Why BlackRock wants to buy up toxic assets
A top investor explains that the Treasury's financing plan inspires confidence, but says "it's still a risky proposition."
NEW YORK (Fortune) -- When Treasury Secretary Tim Geithner unveiled details of the government's plan to help banks get toxic assets off their balance sheets, the plan got an instant boost when such investment firms as PIMCO and BlackRock expressed enthusiasm over the program. BlackRock has also said it will apply to Treasury to manage some of these bad assets. Fortune talked with BlackRock's Curtis Arledge, a managing director and co-head of the firm's U.S. fixed-income department, about the pros and cons of Treasury's plan. Here are excerpts of the conversation:
Why is BlackRock supportive of the toxic-asset plan?
It's going to present an opportunity for investors to get involved in markets in a broader way. These programs are going to help level the playing field between buyers and sellers so that the assets can begin to trade closer to their intrinsic values.
We think investors who buy these assets in the current market environment are going to be able to benefit from buying assets that are attractive, meaning they offer higher returns than they should for the risk that we think they have. Having said all that, these assets are very volatile. It's still a risky proposition. But we still think it's an attractive opportunity.
What part do you find most attractive?
There is term financing. When an investor buys an asset and finances it with overnight borrowings, then they are subject tomorrow to margin calls. If for some reason the markets get dislocated, margin calls can cause investors to have to sell assets well below their intrinsic value. We've seen that many, many times. It's part of what has driven the hedge-fund debacle over the past several months.
So matching funding over a longer period of time allows investors to earn the return of the asset relative to the cost of the funding. [The Treasury] has gotten investors who've wanted to buy assets but were afraid because of the volatility to come back to the market by giving them the confidence that term funding can give you.
Is there any part of the plan you'd like to change?
Some of these assets have variable lives. You might buy a 7-year asset and find out it's a 10-year asset. If your financing goes away based on it being a 7-year asset, and it actually turns out to be a 10-year asset, you don't have it financed for the final three years and that creates what's called tail risk, meaning there can be a tremendous amount of volatility.
I think the Treasury gets it and I think they're going to work with investors to find a middle ground where taxpayers and investors are treated equally in this process.
With banks already having marked down these securities by quite a bit, do you think banks will want to hold onto the assets in hopes that the market improves?
I have two thoughts on that. First, these are the same banks that tried to keep the assets a year ago when they believed they were too cheap then--and that hasn't worked out too well. To the extent that banks have the capital to continue to make that bet, and their shareholders and the FDIC -- who's guaranteeing their deposits -- are comfortable with them making that bet, than I think it's completely reasonable for them to hold onto assets.
Having said that, many banks are going to have to sell because the stress tests are going to find that the banks aren't in as good of shape as they thought they were. Because of the program, they'll have a market to sell those assets.
What's the earliest time frame for any toxic securities to be taken off bank balance sheets?
I think it has started already. Since the announcement Monday, the market prices of the assets that are targeted by these programs have already improved. The mere existence of it has been a catalyst for investors to come into these markets. These assets are cheap in many cases and a lot of investors know it, but they have no incentive to go buy these assets because the prices kept dropping each day and there was no indication of why that would stop.
As for when the buying will happen, I think it's going to happen sooner than people think. I'm optimistic that if BlackRock (BLK, Fortune 500) is selected and can raise funds we'll be able to start buying assets in the May or June timeframe.
So overall, will this program work?
I think it will work to help stabilize the markets. What I don't think is clear is whether the program will work to save the banking system. There are a lot of banks that no matter what you do aren't going to make it. I think this program will actually save the banks on the margin, the ones that wouldn't make it if they had to sell their assets at distressed levels. But there are a whole lot of banks that likely won't have enough capital to withstand the hits they're going to have to take, even with the help this program will give.
Would nationalization be a better solution?
Nationalization is the kind of thing that happens when a bank's management team is no longer the right team to run the institution. If there are banks out there that need to be nationalized right now, I think this program will reduce the near-term likelihood of that occurring because it will give the opportunity, hopefully, for the capital markets to improve enough for banks to clean up their balance sheets.
Having said that, there are certain banks that, no matter what you do, what program you put in place, they simply have too much risk and their losses are too great relative to their capital.
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