When the public-private investment program (PPIP) was announced, we thought it one
heck of a deal for investors, if a more questionable one for taxpayers due to pervasive
potential conflicts of interest. Congress clearly concurred, including in new law a set of
constraints and disclosures that redefine both the whole-loan and legacy-MBS parts of
the PPIP. These won’t pop the PPIP, but its launch – already halting – will slow. In our
view, the MBS part of PPIP will prosper first, with the whole-loan program’s prosects
uncertain. That’s too bad, because there’s a lot in it banks should love, especially in the
wake of the recent stress test.
When the whole-loan PPIP was first announced, banks clamored for the power both to
buy and sell into it. As we said at the time, this meant institutions could profit coming
and going in an opaque arena that lacks the market pricing – such as it is – in the RMBS
and CMBS arenas. Advocates of the two-way street argued that the FDIC would contain
any conflicts because of its pricing methodology. However, cautious as always about the
government’s ability to out-fox private players, we had our doubts.
This debate ended earlier this week when Chairman Bair said she did not plan to permit
banks on both sides of a PPIP deal. This led to a lot of hand-wringing about the
program’s prospects, which is certainly in doubt following the FDIC’s decision to delay a
pilot $1 billion fund originally set for June. Banks appear to be taking their ball home
now that this aspect of the PPIP has been put to bed.
Banks fear that, without sellers as buyers, asset sales into the PPIP will set low market
prices that will then force write-downs throughout comparable portfolios that remain on a
bank’s books. If this occurred, it would of course be very costly. But, will it? We don’t
think so. In fact, we think PPIP is the best way for banks quickly to liquidate troubled-
loan portfolios before the you-know-what really hits the fan.
The only way a PPIP investor would price a whole loan well below a bank’s carrying
value is if the bank has yet to reserve sufficiently against the loan. Remember that the
PPIP is a whopping subsidy to its investors – their initial stake could be matched by
Treasury and then levered up to 6-to-1 with an FDIC guarantee on non-recourse loans.
Returns of at least 30-to-1 are easy in this lucrative, subsidized structure, creating the
incentives at which Treasury and the FDIC aim to sweeten asset pricing to stabilize
financial markets.
To be sure, a lot of banks aren’t well reserved against their highest-risk paper, especially
in areas like commercial real estate. Will this last? We hope not. If bank regulators go
easy on reserves, they’ll just have to pick up still bigger pieces when under-capitalized
banks falter. The hold-and-hope strategy on which PPIP resistance is based is simply
groundless for the most troubled assets in the worst-hit states. PPIP creates otherwise-
invisible demand for these assets that, while it won’t delay the day of reckoning, may
mute it a bit because asset sales now will be more generous than the inevitable charge-
offs to come.
Further, banks shouldn’t look at the PPIP from just the seller’s side. There’s nothing in
any of the pending rules that prevents banks from investing in whole-loan funds as long
as their own assets aren’t in them. With the leverage noted above – not to mention the
non-recourse nature of the FDIC-guaranteed loans – PPIP creates awesome profit
prospects for banks with the capital, capacity and savvy to take some troubled loans at
reasonable prices. Few other parties could service these loans as well as a bank,
sweetening the pot still more, in our view.
All the pessimism about the PPIP is understandable – none of the government’s complex
programs has gone off without a glitch and each is subject to considerable political risk.
However, there’s never been a time when the federal government stood behind so much
for so little. From a policy perspective, that’s far from a good deal – from an investor’s,
though, it looks mighty sweet.
