PPIP Gets Its Debut

So, like a movie monster that won’t die, PPIP is a go. Here’s The New York Times:

Agency officials announced that they had reached a deal to sell $1.3 billion in mortgages from Franklin Bank, a Houston-based lender that failed last November and was taken over by the F.D.I.C.

Residential Credit will put up $64 million of its own money to obtain a 50 percent stake in the venture, which will hold and manage the $1.3 billion pool of mortgages from Franklin Bank.

The F.D.I.C. will own the other 50 percent stake in exchange for providing the loans as well as the bulk of the financing. Instead of taking cash for the loans, the F.D.I.C. will accept a government-guaranteed note for $727.8 million with an interest rate of 4.25 percent.

Agency officials said the deal meant that investors would be paying about 70 cents on the dollar for the loan portfolio…Had the government not provided Residential Credit with the ability to borrow most of the money it needed at low interest rates, agency officials said, the investors would have probably paid about 20 cents on the dollar less than they did.

So private investors have come in with $64m, to get a 50% stake in a company that purchases $1.3bn in mortgages. The Treasury provides the other $64m, while the FDIC provides 6-to-1 leverage to purchase this. The actual bid on the loan is $727m ( which isn’t $64m * 2 * 6, so I need to investigate further).

FDIC even has a a chart outlining it, which reminds me of the charts I used to make outlining the payments (I wonder if they saw them?).

They don’t have a chart as to what the final payments look like given the distribution of asset worth; I’ll go ahead and draw that now:


They are equal on the right-hand side. Residential Credit puts up $64m, on a $727m bid for $1,300m in assets. If the assets are worth less than $727-$64 = $663m, then every additional dollar comes from me and you, the taxpayer. If the assets are worth more than $727m, then we split the earnings with Residential Credit.

So for small price of $64m, or about 8% of the bid, they get half the upside gains while only absorbing a bit of the downside loses. We are also on the hook for a lot of interest rate risk, which I’m not going to bother to quantify. This is a terrible deal – but there were other issues at stake. I remember the original PPIP debates well, and there were only two valid arguments, neither I found very convincing, to allow this giveaway to happen.

Get credit flowing again

The first argument is that it would take banks that were otherwise healthy and allow them to start lending again in the middle of a credit crunch. We taxpayers pay to help unload these loans onto other private markets, so that the bank can start lending again.

But as financeguy points out, the bank in question, Franklin Bank, is dead. FDIC took it over around a year ago, with its balance sheet deep in the red and after losing double digits in loans since 2007. It took a huge gamble in the real estate market, and it got destroyed. This isn’t an otherwise healthy bank with one bad asset on it.


Astute readers may ask “why wouldn’t we just go ahead and pay the extra $64m above to get that other half of the upside? Why don’t we just ride out the loan if we are going to keep all the downside risk?” The reason PPIP was sold was that it would start to create a market price for these assets. Sophisticated hedge fund managers would come in, bid on the price of toxic assets, and then we could use that to start solving whether or not the banks in question were solvent. In addition to getting credit to flow again, getting a decent market price for assets which had frozen would be worth the taxpayer cost.

So, we have a market price for toxic assets. $1.3bn is only worth $727m. Is the Rubin family and the rest of the Obama economics team going to march to Wall Street and use this to mark down the asset values of the largest banks? I’m not holding my breath. Most of the crucial actions taken to replace PPIP – replacing the accountancy rules and enacting the stress test – were used to replace this information problem with methods that produced numbers that were less transparent and more friendly to the big banks.

So we’ve just auctioned out half the upside of this loan while retaining most of the downside for pennies, without accomplishing either of the major goals of why we were interested in PPIP in the first place. I’d like call my elected official but nobody voted for this bill. I seriously worry this is a prep run for bigger bids coming down the line…

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14 Responses to PPIP Gets Its Debut

  1. gt4 says:

    What do you suppose Residential Credit is charging the LLC to manage the assets. I’ll bet its 2-3%. There are alot of fees associated with servicing problem mortgages, I’m sure RC will get its cut all the way down the line. If true, the company could recoup its investment in 2-4 years even if the assets never reach the purchase price. Assuming they’ve got a government guaranteed revenue stream from servicing this $1.3b of loans for a few years, they might be able to get a mezz. loan to finance the upfront equity contribution. At the end of the day, RC’s real capital contribution might be less than $30mm for an upside participation in $1.3b of loans. That’s 40 to 1 leverage with no downside, sounds about right if you think about FNM and FRE’s leverage and business model. Just thinking out loud………

  2. Mike says:

    Exactly, and very well put. I don’t even want to start to dig down into the fees that are being charged, and the extra subsidies in taxpayers holding the interest rate risk, etc. etc.

    If they were really ponying up money, fine, or if we wanted credit to flow or the information to be processed, sure. But for $65m, we should be able to save everyone the trouble….unless this is a pilot for a bigger purchases down the line.

  3. Once you’ve given the ask side a subsidy, then you need to give the bid side a subsidy. That’s the PPIP. The problem is that PPIP is also another ask subsidy, since it can be counted on as a last resort in case of a calamity, allowing more time for the ask side to pray for an upside move in these assets. Until then, it’s a subsidy to the ask people and the bid people, leaving the gap exactly as it was before.

  4. financeguy says:

    Glad you’re blogging this, Mike. I was worried the financial blogosphere might be asleep on this one. I think it’s pretty interesting what’s going on.

    First the numbers:
    It appears that the FDIC got $727.7 million plus $128.4 million in an “equity certificate.” This appears to represent the $64 mill (from Residential Credit) plus the $64 million from the Treasury yes, as funneled through the LLC venture? Res Credit then gets half of the LLC (the Treasury the other half, presumably). That makes the purchase price $856 mill, or 66 cents on the dollar. Not quite 70, except for generous rounding. (By the way, I don’t think the 6 – 1 ratio is anything to worry much about — wasn’t that just the ceiling ratio, with lower amounts possible?)

    Something I couldn’t wrap my head around at first:
    That’s a big overpayment: 50 cents to 70 cents because of the PPIP involvement. That left me scratching my head. But gt4 in comments, above, may have a good point. Res Credit can milk this thing for the fees. If they can milk enough fees, then that may give them sufficient incentive for overpaying so much.

    Now the thing that baffled me originally — why the hell do this in the first place, if you’re the government. As you point out, it’s not smart investment-wise:
    Setting aside the fact it’s obviously a misuse of PPIP — Geithner never said anything originally about buying up assets of dead banks — I wonder if they might be doing this mainly for show, forget about the money-making angle. This may be the “test run” to prove that PPIP can work (by the way, this would also show how dead-set the banks are against it, if the government couldn’t get a single live bank to provide assets for the test run). Now, once you’ve done the test run, who do you want to impress with the results? Seems like that would be the banks, who I think are the big obstacle to getting this off the ground. One way to impress the banks is to show the Franklin assets were bid a full 40% higher because of PPIP. Only a theory but …

    I don’t think this scheme is going to work though. The banks are too smart; they know the math isn’t that much in their favor. Also the NYT mentioned the investors in such assets would be subject to the Home Affordable Mortgage Program, and the banks must know that would be a major downward incentive on the bid price, I’d think. If this program is handled fairly, and the investors are only making money on the assets they buy, I don’t see how you get anything near 40% overbids. If it’s just a fee grab, once the media reveals as much, that will incite outrage across the land and this thing will collapse in a rush of pitchforks and torches. So my gut feel is the banks will continue to keep a wary distance and keep playing accounting games with their books.

  5. L. Haug says:

    But the investors aren’t paying just $64 million, right? They’re paying $64 million, plus $31 million a year in interest. If the portfolio turns out to be worth $727 million, they’re going to take a bath, aren’t they?

    On a more theoretical note, I don’t understand how this description of the deal:

    “They are equal on the right-hand side. Residential Credit puts up $64m, on a $727m bid for $1,300m in assets. If the assets are worth less than $727-$64 = $663m, then every additional dollar comes from me and you, the taxpayer. If the assets are worth more than $727m, then we split the earnings with Residential Credit. So for small price of $64m, or about 8% of the bid, they get half the upside gains while only absorbing a bit of the downside loses.”

    is really that different from the description of any FDIC-insured bank. I mean, if I start a bank capitalized at $64 million, I can issue, conservatively, $640 million in loans, on which I earn profits. If those loans turn out to be worth less than $640-$64 = $586m, then every dollar to cover the losses comes from the FDIC. Every single dollar of profit, though, goes to the bank. So the bank gets all the upside gains while only absorbing a bit of the downside losses. What’s the difference?

    • rootless-e says:

      Nobody bothered to reply to this because the narrative that we are being screwed is not to be abandoned merely because of inconvenient data.

  6. Not the Mike You're Looking For says:

    Could this be the FDIC’s attempt to get a cross-subsidy?

    Here’s the reasoning: According to the media, the FDIC is strapped for cash or believes it will be in the near future. At the same time, it doesn’t want to raise premiums it charges the banks–or at least not right away. So it milks the PPIP system for some extra cash, and all it gives up is the low, low price of 50% of the upside. (Crazy FDIC! Our prices are INSANE!!!)

    Also, is Treasury participating in this at all? I don’t see it in the chart or the description.

  7. ComparedToWhat says:

    I’m wondering how this compares to the Barclays Protium deal.

  8. killben says:

    Can it be stopped before it becomes a epidemic acrosss the country .. I am sure the TOO BIG TO FAIL BANKS ARE SALIVATING …. Imagine the bonuses …JUST RAPE THE TAX PAYER BUDDY .. FDIC is doing a great job of it… buying assets at 70cents when the same is available at 50 cents .. who knows could be 20 cents by the time the housing bust is done!!

  9. financeguy says:

    Huh. Looks like I read this too quickly. It appears that Treasury didn’t kick in any money, as Not Mike says. Rather, FDIC got half of that equity certificate. What a tortured bit of money-pushing. But if FDIC got $727 mill, plus $64 mill for half the equity, plus half the equity which is worth $64 mill, essentially they got about $856 mill right? … Is there any chance this thing was structured by cows? 🙂

  10. Basho says:

    The question I would like answered is: What happens to the cash?

    Assuming the initial stream payments into the LLC from the mortgage securities are greater than the LLC’s interest expense there is going to be cash in there.

    Is it possible for cash to be distributed to the private partners before the FDIC insured note is paid off? What protections are in place to protect the debtholders (taxpayers).

  11. Pingback: Just Baffling « The Baseline Scenario

  12. Linus Wilson says:

    My paper “Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets” at http://ssrn.com/abstract=1476333 argues that the PPIP financial structure is largely irrelevant in terms of the long term returns to the FDIC when receivership assets are sold. The inflated prices that the FDIC gets in the short run are matched by an offsetting loan guarantee liability that bites the deposit insurance fund in the long run. I analyze the RCS transaction in that paper.

  13. Pingback: This Week’s Sign the Lunatics Are Running the Asylum | Cale In The Keys

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