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Reggie Middleton

Reggie Middleton

Who am I? Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I…

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Overview of the Public-Private Investment Program

I have reviewed analyses of the PPIP in blogs and news outlets across the web and have perused the comments section in as well. I am impressed by the bright, cogent analysis but need to warn my blog readers that those early analyses may not be based upon the facts as described in the actual plan but upon speculation as to what the plan may contain. I have had my team review the plan and we will reveal what it means to the analysis that we have released as well as what I foresee for the future. the historically ridiculous (as in one of the greatest rallies ever, based upon a plan that practically no one who participated in the rally has actually read cover to cover) is evidence of technical and momentum orientated traders and not a change in the fundamentals. I'm mot saying that the fundamentals have not changed, but we need a chance to find out. I can say that price discovery needs to occur on a natural level for a sustainable bull market. To my knowledge, that has not happened and it is not a feature of the PPIP. I will explore the plan and its parameters in detail and report back ASAP! Obviously, this will be a topic for discussion at the BoomBustBlog event tonight (BoomBustBlog Networking - Trading Reggie's Research).

About the Program

The US sponsored Public-Private Investment Program intends to target legacy assets - legacy loans (real estate loans held "directly" on the books of banks) and legacy securities ("securities backed by loan portfolios").

The Aim of Program: A huge decline in prices of legacy assets have strained the capital of financial institutions limiting their ability to lend and have increased cost of credit. The stated goal of the Public-Private Investment Program is to strengthen capital base of financial institutions and enhance their ability to lend, ensure efficient price discovery of legacy assets by involving private players and minimizing the risk to taxpayers while providing opportunity to private players to earn sufficient returns.

Legacy Loan Program

The program intends to attract private capital to purchase eligible legacy loans from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment.

Financing: The private participants (individual investors, pension plans, insurance companies and other long-term investors) alongside Treasury will provide equity financing. The Treasury intends to provide 50% of the equity capital for each fund, but private managers will retain control of asset management subject to FDIC oversight (this is an interesting point). FDIC will provide a guarantee for debt financing issued by the Public-Private Investment Funds to fund asset purchases.


Banks would decide which assets (ex. a pool of loans) - they would like to sell.

The FDIC will then conduct an analysis to determine the amount of funding it is willing to guarantee, limiting the leverage to 6:1 (much of the analysis that I have read assumed a foregone conclusion of 6:1 leverage).

The FDIC will conduct an auction for these pools of loans. The highest bidder will have access to the Public-Private Investment Program to fund 50% of the equity requirement of their purchase.

If the seller accepts the purchase price, the buyer would receive financing by issuing debt guaranteed by the FDIC. The FDIC-guaranteed debt would be collateralized by the purchased assets and the FDIC would receive a fee in return for its guarantee.

The Treasury would then provide 50% of the equity funding

The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis - using asset managers approved and subject to oversight by the FDIC.

Private sector investors would stand to lose their entire equity investment in a downside scenario.

Legacy Securities Program (securities tied to residential & commercial real estate and consumer credit).

The goal of this program is to restart the market for legacy securities, allowing banks and other financial institutions to free up capital and stimulate credit flow. Price discovery will also reduce the uncertainty surrounding pricing of these legacy securities held by other financial institutions. My opinion is that this is not true price discovery, primarily due to the non-recourse nature of leverage implemented, which will engender considerably more wreckless risk taking due to the warping of the naturally occurring risk/reward curve!


The Legacy Securities Program consists of two related parts to draw private capital.

Providing debt financing from the Federal Reserve under the Term Asset-Backed Securities Loan Facility (TALF). Non-recourse loans will be made available to investors to fund purchases of legacy securitization assets. Eligible assets are expected to include certain non-agency RMBS that were "originally" rated AAA (read as distressed and most likely sloppily underwritten) and outstanding CMBS and ABS that "are" rated AAA. Duration of loans, lending rates and minimum loan size are yet to be determined.

Match private capital being raised for dedicated funds targeting legacy securities. Treasury will approve up to five asset managers with a demonstrated track record of purchasing legacy assets who would be provided a time frame to raise capital and matching capital would be contributed by the Treasury. Asset managers could also subscribe for senior debt for the Public-Private Investment Fund from the Treasury Department in the amount of 50% (100% in certain cases) of total equity capital of the fund. Thus Manager could manage as far as $4 of assets for every dollar raised (max out at 4:1 leverage).

Our take on the plan

Private investors under Legacy Loan Program have huge downside risk: The position of private investors is similar to an equity tranche in a CDO. These private investors could enjoy huge upside returns on back of massive leverage as high as 13:1, (6:1 is the leverage for fund of which Treasury would contribute 50% of capital) but however they would be the 1st to bear the loss in the event of further losses. These further losses are imminent, in my (and our) view (see the real estate review in the following post).

The very fact that a bank is willing to sell its legacy assets at a discount underscores the potential risk inherent in those securities. We believe prudent institutional investors would be reluctant to be in an equity tranche position in such high risk securities.Then again, I have overestimated the prowess and prudence of institutional investors in the past.

Potential demand for distressed assets in a zero sum game: The success of the plan to a great extent depends upon risk appetite of plan participants towards distressed securities. Despite the fact that there are huge upside potential for these legacy assets, private investors' would have no methodology to determine what prices to bid for these securities since aggressive pricing to buy assets could significantly reduce returns and even result in losses since the underlying assets of these are plunging rapidly. On the contrary conservative price bidding could force massive wave of write-downs for other banks and financial institutions. This seems like zero-sum game where gains of financial institutions at private investors expense and vice-versa.

Willingness of banks to participate in the program and undertake mark-to-mark write downs

There is no incentive for banks to participate in the program unless and until they require immediate capital. Banks which have already taken huge write-downs (ex. the ex-investment banks) would be better off holding these assets until maturity. On other hand banks which have been conservative on their asset write-downs (ex., the Doo Doo 32) would be reluctant to sell their legacy assets under the plan because that would significantly increase the mark-downs.

Risk of overpayment for legacy assets

Guidelines: An independent valuation firm will provide valuation advice to inform the Legacy Loans Program in its bidder selection. Also as mentioned earlier PPIF leverage would be limited to 6:1 based upon analyses performed by the FDIC with input from a Third Party Valuation Firm

We believe that since the first loss is being borne by private investors there would be no incentive to overbid. The price determination is by auction process so market forces could enforce a better price stability than determined by Treasury alone.

Huge downside loss do not justify the potential risk: If one were to simply run the numbers in a simple spreadsheet, you will see that although there is the potential for significant upside, the risk is not trivial.

Sample Investment under the Legacy Loans Program

Pool of residential mortgages:


Price determined by auction:




Equity by private investor:


Equity by treasury:



Face value


Price determined by auction


Debt-Equity ratio


FDIC Guaranty


Equity by private investor


Equity by treasury


Break even price



Actual price


Gain (loss)

Gain / loss
to investor*

% return

Face value





8% discount on FV





10% discount on FV





15% discount on FV





20% discount on FV





25% discount on FV





*Assuming gains are shared on proportionate basis to investment

As seen in the table above the downside risk does not justify the risk undertaken by the prudent investor.The risk/reward profile here happens to be very similar to the equity tranches of the CDO's that blew up last year. We have seen many of those equity tranche investors take 100% losses. After taking an empirical look at the program, I now see why the non-recourse sweetener and excessive leverage had to be added, but the fact still remains that the existence of this highly favorable financing distorts price discovery. If it is an unfavorable risk/reward ratio with near free money that you don't have to pay back, just imagine what the natural pricing would look like without these extra-market incentives!!! For those who want to play with their own assumptions, simply register for a free membership at BoomBustBlog and download the model that created the table above - Quick and Clean Public Private Partnership Risk/Return Model 2009-03-24 09:57:27 57.50 Kb.

Potential Impact on Banks and Insurers

  • Plan could lead to considerable write-downs of assets particularly for those banks and financial institutions who have been conservative in their write-downs in case the securities price determined is considerably less than current valuations. This is most likely where Geithner is planing to plug in the stress testing and the forced capital injection program from the TARP. I believe that many of the insurers, asset managers and regional banks covered in BoomBustBlog have a ways to go in writing down their assets (see topics: Insurers and Insurance, Commercial Banks, and Financial Services).
  • According to estimates, banks are currently holding at least $2 trillion in troubled assets, mostly residential and commercial mortgages. If successful the plan could considerably help banks to transfer their toxic assets and free up their capital. The plan currently plans to buy $500 billion of assets with potential to increase to $1 trillion.

I will follow up on this tomorrow, with further analysis and opinion, and will continue with an update on real estate value trends (undoubtedly and extremely negative). For all who do not realize, downward real estate price trends will considerably distress, further, the most of the assets at the base of the PPIP program.

For those who are not members of the BoomBustBlog, I have detailed this crisis from the beginning in what is now a 36 part series:

Recommended Global Macro Reading:

  1. China Macro Update
  2. Debt - Thoughts On A Global Problem (Part 1),
  3. Banking out of Control (Part 2)
  4. Global Debt Stats (Part 3)

Recommended Reading - The Asset Securitization Crisis:

  1. Intro: The great housing bull run - creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble - A comparison with the same during the S&L crisis
  2. Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure
  3. Counterparty risk analyses - counter-party failure will open up another Pandora's box (must read for anyone who is not a CDS specialist)
  4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. Municipal bond market and the securitization crisis - part I
  6. Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)
  7. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
  8. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
  9. More on the banking backdrop, we've never had so many loans!
  10. As I see it, these 32 banks and thrifts are in deep doo-doo!
  11. A little more on HELOCs, 2nd lien loans and rose colored glasses
  12. Will Countywide cause the next shoe to drop?
  13. Capital, Leverage and Loss in the Banking System
  14. Doo-Doo bank drill down, part 1 - Wells Fargo
  15. Doo-Doo Bank 32 drill down: Part 2 - Popular
  16. Doo-Doo Bank 32 drill down: Part 3 - SunTrust Bank
  17. The Anatomy of a Sick Bank!
  18. Doo Doo Bank 32 Drill Down 1.5: Wells Fargo Bank
  19. GE: The Uber Bank???
  20. Sun Trust Forensic Analysis
  21. Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street
  22. Goldman Sachs Forensic Analysis
  23. American Express: When the best of the best start with the shenanigans, what does that mean for the rest..
  24. Part one of three of my opinion of HSBC and the macro factors affecting it
  25. The Big Bank Bust
  26. Continued Deterioration in Global Lending, Government Intervention in Free Markets
  27. The Butterfly is released!
  28. Global Recession - an economic reality
  29. The Banking Backdrop for 2009
  30. Reggie Middleton on the Irish Macro Outlook


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