CAPITAL MARKETS ALERT: Summary of Public-Private Investment Program Summit

    9 June 2009

    The Securities Industry and Financial Markets Association (SIFMA) and the Pension Real Estate Association (PREA) hosted a conference to discuss the Term Asset-Backed Securities Lending Facility (“TALF”), the Public-Private Investment Program (“PPIP”), the FDIC’s proposed Legacy Loans Program, the Treasury Department’s Legacy Securities Program, and the expansion of the TALF to include commercial mortgage-backed securities (“CMBS”) and “legacy” CMBS.

    The general sentiment expressed at the conference was that TALF has been a success thus far to revive the stagnant mortgage-backed securities market and that the introduction of the TALF for CMBS and legacy CMBS will be in place before that market is able to deteriorate to similar levels. With respect to PPIP, many panelists expressed their lack of surprise in the FDIC’s recent announcement to delay the introduction of the Legacy Loans Program. The speakers pointed to the significant amounts of capital recently raised by banks that would have otherwise depended on the Legacy Loans Program. Additionally, investors and analysts offered mild praise for the Legacy Securities Program, a combination of concern as to the program’s necessity, its ability to function and the suggestion that the TALF’s success will detract from the Legacy Securities Program.

    The following is a brief summary of the conference.

    Remarks by William Dudley, President, Federal Reserve Bank of New York

    In his prepared remarks, Mr. Dudley focused on the TALF, of which the Federal Reserve Bank of New York is “encouraged by the results so far.”

    Mr. Dudley discussed the market conditions prior to introducing the program in November 2008 that necessitated the Federal Reserve’s action to support the market, namely the market’s inability to provide (i) leverage to purchase highly-rated, low-risk assets, (ii) term financing or (iii) protection against very adverse economic outcomes. With respect to the risk posed to the government by the Fed, he pointed out that because the collateralized securities are AAA-rated, losses on the underlying loans must be of significant sizes to reach the senior-level bonds. In addition, the Federal Reserve charged the borrower a haircut of about 10%, depending on the asset class, to protect against losses. And even if a borrower defaults on its loan and puts the collateral back to the TALF, the Federal Reserve has created a special purpose vehicle to purchase the asset with TARP capital. It would require all of the funding available to the SPV to be exhausted in order for the Federal Reserve to realize a loss through this program.

    Mr. Dudley also pointed out the important benchmarks which indicate that the TALF is aiding the ABS market. The volume of consumer ABS securities has been gradually reviving, both among various asset classes and both TALF and non-TALF eligible securities. The last month’s subscription for TALF loans included 13 different offerings valued at over $16 billion. As volume increases, there has been a sharp decline in the spreads on consumer ABS.

    During the question and answer session, Mr. Dudley discussed the difficulties the New York Federal Reserve Bank is facing with respect to expanding the program to Legacy RMBS, including the lack of trust in the ratings the pre-2009 securities received, the fact that some of the securities are no longer rated “AAA” and the general administrative burdens raised by such an endeavor. Mr. Malz addressed this issue during the final panel of the day.

    Mr. Dudley also said the Federal Reserve Board of Governors will look at market conditions later in the year when they decide to extend the program beyond its December 31, 2009 expiration date.

    Panel: Impact on Financial Institutions

    Participants: Guy Moszkowski, Managing Director, Banc of America-Merrill Lynch
                       David Coulter, Managing Director and Senior Advisor, Warbug Pincus LLC
                       Scott Romanoff, Managing Director, Goldman Sachs & Co.
                       Brian Sterling, Principal and Co-Head of Investment Banking, Sandler O’Neill

    In his initial remarks, Mr. Sterling noted that the announcement that the FDIC will use the leveraged financing previously announced for the Legacy Loans Program to sell assets of failed banks out of receivership will help to achieve one of the program’s goals of establishing some sort of secondary market price for pools of “legacy” mortgage loans. He offered that when failed banks’ assets are sold, it will set a market-based price range for healthy banks to use in determining the proper pricing for its assets. Once such prices are established, he suggested the government might then require banks to adjust the book value of their holdings accordingly.

    Mr. Romanoff compared the current crisis with previous ones and remarked that recently, there is plenty of capital available, but insufficient leverage, which is different than the previous downturn in the banking industry. He believes that many banks will hold on to their legacy assets and try to wait out the recession by accessing capital.

    Mr. Sterling pointed out that many of the nation’s smaller banks accessed the Troubled Assets Relief Program (“TARP”) in order to finance acquisitions and other strategic transactions until the government expressed its disapproval for such uses of funds. Many banks are now trying to repay their TARP funds in order to do these deals, and he predicts an increase in the number of strong banks buying up the weak ones and a period of consolidation of banks in the near future.

    View from the FDIC

    Participants: Joseph Jiampietro, Senior Advisor for Markets
                       James Wigand, Deputy Director, Division of Resolutions and Receiverships

    The two speakers shared their thoughts on a host of topics before taking questions. During this session, the FDIC officials stressed that one of the primary objectives of the Legacy Loans Program is to increase the transparency of banks’ balance sheets. In that regard, with respect to future sales of failed banks’ assets through an auction process to access the government-backed leveraged finance, the FDIC will disclose the winning bidder and the accepted purchase price and the identity of all other bidders.

    With respect to the program, they said it had been their intention to sell assets in pools of $1 billion, with $500 million being the smallest pools for sale. They also clarified that banks were never going to be permitted to bid on their own assets at auction, a rumor which had been recently reported.

    In response to a question from the audience as to whether the FDIC would ever securitize pools of assets held in receivership as was done with the Resolution Trust Company, the speakers would not rule it out as a possibility, but that they don’t yet have the “pipeline” of incoming assets to support such a model.

    Panel: Opportunities in Commercial Real Estate

    Participants: Bart Steinfeld, Managing Director, Jones Lang LaSalle
                       Russ Appel, Managing Director, The Praedium Group LLC
                       Phil Riordian, Senior Managing Director, GE Pension Trust
                       Barry Sternlicht, Chairman and CEO, Starwood Capital Group Global LLC
                       David Twardock, President, Prudential Mortgage Capital Company

    The dominant message from the commercial real estate panel was that while TALF’s introduction came long after the ABS market had collapsed, the CMBS market has not yet reached such high levels of defaults and the worst is still to come. The panelists were optimistic that the TALF CMBS and TALF Legacy CMBS will help to prevent the steep decline the ABS markets experienced.

    Mr. Sternlicht stressed the importance of the commercial real estate market and CMBS to state and local governments. The revenue generated by real estate taxes will disappear if the commercial real estate market suffers in a similar way as the housing and consumer credit markets. Without federal support, municipalities could see an increased budget shortfall in the next six months to a year.

    With respect to the TALF, the panelists agreed that the program, which is currently set to expire on December 31, 2009, needs to be extended through 2010 and probably 2011. In addition, a recent announcement that the rating agency S&P may downgrade CMBS issuances from 2005-2007 would cause billions of dollars in securities to no longer be eligible as collateral for TALF loans. Such a move could negatively impact investors, borrowers and prospective CMBS issuers.

    Remarks by David Miller, Director of Investments, Office of Financial Stability

    In prepared remarks focused on the Treasury Department’s Legacy Securities Program, Mr. Miller announced that there are less than 20 applicants being considered as Fund Managers after receiving over 100 applications in April. The Treasury Department is currently performing a diligence review on and checking for potential conflicts with the finalists, and negotiating term sheets with each of them. They hope to announce the five or six Fund Managers in the next one to two weeks. After that announcement, fund managers will have 12 weeks to raise the minimum $500 million. They also plan to release revised program rules and regulations with more details than the previous Terms and Conditions.

    In performing their review, the Treasury Department is not seeking niche fund managers, but rather those applicants with a stable track record of working with the eligible assets both in their size and type. With respect to potential fears that PPIF investors may have related to retroactive rule changes and possible government interference or restrictions, Mr. Miller stressed that they do not intend to take these types of actions and hopes that investors will become more interested once the program is fully operational.

    Panel: Outlook on the Legacy Loans PPIP

    Participants: Margaret Tahyar, Davis Polk & Wardwell
                       Sean Brady, Managing Director, Head of Product Development, Credit Suisse
                       James Harrington, Managing Director, Fortress Investment Group LLC
                       Paul Koches, Executive VP and General Counsel, Ocwen Financial Corporation
                       Jack Schakett, Mortgage Executive, Credit Loss Mitigation Strategies, Bank of America

    Given that the short-term outlook on the Legacy Loans Program is a postponement of the trial program, the panelists discussed the outlook for banks and investors. Ms. Tahyar questioned how banks have only realized one-half of their expected losses based on IMF predictions, but were still able to raise $100 billion in capital in the last month. It was also pointed out that the large banks were able to easily raise money, but the smaller banks will need some sort of FDIC support to remove legacy assets and access capital without the Legacy Loans Program.

    Mr. Brady expects the market to invent private alternatives to government programs, using Credit Suisse’s program that put distressed assets into a SPV and gave interests in the SPV to executives as part of their bonus compensation last year. The panel also discussed recent loan modification programs, Hope for Homeowners and how homeowners, investors, banks and mortgage servicers have been able to work with the Treasury Department to achieve a resolution for all parties.

    Panel: Outlook on the Legacy Securities PPIP and Expanded TALF

    Participants: Stuart Litwin, Mayer Brown
                       Wellington Denahan-Norris, CIO, COO, Annaly Capital Management
                       Laurie Dotter, Senior Vice President, Hunt Realty Investments
                       Chris Flanagan, Managing Director, ABS Research, JP Morgan Securities Inc.
                       Robert Lehman, Managing Director, Mortgage and Structured Finance, Banc of America Securities-Merrill Lynch
                       Allan Malz, Vice President, Markets Group, Federal Reserve Bank of New York

    Mr. Malz of the New York Fed discussed the TALF and its expansion to CMBS and Legacy CMBS. He echoed Mr. Dudley’s remarks, saying that the success of the program will be measured by the availability of credit to borrowers, the decreasing of spreads on securities, the number of new issuances and the introduction of a TALF-like facility by a private provider.

    The TALF CMBS has approved rating agencies beyond Moody’s, S&P and Fitch. Mr. Malz indicated that the list of approved rating agencies is being revised for all TALF programs and a new list could be distributed shortly

    The biggest TALF issues the Federal Reserve are currently facing include:

    (1) Secondary market transactions: They will be needed in the near term to spur lending, establish market pricing for assets and protect against fraud in the TALF.

    (2) Limiting the volume of 5 year loans: The Federal Reserve has approved $100 billion for five year loans, and this must be allocated among Legacy and new CMBS issuances, along with ABS collateral types with five year loans. The Federal Reserve will encourage investors in years 4 and 5 to seek alternative financing sources.

    (3) The use of collateral monitor with TALF Legacy CMBS: The Federal Reserve is going to engage several collateral monitors to determine eligible collateral for the TALF and manage the Federal Reserve’s portfolio risk. The Federal Reserve is still working out the details and will release revised eligibility criteria as soon as possible, but stressed that the focus is o credit quality for the facility.

    Written by Matthew Kulkin