As we do each year at Crunched Credit, we take the end of a calendar year as an opportunity to stop and reflect on where we are, and what the next year might hold. Recognizing the certainty that a successful prediction is more a random event – a blind cat finding a dead mouse, than a product of wisdom and analytic prowess, it remains an important exercise. It bears repeating that refusing to take a view is actually to make a choice, and a pretty silly one at that. So as we at Dechert churn through our budgeting and planning process for 2016, we will make some assumptions about the economic environment and adjust our planning accordingly. Let’s agree, we are going to be wrong about a lot of stuff – maybe everything – but that fact doesn’t excuse the critical need for having a macro view.
Enough with the quibbles and cavils already; here goes. We’re in the seventh year of a slow and steadily grinding upward recovery following the Great Unpleasantness of 2007 and 2008, and there’s certainly no compelling reason to think it’s going to stop and reverse itself into recession in 2016. Interest rates remain at historical lows (which bothers me some) and I actually don’t see a scenario in which they creep up very far anytime soon. Will the Fed really do four 25 bps increases during 2016? I am increasingly doubtful.
The consensus remains, we’ll see 2%-ish GNP growth during the year and that seems sort of right to me. Disappointing perhaps, but right. We had a pretty good job report just this month, at least on the headline number. The rest of the world seems to be going to hell but, hey, for an economy that is essentially inward looking and not beholden to a weak dollar for a strong trade surplus, that’s not all that bad. Money has been flowing into this country through EB-5 and otherwise, and we expect it to continue to do so. If your choices are sitting in Shanghai and waiting to get disappeared, or moving your fortune to Los Angeles, that a pretty easy choice, right?
As we dial down and look at the real estate economy, it continues to look fairly robust and it is certainly not, in any material way, likely to underperform the broader economy.
Overbuilding is not yet a problem. Major asset categories remain healthy, with even office demand beginning to catch up after years of below trend line growth. In the commercial real estate lending space, there seems to be a fair amount of discipline, and some evidence of increasing spreads. The consensus industry view seems to be that capital formation, commercial mortgage lending and issuance of CMBS as well as portfolio lending will do just fine in 2016.
Investors are picky. Perhaps they have become aware that they are large and in charge for the first time in a while. But they are there and will buy our product. Pricing seems to have begun to move out in the primary lending market which is pretty damn important because investors are demanding more yield these days. And it would be nice to think that extra yield could be obtained in the lending space from the borrowers as opposed to being funded from suppressing banker (and lawyer) profitability. Consensus is around $100 billion in 2016 CMBS volume. That’s just fine for us.
So that’s the positive side of the ledger.
What about the continued regulatory war on capital formation? Let’s be clear here – it’s real and consequential. The biggest and most important change confronting the industry is the risk retention rules which, for CMBS, will arrive next Christmas Eve (who says the government doesn’t have a sense of humor?). We hear tell that the mortgage brokers are hyperventilating over risk retention and telling their borrowers, “Enough already with optionality. Get your deals done because you can’t be sanguine about capital formation once risk retention arrives.” I think they’re right. And consequently 2016 will be a banner year for fixed rate and even floating rate mortgage loan originations, at least through the first half, as the users of capital abandon their typical love affair with optionality and queue up to be fed. “Take the money and run” boys when the taking is good will be the motif of 2016.
In addition to risk retention, the ongoing difficulty with liability management under Reg AB II and the looming additional regulatory burdens on capital formation such as the Liquidity Coverage Rule, the Consultative Document on Identification and Measurement of Step-In Risk (what, you haven’t heard of this one? The gnomes of Basel are always busy. More on this in a later commentary, but suffice it to say, it ain’t good), the Fundamental Review of the Trading Book (FRTB) and Volcker, Volcker, Volcker.
Oh, by the way, we have an election coming up. This election and the political tumult ushering us up to the ballot box has a real possibility of being consequential. Populist anger against bankers and Wall Street remains a ready fuel for politicians and we expect continued pressure on the banking system and capital formation both before and after the election. Those horrible bankers will remain many politicians’ and political candidates’ favorite whipping boy and the regulators whose natural animus towards the regulated will only be enabled by this ongoing populist fury to regulate more and to regulate more aggressively. (And don’t forget our friends, the Attorneys General who view any opportunity to open a can of whoop-ass against the banks and Wall Street as a gift on the path to the governor’s mansion).
Black swans and fat tails continue to abound. Maybe they have always been around but it’s hard to think beyond them right now. A revanchist Russia, on the chip on the shoulder expansionist China with what appears to be an increasingly unstable political situation and a swooning economy are more than a little frightening. Continued regional religious and political conflicts throughout the Mideast, and continued monetary and demographic crises in Europe all threaten which would otherwise be an amiable economy in 2016.
And while I’m at it, explain to me how the US ended up with a $4 trillion Fed balance sheet and $4 trillion infused into our economy and no sign of inflation. I don’t like things I don’t understand, and this is right on top of my list. And while we are admitting confusion, what about the US stock market? Reportedly we are enjoying the worst start of the market in history, which swooned again this past week over something. Was it the Chinese economy? Was it the North Koreans having lit up something which they proudly refer to as an H-Bomb? (Now, it’s probably more of a fat boy with a fat boy, but still.) What’s the underlying vulnerabilities causing these continued chaotic warning signs to flash?
We’re reminded, as we look into 2016, that as a little over a century ago in mid-summer of 1914, the western world seem was largely blissfully unaware that within 60 days a million men would be dead and the greatest war the world had seen would begin to grind itself into a stalemate that would last for four long years. Unknown unknowns are just that.
But, please, get off the floor. Take a deep breath. Stop crafting a suitable suicide note. While we can see a lot of risks in our economy and certainly our bullish case has a considerable bias on the downside, it continues to look, net/net, like clear sailing for a while. And a strategy of hope goes, hoping that 2016 goes okay, does not seem unreasonable. And, as you know, there’s nothing to do about these exogenous risks. They’re largely out of our control and we have to play the cards that we’ve been dealt. That means for us, we’re looking at an economy that looks reasonably robust, which is likely to grow through 2016, and looks likely to support a healthy commercial real estate finance marketplace.
That’s my story and I’m sticking with it.