Summarizing the Bailout Efforts

Highlights include Citigroup Inc. (C), Bank of America Corp. (BAC), Wells Fargo & Co. (WFC) and PNC Financial Services (PNC).

With the last piece of the jigsaw puzzle (Geithner’s Financial Stability Plan) placed on the table by the Treasury Secretary this morning, we thought it is time that we put the pieces together and summarize the bailout efforts (mired in alphabet soup) and their current status.

Treasury’s strategy is twofold -- recapitalize the big banks and get the toxic loans off the balance sheet of the banks.

The intention of both the efforts is to make the banks (whose balance sheets have been battered by the huge losses on the risky loans made by them) financially strong so as to enable them to start lending again, which is essential to revive the ailing economy.

The Bush Administration had introduced the Troubled Assets Relief Program (TARP), with the intention of purchasing or insuring up to $700 billion of "troubled" assets. However, later the program was revised to include Capital Purchase Program (CPP), for which the Treasury set aside $250 billion of TARP funds to purchase senior preferred stock and warrants in the banks. CPP has already invested in 500 institutions of all sizes.

The Financial Stability plan announced by Secretary Geithner has three main components:

1) A "stress test" for the banks to assess the risk on their balance sheets and additional capital requirements
2) The expansion of the Federal Reserve's Term Asset Backed Securities Loan Facility (TALF)
3) A Public-Private Investment Fund to remove the toxic assets from the banks

The stress tests are expected to be completed by the end of April, and then we will get to know which banks need additional capital. However, we suspect that the government will end up providing capital to the weaker banks, as private capital for those will not be easy to come by. Then there is not always a clear line separating solvent and insolvent banks. In many cases, the government would simply be choosing which banks deserve to survive.

TALF was finally launched last week with at least 3 deals. The Fed announced that it lent $4.7 billion to TALF borrowers. The completion of the deals suggests the Fed is having some success in reviving the Asset Backed Security (ABS) market, which had shrunk from more than $1 trillion in 2006 to just $3 billion during the first two months of 2009.

The details of the toxic assets plan were announced this morning. The basic approach of the plan is to subsidize private-sector purchases of bank assets. The idea is to start a market for the real estate related assets and to provide a mechanism for valuing these assets. However, given the current challenges in the markets, arriving at a transparent value for such assets is not going to be easy, and the plan may take a long time to have effect on the markets.

With the commitment made so far, the Treasury has roughly $80 billion to $110 billion left in TARP funds of $700 billion. Most of that money could likely end up funding the Treasury's program to recapitalize the largest U.S. banks based on ongoing "stress tests."

While the plans are far from perfect -- and we cannot say that the efforts will result in the end of problem for the banks like Citigroup (C), Bank of America (BAC), Wells Fargo (WFC), PNC Financial Services (PNC), etc. -- we think that these, complemented with the massive efforts by the Federal Reserve to pump in enough liquidity in the markets, the "Homeowners’ Plan" to prevent foreclosures and make housing more affordable, and the proposed regulatory overhaul will have some favorable impact on the financial system.
 

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