Industry Contemplates a Toxic Debt Roadmap

FDIC, it must be said, has not cut off the possibility of reviving this plan; more to the point, the Treasury Department is still officially moving forward with the Public Private Investment Partnership program.

Details of PPIP are still lacking, however. And FDIC's seemingly second thoughts do not lend confidence that it will move forward eventually. Ironically despite, or perhaps because of, the government's mixed signals, there is a growing chorus of voices that think it may be possible now for the private market to process at least some of these toxic securities.

"The tools that are available to banks still exist and those are direct secondary market asset sales, either providing their own form of sell side leverage or selling the assets for straight cash and not looking back," Will Sledge a principal for Mission Capital Advisors tells GlobeSt.com

"If the Treasury and FDIC back off, then the banks must find well-capitalized investors that have the equity/financing to take the assets off their books without government assistance," Alter Group VP Tom Silva tells GlobeSt.com.

"This may be life insurance companies and hedge funds, who are also a source of financing for transactions although they generally play in 50% LTV loan spacs, or private equity/opportunity funds." There is estimated to be about $300 billion sitting on the sidelines waiting to be invested, looking for markdowns and value-added plays, he notes.

Harold Reichwald, Barbara Polsky, and Clayton Gantz at Manatt, Phelps & Phillips further explore the question of how to dispose of these securities if the government pulls back in a recent client note.

A "good bank/bad bank" structure that was employed at Crocker National Bank 25 years ago and then refined in the Mellon Bank – Grant Street Bank a few years later is a possibility, they write. "In both of these situations, and in others that followed, the key was fresh capital that permitted the troubled assets to be transferred off the bank's balance sheet at realistic valuations…Depending on the source of financing and other governance and structural matters, spinning off the shares or interests of a "bad bank" to the good bank's shareholders may allow the bad bank to remain part of the good bank "family" but not in a way that would force consolidation under accounting rules."

Also, negotiated portfolio transactions with willing private buyers remains a strong alternative, may even hold out the possibility of some upside for the selling bank, they also say. "Obviously, only the stronger institutions can afford to take a capital write down that might be required but this would be measured against the current drag on earnings caused by the troubled assets and the management time and expense devoted to them. A cleansed balance sheet with a strong bank management team and franchise inevitably will attract new capital from the market."

One reason why the market hasn't seen the emergence of these strategies is that the government has been playing coy ever since the crisis began last year, beginning with the Bush Administration and continuing with Obama's.

Indeed reading between the lines of the government's pronouncements has become a high art form – made necessary because of the stakes involved. Consider the analysis Adam Weissburg, partner with Cox Castle & Nicholson makes of the FDIC's decision last week.

It requires breakdown of what was said, what was implied and what it means, he tells GlobeSt.com. "What was said was that the FDIC is directing its short term efforts toward the sale of assets taken in by the FDIC in connection with bank takeovers."

What was implied is that the FDIC has reconsidered the advisability and potential success of a wide spread attempt to create a market for operating banks to sell their toxic assets and avoid capital shortfall issues, he continues.

And what it means? "‪Banks and the FDIC have realized that PPIP is not likely to accomplish its stated goals relative to those operating banks."

PPIP will still provide a vehicle for disposing of assets held by the FDIC, Weissburg believes. What PPIP is not likely to do is be used as a vehicle for removing toxic assets from operating banks, he goes on to conclude, for several reasons: many banks have done capital raises, so they have less urgency in disposing of toxic collateral as a way to clean up their balance sheet; some banks are now realizing they cannot grapple with the accounting losses occasioned by note or REO dispositions; some banks that have reserved for losses may actually be in a better position given the revisions to certain accounting rules that allow for more favorable loss reserves --in essence, showing improved financial strength by having over reserved; finally, some banks may believe that they can get better pricing execution if they sell to buyers and provide financing.

"What this means for buyers and sellers is unclear," he says.