Companies Benefiting from Toxic-Asset Plan

The details of the toxic assets plan are still unfolding. At this point, all we know is that the U.S. Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation [FDIC] and the private sector will partner to create a market for the toxic assets currently held by a number of banks.

Initially, the treasury plans to purchase $500 billion worth of bad loans and anticipates that the program will expand to a total purchase of $1 trillion dollars in toxic asset purchases. For private companies that choose to participate, the government will provide very lucrative financing to assist them in purchasing the assets. The government’s goal is to create a market for the toxic assets that are currently held by the banks by creating very lucrative financing terms and guarantees. The hope here is that the new securities created from these toxic assets will eventually become more valuable as a market thaws and traders step in the purchase these assets.

The government is hopeful that private investors, including pension funds, mutual funds and investment banks, will create pools of these assets that can be sold. The banks that hold the toxic assets will identify the assets they would like to sell into these funds. These pools will then be auctioned out to bidders and the highest bidders will get the assets. The government along with the purchaser will jointly fund the purchase of the assets. To give investors further incentive, the government will cap the amount of losses that the institutions can incur to10% to 20% of their investment; any losses in excess of these amounts would be borne by the taxpayers.

The theory behind the governments plan to address the lack of a market in these distresses assets is as follows: Assume that an asset has a face value of $100 and an investor wins a bid to purchase the investment for say $80, the government will finance $70 of the $80 dollars and all that the investor has to bring to the table is $10. The theory is that since the prices of the assets are distressed, the assets should immediately accrue value for the investors and as the market for these assets becomes more liquid, investors stand to make handsome gains from the rise in prices of the assets.

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A lot of the big banks that have already been forced to write down their assets should benefit from the toxic asset plan. These banks include: Citigroup (C), Wells Fargo (WFC) and PNC Financial (PNC). Some of the large regional banks will also benefit, a few of these banks include: Marshall & Ilsley Corporation (MI), First Horizon National Corporation (FHN) and Synovus Financial Corporation (SNV).

The banks will benefit by cleaning up their balance sheets and hence freeing themselves from the risks of these assets. At the same time, they will be in a position to resume lending since many of them are bound by the FDICs reserve requirements and the fears of insolvency, which has led to them hording cash and limiting lending.

A number of companies in the private sector have stated their interest in managing the pool of funds that will be created from the toxic assets. Some of the companies that are expected to participate include Legg Mason Inc. (LM) Pacific Investment Management and Goldman Sachs group inc. (GS). A number of these companies actually expect to profit handsomely from the program. One company was quoted as saying that they expect to make double digit profits from the program.

The investment banks, mutual funds and pension funds that participate will benefit from purchasing these distressed assets with very little downside risk. The only risk to these companies will be their down payments. Any additional losses will be borne by the taxpayers. The upside potential for these investors, if the plans works is huge and a number of these investors expect to reap double-digit gains from their investment.

The companies participating in the toxic-asset plan could benefit handsomely and they could get bit as well. An investor considering a stock investing position in these companies can protect themselves with put options. Put options can be considered the same as “stock insurance“. If a stock investing position drops significantly, the put option limits the loss. Investors can also generate monthly income on investments in these companies. One example of a method for generating monthly income is with a covered call investing position. Investors can also combine a put option and a covered call investing potion to generate income which is protected.

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[tags] U.S. Treasury, Federal Reserve, Federal Deposit Insurance Corporation, FDIC, Pacific Investment Management, C, Citigroup Inc., FHN, First Horizon National Corp., GS, Goldman Sachs Group, LM, Legg Mason Inc., MI, Marshall & Ilsey Corp., PNC, PNC Bank Corp., SNV, Synovous Financial Corp, WFC, Wells Fargo & Co. [/tags]