions holding assets at risk of default where the institution is, once again, considered critical to the economic recovery of the nation. Under this program, Treasury will guarantee certain assets held by the qualifying financial institution. The set of insured assets is selected by the Treasury in consultation with the financial institution receiving the guarantee. Assets to be guaranteed must have been originated before March 14, 2008. Treasury determines the eligibility of participants and the allocation of resources on a case-by-case basis. The program is meant for systemically significant institutions, and could be used in coordination with other programs. Treasury also would provide a set of portfolio management guidelines to which the institution must adhere for the guaranteed portfolio.

What this means to the market – Citigroup and Bank of America have both benefitted from this program. Others will likely follow. Any institution not big enough to qualify as “systemically significant” simply must gear up their servicing efforts, find a qualified subservicer, or consider selling to those in the market for distressed portfolios. MIAC can provide you with a real-time valuation at reasonable costs.

• Public Private Investment Program (PPIF): There are two components of this program for improving overall financial liquidity: the Legacy Loans Program and the Legacy Securities program, created in partnership between Treasury, the FDIC and the Federal Reserve.

 
Legacy loans: This program is designed to attract private capital to purchase illiquid assets from banks through FDIC debt guarantees and Treasury equity co- investment. The FDIC’s guarantee will be collateralized by the purchased assets. Treasury will provide 50% of the equity capital for each PPIF, but private investors will retain control of asset management with oversight from the FDIC.

The Treasury and private investors will invest equity capital in Legacy loan PPIFs and the FDIC will provide a guarantee for debt financing issued by the PPIFs to fund asset purchases. The FDIC’s guarantee will be collateralized by the purchased assets and the FDIC will receive a fee in return for its guarantee. The Treasury will manage its investment on behalf of taxpayers to ensure the public interest is protected. Private investors will retain control of asset management, subject to oversight from the FDIC. Institutions of all sizes will be eligible to sell assets under this program.

Legacy Securities:  It’s no secret that secondary markets for residential real estate, commercial real estate and consumer credit are highly illiquid and trading at prices far below previous market levels. The intention is to incorporate this program into the TALF. (See “TALF” section below.) This program is still being defined, but broadly, the concept is as follows.

Non-recourse loans will be made available to investors to fund purchases of legacy securitization assets. Eligible assets will include non-agency residential mortgage backed securities (RMBS) originally rated AAA and commercial mortgage backed securities (CMBS) and ABS rated AAA. Exact terms of the program are still being discussed.

Additionally, Treasury is putting together a program under which private investment managers will have the opportunity to apply for qualification as a “Fund Manager”. Treasury expects to approve approximately 5 to 10 Fund Managers based on their historical track record in the targeted asset classes. Approved Fund Managers will have a specified amount of time to raise capital to target the designated asset classes and will receive matching equity from Treasury. Treasury equity capital will be invested with these private investors in each PPIF. Treasury expects the PPIFs to initially target non-agency RMBS and CMBS originated prior to 2009 with an origination rating of AAA.

• Term Asset Backed Securities Loan Facility (TALF):  This program is an off-shoot of TARP’S Asset Guarantee Program. In November of 2008, this Federal Reserve Program was established to support the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card debt, commercial mortgage-backed securities (CMBS) and Small Business Administration (SBA) loans. The Federal Reserve Bank of New York (FRBNY) will lend $1 trillion in non-recourse loans to holders of AAA rated ABS backed by new consumer and small business loans.  The FRBNY will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS.  The U.S. Treasury Department--under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008--will provide $20 billion of credit protection to the FRBNY in connection with the TALF. 

Treasury will continue to consult with the Federal Reserve regarding possible further expansion of the TALF program to include other asset classes, such as non-Agency residential mortgage-backed securities (RMBS) and assets collateralized by corporate debt.

With regard to the program’s viability for CMBS, some who have studied the program are skeptical of this approach. They are concerned that the TALF CMBS proposal as framed is very unlikely to restart the CMBS machine because there is no clean exit for all of the risk.  

Just When You Thought There Couldn’t Be More…..

If you’re feeling caught up, don’t, because the White House has just proposed a sweeping overhaul of the way the Federal government oversees financial markets. Under this proposed legislation, the Federal Reserve and the Executive Branch will have vast new powers to oversee previously unregulated areas of the economy. Included in the proposal are the following:

• The Federal Reserve will have the power to oversee virtually all financial institutions in the country, including any commercial company owning a banking charter.
• The government will have the power to take over and wind down any financial institution
• A financial services oversight council will be created to coordinate the various financial regulators and fill in any existing oversight gaps.
• Credit rating agencies will receive more oversight.
• A new consumer protection agency with the ability to provide rules for consumer credit, including mortgages, is being created.
• The Office of Thrift Supervision will likely be abolished and replaced with a new financial institution regulator.
• Several other enhancements to augment financial oversight are recommended.

Much of this information was assimilated from Treasury white papers. For additional information, please visit Treasury. Gov or feel free to contact our Washington office for a broader program summary. 

What this means to the market: So far, the PPIF has had limited success. Some investors have voiced concerns that the program likely will be too small to spur purchases of battered mortgages and other assets. Others have complained that the plan is so vague that they are likely to stay on the sidelines for now. One key question remains: will banks sell the toxic assets at prices investors are willing to pay?

What this means to the market: Turn in your scorecards and get ready for a brand new game. Senate Banking Committee Chairman Chris Dodd, D-Connecticut, and Barney Frank, D-Massachusetts both have said they believe the legislation will be in place by year-end. Look for more ‘get out of jail’ cards in the near future.

What this means to the market: TALF doesn’t expire until year-end. But there is already a logjam of investors who hope to participate in low-cost financing for investments under this program. The Fed has 16 designated dealers of TALF-eligible securities, but these dealers are liable for making borrowers aware of their obligations, so the process is necessarily slow.

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