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PPIP's Tardiness May ReflectInvestor Queasiness About Returns
Asset Securitization Report--SourceMedia (October 2, 2009)

John Hintze

A massive leap in the values of "toxic" MBS since March - albeit from record lows - may lessen the urgency prompting the U.S. Department of the Treasury's Public-Private Investment Program (PPIP). However, it may also dampen investors' returns and increase their risk.

The Treasury chose nine fund managers to partner with July 8 and gave each of them 12 weeks - ending last week - to raise at least $500 million in capital. The government would then match their capital and provide financing to double their firepower to invest in the securities.

But, the agency announced Sept. 30 that only two, Invesco and the TCW Group, were successful, raising a total of $1.13 billion.

The Treasury said it expects the remaining seven to meet the requirements throughout October, and that public-private investment fund (PPIF) managers will have two additional opportunities to bring investors into the funds and still receive government equity and debt financing.

The inability of the seven fund managers, including powerhouses such as AllianceBernstein, Blackrock and Wellington Management Co., to meet the deadline, however, suggests waning enthusiasm in what earlier this year appeared to be one of the few high-yielding, longer-term investments available.

Amherst Securities Group's research illustrates just how far MBS has recovered since its March lows, dulling return prospects for the MBS that PPIP fund managers have in their sights. The firm found securities based on prime and Alt-A loans falling between 40% and 60% in value from the start of 2008 through March 2009, and recovering between 50% and more than 60% by August. MBS comprising 30-year-fixed prime loans are still down 14%, and those based on riskier Alt-A hybrids are off 38%, but those price increases mean significantly less upside potential today than six months ago.

"If you're a PPIP manager, in order to get double-digit returns you're going to be pushed into investing in riskier securities," said Dan Nigro, an ABS portfolio manager at Dynamic Credit Partners, a New York-based investment manager with $5 billion under management.

The Treasury and its chosen fund managers have been tightlipped about PPIP's progress. None of the fund managers responded to queries about the terms to invest in their funds. However, a Sept. 2 memo by Connecticut Retirement Plans and Trust Funds' chief investment officer, according to Bloomberg News, said Wellington Management Co. - a more conservative investment manager - forecasted 13% to 17% gains, while AllianceBernstein and Marathon Asset Management each estimated returns of 18%.

Scott Buchta, head of investment strategy at Guggenheim Capital Markets, the broker-dealer affiliate of Guggenheim Partners, which manages more than $100 billion, said the first round of toxic-MBS buying was alpha-seeking investors such as hedge funds and broker-dealers anticipating demand from PPIP fund managers. Then came the money managers seeking to reinvest capital they had pulled out of the market and needed to "put to work," Buchta said, adding that managers with money on the sideline who wanted to catch at least part of the upside have been more recent buyers.

"Most of the stuff the PPIP managers will have left to focus on is the dicier stuff, priced between 50 cents and 70 cents on the dollar," Buchta said.

That's occurring just as currently higher valued MBS puts pressure on anticipated returns. Because returns are unlikely to achieve the pop that early MBS buyers found, traditional institutional investors such as pension funds and insurance companies are PPIP fund managers' likeliest investor prospects, sources said.

Timothy Isgro, an MBS strategist at Bank of America Merrill Lynch, said the PPIP funds' expected lifetimes - eight to 10 years - and the government-financed leverage make PPIP conceptually attractive to institutions due to the long-term nature of the financing, typically not otherwise available in the market today. The program gives fund managers the option to reinvest the cash flows for the first three years and also to pay investors as much as 8% before allocating cash to Treasury debt repayment.

Isgro believes PPIP managers may find the 8% distribution option advantageous as it improves yields for investors. "Distributing carry has the important effect of supporting falling leverage ratios over time, increasing the effective leverage against which investments are made and amplifying yields," Isgro recently wrote in a report entitled PPIP: Distributing Carry.

However, PPIP managers investing in riskier securities could suddenly find those terms challenging. "If you have securities that aren't distributing a lot of interest payments, you could find yourself in danger of not being able to pay that 8% coupon," Isgro said in an interview.

The run-up in MBS prices does appear to have given investors pause. Aside from fund managers' apparent slow going in raising investment capital - some of which is attributed to government bureaucracy - PPIP does not appear to be a priority among more traditional qualified investors. Jeff Mahoney, general counsel at the Council of Institutional Investors, said the trade group hasn't received any member inquiries about PPIP, and it wasn't scheduled to be discussed at its three-day conference last week, called Navigating the Future.

"We haven't gotten any calls, so I suspect either not too many members are investing in PPIP, or there are no corporate governance issues," Mahoney said, adding that the second possibility was unlikely given the government's heavy hand in the program.

The California Public Employees' Retirement System (CalPERS), one of the largest pension funds, is not investing in PPIP. "We hope it is successful, but at this time we don't see it as the best risk/return trade-off for us," said CalPERS spokesman Clark McKinley, who declined to elaborate.

Part of their reluctance may be investors' gut feeling that they could do better on their own, without the Treasury's helping hand. Christopher Sebald, chief investment officer at $17 billion Advantus Capital Management, noted that the anticipation of PPIP has played an important role in regenerating the MBS markets. Those markets, Sebald said, are now functioning again, and PPIP now mainly serves to remove the most toxic assets from banks' balance sheets.

"Those tend to be the assets that are lowest in value and provide the biggest potential for return, but because of the nature of the underlying loans, they also provide the greatest risk," Sebald said.

Sebald said the PPIP may work out well, but other strategies are now preferable. Referring to the PPIP fund managers' lower end of return estimates, at 13%, he said Advantus anticipates higher returns without using leverage, in part by investing in distressed securities outside the PPIP's focus. They include seasoned subordinated residential MBS backed by 15-year and 30-year loans, as well as auto subordinated securities.

Eton Wells, head of structured products at SecondMarket, which specializes in creating platforms to trade illiquid financial instruments, said his firm is assuming that MBS prices will continue to rise, but, he added, a double-dip is far from unlikely. Either way, institutions participating in those investments may want to trade out of that exposure instead of holding it long term. SecondMarket, Wells said, is now analyzing the potential for building a market in PPIP participations.

(c) 2009 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.
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