Toxic loan PPIP purchases postponed, feared dead

The purchase of distressed whole loans using taxpayer funds under the US Treasury's Public-Private Investment Program (PPIP) has been postponed, the Federal Deposit Insurance Corporation (FDIC) has announced, raising speculation that the scheme might be scrapped entirely.

In a statement released after US financial markets closed yesterday afternoon, the FDIC announced the legacy loan programme (LLP) "will continue, but a previously planned pilot sale of assets by open banks will be postponed" as regulators look into whether the scheme is still needed, as markets appear to be improving.

Under the original LLP plan, financial institutions holding illiquid portfolios of whole loans - or legacy loans - would approach the FDIC in order to sell the assets. The deposit insurer would assess the credit of the loans in question and determine the amount of funding it would be willing to guarantee on the loans, up to a maximum 6:1 debt-to-equity ratio.

The FDIC would then conduct an auction on the loans, with the highest bidder forming a public-private investment fund (PPIF) with the US Treasury, both of which would provide 50% of the equity, with the FDIC providing a guarantee on debt issued by the PPIF to finance the rest of the purchase price, offering public funding of up to $6 against every $1 of equity to buy the toxic loans.

Whole loan sales would only have gone through if the highest bid received at auction was accepted by the selling bank, but the implementation of the scheme now appears to be hanging in the balance.

"Banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor confidence in our banking system. As a consequence, banks and their supervisors will take additional time to assess the magnitude and timing of troubled assets sales as part of our larger efforts to strengthen the banking sector," said FDIC chairman Sheila Bair.

The FDIC stated it will test the funding mechanism contemplated by the LLP in a sale of receivership assets this summer, drawing upon concepts employed by the Resolution Trust Corporation to resolve the savings and loans crisis the 1990s by financing asset sales through "responsible use" of leverage. The FDIC expects to solicit bids for the sale of receivership assets in July.

Bair insisted that the LLP is not dead but her language appeared to indicate that the scheme will only be revived should economic circumstances decline and its implementation become necessary to resuscitate ailing insitutions. "The FDIC will continue its work on the LLP and will be prepared to offer it in the future as an important tool to cleanse bank balance sheets and bolster their ability to support the credit needs of the economy," she said.

Prospects appear to be somewhat healthier for the LLP's sister PPIP scheme, the legacy securities programme (LSP), which aims to clear balance sheets of illiquid residential and commercial mortgage-backed securities (MBS) by partnering the Treasury with private sector fund managers to form PPIFs to buy toxic mortgage securities.

By April 30 more than 100 asset managers had applied to the Treasury for approval to act as one of the five private buyers to be initially appointed under the scheme, prompting the Treasury to consider increasing the number of fund managers at a later date. Each appointed manager - which must have at least $10 billion in assets under management to qualify - will be given a period of time to collect private-sector capital of at least $500 million to invest in their respective PPIFs.

Once those funds are raised, the Treasury will match the amount of private capital in each PPIF and provide loans of up to 100% of the total equity capital of the fund - offering up to $3 of private money against every $1 of public funds.

The LSP is behind schedule, however, as applicant asset managers were due to be informed of their selection by May 15 -the Treasury has still to make a statement.

Further interest in the LSP was piqued by Bair's comments at a press conference on May 27, in which she ruled out allowing banks to buy back their own toxic MBSs partly using public funds, but refused to categorically dismiss whether banks can be buyers of other bank assets. "I think that's an issue that we continue to look at," she said.

See also: The big clean-up
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