Notes from the SIFMA - PREA PPIP Summit

Includes: BAC, GS, JPM, KBE, MS, XLF
by: Sean Ryan

On June 4th in New York, two lobbyist groups held a conference (SIFMA & PREA's Public-Private Investment Program Summit) to discuss the PPIP. The timing was unfortunate, coming a day after the FDIC announced that the program for loans was being put on indefinite hold, but the conference featured many thoughtful participants whose insights are valuable even if the topic at hand is less pressing than it once seemed.

The elephant in the room, of course, was investors' concern that in dealing with the government, the initial (seemingly attractive) terms would be no less written on water than the terms that lured bankers into the TARP Capital Purchase Program during the fourth quarter of 2008. At the luncheon, David Miller of the Office of Financial Stability spoke elliptically of "uncertainty" regarding potential retroactive changes to the terms of the PPIP, and offered his "hope" that this uncertainty will diminish over time.

For better or worse it will indeed diminish over time, but in contemplating investors seriously considering PPIP participation so soon after the TARP debacle, I just can't shake the image of credulous tourists crowded around a street hustler's game of three-card monty in New York's pre-Giuliani days.

Instead of belaboring a program of dubious merit that may never come to fruition, then, I will focus on the two panels that were especially useful to investors in the financial services sector.

As an equity investor, I thought the most useful segment was the panel moderated by Bank of America/Merrill Lynch (NYSE:BAC) brokerage analyst Guy Moszkowski on the "Impact on Financial Institutions". The panel consisted of former BankAmerica Chairman and CEO David Coulter (now with Warburg Pincus), and two FIG investment bankers, Scott Romanoff of Goldman Sachs (NYSE:GS) and Brian Sterling of Sandler O'Neill.

Coulter in particular offered some particularly thought-provoking comments, most notably stating that he is not convinced that we have seen the worst of the current downturn, that bank balance sheets have additional problems not addressed by recent capital raises, that future growth rates are in question, and as a result he has been surprised by the magnitude of the current bank rally. As a result, he suggested that the PPIP loan program may well be revived at a later date.

Sterling pointed out that for community banks, the most pressing concern is construction and development loans which, since they provide no cash flow, would not have been aided by the PPIP anyway. Community banks being left out in the cold was a theme of some other comments from later panels as well, with one participant suggesting that while the TALF makes it easier to refinance and securitize large commercial real estate loans, smaller loans that are the stock in trade of community banks will be more difficult to refinance.

The other particularly interesting panel focused on "Opportunities in Commercial Real Estate," moderated by Bart Steinfeld of Jones Lang LaSalle and featuring, among others, Barry Sternlicht of Starwood Capital Group.

Outspoken as always, Sternlicht offered several interesting thoughts. He suggested that as long as banks don't need to realize losses they probably won't, and that with the PPIP tabled, they are likely to offer for sale only "assets you shouldn't buy" - that is, only those assets on which even eternally optimistic banks have abandoned hope for recovery.

Overall he sounded a very bearish note, saying that he now worries about inflation (and by extension long term rates, and investment exit rates) for the first time in his career, stating flatly that "the real estate market can't divorce itself from interest rates." Unsurprisingly in light of this, he views the current rally as overdone and suggested investors short CMBS now.

To my mind, the key takeaway from the conference was that the two paticipants who have actually run large private sector companies - Coulter and Sternlicht - both expressed substantial skepticism regarding the sustainability of the now three-month-old rally, and the increasingly prevalent view that the worst is behind us.

I happen to share that skepticism; it is simply too easy to envision rising long term rates triggering a reacceleration of home price declines, or a CRE cataclysm to rival that of 1989-91 (potentially exacerbated by renewed talk of nationalizations and similar populist buffoonery in Washington), or more broadly, a reversal of the second-derivative improvements in economic indicators that leads to a re-test of March's lows.

Disclosure: long FAZ, short CMA