April 29, 2010
By Joel Ross


I have said several times in articles and panels, “follow the money.” The industry prognosticators missed the entire downturn because they were not paying attention to the capital markets that really drive the economy.

Well, now the capital markets have turned positive. Credit is flowing again, spreads are way in, money is plentiful and there is a trend toward risk-to-achieve yield. All of this means the economy will sustain an improving trend until one of the black swan events next hits—volcanoes, Greece defaulting, the next Christmas bomber succeeding, Israel attacks Iran. The situation in Europe with Greece and the other PIGS nations, Ireland Spain and Portugal, will get resolved, but you will be affected. The Euro will be weak for an extended period and the dollar will be stronger as a result. It will make it a lot more expensive for Europeans to come to the US. Greece has become one of those black swan events that we thought was an anomaly but which has the potential to cause more disruption that most first expected.

After the Goldman hearings it is highly likely that Congress, which demonstrated that they have no understanding of how trading or Wall St really works, will try to now pass a regulatory bill which will hobble the capital markets. The hearings were very dangerous because they were political theater and not interested in understanding any of what was really happening. If the people like Carl Levin and McCasskil, get their way, there will be a lot less capital to grow the economy and banks and the Fed will be badly harmed. You may not like what Goldman did, but going short is perfectly legal and making profits when others lose is not a crime yet. If it is, we all are the losers.

In the meantime, the harbinger of recovery of any economy is capital, and now there is an excess in the system. All of the grown-ups in the capital markets are getting very concerned there is too much capital coming too fast, and the trend is scary. Too many people are tending to go in the direction we just got over, and that bodes ill at some point down the line.

Causes for concern

What occurred is that a considerable number of groups assembled capital to buy distressed debt and REO assets. Many high-net-worth families decided they had lost enough with professional private equity funds and they were going to invest on their own.

Instead of all the opportunity to buy assets, or even distressed debt, the lenders chose instead to extend and pretend. This was because the United States government decided extend was government policy. There is even talk now that real-estate-mortgage-investment-conduit rules will be changed by the Treasury, and REMICs will be able to extend for five years instead of the current three. That has not happened yet, but it might.

This means the equity funds had no place to invest, so now they are lending. This has all happened during the past 60-80 days. Everything in the capital markets turned upside down almost overnight. This was not expected or forecast to the degree or at the speed it happened.

So now I am able to refinance portfolios at good leverage although high rates. Do not get fooled by stories at conferences and otherwise that you can borrow at 6 percent or 7 percent. Those loans are being done, but only for trophy assets at reasonable leverage, or with personal guarantees, or with relationships. A good trophy office in one of the five major gateway cities can be easily financed today. That is not your hotel. They are not the same thing.

The basic loan today is at 7.75 percent to 9 percent, depending on the asset and the leverage. High-leverage loans on riskier assets are at 12 percent to 15 percent. I am financing a new condo project which just got its certificate of occupancy at 12 percent for 75 percent of discounted pay off cost on the loan buyback.

The main change now is all lenders I spoke to only want to loan to proven borrowers with a track record.

Commercial mortgage-backed security pools are being formed, but so far they are only top quality assets at low leverage and well-underwritten, and the bonds have not yet been sold other than a few almost perfect portfolios. Until Congress decides on the rules for 5 percent collateral (or whatever they finally decide), no major deals will happen, and then they will be relatively small pools of under $1 billion compared to 2006-07,  when pools of several billion were common.

The good news is the capital markets are functioning better and much sooner than we in the capital markets expected—but there is still a long way to go.