Investors hope to win toxic asset lottery

Fixed-income firms and pension plans could be big buyers of bad bank assets under the latest Treasury program. And the worst stuff could be the first to go.

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By David Ellis, staff writer

There is some skepticism about Treasury Secretary Tim Geithner's plan to rid banks of toxic assets. But several investors have already expressed interest in buying up bad loans and securities.
What do you think of Geithner's plan to enlist private firms in the bank bailout?
  • It's good - we need their money
  • It's bad - it won't work

NEW YORK ( -- Could banks have finally found their white knight?

From hedge funds to insurance companies, the government is hoping the vast world of private capital will finally help clear the so-called "toxic assets" that have plagued banks' books.

For nearly a year now, regulators have been courting private pools of capital to help lead the bank recovery. Last fall, for example, the Federal Reserve gave private equity firms more leeway over how much control they can exert over a bank or savings and loan, as well as a greater presence in the boardroom.

Faced with the rising tide of bank failures, the FDIC took similar action in December by widening the pool for bidders of failed banks to investor groups and individuals.

Yet, the results of those efforts have been mixed at best as many investors have largely avoided anything associated with the ailing sector.

Now, regulators are hoping to reverse that trend with the so-called "Public-Private Investment Program" announced Monday.

The program, which required months of preparation and may still undergo further tweaks, will use taxpayers' funds to seed partnerships with private investors that will buy up those toxic mortgages and exotic securities that have waylaid many of the nation's largest banks.

The thinking is that by offering banks an opportunity to purge some of those cruddy assets from their balance sheet, it would not only mean fewer losses for lenders, but would help stimulate the flow of credit in the economy.

Potential players

So far, there have been some indications that interest in the program by private investors could be robust.

Asset manager BlackRock (BLK, Fortune 500) said shortly after Monday's announcement that they were not only interested in managing these so-called "bad assets" but wanted to harness the program for their investors.

Big-name fixed-income firms like Pimco and distressed investors are also shaping up to be major players in the program. Given the wealth of cheap financing being offered by the government and the non-recourse structure of the loans, investors would have little so-called "skin in the game."

"I think it is a real win-win," said a top executive at a New York-based firm that invests in underperforming real estate assets, whose firm has a policy of not speaking with the media.

An executive at another investment firm who asked not to be named said that the public-private partnership was a "very good program" and added that his firm would consider buying loans as long as it is able to service them, that is collect the payments and other administrative duties involved with managing a loan.

The government is already trying to lure other large institutional investors into the fold, including the insurance industry, which collectively oversaw more than $6 trillion in assets as of the end of 2007, according to the Insurance Information Institute.

Some of the nation's largest pension funds, which help manage a significant piece of the nation's wealth, indicated they would approach the program cautiously.

"We will examine the Public-Private Investment Program, as we do any investment program," said Chad Peterson, a spokesman for TIAA-CREF.

Other notable investment firms have focused on distressed assets in the banking sector and troubled mortgages recently as well.

Lone Star Funds, a Texas hedge fund, acquired a chunk of super senior collateralized debt obligations at a deep discount from Merrill Lynch last summer, for example. Buyout shop J.C. Flowers recently was part of a partnership to acquire the failed mortgage lender IndyMac.

And Private National Mortgage Acceptance Company, the California-based asset management firm led by former Countrywide executives better known as "PennyMac", has been busy buying delinquent mortgages from the government.

A spokesman for PennyMac declined to comment about what interest, if any, the firm might have in participating in the Treasury's new program. Spokespeople for Lone Star Funds and J.C. Flowers were not available for comment.

Winning lottery tickets

Regulators have freely admitted that the thorny issue of pricing banks' troubled assets has delayed the program up until now. By paying too much, already-soaked taxpayers would fell the pinch yet again. If those assets fetch too small of an asking price, banks would have to take another round of painful writedowns.

Analysts that track the banking industry worry that some lenders may have little motivation to participate, particularly when it comes to selling their existing troubled loans.

One veteran of the Resolution Trust Corporation, the Congressional-created entity which oversaw the cleanup of the savings-and-loan crisis of the early 1990s, added that the complexity of the latest Treasury program could prove unwieldy for regulators.

"RTC was elementary school algebra and this is like applied math in a graduate school course with a really bad professor that speaks in heavy German," said Kevyn Orr, a bankruptcy partner in the Washington, D.C. office of law firm Jones Day who was formerly a lawyer with the Department of Justice and the RTC.

But banks, and investors, are widely expected to have little trouble striking a deal on many of the rotten asset-backed securities that continue to live on their books.

Espen Robak, president of Pluris Valuation Advisors, a firm which specializes in valuing troubled and other illiquid assets, said lower-grade mortgage securities that have been drastically marked down to just pennies on the dollar could be particularly attractive to investors.

He said there is more potential for investors in these securities to profit, particularly if the U.S. housing market recovers. Plus, the risk of taking a loss is capped by the way the program is structured.

"These are essentially the asset equivalents to lottery tickets," said Robak. "They can pay off in a big way." To top of page

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