Mortgage - Home Loan, Commercial Loan

Citigroup (NYSE:C), Bank of America (NYSE:BAC) and JPMorganon Monday announced plans for a fund to buy mortgage-linked securities in an attempt to allay fears of a downward price-spiral that would hit the balance sheets of big banks.

A person familiar with the discussions said that US banks collectively were expected to put up credit guarantees worth about $75bn for the fund, named the single Master Liquidity Enhancement Conduit (MLEC).

The three banks said that they and “several other financial institutions” had reached “an agreement in principle” on the fund, but that the size of the fund was yet to be determined, in a statement released on Monday morning. The fund could be up and running within 90 days, the banks said.

But bankers said the scheme would evolve with the market and may only be as large as demand requires. The MLEC would be temporary and capped in value, and would not be backed by any state guarantee.

The concept of an MLEC first emerged three weeks ago when the US Treasury summoned leading bankers to discuss ways of reviving the mortgage-linked securities market and dealing with the threat posed by structured investment vehicles (SIVs) and conduits.

The Treasury acted as a neutral “third party” in the discussions, and Hank Paulson,Treasury secretary, was strongly in support of the initiative.

Robert Steel, under-secretary for domestic finance, led the US Treasury side of the discussions, with the day-to-day work handled by Anthony Ryan, assistant secretary. The plan is an attempt to address concerns about SIVs and conduits, vehicles that are often off-balance sheet but closely affiliated to banks.

They typically fund themselves in the short-term asset-backed commercial paper market but purchase long-term securities. The gap between short-term debts and long-term assets has created a vicious funding mismatch in recent weeks because investors have stopped buying notes issued by some SIVs and conduits. There are fears some SIVs may be pushed into forced sales, prompting further declines in the price of mortgage-linked securities that could hurt the balance sheets of some institutions.

“Recently, refinancing in the asset-backed commercial paper markets has been difficult despite the high quality collateral underlying many of these securities,” the banks. “The objective of MLEC is to facilitate these refinancings and to complement other market-based solutions in supporting an orderly and efficient market environment.”

The banks said that they were endowing the fund with certain features, including a cushion of support from junior layers of capital and liquidity backstops, intended to improve the attractiveness of the credit instruments it issues in order to fund the purchase of mortgage-backed securities. “The size of the vehicle, the scope of the liquidity backstops, and the underlying cushion of capital are intended to enhance the liquidity and marketability of the short-term obligations of MLEC”, the banks said.

MLEC is likely to be unpopular with some banks which have already started trading in distressed subprime securities at knockdown prices.

One banker said last week: “The banks have varied enormously in terms of how much they have marked down their books - of course there are some that want to avoid the big write-downs.”

MLEC would operate as a restructuring factory, repackaging credit securities to make them more transparent than existing commercial paper and more attractive to investors. It would only deal in “highly-rated” assets.

Although it is envisaged that the scheme will initially focus on vehicles in the dollar market, it is likely to be extended to European banks as well, and may even be extended to the euro market. The US Treasury declined to provide an official comment on the reports.