Treasury rolls out the TARP

Change at the speed of Paulson

 

The banking landscape is changing and one thing is certain…we’re all going to have to move fast to keep up.  The Treasury department is rolling out the TARP (not a red carpet but hey…this is the government and a TARP will have to do). 

 

The TARP program is designed for the express purpose of injecting capital into the banking system to stabilize it and promote confidence therein.  This is no small program…starting with the initial $250 Billion it will literally change the look of the banking landscape. 

 

The first round of this program saw $125 Billion in capital distributed to the big nine: JP Morgan, Bank of America/Merrill Lynch, Citigroup, Wells Fargo (includes Wachovia), Goldman Sachs, Morgan Stanley, Bank of New York, and State Street Bank. 

 

The Treasury is very aware of the fact that some stigma might be attached to anyone that approached them for capital, so they forced these nine banks to take the money whether they needed it or not.  The goal here is to establish confidence and if everyone is doing it nobody can be singled out as weak for participating.  The remaining $125 Billion will be distributed to “qualifying US Banks”…this is where you come in. 

 

You may remember from our Nordic Banking Crisis review a few weeks ago that capital injections are part of the model that the government will use to get us out of this financial crisis.  All in all it’s a pretty good plan…as we’ll see it’s really good if you’re a community bank looking to boost earnings.

 

There are a lot of details to cover, but to get the ball rolling we’ll look at the big picture first.  We are dealing with a VERY compressed time frame for making decisions on this matter.  The deadline to apply is November 14^th.  That means you have to know all there is to know, educate the board, reach a consensus, fill out the application, and have it submitted in about 2.5 weeks.  That doesn’t leave a lot of time for scheduling committee meetings.  To help out in this regard we have scheduled two webinars that you can use to educate all key personnel on the details of the program and we’ve created all the analytics you need to illustrate how the program would apply to your bank.

 

So given that quick introduction lets dig in…the clock is ticking.

 

What’s a bank to do?

 

Every bank should consider participating in the US Treasury Department’s TARP Capital Purchase Program Senior Preferred Stock and Warrants (“TARP Preferred”) and here is why.

 

• The Treasury TARP Preferred is the cheapest source of capital - by a long shot.  Warren Buffet got a 10% interest rate and warrants equal to the amount invested in his deal with Goldman Sachs.  The TARP Preferred will cost you 5% with warrants equal to 15% of the amount invested.  There is no private capital available at these levels.

• The capital can be used to offset loan and security losses, merger and acquisition considerations or for balance sheet growth using securities in the short-term and loans longer term.
• The break-even point for leveraging the TARP Preferred is approximately 4 times at a spread of 150 basis points. The TARP Preferred is typically non dilutive to current shareholders at this level of levered asset growth.

• You do not have to be a troubled institution or have troubled assets to apply for the TARP Preferred.
• You can apply first while you review the terms of the program.
• The deadline to apply is November 14TH.
• The Treasury will not report applicants, only approved institutions.
• You can withdraw your application if you find the terms unacceptable. 

• Non Public Banks are eligible - Private and Sub S terms from the Treasury department are expected any day now.

 

The TARP preferred is a cheap source of capital, not a cheap funding source. To overcome the cost of the TARP Preferred, leverage will be necessary to blend the cost of the TARP Preferred with lower cost wholesale funding from the FHLB.

 

Attached is an analysis of the US Treasury Department’s TARP Capital Purchase Program Senior Preferred Stock and Warrants (“TARP Preferred”) on your institution using call report information. This model is flexible and can customized to show many variations.  In its current form it provides a very useful “big picture” look to use as a starting point for analyzing how your bank can maximize the potential of the TARP Preferred program. 

 

For a typical bank if TARP Preferred Stock equal to 3% of risk-weighted assets were issued the treasury would have a minimal effective ownership interest. The Treasury effective ownership interest for your institution can be found in the attached analysis.

 

The break-even point for leveraging the TARP Preferred is approximately 4 times at a spread of 150 basis points. In other words, the model suggests that the TARP Preferred should not be dilutive when asset growth of four times the amount of the TARP preferred is achieved. This can be done short term via security purchases with the cash flow from the securities used to fund loans. 

 

We believe the 150 basis point asset growth spread can be achieved. As an example 15-year MBS are trading at historically wide spreads, and offer an excellent opportunity to lever the TARP Preferred capital. Over time as an institution has the opportunity to fund loans, the cash flows from the MBS can fund the loan demand. We believe that to maximize the benefit it is important to purchase securities to lever the TARP Preferred before MBS spreads tighten to historical levels.  The Treasury Department will issue a total of $250 billion of TARP Preferred. If this $250 billion is levered at 10 to 1 it represents purchasing power to buy $2.5 Trillion worth of GSE debt.  The total MBS debt guaranteed by FNMA and FHLMC is roughly $5 Trillion, so the potential for bank purchases fueled by the TARP Preferred could tighten spreads dramatically. Currently MBS Spreads on 15yr paper are historically wide, at approximately 298 basis points over the 5-year treasury compared to a weekly average spread of 117 basis points over a 5-year period. If spreads tighten just 100 basis points the approximate gain is 4% on discounted seasoned 15 year MBS.

 

The attached model assumes that asset growth via loan funding and securities earns a yield of 5% against blended FHLB advances costing approximately 3.5% producing a spread of 150 basis points.  Given the volatility of the markets the spread will change from day to day and can be modeled for you given your asset liability and risk return profile.  We can model the asset growth using the mix of loan funding and asset purchases you deem appropriate for your institution.

 

We strongly suggest you consider applying for TARP Preferred capital.  This is one of those times in history where time is of the essence.  Banks have roughly 2.5 weeks to get the board and management educated on this program before the window shuts.  The big banks were told that if they didn’t participate in the program at the start then they would be locked out in the future…there would be only one chance to take the money.  It is imperative that at the very least you take a studied approach to this topic.  The deadline to apply is November 14, 2008.

 

Because this is such a timely and important topic we are hosting a webinar October 30 at 12:00 noon Central and again Friday October 31 at 12:00 noon central time.  This is the perfect time to get your board and senior management up to speed on this issue.  They can dial in from where ever they happen to be and get all the information they need to make informed decisions.   We are available on an ongoing basis to address analytical needs in support of this process.