Geithner’s gift of your money to “qualified investors”

Geithner opens the vault to “qualified investors.” Are you a qualified investor? Not unless you can use a time warp to send in your application by April 24, 2009. Huh? Didn’t anybody tell you?

Tax Cheat Geithner

TALF (Term Asset-Backed Securities Loan Facility)

Imagine if you were not really in the market for a house but the government came along and said that it would finance 94% of a home’s purchase price with a mortgage rate of less than 3%. Still not interested? Wait, Uncle Sam has some additional sweeteners: if you do the deal and buy the house for only 6% down, you also get the equivalent of rental income every month to the tune of at least an annualized yield of 10% of the purchase price.

But wait there’s still more: if, say, after two years, you decide you don’t want the house any longer, you can just walk away from it. No need to pay the balance of the mortgage (it won’t affect your credit rating), and you can keep the rental income received to date.

That’s essentially the deal that Treasury Secretary Timothy Geithner has offered qualified professional investors who participate in the so-called TALF.

Geithner and the Federal Reserve announced the launch of the TALF in March. The TALF is a $200 billion (on its way to $1 trillion) non-recourse lending program to private investors as a way to encourage them to buy newly underwritten securities backed by auto loans, credit-card receivables and student loans, among other asset classes. (The TALF program is set to extend, in June, to the issue of new commercial real-estate mortgage-backed securities.)

The Reason for TALF

Most banks no longer hold the loans they make. Instead, the loans are bundled into securities that are sold to investors, a process known as securitization.

Unfortunately, the securitization markets broke down last summer after investors suffered steep losses on these investments. So banks and other finance companies can no longer shift loans off their books easily, throttling their ability to lend.

The result has been a drastic contraction of the amount of credit available throughout the economy, perhaps as much as $1.9 trillion of lending capacity.

The Obama administration hopes to jump-start this crucial machinery by effectively subsidizing the profits of big private investment firms in the bond markets. The Treasury Department and the Federal Reserve plan to spend as much as $1 trillion to provide low-cost loans and guarantees to hedge funds and private equity firms that buy securities backed by consumer and business loans.

TALF’s appeal to investors

To stimulate the sale of securities based on securitizations to qualified private investors the government is offering a very good deal.
“I’ve had accounts that dropped everything they were doing to take a look at this TALF financing,” one Wall Street trader explained. “It was like nothing they had ever seen. It beats any financing that the private sector could ever come up with. I almost want to say it is irresponsible.”

Qualification as a TALF investor

Investors interested in borrowing from the TALF program have to be approved by the Treasury and then, once approved; have to set up an account with a broker-dealer that is subject to a variety of the usual terms and conditions.

The form to become a qualified investor (http://www.treas.gov/press/releases/reports/legacy_securities_ppif_app.pdf) is 12 pages long, and had to be submitted by April 24, 2009. That is too late for all but the insiders. However, those who have not qualified can presumably (hopefully) find an insider to partner with in some form or other.

Once qualified, the investor then must indicate a desire to buy, say, at least $10 million of one of the dozen or so deals, worth an aggregate of around $25 billion, which have come to market since the TALF program was set up in March.

The way the TALF works in practice is this: The amount of equity an investor has to put up depends upon the assets involved, the term of the loan or lease of the underlying asset and the credit quality of the underlying borrower.

For example, a loan to buy a three-year security backed by a group of credit-card receivables from high-quality borrowers would require an investor to put up 6% of the capital and can then borrow the rest from the TALF through his brokerage account.

To buy a two-year high-quality credit-card receivable security, a borrower would put up 5% of the face amount of the securities purchased. Auto receivables require as 12% equity investment for a three-year security. Small business loans require 5% down. Student loans require 10% down for a three-year deal.

An investor interested in a $10 million slice of three-year credit card receivable would put up 6% of the money – $600,000 – and borrow the balance of $9.4 million from the TALF at a rate of three-year LIBOR plus 100 basis points (that’s 2.85% at this moment.) Depending on all sorts of assumptions, the yields on these investments are said to be in the 11% to 15% range, especially attractive since the TALF loans are non-recourse to the borrowers – you can just walk away and lose only your underlying equity investment and the collateral but you are not held responsible for the unpaid portion of the TALF loan itself.

In addition, the TALF loan is not marked-to-market so if the underlying collateral deteriorates in value, the investor is not required to put up more equity. What’s more as the car payments or credit-card payments on the underlying security are made, the payments are distributed to the government and the investor on equal footing – that means the investor starts getting paid back at the same time as the government even though the government is the senior secured creditor and even though an investor has put up only a small fraction of the original money.

One private equity investor, who would not normally have looked at investing in such a deal but did, called this particular aspect of the TALF “shockingly good” – for qualified investors, that is…