2021 Golden Turkeys

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Welcome, dear reader, to our annual Golden Turkey Awards.  But for my commitment to absolute fairness and concern over the appearance of impropriety, I would have awarded the first Golden Turkey Award to Dechert for actually getting the Golden Turkey Awards done this year.  What a crazy year end.  The market is insane.

On the other hand, while time is short, there’s plenty to bloviate about.  I remember last year we were absolutely ready for the end of the Trump administration because the Biden administration promised a “dull is cool” vibe.  Well, dull has been a failure.  The farrago of lingering Covid, a return to something which is clearly not normalcy, but something new and with a pond full of black swans flopping around, it is not dull.  So, how’s that working out for you?  The follies of 2021 at least make writing this column easier.  So, we went digging for inanity for the purpose of making gentle fun of things that broadly annoy us and, shockingly, we found things to talk about.  So, here we are once again.

You Going to Believe Me, Or Your Lying Eyes Award.  This award goes to the entire bureaucratic apparatchiki in the White House, Treasury and the Federal Reserve, who knowingly and unconvincingly talk about transitory inflation long after transitory had left the station.  Sure, it’s transitory.  As John Maynard Keynes famously said, “[i]n the long run, we’re all dead.”  It’s monetary policy, baby.  Supply disruptions don’t help, pent up demand doesn’t help, but you’ll have to rip my monetary theory convictions from my cold, dead hands.  I’m not buying Modern Monetary Theory, even if the savants on the heights seem to think it’s cool…or at least convenient at the moment.  The government pumps trillions of dollars into the economy, all borrowed (and demonstrably not all sterilized); inflation simply cannot be avoided.  If the MMT gang is right, then marvelous; we’ll all have a great time.  Some talking heads continue to support this transitory schtick, but it just doesn’t seem like they have their hearts in it.

Atom Bombs and Mosquitoes Award.  Goes to the International Banking Combine and our friends at the Federal Reserve for killing off LIBOR because a couple of bankers diddled the rate (and then they went to jail).  Come on, people.  Everyone who matters has been woke (in the initial meaning of the word) for a very long time to the artificial underpinnings of LIBOR and it really didn’t matter much, did it?  Markets seem to do just fine on a bunch of bankers using windage to make up a rate at which they would borrow, if they did borrow, but they didn’t borrow and that was fine and dandy.  Underlying transactional activity has been de minimus for years.  All of a sudden, we did the Captain Reynard thing and were shocked, shocked at the lack of underlying transactions supporting the index and blew up the entire $300 trillion plus (that’s trillion with a “t”) market by insisting we move to SOFR, SONIA and the equivalent European and Japanese rates.  Kudos to the Europeans, while the owners of a largely Byzantine, opaque and capricious bureaucracy, proved they can still ultimately be practical and picked a substitute for LIBOR which is sort of still like LIBOR.  Perfidious Albion, including the United States, threw the baby and the bath water out together to pick a risk-free rate that will require enormous changes in the market to adjust for it.  Oh sure, we’ll get through this and learn how to price off it, but the disruption, waste of time and energy, legal fees (oh, wait, that’s not so bad), the anxiety of transitioning from the LIBOR we had learned to love over the past 40 years to this new rate is an astonishingly high price to pay for the malfeasances of a couple of bankers.  Okay, I’ll stop whining now.  My therapist says it’s not good for me.

You Can’t Possibly Be Serious Award.  Goes to everyone who has said, and still says, Covid will end and we will go back to the way the world was before it.  You can’t possibly be serious!  For office workers, are we really going to go back to the office 5 days a week?  Are we really ready to re-embrace commuting as a terrific way to spend a couple of hours a day?  (I don’t know about you, but my commuting muscles have well and thoroughly atrophied by now.)  The pandemic was an accelerant for virtually everything and there’s no backup gear on this transmission.  I don’t know what’s going to happen to the demand for office space and retail space but I’m sure it will be a different place.  Will re-urbanization occur?  Will more folks look to rent and not buy housing?  Will business travel go back to its pre-pandemic levels?  Will industrial demand continue to go higher and higher?  I have no idea, but I’m virtually certain that having no idea might be the only smart thing to say about accelerants and change.  When and if Covid contracts into just another irritating but manageable disease like the flu (from my mouth to God’s ear) the economy and commercial real estate world will have been irrevocably changed.  All we can do is stay nimble and ride the dragon.  And to the MMT gang for asserting, largely with a straight face, that spending many trillions on our infrastructure and our BBB bills will not only not add to inflation but constrain inflation.  Hmm.  That’s all I gotta say on that point.

I’d Like to Thank ESG Acolytes Award.  Goes to everyone out there who has decided that financial transactions must be repurposed in support of environment, social and governmental policy commitments.  Putting aside questions about the social utility of all this, I want to thank everyone driving change in this space on behalf of all transactional lawyers.  I will note in passing that the financial industry has done a reasonably good job on “E.”  We worry about environmental contamination, we worry about flood, we worry about structural integrity and earthquakes, we worry about fire suppression, we worry about energy efficiency because all of those clearly impact credit.  No shaming of banking troglodytes needed here.  But “S” and “G,” remain largely aspirational and a bit of a muddle.  It has been said that that which you cannot measure, you cannot manage and right now there are no agreed-upon metrics for measuring “S” or “G.”  Oh sure, there’s some things that we think are clearly good “S” (workplace housing, etc.), but beyond that, it’s the big muddy.  “G” is arguably even worse.  Maybe we need to inquire into the governance characteristics of borrowers as part of the credit process?  Maybe we need to insure diversity inclusion in financial counterparties?  Maybe.  Eventually, someone will create standards, an agreed-upon glossary, metrics and we will move forward nicely.  Give this industry a set of rules, and it will execute.  But win, lose or draw here, think of the transactional friction resulting from bringing these concepts into the calculus around investing.  In private (and I don’t share this with anyone) I gloat a bit like a mad scientist in a bad 30s’ sci-fi movie over the brain damage, the time and energy that will be absorbed drafting new risk factors, discerning a line between puffery and real achievement, dealing with a reality that for a very long time, we won’t have agreed-upon standards; we continue to deal with everyone’s own standards.  Think of the conflicts.  Think of the securities claims.  Oh my!  Perhaps the planet and equity will one day be served, but lawyers are winners right now.

The Birds Gotta Fly, Regulators Gotta Regulate Award.  This award has got nothing to do with finance, but since it really annoys me, it goes on the list.  This award goes to whoever figured out that this country should spend millions, if not hundreds of millions installing large bulky, ugly and surly complex electrical signage all across our highway system that delivers such sagacious observations, such as Exit 7 is 11 miles away and will take you 13 minutes to drive there.   Hello folks, has anyone noticed that pretty much everyone has iPhones and GPS?  Has anyone actually looked at a map recently?  What operational intelligence is provided by these ubiquitous signs?  Every time I see these signs, I wonder how much money we spent telling me that it’s 11 minutes to the next exit that I know is 11 miles away?  What I want to know is who is manufacturing and installing this signage and exactly why our august government thought it was a good idea to spend that money?  Who’s got the pictures?  This simply can’t be justified on the merits.

Couldn’t We Have a Do-Over Award.  Goes to those who still think risk retention was a great idea.  Risk retention, brought to us by Dodd-Frank in 2010 and finally implemented almost 6 years later, is a total and complete bust (once again, except for the lawyers who have a jolly good time with all of this).  Does a 5% by value subordinate bond position really result in higher levels of alignment?   It just gets priced into the deal, doesn’t it?  And then what bright light (thank you by the way) came up with the third-party purchaser mechanic applicable to commercial real estate?  That truly makes it just a pricing exercise.  Or how about the vertical risk retention which requires the sponsor to hold 5% of each class of securities up and down the capital stack?  In this case, virtually all the retained position is investment grade.  Pretty easy to finance.  And, my oh my, don’t you love the Majority Owned Affiliate notion?  This is by far the biggest hole in the regulatory boat.  Even a super tanker that might get stuck in Suez could navigate easily through this particular “alternate modality of compliance” (heaven help us, not a loophole!).  Look, I’m willing to highlight this nonsense because I’m absolutely certain it doesn’t matter.  It’s not going to change, ever.  No regulator is going to say, “Oh, I didn’t realize that,” and take risk retention away or materially change the rules.  The transactional friction, the cost, the accounting fees, the legal fees associated with managing through the risk retention mechanics of securitization (and don’t get me started on the Europeans… more on that below) is wildly disproportionate to any potential alignment value.  If you like alignment, Mr. Investor, buy CRE CLOs, that’s a market segment that results in the sponsor holding 15-20% of the risk of the transaction.  Now that’s alignment, baby.  Isn’t it at all possible that when we find out something doesn’t work, we think about changing it?  Wasn’t it Churchill who, when accused of flipflopping, observed that when the circumstances change, he changes his mind.  What about you?

We’re Number Two Award.  Goes to the European Community for creating a risk retention regime with compliance obligations for both the issuer and investor that is extraordinarily difficult to meet.  European risk retention is hair-pulling at the best of times.  Sometimes it seems nigh on impossible.  First, they attempted to make the rules applicable before implementing regulations were done. Then the implementing regulations come out and no one coulda agree what they mean.  And then the implementing regulations continue to get changed.  Our London office is fantastic; the London securitization bar is extraordinary, but every time we do a deal, we get structural tweaks out of London because there is simply no clarity.  Not to pile on here, but it’s even hard to get a straight answer as to what is a securitization in Europe.  Oh, sure, it includes things that in the US we call securitizations, but it’s more.  Cross collateralize a warehouse with a loan?  Bingo!  Securitization.  And, oh my, if you have a securitization, all hell breaks loose.  For reasons which are obscure, at least to me, European governments seem to have a deep and abiding hostility toward securitization (perhaps that’s because it came out of London).  Consequently, among other things, the risk-based capital regime for securitization is punishing, putting a premium on making sure a transaction that might be a securitization or even securitization-like, is not a securitization.  The risk-based capital regulatory scheme makes opaque seem clear.  And by the way, would it have been too much to ask for the US and Europe to get together and agree on something?  Those are the two largest capital markets in the world.  How hard would it have been to simply agree on common standards?  Oh, I know, that’s silly.  The securities administrators and accountants have been trying to reconcile GAAP to IAS for a thousand years, without any success.  But really, couldn’t we try a little?

Predictions are Hard, Particularly About the Future.  This award goes to the entire market who wildly underappreciated the growth and attractiveness of the CRE CLO market sector.  Your correspondent here thought he was being wildly aggressive back last January by predicting a $30 billion run rate for 2021.  (Let’s face it, I picked a big number just because I knew that would get me in print.)  Oh well, I was wrong, but everyone else was wronger with relatively low guesses for 2021 production.  And like most of these sorts of guessing games, in hindsight it is clear what we missed.  If one had taken into account the relative attractiveness of floating rate debt in a market of entirely static interest rates, the significantly enhanced flexibility of the floating rate market, the forward thinking and active management available in the CRE CLO and the fantastically high level of alignment between sponsor and investors in a transaction structure that results in the sponsor holding 15% to as much as 20% of the first loss risk in every transaction, it should have been a “no duh” moment for us all.  $40 billion this year?  $60 billion next year?

So there you have it.  A lot to pick from, while we could go on, time is short.  We’ll start building an inventory for next year.

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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