Alistair Darling provides more information but work continues on the detail of obtaining the necessary state aid approval from Brussels.
The Treasury has released further details of its Asset Protection Scheme for UK banks. If you would like to read our initial report on this scheme, please click here.
What does the scheme do?
In essence the scheme provides protection against losses on a pool of eligible assets, which have been investigated and approved for coverage (covered assets). There is an “excess” or “first loss retention” by the participating bank, which means no protection payments are made in relation to losses up to the first 10% of the agreed value of the asset pool. Banks may, however, have already made accounting write-downs against part of the value of the covered assets; this may effectively mean that the amount of future losses, which are not protected, are less than 10%.
Once the 10% loss threshold is reached, further losses on the covered asset pool are insured as to 90%, so the bank retains a 10% “vertical share”.
Restrictions and conditions
The scheme avoids a full “bad bank” split and management of the covered assets remains with the participating bank. However, this will be subject to a number of restrictions and conditions, including the right for the Treasury to appoint an independent asset manager in various circumstances.
There will also be requirement for participating banks to agree “to increase lending to credit worthy borrowers in a commercial manner”. Banks will have to agree remuneration policies for those managing the assets with the Treasury so as to align their interests with those of “the payer”.
In return for participation in the scheme the bank will have to pay a fee, which can be paid in cash or securities.
Accounting and regulatory capital implications
There are complex issues relating to the accounting treatment of the protection in the participating bank’s accounts with the possibility that the protection will be provided as a financial guarantee or as a derivative contract. The regulatory capital implications are also important both for the bank and the government’s objective of increased lending. The fee can be paid in cash but the regulatory capital impact can be improved by paying through the issue of core tier one capital instruments. For further details, please see the FSA’s statement on the capital implications of the scheme issued yesterday.
What next?
The scheme is not yet in operation and is subject to individual negotiation and various clearances including EU state aid approval. The European Commission issued guidance Wednesday on the state aid regime and the process and conditions for approval for impaired assets schemes in the banking sector (covering both bad bank schemes and asset protection schemes). If you would like to read our report on this guidance, please click here.
