March 25, 2009

Smart stuff - Google is joining a $5.75 million investment round in Pixazza, a start-up that hopes to profit by overlaying photos on the Web with links that let people buy the products in the images.

Treasury Secretary Geithner said the dollar will remain the world's dominant reserve currency, after earlier comments about a Chinese proposal weighed on the dollar.

New-home sales climbed for the first time in seven months during February, another favorable sign for the housing sector, but the data also showed prices tumbled. Separately, durable-goods orders unexpectedly climbed during February, but demand in the prior month was revised down deeply, an adjustment countering the idea of a rebound in the slumping manufacturing sector.

Mark to Market Accounting and a True-Up Provision: With the FASB board set to vote April 2nd on potential changes to FAS 157, support is building to allow banks a one-time recovery of equity capital from recent OTTI charges related to fair value accounting. Retroactive accounting pronouncements are rare and often not supported by the accounting industry. However, a so-called true-up of capital lost through fair value accounting would be a tremendous boost for many banks especially those that took the charges in 4Q-2008. The Federal Home Loan Bank of Seattle is perhaps the best example of the stereotypical business that would benefit from a true-up provision. The Seattle bank took an OTTI charge of $304.2 million in 4Q on private label mortgage-backed securities classified as HTM-Held-To-Maturity even though it had identified just $12.0 million in principal loss. That charge forced a net loss of $241.2 million in the quarter and resulted in a $78.9 million accumulated deficit as of Dec. 31, 2008. Federal Housing Finance Agency regulations prohibit an FHLB with an accumulated deficit from issuing dividends, meaning any bank with a borrowing relationship with the Seattle bank now has capital tied up in a non-earning asset. Beyond the Seattle bank, any institution that took an OTTI charge in 4Q could stand to benefit significantly if a true-up provision is allowed. If that were to occur, some institutions would be trading at substantial discounts to tangible book value.

Will Banks Want To Play In The Treasury's New Sandbox? This week the public received details from the U.S. Treasury on two separate Public-Private Investment Programs for legacy loans and securities. Of the two programs, we view the Program for Legacy Loans as potentially beneficial to most community banks by providing liquidity and price discovery on a levered basis for distressed loans and other assets. A general recap of the program is that the Treasury will provide a matching contribution for equity capital raised by public-private investment funds (PPIFs). The FDIC will then provide guarantees on debt financing of up to 6x invested capital, with leverage based upon third party valuations that will determine appropriate leverage for each pool of assets based on such factors as expected cash flows, risk, expected lifetime losses, location, maturity, etc. To be sure, banks will now have a market in which to remove troubled assets from their books and levered financing should create higher bids than what can be found today as well as remove uncertainty regarding value of assets on banks' books possibly increasing investor interest, BUT with this comes risks which we outline below:
• Banks who decide to participate in the Legacy Loan Program will have the pool of loans which are priced through a third-party valuation firm engaged by the FDIC that will provide valuation advice and initial views on appropriate leverage. As the FDIC wants to avoid risk of loss, we doubt that full 6-to-1 leverage would actually be provided for most loan purchases reducing the potential value of offered bids. In addition, the FDIC will charge a debt guarantee fee, as yet undisclosed, plus be reimbursed for program oversight expenses both of which will be paid by PPIFs. It is certain these fees would be factored into asset bids made by PPIFs, thus further reducing the value of offered bids.
• The bids provided by PPIFs will in most cases be no greater than the valuation determined by the third party valuation firms, and more likely than not would be a discount to the valuations provided.
• Whether or not a bank decides to accept an offered to bid on assets auctioned, they cannot erase the fact that a market price has been established for their assets (i.e., no longer does ignorance = bliss). Technically, the assets would need to be marked down to this price on the balance sheet whether they are sold or not. Banks will need to have the capital capacity to take necessary marks against these assets.
• If the bank does sell the assets, the purchase price received will be paid in cash for the equity portion, and in FDIC guarantees for the debt portion of the financing, which the banks will be able to resell into the market if they choose. Should the market determine for whatever reason a discount is necessary on these FDIC guarantee debt securities, banks will lose even more money if the need to sell the securities arises in order to free up cash for liquidity purposes.
• We believe it's possible that (a) some banks will be reluctant to access the program because of the definite mark on distressed loans that will be established; and (b) payment of the purchase price in FDIC guarantees may not create the liquidity to lend as the Treasury hopes. However, we do like the FDIC guarantee as it sufficiently leverages taxpayer resources to address the enormous industry-wide loan and securities issues. Moreover, it seems possible to us that banks may be able to sell their guarantee (more details to follow here - the language reads as if the guarantee could be transferrable).
• Don't forget, one of Treasury's goals is to maximize taxpayer return and ensure through private sector price discovery the Treasury does not overpay for assets. Nowhere is there a goal to minimize losses to banks.