Private equity gets star role in $1trn US bank bail-out

The US Treasury has unveiled a plan to combine public and private equity to buy up to $1 trillion in banks’ “toxic assets”. It is part of the US government’s ongoing efforts to unfreeze the credit markets and stop the spread of the financial crisis.

The Treasury will use up to $100 billion from the Troubled Asset Relief Programme and capital from private investors to buy real estate loans on bank balance sheets and securities backed by loan portfolios. The plan would initially generate $500 billion in purchasing power to buy such legacy assets and ease pressure on bank balance sheets. The programme could expand to $1 trillion over time, according to documents from the US Treasury.

“This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly,” the Treasury said. “Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis … but if the government acts alone in directly purchasing legacy assets, taxpayers will take on all the risk of such purchases.”

Congress needs to craft oversight of the programme so the capital injections are not abused, but that regulations do not deter private market participation, Treasury Secretary Timothy Geithner wrote in an editorial in the Wall Street Journal Monday.

“We need to be very careful not to discourage those investments the economy needs to recover from recession,” Geithner wrote.

The programme is split between purchasing legacy loans and legacy securities. Under the loans portion, private investors will be able to purchase eligible loans from participating banks through Federal Deposit Insurance Corporation debt guarantees and co-investments with the Treasury. Once the assets have been sold, private fund managers will control and manage the assets until final liquidation, subject to FDIC oversight.

Under the securities portion, Treasury will approve up to five assets managers, and possibly more, that will

be provided with co-investment opportunities and debt for the purchase of legacy securities originated before 2009 with a rating of AAA at origination. Managers selected will have a period of time to raise capital for the designated asset classes and “will receive matching Treasury funds”. Asset managers selected for the programme will be able to request senior debt of up to 50 percent of the total equity capital of the funds they raise, and in some cases up to 100 percent. “The fund manager has full discretion in investment decisions, although it will predominantly follow a long-term buy-and-hold strategy,” the Treasury said.

Such public-private partnerships aimed at re-starting private capital flows to the marketplace are “tremendous opportunities for investors”, Wes Edens, chairman of Fortress Investment Group, said during a recent earnings call. “We have had very active dialogue with the government on a number of different levels regarding their initiatives with respect to … legacy assets and the like.”

The US government has already been working with private equity firms for the past few months; its Troubled Asset Relief Programme has been injecting needed capital into troubled banks and private equity firms have in turn backed those banks.

Distressed investment specialist MatlinPatterson in January paid $250 million for a 78 percent stake in struggling Flagstar Bancorp, a publicly held saving bank, and the US government injected about $266 million in the bank as part of the deal.

The Carlyle Group has raised about $1 billion and targeting $3 billion for its debut distressed financial services fund, and made a $75 million investment in Boston Private Financial, a wealth management company, which obtained preliminary approval in November to receive $150 million from TARP.

Christopher Flowers, who heads up JC Flowers, said during a speech in February that he is looking to partner with the government in investments in troubled banks. Flowers’ firm was part of an investment consortium that purchased IndyMac from the FDIC for $13.9 billion. Under the terms of the deal, the reorganised bank is to absorb the first 20 percent of losses and the FDIC will assume the rest.