Sunday, November 11, 2007

Remember the Big Bank Bail-Out Fund (MLEC) – It is Still in the Formation Stage

Remember the big bank bail-out fund (MLEC) that three large US banks started in October, well it is still with us. Evidently, the banks are still working out some of the bugs, but with all that has happened in the last four weeks or so the three banks are under even more pressure than before to get the process off the ground. Text in bold is my emphasis. From the WSJ:

Worsening credit markets are pushing bankers to accelerate the creation of a rescue plan for a group of struggling investment funds.

. . . . Citigroup, B of A, and J P Morgan have been working for weeks to put together a super-fund, backed by as much as $100 billion, to prevent a fire sale of assets by the funds, known as structured investment vehicles. The SIVs, designed to issue short-term debt and buy assets that generate higher returns, have been losing investors since turmoil in the credit markets began this summer.

Increasingly, managers of some SIV funds have given up on raising money via the short-term debt markets they once relied on for funding, said Paul Kerlogue, senior credit officer at Moody's Investors Service, during a teleconference yesterday.

That raises the threat that SIVs could sell off the assets they own, further destabilizing financial markets before the rescue fund is in place.

The deepening troubles have dialed up the pressure on bankers to get the fund running as soon as possible. "All it does is turn up the temperature," said one person familiar with the process. "There was an extreme sense of urgency when we started, and there's still an extreme sense of urgency."

People familiar with the rescue plan maintain that it remains on track, and a new detailed financing plan could be in place within a week. A person familiar with the situation said there have been major refinements to make the plan attractive to banks, and to investors who would buy IOUs issued by the super-sized fund.

In addition to figuring out the fund's structure among themselves, the banks have been hashing out details with the rating agencies. Their blessing is particularly important because the fund's IOUs will need to be rated. The banks were planning to meet with the rating agencies yesterday or today.

If rating agencies give a nod to the plan, a term sheet can be distributed to potential members of a banking syndicate later next week, this person said. Those banks haven't been formally contacted.

Officials at the Treasury Department, which played host to early discussions on the plan, remain optimistic that the fund will be completed and aren't worried about the amount of time it is taking, a person familiar with the matter said. While troubles in the credit markets continue, this person said the Treasury Department always expected there would be problems.

Created in the late 1980s by Citigroup, SIVs today number 30 and hold about $300 billion in assets. Since June, the funds have sold tens of billions of dollars in assets. The SIVs own bank debt, residential-mortgage securities and debt pools known as collateralized debt obligations. The recent problems emerged when investors quit buying the IOUs because of concerns the funds had exposure to subprime loans.

The plan for the rescue fund emerged in October and has been supported by the Treasury Department. It has involved teams of bankers and lawyers trying to come up with a structure in weeks that typically can take a year to build.

Meantime, the SIVs' predicament has worsened, as ratings downgrades have affected some of the highly rated securities they hold. The downgrades have forced Citigroup and other banks to announce billions of dollars in write-downs. The losses among banks raise questions as to whether their backing will be enough to sell the rescue plan to investors.

The bailout fund intends to buy SIV assets using money raised in the market for asset-backed commercial paper, where banks and companies borrow for periods from one day to a month or so.

That could be a problem, because investors are shying away from the market. In the euro commercial-paper market, investors have grown worried even about bank-affiliated funds, called conduits, because of concerns about the health of the banks. In the U.S., the asset-backed commercial-paper market shrank by $29.5 billion for the week ending Nov. 7, according to Federal Reserve data.

Some debt investors say the super-fund's commercial paper would be less attractive today than it would have been just a month ago. As a result, they would want to be paid even more compared with corporate commercial paper.

"I think the premium has gone up," says Tom Atteberry, a fund manager and partner at First Pacific Advisors, a money management firm in Los Angeles with $11 billion in assets and $2.6 billion in fixed income. He believes a premium of at least one percentage point over comparable corporate paper would be necessary for his firm to consider IOUs issued by the fund.

Another challenge facing the fund is whether it would be paying artificial prices for assets such as mortgage securities in which trading has all but disappeared. In an appearance before the Joint Economic Committee of Congress yesterday, Federal Reserve Chairman Ben Bernanke said the plan could work, but he cited the question of how the assets would be priced.

Under one plan, the super-fund would take bids for SIV assets from three brokers, including one bank providing a financial backstop to the fund. One concern is that brokers who didn't intend to buy the assets could seek to manipulate the prices.

Citigroup is a backer of the rescue fund, but it also is juggling multiple fronts. Citigroup operates seven SIVs, which are facing funding problems. This week, the bank announced a workout plan to handle its own losses on securities tied to subprime loans by putting some $55 billion of the securities into a special unit.

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