2019 Golden Turkey Awards

As is our tradition here at Crunched Credit, each year, about this time, we award our Golden Turkey Awards.  Once again, I must say that we are utterly blessed with so many worthy candidates. The truly deserving have once again wrangled with vision and astounding persistence to earn a spot on our acclaimed list.  To those of you who we must disappoint, please accept our sincerest apologies. We recognize and applaud the half-witted things that you did so breathtakingly well, just not as well as this year’s winners. There is always next year!

So, as we get ready for the season of cheer, let’s all take a moment of silence to pour one out for our 2019 winners:

The Self-Inflicted Wound Award… goes to Killing LIBOR.  This hot mess has already gotten our attention here at CrunchedCredit.  Read our recent commentary, Killing LIBOR, a Victory for Irrational Rectitude if you really want to marinate in outrage.  It makes the top of our list because of the breathtaking idiocy of disrupting a $350 trillion global finance market because we finally noticed and were outraged by something which has been true, and we knew had been true, since the inception of LIBOR (There’s gambling going on here?  I’m shocked, shocked!).  LIBOR is a made up rate, folks; the rate at which big banks would borrow if they did borrow, except they don’t borrow.  It’s a rate supported by very few underlying real transactions and we’ve been good with that for 30+ years.  And then we discovered a couple of British bakers diddling the rate for their own pecuniary benefit and lost our minds.  Punish the bankers?  Sure, but while we’re at it, let’s punish the entire market!  On the dopy scale, that’s right up there with the Great Leap Forward, 7th Earl of Cardigan (perhaps a better sweater than soldier), telling his light brigade, “Hey chaps, let’s go charge those pesky cannons, how hard can that be?” or, whatever the hell they were thinking in St. Petersburg when they put Rasputin in charge.  What a mess.  Now we’re going to have to transfer billions and billions of dollars of financial products from legacy LIBOR to this new rate, cooked up by the ARRC, known as SOFR.  Worse, we’re replacing a rate in which we have all been comfortable pricing financial assets for decades, because it was perceived to contain a baseline of macroeconomic risk, to a riskless Treasury repo rate that pairs poorly with most financial products.  It’s not Y2K, and for the avoidance of doubt as the Brits (an Award winner in their own right!) might say, I’m not talking my book.

The Dysfunction Award… goes to, as it does every year, our national government.  Has it been getting worse?  Name-calling and vilification from both sides of the aisle has actually become the only thing our gloriously elected representatives seemingly can do well.  The threat of revanchist China, the trade war, the middle east, the North American Free Trade Treaty, the deficit, the budget, tax and education policy, infrastructure and all those other pesky things that governments are supposed to do, remain undone and there is little prospect that Washington will get back to business.  As our recent post The Calamity of the Weaponized Narrative contends, this transcendence of vilification over actually doing anything can’t end well.

The Hey, I’m Still Impotent…er… Important Award… goes to the United Kingdom (with a very close second place finish by the European Union).  The sun long ago set on the British Empire when everything they did, whether for good or ill, was consequential.  But, looky, looky, they can still make a world class mess out of things, can’t they?  BREXIT.  I could make an argument that decoupling the United Kingdom (to the extent there still is a United Kingdom) from the dysfunctional polity of Europe and its Department of motor vehicle quality government in Brussels, might be, in the long run a good thing (but we’re all dead in the long run, right?), but what is incontrovertible is that they are making a hash of it in the here and now.  Hope it all works out, but the world needs another shock to the efficient operation of financial markets right now like it needs a social disease, but let’s not just blame our friends the Brits.  The European Union also is complicit in this mess and neither side is entitled to anything other than derision for how they have gotten to this current state of affairs.  Okay, the Europeans are pouty because the Brits started it, and I get that, but be adults here and get over it.  Isn’t there a lingering concern out there that maybe the European Union just doesn’t work anymore?  A zombie construct staggering after an implausible vision?

The Why Don’t You Like Me? Award… goes to the Financial Account Standards Board (FASB).  This group of academic gnomes sitting in leafy Wilton is perhaps the single greatest reason that no one can understand a financial statement anymore.  It’s a place where vision trumps practical utility and there is perhaps no better example of that than the FASB’s current championing of the Current Expected Credit Loss (CECL) standard set to be implemented beginning in 2021.  CECL is based on the beautiful but flawed notion that the current incurred loss model of accounting for the performance of financial assets where losses are booked only when it’s apparent that losses will be incurred, is dangerous and contributed to the failings of the Great Recession.  The answer?  It’s simple, isn’t it?  Book a loss when you make a loan.  Huh?  You can’t even really say that without a bit of an eye roll, can you?   Come on, I’m challenging you.  A silly idea at best, an unintentional pro-cyclical idea at worst and an idea whose implementation will cost a gazillion dollars.  Maybe it’ll employ a lot of accountants and perhaps that’s the actual point here.  See CrunchedCredit’s defenestration of this silly rule in Beany and CECL.

Dr. Doolittle’s Pushmi Pullyu Award… goes to the Federal Reserve (and we award this with some sympathy).  For those of you bereft of children or grandchildren, Dr. Doolittle’s Pushmi Pullyu was an animal with a head at both ends.  Which way is forward?  We’re certainly addicted to the Fed put.  So every time a governor speaks, mutters, winks or is flatulent, the market moves.  That itself is a horrible burden and materially a new thing.  On the other hand, how would you like to be Chairman Powell getting Twittered by the White House every other day?  Can’t be fun, can it?  Who knows whether the Fed was right or wrong when they hiked Fed funds in late 2018, and then rapidly reversed course and lowered it in 2019.  I certainly don’t know what’s going on and I’m more that somewhat concerned that in their little Ph.D. burdened heart of hearts, they don’t either, and therein lies my sympathy.  I don’t think anyone knows what’s happening to this economy any more, as all the traditional verities have broken down and Monday, Wednesday and Friday, we’re on the cusp of a recession; on Tuesday or Thursday, we’re about to have 3 more years of glorious expansion.  And those poor sods have to publically put a stick in the ground every other month.  Opportunities for embarrassment are manifest.  Data dependent?  Data bedazzled?  Maybe just data confused.

The Please Be the Next Y2K Award… goes to the incredibly random yield curve.  OMG – the yield curve has inverted.  Doom is at hand.  Really?  One day this past summer when the curve first inverted, the market sold off 800 points.  What was that about?  Since the economic consensus is that an inverted yield curve merely indicates a recession is likely within the next 12-24 months, what possible sense was there to the markets selling off the day it was announced?  AI run wild?  The Borg?  By the way, we at CrunchedCredit have sort of figured out there is a recession coming soon (how about that for insightful) in any event.  The next recession has been two years away for the past six years, and let’s be clear, we will have a recession.  But when?  In any event, the yield curve has now uninverted and there’s more than a passing suspicion among the economic consigliere that the inverted curve may have lost its predictive mojo.  An inverted yield curve has preceded every recession in the past 60 years.  It’s also predicted 12 out of the last 8.  This one is Y2K.

The Wicked Witch of the West Award… goes to the incredibly shrinking conduit CMBS market.  It’s the ice cube in the broken freezer.  From a 2008 high of almost $190 billion, and following a complete collapse in the muggy environs of the Great Recession, it seems the conduit market can’t get out of second gear.  With $40 billion in 2018 and an expected kick ass total of $46 to $48 billion in 2019, it might be too soon to conclude that the business has been entirely marginalized, but the trend line is not great.  I’ve said this before and I’ll say it again; the borrowers don’t like us much.  The CMBS industry was born to provide higher proceeds on a non-recourse basis to B and C properties in secondary and tertiary markets and the pain of dealing with the structural crankiness of the CMBS model was offset against the benefits of getting a deal done which might not otherwise get done and done with higher proceeds and at lower cost.  When that’s no longer the value proposition, the cranky clunky and annoying structure of the conduit market is all people see.  Everyone knows the model needs to change, and yet we don’t get it done.  Oh, sure, we nibble around the edges of the servicing paradigm, but it’s fundamentally not working.  We wrote about this back in It’s Time to Fix Securitization: Are We Dinosaurs Staring Into the Tar Pit? as a clarion call to get after it and fix it.  Crickets… oh, well.  I do CRE CLOs.

The Frankenstein’s Monster Award… goes to Risk Retention.  Another victory of a good theory over market realities.  This was supposed to make the world safe for securitization, which had become a dirty word during the Great Recession.  If the securitizers had to eat their own cooking, the cooking would be better and all would be well.  Didn’t work.  Never could.  Never would.  Did it change behavior?  Certainly there is no data to support such a sunny conclusion.  Has it cost a great deal of money?  Boy oh boy.  The amount of energy (legal fees), management attention and structural pretzel making that the risk retention rules have birthed is extraordinary.  The problems associated with this dopey idea are legion, but let’s just start with this notion of why in the world is it a really good idea that our prudentially regulated banks should end up holding entirely illiquid assets?  How is that in any rational universe a good idea?  And, by the way, why hasn’t someone ginned up enough courage to go to the regulators and say could you fix what’s wrong here?  The fact that we haven’t is a story in and of itself.

The Rorschach Test Award… goes to Donald J. Trump and Congressman Adam Schiff for each being broadly loathed by almost half the country.  Extraordinary.  This is one of those Man in the High Castle things where alternate universes sit side by side, each with their own soundtracks of Fox News and CNN.  Politics has always been personal, but we’re sort of at the point where the lovers and loathers know very little about what policies these men actually champion (to the extent they do – and that’s a separate problem); they just hate the sonofabitch.

Ratings Agencies in the Crosshairs

Back in the febrile, hyperventilated times that birthed the Dodd-Frank Wall Street Reform and Consumer Protection Act (blessedly known simply as Dodd-Frank), one of the issues that energized the activists’ intent on “fixing” what was wrong was the notion that the ratings agencies were complicit in the overpricing of financial assets.  In a “want for a nail, a shoe was lost” sort of way, overpricing of financial assets caused asset bubbles which led to or exacerbated the apocalypse.  The culprit?  The issuer pay model by which the issuers which retained the ratings agencies to rate their securities paid the ratings agencies’ fees from the proceeds of the related securitization.  From a certain perspective, this was having the prisoners hire the guards.

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HVCRE ADC Update: Regulators Propose Eliminating Exemption for Land Development Loans

Just when you thought the regulators had forgotten about HVCRE ADC, they issued a new notice of proposed rulemaking like they were Beyoncé surprise-dropping a new album. And then…they disappeared again! We were waiting for more news before alerting our readers but nothing has come to date. To bring those not in the HVCRE ADC-hive up to speed, the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) reformed the capital rule for acquisition, development and construction loans (HVCRE ADC exposures or loans) back in May 2018, but the regulations have yet to be conformed to the statutory regime.

Under the current statutory framework, an HVCRE ADC loan is a credit facility secured by land or improved real property which (A) primarily finances, has financed, or refinances the acquisition, development, or construction of real property; (B) has the purpose of providing financing to acquire, develop, or improve such real property into income-producing real property; and (C) is dependent upon future income or sales proceeds from, or refinancing of, such real property for the repayment of such credit facility. Among other exceptions, the current statutory regime includes an exemption for loans that finance the acquisition, development, or construction of one- to four-family residential properties (the paragraph 2(i)(A) exemption).

On July 12, 2019, the Federal Reserve, FDIC and OCC released a Notice of Proposed Rulemaking (2019 NPR), in response to comments submitted to their September 2018 Notice of Proposed Rulemaking (2018 NPR). The 2018 NPR was meant to conform the regulatory capital rule to the updates brought about in EGRRCPA and the 2019 NPR supplements the previous proposal to narrow the paragraph 2(i)(A) exemption. Continue Reading

Proposed Tax Rules on LIBOR Replacements Answer Some (But Not All) Questions

Last week, the U.S. Department of the Treasury released proposed rules providing tax guidance around various LIBOR replacement issues.  Long anticipated.  The defenestration of LIBOR will leave considerable broken glass in its wake.  Perhaps just so the tax professionals wouldn’t feel left out, the end of LIBOR will create a series of tax problems.  Very briefly, changing the price index of a loan, and certainly a mortgage loan, might be a significant modification under the so-called 1001 Rules.  The result of that?  Without a fix from our friends at the IRS, that change may be deemed an exchange of an old financial asset for a new one, creating potential gain or loss, violating the REMIC requirement that pools be static and violating the provisions of the REMIC rules.  Obviously, those adverse consequences under the tax code were not intended by anyone and it would seem that we ought to get a simple fix.  Changing the index is not a significant modification and therefore none of the other follow-on bad things happen.  The end.

While, as we’re sure everyone knows, it’s not that simple and the IRS, instead of saying, “you got it fellas, we’re good,” has given us 50 pages of new regulatory code speak. We suggest that you read our OnPoint and we certainly invite you to read the release, which is subject now to public comment, because it is critically important that we get this right.  Here’s a spoiler alert, while the proposed rules basically work, they do create problems and issues which we urge the industry to address to see if we can get this right before the proposed rules go into effect.

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Quick Note: What Will the ARRC Recommend for the Spread Adjustment?

The LIBOR transition process is an affair of headache-inducing complexity.  Amidst the thousands of gallons of ink spilled on the subject, we thought it might be useful, from time to time, to give you some important information in  bite-sized servings (don’t worry, we will continue to publish lengthy, irreverent commentaries on the subject that our long-time readers have come to expect).  So here’s your first Quick Note.  What will the Alternative Reference Rates Committee (“ARRC”) recommend for the spread adjustment?

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Welcome to the Future

Long ago, I read a book by a man named Herman Kahn, one of the founders of the Hudson Institute and a well-known public intellectual.  The book was entitled On The Year 2000.  (He was more famous for that truly uplifting missive, On Thermonuclear War.)  I suspect I didn’t understand a lot of it, but I was jazzed by this apparently serious effort to peer into the future.  How cool!  Mr. Kahn was an interesting character; think of a banal-looking, rotund academician, who talked about nuclear annihilation like I discuss box scores.  He was, in fact, an inspiration for Stanley Kubrick’s Dr. Strangelove and for General Jack D. Ripper’s famous line in that wonderfully dark comedy, “Casualties?  50 million…tops!”  A father of US nuclear deterrent strategy and a considerable intellect, he actually got much of what he thought of the Year 2000 wrong, but in a fun way.

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Panting for a Recession

We seem all atwitter about the notion that a recession is about to happen; almost aroused by the prospect. A NASCAR crowd just waiting for a crash? Or is this a Waiting for Godot thing, as the chattering class bloviates excitedly, pointlessly and largely cluelessly? Maybe it’s the 24/7 news cycle at work… Did we run out of car crashes, shootings and natural disasters and needed something to rivet and terrify the unwashed? Or is this just politics? For obvious and entirely understandable reasons, every Democratic wannabe presidential candidate is desperately hoping a recession will arrive before the election. But to be honest, a lot of serious types motivated neither by a political gloom premium, weak ratings nor an affinity for NASCAR, seem to be talking it up as well, clinging to the recession on the doorstop narrative, no matter what (God, guns and macroeconomic theory?).

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Like Bonds, But Not Bankers, the CRE CLO is Maturing

With apologies to Madeline Kahn, in this case, it indeed is twu, it’s twu! The CRE CLO technology is maturing and evolving into the stable, match term, non-recourse, non-marked to market, dynamic portfolio lender lever technology that its fans (me among them) always thought that it could be. It’s just taken some time.

Tainted by the wildly different, and in hindsight entirely zany, CRE CDO securitization from before the Great Recession (most, but not all, of which died ingloriously before that recession was over) and after having creeped back into usage in the marketplace between 2012 and 2016, the CRE CLO as a technology to securitize whole mortgage loans is finally maturing into a stable and useful tool in the toolbox of the portfolio lender. Growing from a handful of deals in the period 2012 through 2016, total CRE CLO production was around $15 billion; in 2017 it was $7.7 billion; in 2018 it was $14 billion; and in 2019 it would appear to be on track to perhaps be a $20 billion securitization market. Ignoring for the moment black swans, orange swans, dictators, Brexiteers and sundry other loons on a mission to derail our economy or the modern world writ large, the CRE CLO market sector should continue to grow at a respectable pace with only the obligatory brief respite shared by all structured products, during the next recession, whenever it might occur. Continue Reading

Killing LIBOR: A Victory for Irrational Rectitude

The US economy is about to pay the butcher’s bill for a massive disruption of worldwide financial markets resulting from the elimination of the London Interbank Offered Rate, or LIBOR.  And, we are doing this on purpose.  It seems the denizens of the heights of our international financial fabric felt they had to do this in light of the discovery that a handful of bankers had unlawfully colluded to cause LIBOR to be mispriced for their personal advantage.  As Captain Renault said, “I’m shocked, shocked!”  This was so bad that we had to blow up the LIBOR index upon which trillions of dollars of financial assets are based?  While bankers behaving badly is a problem, why are we punishing markets because our banking regulatory cadres failed to prevent bad behavior?  At best, this is a monument to irrational rectitude.

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Beany & CECL – Episode 2

Just a few short months ago we took on the breathtakingly ill-conceived Current Expected Credit Loss (CECL) standard that the Financial Accounting Standards Board (FASB) proposed to implement starting in 2020.  CECL will require major shifts in the way lenders model, forecast and reserve for future losses.  It would materially drive up capital requirements, impair earnings and ultimately drive spreads higher to the borrowing community.  And by the way, it would be pro-cyclical.  If we were actually going to do these things (and we shouldn’t), an unelected financial standard setting committee is surely the wrong party to hold the pen.

The lending community screamed bloody murder, and for good reason.  Luckily, the small banking community was at the forefront on this cri de coeur.  While the money center banks may be one of our pols’ favorite whipping boys, everyone in politics loves the small banker (visions of Jimmy Stewart dancing in their reptilian brains) because those bankers made loans to their constituents, support their local community and, oh, by the way, made significant political contributions.

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