2014 Outlook

by Dechert LLP

I have been mulling our 2014 Outlook for some time and decided to wait until after the New Year and CREFC to write.  Just in case we got the whole Mayan calendar end of the world story wrong by a year (hey, it was 5000 years old) which would make the whole prediction thing a bit irrelevant, I elected to wait and possibly save me some work.  But we’re still here and settling into 2014.  It’s time. 

You’ve got to have a view, right?  We at Dechert are trying to run a large international finance business which is highly derivative of the health of the capital markets and the commercial real estate markets.  We have a 2014 now and we are voting with our money.  We are growing our team, hiring laterally both in Europe and the United States, and acting for all intents and purposes as if 2014 is going to be gang busters.

Lawyers are notoriously hostile to strategic planning.  We went to law school and didn’t get an MBA for a reason, but not taking a view and then running your business without any base line assumptions about the market is actually taking a view without recognizing what you’re doing.  That’s dumb. 

So we’ll take a view and manage our business accordingly.  So, we could be wrong, not shocking, right? But it beats Brownian motion. 

We look at data.  While that’s rearward looking and hardly compelling, it is useful.  The MBA, CREFC and the banks do a credible job of publishing lots of good data.  We talk to mortgage brokers and real estate brokers; they are the canaries in the mine for what’s happening on the ground in the primary economy.  We talk to our servicing, portfolio and CMBS origination clients.  We talk to the bankers on the CLO desk and the asset-backed desks.  We read, with a grain of salt, what all the chattering class has to say.  (Broadly speaking, I have considerably more faith in people who are expressing their views only by spending money than in those who are expressing their views by expressing ink onto a page.)  This year’s CREFC’s Investor Conference was the equivalent of Seattle’s 12th man, cheering wildly for a great 2014.  My 1500 (or so) friends and I did everything short of sing Beethoven’s 9th Symphony’s Ode to Joy to ring in the year.  The experience does regrettably bring to mind the old saw that John D. Rockefeller knew the end was neigh when he got stock picks from his taxi cab driver.  But let’s not dwell on that too much, the data is compelling.

So, at Dechert, we think 2014 will be a pretty good year – no, take that back, a really good year.  Here’s why:

  • GDP looks like it will grow at or better than last year.  2.5% is the new 4%;
  • The stock market looks to continue to grow but is, perhaps not yet, bubble-ish;
  • Our government and honorable elected representatives seem to have exhausted themselves in intestine political warfare and for good or ill, it doesn’t look like we will see many more changes in fundamental rules over the next year.  Therefore, we may have a tad more regulatory certainty (and we can surely ignore risk retention until 2016);
  • The yield curve is steepening, which is good for banks, but at the same time valuations are going up.  Treasury securities have been moving at a stately pace for the past several months and there certainly has been no evidence of crisis.  We think the 10 year may continue to grind up over the course of the year to 3.5-4% and as long as it doesn’t blow up 200 basis points in a heartbeat, we do not think that it is a negative for capital formation;
  • At least US banks and other lenders are pretty healthy.  We are hopeful that the feeding frenzy of our various federal and state governmental agencies and their sundry ambitious officials treating our banks as governmental piggy banks for the distribution of further governmental largess has come to an ignominious end.   So maybe our banks can spend more of their time and energy looking to the future and to business;
  • There are cranes.  Development was suppressed for many years following the great recession and we’re in for a sustained period of enhanced development activity.  Hardly the gold rush, but at least in the 24/7 cities, a positive development for capital formation;
  • Less properties are underwater, property cash flows are improving and the ability to refinance is improving across all markets including secondary and tertiary markets.  That’s a good thing;
  • The tsunami of refinancing of major projects which has been predicted to occur in 12 months for the past 36 months if probably finally here with an enhanced demand for refinancing of major projects through 2014 and well into 2015; 
  • Demographics are positive for the residential sector and the GSEs may leave a little more room for conventional lenders.  Something for everybody;
  • As the housing market grinds back up to some level of normalcy, and the stock market continues to accelerate, the wealth effect kicks in (see bullet one for prospects for growing GDP);
  • In Europe (where significant risks reside, see below) demand is picking up and CMBS and capital markets financing alternatives for commercial real estate are showing some life.  As domestic banks continue to pull in their horns, there will be opportunities for well capitalized international banks, largely operating out of London, to do robust business.  As we have a significant presence in London, we think this is a good thing; and
  • Animal spirits are real.  Animal spirits have picked up.  Hostility toward structural complexity and innovation is waning and the reflating market is looking for financial solutions for the users of capital and investors.  That’s a very good trend.

So all that’s good and we think, on balance, the positives outweigh the negatives.  Ok, I said let’s not dwell on the negative and I really mean it, but maybe just for a moment?

Anyone see the Wolf of Wall Street?  Anyone ever been to a party like that?  They obviously didn’t invite the lawyers.  There are always remaining risks of excessive exuberance and the disregard for risk which were part of the late, end of cycle bacchanal. There remain risks in the US political system where the current level of stalemate with a tiny soupcon of cooperation, could still break down prior to the 2014 elections and it is a bad thing to underestimate the damage that both an activist or a completely dysfunctional government can do to markets when it sets its mind (mind?) to it.

Europe is still a mess and for all the talk about the crisis having passed, it hasn’t.  Interbank lending is at an all time low, banks are continuing to trade real loans on their balance sheet for sovereign debt, deals are done solely to obtain liquidity from the ECB and fundamental economic and fiscal reform that everyone seems to think is necessary is nowhere in sight.  The efforts to create a fed-like banking union have clearly collapsed, even if initiatives have been announced with very positive sounding names (a homage to “1984”), nothing has really happened and banks are left to their sovereign devices.  So Europe could turn materially south on us in the course of the year as opposed to the whopping seven tenths of a percent GDP growth now anticipated, and that would be a problem.

And then, of course, there is geopolitical risk.  Has anyone looked at the news lately?  Happy thoughts and positive thinking start to fray when one lifts his or her eyes over the horizon to what’s happening around the globe.  The Mideast remains a mess.  Just because it’s been a mess for years, without any material adverse consequence from the U.S. domestic market doesn’t mean that it will stay that way; China and Japan are playing a dangerous game made all the more frightening given all our treaty obligations to Japan (think 1914 if you are of a depressive cast).  Africa takes a step forward and then a step and a half back; and as recently reported in the FT, international capital movements have slowed to levels not seen in many, many years.  500 year floods now happen every seven years; tails are fat, unknowns are unknown and no one would or should forget it (again). But chill out, you gotta take a view, you’ve got to run a business and the evidence closest to home is that 2014 will be a pretty good year.  That’s my story and for the moment I’m sticking with it.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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