Friday, 05 June 2009 01:00

Banker Busted?

From Bloomberg :

June 5 (Bloomberg) -- The day after Countrywide Financial Corp. Chief Executive Officer Angelo Mozilo arranged to start $139 million in stock sales, he told two top deputies there was “no way” to value one of its most popular mortgages.

“We are flying blind on how these loans will perform in a stressed environment of higher unemployment, reduced values and slowing home sales,” he wrote in a 2006 e-mail released yesterday by the Securities and Exchange Commission. “We have no way, with any reasonable certainty, to assess the real risk of holding these loans on our balance sheet.”

[Actually, I sort have an idea of how those loans will behave. See the content from a previous post:

Analysts at Moody's Investors Service warned Tuesday that U.S. banks with debt that is rated by the Moody's Corp. unit face about $470 billion in losses through next year. If the economy continues to suffer, those losses could swell to $640 billion, and Moody's would likely accelerate its bank-debt downgrades.

"In such a scenario, absent continuation, and likely deepening, of U.S. government capital and liquidity support programs for the banking industry, numerous banks would be insolvent," the Moody's analysts wrote. [We all know where you have heard that before. Review the data in my recent posts if you doubt this:

  1. BoomBustBlog.com's Realistic Recast of SCAP BoomBustBlog.com's Realistic Recast of SCAP 2009-05-12 14:52:09
  2. My comments on the NYC condo market which seems to have wrinkled a few overly-sensitive feathers. Be sure to read through the comment section.
  3. Then be sure to read The Truth About the Banks Has Been Released: the open source spreadhseet edition and The Re-Release of the Open Source Mortgage Default Model.
  4. After that, if you're bored, there is always the T2 Partners analysis or even the NY Times' perspective.]

The funny thing is, the industry is still flying blind, still cannot value the mortgages, and the only thing that they really do know is that they are value vacuums. Thus, the healthier banks ate the sick banks with government

Published in BoomBustBlog

From the Wall Street Journal:

Banks are having an easy time dialing for dollars.

J.P. Morgan Chase & Co., Morgan Stanley, American Express Co. and regional bank KeyCorp said Tuesday they sold a combined $8.7 billion in common stock. That pushed the total value of shares sold by the 19 financial firms that were stress-tested by the government to at least $65 billion since the results were announced May 7.

... Money is pouring in so fast that surprised bankers can hardly believe it, especially since most investors didn't want to go near financial stocks just three months ago, even though they were nearly 40% cheaper. [Possibly even more so sinceI believe the real estate malaise may actually pick up in intensity. Sales will probably occur at a faster pace, but at a lower and lower price point, causing the derivative and debt products associated with those products to drop even further in value. This includes commercial, residential, office and retail properties.]

"It's easy to raise capital now," one executive at a bank that recently raised capital through a public stock offering said Tuesday. Investors are "happy to gobble it up." [A fool and their money...]

Some investors who participated in recent bank-stock sales said the logic is simple: The likelihood that the economy will veer off a cliff is dwindling, and many banks look cheap on a price-to-earnings basis. [This is probably because it is now acceptable to make up your own asset values and write-downs in reference to legacy assets/toxic waste/horrible investment decisions, thuse the earnings portion is highly subjective. I never thought that I would be saying earnings are subjective. The world that we now live in...]

"The Armageddon trade is off the table," said David Tepper, president of Appaloosa Management LP, a Short Hills, N.J., hedge-fund firm that owns shares of Bank of America Corp., SunTrust Banks Inc. and Fifth Third Bancorp. Based on likely earnings in 2011 and 2012, the banking industry "may be the cheapest sector in the market," he added. [Love to see his returns for the last two to three years...]

Appaloosa participated in a common-stock offering and preferred-share swap by Bank of America, according to a person familiar with the situation. The Charlotte, N.C., bank said Tuesday it has raised nearly $33 billion and "now believes it will comfortably exceed" the $33.9 billion it was told to raise by the Federal Reserve.

Mutual funds and other large institutional investors have been aggressive buyers in some of the stock offerings, according to people involved in the deals. Because lots of those investors had previously shunned bank stocks, they lagged behind the overall market when bank stocks rallied starting in March. This month's frenzy of deals was a chance to increase exposure to the industry at a slight discount to the market price. [Fools and their money...]

Analysts at Moody's Investors Service warned Tuesday that U.S. banks with debt that is rated by the Moody's Corp. unit face about $470 billion in losses through next year. If the economy continues to suffer, those losses could swell to $640 billion, and Moody's would likely accelerate its bank-debt downgrades.

"In such a scenario, absent continuation, and likely deepening, of U.S. government capital and liquidity support programs for the banking industry, numerous banks would be insolvent," the Moody's analysts wrote. [We all know where you have heard that before. Review the data in my recent posts if you doubt this:

  1. BoomBustBlog.com's Realistic Recast of SCAP BoomBustBlog.com's Realistic Recast of SCAP 2009-05-12 14:52:09
  2. My comments on the NYC condo market which seems to have wrinkled a few overly-sensitive feathers. Be sure to read through the comment section.
  3. Then be sure to read The Truth About the Banks Has Been Released: the open source spreadhseet edition and The Re-Release of the Open Source Mortgage Default Model.
  4. After that, if you're bored, there is always the T2 Partners analysis or even the NY Times' perspective.]

One executive at a New York bank said investors seem to be embracing any tidbit of good news, while ignoring red flags about banks' ill health. ["Red flags"! I see it as blatant "Watch the f#@$k out!" signs!] He compared the industry with an intensive-care patient who has stabilized but remains critical. "A bucket of cold water will be thrown in people's faces," the executive said.

By one measurement, investors are more enthusiastic about the industry's future than bank executives are. At the 15 stress-tested banks that have raised capital by selling stock to the public, no senior executives have recently reported buying shares themselves, according to Jonathan Moreland, director of research at InsiderInsights.com. [Of course not, they are tired of losing money!] The New York firm tracks stock-buying and selling patterns among corporate executives.

Published in BoomBustBlog

It appears as if someone at the Fed has been reading my scathing criticisms of the Stress Tests and the banks true conditions and prospects - and have actually taken a recommendation or two to heart...

From the WSJ: Fed Cools Banks' Faith in Future Revenue

Big banks were hoping billions of dollars in future revenue would help them fill the capital holes found in the government's stress tests earlier this month. Now the Federal Reserve is limiting how much of that performance can be counted, according to people familiar with the situation.

The Fed's decision is forcing Bank of America Corp. to come up with billions of dollars in capital from other sources, these people said. Other stress-tested banks also have revamped their capital-raising plans or might need to, including PNC Financial Services Group Inc. and Wells Fargo & Co.

Published in BoomBustBlog

Everybody in the media says the worst is over, and we have visited a generational low in March. I say to myself, how in the hell do they know that? I know there are no astute real estate investors who believe such, and it is the leveraged real estate, derivatives and the real assets which first collapsed the big banks in the first place. As long as the value of the real estate goes down, the value of all of the assets attached to it will go down - and they have a loooong way to go. Then you have the necessary correction in all of the other bubblicious assets - levered loans, credit cards, credit lines - both consumer, corporate and small business, commercial loans, leasing, etc. We ain't done yet, not by a long shot.

In September of 2007, when I first started this blog, I warned of over-reliance on the Case Shiller indices (see The Real Trend in US Housing Prices... ), due to the narrow definition of what a house was. It excludes semi-detached housing, condos, coops, multi-family and investor properties, not to mention new construction. Well it appears as if someone in S&P was listening, since some of the holes in the index have been plugged. There is now a condo index, which reveals some interesting trends, the foremost of which portends a Miami-like residential real estate depression in dense urban areas such as NY, DC and LA.

There are significant economic differences in building condo units vs single houses. For instance, once you are finished building a house you can sell it. So, if you are building a master planned community and are running into problems, you can still  sell homes off individually. In a condo building you are forced to finish practically all of the units before delivering them. In cities such as NY, you cannot pre-sell units before issuing a red herring, which is an informational document demanded by the state regulator. Cities such as Miami have no such protections, and you see now that has ended. The condo scene in the Miami/Ft. Lauderdale is downright ugly, and doesn't seem to be getting much better.  What most people don't realize is that the same thing is coming to the more dense real estate geographies, including the big daddy of them all - NYC! You see, condos and coops are 90%+ of the "owner-occupied" housing in Manhattan, thus those Case Shiller numbers that everybody is used to seeing really has nothing to do with the real estate in NYC, proper, and not much to do with NYC at all (which has a lot of multi-family brownstones, 2-4 family attached housing, condos and coops).

The most recent Case Shiller Condo Index is below, and it shows a big dip in the dense urban areas.


Published in BoomBustBlog

I have received some feedback on the open source mortgage default model and data, and consequently took it offline due to the possibility that there may have been a material error (see The Truth About the Banks Has Been Released: the open source spreadhseet edition for the background). I have had it reviewed and reviewed it myself several times in light of the external inputs and am now putting a revised version back online for all to download, modify and or distribute. To give a quick background on what was going on, I received a notice of potential errors from a reader, along with suggestions on how he felt the model could be improved. I checked the SCAP Loss Assumptions file that he sent and although there is a difference of approach followed by us and the reader regarding estimation of loan loss rates, we have found both the methods acceptable. The key difference is that the methodology (as explained below) followed by the contributor requires certain (additional) assumptions to be made while we wanted to refrain from making additional assumptions to remove any subjective biases and base our analysis using Fed's data to the maximum extent possible. For those that do not wish to read through this lengthy history, let it be known that the end result of the reader's input, and to a lesser extent our slightly tweaked methodology both resulted in a HIGHER loss rates for mortgages (and consequently, the banks), not a lower one. So, if the original open source model was to be considered inaccurate, it would be leaning towards the optimistic side, which further drives home my point and thesis concerning the government's bogus stress tests and the current and future state of many US banks (see Welcome to the Big Bank Bamboozle! for the detailed story). Banks and asset managers have rallied enormously again, causing me to recheck my thesis and research, and yet still, I find absolutely no indication of my viewpoint being in error. This situation is similar to the dot.com era where many fundamental types tried to short the internet companies, and many got blown out of the water before the industry and the entire market collapsed. Past is not prologue, but I have been in this minimum vaue view of what I consider overvalued assets and markets when I sold off my real estate in 2006. Patience is hard to come by when you are facing against the wind, but I am not comfortable going against both the math and common sense.

One potential source of the perception of error was the inclusion of Alt-A ARMs resetting after 24 months (the 24+ month column in the Alt-A tab) in the cumulative loan loss rate section for 2 years. We feel that the exclusion of Alt-A ARM resetting after 24 months would underestimate loan losses during the actual 24 month period due to a variety of reasons, the least of which are the facts that once a certain LTV level is breached you will have early loan recasts (see The banking backdrop for 2009 where I warned of this at the beginning of the year) and the fact that there will be some defaults before an initial reset is achieved.

Those who just want to dowload the model click here (Revised SCAP Assumptions Public Open Source Version 1.1 Revised SCAP Assumptions Public Open Source Version 1.1 2009-05-18 15:15:47 1.21 Mb), otherwise read on to how I got to the second slight revision of the model.

Published in BoomBustBlog
Tuesday, 12 May 2009 01:00

Welcome to the Big Bank Bamboozle!

I have produced a downloadable PDF which clearly shows exactly how far off the banks and SCAP bank stress tests are from the delinquency and foreclosure information that the Federal government distributes itself. This document is in response to the Government's release of the official bank stress test results, which I honestly feel is a slap in the face to anybody with two brain cells to rub together. Please reference page 7 of the document hyperlinked above, as well as the individual bank's "adverse scenario" projections for various loan categories (towards the end of the document) over the next two years and compare them to the loan loss snap shots that I have gathered below from last December and March, directly from the Federal Reserve's public web site. There is no need to wait two years when the worst case scenario is here and now.

This is the government's summary findings of the potential "WORST CASE" losses over the next two years for all 19 of the bank holding companies that were subject to the government's stress test.

19_bank_scap_results.gif

Here are some highlights of interest from my report to compare and contrast:

Alt-A loans

  • Nearly 36% of Alt A loans had least one late payment over the past one year. In Florida nearly 48.5% of Alt-A loans had at least one late payment over the past one year followed by Nevada (43.5%) and California (41.6%).
  • Alt A loans 90+ days past due were 8.7% of total loans with California and Nevada having the highest 90+ days loans past due at 11.3% and 10.3% of total loans, respectively.
  • Overall 30.4% of Alt-A loans are in risk of default based on prorate share (based on weighted average foreclosure / past due loans and REO loans for each state with weights based on average loan outstanding at each state).
  • Nearly 42.8% of Alt-A loan outstanding were originated on or before 2005 while 35.6% and 21.6% of loans were originated during 2006 and 2007, respectively. With S&P Case Shiller declining by nearly 19% , 29% and 29% since 2005, 2006 and 2007, respectively most of these loans are currently underwater in view of the fact that average LTV at origination for Alt-A loans was at 81%.
  • Overall net charge off for Alt-A loans (cumulative 2 years assuming current delinquent and foreclosed turn into expected charge-off over a two year time horizon) is expected to reach as high as 23.9% significantly higher than Fed's implied loss rate assumption of 9.5%-13.5% under the adverse case scenario. Fed's adverse case and base case assumption for subprime charge offs is even lower than current loans past due which is at 13.0%.

Subprime Loans

  • Nearly 64% of subprime loans had least one late payment over the past year. In California and Florida nearly 67.1% and 71.8% of subprime loans had at least one late payment over the past one year.
  • Overall 50.2% of subprime loans are in risk of default based on prorate share (based on weighted average foreclosure / past due loans and REO loans for each state with weights based on average loan outstanding at each state).
  • Nearly 48.6% of current subprime loans outstanding were originated on / before 2005 while 36.3% and 15.1% of loans were originated during 2006 and 2007, respectively. With S&P Case Shiller declining by nearly 19% , 29% and 29% since 2005, 2006 and 2007, respectively most of these loans are currently underwater in view of the fact that average LTV at origination for Alt-A loans was at 84.2%.
  • The current LTV for subprime loans is at 115% with Nevada and Arizona having the highest LTV at 154% and 146%, respectively.
  • Overall net charge offs for subprime loans (cumulative 2 years assuming current delinquent and foreclosed turn into expected charge-off over a two year time horizon) is expected to reach as high as 41.4% significantly higher than Fed's implied loss rate assumption of 21%-28% under the adverse case scenario. The Fed's adverse case and base case assumption for subprime charge offs is even lower than current loans past due which is at 28.9%.

The full report, complete with sources and methodology is available here, free of charge. I simply ask that you forward it to your local congressman/woman and/or favorite media personality. The Truth shall set you free (or get you locked up, depending upon which side of the Truth you are on):
pdf BoomBustBlog.com's Realistic Recast of SCAP 2009-05-12 14:52:09

For those of you in the media who may not be familiar with my previous work, I have a strong track record in calling this credit crisis:

  1. The Commercial Real Estate Implosion: I called it in 2007 - "GGP has finally filed Bankruptcy, Proving My Analysis to be On Point Over the Course of 18 Months".
  2. The Investment Bank Implosions: Bear Stearns (Is this the Breaking of the Bear? [Sunday, 27 January 2008]) - and - Lehman Brothers investment banking/CRE implosion connection (Is Lehman really a lemming in disguise? [Thursday, 21 February 2008])
  3. The Mortgage Banking Implosion: I called it in 2004, publicly on the blog in 2007 - Countrywide and Washington Mutual (Yeah, Countrywide is pretty bad, but it ain’t the only one at the subprime party… Comparing Countrywide with its peer)
  4. The Regional Bank Implosion: Spring of 2008 - nearly all of the failed or failing regional banks of significant size (As I see it, these 32 banks and thrifts are in deep doo-doo!)
  5. The Monoline Implosion: 2007-2008 - MBIA (A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton) and Ambac (Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap and Follow up to the Ambac Analysis), among others including the residential homebuilders and their abuse of off balance sheet JVs - well in advance.

I suggest everybody read up on how we
got here. I started taking defensive action in 2004, and implemented my
offensive actions 2007 - right around the time this blog was started.
Read my blog by blow analysis below...

Published in BoomBustBlog

I dedicate this article to those loyal readers who tell me that there
are times that you can't rely on fundamentals. I respectfully disagree.
Over time, 1+1 will always equal 2. As a matter of fact, when people
tell me 1+1 = ANYTHING other than 2 is when I start looking for
opportunity. That's what I do for a living. See more about my
occupation here, "The Great Global Macro Experiment, Revisited".
Now is the most appropriate time to make use of the fundamentals. You
see, when you are able to master a high level of analysis, you can
actually SEE PEOPLE LYING! Lies lay the seeds for significant financial
profit, for somewhere behind the lie lays the truth.

The Supervisory Capital Assessment Program: Revisited

We have conducted analysis of Fed's assumption for loan losses for
Supervisory Capital Assessment Program by taking into account current
delinquencies, foreclosure and charge-off to determine severity of
assumptions. Below is the summary findings of the potential "WORST
CASE" losses over the next two years for all 19 of the bank holding
companies that were subject to the government's stress test (taken from
page 7 of the official stress test results).

19_bank_scap_results.gif

Now, this is supposed to be Armageddon numbers for up to two years into
the future. Let's compare this to the data we have gathered from
credible sources, and potentially even some incredible sources. The
primary source of default and delinquency data was actually the Fed itself,
believe it or not, the same guys who gave the stress test in the first
place and currently stating that banks are well capitalized!

The table below presents a comparison of the Fed's SCAP (stress test)
assumption for cumulative 2 year loss rate and likely two year
cumulative expected losses based current trends in charge-off's,
foreclosure and delinquency taken in large part from the Fed's public
website. When looking at this table, be sure to reference the actual
results above, and the definition of Fraud.

The Supervisory Capital Assessment Program

Fed 2 yr cumulative loss rate

Current trend

Base Case

Adverse Case

Net Charge-off rate 1

Foreclosure2

Deliquency3

These scenarios trends have already breached the worst case scenario

First Lien Mortgages

5 - 6

7 - 8.5

8.86%

3.92%

<---------

Prime

1.5 - 2.5

3 - 4

4.89%

<---------

AltA

7.5 - 9.5

9.5 - 13

19.98%

5.00%

9.69%

<---------

moratriums have temporarily kicked foreclosure filings down the road

Alt‐A ARM

15.03%

<---------

Subprime

15 - 20

21 - 28

36.18%

13.7%

21.88%

<--------- (charge offs) moratriums have temporarily kicked foreclosure filings down the road

Second/Junior Lien Mortgages

9 - 12

12 - 16

Closedend Junior Liens

18 - 20

22 - 25

HELOCs

6 - 8

8 - 11

4.00%

2.45%

C&I Loans

3 - 4

5 - 8

2.70%

2.58%

CRE

5 - 7.5

9 - 12

>12%

5.36%

<----- Trend is already higher than predicted, but current losses in range

Construction

8 - 12

15 - 18

10.24%

Multifamily

3.5 - 6.5

10 - 11

1.30%

Nonfarm, Nonresidential

4 - 5

7 - 9

Credit Cards

12 - 17

18 - 20

>20%

5.56%

<----- Trend is already higher than predicted, but current losses in range

Other Consumer

4 - 6

8 - 12

5.38%

3.32%

Other Loans

2 - 4

4 - 10

2.15%

1.05%

Notes

1)
Computed for Alt A First Lien Mortgage, Alt A ARM and Subprime based on
Fed data for Foerclosure and past due loans adjusted for LTV and
housing price change.

1)
HELOC, C&I, Other consumer and Other loans are as of December 31,
2008 representing 2 yr cumulative loss rate and are sourced from FDIC
and Federal Reserve. Credit Card charge-off as per Moody's estimate.
CRE charge-off's as per Deutsche Bank estimates.

2)
Foreclosure as of March 31, 2009 from Bloomberg except for Subprime
foreclosures which is as of December 31, 2008 and is sourced from
Mortgage Bankers Association.

3) Delinquency as of December 31, 2008 sourced from MBA, FIDC and Federal Reserve

First Lien Mortgage

Mortgage foreclosure rate stood at 8.86% as of March 31, 2009 with US
home foreclosure filings increasing 46% to 341,180 as of March 31, 2009
over last year. This number is significantly understated due to the
fact that many, if not most, of the largest lenders were either under
or just exiting a moratorium on foreclosures in the US. This
moratorium, or more accurately, the lack thereof, will cause an extreme
spike in foreclosure fillings in the upcoming months. As U.S housing
prices continue to decline (with S&P Case Shiller Index declining
5% in 2009 in the first two months) mortgage forecloses and
delinquencies are expected to reach additional historical peaks
resulting in higher loan losses for banks on real estate loans. The
Fed's 2 year cumulative loan loss rate for Alt A loans (7.5%-9.5%)
appear overly optimistic and is even lower than current delinquency as
of December 31, 2008 (9.69%). Based on the Fed's data (that's
right, this data is sourced directly from the Fed itself, which
explicitly contradicts the data that the Fed released for its stress
tests
) for Loan losses for Alt -A loans as of March, 2009 (for
loans past due and current foreclosures) adjusted for recovery based on
LTV taking into consideration price decline and original LTV, 2 yr
cumulative losses for Alt A is expected to reach 19.98% which is
significantly higher than Fed's adverse case of 9.5-13% - nearly twice
as much
! The Alt-A category is probably one of the most dangerous
for the banks, for this is expected to literally explode over the next
24 months (and is in part masked by moratoriums), as is confirmed
through our independent research and, ironically, through the Fed's
data itself! I strongly suggest that those who are interested in this
mosy on over to Mr. Mortgage's blog, for a peek at what is "really"
happening in regards to foreclosures in California - see "4-23 March Final Loan Default Wrap-up". This is the man that sounded the trumpet along with myself regarding Lehman Brother's RE exposure.

Now, in case my bold font and italics are wasted on some of you, let me
state this again. The Fed says X through the stress test assumptions,
and now the results, yet if you simply surf over to the other side of
the government's own web sites, they offer actual default and
foreclosure rates (among other data), that are considerably more dire
than they asked you (the tax payer and investor) to believe is credible
and "not that bad". My previous post requested that BoomBustBlog
readers consider the technical and legal definitions of Fraud - see "Preparations for Monday's and Tuesday's Articles". Keep this in mind as we move forward.

Published in BoomBustBlog
Thursday, 26 March 2009 01:00

Reggie Middleton on PPIP, part 2

This is part 2 of Reggie Middleton on the government's Public-Private Investment Plan. You can find part 1 here: Reggie Middleton's Overview of the Public-Private Investment Program.

Public-Private Investment Program

Impact on Lending

The program's aim to ensure that banks kick start lending is most likely overly optimistic. The program's core premise that the banks are reluctant to lend due to a overhang of legacy assets is based on a false assumption. The many reasons banks are unwilling to lend - not withstanding a dearth of capital - include fast deteriorating economic conditions, poor credit quality of borrowers, increased risk aversion, and the tumbling prices of underlying assets. Banks will continue to remain cautions unless, and until, the real economy stabilizes or risk acting against the best interest of their shareholders (and their bonus programs), defeating the very (stated) purpose of the program. Any program which focuses only on securities without focusing on fundamentals that affect the underlying assets (economic fundamentals) would fall short of its intended purpose. Common sense from my perspective, but I've always been sort of different so maybe I see things in,,, differently...

Lack of liquidity

The second basic premise of the plan's success lingers upon adequate participation from private investors. Even based on the assumption of maximum leverage granted by FDIC to everybody for everything that can possibly be purchased by anybody in the program (6:1) private investors would have to come up with $68 bn of funds (in this investor scary environment) to achieve the $500 bn target of legacy assets and $136 bn to purchase the full stated $1,000 bn of legacy assets promised to be leveraged into by the government. If the Fed's valuation committee is just slightly more conservative in its valuation estimates and uses lower (but more realistic, at least on average) leverage (ex. 4:1) granted to everybody for everything that can possibly be purchased by anybody in the program, then private investors would need to raise $188 bn to achieve the target goal of $500 bn and $375 bn to achieve target of $1,000 bn. Lest we show our short term memory propensity, do not forget that there are $2 trillion+ of these assets out there, not $1,000bn! So even with the government program maxed out to the fullest, we are still touching only 50% of the asset pool, as the underlyings to these assets are still in rapid descent that will probably not cease for some time.

Click this graph to enlarge to print quality.

shiller_house_price_graph.png.png

Let me put this into perspective for you. The entire hedge fund industry is currently only about $1.5 trillion in assets under management (with many of those assets still fleeing as the lockups expire and the exit gates that were thrown up last year to prevent a run on the fund start to open). So, to fund the government's equiity tranch of the program, every hedge fund will have to invest 33 cents of every dollar under management. Hmmm! Garnering such an enormous amount of capital from private investors would require a significant amount of time and persuasion that could significantly delay the process and further depress the asset prices and the economy along with it. That is assuming it can be done at all (most likely not) - after looking at and digesting the numbers above appear to be increasingly unlikely. Despite all of these very real facts, the broad market participated in the biggest rally ever, in the history of exchange traded stocks in the US. What's next, see the graph here: Bear Market Rallies Shake Out Weak Hands!

(In Billions)

$500

$1,000

Legacy Loan Program

Legacy Securities Program

Total

Legacy Loan Program

Legacy Securities Program

Total

$250

$250

$500

$500

$500

$1,000

Min Pvt contribution

Leverage

6: 1

4: 1

6: 1

4: 1

to make the plan

FIDC / Federal Reserve

$214

$200

$414

$429

$400

$829

work

Treasury

$18

$18

$36

$36

Private Investor

$18

$50

$68

$36

$100

$136

Max Pvt contribution

Leverage

1: 1

1: 1

1: 1

1: 1

to make the plan

FIDC / Federal Reserve

$125

$125

$250

$250

$250

$500

work

Treasury

$63

$63

$125

$125

Private Investor

$63

$125

$188

$125

$250

$375

Risk and Reward in the PPIP!

ppip_worksheet_with_collusion_8813_image002.png

Now, to be fair to Geithner, et. al., he (they) never declared the PPIP to be a be all and end all. What he did state was that this was a method of facilitating price discovery. It was to be bundled with a variety of other tactics, from quantitative easing to forcing capital down the throats of banks that fail government mandated stress tests. Well, looking at everything as a package, it does tend to make sense. The caveat is that although I definitely see the logic in the whole plan, the market seems to have misconstrued what I see as somehow being positive for extant bank common and preferred shareholders - NOT!!!! It may very well end up being a positive for the banking system, but I wouldn't even buy a bank stock with YOUR money!. Now, on to the biggest potential problem with the plan...

Possible loopholes

The plan specifically provides for the exclusion of SIVs (off balance sheet Structured Investment Vehicles of banks) from investing in the bank's legacy assets through PPIP by excluding affiliates of banks participating in distressed assets .So technically a bank cannot set up an SIV with a more than 10% stake and overbid for those assets.

However there is no such mechanism as such to prevent private investors to engage in collusion and overbid for securities, risking tax payers' money since both the parties stand to gain in such an event (out of this three party affair).

"Private Investors may not participate in any PPIF that purchases assets from sellers that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF."

Seller Bank A

Seller Bank B

Face value

100.0

Input

Face value

100.0

Input

Price determined by auction

80.0

Input

Price determined by auction

90.0

Input

Current fair value in books, cents to dollar %

60.0%

Input

Current fair value in books, cents to dollar %

80.0%

Input

Debt-Equity ratio

6.0

Input

Debt-Equity ratio

6.0

Input

Debt FDIC Guaranty

68.6

Debt FDIC Guaranty

77.1

Equity by private investor, Bank B

5.7

Equity by private investor, Bank A

6.4

Equity by treasury

5.7

Equity by treasury

6.4

Interest on FDIC Debt

4.0%

Input

Interest on FDIC Debt

4.0%

Input

Fair value, cents to dollar %, actual at EOP

25.0%

Input

Fair value, cents to dollar %, actual at EOP

30.0%

Input

As seller of Legacy Assets to PPIP

Bank A

Bank B

Gain on sale to PPIP

20.0

10.0

Bank B (assuming it has purchased Legacy asset of Bank A

Value at EOP

Gian (loss)

Interest on FDIC debt

Gain to equity investor

Gain / loss to Private investor*

% return

Gain / loss to Tax Payer

75% discount on FV

$25.0

($55.0)

$2.7

($57.7)

($5.7)

(100.0)%

($52.3)

Bank A (assuming it has purchased Legacy asset of Bank B

Value at EOP

Gian (loss)

Interest on FDIC debt

Gain to equity investor

Gain / loss to Private investor*

% return

Gain / loss to Tax Payer

70% discount on FV

$30.0

($60.0)

$3.1

($63.1)

($6.4)

(100.0)%

($56.9)

Net Gain (Loss) Bank

Bank A

Bank B

Taxpayer

As seller of Legacy Asset

$20.0

$10.0

<--As long as bid value is greater than economic value banks stand to gain as seller

As Investor

($6.4)

($5.7)

<--Maximum loss as pvt investor is only to the extent of equity

Net Gain (Loss) Bank A

$13.6

$4.3

($109.2)

<--Maximum loss to tax payer virtually unlimited. Banks stand to gain both from sale of legacy asset and as investor.

In the model above (which you can download for free for your own use: PPIP full model, with collusion and implied leverage PPIP full model, with collusion and implied leverage 2009-03-26 01:00:41 202.00 Kb) we have assumed that Bank A and Bank B both participate in the PPIP program. Current fair value of Bank A's asset are at 60 cents on the dollar while Bank B's assets are at 80 cents on the dollar. However during the auction Bank A's and Bank B's assets are sold at 80 and 90 cents on the dollar, respectively. Bank A purchases Bank A's asset with equity investment of $6.4 while Bank B purchases Bank A's asset with equity investment of $5.4. At the end of period the actual value for these assets of Bank A and Bank B (originator) were 40 cents and 60 cents on the dollar, respectively.

Although both the banks lost 100% of their respective equity under the PPIP they were considerably better off (and I do mean considerably) selling each other their legacy assets, (effectively, selling them to the Treasury) with tax payers taking the ultimate hit. This should be safeguarded against. No need to worry, unless bank management takes out this blogger in the near future, I and my team will have our eyes out for such shenanigans. I can't guarantee I will catch it, but I wouldn't bet against me, either!

The Implied 14x Leverage Effect

Jeff S. posted the following comment on BoomBustBlog:

Am I mistaken in that the "Treasury Equity" is being funded by the remaining TARP balance? If so, is this not a deceptive title in that this "Equity" is really no different than the additional PPIP funds, and therefore, should be classified as "Debt?" And if so, does this not make the leverage ratio 14:1 (84/6) and not the stated 6:1?

Me thinks we are being lied to again. But I could be wrong.

Please advise...

In response:

There are 2 parts of the plan - the Legacy Loan Program and the Legacy Securities Program.

The Legacy Loan Program would purchase legacy loans through the Fed Guaranty (limited to leverage of 6:1) and the balance would be contributed equally between Treasury and Private Investor.

As a result under the assumption of maximum leverage (6:1 D/E) the effective Debt/Equity for the participant is 13:1, or leverage of 14.0x. We have highlighted the same in the structure, although probably not in the most lucid way, and we believe that Fed has provided sufficient information on the same without the intent of misleading the investment community,

Every $100 Dollar Invested
Debt / Equity* Contribution by FDIC Contribution by Treasury Contribution by Pvt Investor Contribution by FDIC Contribution by Treasury Contribution by Pvt Investor Effective D / E for Pvt Investor Effective Leverage
6: 1 6.0 0.50 0.50 86 7 7 13x 14x
5: 1 5.0 0.50 0.50 83 8 8 11x 12x
4: 1 4.0 0.50 0.50 80 10 10 9x 10x
3: 1 3.0 0.50 0.50 75 13 13 7x 8x
2: 1 2.0 0.50 0.50 67 17 17 5x 6x
1: 1 1.0 0.50 0.50 50 25 25 3x 4x
Published in BoomBustBlog

I would like to make it clear that MBIA and the other
monolines have assisted the investment, commercial and mortgage banking
industry in the significant inflating of the perception of capital available.
If (or more aptly, when) this charade comes to an end (apparently
imminently) the banking system will recieve another, quite significant
shock to the system. One of several very interesting emails that I
received over the weekend.


Reggie,


I am e-mailing about MBIA's recent restructuring announcement, which
involves the transfer of $5B out of MBIA Insurance Corporation to one
of its subsidiaries, MBIA Illinois (to be renamed). $2.9B of the $5B
was paid for MBIA Illinois to reinsure 100% of MBIA Insurance
Corporation's public finance exposures. The remaining $2.1B was
transferred via a return of capital to MBIA Inc., MBIA Insurance
Corporation's parent. Concurrent with the transfer, MBIA Insurance
Corporation's ownership interest in MBIA Illinois has been confiscated
and transferred to another MBIA subsidiary. On the surface, this
wreaks of blatant theft and fraud.

Published in BoomBustBlog