Thursday, January 22, 2009

Bank Bailout: Two Sides of The Non-Nationalization Coin

The drama in U.K. financials this week highlighted the systemic division as to how different governments approach the "bail out" problem absent of an outright nationalization. The current two main options on the table, which Obama's administration will have to pick and choose from unless he decides to nationalize Citi, BofA, and others outright, are the "aggregator bank" and the "bad bank" models, as seen in the U.K. and in Switzerland, respectively.

Swiss National Bank (SNB) Model

In the SNB model, a Special Purpose Vehicle was set up to acquire up to $60 billion in bad assets from UBS' balance sheet. SNB provides 90% while UBS keeps a 10% equity piece (first loss) in the form of an option to acquire the remaining assets after the loan has been paid off. The main difference between the Swiss arrangement and what the U.S. has done with Citi and Bank of America, is that the bad assets are removed from UBS' balance sheet while they remain on the books of the two US banks, though ring-fenced and with a low 20% risk weight.

In Switzerland, the National Bank takes the UBS bad assets off the balance sheet of UBS, placing them into the government sponsored SPV. A key advantage of this approach is that it clearly separates the legacy bank into good and bad portions isolating the uncertainty into the SPV. A key difficulty remains pricing of the assets. The SNB states a reliance on an "independent valuation agent" which is indicative of the current environment's "objective" valuation options.

The ultimate losses for Swiss taxpayers will not be known for years, with a degree of protection set in the 10% size of the first loss component.

UK Model

In the UK, the approach is almost inverse: instead of bad asset isolation, the UK government has been focused on injecting large amounts of equity into troubled banks, even nationalizing some. In this week's example of RBS, the government is raising its equity stake from 58% to 70% by converting GBP 5 billion preference shares into common stock. Despite the UK treasury's recent plans for an asset purchase facility and an asset protection scheme, so far equity infusions have been the only viable model used.

(hat tip to BAC for some legwork)
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