IndyMac, the largest bank failure of 2008 other than Washington Mutual (and the third-largest in U.S. history), is back! The FDIC, which took over the thrift's operations last July, has reached an agreement to sell IndyMac to a group of investment firms. Is this a sign that banks, bank loans, and mortgage-related securities have finally become attractive?
Not so fast. Read the fine print and you may conclude that it simply reflects how far the government will go to attract private capital to this banquet.
Comfortable loss-cushion included
The "New IndyMac" includes a loan portfolio of $16 billion and a securities portfolio of $6.9 billion. As the Wall Street Journal's "Heard on the Street" points out, if these are to be shoehorned into a $13.9 billion balance sheet (the size of the new entity), that implies substantial writedowns.
Those writedowns create a big cushion against losses for the buyers. Furthermore, there is a loss-sharing agreement on specific assets (the most toxic, no doubt), with the FDIC bearing the brunt of any losses beyond a 20% loss.
The investment consortium is led by Steven Mnuchin (Dune Capital Management), a former partner of Goldman Sachs (NYSE: GS). Paulson & Co., which made a massively successful bet against subprime mortgages in 2007 is also participating, as are an affiliate of Soros Fund Management and MSD Capital, the investment firm that manages the wealth of the eponymous founder of Dell (Nasdaq: DELL).
Not all freely struck deals are equal
These folks are deal-makers, and we can't fault them for trying to extract the best terms on behalf of their investors. However, as taxpayers, the FDIC effectively represents us in this transaction. I'm a free-market kind of guy, so I like to see solutions that involve private capital. However, if the FDIC provides excessively generous terms, it distorts the relationship between risk and return. Instead, they need to ensure that the deals they negotiate don't have taxpayers subsidizing the returns of private equity investors.
Admittedly, other transactions arranged between two private parties also appear to have been lopsided: Merrill Lynch (now part of Bank of America (NYSE: BAC)) sold $30.6 billion in collateralized debt obligations (CDOs) to Lone Star Funds last year for $0.22 on the dollar and provided financing for the sale. In 2007, Citadel extracted its pound of flesh in a complex deal to rescue E*Trade (Nasdaq: ETFC).
Still, the IndyMac deal could create a bad (and highly visible) precedent. What if the government were to announce the breakup and sale of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE)? The money men (and women) must be licking their chops at that idea.
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