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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Unsettling Settlements: US and European Banks in Crosshairs of Regulators
Tuesday, November 12 2013 | 04:18 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

There remains important questions and unknowns about regulators monitoring role,” says Asim Ali, Managing Director of NewOak. “What is it about large financial institutions and financial misconduct that is so difficult to untangle? Is it the opacity embedded within certain classes of financial assets? Is it the financial myopia associated with material returns? Is it the absence of due diligence processes associated with governance, risk management, and compliance or lack of well-articulated financial regulatory framework?”
“These questions may sound like rhetorical statements, but they raise important questions about the ‘form’ and ‘function’ of the financial system, especially the role of regulators in monitoring different nodes of financial compliance. Let’s take three recent examples: 1) mortgage-backed securities (MBS) and the financial debacle of 2008; 2) the London Inter bank Offered Rate (LIBOR) rigging; and 3) the allegations of manipulation of foreign exchange markets.”
“In the case of MBS, the flurry of recent settlements with many leading financial institutions may yield some political dividends for the US government, but we still don’t know what exactly these institutions did wrong or if it was general over-exuberance and a financial bubble? In other words, unless we know where the culpability lies behind the MBS fiasco, enacting myriad indecipherable regulations and striking settlements is a short-term solution.”
“For now, settlements galore are a ‘win-win’ proposition for the US and European governments and the banks. The banks want to put these matters behind them, move on and begin the work of restoring their reputations, while governments and regulators want to be seen by the public as actively pursuing and disciplining these financial institutions for their profit-at-all-costs mentalities and lax risk management thereof.”
“Still, the two-fold question remains about the ‘form and function’ of the financial system, especially with respect to the issue of securitization and MBS, and the appropriate role of regulators in the regulation of financial institutions, the due diligence responsibilities of institutional investors and their basis for investing in structured securities.”
“Similar analysis could be deduced examining the second case around the LIBOR where some European and American banks allegedly colluded on inter-bank interest rates. Again, banks under scrutiny desire to reach settlements with regulators, minimise reputational damage and move on - even as the global financial system was shaken due to manipulation with the LIBOR benchmark that is, according to The Economist, “used to set payments on about US$800 trillion-worth of financial instruments, ranging from complex interest-rate derivatives to simple mortgages.” Likewise, in the final case for the US$5.3 trillion foreign exchange market, regulators have again found themselves in a reactive mode over allegations of foreign exchange rate fixing.”
“What these cases illustrate is it is insufficient to file lawsuits against the banks but then agree to settlements that penalize monetarily but provide no real long-term solutions to strengthen financial governance and compliance and avoid inherent potentially irrational short-term behavior by the entire market.”
“This is clearly evident from analyzing these three examples of financial markets that have had ‘systemic’ effects: the MBS-driven credit crisis, the LIBOR rate fixing and the foreign exchange market—the last two of which unfolded well after the 2008 financial crisis that spawned tighter regulations and more aggressive pursuit of financial misdeeds.”
“Yet, the reality seems to be that regulators are still trying to design an effective oversight model without having a full grasp on the “form” and function” of the financial system. In the meanwhile, as regulatory uncertainty continuous to weigh in on the markets, the banks, investors, and borrowers are in search of ways to get back to a smooth functioning securitization market to serve all parties, investment and capital.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Commercial Real Estate: Approaching a Bubble?
Tuesday, November 12 2013 | 04:18 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Everybody is searching for yield in commercial real estate, and some are chasing it to smaller markets to achieve 8+% capitalization rates with as-rented income," says Ron D'Vari, CEO and Co-Founder of NewOak.
"Shortly after the crisis, international and institutional capital found commercial real estate in gateway cities (e.g. Manhattan, San Francisco and Los Angeles) fairly attractive from both income and capital appreciation standpoints. However, the demand for prime commercial properties soon exceeded the supply. Given that the lease incomes on these properties were still protected by long term leases with established corporations, there were much fewer forced sellers and broken leases than tertiary markets. Substantial new capital from institutional and overseas investors quickly poured into the sector causing a rebound and forced down the cash-on-cash yields to near pre-crisis levels."
"The smaller markets were not so lucky. Many newly built commercial properties lost key tenants, and a great many went dark or became fractionally occupied with substantial rent discounts. As a result commercial rents and prices plummeted and many owners/operators gave the keys back to the banks and walked. This was because they could not fully service their debt and/or their equity had vanished. Despite very attractive yields even with as-rented income, most institutional investors were restricted from investing in B and C property categories and could not take advantage of the unique bargains to be found."
"With much tighter capitalization rates approaching 6% in major cities, banks and investors are forced to give a fresh look at secondary and tertiary markets which they would have avoided otherwise. Capitalization rates in mid-tier cities such as Houston are around 7 to 7.5% in the central business district and wider in suburban markets. Investors that are able to consider tertiary cities are looking to make over 8.5% with current leases."
"Given attractive rents and competitive economic conditions, many businesses have considered moving out of major cities. Despite the still anemic economy, the business migration has helped stabilize commercial property lease incomes in cities such as Reno, Nevada, and Charlotte, North Carolina. The CMBS market also has become more amenable to reopen, lending in tertiary markets to properties rented to established corporations. As a result, equity investors in secondary and tertiary markets are able to borrow from banks over 65% of their purchase price and create an attractive return while interest rates remain low."
"While the gap in the capitalization rates between prime and secondary markets are expected to close, the rents will remain relatively low in tertiary markets as new properties are built. The tertiary commercial real estate markets are not yet in the bubble zone but are not for the faint of heart either. There is high risk that rising interest rates will soon scare away the new buyers. Hence the current investors will face a fairly illiquid market for their investments. In the meanwhile, everybody is happy as the specialty real estate funds show high returns and bankers and brokers make their commissions."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Home Prices Are Up: So Why Worry?
Tuesday, November 12 2013 | 04:17 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"With home prices up 12% year-over-year for September, the housing market represents the brightest spot of the US recovery,” says James Frischling, President and Co-Founder of NewOak. “However, slowing growth and the 0.2% increase in home prices from August to September was the smallest gain since the beginning of the year.”
“Given the strong recovery and performance witnessed in housing, a slowdown in the appreciation of prices was expected by many economists, especially with rising interest rates. But there are also significant headwinds buffeting the housing market in the form of tax increases, spending cuts, regulatory changes and healthcare reform. Coming together, these headwinds are pushing hard against progress on jobs creation and consumer confidence.”
“Sure the recent jobs report was better-than-expected, but a significant percentage of the jobs created were in lower-paying sectors. Leisure and hospitality, especially food services, were strong contributors to the October report along with retail sales. However, the uncertainty facing businesses are forcing many industries to hold off on hiring and many are cutting worker hours below 30 a week to avoid the healthcare mandate. As the Affordable Care Act is now being implemented, consumers are learning more about the increased costs they will face and this will impact their spending.”
“A lack of job creation and a concerned consumer does not suggest the good times will keep rolling for the housing market. The Fed’s easing and zero interest-rate policies have armed Wall Street and many hedge funds with the capital to deploy and the housing and stock markets have been the primary beneficiaries.”
“Significant home price appreciation should come along with a healthier economy, including a better job market. If home prices are pushed out of reach for the buyer, gravity will take care of the rest.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

The Next Big Battlefront For Banks May Be Alleged Forex Manipulation
Thursday, November 07 2013 | 09:17 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Banks continue to battle in court over their role in the housing bubble/collapse and are also heavily focused on sifting through the mess associated with the Libor scandal,” says James Frischling, President and Co-Founder of NewOak. “However there seems to be no shortage or limitation on the number of issues the banks can face. The next big thing is already here and involves accusations of foreign-exchange rate manipulation.”
“The banks are trying to get out in front on this one and a number of them have announced their own efforts to review trading practices after regulators launched a formal investigation earlier this month. The media brought the issue of potential wrongdoing in the foreign-exchange market to light back in June.”
“Some $5.3 trillion is traded every day in the global foreign exchange markets so, similar to the accusations in the mortgage fight and Libor scandal, the law of large numbers applies and with it the likelihood that the many participants in these markets may get caught up in the net. The alleged wrongdoings involve collusion among some of the world’s biggest financial institutions to set prices and the front-running of client orders.”
“A number of banks have already suspended staffers on their currency desks as internal investigations try to keep pace with the investigations by global regulators. While all the investigations are in the early stages, the tone on both sides when commenting on the probe appears to be one of ‘cooperation’.
“The foreign-exchange scandal has the potential to match the size and scale of the Libor scandal. The banks want to put these issues behind them and focus on their business. With new scandals being added to the docket, focusing on business as usual is going to prove hard to do.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Federal Reserve's 2014 Stress Scenarios; Forecasting a Developing Bubble?
Thursday, November 07 2013 | 09:17 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The Federal Reserve 2014 annual stress scenarios points to concerns in valuation of certain assets including debt and equities," says Ron D'Vari, CEO and Co-founder of NewOak Capital.
"This Federal Reserve expansion announcement of their stress testing program from 18 large banks to 30 banks was not a surprise. The additional 12 banks will be subject to capital adequacy review for the very first time. Its purpose is to continue to lead banks to improve their risk management program as well as their capital base to avoid another financial crisis. However, the 2014 scenarios represent the most dire economic shocks resembling the 2008 bubble burst."
"Concentrated counterparty risks has been a concern highlighted in the 2014 annual stress tests. The top six banks need to show they can withstand a sudden default by one of their largest counterparties. This combined with Dodd Frank rules will incentify banks to use more and more cleared derivative instruments and penalize non-cleared derivative transactions."
"The Fed's "severely adverse” scenario specifies an unemployment rate of 11.25%, 25% slide in the U.S. Home Prices, and stocks dropping by 50% while imposing a Euro area back into recession and Asian developing countries experience a sharp slowdown. The housing price shock is a concern of Federal Reserve, particularly in the areas that have recently risen sharply. The increase in the severity of housing shock combined with risk-retention will dampen the expected non-agency RMBS revival on the margin. This is partly because of a higher capital cost for the larger banks under severe scenarios as well as other compliance related costs."
"The 2014 annual test scenarios are not meant to be a base case forecast by the Federal Reserve. Yet the severity of the scenarios indicate that policy makers are becoming increasingly more concerned that their own unprecedented Quantitative Easing have indeed increased the risk of a bubble burst as the massive liquidity will be taken away. Aftershocks are known to sometimes cause more damage than primary earthquakes. Perhaps testing for strong aftershocks are finally becoming a relevant concept for financial stress testing."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Bank Liquidity Coverage Ratio: Could Minimum Requirement Prevent Credit Crises?
Thursday, November 07 2013 | 09:16 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The Federal Reserve's latest proposed rules to strengthen banks and the largest institutions' liquidity status have been anticipated for sometime, but should be continually assessed for its effectiveness to avoid a credit crises," says Ron D'Vari, CEO and Co-founder of NewOak Capital.
"Certain sized banks and systematically important financial institutions (SIFIs) will be required to hold a certain amount of liquid assets. These assets must be equal to or greater than projected cash outflows minus projected cash inflows during a defined short-term stress period. The ratio of liquid assets to projected net cash outflow (Liquid Coverage Ratio, or "LCR") is required to be a minimum level."
"The severe liquidity squeeze during the credit crisis has been attributed to counterparties unable to extend credit to each other due to the lack of reliable information on the parties true capital positions. Hence firms relying on short-term funding were unable to roll over this funding. Many otherwise liquid positions were unable to be unwound by weaker entities. This added to the liquidity squeeze. As a result global central banks had to intervene."
"Minimum capital and LCR rules will inevitably impact bank's lending behavior and risk taking behavior, both short and long term. This impact has already been seen in mortgage servicing rights ("MSRs"). Many larger banks have already or divested part of their servicing portfolios. Citigroup is the latest example."
"By identifying certain assets as liquid and eligible as capital, and others as not eligible, there may be further squeeze on liquidity at the onset of a future credit crisis - even though the institutions may be initially well capitalized. The true impact will not be known until the next crisis."
"One can argue that no realistic minimum LCR and standardized risk-based capital can prevent the erosion of confidence in a significant asset bubble burst. However, net-net the probability of such occurrences have been lowered by increasing the capital and liquidity requirements - assuming they have not caused other assets to become less liquid."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Private Label RMBS: Primed for a Comeback?
Thursday, November 07 2013 | 09:16 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"In 2005 the non-agency residential mortgage-back securities market was creating over a $1 trillion in product; by 2008 the machine essentially shutdown,” says James Frischling, President and Co-Founder of NewOak.
"Five years after the financial crisis, the GSEs and FHA are responsible for over 90% of all mortgages. Mortgage market participants question when, or if, the private label mortgage market is going to make a return.”
“The Federal Housing Finance Agency recognizes the unsustainable levels of government involvement. There’s even genuine bipartisan support for GSE reform (and let’s face it, there isn’t much bipartisan support for much of anything nowadays). However, with Fannie Mae and Freddie Mac making so much money, what government officials say may be different from what they do.”
“Thanks in a meaningful way to the Fed’s monetary policies, private capital is flush with cash and strengthened balance sheets. They have also identified that, as a result of the GSEs raising guarantee fees and tightening credit standards, the opportunity to re-engage in the private mortgage market represents a compelling opportunity.”
“The territorial lines that divided up the roles and responsibilities of the private label market are now very much blurred. Hedge Funds that once invested in private label mortgages are now originating them. Private equity firms have entered the REO-to-rent space and there’s equity interest in creating new or re-capitalizing old mortgage insurers. Even the largest provider of loan due diligence and surveillance, Clayton Holdings, is expanding it securitization group in preparation for the return of the private mortgage market.”
“Despite the capital available and renewed interest in the private label market, restoring investor confidence is a critical piece of the puzzle. In order to accomplish this, transparency in the manufacturing process will need to be dramatically improved. If this can be achieved, there’s significant investor appetite in the private label market.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Fed’s Zero Interest Policy: Pensions Reach for Yield?
Monday, October 21 2013 | 12:17 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"As the Federal Reserve continues with its easy monetary policies, pension funds, like many other investors, are left to search for yield,” says James Frischling, President and Co-Founder of NewOak. "While equity markets are at all-time highs, savers and more traditional debt investors continue to be hurt in this near-zero interest rate environment.”
“In order to meet growing retiree obligations, public pension funds, are not only adding risk to their portfolios, but they’re doing it through non-traditional investment channels. Private equity firms and hedge funds have been on the receiving end and the beneficiaries of these flows.”
“At a time when pension funds as well as mutual funds investors find themselves desperate for yield, having more investment choices would only appear to be only a good thing for the investment community. However, many of these alternative asset managers provide far less transparency than the traditional investment strategies these pension funds are typically working with.”
“The trend for pension funds across the US has been to put more money into riskier investments as they confront the funding gap and growing obligations for retirees. Slow economic growth and record-low interest rates are putting more pressure on these pension funds to reach for yield.”
“Investments in alternative assets are harder to value and far less transparent. The managers of these strategies also charge substantially higher fees and typically take about 20% of the returns. With the allocation to alternatives having doubled to nearly 25% since 2006, its clear the trend is to try to use alternatives to boost returns. Let’s hope they get what they’re paying for.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Single-Family-Rental Securitization: New Trend?
Monday, October 21 2013 | 12:17 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“Securitization technology can be applied to cash flows of any asset class, as long as there is a transparent and supportable basis for estimating the underwritten cash flows as the basis of paying the debt holders. Single-Family-Rental cash flows are no exception if they can be properly managed and modeled, ” says Ron D'Vari, CEO and Co-founder of NewOak Capital.
“In the case of Single-Family Rental potential securitization, the required underlying data for developing reasonable models include the property information such as appraised value as well as current rental status and rent basis, future rental forecast, and ongoing maintenance management fees including advertising costs and vacancy. Yet in addition, the track record of the portfolio management company and its underlying asset management strategy are also important.”
“There are some similarities with multi-family loans but there are many significant differences that require careful consideration. First and foremost, there has not been much history in operating Single-Family-Rentals on a national scale. The owners of these assets tend to be Special Purpose Vehicles (“SPV”) formed and managed by private equity and hedge funds with less than few years of experience in setting up and building out the necessary infrastructure to acquire, fix, and rent single family homes in various concentrated geographies. So far these assets have been acquired in bulk from banks after foreclosure. They often require renegotiating with the occupant, often former borrower, and fixing the property and re-renting them. This requires further capital, time and resources.”
“The key questions from the investors in the debt securities are the stability of net operating income (“NOI”) going forward. Estimating NOI requires making assumptions on gross rent trends, but also rental fees and maintenance reserves in addition to insurance and taxes. Further, one has to assess the demand for renting single-family homes which will be affected by local demographics and competing products such as home ownership and apartment living. As an example some folks don’t like to mow their own lawns or pick up their packages at the post office. While there may be no direct database addressing this lifestyle preference, there are plenty of fragmented databases that can be patched together to develop conservative assumptions even though the asset class is new. Servicing and investor reporting challenges will also have to be addressed to comfort investors and rating agencies. Thanks to the Big Data and cloud computing technologies, there is nothing a good team of quantitative analysts cannot make transparent.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Bitcoin: Could Regulation Boost Credibility and Legitimacy?
Tuesday, October 15 2013 | 11:35 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Advancements in digital currency will be a threatening concept to the banking establishment and regulators because of its disruptive nature," says Ron D'Vari, CEO & Co-founder.
"The advanced cryptographic algorithms and associated network ("Bitcoins") allows financial transactions between parties without involvement of banks and government oversight. The Bitcoin currency and related businesses have started to grow and have received financial backing from established venture capital firms."
"Bitcoin can facilitate rapid movement of money and payments. This could compete with existing bank-based financial transaction systems which are regulated. As it stands crypto-currency remains unregulated and can facilitate cross-border transactions without any government oversight."
"Some abuses of Bitcoins for illegal purposes has drawn attention to the need for some form of regulatory framework. Such oversight would further boost the credibility and legitimacy of the crypto-currency system. However, it remains unclear what such a regulation framework may look like and who is allowed to play. Enforcement of such a regulations with also take on a challenges of its own. Given financial security and money-laundry concerns, this requires immediate attention."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

SEC: Regulator or Top Cop?
Tuesday, October 15 2013 | 11:35 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"At the Securities Enforcement Forum is Washington, DC last week, SEC Chair Mary Jo White spoke about her agency more in the context of law enforcement and less as a regulator,” says James Frischling, President and Co-Founder of NewOak. "In an effort to reinvigorate enforcement at the agency, Ms. White wants Wall Street’s top cop to be tough, but fair, but to be clear, she wants it to be tough.”
“In her talk about her agency’s plans, Chair White made reference to the ‘broken windows’ strategy that was employed by New York City Mayor Giuliani and Police Commissioner Bratton in the 90s. Under the Giuliani administration, the NYPD pursued all infractions no matter how small to send a message of law and order. Chair White believes that investors want a securities regulator that is watching out for all violations, not only waiting for the biggest ones that bring with it the most media attention.”
“Critics feel the SEC should have done far more over the past five years in connection with the most significant financial crisis since the Great Depression. Under the leadership of Chair Shapiro and enforcement Chief Khuzami, the shake-up of the agency began in early 2010 with the establishment of specialized enforcement units, the recruitment of additional experts and the ability to reward cooperation with investigations.”
“With the statute-of-limitations deadlines looming on financial crisis matters, Chair White is going to further the agency’s enforcement efforts by focus on expanding its field of vision and reach and also by pursuing more aggressively the gatekeepers who neglect their duties. There’s a lot of ground to cover in the financial markets and the top cop can’t be everywhere. However, if the agency can help make the markets safer and more secure from crime, more participants will choose to be part of it. Just look at what an aggressive stance on crime did for New York City real estate.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Government Shutdown Today, US Default Tomorrow?
Friday, October 11 2013 | 10:43 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"While Wall Street fully expects Congress to raise the debt ceiling and avoid putting the country at risk of a recession as a result of the US defaulting on its debt, the probability of the unthinkable scenario has increased since the government shutdown began,” says James Frischling, President and Co-Founder of NewOak. "The US government will default on its debt if the nation’s $16.7 trillion cap on government borrowing isn’t raised.”
“A few of the most dangerous words in the financial markets are ‘this time it’s different’, but that’s exactly what President Obama and his Administration have been warning. They believe that there exists a faction of government that is willing to let the country default on its obligations. With the President’s current position that he is not willing to negotiate changes to the affordable care act and other spending reductions unless Congress ends the government shutdown and raises the debt ceiling, we have a stand-off that has Wall Street preparing for how it would handle US Treasuries if a payment is missed and a default ensues.”
“Wall Street and the President agree that the US defaulting on its debt could potentially trigger economic mayhem. But at present, despite the alarmist rhetoric, Wall Street does not believe that Congress would act so irresponsibly as to put our economy in such danger.”
“Wall Street’s reliance on logic may be what the President is worried about, as the deadlock in Congress appears more serious than market actions suggest. The US has never defaulted on its debts and it’s not expected to now. However, the increase in uncertainty has the ability to disrupt the financial markets as a result of the loss of confidence. Washington turmoil doesn’t help, but a prolonged shutdown will continue to increase the risk of a US default.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Housing Growth: Will it Moderate Further?
Friday, October 11 2013 | 10:43 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The U.S. housing price appreciation trend will have to moderate further to stay affordable and avoid another housing bubble," says Ron D'Vari, CEO and Co-founder of NewOak.
"The combination of higher rates and the rise in home prices to almost near pre-crisis levels in some parts of the country have pushed mortgage burden over 33% of borrowers' monthly income. With the expected rise in interest rates and even a moderate rise in home prices in some of the major cities, the mortgage expenses can exceed 45% of borrowers' monthly income. This could soon be approaching pre-crisis housing unaffordability. Falling affordability should naturally dampen demand for homes, absent institutional demand from own-to-rent investors. In some markets institutional investors have been a major catalyst for the rise in foreclosed home sales prices jumping above retail levels. However it remains to be seen if institutional demand will continue if the trend continues."
"Assuming other factors stay the same, the increasing household formation and increasing supply due to new construction will keep demand and supply of homes in balance. Absent a major acceleration in income growth and job formation, the home price appreciation is bound to moderate to its long term sustainable trend of 3% to 4% per annum. The moderating trend should help bring more stability to home prices and support a more favorable environment for housing credit."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Regulators' Stance on Securitization -- Evolutionary or Reactionary?
Monday, September 30 2013 | 11:17 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"New regulations designed to govern securitization after the 2008 credit crisis are widely believed by market practitioner to further curtail securitization activities, if not revised, when implemented," says Ron D'Vari, CEO and C-founder of NewOak Advisors. "The rules are not yet fully in place and have not yet been tested for their potential unintended consequences."
"The full impact on the markets of the new regulations will be felt more directly when Basel III and Solvency II go into effect full force over time. These will touch risk-based capital requirements, retention (i.e. skin-in-the-game), due diligence, representations and warranties, reporting, and servicing requirements. The much higher risk-based capital requirements alone will reduce profitability of the securitization and force many players to reconsider."
"The financial institutions have been quietly hoping that the regulators will gradually make the rules less onerous and practical with improving economy and reduced political pressure. In fact, the Financial Times reported that the Basel Committee on Banking Supervision may soften the rules as they need to be reviewed to meet the appropriate structure for various asset classes.
"As it is, the regulators have complained publically about the widely varying interpretation and application of the rules by different banks in Europe and to a lesser extent in the U.S.. Any softening of the risk-weighted capital should come with the tightening of how the rules are applied and a great deal of independent model validation. It is our view that as regulators become more experienced with various aspects of the risks in securitization and can discern the differences in sensitivities of various asset classes and structures, the rules will evolve with them and become more in line with reasonable risk probabilities expected through a full cycle."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Government Shutdown: Adding to Uncertainty??
Monday, September 30 2013 | 11:16 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"As neither side appears willing to negotiate on the issue of the affordable care act, the federal government is moving ever more closely to a shutdown,” says James Frischling, President and Co-Founder of NewOak.
“Unless a compromise is reached or one side folds their hand, the US will have its first shutdown in 17 years, which will add even greater uncertainty to the markets. The major averages closed lower last week amid concerns that a government shutdown was becoming the more probable scenario.”
“While it seems the current political environment brings these situations to fervor only to find a solution in the last hour, with the markets still somewhat confused and trying to digest the Federal Reserve’s decision not to begin tapering, adding any additional uncertainty isn’t what is needed right now.”
“A shutdown will have a negative impact on the markets, but the extent of the impact will depend on how long it takes for a deal to be reached. The markets can recover quickly from short shutdown, but a prolonged shutdown would have a negative effect on economic growth and be another body blow to an already weakened consumer. Consumer sentiment fell to 77.5 in September, reaching its lowest level in nearly five months.”
“The focus this week will therefore be whether a government shutdown can be averted and if not, how long it will last. But this game of chicken is the first of a double-feature, because Congress must agree by October 17th to increase the $16.7 trillion on federal borrowing or the US will default on its debt. While default is unthinkable, the concerns add to uncertainty and uncertainty doesn’t help the economic recovery.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Mortgage Rates Rise: What Happens to Mortgage-Related Jobs?
Monday, September 23 2013 | 11:24 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Mortgage rates hit a low of 3.35% in May, but have been pushed higher ever since as a result of the Federal Reserve signaling that the tapering of its $85 billion per month of debt purchases was on the way,” says James Frischling, President and Co-Founder of NewOak.
“With the spike in rates, the refinancing business dropped significantly in the 2nd and 3rd quarters. As a result of the dramatically lower refinancing activity and with the belief that the market has seen the last of the lowest rates, banks are shedding mortgage jobs. Wells Fargo announced cuts of over 1,800 mortgage-related jobs while Bank of America plans to cut over 2,000. These two banks, as well as other players in the mortgage space, are right-sizing their mortgage business in response to the wind being taken out of the refinancing boom.”
“The recovery of the US housing market was fueled significantly by the Fed’s easy monetary policies, bond buying and commitment to low rates. Housing represented one of the truly bright spots of the economic recovery. But with the Fed signaling a pullback, mortgage rates have spiked, which impacts a key part of the mortgage lending market and one of the consequences will be a hit to the labor market.”
“The Fed last week caught many market pros by surprise when it announced no change to its bond buying program. It’s a clear sign that the Fed is concerned about the strength of the recovery. However, after all the signaling and without any follow through, there’s confusion about when the Fed’s tapering will actually begin. The Fed may have been trying to prepare the market for the inevitable pullback, but signaling damped the enthusiasm for mortgages and is going cost thousands of jobs.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Electronic Bond Trading Platforms – Solution to Illiquidity?
Monday, September 23 2013 | 11:24 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“Away from the government guarantee instruments, corporate and structured products continue to become less liquid, and electronic bond trading platforms are not going to solve the inability of investors to trade more easily for a host of reasons,” says Ron D’Vari, CEO & Co-Founder of NewOak.
“Bond electronic trading platforms developed by Morgan Stanley or Goldman were supposed to bring more transparency in the market place and allow buy-side to buy-side bond trading, hence enhance liquidity and two way flows in markets such as corporate bonds.
Unfortunately, the buy-side participation has been low and the systems have not attracted enough clients to create two-way flows. While some attribute that to single-dealer platforms and lack of trust by the buy-side of the sell-side, the real issues are more profound than that. Corporate bond and structured product markets tend to be dominated by institutional players.
Institutional investors tend to hold and trade specific bonds in larger sizes across multiple accounts. Any particular trade needs to be allocated across multiple accounts -sometimes over 20. Therefore these trades need to be executed at a single price or it would create massive operational issues.
Traditionally the over the counter (“OTC”) has worked much better when the sell-side banks could hold large inventories in anticipation of trades. However, due to price/spread reporting rules, dealers have been less willing to commit capital to hold inventories. The diminishing desire to hold inventory has been getting worst with more stringent capital requirements as well as lower leverage. ”
“The non-government bond prices are a function of the yield of the reference U.S. Treasury bonds they are traded with respect to as well as specific bond spread. Due to the fast movement of reference Treasuries, any price quote on an electronic system will be obsolete very quickly. As a result, buyers and sellers need to arrange first a lock on the specific bond’s spread and then price the trade at a convenient time and allocate the trade to various accounts. Therefore the most natural system would be the OTC and not equity like exchanges. While electronic bond trading volumes are increasing, most of that have been in smaller odd lots. In the meanwhile most banks are expected to report a market-wide slowdown in fixed income trading activities during the summer and hence lower profits.
The Fed’s postponement of the its tapering of QE has also delayed the anticipated increase in fixed income trading volumes. Fortunately, many issuers have taken advantage of this to come to market and issue bonds in September which offsets the impact of lower trading volumes.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

4th Quarter Growth and Housing - Accelerating?
Monday, September 16 2013 | 11:35 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The 5th year anniversary of the collapse of Lehman Brothers brings a great deal of Monday morning quarterbacking,” says James Frischling, President and Co-Founder of NewOak. “Whether you believe Former Treasury Secretary Hank Paulson is an American hero or Dodd-Frank is a future problem solver, the overarching question is simply this: do you believe the US financial system is safer after all the bailouts, quantitative easing, regulatory changes and lessons learned from the financial crisis?”
“Increased capital charges and far greater scrutiny and oversight of the largest financial institutions, all lead to the conclusion that the answer is a definitive ‘yes’. However, the largest financial firms have only become larger as a result of the financial crisis. According to SNL, the 6 largest banks now have 67% of all assets in the US financial system, a 37% increase over the last 5 years.”
“The issue of safety in the system, however, isn’t simply about size. Money flows are also incredibly important, so the plumbing in the financial system or what is referred to as ‘repo market’ can’t be disrupted. The wholesale funding market is what allows money to flow freely throughout the system. The disruption of the funding market contributed mightily to bringing Wall Street’s problems to Main Street and there’s concern that little has been done to regulate or make meaningful changes in that area of finance.”
“The $4.6 trillion repo market operates on trust and confidence in the system, but we’ve seen how fast it can disappear. For our system to truly be considered safer, more focus needs to be paid to the pipes that keep the capital flowing."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Is Our Financial System Safer? Check the Plumbing.
Monday, September 16 2013 | 11:35 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The 5th year anniversary of the collapse of Lehman Brothers brings a great deal of Monday morning quarterbacking,” says James Frischling, President and Co-Founder of NewOak. “Whether you believe Former Treasury Secretary Hank Paulson is an American hero or Dodd-Frank is a future problem solver, the overarching question is simply this: do you believe the US financial system is safer after all the bailouts, quantitative easing, regulatory changes and lessons learned from the financial crisis?”
“Increased capital charges and far greater scrutiny and oversight of the largest financial institutions, all lead to the conclusion that the answer is a definitive ‘yes’. However, the largest financial firms have only become larger as a result of the financial crisis. According to SNL, the 6 largest banks now have 67% of all assets in the US financial system, a 37% increase over the last 5 years.”
“The issue of safety in the system, however, isn’t simply about size. Money flows are also incredibly important, so the plumbing in the financial system or what is referred to as ‘repo market’ can’t be disrupted. The wholesale funding market is what allows money to flow freely throughout the system. The disruption of the funding market contributed mightily to bringing Wall Street’s problems to Main Street and there’s concern that little has been done to regulate or make meaningful changes in that area of finance.”
“The $4.6 trillion repo market operates on trust and confidence in the system, but we’ve seen how fast it can disappear. For our system to truly be considered safer, more focus needs to be paid to the pipes that keep the capital flowing."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Rating Agencies: Supply or Demand?
Monday, September 09 2013 | 11:59 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The role and responsibility of the Credit Rating Agencies in connection with the financial crisis continue to be a hotly debated topic,” says James Frischling, President and Co-Founder of NewOak.
“However, while there’s been significant scrutiny over the way these rating agencies operate (and specifically the potential conflicts of interest given the fees are paid by the Wall Street firms that engage them), far less debate has taken place on the investors’ reliance on the rating themselves.”
“The relationship between the sell-side firms and the rating agencies are viewed by many as one akin to ‘Bonnie & Clyde’ and the war this dynamic duo was able to wage on the unsuspecting buy-side. However, with the benefit of hindsight, it’s clear that a complete over-reliance on these rating was a major factor contributing to the investment decisions.”
“Part of the over-reliance problem can be attributed to the regulation and requirements of many fund managers which force them to only invest in securities that carry specific (high) ratings. Both the European Commission and the SEC are trying to address this issue with their respective reforms and rules in an effort to better protect the consumer.”
“The other part of the over-reliance problem was self-inflicted by the buy-side and was the result of essentially outsourcing many credit decisions to the rating agencies. The speed and complexity in which products were being created by an army of sell-side firms overwhelmed the resources of many buy-side firms, who then relied on the rating agencies to help aid them in their investment decisions.”
“Rather than rely on the rating agencies, these buy-side firms would have been better served by leveraging independent financial markets advisors to compliment their internal resources. With structured and securitized products once again heating up, let’s hope memories aren’t short and lessons have been learned.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Wind Down of Fannie and Freddie Mac: First Order of Priority?
Monday, September 09 2013 | 11:59 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“Fannie and Freddie Mac (“GSEs”) reform is badly needed but there are many other areas of housing finance that need to be fixed first to reach a more rational mortgage markets,” says Ron D’Vari, CEO and Co-founder of NewOak.
“A total wind down of GSEs doesn’t make sense before making meaningful headway in reducing the overall financial system risk to systematic housing price volatility and corresponding mortgage credit risk.”
“A more transparent and self-disciplined mortgage credit market is even more critical and urgent to the future of housing markets than winding down the GSEs. All things the same, the wind down of GSEs would first naturally lead to the transfer of the housing systematic risk to the banking system. However, the banks are not necessarily 'private sector' per se as they indirectly benefit from protection by FDIC and Federal Reserve policies. The core issue is dealing with the 'too big to fail' paradox which has been at the heart of many of Dodd Frank provisions. The new banking system regulations are intended to reduce the systematic risk caused by the larger banks but we are far from full implementation and achieving its objectives at this point. Once meeting Dodd Frank’s objectives, it would also naturally force banks to limit their exposures to mortgage risks - credit, market, operation, compliance and legal. This could also indirectly lead to curtail lending and keeping housing prices in check. This should dampen abrupt and violent real estate cycles like the one encountered through credit crisis.”
“One of the key contributing factor to the housing related systemic risks has been U.S. fragmented and borrower-friendly mortgage workout and foreclosure laws. The borrower friendly laws add to the overall costs of mortgage finance by encouraging defaults. Ideally, the federal laws should target addressing that. Recourse mechanism after foreclosure has been effective in many countries (e.g. U.K. and Australia) but is not in the cards for the foreseeable future in the U.S.”
“The U.S. mortgage markets will adapt gradually to diminishing roles for GSEs. The market will ultimately converge organically to a more optimal and rational national mortgage system. Ideally banks will be measuring their mortgage credit risk along rates risk more explicitly through stress testing as well as tighter compliance oversight. One likely course of evolution is that the aggregate mortgage credit risk will be distributed to a wider private “real” money investors that will gradually learn efficient ways to invest in mortgage credit markets. This will be through more effective risk management and underwriting tools, data, surveillance, technology, and credit dash boarding.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Eminent Domain: Will it Backfire?
Tuesday, September 03 2013 | 09:29 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The City of Richmond’s use of Eminent Domain to seize underwater mortgages will backfire and freeze their local housing market,” says James Dooley, Managing Director of NewOak Advisors. “The city is shooting itself in the foot.”
“Multiple lawsuits have been filed against Richmond and are likely to last three to five years given the industry’s stiff opposition to eminent domain. It’s unlikely that a title company or lender would underwrite new loans with this much legal uncertainty. And the Federal Housing Finance Authority has already refused to insure loans where eminent domain is used, effectively eliminating Fannie Mae and Freddie Mac which is large component of the overall mortgage market.”
“The very homeowners that Richmond seeks to help will instead be harmed. Just like Georgia, which enacted assignee liability rules, and Illinois, which imposed County review of each loan application, Richmond will learn that making unilateral changes to the basic fabric of the mortgage market will only serve to drive lenders away.”
“The mortgage industry is united in its efforts to quash Richmond’s use of eminent domain because it undermines basic principles of the mortgage industry and would wreak havoc on the housing markets if allowed to spread to other municipalities that have considered its use.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Economic and Market Uncertainty: Clearing Up after Labor Day?
Tuesday, September 03 2013 | 09:27 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“After a volatile summer, events of this month may help clarify the direction and volatility in the U.S. bond yields, mortgage rates, housing prices and sales,” says Ron D’Vari, CEO and Co-Founder of NewOak. “In turn these will set the tone for volatility in equity and emerging markets.”
“Equities have had their worst month in August since May of this year. Bonds have also had their fourth consecutive month of negative performance. According to Barclays Capital broad bond market indices, the U.S. Government and Aggregate bond indices have returned -3.05% and -2.81% year-to-date, respectively, and are expected to continue to underperform baring a major surprise. Emerging markets, particularly countries with a high current account deficits, have also declined dramatically as their currencies plunged. With somewhat faster-than-expected observed growth in Europe and China, oil, gold and other raw materials have beaten bonds, stocks and the dollar by a wide margin in the last three months. This has been further aggravated by high likelihood of military strikes in Syria.”
“September will bring further evidence of the Fed’s tapering of its bond purchases which most investors and markets around the globe have been anxiously watching. Like a heavy weight on a compressed spring, QE have suppressed volatility in bond prices, equities and emerging market currencies until this May. Relaxation of the artificial restraints by tapering QE will undoubtedly bring further volatility to the markets until it adjusts to its intrinsic new equilibrium. Strong August jobs figure may accelerate that expectation. The emerging markets are rather sensitive to higher U.S. interest rates as it leads to further erosion of developing countries’ currencies and capital inflows that are badly needed to finance their faster paste growth.”
“Among important effects that will gradually creep in are the direction of U.S. housing prices, home sales, mortgage rates and consumer confidence in light of sharply higher rates. A swell in financing costs (20% higher from the lows of May) is already cooling demand for new purchases as higher rates combined with higher prices have already lowered home affordability. Home refinancing is also already sharply down. This has led to several big banks announcing mortgage finance staff reductions eliminating thousands of jobs. We shouldn’t forget the impact of a number of Dodd Frank related housing finance regulations that are just becoming active. Markets will also be watching the renewed congressional debt ceiling wrangle. Collectively these factors may counter other positive factors impacting the fragile job market and dampening of the economic growth. As a result the Federal Reserve may have to pause its QE tapering as they have said they will be data driven. Nonetheless volatility is here to stay until the world can truly be off the QE opium and rates achieve an equilibrium consistent with its intrinsic economic strength.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

US Banks: Feeling a Squeeze?
Tuesday, September 03 2013 | 09:27 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"After 6 years of inflows, US banks experienced an overall decline in deposits in the 2nd quarter,” says James Frischling, President and Co-Founder of NewOak. “At a time when banks are under regulatory pressures to reduce leverage and hold onto more cash, investors pulling funds out of their accounts are contributing to a squeeze on the banks from both the top and the bottom.”
“At the onset of the financial crisis, the largest banks were the primary beneficiaries of unprecedented inflows. Over the past 6 years deposit balances increased about 40%. The key driver of these inflows was safety, and the largest banks represented a flight to quality away from riskier money managers and mutual funds. The crisis brought with it a ‘risk-off’ mentality for many investors, so the safety of savings and checking accounts was the driver of these flow of funds.”
“The ‘risk-on’ trade has been in vogue since the Fed brought interest rates down to near zero, and retail investors have started to embrace adding risk to their holdings. In response to the decline in deposits, banks will need to increase the interest rates paid on these accounts. The banks benefitted from the fear-factor during the crisis and attracted funds as a result of the perceived safety they afforded investors as opposed to increased rates. During the crisis, interest rates on deposits fell from over 3% at the onset to a low of about 0.25%. In this environment, in order to maintain current accounts, the banks will need to pay more.”
“Meeting the regulatory requirements and increasing liquidity ratios as mandated by Basel III has been a challenge to the banks. It will be that much harder to do if deposits continue to decline.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Fed Policies: Coordination not Acceleration?
Monday, August 26 2013 | 12:33 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"All the talk and signaling of the Federal Reserve’s near-term tapering of its monetary stimulus resulted in a selloff of highly rated securities and also dealt a blow to the stocks and currencies of a number of emerging countries,” says James Frischling, President and Co-Founder of NewOak.
“The Fed’s unprecedented quantitative easing has been the key driver of the recovery in US equity markets It has also resulted in significant capital inflows into emerging countries. The risk-on trade was the right call in the face of the coordinated efforts among central banks to flood the financial markets with capital in order to keep interest rates low and provide ample liquidity. With a change of course looming, investors are understandably pulling back in the areas that were the primary beneficiaries of the easy money.”
“The Fed was the leader of what proved to be a globally coordinated effort to confront the financial crisis. There’s no reason to believe that the Fed won’t again lead the effort to end these highly accommodating policies.”
“But each country has its own domestic needs and agenda. While preventing a far greater financial collapse was the reason behind the unprecedented global stimulus, reversing course in order to prevent future asset bubbles isn’t something that is universally agreed upon.”
“The Federal Reserve will continue to talk and signal a reduction in its bond buying program, but the economic data will ultimately determine the timing and speed of the tapering. Countries that benefitted from the flat US yield curve will have to adjust to the Fed signaling and ultimately implementing less accommodating policies.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Home Sales: Cause for Concern?
Monday, August 26 2013 | 12:32 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Existing home sales are signaling a different message than home builders confidence, new-home purchases and direction of home prices," says Ron D'Vari, CEO and Co-Founder of NewOak.
"The July home sales at 394,000 annualized pace was certainly surprised the market on the negative side. The reported number was lower by more than seven times historical standard deviation between the poll's forecast (487,000 annualized) and the actual reported outcome. Paradoxically at the same time, the adjusted new-home purchases were higher in July by 6.8% over the same period in 2012. The July median home prices also increased 8.3% over 12 months ago."
"Despite the spike in mortgage rates, the general sentiment is that home prices and housing demand will be on the rise with an improving job market and consumer confidence. Supply of homes are also expected to remain in check with tight inventory, constrained construction resources, and less willing sellers. Hesitant home buyers are more and more willing to go on home purchase hunt and seem to be able to afford higher prices and rates."
"While Fed is bound to start tapering down QE 3 soon, mortgage rates already reflect most of that if not already over done. The U.S. housing market, employment and consumer confidence will remain highly interdependent but expected to improve gradually given current overall economic dynamics. However, a bigger puzzle will be how GSEs are restructured and government housing policies are redefined."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Rising Home Sales: Will they Dampen?
Wednesday, August 21 2013 | 07:36 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Despite higher rates, U.S. existing and new home sales are apt to continue to increase, and already have reached the highest since credit crisis began," says Ron D'Vari, CEO and Co-Founder of NewOak Advisers.
"Gradual but steady improvements in the U.S. economy and consumer confidence are driving home, construction and auto sectors. The key question remains if the fundamental economic drivers are strong enough to withstand paring down QE 3 and higher rates. Improving labor market and rise in income have propelled rising consumer confidence. This dynamic plus limited supply and improving sales have supported rise in home prices and spread the moves to the secondary and tertiary markets."
"Consumer confidence remains fragile and subject to quick reversal. Already there are some signs of weakening in single-family construction and consumer confidence due rise mortgage rates. The market concerns have already been reflected in the under performing home builders stocks since the 100bp mortgage jump to 4.4%. Borrowers still have access and have shifted to ARM and hybrid mortgages. However, even though affordable now, they are perceived risky given the lessons of the past."
"It is given July home sales will rise. Higher mortgage rates combined with rising home prices have impacted home affordability down vs. rental. This will ultimately impact home sales. Markets will be scrutinizing housing sector dynamic carefully looking for tell-tale signs of the economy. But economy-job-housing will remain a chicken and egg omelet puzzle to solve."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Adding Credit Risk: What’s Old Is New Again?
Wednesday, August 21 2013 | 07:36 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The demand for higher returns and lower rated fixed income assets has soared since Fed Chairman Bernanke made it clear that the tapering of its monetary stimulus program would commence before the end of the year,” says James Frischling, President and Co-Founder of NewOak.
“Fear of rising rates has resulted in a selloff in the highest rated and safest securities, while junk bonds and loans have seen modest gains. Investors are willing to add credit risk to their portfolios in order to pick-up the additional spread associated with these riskier assets and shorten duration.”
“In addition to the search of yield in the face of the Fed’s tapering, the demand of these lower rated loans has also been fueled by the strong return of the Collateralized Loan Obligations (CLO) market. While structured finance took a beating as a result of the financial crisis, the CLO market weathered the storm better than their ABS CDOs cohorts.”
“The demand for these assets is allowing issuers to seek more favorable terms in exchange for their paper. Increased leverage and payment-in-kind are just two examples of the borrowers starting to push the envelope and bringing back some pre-crisis issuer friendly terms. If covenant light loans make a meaningful return, it will be clear that what’s old is new again and the lessons from the financial crisis may be short.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Is The Financial Sector Sexy?
Tuesday, August 13 2013 | 08:14 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"When you think of sexy stocks and sectors, technology companies usually come to mind. But after posting a nearly 25% return this year, the financial sector deserves a lot more respect and attention,” says James Frischling, President and Co-Founder of NewOak.
“The importance of the financial sector can’t be understated. The collapse in housing and the financial crisis brought many of these companies to their knees and without a properly functioning financial system the US economy became unraveled and destabilized. Unprecedented government support and stimulus provided the necessary backstop and helped turn things around. Now with the banking sector making a strong comeback, it’s a good sign for the economy as a whole as the increase in lending can help feed more borrowing, jobs creation and consumer demand.”
“The core four banks of the US – Wells Fargo, JP Morgan, Citibank and Bank of America have been the biggest drivers of the rebound and performance of the financial sector. While each have rebounded remarkably since their respective lows in March 2009, their performance is even more impressive given the tremendous headwinds they’ve faced. The regulatory scrutiny and changes in order to protect the financial system from another collapse have added significant costs to these businesses, while the private and government litigations associated with the financial crisis have also forced these institutions to take large reserves.”
“Despite these challenges, the financial index rallied to become the second most important index of the entire S&P 500, trailing only the technology sector by a small margin. Technology may be the seen as the sexy and cool sector, but like the story of the Tortoise and the Hare, the slow moving and somewhat boring banks may prove to be the ultimate winner.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Agricultural Land Prices: A Bubble to Burst?
Tuesday, August 13 2013 | 08:13 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“While agricultural land prices are due to soften from their highs as a results of several factors including 40% drop in corn prices from their peak last year, it is not cause for alarm but should be carefully watched,” says Ron D'Vari, CEO and Co-Founder of NewOak Advisor.
“In areas of the country such as Iowa and Nebraska, farmland prices have nearly doubled since 2009. Unique conditions driving prices of farm land to their record high include: 1) rising global demand for commodities such as corn and cattle, 2) upsurges in crop prices, 3) the Federal Reserve’s extraordinary easy monetary policy, 4) investors’ huge appetite for hard assets, and 5) hunger for achieving higher returns over unprecedented low U.S. treasury rates. There is also signs of increased lending by non-bank finance companies along with amplified vendor finance.”
“Many of these financial factors are expected to reverse in 2014 onward. Rising interest rates and normalization of crop and cattle prices will inevitably lead to some correction in land prices and rents. Some fear that the outcome may resemble the last housing bubble burst. Despite agricultural land values having reached their all-time highs, investors and policy makers don’t seem to be particularly alarmed and many are not even familiar with it. Any correction is expected to be kept under control by the fact that farmers and agricultural landowners have not been over levered and most purchasers have been strong added value local hands as opposed to speculators. High crop prices in the last few years have allowed them to pay down debt and lock in extraordinary low long-term interest rates. Hence farm land debtors are expected to be willing and able to hang on to their land through the correction and service their loans. Another mitigating factor is that supply of farmland is expected to remain constrained. Some will see a potential 20% to 30% drop in prices of farm land an opportunity to buy. While the agricultural land price correction is expected to be controlled, the buildup is likely to still create concerns for those over exposed.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Alternatives to Eminent Domain for Underwater Mortgages?
Wednesday, August 07 2013 | 06:57 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Cities now studying eminent domain as a way of solving foreclosure of underwater mortgages may have better alternatives," says Ron D'Vari, CEO of NewOak Capital.
"Cities are examining proposals to confiscate underwater home loans and writing the down to a lower balance in line with current home prices. This is to make the loans in line with the market value of the property and presumably provide incentive for the existing owner to stay. Hence the owners would be more apt to take care of their houses and improve the feel of the neighborhoods."
"The eminent domain of mortgages have not yet been tested and is bound to be contentious and legally complex as servicers of the RMBS trusts are not contractually and legally allowed to sell mortgage loans due to REMIC laws and their pooling and servicing agreements."
"Even assuming one can jump over the legal and contractual hurdles, many other complications remain. First, cities have to line up private equity investors to buy the loans at "market value" which may not be so easy to determine in high foreclosure cities and neighborhoods. The loans have to be written down to values lower than the home prices to leave a meaningful equity for the existing owners to incentivize them to stay. The forced process of setting values and new loan balance between servicer, new investor, the borrower, and city will by itself be very complex and full of controversies."
"Mortgage lenders and banks will most likely stop lending in cities pursuing eminent domain. The regular market for existing and new home sales will shut down due to lack of mortgage financing. Home prices will be pushed even lower, exasperating the very problem attempted to be solved."
"One alternative to eminent domain for stopping foreclosures is to create special loan programs to enable the underwater borrowers to approach their servicers with reasonable and more attractive payoff proposals than can be achieved through foreclosure. Borrowers with stable incomes may find government guaranteed loans supported by reasonable current home prices. Servicers are apt to consider borrower-initiated proposals in lieu of foreclosure if it leads to higher recovery. This should ultimately turn the negative cycle and attract even new buyers to the cities affected."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Rating Agencies: Under Scrutiny?
Wednesday, August 07 2013 | 06:56 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"A recent report has accused S&P of winning business by offering more favorable ratings than its biggest competitors – Moody’s and Fitch,” says James Frischling, President and Co-Founder of NewOak.
“The rating agencies were accused of contributing to the financial crisis for issuing ratings that didn’t accurately reflect the risk associated with mortgage-backed securities and other structured products. The current system (in which the banks pay for the services of the rating agencies) creates potential for conflicts of interests and the perception is that it could incentivize a rating agency to offer higher ratings in exchange for greater market share.”
“The key question is this; five years after the start of the financial crisis, how important are the rating agencies for the return of the private-label mortgage market? Freddie Mac is leading an effort to launch a new product that will use a risk-sharing structure in the hopes of attracting investors back to the private-label market. Fannie Mae is expected to follow suit if investors embrace the new product.”
“Wall Street and the FHFA aren’t the only parties interested in seeing the return of the private-label mortgage securities market. Investors also have appetite for residential mortgage credit risk, but need a product that addresses the lessons learned from the bursting of the housing bubble.”
“The current Freddie risk sharing offering may move away from the traditional rating agencies and instead consider obtaining a rating from the National Association of Insurance Commissioners. Even if they go with a traditional rating agency, many investors say they rely far less heavily on the agencies as the financial crisis demonstrated the need for investors to do their own credit work. If true, it looks like some important lessons were learned from the crisis and the result might be the return of the much needed private RMBS market.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Rating Agencies: Under Scrutiny?
Wednesday, August 07 2013 | 06:55 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"A recent report has accused S&P of winning business by offering more favorable ratings than its biggest competitors – Moody’s and Fitch,” says James Frischling, President and Co-Founder of NewOak.
“The rating agencies were accused of contributing to the financial crisis for issuing ratings that didn’t accurately reflect the risk associated with mortgage-backed securities and other structured products. The current system (in which the banks pay for the services of the rating agencies) creates potential for conflicts of interests and the perception is that it could incentivize a rating agency to offer higher ratings in exchange for greater market share.”
“The key question is this; five years after the start of the financial crisis, how important are the rating agencies for the return of the private-label mortgage market? Freddie Mac is leading an effort to launch a new product that will use a risk-sharing structure in the hopes of attracting investors back to the private-label market. Fannie Mae is expected to follow suit if investors embrace the new product.”
“Wall Street and the FHFA aren’t the only parties interested in seeing the return of the private-label mortgage securities market. Investors also have appetite for residential mortgage credit risk, but need a product that addresses the lessons learned from the bursting of the housing bubble.”
“The current Freddie risk sharing offering may move away from the traditional rating agencies and instead consider obtaining a rating from the National Association of Insurance Commissioners. Even if they go with a traditional rating agency, many investors say they rely far less heavily on the agencies as the financial crisis demonstrated the need for investors to do their own credit work. If true, it looks like some important lessons were learned from the crisis and the result might be the return of the much needed private RMBS market.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Next Fed Chairman Debate – Yellen vs. Summers?
Tuesday, July 30 2013 | 08:32 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Last week a group of Democrats advanced a letter in support of Janet Yellen to be the next chairman of the Federal Reserve,” says James Frischling, President and Co-Founder of NewOak. “While the independent-minded Fed historically prefers to avoid being viewed as part of the political process, the move by the Democrats clearly brings the Fed into the political debate.”
“Given the importance the Fed has played in not only averting a far greater financial crisis, but also in the historic rally in equities, the focus on who will succeed Chairman Bernanke is warranted. In Yellen’s favor is that she’s been the #2 Fed ranking official since 2010, has been a supporter of the accommodative monetary policy and is viewed favorably by her colleagues at the Fed as being smart headed with her hand on the pulse of the public. She has also been a key figure in the Fed’s unprecedented efforts to expand its communications strategies.”
“There’s talk that the position was promised to Larry Summers and given the President’s tendency to surround himself with former colleagues and friends, the Democrats that signed the letter may have felt it was necessary to announce their preference.”
“It also can’t be ignored that if appointed, Yellen would be the Central Bank’s first female leader in its 100-year history. With this nomination, President Obama has the opportunity to leave his mark on the Central Bank. If the President decides to nominate Yellen, the first woman to lead the Fed may also be the most qualified candidate and the overwhelmingly preferred choice. Can there really be any other choice?”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Muni Bonds - Created Equal?
Tuesday, July 30 2013 | 08:32 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Some of the self-sufficient municipal entities have adequate revenue to make their debt payments in full irrespective of the financial weakness of their municipal parent," says Ron D'Vari, CEO and Co-Founder of NewOak.
“Detroit’s bankruptcy is creating an opportunity for investors to profit from some of the city’s utility and essential services bonds. Some of these are trading at large discounts despite the high likelihood for payment of the full principal and interest. Detroit’s unconventional Chapter 9 filing has created a potential risk that some of the revenue bonds may get caught in the restructuring litigation due to potential classification as being unsecured by Orr’s restructuring plan.”
“Revenue bonds are backed by the issuing municipality’s power to impose taxes and fees for the associated essential services in order to meet the entities bond obligations. The investors have traditionally viewed these as a secured obligations separated from other unsecured liabilities of the municipalities. However, as the Chapter 9 Federal bankruptcy process has been rare and may intersect with many other laws of the city and state (including constitutional ones), a full legal analysis leaves a risk of unexpected outcomes."
"There is a distinct difference between general obligation bonds and revenue bonds backed by economically viable entities’ revenues. The revenues should be segregated from the general funds according to the underlying documentation. The revenue bond documents are typically complex and could leave room for interpretation. Therefore, sophisticated investors may have to be review them for potential flaws and inconsistencies.”
“While the Detroit bankruptcy has created some new opportunities for distressed investors, it also has created a big issue in the confidence of the market, particularly less risk tolerant investors. While answers are still to be determined in the courts, it is clear that all muni bonds are not created equal and investors need to analyze more stressful conditions. There is a general hope that a side benefit of the credit crisis may very well be bringing back discipline to the public finance long term. This will call for better financial governance of municipalities as well as a much more disciplined public finance capital markets.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Housing and Auto: Propel Economic Expansion?
Monday, July 22 2013 | 11:16 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Unprecedented low interest rates and reasonably available credit have fueled the U.S. housing and auto sales recovery momentum," says Ron D'Vari, CEO and Co-Founder of NewOak.
"The two sectors, in turn, have contributed greatly to the stabilization of manufacturing sector which has previously been a weakness to U.S. economic growth."
"Economists forecast the sales of previously owned homes will rise from 5.18 million to 5.26 million annualized rate in June from 5.18 million in May. The continued recovery and normalization of the housing sector and rising construction is essential to the entire economic expansion. However, the housing improvements momentum is not certain. For the foreseeable future, housing, construction and auto sectors' expansion will be highly sensitive and contingent on the low interest rates and the Federal Reserve's QE policies."
"While short term momentum will be positive, the risk is that the inevitably higher mortgage rates will dampen the housing growth as well as add to the market volatility. This risk has been the main reason Bernanke and other Federal Reserve board members tried to calm the market by reiterating their cautious stance and willingness to push out the tapering of QE 3 until economy has shown real sign of health."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Is Detroit’s Bankruptcy a Sign of the Times?
Monday, July 22 2013 | 11:15 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"With Detroit’s bankruptcy filing (the nation’s largest government bankruptcy in history) a debate is emerging whether this, is specific to Detroit, or a sign of more trouble to come,” says James Frischling, President and Co-Founder of NewOak.
“Those that argue Detroit’s bankruptcy is unique are focused on population decline, the auto industry and mismanagement of operating budgets. Detroit’s population dwindled over the past 60 years from a high of 1.8 million in the 1950s to less than half that number today. The economic situation has been particularly brutal on Detroit, compounded by the fact that it has an over-reliance and dependence on the auto-industry. Finally, to meet the obligations of its pensions and health insurance and as a result of the declining tax revenues, the city borrowed heavily to meet its operating budgets. All of this has brought Detroit to its Chapter 9 filing.”
“But caving under the weight of nearly $20 billion of unfunded pension liabilities is exactly what is scarring municipal bond investors that other cities may follow suit. Chicago and Los Angeles, for example, carry unfunded pension liabilities of $19 billion and $30 billion respectively.”
“Municipal bond investors have been pulling money from muni market funds for eight consecutive weeks, including nearly $1.5 billion last week. The Barclays Municipal Bond Index is down 2.7% thus far this year and issuance is down 10% from the same period last year.”
“Michigan is being criticized for failing to provide sufficient help for Detroit, so the question of contagion will also weigh on how other states will manage its troubled cities. The Federal government could step in with support, but that’s a Pandora’s Box that is too dangerous to open. Detroit filed because they’re on their own and had no choice. Who’s next?”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Fannie & Freddie: Are the GSEs a Good Investment?
Monday, July 15 2013 | 02:31 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Fannie Mae and Freddie Mac were among the most actively traded shares by retail investors in June,” says James Frischling, President and Co-Founder of NewOak.
“Retail investors are betting that these companies present opportunities with strong upside, despite being delisted from the NYSE and put into conservatorship by the government.”
“Critics claim these companies were contributors to the housing bubble and the resulting financial crisis. They will also argue that without a government bailout, the failure and complete wipeout of private investment in the companies was a certainty. However, a number of savvy hedge funds have filed have filed lawsuits claiming that the government is taking too much profit on the rescues of Fannie and Freddie and that the preferred shares of these mortgage giants should receive some of the windfall that has been created as a result of the recovery in the housing market.”
“The bailout of Fannie and Freddie was intended to bring some calm to the volatile markets of 2008, satisfy demands from global debt holders of the GSEs, as well as protect and support the residential housing market.”
“The decision to put the GSEs into conservatorship and leave 20% of the stock outstanding was done under great stress and pressure. A number of hedge funds see the value in these shares and retail investors now see the value as well.”
“Are these shares under-valued and represent a buying opportunity? Too early to tell, but if Hank Greenberg can sue the government over the AIG bailout, a shareholder lawsuit over the GSEs seems par for the course.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Treasuries & Mortgages: Fair Value?
Monday, July 15 2013 | 02:31 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Yields for U.S. 10-year Treasuries and 30-year Fixed-Rate Agency RMBS have jumped over 1%," says Ron D'Vari, CEO and Co-Founder of NewOak Capital. "However, they have reached a fair equilibrium given current information on economy, employment and the Fed's posture."
"Markets are reacting to the speculations of the Fed's precise timing and manner of trimming QE3 stimulus. Most experts believe it is inevitable and it will come sometime early in early 2014. However, the ultimate determinant of the equilibrium rates will be real economic growth and expectations of medium to long term inflation. Real yields are set by the spread between nominal yields and expected inflation, which is primarily driven by how far the nominal growth exceeds natural growth capacity of the U.S. economy. Both factors look favorable for the foreseeable future and point to the rates staying relatively low given the significant capacity under utilization and the unemployment picture in the U.S.."
"The U.S. economy has been running far below its natural capacity to grow as evidenced by the huge number of previously employed that have left the job pool losing hope to get a job. This is further exasperated by the housing over capacity. Also, the U.S. aggregate demand has been artificially supported by government spending which also will have to end at some point given the budgetary prospects."
"Contrary to the market's short term reactions, the long term rates would tend to be kept in check given the inevitable end to QE3 and slower growth in government spending. Higher mortgage rates will also dampen housing. Should the intermediate- and longer-term rates go higher, the steeper curve will encourage banks and sovereign wealth funds to increase their treasury and mortgage holdings. With the 10-year real yield over 1.5% and 30-year FR mortgage rates reaching 4.5%, U.S. bond market has reached an equilibrium for the time being and deserve a new look by the investors."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Bank Capital Rules: Loopholes Closing?
Monday, July 08 2013 | 11:21 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Despite all the talks of tightening bank capital requirements globally, specific loopholes in regards to internal ratings based ("IRB") approach to credit risk and risk-based capital will not be identified and closed anytime soon," says Ron D'Vari, CEO and Co-Founder, NewOak Capital Advisors.
"The latest study through Regulatory Assessment Consistency Programme ("RCAP") by Basel Committee has identified that there is about 20% variation in the internal ratings-based approaches in estimating credit risk across various investments among various banks. RCAP's study was based on information from over 100 banks around the world and 32 large international banks. RCAP's study results indicated a potential structural bias toward underestimating risks and overstating capital ratios in certain jurisdictions, more so in certain asset classes."
"The degree of flexibility permitted in implementing risk-weighted capital rules using internal models in various jurisdictions has been criticized, particularly in Europe. While the study indicates that the U.S. banks were in general above standardized approach, the banks from the rest of the world were dispersed on both sides. The sovereign exposures seem to be a key area with significant variations. Some of the larger banks in Europe may be holding less capital against certain asset classes than the American banks."
"While the discrepancies among banks' internal rating-based models have been suspected by market participants and regulators, RCAP's latest report puts additional pressure on regulators to impose fresh new rules and tighten the existing ones."
"No doubt the rule setting committee is searching for finding ways to narrow the deviations and reduce use of loopholes to artificially look stronger on capital adequacy. Some have suggested instituting a minimum risk-weighted capital as way of fixing the inconsistency. However the latest report doesn't hint at any clear solutions."
"Given the current state of European economy, policy makers have been simultaneously worried that imposition of any new rules may by itself cause further credit squeeze and economic issues. We expect further discussions among key policy makers starting in September but see no real changes in sight until gradual healing of the economy is in real motion."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Slow & Steady Jobs Growth – The New Normal?
Monday, July 08 2013 | 11:20 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The Labor Department’s June non-farm payroll report beat expectations with 195k jobs created,” says James Frischling, President and Co-Founder of NewOak. “The stronger than expected report was fueled further with the significant revisions to the last two months of data adding another 70k jobs to the total, which brought both April and Mat to nearly 200k jobs created.”
“While the second quarter jobs creation was slightly lower than the first quarter (monthly averages of 196k and 207k respectively), the growth adds a great deal of fuel to the fire that the Fed will begin to taper its $85 billion in monthly bond purchases in the coming months.”
“Despite the better than expected results, the unemployment rate remained unchanged at 7.6% as a result of the increase in the number of people that returned looking for work, a positive sign that things are getting better on the jobs front.”
“Chairman Bernanke has said the central bank could begin pulling back on stimulus efforts later this year if the jobs market continued to show signs of strength. The jobs created thus far this year are certainly good news, but the unemployment rate still remains well above the 6.5% level the Chairman set as the threshold level for pulling back.”
“With confidence that the jobs market will continue to improve, expect the Fed to announce the reduction in its bond buying in September or December. The counter balance to this pullback will be the consumers, who are more positive on the economy than at any time since early 2008. With the stock markets at or near all time highs and with the strong recovery in housing, the wealth effect should help consumers spend more when the Fed starts to spend less.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Third Party Reviewers: aka- The Referee?
Monday, July 01 2013 | 11:07 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The American Banker published an article last week highlighting a potential solution to help jumpstart the dormant market for private-label mortgage backed securities – bringing a 3rd party reviewer into the transaction in order to determine who is on the hook for bad loans,” says James Frischling, President and Co-Founder of NewOak.

“The article says the reason investors are reluctant to buy private-label securities is they do not trust the trustees to look after their interests. The role of a 3rd party reviewer or “referee” is not limited to private-label mortgages and is an important part of bringing securitization and leverage transactions back into the fold.”
“Many private-label and structured transactions that resulted in losses are now in litigation as the parties fight about the price of the collateral, the performance of loans and the seizure and liquidation of collateral. The role of a 3rd party reviewer or referee at the onset of the transaction could have prevented these disputes.”
“So if the return of private-label mortgage market is dependent on the inclusion of a 3rd party reviewer to help balance the needs of the risk-seller and risk-taker and the myriad of other securitization and leveraged transactions that would also benefit from the inclusion of this participant, why is there such a lack of utilization of such an important role? The answer is that the buyers or sellers of risk are reluctant to include the cost of this role in the transaction unless it’s absolutely necessary.”

“These transactions are negotiated and entered into by sophisticated investors. Historically, the experts that can play the role of the referee are only utilized after things have gone wrong. The inclusion of such parties at the onset of the transaction may prove to be what’s needed to truly re-launch the securitization market.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Mortgage REITS: How Will They Fare?
Monday, July 01 2013 | 09:09 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“Investors shouldn’t dump their mortgage REIT (“mREIT”) stocks too quickly because their dividend payout yields are expected to remain high as long as the Fed keeps the short rates real low,” says Ron D’Vari, CEO and Co-Founder of NewOak.

“mREITs were beaten over the last month with the trend accelerating early last week as the agency 30-year fixed-rate mortgage (“FRM”) rates jumped by as much as 1.20% reaching above 4.5% mark. This means a new 30-year mortgage borrower’s monthly payments will be higher by over 30% than a similar borrower’s payment just a month ago. Movements of this magnitude over such a short time span are unprecedented. Therefore it is not surprising that investors are reacting this way.”

“Over the last few years, agency-only mREITS yielded higher than most other stocks including equity REITS. The mREITs’ high yields were generated by borrowing at the short rate and lending at the higher longer FRM rates. Hence, through leverage mREITS have paid out double digit dividends while bank deposits have paid close to nothing.”

“The Federal Reserve’s signaling of the QE3 tapering soon spooked the mortgage markets causing the carnage even though it will depend on continuation of positive data. Despite the jump in FRM rates, many mREITs have continued their still high dividend rates, albeit somewhat smaller. The income from the mREITs underlying mortgage portfolios haven’t changed, and neither have their short term borrowing costs. Given it will be quite a while before the Fed increases short rates, mREITs ability to pay high yield should last at least another year or two until they start to hedge their portfolios.”

“In fact higher FRM rates and steeper yield curve (i.e. larger spread between short and longer dated rates) should be positive longer term for the mREITs. Steeper yield curve would encourage bank buying of FRM which would offset Fed's pairing down. Mortgage REITs could potentially also benefit from a changing mortgage finance market that may lead to lower defaults for non-agency mortgages. However mREITs are expected to remain very sensitive to interest rate due to natural leverage and also tightening regulations. This will be particularly the case for agency-only mREITS and less so for non-Agency floating RMBS REIT strategies. While they will be volatile, mREITs will continue to be highest income stocks but their relative advantage would become narrower.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Mortgage Rates: Rising Faster Than Treasuries?
Monday, June 24 2013 | 11:15 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“Over the last month, 30-year Fixed-Rate Mortgage rates rose much more than the US 10-year Treasury rate,” says Ron D’Vari, CEO of NewOak.
“The market read Bernanke’s speech as a signal the Fed is increasingly becoming confident that U.S. economic growth is on a more solid path and has overcome the government spending cuts. Therefore the markets quickly re-priced a much higher probability of Fed tapering QE. The Fed’s programatic purchases of government-guaranteed MBS has kept the 15- and 30-year Fixed-Rate mortgage rates artificially lower."
"However, QE has a larger impact on the fixed–rate mortgage rates than the US Treasury rates. The Freddie Mac 30-Year Fixed-Rate Mortgage Benchmark is widely quoted in media to inform consumers as to the trends in mortgage rates. Over the last month this measure has increased over 40 bp whereas the 10-year US Treasury has moved up by 27 bp over the same period.”
“The latest moves in MBA’s Market Composite Index of mortgage activity reflects the real mode of the market. Over the last month, this report has indicated a meaningful drop in mortgage applications as a result of rising mortgage rates. The Fed’s latest posture could incite a short term spike in home purchases and mortgage refinancing due to a rush to lock in rates before the rates rise further. However housing data, such as S&P/Case-Shiller Home Price Indices, generally lag the current state of housing by a couple of months due to the normal time it takes to close on real estate as well as the lag in the reporting of the data itself.”
“Considering the anticipated rise in home inventories, as indicated by the rise in new permits, as well as higher mortgage rates, we expect an easing tendency on home prices. The impact will be much more pronounced if the stock market re-pricing continues much longer causing consumer confidence deterioration. Collectively this may lead to the market re-evaluating how quickly Fed could afford to reverse QE.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Housing Bubble Already?
Monday, June 24 2013 | 11:14 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"US home prices increased by over 12% in April, the 2nd straight month of double-digit gains and the biggest jump since February 2006,” says James Frischling, President and Co-Founder of NewOak.
“It was only a year ago that talk of housing finding its bottom took shape. Now the market is talking about the potential of another housing bubble.”
“Low interest rates, tight inventories and the wealth effect generated by the strong rally in the equity markets are some of the key factors driving homes prices higher. Add to that the sense of urgency for investors to act before interest rates move higher and homebuyers are being pushed into bidding wars.”
“While it’s clear that not all areas are being treated equally, in major cities, the demand for good properties is high and sellers are getting deals done quickly and often at a premium to their initial asking price.”
“What surprises many experts and calls into question the sustainability of this housing boom, is the spike in prices despite the lack of improvement in both jobs growth and incomes. However, a recent history lesson reveals that from August 2002 to April 2006, home prices increased by double-digits for 45 consecutive months, so 2 months of consecutive 10+% gains shouldn’t be alarming.”
“Add to that the vast amount of institutional money raised that was to be deployed in search of distressed properties and you can imagine it’s contribution to the rally in prices in other parts of the housing market now that the deeply discounted investment play has been picked over.”
“Wall Street, more than Main Street, is fueling this rally. With the amount of money being allocated to housing market, the call of a bubble is completely premature.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Bank of Japan Imitates Fed: Unprecedented Stimulus
Monday, June 17 2013 | 11:29 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"About six months ago, newly elected Prime Misiter Shinzo Abe took a page out of the Federal Reserve’s playbook and embraced an aggressive form of monetary and fiscal policy,” say James Frischling, President and Co-Founder of NewOak. “The Bank of Japan undertook its own open-ended quantitative easing program designed to halt deflation by devaluing the yen and creating a more advantageous environment for Japanese exporters.”
“The BOJ strategy is in sharp contrast to the actions taken in Europe where fiscal austerity remains the name of the game. The early results of Japan taking a page out of the US playbook were a surge in Q1 economic growth – 3.5%. Europe’s economy on the other hand shrank for the 6th quarter in a row.”
“The equity markets in Japan have responded to the unprecedented monetary stimulus in a similar manner to what has been witnessed in the US. From November to late May, the benchmark Nikkei 225 stock index rallied over 80%.”
“The risk facing the economic growth and equity market rally in Japan is the overarching concern that the BOJ isn’t committed to the bond buying program or will fail produce the on-going stimulus required. The US embarked on a series of quantitative easing programs (creatively named QE1, QE2 and QE3) in order to stabilize the economy, create modest jobs growth and produce a wealth effect as a result of the recovery in housing and a multi-year rally in equities.”
“With talk about the Fed needing to taper or exit, it’s the BOJ that is doing the spending and getting the headlines for its aggressive actions. Can the creation of an economic recovery simply require the massive expansion of the central bank’s balance sheet, low rates and currency devaluation? It appears its Japan’s turn to try.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Distressed Mortgage Loans: Should Gses Be Selling?
Monday, June 17 2013 | 11:28 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"In its latest report to congress, the FHFA rated both GSEs as still "Critical Concerns" in the area of credit risk because of their large legacy books of single-family loans," says Ron D'Vari, CEO and Co-Founder of NewOak.
"GSEs' distressed and illiquid assets include nonperforming loans, modified loans, and non-Agency securities. FHFA's Enterprise Risk assessment of GSEs includes credit, market, operation, and model risks. Despite the gradual improvements driven by housing, delinquent loans and Real Estate Owned ("REOs") continue to be at very high level. HARP refinance and modified loans also constitute an emerging risk but more so at Freddie Mac. There are also new concerns raised by a large number of sales of mortgage servicing rights ("MSRs") by banks to non-bank servicers in 2013. The servicing concerns are magnified by the new stringent regulatory rules. Counterparty risks, such as mortgage insurers and mortgage bankers still remain a significant concern."

"While GSE earnings have improved, the sustainability of the unique business opportunities starting 2009 are still questionable given the U.S. interest rate outlook. FHFA has encouraged GSEs to reduce their credit risks by gradually selling down their distressed and illiquid loan portfolios. A programatic selling of distressed assets by GSEs will be much welcomed by the markets as many Private Equity and hedge funds are desperately looking for viable products to deploy their optimized solutions and operational infrastructure."
"It would be a smart move by GSEs to sell into a rather strong market bid for illiquid assets and focus more on their ongoing support role for housing finance. Market bids currently reflect the rather scalable private funds efficient infrastructure for optimal servicing and loss mitigation strategies. These strategies take full advantage of modification, short sale,and potential REO-to-Rental exit as opposed to REO sales. That being said, in reality, so far U.S. large banks have been more agile in selling down their risks and focusing on profiting from the normalization of housing finance. Markets are waiting for the GSEs to join soon and the expectations are they will. However, they may come to the party a bit late."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Unemployment Rate: Job Market Dropouts Count
Monday, June 10 2013 | 11:13 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Increasing labor force participation, declining government employment and slow employment growth are expected to keep the unemployment rate stable for the balance of 2013 and part of 2014." says Ron D'Vari, CEO and Co-Founder of NewOak.
"U.S. payrolls rose by 175,000 in May, indicating general business optimism and willingness to hire. This has increased the likelihood of the Federal Reserve trimming its bond buying, anticipated by the market to start in the fourth quarter of this year. Any good news for the U.S. employment rate will set off fears of a faster slowdown of Fed's stimulus.”
"An often overlooked factor is the labor force participation rate. It is well known that post crisis the unemployment rate was understated because of dropouts from the labor force - perhaps by as much as half a percentage point. This dynamic is changing with the current economic improvements underway. Thus labor force participation rates are expected to rise which will pressure the unemployment rate up. As an example, despite the 175,000 new jobs the unemployment rate remained essentially unchanged at 7.6 percent in May. Some labor economists forecast a rising unemployment rate as high as 8% with new jobs offsetting only the dropouts re-entering the job market."
"The aggregate government employment statistics are also expected to continue their downward path, hence pressing up the unemployment rate. Furthermore, Obamacare impact on employment growth are expected to kick in gradually despite the fact that the actual laws will become effective in January of 2014."
"The U.S. overall employment growth will remain slow despite improving economy for the next twelve months. In turn, we expect the Federal Reserve to remain cautious and slow down the stimulus very gradually and only when unemployment rate has reached a stable level of 7% target. Full employment status will be achieved many years away at current expected job creation rates."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Time for the Federal Reserve to Taper?
Monday, June 10 2013 | 11:11 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Former Federal Reserve Chairman Alan Greenspan and a number of other market pros went on the offensive with the suggestion that central bank intervention was actually holding back stocks from achieving even higher levels,” say James Frischling, President and Co-Founder of NewOak.
“Greenspan wants the Fed to start pulling back on easing, and called for the tapering process to begin. At its core, the sentiment from taper supporters is that the Fed’s policies are hurting confidence and keeping trillions in cash on the sidelines.” “The Fed’s dual mandate is to promote maximum employment and stable prices. While we understand the significant effects the Fed’s policies have had on the markets, it’s the improving, but still underperforming labor market and benign inflationary pressures that are keeping the Fed’s foot on the gas with respect to its accommodating monetary policies.” “Friday’s May employment report was positive and beat expectations, but still fell short of putting in motion the types of numbers needed to have the Fed change course. To the contrary, the report suggested economic growth is sufficiently marginal to justify the Fed maintaining its bond buying program over the next few months and wait until more information comes to light before making any changes.” “The Fed wants to see the results from the second quarter and the impact of higher taxes and sequester cuts on the economy. The taper-supporters believe the Fed is hurting confidence. Consumer confidence currently stands at a 5 year high. Add to that the rebound in housing and improving employment picture and the picture is clear that tapering will come, but not because it will help stocks rally further.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Housing: Critical to US Economic Growth?
Thursday, June 06 2013 | 09:26 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“The US housing sector may finally become a direct and meaningful contributor to US economic growth in 2013 and beyond,” says Ron D’Vari, CEO and Co-Founder of NewOak.

“We forecast about 0.5% boost to the GDP supported by already observed trends in new and existing home sales as well as permits. The US economy has primarily been pulled out of the recession by government and consumer spending, and to a lesser extent by export-driven manufacturing. Up to as early as 9 months ago, residential construction had been very much absent. While the gradual stabilization of home prices kept the economy from falling into a tailspin, other factors (government and consumer spending) helped dig the economy out of the great recession. Until recently home building and related activities were not contributing much to the GDP as housing construction had fallen to its lowest historical levels, far below its natural equilibrium.”

“Stocks and bonds have appreciated due to global synchronised quantitative easing, yet this is not sustainable long term. Fast hands will sell at the first sign of any changes in Fed policy. However, despite the long reaction time, US home price are starting to show signs of getting back to their historical mean growth of 3% to 5% nationally.”

"Currently the main drivers of housing prices seem to be slowing REO sales volume and a large amount of private equity capital is rushing into the sector. Over time, we expect a gradual shift to end-user demand due to improved employment, household formation and fewer REO sales countering fading of private equity investments with improved home prices.”

“The housing sector touches many parts of the US economy including home builders, mortgage finance, construction companies & services, general contractors, construction supplies & fixtures, raw materials, home furnishing and appliances and related retail companies. Because of large reliance labor, the economic multiplier to the housing sector has been high. Therefore smart investors will be trying to read the tea leaves of the housing sector looking for telltale signs of the U.S. economic growth.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Home Prices: Why Do Lag Stocks?
Monday, June 03 2013 | 12:11 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Despite the 150% rise of the stock market from its lowest point in 2009 - and surpassing its pre-crisis high - the housing market has far to go to catch up its last peak," says Ron D'Vari, CEO and Co-founder of NewOak.
"Homes constitute an overwhelming part of the American household's net worth. While wealthy Americans have significant allocation to stocks and bonds, most Americans are under exposed to stocks and haven't benefited much from its rise."
"Given that home prices are still over 25% below their peak on average, and many Americans have lost their homes, we still must repair the damages to the economy incurred during the crisis. Many Americans have no equity in their homes, and over 25% of borrowers have negative equity in their houses placing them into net negative worth."
"Despite the GDP growth gradually crawling back toward the 2 to 2.5% range, economic stimulus has not been sufficient to propel the economy to cover the hole left by the great recession. Even though corporations and banks have repaired their balance sheets and are enjoying record profits, households' balance sheets have been weak and will remain so until housing prices fully recover and unemployment gets back below 7%."
"Structurally the secret has been low interest rates and inexpensive money to those with access. This has had a disproportionate impact on stocks over housing. Investors can easily pledge stocks and bonds to secure loans from their brokers to leverage them and benefit from a market rise. Margin interest rates can be as low as 1% but are typically near the prime (3.25%). By contrast refinancing has not been available to many homeowners because of their negative equity, unemployment, or damaged credit records situation."
"Housing is critical to a full economic recovery but will take time to normalize back to its historical norm. Hence, it naturally lags stocks yet it has the right momentum. Nevertheless, without significant rise in household income, it will be naturally capped by affordability and much stricter lending criteria."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Home Prices: Why Do Lag Stocks?
Monday, June 03 2013 | 12:11 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"With all eyes on the Federal Reserve and the talk about the timing of tapering, the May jobs report on Friday will be the most anticipated and watched release this week,” say James Frischling, President and Co-Founder of NewOak.
“The Fed has made the strength of the labor market a key factor in determining when it will start to pull back from its bond buying program. Good economic data including consumer sentiment reaching a 5 year high has people trying to figure out when the Fed will exit, but only meaningful jobs growth will push the Fed to the sidelines.”
“Stock market highs and a strong recovery in housing have resulted in the market being abuzz with the Fed’s easing off its accommodating position. But with inflation benign at 1%, only a sustained improvement in the labor markets will force the Fed’s hand. The rally in the markets and the improvements made in corporate balance sheets can be attributed largely to the action taken by the Fed. Yet there are concerns that the Fed is creating asset bubbles and have maintained its aggressive buying too long.”
“The economy needs a series of 200k reports in order for the Fed to have sufficient confidence that the recovery is self-sustaining. With expectations of jobs creation in May at around 160,000 nonfarm payroll (which would be slightly weaker than the 165,000 April report), we’re still below the numbers required to bring down the unemployment rate currently standing at 7.5%. The Fed said 6.5% was the target rate before it would start the process of taking the punchbowl away from the party. Unless the summer months bring on a hiring spree, the Fed may need to stay its course for the remainder of the year.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Monetary Stimulus:Time to Reduce?
Tuesday, May 28 2013 | 03:55 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The U.S. economy is still running far below its natural average growth while there is debate if it is time for Federal Reserve to start reducing the pace of monetary stimulus," says Ron D'Vari, CEO & Co-Founder of NewOak.
"Growth is starting to pick up in the US leading to the stock markets 17% rise. Signs, such as durable orders and housing permits, indicate that economy will further accelerate in 2013's second half. Nonetheless, the equity markets have retreated lately on the fear of Fed's scaling back of monetary stimulus and the budgetary cuts already in place."
"While U.S. GDP growth has gradually risen to 2.0%, it comes on the back of a deep recession and slow recovery while still facing a fairly weak global growth picture. Europe is struggling with a negative to flat growth. Its deep structural and austerity measures will take much longer time to heal. The sovereign bond markets have calmed down but remain fickle."
"China is also struggling to promote internal consumption to counter its slowing growth in export. While this is relatively good news for those fearing inflationary pressures due to natural resource limits, it dampens prospects of China balancing out Europe's problems. However, Japan's new pro-growth policies and targeting 2% inflation seem to be changing the dynamics there."
"Federal Reserve officials have signaled they will have a better sense by the fourth quarter of 2013 if the economy is on a sustainable path. They will decide then if it will be the right time to take away some of the stimulus punch. Given the fragility of the global economy, it is hard to see how a few more data points can create confidence that the economic normalization is on a solid path. Therefore, the markets will be on the edge and investors will treat any sign of reduction of Fed's security purchases as time to take some chips off the table. It is wise for investors to fasten their seat belts while going through the interplay of economic data and the Federal Reserve policy expectations and actions. Sometimes the anticipation can be worst than the news itself which is bound to come."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Regulators Worry & Economists Cheer?
Tuesday, May 28 2013 | 03:53 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Securitization and shadow banking are both at post financial crisis highs,” say James Frischling, President and Co-Founder of NewOak. “While the return of these leveraged investments and vehicles may cause some concern among regulators, economists see them as important components for the recovery to gain more footing and potentially steam.”

“The securitization market has generated nearly a quarter of a trillion of volume so far in 2013, a 14% increase in the same period in 2012. While the current figures represent a fraction of the volume generated before the financial crisis, the importance of this market to help generate lending shouldn’t be underestimated. Add to that the growth in the shadow banking system, which has amassed assets of $16 trillion which exceeds all the assets held in private depository institutions, and the potential boost to economic growth becomes clearer.”
“The technology behind securitization and the risk transfer associated with shadow banking weren’t the cause of the financial crisis. Poor credit quality, an over reliance on ratings and insufficient due diligence and analysis were the root causes of the crisis. With improving credit quality, more conservative structures and far greater scrutiny, the return of securitization and shadow banking may lessen the blow when the Fed starts tapering their bond buying program.”

“Heightened regulations and specifically higher capital requirements for banks, combined with an onslaught of litigation is forcing more money into the shadow banking market. Private equity firms along with other non-bank financial intermediaries will be benefit from the continued growth of the shadow banking system. Fortunately, if executed properly, so too will the economy.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Housing: Critical to US Economic Growth?
Monday, May 20 2013 | 12:16 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“The US housing sector may finally become a direct and meaningful contributor to US economic growth in 2013 and beyond,” says Ron D’Vari, CEO and Co-Founder of NewOak.
“We forecast about 0.5% boost to the GDP supported by already observed trends in new and existing home sales as well as permits. The US economy has primarily been pulled out of the recession by government and consumer spending, and to a lesser extent by export-driven manufacturing. Up to as early as 9 months ago, residential construction had been very much absent. While the gradual stabilization of home prices kept the economy from falling into a tailspin, other factors (government and consumer spending) helped dig the economy out of the great recession. Until recently home building and related activities were not contributing much to the GDP as housing construction had fallen to its lowest historical levels, far below its natural equilibrium.”

“Stocks and bonds have appreciated due to global synchronised quantitative easing, yet this is not sustainable long term. Fast hands will sell at the first sign of any changes in Fed policy. However, despite the long reaction time, US home price are starting to show signs of getting back to their historical mean growth of 3% to 5% nationally.”

"Currently the main drivers of housing prices seem to be slowing REO sales volume and a large amount of private equity capital is rushing into the sector. Over time, we expect a gradual shift to end-user demand due to improved employment, household formation and fewer REO sales countering fading of private equity investments with improved home prices.”

“The housing sector touches many parts of the US economy including home builders, mortgage finance, construction companies & services, general contractors, construction supplies & fixtures, raw materials, home furnishing and appliances and related retail companies. Because of large reliance labor, the economic multiplier to the housing sector has been high. Therefore smart investors will be trying to read the tea leaves of the housing sector looking for telltale signs of the U.S. economic growth.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

White House Scrutiny: Do Markets Care?
Monday, May 20 2013 | 12:14 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Life is often far more interesting than art. You couldn’t script the combination of headlines that hit the White House at the same time which included the IRS scandal, Benghazi talking points and AP probe,” says James Frischling, President and Co-Founder of NewOak.

“Despite the headlines, the markets logged a rally for the 4th straight week in a row reaching new highs. The White House issues may attract attention, but they’re not derailing the rally.”

“Controversies will not disrupt enthusiasm for stocks. The markets have not been the beneficiary of the political gridlock in Washington. It’s been the aggressive action of the Fed and the actions taken by the Treasury at the onset of the crisis that are the key drivers of the market performance.”
“Despite the importance of the current issues, the markets are watching the Fed and trying to gage the timing of any exit from the current policies. Since the Fed’s quantitative program has been the key driver, the exit could alarm the market that the punchbowl has been taken away from the party. Given the gains in the jobs market and a meaningful improvement in the federal budget deficit, there’s an understandable sense that the end of QE is very much in the cards.”

“Expect the Fed to want to get a read on the growth in the second quarter and specifically how the sequester cuts are impacting the economy. At that point, the tapering or the relaxing of an accommodating system should begin. The markets can continue to perform well in an environment of tapering.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Stock Markets High: Cause for Alert?
Monday, May 13 2013 | 10:31 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Stock market indexes are at a record high but so are better-than expected corporate earnings driven by monetary stimulus and supporting evidence for improving housing and steady economic growth," says Ron D'Vari, CEO and Co-Founder of NewOak.

"While no clear reasons for acceleration exist, the U.S. economy ahead is less subject to derailment from its slow recovery than anytime in the last five years. Europe is still struggling to deal with unemployment and recession, but threat of collapse is less likely. US budgetary issues remain but the system seams to be coping with it. Consumers are holding up despite the tax increases. A key issue remains unemployment, which must ne corrected to support a robust fundamental growth. The U.S. housing sector continues to be the bright spot."

"When analyzed in light of earnings and steady expected growth, the stock markets valuation is not out of line with the historical norm. The market's expectation of growth are very much predicated on the central banks stimulus continuing as long as the unemployment picture in U.S. and Europe has not normalized and inflation remains benign."

"Another reason for a lower probability of market crash is there is still plenty of investors with cash waiting in the wings for a potential dip to add to their equity exposures."

"It is hard to short U.S. consumer and housing sectors. Baring another global crisis many expect U.S. to do generally well. While risks remain high in the equities and debt markets, we recommend near normal exposures to the equity markets."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Mortgage Industry Rebuilding - Indicator of Robust Growth or Potential Bust Ahead?
Monday, May 06 2013 | 03:35 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Housing and mortgage market's gradual healing (according to some over exuberance) may be an indicator of a more robust U.S. economic recovery ahead despite continued concerns in Europe and parts of Asia," says Ron D'Vari, CEO and Co-Founder of NewOak, an advisory and risk management solutions firm.
"S&P 500 and Dow have both broken through important psychological barriers of 1600 and 15,000, respectively. These self-reinforcing trends have strengthened confidence in the American economy to be able to accelerate soon. The recent market momentum has been fueled by several factors including above forecast home sales, ECB interest cuts and consumer confidence rise."
"That being said, less bullish investors are looking for further fundamental evidence to commit capital. One area for a leading signal is the residential mortgage market. A healthy and vibrant mortgage industry will be critical to propelling housing and related industries which could fuel a broader base robust economic expansion. Despite a barrage of regulatory changes that could dampen the residential lending activities, the mortgage industry has been relatively upbeat. The May 5-8th gathering of mortgage professionals in New York city at MBA's National Secondary Market Conference & Expo is expected to attract a large and diverse group of professionals in residential and capital markets, mortgage originators, mortgage investors, investment bankers, rating agency professionals, risk managers, mortgage lenders, mortgage insurers, FHLB members, regulators, wholesale, correspondent and retail production executives, CMBS investors, buyers and sellers of distressed assets, mortgage brokers, warehouse lenders and securitizing banks."
"The events title of "Be the Bull in a Bear Market" speaks a lot about the mood and the reality of the market. While the costs of administering the new mortgage and banking regulations are unknown, the industry is hoping they can address that if the volumes keep up. Of course this will depend on the housing markets keeping up its latest trends and Fed not spoiling the party anytime soon. While the market is betting on the bulls winning, a potential bust could arise if the Fed takes the punch bowl away too early, the compliance with regulations becomes unbearable, or the banks decide to pull back."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Slowest Job Market Recovery Since WWII
Monday, May 06 2013 | 03:35 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The combination of a better than expected nonfarm payroll for April and upward revisions for February and March eased concerns that the job growth had stalled and took stocks higher,” says James Frischling, President and Co-Founder of NewOak.
“Nonfarm payrolls rose by 165,000 in April and the unemployment rate ticked lower to 7.5%, the lowest level since December 2008. The most positive aspects of Friday’s report were the revisions made to the two prior months where February was revised from an initial reading of 268,000 to 332,000 and March was revised from a paltry 88,000 to a minimally acceptable 138,000. The identification of an additional 114,000 jobs than initially reported softens the blow of what had appeared to be much weaker than expected jobs growth following a number of strong months.”
“The March report brought on fears that the economy was about to enter a spring slowdown for the 4th year in a row. While the April report and associated revisions don’t change everything, it was enough to ease fears of a slowdown and take the markets higher.”
“While the April report was seen as good news by the markets, for the nearly 12 million people unemployed in the US, this is the slowest job market recovery since World War II. With across the board Federal budget cuts as part of the sequester and higher payroll taxes on employees, economic growth is likely to slow. In this environment, in order for Companies to protect the bottom line, a conservative approach to headcount may be what’s necessary and that doesn’t bode well for jobs creation.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Q1 GDP Missed Expectations - Do Markets Care?
Monday, April 29 2013 | 12:14 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Friday's GDP report showed the US economy did not gain enough steam to meet expectations," says James Frischling, President and Co-Founder of NewOak.
"GDP expanded 2.5%, not a bad result when you consider how growth stalled at 0.4% in Q4 2012, but still missed the consensus 3+%. The markets, however, shrugged off the number, much like it's done with any news that disappoints."
"The economy has downshifted and the risk is that it will suffer a spring swoon for the 3rd year in a row. Higher personal taxes and lower government spending will have an effect on demand."
"Business spending on equipment and software dropped sharply, growing at a rate of 3% compared to nearly 12% in Q4. Whether or not the cooling in business investment can be blamed on the $85 billion in mandatory government spending cuts remains to be seen and is open for debate. While it might be too early to blame the cuts on the political rhetoric leading up to the sequester, we can all agree that it was severe and could have very well led CEOS to decide to hold-off on spending."
"The silver lining from all this is the conclusion that modest growth, combined with low inflation leaves little doubt that the Federal Reserve will continue with its multi-billion bond purchase program designed to keep rates low. Since the rally in equity markets is being dominated by the actions of central banks globally, the GDP report will help the Fed stay the course. This is good news for the bulls and worrisome for the deficit hawks."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

True Alt-A Jumbo Loans – Belong In Income Portfolios?
Monday, April 29 2013 | 12:13 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“Whole loan portfolios of well underwritten Alt-A jumbo residential loans with full documentation deserve consideration in constructing diversified income-oriented investment plan,” says Ron D’Vari, CEO & Co-Founder of NewOak.
“Disciplined underwriting of first-lien single-family residential mortgages with consideration of all relevant sources of income, including traditional W-2 income, of borrowers with good credit history and full documentation constitute a sound basis for designing a high quality mortgage lending program. However, due to strict capital rules and Dodd-Frank regulations most banks are not able to lend on such mortgages. As a result private capital sources and specialized REITS are beginning to create such lending programs and are commanding much higher yields than regular conforming mortgages.”
“The true Alt-A jumbo mortgage whole loan portfolios are based on investing in first-lien mortgages on single family homes made to high net-worth individuals that are fully underwritten with consideration of documented alternative income sources. The disciplined underwriting process focuses on all relevant income sources of the borrower as well as traditional narrowly defined income sources such as W-2 earnings (“Eligible Loans”). These loans are typically restricted to no more than 65% loan-to-value established based on independent appraisal combined with thorough in-house review. Given the variety of potential income sources encountered, the underwriting decisions are typically made on a case-by-case basis to ensure ability to pay and safety of principal investment.”
“The rates on true Alt-A jumbo loans will typically be higher than that of a conforming loans due to the higher return requirements of non-bank end investors. Borrowers would need to carefully assess if a jumbo loan is right for them considering their specific financial facts, loan needs and down payment capabilities. Jumbo loan limits vary by zone and are influenced by the general housing conditions of the area in which the property is located. Jumbo loans can range anywhere from $417,000 up to $3 million depending on location, borrower financial ability to pay, and size of the down payment.”
“True Alt-A jumbo mortgages can be used to construct portfolios of whole loans with stable cash flows and attractive coupon (typically 500-600bp over Libor). The unlevered Alt-A jumbo mortgage loan yields are comparable to high-yield corporate bonds and often beat most levered structured products such as legacy non-agency RMBS. Given the high quality of borrowers (high-net-worth with FICO score over 700), level of subordination (at least 40%), high quality collateral (homes in top areas), and accelerating housing industry, the cumulative loss expectations on True Alt-A Super Jumbo should be much lower than high yield corporate bonds but have less liquidity. Therefore income-oriented institutional investors should carefully consider well underwritten Alt-A jumbo mortgages as part of their asset allocation.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Debt Paradox: Growth At Even Lower Yields?
Monday, April 22 2013 | 01:28 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"BOJ's unprecedented move to join the global easing of monetary policies to revive growth has spurred an unintended emerging markets bond bubble," says Ron D'Vari, CEO & Co-Founder of NewOak.
"A weakening yen caused capital flows out of Japan into non-Japan Asia and developing countries. With already low G-7 yields, fixed-income flows have flown into the emerging markets in search of higher yields and push them to record low yields. The local currency yields of countries like Turkey, the Czech Republic, Poland, Mexico and South Africa are hitting their lowest ever. Philippine and Korea yields have hit lows of 3.29% and 2.51%, respectively, near the first of April and are holding steady."
"For Japan to grow, this would need to reverse with capital flows ultimately coming back in form of direct investments to support a higher production and consumption. That will drive Japanese yields to a higher equilibrium level over time and make yen to give back some of its cheapening."
"Non-Japan Asian emerging debt markets have come a long way over the last decade and are now offering a truly viable alternative to the developed countries bonds. With access to even cheaper capital, non-Japan Asian economies growth will be even more robust. Unlike the past, growth may not be accompanied with too high an inflation. For now this makes possible simultaneous coexistence of low yields and prospects of sustained higher growth. Enormous capacity to grow and human resource expansion plays a key in explaining the paradox for the time being."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Structured Products – Is it Safe to Re-enter the Water?
Monday, April 22 2013 | 01:28 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Led by the return of both commercial and corporate loans, the securitization industry is making a comeback,” says James Frischling, President and Co-Founder of NewOak. “The low interest rate environment is pushing investors to search for yield. Structured products are once again of particular interest for the attractive returns they offer.”
“The combination of higher quality loans underlying the securitizations with greater scrutiny of the products coming from the heightened regulatory environment helped convince many investors to return to this market. Add the deleveraging and forced liquidations of huge positions held by the banks and private equity firms and hedge funds stepping in with the necessary capital, and it’s clear why leverage and the search for yield may be the solution to problems caused by leverage and the search for yield.”
“The banks have made significant strides to improve the securitized deals coming to market, starting with the making of higher quality loans and then creating transactions that are more diverse and less leveraged. Investors are also conducting far greater due diligence and leveraging third-party firms to validate both the collateral and structures.”
“One specific area where market participants appear to have learned from history is in the area of dispute mechanics. Leverage makes good times better and bad times worse. When asset prices fall, margin calls and the potential collapse of transactions are predicated on the value of the underlying assets of a leveraged transaction. Establishing at the onset of a transaction the mechanics and procedures for calculating the underlying asset value in case of a disagreement will reduce the risk of the financing provider and leverage buyer being in court later.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Mortgage Lending Is Easing: The Administration Wants More?
Monday, April 15 2013 | 11:37 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The housing market continues to be one of the brightest spots in our economic recovery,” says James Frischling, President and Co-Founder of NewOak. “The improving housing market can be attributed to historically low mortgage rates, a tight supply of homes available for sale and an improving economy which allows potential buyers not to be so scared of coming back to the market.”
“Another key factor contributing to the momentum in housing is the enthusiasm of lenders, specifically regional banks and credit unions, to open up the books and make more loans. Lenders claim the requirements for securing loans remains rigorous and difficult for borrowers without stellar credit, but the mortgage products being offered certainly resemble the more aggressive financing options that were available at the onset of the financial crisis.”
“Mortgage finance is a very profitable business. How profitable? Just look at the record breaking year for Fannie Mae, earning $17 billion in 2012, while Freddie Mac posted earnings of $11 billion. The two agencies made over $50 billion in payments back to the Treasury and are predicted to pay back all the taxpayer funds by 2019. Fannie and Freddie have backed over 90% of all MBSs since 2008. The administration wants to reduce their roles in the mortgage market and the opportunity of generating attractive returns may just be what’s needed to bring back private capital.”
“The administration wants banks to lend to a wider range of borrowers and to take advantage of the taxpayer-backed programs. The idea is simple enough - that more Americans should benefit from the recovery in housing. The risks are also large – excessive risk taking could send us back from where we just came.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Defined Pension Benefits: How Defined Are They?
Monday, April 15 2013 | 11:37 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The economic crisis of the last six years, anticipated federal law changes, and a host of other factors will lead to re-defining what was supposed to be defined pension benefits for millions of U.S. pensioners," says Ron D'Vari, CEO and Co-Founder of NewOak.
"The corporate bankruptcies, market losses, and current issues with a large number of multi-employer pension plans, combined with anticipated federal law changes, will lead to reduction of the previously defined pension and post-retirement health care benefits of many retirees. This is on top of the low interest rates earned on pensioners other savings."
"Still uncertain are the rules that will be negotiated in congress to replace the 1974 federal rules governing pension plans set to expire in 2014. In anticipation of this, a team of unions and corporations are working to propose changes that can be used as the basis of congressional debates. The latest coalition's report suggest undoing some of the previous guarantees."
"Few would argue that many multi-employer pension plans are in deficit funding status as they only have enough funds (as low as eighty percent) to cover future liabilities. Something must be quickly be done to stop this from getting worse. The quicker a comprehensive solution is adopted, the higher the chances a greater portion of the long term benefits can be saved."
"The pensioners would be better off to give up some of their front-end defined benefits to reduce some of the pressure. Upfront reductions in benefits would open up room for better management of the underlying assets and could lead to higher returns and reversing some of the lost benefits. Otherwise the underfunded plans have to be frozen and immunized in a historically very low interest rate environment. Clearly no one would want to lock in the losses."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

MBS Central Counterparty: What's Holding It Back?
Monday, April 08 2013 | 11:33 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“There are many ways the buy-side could benefit from a regulated multilateral Central Counterparty ("CCP") trading platform for executing To-Be-Announced (“TBA”) agency MBS, a form of OTC derivatives," says, Ron D’Vari, CEO and Co-founder of NewOak. "The key drawbacks are initial and variation margins as well as related operational and collateral management challenges.”
“The Agency MBS TBA market is over $5 trillion in size and it is one of the most liquid OTC derivatives markets. The overall long and short trades net out every month. Some of the TBA positions settle through electronic delivery of conforming agency mortgage loan pools, and the remaining trades roll over to the next month at market levels. The MBS TBA market has had an established trading platform for some time which is now part of the Fixed Income Clearing Corporation (“FICC”), a subsidiary of DTCC. The FICC has also developed the necessary services to support an MBS CPP for several years: Specified Pool Trade ("SPT"), Pool Substitution for Electronic Pool Notification ("EPN"), and Pool Netting service with the FICC as the guarantor on all netted trades and the novation counterparty on eligible pool obligations.”
“Most asset managers do not post collateral on their TBA positions. CCP platform for TBA by construct requires initial and variation margins. Partly due to daily margin requirements, most TBA trades remain to be bilateral and have not been settling through the FICC CCP. Many buy-side firms don’t have the streamlined straight-through-processing of derivatives and lack robust collateral management and posting. However, TBA CCP would offer lower systematic risk and mitigates the counterparty risk to the real money accounts. Given the general resistance to strict margin rules and absence more stringent capital requirements, it is not certain when majority of TBA participant would migrate to FICC CPP. Hence we expect TBA would remain a bilateral derivatives market for the time being.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Equity Markets – April Showers?
Monday, April 08 2013 | 11:33 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The March jobs report delivered mixed headlines – less than expected job creation, but an improved unemployment rate,” says James Frischling, President and Co-Founder of NewOak. “A careful look at report, including the number of Americans no longer looking for work, gives reasons for folks to be concerned about the strength of the recovery.”
“While the negative report provides some level of evidence that the recovery is fragile, it also gives the Fed reasons to maintain its existing policies and to continue with its bond buying programs. For equity markets, the Fed’s policies have been the single most important driver of stocks. While a weak jobs report is bad for Main Street, it may prove to be just what Wall Street needs to get through the second quarter.”
“Over the past three years, April has proven to be a key turning point for the markets with peaks being followed by 10% to 19% declines. With consumer confidence falling and volatility sitting at multi-year lows, complacency seems to be taking shape and there’s a growing concern of a pullback. Add to that the start of earnings season and concerns that estimates are too high and you have to worry whether April will again prove to bring a correction. It’s hard for stocks to rally when earnings are being revised lower.”
“The result puts an even greater spotlight on Chairman Bernanke, who will be speaking twice this week in addition to the release of the Federal Reserve’s minutes from the last meeting. A strong message from the Fed about a continuation of the monetary backstop is what the market will need to avoid a fourth April pullback in a row.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Stocks Performed in Q1, So What’s Next?
Monday, April 01 2013 | 01:39 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"New York Senator William Marcy famously said, ‘to the victor go the spoils,’. In the first quarter of 2013, the bulls were the big winners and were rewarded for their risk-taking in US equities,” says James Frischling, President and Co-Founder of NewOak. “US equities delivered record highs and the Dow Jones Industrial Average had its best quarter since 1998. So where do we go from here?”
“Whenever you’re in record territory, it’s only natural to worry about when the party is going to end and about staying too long. The first quarter was fueled by low rates, renewed liquidity and a growing optimism that economic growth was improving. Heading into the second quarter, rates remain low and liquidity abundant, but the economic growth story carries both questions and challenges.”
“While it no longer gets the headlines, expect economic reports to start showing some level of weakness in the coming quarter as a result of the government spending cuts starting to impact the economy. Federal spending will drop by more than $40 billion through the end of the year because of the automatic spending cuts that were created as part of the debt-ceiling compromise. Paychecks are also smaller as a result of the yearend tax increases in connection with the Fiscal Cliff. There’s no doubt that both revenue increases and cuts in spending are important parts of fiscal responsibility, but they also hurt consumer confidence and create headwinds for growth.”
“Over the past three years, April has proven to be a turning point where peaks were followed by 10% to 19% drops. Don’t expect a repeat of years past, but a pullback of 5% to 10% is certainly not unreasonable.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Rental Housing: Is Institutional Investment Strategy A Lasting Phenomenon?
Monday, April 01 2013 | 01:39 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Due to hundreds of thousands of foreclosed single family units made available for sale by servicers, institutional investors have become attracted to and investing in the 1-to-4 unit rental housing strategy," says Ron D'Vari, CEO and Co-Founder of NewOak.
"Private equity funds are actively pursuing the strategy of buying up foreclosed single-family properties, repairing and renting them ("REO-to-Rent"). This is a change from the earlier REO activities by local players that flipped the properties to buyers that intend to occupy them. The end owner-occupants would be able to finance these units at historically low interest rates. The scope of these activities were limited due to capital constraints and qualified owner-occupant home buyers."
"Institutional investors have been using some of the same savvy local groups that were buying REOs in auction, fixing and flipping them. The difference now is that the local bidders intended to sell them to PE funds. Hence, REO sale prices have been steadily rising. This has contributed to the perception that the housing recovery is on the way."
"The skeptics have questioned the real quality and depth of the US housing recovery which had been occurring in the midst of the highest foreclosure activity. Despite accelerating residential REO liquidations, the auction prices of single-family housing have been steadily rising due to the institutional investors demand."
"To maximize their recoveries, GSEs also have put in place REO-to-Rent programs of their own. Under Freddie Mac's REO Rental Initiative, labeled as a temporary initiative for the time being, qualified former owners have an option to lease properties in which they still reside in after legal foreclosure by servicers on behalf of Freddie Mac. However, to qualify for the rental, the house must be in good condition, meet state laws, local code requirements, and be environmentally free of hazards. This could be an issue unless the servicers are willing to deal with the deferred maintenance."
"The rental housing strategy is spreading to London and south of England. Prudential asset management is about to become one of the first institutional investors to enter the UK rental housing market by purchasing of more than 500 homes from the Berkeley Group. This will be a pivotal transaction and will encourage others to follow."
"Once the institutional infrastructure for investing in single-family housing has been established and scaled up, many expect the funds to continue it as long as the income and returns stay relatively attractive. This phenomenon is partly driven by another set of forces well in place. Many potential first-time buyers who have recently entered the job market from schools are no longer eligible for loans due to large amount of student loans they have taken on. This keeps an upward pressure on rents but help home prices remain stable. These factors combined with low interest rates, continued supply, and desperate search for higher yields, will keep the rental housing returns relatively attractive to institutional investors for foreseeable future."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

U.S. Economy: Consumers Hold the Key?
Monday, March 25 2013 | 11:01 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Despite all the headwinds of rising payroll taxes, spending cuts, and Europe, U.S. consumer spending is still expected to accelerate and stay robust throughout 2013," says Ron D'Vari, CEO & Co-Founder of NewOak.
"The outlook for the U.S. domestic demand has been steadily strengthening. Consumer spending has been key and will be propelled by gradually improving employment, rising personal income, sustained strength in housing, and buoyant stock prices. Expanding economic activities in housing and various manufacturing sectors including larger ticket goods (e.g. autos, capital goods, and aircrafts) are broadening the U.S. economic recovery and adding to the overall resilience."
"To be sure, new home sales trend of annualized 450K+ and expanding existing home sales are still significantly below pre-credit crisis years. However, the 8% annual rise in home prices in the top 20 metropolitan areas has been powerful in fueling consumer confidence, albeit from a low base and sales been partially driven by investors and not for primary residence."
"Globally, recent announcements by Boeing and Airbus of winning large commercial aircraft orders confirm general economic optimism. Nevertheless, some investors are concerned if this is driven by overheating markets rather than real sustainable demand growth. In the case of aircrafts, the rising orders have been driven by airline expansion plans and have not yet been substantiated by actual consumer demand."
"Events in Venezuela, instability in Turkey’s neighbors, and economic uncertainty in parts of asia such as Vietnam don't seem to be disrupting emerging market capital flows and record low borrowing costs. Hence, we don't expect a major surprise given improving trends in the global financial market structure all around."
"Resilient U.S. personal spending will be the main driver of the U.S. economy and provide support for the global economy. Five years of torturous economy has created a significant pending demand. Absent a major global set back, we expect continued positive trends and would be watching consumers as one of our leading indicators."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Crisis in Cyprus: Unprecedented Measures?
Monday, March 25 2013 | 11:01 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"With Cyprus’ need to raise 5.8 billion euros in order to receive a 10 billion euro bailout from the EU, an unprecedented levy on depositors appears inevitable,” says James Frischling, President and Co-Founder of NewOak. “Similar to the difficult negotiations and the ultimate measures taken by other EU members, there are times when only hard choices are available.”
“While the proposal to seize some percentage of deposits above a certain threshold was met with understandable outrage, the reality is that the Cyprus’ banking sector was severely hit by its exposure to Greece and a history of risk taking – according to the governor of the Bank of France, Cypriot banks took risks that were simply not allowed in France. German officials added that the Cyprus’ offshore-haven business model was never sustainable.”
“When two of the biggest members of the EU are so critical of Cyprus’ banking sector, it’s no wonder to the extent in which the EU will push Cyprus into accepting pain in exchange for a bailout. It appears the requirement to hit depositors is a rifle-shot at what the EU believes is the cause of Cyprus’ banking crisis: the lowest corporate tax rate in the EU to attract companies and outsized interest rates to attract customers worldwide.”
“Recent history shows that when faced with the choice of accepting tough financial measures or not receiving help from the EU, the country in need takes its medicine. In the case of Cyprus, the medicine it will be forced to take will forever change its status as being among the best place for international companies to continue doing business.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Private Equity Firms – Wooing the Average Joe?
Monday, March 18 2013 | 12:09 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The Carlyle Group, one of the world’s largest and most successful private equity firms, recently lowered the threshold for investment to $50k,” says James Frischling, President and Co-Founder of NewOak. “The reduced threshold is clearly an attempt to tap into an investor base that represents trillions and until now was not the focus of PEs firms.”
“Carlyle and its peer group had until recently limited its client base to multimillion-dollar investments. The lowering of the investment thresholds comes at a time when stock markets are at all-time highs and fixed income yields are at historic lows. So in an environment where investors are searching for returns, some of the most prestigious PEs firms are opening their books and giving retail investors the opportunity to participate in what has traditionally been an investment community that was off limits to anyone other than the super-wealthy.”
“Critics of the move highlight the aggressive fee structure, which in the case of the new Carlyle fund is 1.5% for the manager and 1.8% for the feeder for a combined 3.3% running management fee. There’s also the performance fee which accounts for 20% of the profits which will go to the manager. While these numbers appear high and are obviously far more expensive than mutual funds, the returns of these PEs funds can far exceed those from equity and bond fund managers. Based on some historical performance of the major PEs firms, one could argue that the investors are getting a great deal. Firms like Carlyle and Blackstone have access to opportunities that are truly unique, so the high fees may be very justified.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Future of Finance: More Consumer Friendly?
Monday, March 18 2013 | 12:09 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Our post credit crisis' competitive landscape, forced by factors such as excess liquidity, low rates, technological advances, and new ways of connecting to potential borrowers, will gradually be leading to a more consumer-friendly lending environment," says Ron D'Vari, CEO of NewOak Capital.
"The new regulatory requirements forced traditional lenders to pull back and examine their various business lines. The traditional entities include banks and legacy finance companies. As a result, new entities that are not burdened by the legacy issues and systems, are entering the lending markets driven by fresh approaches and armed with less restrained private capital.
The new entrants are trying out more adaptable approaches to the borrowers' financing needs, ability to pay, and ongoing servicing realities than traditional channels were able in the past."
"As a result some finance sectors are beginning to become more borrower friendly because of the new private non-bank finance companies. There are also emerging finance programs, such as peer-to-peer and crowd funding, now expected to evolve and provide more meaningful options to borrowers."
"Non-conforming mortgage origination market itself is also finally coming to life. The mortgage sector has been overwhelmingly driven by conforming mortgages dominated by the larger banks. The number of the non-bank lenders have grown, including mortgage REITs and hedge funds. This trend will accelerate due to the attractiveness of the yields in the wholeloan sector vs other fixed income products. This hasn't yet meant that the mortgage lending standards are being lowered."
"Another important area of advances is in establishing the match between qualified borrowers and the right lenders providing programs meeting their specific needs. The progress is due to many web technological advances. As a result borrowers have been empowered with better shopping options."
"Due to the new strict consumer protection rules going into effects, the servicing industry is also going through a transformation of its own. One emerging area has been banks selling mortgage servicing rights ("MSR") to non-bank entities."
"Many hedge funds and private equities are looking into investing in the MSRs in a large and meaningful way. The new investors do not necessarily want to perform the servicing task itself, which requires elaborate and expensive infrastructure investments, hence sensitive to the economies of scale."
"Economic investing in MSRs require an ability to forecast borrower behavior such as mortgage prepayments and delinquencies. Specialty analytic firms such as NewOak have been getting busier helping economic investors to properly assess and value potential MSR pools."
"We expect the non-bank finance ("NBF") and related servicing sector will be a high growth sector and very dynamic - not just in the U.S. but also globally. NBD growth will accelerate for the next two to five years with the economy and will attract a great deal of fresh capital and technological and operational innovation. Despite regulatory and policy concerns, the consumers and economy will be the direct beneficiary of the NBF growth."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Global Financial System: Proven its Resilience?
Tuesday, March 12 2013 | 09:05 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Despite the great recession, European sovereign debt crisis, and many conduits, financial companies and bank failures, depositors and money market participants in the U.S. and Europe haven't lost any of their principal savings," says Ron D'Vari, CEO & Co-Founder, NewOak.
"Ever since the summer of 2008, the overall financial system has toyed with chaos and has appeared to go on the verge of collapse many times. Throughout both banking and shadow banking systems have masterfully been kept solvent by the central banks, albeit at the cost of little compensating yield to the savers."
"In retrospect, the early liquidity disruptions experienced by Special Investment Vehicles ("SIVs") and bank-backed conduits have ended up to be the tip of the iceberg, though it was not a foregone conclusion at the time.
" SIVs and bank-conduits -- which had issued several trillions of Asset-Backed commercial paper notes ("ABCP") held by money market and corporate cash accounts -- were initially viewed to be safe, yet later proved not to be safe in vehicles not fully backed by the banks. Early on, the money market and short-term bond investors couldn't distinguish between credit and liquidity impairments. To some, the so called liquidity crisis had appeared as an opportunity of a life time."
"Events of the second half of 2008 helped clarify the magnitude of the underlying issues as liquidity problems abruptly turned to credit blowups. As a result, in the absence of any other safe haven, many investors rushed in to sovereign bonds, unaware of their own pending crisis to be discovered later."
"The financial collapse of Lehman and Iceland forced policy makers rushing to rescue many others such as Ireland, Portugal, RBS, Citi Group, UBS, Washington Mutual, Merrill Lynch, and Wachovia. This was a stopgap until much more comprehensive plans were globally coordinated to gradually to help economy and markets dig out of the crisis."
"Speeding forward six years, there are still many sizable government-backed entities struggling with insurmountable debt in the foreseeable future. This is particularly true in the Europe market but also in certain public sectors in the U.S.."
"Greece exposed the fundamental flaws in the Euro system's construct. By now, markets come to believe that these would eventually be resolved but have accepted that it will take a long time. The European leaders have moved on to address the fiscal and political quarrels in Italy, uncontrollable unemployment in France, and rescue plans for Cyprus in an effort to avoid another sovereign market turmoil. Germany and other northern European countries are reluctantly learning that they are all in this together and hence need to be more flexible in their approach."
"Throughout the crisis, overwhelming majority of bank depositors and money market funds have been made whole because they are the backbone of the financial system. Collective acknowledgment of the safety of the short time deposits in retail and corporate cash accounts, fiduciary or institutional, has proven pivotal to eventual return to normalcy. Overall the system has worked, but has been rocky at times. Accordingly, Cyprus officials' insistence on keeping depositors out of its debt restructuring makes sense and is consistent with the monetary policies of the past elsewhere."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Strong February Jobs Report – Is the Employment Picture Rosy?
Tuesday, March 12 2013 | 09:04 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Friday’s jobs report was better than expected with employers adding 236,000 jobs, far better than the 160,000 most economists were expecting,” says James Frischling, President and Co-Founder of NewOak. “In addition to the jobs created, the unemployment rate fell from 7.9% to 7.7%, the lowest level since December 2008. The February Labor Department data helped propel stock markets higher. So is everything rosy?”
“While the job growth was a surprise to the upside, there is growing concern that much of the improvement to the unemployment rate is the result of an increasing number of Americans no longer looking for work. Today, if the participation rate were the same as it was when President Obama took office, the unemployment rate would be nearly 11%. The participation rate, which now stands at 63.5% is the lowest level since 1981.”
“Another worry about the unemployment rate is that it was calculated before the sequester and the resulting across the board budget cuts were put into effect. The concern is that the federal spending cuts and its impact on employment will be felt later this summer and will harm the economy and will be a blow to the employment picture.”
“The strong stock market performance and the improvement in corporate balance sheets will hopefully pave the way for real improvements in employment. However, wealth creation on Wall Street doesn’t mean job creation on Main Street. The regulatory environment still makes investing in human capital a challenge and companies are doing everything they can to improve efficiencies so they can continue to do more with less.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

European Debt Crisis: Coming Back to Life?
Monday, March 04 2013 | 02:56 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"When ECB President Mario Draghi used his own version of a bazooka in the form of three year loans at cheap interest rates, short-term yields of some of the most challenged EU members dropped sharply,” says James Frischling, President and Co-Founder of NewOak. “The move by the ECB prevented rates from spiking to levels that would topple countries and the European Union appeared to become more integrated and the European Debt Crisis appeared to have been averted.”
“The elections in Italy and the resulting political uncertainty are sharp reminders of just how troubled the region really is and how dangerous its debt crisis continues to be for the EU and the global economy. The message from the preliminary results is clear: parties that push for austerity as a means of cutting deficits will not be well received.”
“The upheaval in the Euro zone’s third largest economy is a wake-up call for indebted countries. Voters are not going to support agendas that call for labor reforms and budget cutting. The ECB, like the Federal Reserve, will continue to signal to the markets that their easy monetary policies and commitment to low interest rates will remain and that they have the tools to combat inflation and exit when appropriate, but these central bankers are working without the help of the elected leadership.”
“The inability of US officials to avoid the sequester was a sign that while the US needs to cut spending, they would rather blame some predetermined arrangements than risk owning any specific cut. Central banks have bought politicians some much needed time to bring down its debt levels, the politicians, however, won’t keep their jobs if they do.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Big Data: Revolutionizing Bank & Finance Risk Management?
Monday, March 04 2013 | 02:56 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“Big data is already revolutionizing most commerce, bank & finance credit and market risk management will be no exception,” says Ron D’Vari, CEO of NewOak.
“Timely and accurate information on borrowers, counter parties, suppliers, clients, and markets are the fundamental ingredients for ongoing life-cycle analysis of credit and market risks. This encompasses sourcing, filtering, originating, underwriting, compliance, validation, pricing, documentation, closing, servicing, monitoring, and mitigating risks over the entire life cycle of exposures -- typically a vast number of them. Businesses such as mortgage banking, small to middle market banking, commercial lending, consumer finance, retail banking, insurance, and asset management involve massive amount of data that dynamically change over time with global and local socio-economic fluctuations.”
“Traditionally, the vast amount of data and corresponding documents have been compartmentalized across series of departments/parties spanning from origination to servicing. This has not been by choice but forced by the sheer magnitude of the data and the technology available just a few years ago. The only way to deal with the layers of data embedded in the legacy business applications was to keep them fragmented. The opaqueness of underlying data layers have made real-time access and business analysis nearly impossible under the traditional structure. The opaqueness of underlying credit have undoubtedly contributed to the credit crisis. During the credit crisis, the changes in credit performance became abrupt driven by rapidly changing exogenous macro factors.”
“The analytical tools and corresponding technological infrastructure required to perform real-time analysis across an entire financial institution’s business lines and credit counterparties have become a necessity. This change has been mandated by stringent internal credit risk management standards as well as compliance with a myriad of new regulatory requirements. Many of the pending regulatory requirements are not yet defined and are still being finalized. Fortunately the new generation of enterprise systems incorporating big data architecture and processing tools can integrate vast amount of structured and unstructured data sources gathered from variety of channels. These systems will allow fact-based critical and complex credit and risk management analyses be done on a timely basis. If this the big data trend gets adopted by most institutions, it would naturally lead to a more transparent and dynamic credit monitoring and policy settings and help avoid domino action caused by spreading credit risk across banks and financial institutions globally. And that would be a bone fide revolution over status quo in bank & finance.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

TIPS Misunderstood?: Looking at Treasury Inflation Protected Securities
Friday, March 01 2013 | 11:04 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"While many institutional investors are rushing toward inflation linked securities ("linkers") such as TIPS to protect themselves against more tolerant monetary policies toward inflation, they are still exposed to real growth acceleration," says Ron D'Vari, CEO and Co-Founder of NewOak.
"Inflation linked securities such as TIPS are inflation neutral. However they are highly exposed to expectations of acceleration in real growth. This is because investors receive a fixed real rate plus inflation index. Real growth exposure is harder to hedge in fixed income securities other than going straight into floating investments. At the moment straight floating bonds pay very little in current income but are fully hedged against both inflation and real yield rises with ongoing coupon adjustments."
"Significant majority of fixed income instruments tend to have a fixed nominal coupon and hence exposed to both higher inflation and real growth. Given markets wariness of pending inflation and accelerating real growth, nominal bonds are appearing very risky. This is contingent on one believing in accelerating global growth."
"The gap between nominal yields of longer dated government bonds and linkers is currently around 1.70% ("break-even inflation") while the 2013 inflation expectations are around 2.7%. Investors' fear of rising rates have pushed them into cash or inflation linked securities causing them to outperform nominal bonds. With rising yields, both nominal and real all bonds, nominal and linkers, will underperform cash and floating instruments."
"The rising growth risks are real as there are clear signs of accelerating global growth. Therefore the bond investors may need protection from rising consumer prices and accommodative monetary policies which should jump start growth. There is a likely scenario where growth picks up while inflation remains subdued. Under such a scenario, the TIPS and other Linkers would underperform nominal bonds and floaters. Nevertheless some economists believe both inflation and growth will remain subdued given the major challenges with unemployment, budget constraints and upcoming austerity measures."
"While it may feel safe to be in inflation linked bonds or TIPS, other alternatives should be evaluated. The viable alternatives include cash, pure floating bonds, or hedging out interest of fixed coupon bonds."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Sequester or Bernanke: What Do Investors Care More About?
Friday, March 01 2013 | 11:04 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Congress must reach a compromise by Friday to avoid the automatic spending cuts which are part of the sequester,” says James Frischling, President and Co-Founder of NewOak. “Of key concern is the mandatory $85 billion in spending cuts this year which could impact the economic recovery as well as highlight to the market the gridlock that continues to dominate Washington.”
“Despite the looming significant cuts, markets have been relatively calm. This might change this week. While the Senate is set to consider bills that would avoid the cuts over the next few days, expect investors to closely watch the testimony of Chairman Bernanke to Congress on Tuesday and Wednesday. Investors know that Federal Reserve’s commitment to low interest rates and monetary policies have been the most important driver of stock market performance. Any signs from the Chairman that such policies, like all good things, need to come to an end, will be seen as far more significant than the drama playing out in the sequester negotiations.”
“The minutes from the Fed’s January meeting spooked markets because it showed that a number of policymakers thought the asset purchases may need to end even before significant improvements to the job market can be achieved. The market reaction to the news sent the US dollar to a four-week high against the euro and triggered a selloff in stocks. The Fed knows just how much investors have come to rely on its easy money. Communicating how these monetary policy changes will take place will be the Chairman’s next most important job”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Will the Looming Spending Cuts Spook the Markets?
Tuesday, February 19 2013 | 01:04 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"With less than two weeks before the automatic spending cuts go into effect unless Congress and the President cut a deal, the conviction of the bullish equity investors is once again being tested,” says James Frischling, President and Co-Founder at NewOak. “Will this lead to a market correction?”
“The sequestration is the extensive and mandatory cuts that were developed back in the summer of 2011. Congress was unable to agree on a deficit reduction package and the belief was that massive cuts to both defense and non-defense items would force a compromise. Both sides agree that allowing these cutes to take effect would have a severe impact on the economy, however, with less than two weeks to go before the cuts are enacted, neither side appears willing to compromise.”
“Economists unilaterally agree that the cuts would take a bite out of the economy and market pros are warning that the reaction to this self-inflicted wound could be severe. Investors are once again being asked to watch Washington come together in the last moment to solve what will otherwise prove to be a major blow to the markets.”
“Despite the growing rhetoric and warnings, investors seem to have become desensitized to the Armageddon story and for good reason: they’re convinced Congress will reach a compromise. They also believe that if our deficit is the result of our having a spending problem, then being forced to cut spending can’t be all that bad. While investors may be underestimating the impact these mandatory cuts will have on the markets, they do understand that our country has to change its spending habits.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

OTC Derivatives: Regulatory Changes are to Tame or Slay the Markets
Tuesday, February 19 2013 | 01:04 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The Revised proposal released by the Basel Committee on February 15th will exempt banks from posting the first €50 million of collateral as initial margin for non-cleared swaps and will delay full compliance until 2019,” says Ron D’Vari, CEO & Co-Founder of NewOak.
“Basel III rules are intended to primarily enhance the quality and transparency of the banks’ capital base. The rules will also be strengthening the framework for the capital coverage through several mechanisms including a more integrated approach to market and counterparty credit risk, dynamic counterparty’s CVA (credit valuation adjustment) adjustments, and enhanced capital requirements for counterparty credit exposures and repo financing. The more stringent capital requirements for non-cleared bilateral swaps are meant to provide incentives for the banks to move to centralized exchanges as counterparties for standardized OTC derivatives.”
“One of the areas of concerns has been the harsher initial margin collateral requirement for non-cleared swaps starting from 2015 and associated eligible collateral liquidity scarcity. The revised proposal provides more time for compliance and reduces the estimated total eligible collateral need by over half to a more manageable €700 billion. The banks and the larger end-users have been objecting to the initial proposal and were worried about the scarcity of available eligible collateral and tight liquidity due to the sheer size of the total collateral requirements. Further, the banks needed more time to deal with simultaneous issues of economic slowdown, deteriorating credit, and weakening capital positions of European banks. Some predicted that the initial proposal would have significantly shrunk the overall size of the OTC derivatives and left many parties without reasonably-priced hedging alternatives.
“The revised proposal softens some of the concerns and allows for a smoother transition. Furthermore, the common standards between Europe and US should also eliminate any potential arbitrage by market participants and related distortions. Net-net, the revised proposal will help tame the OTC derivatives market by shoring up counterparty risks in both centrally-cleared and non-cleared swaps without clearing secondary eligible collateral liquidity squeeze. This will reduce the need for collateral transformation services some of the trustee banks are gearing up to provide when the program is in full force.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Search for Yield: Are Chinese Nonperforming Loans Attractive?
Monday, February 11 2013 | 11:07 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"As nonperforming loan levels held by banks and trusts in China are rising and yields in sovereign and high yield corporate bonds are falling, international alternative investors are looking to jump in," says Ron D'Vari, CEO and Co-Founder of NewOak.
"Nonperforming loans made to property developers, local governments, mining companies, technology and manufacturers are starting to weigh in on the banks and lightly regulated private trust asset managers. These entities are being forced to clean up their balance sheets by regulators and they have to sell them at deep discounts to alternative distressed funds."
"Investors' realized returns will depend on the ultimate performance of borrowing entities, collateral taken, and the amount of partial repayments by borrowers, and the time it takes to work them out."
"The restructuring rules in China follow a different and vaguer legal path than the U.S. The borrowing entities are typically not shut down and investors are forced to swap their debt to equity ownership or go after the collateral assets such as real estate. The distressed specialists need to have a very good sense of their workout strategies and the associated legal process challenges and make sure they don't over pay for the nonperforming loans to begin with. In some cases, the prices paid have to be even below 10% of the face value to make the expected returns to become attractive enough for the investors' troubles."
"Under normal circumstances, the banks and trusts are not inclined to sell the loans at deep discounts and try to hold on to them as long as they can as they have cheap deposit funding. It requires sever regulatory capital rules to force banks to consider selling these loans. The discounts depend on the supply and demand and chinese banks' capital shortfall situations and how desperate they are."
"Given the improving economic winds in the U.S. and lower corporate defaults, the alternative investors are starting to consider opportunities elsewhere. Asian distressed debt is becoming sizable enough to merit attention of the distressed-debt hedge funds."
"There is already domestic demand for nonperforming commercial loans in China and foreign specialist hedge funds are raising dedicated capital pools to start investing in them. The actual amount of non-domestic investments in Chinese distressed-debt to date are still relatively modest but are expected to rise. The volume of distressed loans are expected to continue to increase because of a massive number of marginal loans made during the global financial crisis of last five years to artificially avoid economic slow down. These loans have started to go sour and are causing capital inadequacy issues for the Chinese banks and shadow banking."
"While distressed Chinese debt investing will be a developing opportunity to watch, there are plenty of opportunities in Europe to act on today which may have higher return potentials."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Time For Alternative Investments?
Monday, February 11 2013 | 11:06 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Major bond fund managers are calling for an end to the bull-run in bonds and US equity markets are trading at multi-year highs,” says James Frischling, President and Co-Founder at NewOak. “Where do investors go for returns?”
“Many investors have missed the rally that began when the Federal Reserve started pumping money into the system and committed to a low interest rate policy in order to avert a far greater crisis. The actions of the central banks were intended to save the financial system. Inflating asset prices was a welcomed consequence of these policies.”
“With bond gurus warning of an inevitable increase in interest rates and hit to bonds and with equity markets trading at historically high levels, investors with capital to deploy are searching for returns. The environment suggests the risk-on trade is still very much in effect, but the liquid markets represent a scary place to deploy capital given their performance over the past few years.”
“The scenario is leading many investors to look at the off-the-run assets and less liquid markets in search of yield. A myriad of loan products as well as commercial and residential mortgages are in need of funding. The new regulatory environment is making it more difficult for banks to be an owner of these assets as a result of the capital charges.”
“The deleveraging of the banks has led to opportunities for PE firms and hedge funds to provide capital at attractive returns to what was previously a bank driven market. The level of due diligence and asset expertise required is substantial, but the opportunity to get paid for the risk is very attractive.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

GDP’s Surprise Drop – Signs of a Slowing Economy?
Monday, February 04 2013 | 11:20 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The US economy dropped 0.1% in the fourth quarter, a report that defied expectations for slow growth,” says James Frischling, President and Co-Founder of NewOak. “The surprise contraction raises concerns about the economy’s ability to handle the tax increases just imposed and the spending cuts that will take effect in March unless Congress acts.”
“However, much of the GDP contraction can be attributed to the drop in defense spending and a slowdown in inventory accumulation. Hurricane Sandy was also a factor, but the drag on output last quarter could reverse this quarter as a result of spending associated with rebuilding projects.”
“Looking beyond the GDP announcement, the employment picture is improving and is healthier than many expected. Employers added 157,000 jobs in January and according to the Labor Department, 127,000 more jobs were created in November and December than previously reported. Another positive driver for the economy was found in a report from the Institute for Supply Management which showed factory activity hit a nine month high in January. Add to that the surge in car and truck sales and an improvement in consumer confidence despite the smaller paychecks (as a result of some federal tax increases) and the positive news helped drive the Dow Jones to its highest level since October 2007 and the S&P a 5-year high.”
“The pace of job growth continues to be too slow for the many millions of Americans that are unemployed or underemployed, however, that continues to give the Federal Reserve the ammunition it needs to continue with its bond-buying and low interest rates policies. Positive economic reports combined with the Fed’s commitment to low interest rates? That’s a combination that can drive these markets higher.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Pension and Sovereign Wealth Funds: Over Allocated to Bonds?
Monday, February 04 2013 | 11:19 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Pensions and sovereign wealth funds are rapidly re-evaluating their substantial allocations to bonds and are considering commercial real estate, private equity, emerging markets equities and alternative assets," says Ron D'Vari, CEO and Co-Founder of NewOak.
"Recent announcements by entities such as Japan's Government Pension Investment Fund ("GPIF"), Norway Sovereign Wealth Fund, and CIC are just the tip of the iceberg in a move out of bonds to other assets with more attractive risk-reward profiles."
"Sizable allocations to bonds before and during the crisis has been critical to the shoring up of returns of most pension and sovereign wealth funds. With economic prospects reverting to steady, but relatively modest growth, many large pension and wealth funds are questioning their overweight to bonds and are gradually considering to reverse them."
"Given low yields in sovereign bonds and other fixed income assets, institutional funds are seeking diversification, current income, yield, inflation/principal protection in the more conservative US and global commercial real estates."
"Most experts fear the interest rates in the U.S. and Japan will have to go up relatively soon given the monetary policy and economic cycle. That leaves vast sums of money invested in fixed income at some of the lowest historical yields at risk of under performance once the momentum changes."
"The recent rally in the global stocks and corresponding bonds under performance have been powered by stronger-than-expected Corporate earnings, continued aggressive Federal Reserve stimulus efforts, investors confidence in the U.S. housing and domestic recovery, and China's revived economic expansion. A number of positive news have driven the markets up and created more justification for the stock market rally and bond market under performance. The U.S. economy's contraction at the end of 2012 was a surprise but it is explained by several factors including the economic disruption caused by hurricane Sandy and subsequent reconstruction efforts."
"While it is quite likely that substantial amount of investments will be re-allocated out of fixed income, it will not be sudden. Hence bonds will remain a core holding for most pension and sovereign funds but other asset classes will be added on the margin for diversification."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Can Anything Derail the US Equity Rally?
Monday, January 28 2013 | 03:31 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"With the US equity markets now trading at multi-year highs, and with record setting money flows, can anything derail this rally?" asks James Frischling, President & Co-Founder of NewOak.
"The answer is the sequester and the associated spending cuts that were agreed to back in 2011 and that will take effect on March 1st. The Fiscal Cliff debate was resolved with little effect felt by the markets. Investors had been conditioned not believe the rhetoric of either side and to believe that a deal would be reached. This political movie of a last minute deal that would save the day was known and the investors didn't blink."
"More recently, many have viewed the move by Republicans to extend the US borrowing authority as yet another sign of cooperation with Democrats, but that might be an overly optimistic conclusion. Conservative lawmakers have said they're ready for a budget fight and for the sequester to happen. While the amount of defense cuts, $600 billion over ten years, isn't exactly what the Republicans want, they seem prepared to let them happen as part of the overall $1.2 trillion in cuts to bring down spending. The Democrats are far from in love with the sequester as well. The non-defense cuts include many programs near and dear to the White House, including the FDA, EPA and National Institutes of Health."
"The sequester would take its toll on growth in 2013. By some estimates, the cuts could hit growth by nearly 1% and our modest recovery is too vulnerable for that amount of wind to be taken out of its sail."
"The equity markets have been the beneficiary of the Federal Reserve policies, as well as the policies & actions of central banks all over the world. Given their historically low position in terms of asset allocations and with strong inflows to equities, it appears nothing can stop the rally. The sequester could be an event that changes that view."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

U.S Housing Recovery: Why is it So Critical?
Monday, January 28 2013 | 03:31 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"A steady U.S. housing recovery is essential to a robust U.S. economic growth and prospects of future corporate earnings expansion," says Ron D'Vari, CEO & Co-Founder of NewOak.
"Housing markets are directly tied to everything from tools, construction material and equipment, furniture, kitchen equipment, to HVAC. Many of these sectors have been dormant since early 2008 and they are needed to validate the recovery. More importantly any sign of true bottoming and steady recovery will help to build corporate confidence to grow spending and add new jobs. Employment and housing have been the prime areas targeted by the Federal Reserve and government to normalize."
"While data on the home improvement industries is starting to show positive but preliminary signs, more information will be needed to convince the markets. The risk is that 2012 housing improvements were not permanent and was driven by short term activities of local speculators and hedge funds. The shear number of borrowers in negative equity status and the non-performing residential mortgages pose a threat to supply-demand imbalance that can disturb the apple cart."
"Absent true demand, the housing market can revert backward quickly with any signs of banks starting to clean out their books of the non performing mortgages and REOs. The implementation of new accounting and regulatory capital rules would be the catalyst to such dispositions."
"Housing has to lead the economic growth from here on. The U.S. economy is running out of all other engines of growth but housing. The consumers are tapped out and are de-levering while corporations are overly cautious. True housing demand will come when new jobs are created and real wages rise. The low interest rates help but buyers need steady income to qualify. Hence we seem to be stock in a chicken and egg dilemma. Until corporations become more confident, they are going to be cautious in adding jobs."
"Early data on housing-related corporate earnings are promising but we are not anywhere close to be out of the woods. We need banks to start normalizing mortgage lending standards and Fed keeping the rates low to work-through the distressed properties. Markets are keeping their fingures crossed but are already expecting and that is the risk."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Main Street Returns to Stocks: A Bearish Sign?
Tuesday, January 22 2013 | 11:02 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Lipper reported that stock funds, including mutual funds and ETFs, had inflows of more than $18 billion for the week ending on January 9th,” says James Frischling, President and Co-Founder at NewOak. “This is the fourth largest weekly inflow since Lipper began tracking such data in January 1992.”
“Much has been made of Main Street’s lack of participation in the rally now entering its 5th year. The S&P is up 119% since the bull market began on March 9th, 2009, but many retail investors have pulled their money from equities and instead chosen to invest in the perceived safety of bonds. In the 5 years ended in 2012, US stock mutual funds have seen over $550 billion of outflows, while bond funds had $1 trillion of inflows.”
“Investors have been unwilling to forgive the equity markets for the dramatic plunge that was brought on by the financial crisis. Some of the fear of re-entering the market can also be attributed to the memory of the crash in 2000 that was brought on by the bursting of the technology bubble. The combination of these two brutal market routs has left a long-lasting and bitter taste in the mouths of investors.”
“Another reasons investors have been suspect of the bullish market is the question of how much of the run belongs to the actions of the Federal Reserve and European Central Bank. The commitment to low-interest rate policy and various forms of stimulus injected into the market have certainly helped to push these markets higher.”
“However, with so much money still on the sidelines and with PE ratios indicting an equity market that isn’t overvalued by historical measures, money flows from Main Street may be what drives this market higher.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Credit Markets: At Risk of Blowing Up?
Tuesday, January 22 2013 | 11:01 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"While at the first glance, investors' appetite chasing yield appears to be insatiable and irrational, it can be rationalized," says Ron D'Vari, CEO and Co-Founder of NewOak.
"Last week's successful Paraguay's bond sale, a first time issuer in the global markets, is a good indication that fixed-income managers are out looking for yield anywhere they can. Paraguay's dollar-denominated 10-year bond priced at a yield inside 290 basis point over 10-year US Treasury bonds. The investors are not getting much of a premium for the risk they are taking in a small country that faces political instability with over one-third of its population in poverty."
"The risk premia for high-yield corporate bonds (i.e. spread over treasury) are at the lowest in five years, with the absolute yields at a historical low ever since the junk bonds were created in 1970s."
"Given where we are in the economic cycle, the credit markets may not be all that irrational and could even be better justified than the pre-crisis tight spreads. Factors contributing to the very slim credit premia are: 1) unprecedented policy easing by central banks around the globe, 2) low inflation, 3) low defaults, 4) moderate growth, and 5) lack of many alternatives to invest cash. Corporate default rates are low and are expected to stay low due to the healthy cash positions of corporations with low inflation expectations. Moderate global growth combined with low inflation creates a stable environment for both human, supply chain, and commodity resources. These factors lead to ideally low volatility financial conditions for corporations."
"The overwhelming demand by a global system flush with cash desperate to be invested in fixed-income assets with any yield combined with relatively low volatility rationalize collapsing credit spreads. While high-yield bonds may not be about to blow up anytime soon, they leave very little room for any mistake. Also the same thing can be said about global equities as well."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Larger US Banks: Prospects and Challenges
Monday, January 14 2013 | 12:19 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The Fed's extended super-low rate policy and asset purchase program have started to put pressure on banks' net interest margins," says Ron D'Vari, CEO & Co-Founder of NewOak. "A flat interest rate curve is not good for the banks longer term profits. While larger banks have been attracting new deposits at a faster rate and have enjoyed paying low interest on deposits, most are having difficulties to find good opportunities to put the cash to work other than mortgages."
"The US mortgage refinancing wave has been a strong earnings growth engine for the larger US banks like Wells Fargo, JP Morgan and Citi. However, the longevity and the extent of the refinancing wave may be starting to dampen before other lending opportunities arise. Given that a relatively high portion of the large banks' profits have been coming from mortgages, they are bound to shrink absent other growth factors."
"For banks to continuing to expand their profits, the mortgage refinance wave needs to be followed by a strong aftershock. At this time, a general lending expansion will be contingent on further acceleration of US growth, expansion of housing starts, and higher borrowing demand by corporations. So far, stock markets have given banks the benefit of the likelihood of these to be occurring. To the extent that these events get delayed, the stocks of large US banks may come under pressure. Nevertheless Warren Buffett's statement that 'our banking system is in the best shape in recent memory' may have some merit as US banks have rebuilt their tier one capital and have good liquidity."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

More Upside for the Banks?
Monday, January 14 2013 | 12:18 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"This is the first full week of 4th quarter earnings season and the financial sector, as always, will dominate the announcements,” says James Frischling, President and Co-Founder of NewOak. “With banks still valued below their historical levels and as a result of the improvement in credit, there’s reason to be bullish on this sector.”
“The usual earnings season gamesmanship of lowering estimates ahead of the announcements has been in full effect. Lowering the bar only to exceed the modified expectations is common and that strategy appears to be more pronounced in the financial sector than nearly any other corporate sector this quarter with earnings estimates having been driven down from about 16% to below 9%.”
“Despite the expectations managing, there are also good reasons to like financials. The daunting regulatory changes that have continued to weigh on the financial sector are now vastly implemented or have at least been more clearly defined. This removes a great deal of uncertainty that has plagued the financial sector and has created at least some level of competitive advantage to the largest banks. The recently announced mortgage guidelines also give the banks clarity on lending, which is something the market was looking for. An understanding of the regulatory framework and lending requirements should create a positive backdrop to the banks.”
“Among the challenges facing financials, the flat yield curve has hurt profitability. But with the economy recovering and with the continued growth in housing and the loan activity that comes with it, a steepening yield curve will improve net interest margins and boost earnings. These tailwinds won’t allow the banks to continue to trade at book value for very long.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Stock Indexes: Are They Ahead of US Growth?
Monday, January 07 2013 | 12:04 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"The recent global markets rally is more about investors' hunger for yield than prospects for healthy growth in the US," says Ron D'Vari, CEO and Co-Founder of NewOak. "While US growth has remained fairly tepid, US and global markets turned jubilant last week over the superficial avoidance of so called "the fiscal cliff". Unemployment is still at 7.8% and new job creation has stayed on average about 150,000 a month for over two years."
"Two regional presidents have said that the Fed will end its bond purchases in 2013 when the unemployment approaches 7.0%. The Fed has also set the bar at 6.5% unemployment level for the rate hikes. Last Friday's moderate job numbers was interpreted by the markets that low rates and bond buying will have to stay longer and hence continued its first week rally."
"The US growth will be still dampened by the tax hikes and spending cuts to deal with the unavoidable US debt ceiling issues ahead. There are reasons to believe US will not average much over 2% annual growth over the next decade. The factors contributing to the lower-than-historical US longer term growth potential include aging demographics, inferior education system, higher taxes and health care costs, fewer high impact technological advances. Nevertheless, the equity markets may continue to rally on marginally improving growth and unemployment data. Stocks would stay favored by investors compared to the less attractive alternatives of low-yielding cash and high risks in bonds due to rise in rates."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Fed’s 6.5% Unemployment Rate Baseline: A Party Spoiler?
Monday, January 07 2013 | 09:08 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“The Fed’s guidance of 6.5% unemployment was meant to bring stability to the rate markets, and also signal zero-short-rate policy is here to stay until US economy is humming,” says Ron D’Vari, CEO and Co-founder of NewOak.
“However, the economic forecast models the Fed bases its policies on are highly questionable under the current fragile recovery environment. Should the unemployment rate keep falling in 2013, may not necessarily mean a firmer economy and it would not necessarily mean a true resolution of the structural issues in the US economy.”
“A significant part of the US current economic momentum and housing recovery are driven by the Fed’s punch bowl of securities purchases and low rates. In the meanwhile, the fiscal spending and tax policies continue to be a huge drag on the consumer and corporate sentiments. The biggest fear in the market is that the Fed may reverse its ultra-easy monetary policy before the underlying economic structural issues holding back growth is actually resolved. US Treasury bonds’ yields would likely rise with any sign of the U.S. growth outlook brightening. Such a reversal in expectations may take some time, but a change in market dynamics is anticipated well before any actual Fed moves.”
“US unemployment may continue to fall from its November 7.7% rate while the fiscal and tax situation worsen. That may not truly justify that we are getting closer to the Fed being near stopping securities purchases and actually raising short interest rates. Nevertheless, the markets will be forced to make those assumptions. This dynamic would drive the longer term rates higher ahead of full economic recovery. That may spoil the party motivated by early signs of healthier US economic growth.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Debt Ceiling: Real Threat to the Economy & the Markets?
Thursday, January 03 2013 | 09:06 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"If Washington fails to reach a deal preventing the economy from falling off the fiscal cliff, lawmakers still have time in January to take corrective actions and reverse a number of the effects,” says James Frischling, President and Co-Founder of NewOak.
“Instead of making the December 31st deadline a date to be feared, the markets are looking for signs that a compromise will ultimately be reached. The bigger concern - and one that has a recent history of hitting the markets - is the US debt ceiling. Treasury Secretary Geithner said the US will technically reach its debt limit at the end of the year. If Washington fails to reach a deal to increase the nation’s debt ceiling, the threat of default and the fear of another credit downgrade could create a panic in the financial markets.”
“The memories of the debt ceiling fight in 2011 are still very fresh in the minds of investors. Markets experienced sharp losses during the negotiations and the negative pressure continued even after a bill to increase the ceiling was passed because of how close lawmakers came to allowing the US to default. The S&P responded by downgrading the US sovereign rating to AA+.”
“So with Republicans and Democrats fighting over a deal to avert the fiscal cliff, only to be followed by the potentially more threatening debt ceiling, the relative calmness of the markets may be what has allowed both sides to hold firm. Congress seems to act more productively when the markets force its hand. If the two sides don’t find a way to come together and make a deal, a market plunge might just be what they get in January.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Japan's Deflation Solution: Monetary Easing or Currency Devaluation?
Thursday, January 03 2013 | 09:05 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Shinzo Abe, the incoming prime minister of Japan, declared his intention to counter currency devaluation attempts by the U.S. and Europe by also weakening the Yen," says Ron D'Vari, CEO and Co-Founder of NewOak Capital.
"The Bank of Japan (BOJ) is also considering a price stability target and mentioned a program to provide money at very low rates to banks to increase their loans with the hope to stimulate growth. The U.S. and Europe have been pursuing aggressive monetary policies attempting to stimulate their economies, by buying bonds and increasing the Dollar and Euro money supply. Yet, others like South Korea, have intervened directly in currency markets. This has pushed Yen-to-Dollar as low as mid 80's."
"There inevitably would be a currency war starting if most developed countries try simultaneously to print money, follow expansionary policies, and also target to devalue their currencies. Japan deflationary pressures are already strong so it is understandable that Japan would try to defend its currency, and not go too far below 85 Yen/Dollar."
"A stable, albeit strong, yen is what Japan could best hope for. Currency interventions are not known to be effective and we don't expect Japan to actually engage in them unless yen strengthens beyond ¥80/US$. Therefore, given most of the developing countries will be easing, we expect yen to stay in a range near its current ¥85/US$. As to a revival of growth in Japan, we may all have to wait."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Reading Economic Tea Leaves: Oil, Soybeans, US Dollar & Gold
Monday, December 17 2012 | 12:33 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Oil has extended its recent weekly gains with signs of economic growth in the US and China,” says Ron D'Vari, CEO and Co-Founder of NewOak Capital. “Also, we are seeing an improved probability that the European Union will be able to address its structural issues over time."
"The West Texas Intermediate crude ("WTI") has also rallied recently despite a shale boom that led to its 12% fall this year. The US factory outputs have steadily increased and had its highest growth in two years in November. Recent Chinese data similarly indicates manufacturing expanded there at a faster pace this month. Soybeans also advanced above $15 for the first time in more than five weeks, driven by a strong domestic and foreign demand supporting the global economic optimism."
"The dollar has also strengthened after Japan’s general election increased speculation that the central bank will pursue much more aggressive stimulus policies to reverse deflationary pressures and promote growth. Gold has also weakened recently due to improved prospects of real global growth driven by the US and China. Despite that Gold has advanced 8.2% so far this year primarily due to expansionary policies of the US, China and Europe that led to devaluing currencies. Overall, the movements in commodities and the US dollar seem to be consistent with the general sentiments about higher prospects of global growth."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Fiscal Cliff: 2 Weeks Before Dramatic Compromise?
Monday, December 17 2012 | 12:32 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"In the film Rocky IV, Rocky Balboa lands a hard punch in the 2nd round that cuts Ivan Drago,” says James Frischling, President and Co-Founder of NewOak Capital. “From that moment on, you knew a dramatic finish was coming. Yesterday US House of Representative Speaker John Boehner offered to accept a tax rate increase for the wealthiest of Americans. While the offer was rejected, the Republicans signaled negotiations are very possible and we should expect a dramatic compromise to be reached.”
“President Obama continues to campaign for higher taxes on the wealthiest of Americans, while the Republicans have until now been offering the closing of loopholes as the best way to increase revenues. As far as the President is concerned, there would be no deal without such an increase and various polls have indicated that the Republicans, far more than the Democrats, would be blamed for failing to reach a deal and our economy falling off the cliff. The Republicans have just broken the stalemate and offered a tax increase on the wealthiest Americans, but have raised the bar from $250k to $1mm.”
“With this move, the Republicans have now shown that a tax increase, at least for Americans at some level of income, is an acceptable part of reaching a deal. The markets have been watching the negotiations closely and patience has started to wane. The Republicans’ offer to increase taxes, albeit on a smaller percentage of Americans, may be the proof investors have been looking for in connection with a deal getting done and may create some enthusiasm for this market heading into yearend.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Markets Cue: All Good Again?
Thursday, December 13 2012 | 11:33 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“All of a sudden the markets seem to be discounting most of the risks and concerns that held them back all along this year,” says Ron D’Vari, CEO and Co-founder of NewOak Capital.
“Investor optimism partly emanates from the early indications that Chinese economy is back on track for accelerating growth, albeit at lower than 10% per annum for the last ten years but with higher quality growth. So far, most of the recent increases still come from government owned enterprises while smaller businesses have not yet seen a similar boost.”
“Also driving investor optimism, there is less fear of a Euro break-up and Greece may be less of a noise — at least for the near term. Just the threat of ECB bond purchases and prospects of Euro crisis structural solutions have created a massive European bond rally in the peripheral countries of Spain, Italy and Portugal after a tumultuous two year roller coaster ride. 10-year yields in Italy and Spain are at their lowest for quite some time. It is not all set as the markets will still be watching carefully the success of Greek bond buyback program and next year’s debt rollover by Spain and Italy.”
“Concerns remain about overall global economy outlook. Eurozone manufacturing activities continue to be soft. In Asia, South Korea and Taiwan are still struggling to turn their economy around while India output is trending upward over the last five months.”
“US housing market stabilization and positive consumer confidence for the time being are also helping to feed the market’s risk taking attitude. However, the situation remains very fragile as all eyes are turned to the political wrangling over how to avoid a fiscal cliff. If anything, the developments over the weekend showed the deep divide and provided little comfort that any budget deal is imminent. Taxes and regulations remain to be key concerns.”
“To sum it up, it is not all good by any means in the global economic outlook but the pain killers seem to be working for now. Cheers!”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Fixed Income Markets – 2013 Prospects
Monday, December 10 2012 | 02:35 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“With interest rates so low and no real prospects of rising anytime soon, investors will continue searching for yield but remain on the edge because of US fiscal policy impasse and reform struggle in Europe, says Ron D’Vari, CEO and Co-Founder of NewOak Capital.
“Sovereign and central bank investors will continue holding US Treasuries and Agencies as part of their core holdings. However, other institutional investors are looking into new areas to boost their fixed income returns but are doing a lot more due diligence. Beyond higher yielding corporate bonds, emerging markets, and new issue structured products such as ABS, CMBS and CLOs, many sponsors are opening up to several other alternative areas.”
“Among the areas being considered are CLO equity, distressed RMBS and CMBS and re-REMICS, distressed and new originated residential and CRE loans, REO-to-Rent, and esoteric securities such as timeshare, aircraft, and subprime auto. Many say investors are applying aggressive recovery assumptions to legacy distressed RMBS and demanded lower yields, driving prices higher. However, the lack of clarity in securitization regulations, capital requirements, servicing limitations, and questions on RMBS waterfalls will continue to restrain non-agency residential RMBS securitization.”
“New CLO issuance will continue to grow due to demand but will be constrained by the spread tightening of the underlying leveraged loans as well as skinny equity IRRs. New-issue CMBS markets will also be active, but supply will be limited by subordinated capital. We expect underwriting standards in CMBS continue to gradually ease yet informed investors will keep them in check for the time being. Investors with proper capabilities will invest directly in whole-loan corporate bonds, residential, and commercial loans, both distressed and new origination. Overall we anticipate fixed income opportunities and higher yields will be in less liquid markets.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Knowledge-Driven Investing: Does it Risk to be Insider Trading?
Monday, December 03 2012 | 08:53 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

"Life science investing has the potential for enormous pay-offs, yet poses even greater risks than most other investments," say Ron D'Vari, CEO and Co-founder of NewOak Capital Advisors.

"The risks are the highest in early-stage new drugs due to their tent-pole nature, yet so is the need for capital to develop them. Given their intrinsic high risk-reward profile, the financial performance of even the largest biotech companies depends heavily on the success or failure of their top new drug prospects. This makes the returns of biotech companies developing new drugs or procedures highly volatile as many of their existing patents may be expiring."

"Investing in biotech companies requires skills in estimating the odds of the outcome of new drugs in pre-clinical testing. The process involves "mosaic theory", i.e. building overall pictures of the biotech companies' prospects and get an edge over other investors."

"Biotech investing is a high-stakes game requiring highly specialized knowledge which investment companies cannot afford to have in-house. Through a mosaic theory portfolio managers put together prospects of the companies working on developing new drugs for diseases such as Alzheimer or Parkinson’s. More sophisticated investment companies look to access the relevant knowledge through expert-network firms with industry specialists involved in the research and development."

"Interaction with industry specialists runs the high risk that, along with publicly available but complex scientific knowledge, some confidential information gets passed on. The ambiguity between "mosaic" theory and actual confidential information has been the central issue in several recent insider-trading SEC enforcement cases. These issues are highlighted in the highly publicized case on Mr. Martoma, previously a SAC portfolio manager, charged with using secret clinical trial results attributed to a doctor involved."

"Given the much higher transparency required of the hedge fund industry, knowledge-driven investing in public companies is a sensitive area and needs to be carefully managed from regulatory and ethical compliance point of view. A properly managed process can be kept clear of insider-trading rules."
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

FX Swaps & Forwards Exempted: Does it Reduce Market Risks?
Monday, December 03 2012 | 08:42 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“The US Treasury’s decision to exempt FX swaps and forwards from Dodd-Frank’s rules should be a relief to many businesses and end-users employing them as natural currency hedges,” says Ron D’Vari, CEO and Co-Founder at NewOak Capital.
“It wasn’t at all clear from the beginning if centralized clearing of FX swaps and forwards would make them more transparent and reduce systematic risks. The corporations hedging their natural FX exposures were not adequately equipped to manage the collateral posting requirements under centralized clearing.”
“The FX swaps and forwards centralized clearing rules would have reduced market making and liquidity activities as the trades are typically large and risks are high. The centralized clearing “exchange-like” market structure would have increased the risks to the market makers and liquidity providers. This would have discouraged them from those activities and ultimately would have increased the costs to all investors and businesses and curtailed true hedging. The corporations unhedged currency risks would have been transmitted to the equity markets and created other systematic risks and volatility of its own.”
“In the case of FX, the counterparty risk management and market making are perhaps better handled in the OTC markets where there are far more flexibility and risk mitigation tools in addition to collateral. Given the existing extensive oversight by the FED and central banks, the centralized clearing could have been too restrictive due to sheer size.”
“This is not to say that Over-the-Counter (”OTC”) FX swaps and forwards markets cannot be made more transparent and liquid through more open platforms and more live pricing information. There are many private electronic FX trading platforms that are looking to add derivatives capability and allow buyside to buyside trading as well as encourage market making in more anonymous basis.”
“The US Treasury decision removes a major regulatory uncertainty from the market place. This should help the fixed income markets that are already challenged by increased sovereign risks, not to mention the Fiscal Cliff.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Could the US Budget Stalemate Sabotage Growth?
Monday, November 12 2012 | 09:55 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

With the Chinese economy bottomed out and the US job market’s gradual improvements, delicate management of the US deficit will be vital to sustaining growth,” says Ron D’Vari, NewOak Capital.

“As recently as 6 months ago, combined factors such as US housing, unemployment, the European crisis, and China’s slowing growth were amonst the biggest threats to the global economy and markets.”

“Recent data indicates a positive change in the US housing dynamics and consumer confidence. Also, due to improving capitalization of the US banks, they are much more inclined to make credit available across consumer, real estate and business sectors.”

“While in the short term Hurricane Sandy will impact housing and CRE credit negatively, the post hurricane reconstruction activities in the Northeast is expected to add to the overall GDP growth.”

“China’s sign of recovering from a seven-quarter slowdown takes pressure off the new leaders which are expected to introduce new stimulus and projects.”

“Based on major global factors, headwinds will be gradually turning into tailwinds. Nevertheless, the structural and fiscal problems in both U.S. and Europe will continue to pose a serious risk. The delicate handling of fiscal policies in both US and Europe shouldn’t be miscalculated as economic growth will remain fragile.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Stress Testing: Is it Stressful Enough?
Monday, October 01 2012 | 01:55 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

“Running stress testing for banks is stressful,” says Ron D’Vari of NewOak Capital. “If a bank reports too little stress losses, markets don’t believe it, and if it reports too much, a bank’s existing equity will be crushed by the new equity that must be raised. The process is more of an art than a science. A lot depends on macro assumptions such as central bank policies, etc.”
“Data gathering is a necessary evil and in most cases, leads to building permanent business intelligence dashboards that help future ongoing operations. The process of arriving at all inputs and assumptions can be tedious but helps the bank organize and provide further transparency for internal and external facts and implied views.”
“The key is documenting and validating the basis for the final conclusions. From the outside, it may look like an educated crystal ball. There is always a chance for reasonable experts to disagree, especially during times of economic uncertainty and credit performance. But by being transparent, banks will develop credibility and improve their valuations and capital access.”
“After going through the stress of running stress tests, in the end, the real value will be improved transparency, more educated risk taking which help banks to really figure out their best areas of core competency.”
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Scenario Analysis: Can US Banks’ Correlation to the Eurozone Be Measured?
Monday, August 20 2012 | 02:26 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Determining how a financial institution will be affected by the exit of one of the peripheral countries is a much more involved exercise than just measuring direct exposures.

Bank analysts have been paying close attention to the major financial institutions direct exposures to the peripheral countries to the extent they are being reported. However the impact of a breakup goes far beyond just the direct exposures in securities and derivatives entities domiciled in the peripheral countries.

Major Banks have prepared for potential separation of peripheral countries from the Euro, but to a much lesser extent for a total demise of the Euro. Given the high expense of hedging or selling the direct positions, they are mostly watching the direct positions much more closely.

In addition, if there are ambiguities in the documentation of loans and derivatives due to departure of a country, the banks have been trying to amend them or stop rolling them at maturity. Furthermore, the sensitivities of the underlying collateral are being calculated to a potential breakup and remedied.

Despite these efforts, a thorough correlation analysis could require taking into account the impact of exposures to other non-euro parties including through derivatives counter-parties, posted collateral, and securities with issuers that could fail in their obligations because of their own other exposures. Even though the ultimate domino effects may be uncertain, a thorough scenario analysis is advisable.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Eurozone: Will The ECB Intervene?
Thursday, August 02 2012 | 12:54 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Markets rally, ignited by the verbal signals of the European Central Bank (ECB) and politicians, could fizzle when actions don’t follow soon.

The increased chances of the ECB intervening to cap Spain’s and Italy’s borrowing costs raised hopes that the Eurozone contagion may be containable, hence the rally. The ECB and European leaders of France and Germany appear to agree with the independent central bank’s stated intention of pursuing a more aggressive firefighting role if conditions require.

The theory is that a key ECB obligation is to defend the integrity of Eurozone and the single currency. Hence purchasing of sovereign bonds are well within ECB’s toolbox as long as it is not for the monetary finance of national governments.

Nevertheless, the ECB and politicians all have stated there are preconditions to the actions, such as a legally binding contractual agreement with member government to be committed to a financial reform program. This could mean that the European Financial Stability Facility (EFSF)would have to act first. However, there are no evidence of such discussions in the works between EFSF and Spain at this time. In the meanwhile, markets have moved to a “risk on” mode but that may not last given also the lackluster growth prospects in the U.S. and China and no expectations of imminent QE III action by Federal Reserve.
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Janet Tavakoli, President, TAVAKOLI STRUCTURED FINANCE

Facebook: Is Stock Research Rigged?
Thursday, August 02 2012 | 12:52 PM
Janet Tavakoli
President, TAVAKOLI STRUCTURED FINANCE

Facebook announced its earnings on July 26 after the close of trading. Its share price fell 8.5 percent to 26.845 before the market close in the wake of Zynga's dismal report. Facebook's own report raised questions, and shares fell 10.7 percent to 23.97 (as of this writing) in after-hours trading.

While Facebook claims 955 million active users, that doesn't translate to protected revenues. Its sales increased to $1.18 billion, but it earned only 12 cents per share (adjusted) for the second quarter of 2012. Facebook had a fourfold increase in marketing costs and its operating margin declined to 43 percent from 53 percent last year. It also took a one-time charge for stock-award accounting to post a loss for the quarter of $157 million for an unadjusted loss of 8 cents per share.

Analysts' Rosy Price Targets

ZeroHedge.com shows that stock analysts--including analysts whose firms made handsome fees for participating in Facebook's May 17th IPO -- had recent average price targets of $37.74 for Facebook. This is just below the IPO price. Only one of 38 analysts had a sell recommendation on Facebook.

How do these "analysts" justify a multiple that is higher than 95 percent of the stocks in the S&P 500? It seems that either analysts are compromised, or they are painting overly optimistic scenarios based on nothing more than hope. It's interesting that their hopes are aligned with the hope some of their firms have for future fees.

Over-Hyped IPO

After Facebook's May 17th IPO, I made a public bearish bet on Facebook. I made a bet it would fall in value, or at least that sentiment would turn negative. I took a profit on the bet in June. If I had failed to monetize at a profit, I could have called JPMorgan CEO Jamie Dimon to claim it was a hedge, since he had the nerve to pull that one when he appeared before Congress to explain billions of dollars in losses on credit derivatives bets in his London CIO unit. (Dimon later admitted it changed into something else, i.e., a bet.)

Facebook's IPO was emotion in motion. It seemed to me the pricing was based on hot air. At the time Facebook had $3.7 B in annual revenues of which 85 percent came from advertising, and it had only $1 billion in net income.

In my opinion, the game was to bring the IPO at an inflated value and hope Facebook can acquire viable companies with its inflated shares. It's a game of brinkmanship. The investment banks that helped inflate Facebook's share price may stand to earn fees as Facebook acquires other companies. Unfortunately, the fall in value puts a damper on these plans.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Eurozone: Demystifying Money and Credit Flows
Monday, June 25 2012 | 09:59 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

There’s been a great deal of money movement around and out of the Eurozone, with heightened chances of a Greek exit from the Euro, and an erosion of confidence in the Spanish and Italian banking system and government bonds.

The elevated flow of capital out of Spain, Greece, and to some extent Italian systems have been channeled into buying bonds of Germany, the Netherlands, and some short term Swiss bonds. The increased cash in the non-peripheral euro banks has been swept into ECB and, in turn, been offered back in loans to Spain, Italy and Greece as LTRO or short term.

In order to keep the Swiss franc stable, SNB has been swapping its dollars into the Euro, so far successfully.
The actual flows are a bit more complicated given cross country flows of stocks, bonds, cash and long/short currency positions of speculators.

Late last week there’s been some anomalies as German rates rose—they are now being viewed to be trading at super premium. The premium is not justified given that there are no reasons for German existing Euro bonds to be converted if Germany decides to leave Euro.

US and European central banks are standing ready to inject as much liquidity to support the Eurozone and avoid financial system interruptions, as a fallout of Greece elections outcome -- or lack thereof. Most large banks and financial institutions have also had fire drills. It will be interesting to see how it will all play out early next week.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Banking Regulation: Separation of Retail and Investment Banking?
Monday, June 18 2012 | 02:04 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Regulators across the globe are following different models to ring fence retail and investment banking, while shoring up capital requirements at the same time.

Along increasing minimum risk-weighted capital, tighter regulations are focused on limiting or ring-fencing banks’ proprietary businesses from mainstream retail functions. However, the evolving regulatory models in U.S., U.K., France, and European Union are different. European banks are lobbying hard against a scenario with outright separation of retail and investment banking such as UK Vickers Reform. For example banks in France prefer more an approach along the proposed U.S. Volker Rule limiting proprietary trading as opposed to UK’s Vickers Reform.

The EU’s bailout of Spanish banks without a demand for austerity is just dodging a bullet where many more are expected, perhaps next in Italy and potentially in France. In fact, the driving issues of Spanish banks have less to do with investment banking gone array than the good old disciplined lending practices and systematic risk. The more sophisticated and global Spanish banks (e.g. Santander and BBVA) have fared better than traditional Spanish retail banks with over exposure to Spanish real estate sector. The global banks with both retail and investment banking have benefited from more diversified exposures and better risk management.

In the end the arguments will hinge on the importance of market-making vs. credit functions played by the larger banks for a smoother operation under an ultra-connected global economy. For market practitioners, it is hard to visualize the two functions can live under totally separate roofs given the complexities involved. It is our view that over time regulators will also develop a similar appreciation and consider more gradual changes with reasonable implementation costs to the economy as a whole and banks.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

IMF Funds Victory & Earnings Reports are up, so why aren’t Investors buying?
Monday, April 30 2012 | 08:16 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Christine Lagarde of IMF failed to make her goal of $600 billion in pledges, yet it’s a victory to have reasonable funds to put away for a rainy day.

Still IMF will have key new challenges ahead driven by confluence of new geopolitical, economical and regulatory forces all coming at the same time.

On the geopolitical front, IMF for the first time will have to officially acknowledge increasing direct involvement of key contributors such as Japan, China, and Brazil in the overall decision making process. This is further complicated with the need for growth capital both in developing countries as well as Europe which is hit with full force of the austerity measures.

Parts of Europe will continue facing recessionary forces that will impact global growth. Many European banks active in project finance in BRICs and South Asia find themselves short of capital due to sovereign and other credit issues in Europe itself.

Given slower growth abroad, China’s domestic economic policies will take on greater importance and there will be less Chinese investment capital available to fuel growth internationally.

Another big unknown is the impact of the new regulations globally coming on line at the same time.

The world once again will be looking at US economy to pull the world out of potentially spirally destabilizing forces.

Given these issues, IMF and most policy makers globally will be preoccupied with growth. Austerity measures need to be carefully balanced with other stimulus policies to avoid what is characterized by some as the ice ages.
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Douglas Long, EVP Business Strategy, PRINCIPIA PARTNERS

ABS Market Pricing Research
Thursday, April 26 2012 | 12:45 PM
Douglas V. Long
EVP Business Strategy, PRINCIPIA PARTNERS

ABS/MBS secondary pricing and data challenges continue to be a major topic of discussion by the securitisation industry. I’ll be moderating a lively session at Global ABS in Brussels this year examining the innovations in structured finance data and what we can expect as the market searches for greater commoditization and data standardization.

In conjunction with this, Principia is garnering feedback from the market about the key issues in secondary market pricing for ABS, the use of performance, issuance and loan level data and the range of analytical and cashflow models available to investors in ABS and structured credit.

The first of three short surveys we are conducting can be taken here.

I would greatly appreciate your input; the results will then be shared at Global ABS and sent to you should you be interested.

Our aim is to build a comprehensive and completely independent view of the key services available to investors throughout the ABS valuation process - from initial price discovery, through ongoing evaluation, forecasting and accounting. The plethora of vendors collating and distributing market data, performance data, cashflow models and granular loan level information is overwhelming. As an investor who should you choose for which asset classes? Who is using what, where? We would like to provide detailed answers to those questions.

When asked what technical challenges investors faced over the coming year in our last survey, the CIO of a major UK Credit Investment Fund stated: “as far as our firm is concerned, streamlining trade information capture and reducing the number of stand-alone spreadsheets will be a major priority in the next 12 months.”

Consolidation, standardization and operational efficiency in the access and management of multiple sources of data is a real and present challenge. In our last market survey, 35% of investors stated that managing their global structured finance exposures in a single integrated environment was the biggest operational hurdle to overcome. We hope the results will demonstrate how the market can better streamline and make the most of the vast amount of data available today and help investors to choose the best pricing providers across the ABS asset classes and geographies in which they invest.

Take the survey here.

I look forward to sharing the results with you shortly.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

U.S. Equities: Vulnerable to Pullback?
Friday, April 13 2012 | 09:17 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

The first-quarter earnings reporting season starting this week will be watched carefully - and most likely profits will fall across most sectors.

Despite Q1 earnings contraction, the market expectation is that growth will be accelerated toward 4th quarter and will continue in to 2013. However, near term the key to market direction will be the guidance provided by management, as well as how many companies beat expectations and by how much.

While the ISM reported a modest rise in March manufacturing activity, Friday’s US employment numbers disappointed the markets by non-farm payrolls rising by just 120,000 in March vs. expectations of a 205,000 rise. This has validated Chairman Bernanke’s concerns about the sustainability of the last six months US job growth. Despite these concerns, the latest U.S. FOMC comments tried to guide down markets’ expectations of a potential QE3.

Furthermore, stress levels in European markets have been ratcheting up and the spot light is coming back on Spain and Italy’s structural and banking issues. Markets also believe that it is unlikely that the ECB will continue to provide liquidity to banks to simply finance governments’ budget deficits. Given the uncertainties of growth and government liquidity policies, both Equity and Bond markets are expected to be volatile.

While equities and credit spreads are vulnerable to pullback, the overall global growth is bound to accelerate. Therefore, we are constructive on select growth equities and non-government bonds, especially emerging markets.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Emerging Market Investing: Implications of New East-to-East Trade Growth?
Tuesday, April 03 2012 | 10:31 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

A whole new pattern of global investing has emerged following changing global trade trends accelerated by the financial and European sovereign crises.

With the global markets rally of the last 6 months, helped by narrowly avoiding a systematic major disaster in Europe, investors are looking for further diversifying away from the developed markets into the fast growing emerging markets. However, this doesn’t mean investing just in BRICs primarily driven by west-to-east trade growth. The world trades having recovered strongly, investors are developing new strategies reflecting the new global trade patterns.

Focusing just on individual emerging markets, such as China and India, misses the far greater growth opportunities arising from accelerating intra-regional business and trades. There are unique opportunities in Southeast Asia’s frontier markets but they come with a high degree of risks, such as corporate governance, political and legal.

Economies such as Indonesia, Vietnam, Malaysia, Thailand, Cambodia, Laos, and even perhaps Myanmar offer enormous potential for growth given that their GDP per capita still ranges from as low as $800 to slightly over $9000 per annum and have a lot of room to expand. By contrast for example Singapore’s GDP per capita is over $50,000. However, Singapore’s economy is fairly open and hence will be subject to the volatilities of global economy and not much diversification in general.

The new investment opportunities initially tend to follow the foreign trade patterns, hence they are focused in agriculture, natural resources, energy, infrastructure, transportation and tourism. Over time they will naturally expand into manufacturing and services.
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Janet Tavakoli, President, TAVAKOLI STRUCTURED FINANCE

Greece and Credit Default Swaps: Bucking the ISDA Cartel - Part Two
Monday, March 19 2012 | 09:28 AM
Janet Tavakoli
President, TAVAKOLI STRUCTURED FINANCE

Leverage and Language

Since I wrote the first edition of my book, Credit Derivatives and Synthetic Structures in 1998, (John Wiley & Sons, second edition 2001), nothing has changed for the better in the credit derivatives market. It is the first trade book about credit derivatives and stresses that these products are primarily used for leverage. The overwhelming problems are pricing and the risk of misinterpretation of the meaning of the contract language.

Language "Arbitrage"

Sometimes contracts are maliciously written to disadvantage the unwary; this is also called "language arbitrage," because manipulating the language makes a risk-free gain for the perpetrator. In April 2005, I explained to the International Monetary Fund (IMF) that no one in the credit default swap market should trust ISDA "standard" documentation. One has to rewrite the contract language to protect one's own interests.

The following is from my March 12, 2010 post, "Washington Must Bank U.S. Credit Derivatives: Games and Gold," on problems with U.S. credit derivatives, but it applies to the problems with credit default swaps on Greece today.

Sovereign Credit Default Swap Contracts: Tower of Babble
The credit default swap market has a history of conflicts, and the worst of them occur when it is time to settle up. For example, hedge funds Eternity Global Master Fund Ltd. and HBK Master Fund LP thought they purchased protection against an Argentina default and sued when J.P. Morgan refused to pay off on Argentina credit protection contracts Eternity had purchased.

J.P. Morgan's posture was different when it wanted to collect on the protection it bought from Daehon, a South Korean Bank. J.P. Morgan claimed the slightly different contract language met the definition of restructuring under the credit default protection contract it had with the South Korean Bank.

The problem today is that some owners of credit default protection on Greece think they should be able to declare a credit event, but the ISDA cartel has issued an opinion that according to its interpretation of the documents, there has been no default. The problem has always been that contract language is subject to both abuse and "interpretation."

Greece and the ISDA Cartel: Language Games

There are a variety of problems that arise with credit default swap language. The two biggest are disputes about the definition of a credit event and disputes when it's time to settle up after everyone finally agrees a credit event has occurred. Settlement disputes arise over the value of the physical instrument delivered (for physical settlement) or with the calculation of the cash settlement amount (for cash settlement).

Recently the ISDA committee, which is stacked with the large financial institutions that dominate the trading of these products, ruled that no credit event has yet occurred for holders of credit default protection on Greece, if one used "standard" ISDA documentation.

The committee is controlled by the largest banks and financial institutions that trade these products. You can view the list here. For the Americas, the committee includes Voting Dealers: Bank of America / Merrill Lynch, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase Bank, N.A., Morgan Stanley, Societe Generale, UBS, and Voting Non-dealers: BlueMountain Capital, Citadel LLC, D.E. Shaw Group, Elliott Management Corporation, and Pacific Investment Management Co., LLC.

Credit Default Swaps: A Speculators Dream of Leverage

Given all the problems for hedgers, why has the credit derivatives market grown like crazy to notional amounts in the tens of trillions of dollars?

Speculators poured into the CDS market because of its tremendous leverage. If you think a bond might go down in value, or if the bond is downgraded, the credit default swap will gain in value, even if no default occurs. A speculator who gets in early enough can exit the trade at a huge profit and is out only the amount of the premiums paid in the meantime.

It's as if you bought a life insurance policy on your sovereign neighbor, known to those paying attention to be a reckless-driver, and then made a killing when your neighbor had a fatal accident. Obviously, you know it wouldn't be fair play to tamper with your neighbor's brakes, but others who stand to make a huge gain might be tempted.

Speculators look for huge swings in value. Some speculators aren't too fussy about how those swings in value occur and sometimes try to help it along by say, stoking a rumor mill or other market machinations.

Since credit derivatives often allow speculators to get the benefit of high leverage for very little initial outlay, credit derivatives, which were once touted as hedging tools, have become dominated by speculators.

Pricing is Always an Issue: You Can't Trade With a Screen

If a speculator bought credit default protection on Greece a couple of years ago, the speculator wouldn't have paid much in premiums and today can make many times the initial outlay. For example, during the past couple of years (depending on when one entered and exited) a few hundred thousand dollars could net a gain of several million on a $10 million trade.

But the trade is for people with deep pockets, because the pricing is controlled by a handful of traders, and when you ask for a price, the screen price becomes irrelevant and all of the "market makers" suddenly offer you the same lousy price. In one recent example, a speculator with a $10 million notional CDS claimed that he was being ripped off for $500 thousand after being low-balled in a bid for the protection he had purchased long ago. That $500 thousand isn't merely 5 percent of the notional amount, since it represents a much larger percentage of the gains to which he believed he was entitled. This sort of thing happens all the time, since pricing is controlled by a small group of market makers who often have a buyer lined up on the other side. Any money the "market maker" middleman squeezes out of buyers and sellers becomes profit.

Speculators aren't as fussy about language, because unlike hedgers, they aren't trying to match off risk. Often the interests of speculators and hedgers are misaligned, since hedgers often prefer that the underlying bonds (or other risk) recovers -- the risk is rarely completely hedged, because hedges are expensive. But speculators often make a naked bet. If a speculator is long credit default protection, the worse things get, the more the speculator makes.

Protect Yourself

There are so many issues in the credit derivatives market, that it's impossible to cover them all in a post. The Dodd Frank Act won't resolve the problems in the credit derivatives market, and bank lobbyists were successful in neutering effective change.

The disputes over credit default swaps on Greece highlight the fact that most participants in the credit derivatives market are at the mercy of ISDA when it comes to interpretation of ISDA's language. The only solution to that is to exercise one's rights, and insist on a custom-made over-the-counter contract that protects one's interests. As the past few years have shown, "regulators" won't protect investors either before or after the fact. You have to protect yourself.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Greek Bond Restructuring - Do Bondholders Understand the Complexity?
Monday, March 12 2012 | 09:14 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Greek sovereign bond restructuring has been both a prisoner’s dilemma and a game of chicken.

By next Thursday private holders of Greek bonds must decide if they accept a ‘voluntary’ bond exchange to reduce the face value of Greece’s overall debt by about €100 billion, involving a variety of sweeteners.

The restructuring proposal is a complex game of chicken by both sides. The deal will collapse if the holdouts exceed one third of private bondholders. Greece has to get at least two thirds of holders to participate or the Collective Action Clauses they have inserted becomes invalid. In actuality, Greece needs over 75% of the bondholders to endorse the proposal. Otherwise, both sides will lose as there appears to be no other solutions offered, making a default the de facto scenario.

Most of the posturing has already happened and presumably pre-negotiated via the Institute of International Finance representing a large body of investors. The bondholders had more leverage when the world was afraid of Greek default and/or ISDA declaring the exchange an Event of Default triggering a host of other defaults. But that has changed.

The entire process is a great learning experience in implied options and pre default collective bargaining. Most investors didn’t consider the borrowers’ option not to pay! In distress, what’s not in the documents can play as big a role as what’s in black and white!
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Janet Tavakoli, President, TAVAKOLI STRUCTURED FINANCE

Greece and Credit Default Swaps: Bucking the ISDA Cartel - Part One
Monday, March 05 2012 | 09:59 AM
Janet Tavakoli
President, TAVAKOLI STRUCTURED FINANCE

Credit derivatives were originally hyped as hedging tools to protect the value of a portfolio. For example, if you own a bond, you can buy protection against the possibility of default by paying a protection premium, similar to the premium you pay on an insurance policy. The difference between insurance and the credit derivatives known as credit default swaps (CDS) is that you don't actually have to own the bond in order to "buy protection." But like an insurance policy, you have to negotiate the terms of the contract.

Leverage and Language

Since I wrote the first edition of my book, Credit Derivatives and Synthetic Structures in 1998, (John Wiley & Sons, second edition 2001), nothing has changed for the better in the credit derivatives market. It is the first trade book about credit derivatives and stresses that these products are primarily used for leverage. The overwhelming problems are pricing and the risk of misinterpretation of the meaning of the contract language.

Language "Arbitrage"

Sometimes contracts are maliciously written to disadvantage the unwary; this is also called "language arbitrage," because manipulating the language makes a risk-free gain for the perpetrator. In April 2005, I explained to the International Monetary Fund (IMF) that no one in the credit default swap market should trust ISDA "standard" documentation. One has to rewrite the contract language to protect one's own interests.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

US-China Commerce: Is It Going Local?
Monday, February 13 2012 | 01:00 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Increasingly cities and states are building their own direct commercial relationships with Chinese entities, sometimes directly contrasting the overall US human rights, trade, currency, and geopolitical agenda.

Given the importance of new investments and jobs, US local governments are aggressively pursuing their own strategies to develop direct commercial channels with China attracting capital and promoting trade. The general perception is that China is stealing jobs away from Americans and people from other developed countries. However, the internal growth of the second largest world economy has been driving demand for agricultural products (corn, beef), commodities, transportation, and luxury goods. Recent visible examples of that are Apple iPhone and iPads.

Furthermore, given a strong Yuan, Chinese companies are making direct US investments and creating jobs. Chinese billionaires have also invested in areas US investors have begun to shy away from, such as Hollywood movies and US media companies. Yet on the other hand, many US firms and conglomerates have increasingly established a local presence in China, such as GE, Citigroup and US auto companies.

While on the surface the US-China trade deficit is still growing, the actual US export to China itself is flourishing. This is due to growing overall volume of trades. As long as that is the case, states and cities will continue to expand their ties, and rightly so.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

RMBS: Who is the Servicer? (And Does it Matter)
Wednesday, January 25 2012 | 08:08 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

There are no national mortgage servicing standards. Score cards based on actual observed performance indicate servicing standards matters substantially. In the case of RMBS servicing data doesn’t lie.

Performance varies dramatically along various measures such as modification, short sale, balance reduction, foreclosure procedures & time lines, stop advancing, and REO liquidation strategy and recovery rates. They all affect magnitude and timing of cash flows that flow through RMBS waterfall.

The servicing industry is going through another wave of consolidation for non-agency sector. This creates variations in trends in even pools post transfer, not to mention servicing interruption impact.

Servicers’ incentives and economics are critical to the loss mitigation, default management process, hence recovery performance. Under current model (fixed-fee), servicers don’t have much incentives to dedicate optimal resources as their fees are limited. The performance is also affected by volume of troubled loans and corporate strength. The legacy servicing fee model is being questioned by regulators and investors for future securitizations and is expected to change.

There are several proposals to create an alignment of interest and better servicing incentives. Until then investors need to take that into account security by security and servicer by servicer.
0 Comment | Add Comment(s) | RMBS, Servicing_standards, Economy, Investing,


Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Volatility in 2012: Will It Linger Longer?
Tuesday, January 17 2012 | 10:18 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

While European woes have led to investors’ fears and market volatility, a host of other hazards pose potential dangers. Despite the US markets recent positive trends in GDP and employment, key uncertainties remain: housing market, foreclosures, budgetary political impasse, tougher regulations and legacy mortgage litigations. We should not forget that several trillion in planned budget cuts are still ahead. The impact of the slowdown in BRICs, jointly due to the European crisis and their own natural economic evolution, may not be compensated by the US economy and emerging markets.

The potential in rapidly expanding BRICs’ credit markets, particularly in China, should be watched. As an example, the first domestic AAA default in China had the potential to send shockwaves through the Chinese economy but was cured by the bond guarantor. The Arab Spring, Egypt’s election, and potential Iranian blockade of Strait of Hormuse are still looming.
0 Comment | Add Comment(s) | Europe, BRICs, Economy, US_markets, China, Investors,


Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

How Issuers can Increase Investor Interest in CMBS2 Mezz
Monday, January 09 2012 | 08:34 AM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

Why New Issue CMBS deals see little interest in Mezz classes and what Issuers can do about it.

A year ago around this time, the mood amongst CMBS market participants was quiet optimistic. Estimates of new issuance for 2011 from market participants generally ranged from $35 Bn to $70 Bn or more, on the way to $100 Bn in a few years. However, over the course of the year, the optimism has faded. New issuance totaled just $30 Bn in 2011, and forecasts are not much higher for 2012.

With more conservative underwriting, higher subordination levels from rating agencies, and wider spreads, new issue CMBS was expected to be attractive to investors. Yet, investors seem to have pulled back, and spreads have widened for both legacy and new issue deals. Macro level issues, especially uncertainty about Europe, are part of the reason. However, CMBS spreads have been far more volatile than other sectors including corporate and other ABS. As the table below shows, even new issue AAA CMBS spreads widened a lot more than other sectors. This spread volatility not only deters investors, but also loan originators from making new loans as they do not have a good hedge to protect them while aggregating loans for securitization. It also requires wider spreads for CMBS loans which makes them less attractive to borrowers.


One of the main reasons CMSB spreads widen quickly is that the sector has far fewer investors than other ABS sectors and corporate bonds. The reason there are fewer investors is that, with fewer loans, CMBS deals are lumpy and investors need the expertise to analyze collateral at the loan level. Not every investor has that expertise. So, they can feel comfortable analyzing RMBS, Credit card, Auto, Equipment, and Student Loan etc deals, but not CMBS. The creation of a super-senior AAA tranche helped bring more investors to AAAs by making the tranche safer needing less analysis. That is part of the reason AAA spreads have tightened.

Spreads for classes below AAA, however, continue to be very wide, as the mezz tranches have even fewer investors. Unfortunately, Insurance companies, which are perhaps the most knowledgeable commercial real estate investors and ones with resources to analyze the CMBS deals at loan level, tend to buy mostly senior tranches. Mezz tranches are left to a very small set of buyers. That means lower liquidity for these tranches, and less certainty about receiving a decent bid if needed. An additional issue is lack of transparency on pricing, as these are small tranches that do not trade frequently and each one is different depending on deal collateral. These factors make these classes even less attractive to buyers.

The table below shows the structure of a recently priced CMBS deal. The $674 mm deal has $118 mm of senior AAA, $55 mm of junior AAA, $104 mm of mezz tranches and $44 mm of B-Piece.


What makes Mezz tranches more difficult for investors is that they have lower credit enhancement than AAAs and they are generally very thin tranches representing about 3% to 4% of the deal. In other words, a 3% higher collateral loss could result in 100% loss on the tranche. That means investors require even more conviction and expertise to invest in these classes. The thin tranches are also more susceptible to rating downgrades if any collateral in the deal faces problems. This fear of ratings volatility is another big concern for investors.

One idea, that addresses both the spread volatility and the potential ratings volatility, is to do the opposite of what we did for the AAA – combine all the Mezz tranches into one single class. In this deal, instead of creating classes B, C, D, and E, there could be just one Mezz class. It will be a $104 mm class with average rating of around A-. At a thickness of 15% of the deal, this class will not be at risk of 100% loss if collateral loss increased by mere 3%, and so will be much less susceptible to spread and rating volatility. Also, with just one larger class, there will be more owners of that class and there is likely to be more trading and visibility on spreads, enhancing transparency and liquidity. If the combined Mezz tranche is priced around 640 over swaps or tighter, the issuer will have the same or better economics as with the tranched mezz structure. This will still be a significant pickup in spread for the same rating compared to other sectors and will probably bring in some new investors who were considering CMBS but were hesitant. At about 15%, the Mezz tranche is thicker, but still a small part of the deal. So, even a small number of new investors will make a difference.

And the issuers can try this structure without taking any risk at all. That is possible by using a structural feature that has been used in residential deals (which are also REMICs): Exchangeable Classes. The deal can be setup so that some investors can buy the tranched classes while others buy a single Mezz class. The structure allows owners of one form to exchange for the other form at any point in future using the proportions defined in the documents. This has been used for a long time. I used exchangeable classes extensively in $52 Bn of new CMOs when I was trading and structuring CMOs. Freddie, Fannie, and Ginnie deals regularly have them under the names MACR, RCR, and MX respectively.

There is no single magic bullet, but small changes can sometimes make a big difference. Some, like this one, are easy to try with a little extra work, no downside, and possibility of enlarging the pool of CMBS investors with all the benefits that come from it for investors, issuers, and people employed in the sector.

Note: A version of this article was published in Thoughts on Markets & Economy
0 Comment | Add Comment(s) | CMBS, Securitization, Mezz_tranches, Exchangeable_classes, Investors,


Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

China Home Prices Cooling Off: Is It a Blessing?
Tuesday, January 03 2012 | 10:30 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

The latest home prices data in China confirms the broad-based falling trend for home prices in China. New home prices dropped from the previous month in 49 of the cities monitored by the government, according to the Chinese national statistics bureau. The dampening of home sales and falling prices is a natural outcome of government real-estate industry curbs. Despite the European crisis and other easing measures, the government has reiterated its tightening property policy and intensified the restrictive measures this year by raising down payment and mortgage requirements, and have imposed further home purchase restrictions in key cities. Analysts expect the real-estate policies are targeting home prices to fall by as much as 20% from their peaks in 2011.

The government’s main goal is to reduce speculation in the sector and avoid a drastic credit bubble burst induced by real estate. The restrictive measures seems to be working gradually and are expected to further cool off Chinese property markets throughout 2012. The controlled and gradual falling of Chinese home prices may prove to be a blessing and not cause for concern. In retrospect, it would have been wise if the US government had followed a similar path and imposed more restrictive mortgage lending measures starting in 2004 to prevent the precipitous and uncontrolled home price fall in 2007.
0 Comment | Add Comment(s) | China_Home_Prices, Financial_Crisis, Litigation, Real_Estate,


Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Collateral Management Rules: Flawed or Too Complex?
Tuesday, December 13 2011 | 01:40 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

MF Global clients’ unaccounted segregated funds case indicates that re-hypothecation can be potentially used as a loophole.

The international rules for movements of cash and collateral accounts for brokerage firms are complex. With the off-balance-sheet accounting for sale-and-repurchase agreement (”repo”), it is usually hard for the regulators to get a really transparent picture of the capital adequacy and liquidity of larger broker dealers.

Depending on each account’s permission settings, brokerage firms may be able to purchase U.S. treasuries, and in some cases non-U.S. sovereign bonds in their own name using the unencumbered clients’ segregated funds and re-hypothecate them to back their own trades.

The U.S. re-hypothecation rules are much stricter than the UK rules. Hence many prime brokers’ agreement terms allow for a U.S. client’s collateral to be transferred to the prime broker’s UK subsidiaries under a Global Master Securities Lending. This typically shows up under ‘Consent to Loan or Pledge’ provision.

The Dodd-Frank Act attempts to bring in more transparency to the middle and back office operations involving the mechanics of the clearing and settlement of cash and derivative trades, the movement of cash and collateral, and risk management. It remains to be seen if the new rules avoid re-hypothecation loopholes.

It is clear that collateral management rules will remain complex, however, the jury is still out if they would be less flawed.
0 Comment | Add Comment(s) | Collateral_accounts, Prime-brokers, Dodd-Frank_Act, Transparency,


Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Global Malaise: Is Free Trade in the Asia-Pacific Region the Savior?
Wednesday, November 16 2011 | 08:07 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

While all eyes have been focused on the financial troubles in Europe and looking for a quick monetary fix, President Obama and Asia-Pacific leaders have been concentrating on forging a free trade regime and touting it as the main engine for the global economic recovery going forward.

The fallout from Europe’s crisis is the lowering of global growth expectation. This would further exacerbate the fiscal and monetary issues across the developed world. The Global leaders have been desperately looking for real sources of global economic stimulation. While China has hinted on economic policies growing their imports in balance with their exports, the market has been skeptical due to economic contractions elsewhere. With the rapid growth of the middle class across the Asia-Pacific region, job growth in western economies will have an enormous dependency on not only domestic economic competitiveness but also free and open trade across the region.

A U.S.-backed plan to bring about an Asia-Pacific free trade zone has gotten somewhat of a boost by Japan, Canada and Mexico, expressing preliminary support despite China’s cool reception. To be realistic, agreements on free trade rules are hard to achieve politically, invariably because the protected economic sectors (typically unionized) will lose their advantages, hence politically resistance, while others get to benefit from their ability to export. Given the complexity of the job market and public opinion dynamics, it is naive to expect the Asia-Pacific free trade initiative as the cure to the current problems, but the hope is it will be the long term savior.
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Janet Tavakoli, President, TAVAKOLI STRUCTURED FINANCE

Clear and Present Danger
Tuesday, November 01 2011 | 10:44 AM
Janet Tavakoli
President, TAVAKOLI STRUCTURED FINANCE

The United States is the largest debtor nation in the history of the world, and our borrowing is increasing. In 1950 spending for social programs was only one percent of the total Federal Budget. As the economy grew, social programs expanded to include Social Security, Medicare, Medicaid, Food Stamps, Unemployment Compensation, Supplemental Security for the Disabled, and educational programs. In 1983 as the United States pulled out of an ugly recession and brought inflation under control, social programs consumed 26% of the budget. In fiscal year 2012, they'll eat up an estimated 57% of the budget.

The original idea was that if everyone agreed to chip in a small percentage of ever growing income, the percentage of social spending would never have to change even if the programs grew. The percentage for social programs could stay constant because if income doubled every twelve years or so, the amounts available for welfare would also double. Military budgets soared, the U.S. waged unfunded wars, the banking system was bailed out of the consequences of unwise lending more than once, and government bureaucracy grew rapaciously. All of this would likewise be covered by taxes assessed on growing income, or so the theory went. Like many academic economic theories, it was a convenient but misguided story. No country has ever managed to create a perpetual growth machine for its economy.

Time and again U.S. growth was brought to a standstill by (among other things) oil shocks of the kind the U.S. experienced in 1973 and 1979, monetary shocks of the kind the U.S. experienced in 1981, and systemic financial crises of the kind the U.S. experienced in 2008 and will likely experience again in the not too distant future.

Growth in the U.S. has been hobbled by moving many of our smokestack industries and soft manufacturing industries offshore. Traditionally weakening the dollar relative to stronger currencies like the Chinese yuan (the renminbi) stimulated growth as relative labor costs sank in the U.S. Today, much of the benefit of this strategy leaks to offshore manufacturing facilities.

Periods of anemic growth meant the U.S. had to raise taxes, but there is a limit to how much the economic engine and the population will tolerate. Hiking tax rates invites inflation, and artificially low interest rates are a hidden tax that punishes savers while food, energy, and medical care costs have soared. The U.S. can impose consumption taxes on liquor and other discretionary items, impose higher taxes on the rich, and possibly impose a confiscatory wealth tax, but eventually the U.S. will reach a point where this will be counterproductive.

U.S. debt now approaches 100% of GDP. In the long run the U.S. will have to cut social programs and increase taxes, but in the short run the U.S. cannot adjust quickly enough. If the U.S. has to pay its debts and it can't tax more, then it must borrow more. In fact, we are borrowing more, and how we borrow matters.

High rates of debt to GDP are the chief danger to any country's economic future, and any method of borrowing holds its special brand of danger. There are only three ways to fund a government deficit: foreign borrowing, domestic borrowing with monetary expansion, and domestic borrowing without monetary expansion. The U.S. has chosen a combination of the first two. Of the three, the way to get into big trouble very fast is to become dependent upon foreign borrowing. Treasury note and T-bill issuance as of second quarter 2011 was around $14.4 trillion, and the total bond market size estimate by SIFMA (less intergovernmental debt held by the Federal Reserve and Social Security Trust) was around $9.2 trillion. Total foreign holdings of $4.5 trillion represented around 31% of total Treasury issuance or around 48% of SIFMA's estimated government bond market. China's and Japan's combined holdings represent around 14% of total issuance or around 22% of SIFMA's estimated traded government bond market. As of June 2011, Japan held $911 billion or around 20% of U.S. foreign U.S. Treasury holdings, and China held around $1.16 trillion or approximately 26% of foreign U.S. Treasury holdings.

Why are foreign borrowings such a huge risk for the United States? The funds are currently kept in dollars a lot of which is with American banks. That money is yankable and that can cause a run on the dollar. Military leadership addresses the threat of attacks, and administrative leadership must address the clear and present danger of financial withdrawals. The dollar is still the world's reserve currency, but that advantage doesn't make the dollar bullet proof. U.S. dollars can be converted to yen or to euros. On October 17, China took a key step to internationalizing the yuan and making it an alternative to petrodollars if not an alternative reserve currency; Hong Kong's Chinese Gold & Silver Exchange Society now offers gold quoted in yuan.

This might have been worth the risk if foreign borrowing had been invested for roads, high speed railroads, new industries, cheap energy, airports, and to fund scientific research. The debt would self-liquidate. Instead, some of the debt has been used for transfer payments to fuel current consumption or for items like farm subsidies. It's as if you mortgaged your house to buy groceries. Eventually you'll have no house and no food either. Moreover, a very large chunk of the debt has been monetized through Federal Reserve Bank purchases and used to fill gaping holes in bank balance sheets. Unrepentant banks resist reform and dilute attempts at regulation while soaking up ongoing subsidies. All of this is dead-end financing at the expense of citizens that saved their money and pay taxes.

Greece's distress is an extreme example of what happens when debt service is high but investment in the economy is insufficient. According the Wall Street Journal, "Parliament member Panagiotis Kouroumplis...supported the first bailout, but, he says, 'every single euro we got went for debt. We haven't spent a single euro on development.'" The U.S. has a bigger and broader economy, but our bailouts--and the financial malfeasance that preceded and follow them--have nonetheless given our producing economy a body blow while chiefly benefiting fee-seeking dead-end financiers that eat up an outsized percentage of the nation's GDP.

In 1978, we averted a near-crash of our financial system after Kuwait refused to renew a more than $1 billion deposit with J.P. Morgan (then Morgan Guaranty). The Federal Reserve intervened to stabilize the dollar and averted a "19th Century financial panic" that would have triggered a "genuine depression."[1] In 1979 as tensions escalated with Iran, the U.S. sequestered Iranian assets to prevent a repeat of the near-crash in 1978. In the first years after these events, the U.S. seemed to have learned its lesson and reduced foreign borrowings--including borrowings from the Saudi's and Kuwait--to around 7% of total borrowings. Decades of bad policies, unfunded wars, and uncontrolled chaos in the financial system ballooned our debts and our foreign borrowings. Today's foreign borrowings are 31% of total issuance or 48% of the estimated government bond market. The U.S. is in hock to foreigners again, particularly to Asia.

How does the U.S. try to counter the danger represented by foreign borrowings? After exporting our profligate spending to China with no intention of reform, we wield the implied threat that if China doesn't continue to lend to us, it will go down with us. The Chinese may not see it that way as they feel the pinch of inflation, experience inevitable cyclical growth slowdowns, and develop new trading partners.

Foreign borrowings of the United States represent a clear and present danger to the U.S. dollar and to the U.S. financial system. Potential dumping of U.S. dollars would start a run on the currency and a financial panic that would tip our already precarious economy into a deep depression. No matter how much currency central banks use to try to manipulate exchange rates, the market always has more. The U.S. needs contingency plans against a large scale withdrawal of funds from the U.S. and from U.S. financial institutions. In the gravest extreme to avoid a run on the U.S. currency and a collapse of the U.S. economy, the U.S. requires a standby plan to sequester a foreign nation's funds, just as we have done in the past.

1 Janssen, Richard F., and Levine, Richard J., "A Threat to Economy Was Factor in Pressing U.S. to Defend Dollar," Wall Street Journal (Front Page), November 6, 1978.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

EU Theater: Halfway Mark!
Thursday, October 27 2011 | 01:27 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Progress has been made in the first of two EU summits to tackle the EU crisis, as Germany has won its way to rule out tapping the ECB’s balance sheet to leverage the EFSF rescue funds.

The various approaches now seem to be converging. The estimated €100 billion bank capital deficiency will first be met by banks, then by national governments, and lastly by the EFSF, under strict conditions. The EFSF will also guarantee new government bond sales as a way of leveraging its firepower. However, we don’t believe ring fencing alone will be the full solution. The EU needs to build enforcement mechanisms for fiscal discipline that have real teeth. It also needs a lender of last resort with a real financial mandate. Private conversations between leaders, such as those with Berlusconi over the weekend, are ultimately not the way to go. Markets have been demanding explicit enforcement mechanisms that are currently lacking. The EU is starting to acknowledge that its governing treaties need to be revised to ensure better management in the future. However, no one expects meaningful changes anytime soon, so we should expect more of the same EU theater ahead.
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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

Understanding Markit’s TRX.II Index for Hedging CMBS Loans
Friday, October 07 2011 | 09:19 AM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

Newly launched TRX.II may seem complicated, but is not difficult to understand.

Markit launched TRX.II or TRX 2 indices this week. Details and various documents can be found on their website, but for those not familiar with the working of the index, or if the details on upfront payment and dynamic nature of the index are not clear, this article might help understand the mechanics and the underlying logic.
The Basic Concept

The concept is simple. Going long or buying the TRX.II (or TRX) index is similar to buying a bond. If you buy a bond, you get the coupon. Also, if the spread goes lower or tightens, resulting in lower yield, the bond price increases. Same is true with going long the TRX index. If you go long the index, you get a coupon, and if spread tightens, the value of your position goes up. And just like a cash bond, if spreads widen, the value of the position goes down.

The concept is similar, but there are some differences in implementation as the TRX is a contract (Total Return Swap contract) rather than a physical bond. For one party to go long, there has to be another party to take the short side. All that is needed for a TRX trade are the two parties wanting to take the opposite positions, and neither has to actually own or find the underlying bonds to initiate or close a position. TRX contracts will trade with quarterly expirations with a maximum length of one year. Since the contracts will be standardized, the trade may be initiated with one party taking the other side, and may be closed before expiry, if desired by either party, by doing an opposite trade with a third party. This ability to short easily is what makes it possible for loan originators to hedge their loans being aggregated for securitization.

Once they enter into a contract, at the end of every month, the short party pays the coupon equivalent to the long party. Also, if the spread is tighter at the end of month than at the beginning, then the short side pays the price appreciation calculated based on average duration and spread change to the long side, and vice versa. These payments take place at the end of every month, or till the end of contract. Each month, the spread at the beginning of the month becomes the new starting point for spread change for that month. Also this spread is the coupon that the long party gets for that month. It is paid by the short party and represents the cost of hedging.

Upfront Payment

The main purpose of the upfront payment in TRX is to handle trades initiated in the middle of the month.
For example, if someone goes long on 11th day of month, they should get the coupon only for the remaining 20 days in the month, even though the short will pay full 30 days interest or coupon at the end of the month. So, just like in cash bond, the buyer pays an accrued interest for 10 days to the short. Net result will be the short will pay and the long will get net 20 days of the coupon for that month.

Similarly, upfront payment adjusts for spread movement and traded spread. An example may help. Let’s assume the spread at the beginning of the month was 200, at the time of the trade was 230, and at the end of month was 220. In this case, spread tightened from 230 at the trade date to 220 at the end of month. So, the long party should get payment for the value of 10 basis points tightening at the end of the month. However, the standard payment mechanics will see widening from 200 at the beginning of the month to 220 at the end of the month, and will require the long party to pay the value of 20 bps. The upfront payment provides the adjustment that enables the normal end of month payments to take place in the usual manner. In this case, the upfront payment will be the value of 30 basis points (30 bps widening from 200 at the beginning of the month to 230 trade spread) paid by the short to the long. The net effect will be the long getting the value of 10 bps tightening, as he should.
Revolving Nature of TRX.II

One big difference between TRX and TRX.II is that TRX.II is a dynamic index and has a revolving underlying portfolio whereas the original TRX or TRX.I was a static index. The TRX.II will be rebalanced every quarter to include recent deals meeting the inclusion criteria. The initial TRX.II index has 18 bonds. The index rules specify a maximum of 25 bonds. Once the index reaches 25 bonds, the older bonds will be removed as new bonds are added.

The dynamic nature introduces some complexity, but key points to keep in mind are that all TRX.II trades for a specific maturity are fungible with one another and each payment calculation references spreads and average duration for the same set of index constituents. What that means is that when the index changes, the end of month spread for payment at the end of that month is based on the old index, and the starting index for next month is based on the new version of index with new bonds. To enable this, Markit provides numbers for both the old and new version of the index. Rest of the mechanism stays the same.

Spread Determination

The spreads used for monthly settlements are calculated and provided by Markit based on spreads provided by the ten participating dealers for the underlying cash bonds. The fact that the TRX.II will settle every month to actual cash bond spreads means that it will be expected not to stray too far from cash bond spreads. The resulting high correlation with spreads on recently issued cash bonds makes the TRX.II a good hedge for loan originators.

The dealers provide spreads on the individual constituent bonds, not the spread for overall indices, which are computed by Markit. This ensures consistency between spreads for the old and new versions of the index, when the index is adjusted to include new deals.

For the more technically oriented, Markit’s calculation methodology involves using individual bond cashflows to calculate prices from the average bond spreads for each bond and then using aggregated index cashflows and average price to generate index spread, weighted average life, and duration. The end of month calculation of price change from spread change uses the averages of beginning and ending durations and index prices, which captures the majority of the convexity effect.

Outlook for TRX.II

I have asked for creation of a new TRX index for a long time (Restarting CMBS Lending, Feb 9, 2010). So I am happy to see it getting launched. I also like that Markit created a dynamic index which will always reflect spreads on new issue bonds, though that makes it more attractive to hedgers than to investors who may prefer to go long a known set of bonds.

TRX.II is a much better hedge than CMBX as it settles every month based on cash spreads and so is correlated with cash bond spreads, unlike CMBX which pays only when there are actual defaults (far into the future) and can trade purely based on technical factors with no correlation to new issue cash bond spreads. TRX.II is also a better hedge than TRX.I which references the old legacy CMBS deals and does not correlate well with new issue CMBS spreads.

One question on the minds of many people is if the index will gain traction. The general view is that the demand from originators will be there to short to hedge loans being aggregated for sale via securitization, but there may not be enough demand from the long side. It may turn out to be the other way. With spreads wide at present and few deals in the pipeline, the index may see more demand from long side than short side. Hedging of loans for spread movement today is not an almost mechanical process it used to be (CMBS Hedging Requires a New approach, July 5, 2011) and different originators favor different strategies. However, no matter what method is used, hedging has a cost. When spreads are wide and expected to tighten, many originators prefer to hedge just the interest rates and not the loan spreads. Barclays created a CMBS 2.0 index earlier in the year, but it has not been used much, partly for that reason. The TRX.II may benefit from the fact that some originators are now being pushed by their risk management groups to be fully hedged, and TRX.II will have higher correlation with actual cash bond spreads than any alternative. Also, TRX.II has ten licensed dealers. So, there may be more liquidity and more openness by their internal origination groups to use it for their hedging.

Note: A version of this article was published in Thoughts on Markets & Economy (http://marketsandeconomy.wordpress.com/ )
0 Comment | Add Comment(s) | CMBS, TRX, TRX.II, TRX2, TRX-II, TRX-2, TRX.I, CMBX, Synthetic_CMBS_Index, Loan_Hedging, Markit, CRE_Loan_Warehouse_h, Commercial_Real_Esta, linkedin, TRX2_101, TRX2_Tutorial,


Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Crisis of Confidence - Opportunity for Adding Alpha in Debt and Volatility?
Monday, October 03 2011 | 11:41 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

While there have been significant signs of a slow-down in economic growth since May, you wouldn't know it by looking at U.S. retail sales – up 0.5% in July, 8.5% higher than last year, and up 8.2% for May-July.

Retailers have grown their earnings on average by 11% in the second quarter.

However, there are a lot of clouds on the horizon as consumer confidence is weakening, which is heavily influenced by exogenous factors such as the stock market, political uncertainty and negative headlines.
As a result, many are bracing for a much weaker second half due to consumers confronting the prospect of losing their jobs.

This is primarily a crisis of confidence rather than the much deeper financial crisis in 2008 and 2009, driven by the balance sheet of banks being bloated and over-leveraged with bad real estate debt.

Most concerns today are attributable to one of the following key issues:

1) Eurozone Identity Crisis - fiscal union or breakup of euro
2) Poor US Budget Gap Management – political stalemate and age of austerity
3) US Structural Problems - shadow housing inventory and poor employment mix
4) Central Bankers Dilemma – price stability vs. growth
5) Harsh Regulatory Environment – over regulation, e.g. risk retention rules, collateral margin requirements for OTC derivatives

Despite all the negatives, there are vast global opportunities to add alpha in debt-like investments with stable cash flow or take advantage of the much higher volatility than normal to accumulate diversified global equities and manage the beta risk.

Of course those looking for undiscovered sources of alpha in over-picked public markets must work harder and possibly retrain themselves as riding the beta waves of return has gotten riskier than ever.

Despite the unprecedented low base yields across the curves, there are very unique opportunities created due to the availability of credit for certain out-of-favor fixed-income asset classes.

The opportunities can be categorized in two ways – short-and-juicy and long-and-stable.

Examples of high alpha but short maturity include:

1) government guaranteed mortgage warehouse equity funding
2) single-family REO rehab finance
3) supply chain finance (factoring)
4) consumer durable leases
5) fully-collateralized premium finance.

In most of these cases the average life is less than one year and as short as 1-2 months. The yields for these opportunities are double digit, depending on the position in the capital structure.

Alternatively, investors can consider Norwegian 3-month NIBOR at 2.93% and 2-year Norwegian Government bonds yielding around 2.20%. The risks in the former opportunities are operational in nature and controllable. The risks in the latter entail leverage, currency and rate differentials.

Examples of the longer term opportunities with stable cash flows requiring non-traditional infrastructure include:

1) newly-originated non-agency residential whole loans
2) newly-originated commercial real estate loans
3) senior-secured loans to specialty finance companies
4) middle market senior secured loans
5) municipal revenue bonds
6) esoterics including structured settlements
7) renewable energy project finance
8) tenant improvement finance for commercial tenants
9) nonperforming residential, student and consumer loans (non- securities).

Both short-and-juicy and long-and-stable opportunities require special infrastructure for understanding the underlying fundamentals, disciplined management of the origination, credit due diligence, funding, closing, servicing, workout, and investor transparency.

Further, it requires a special origination operating platform and tight operational and financial risk management.

In the highly volatile world of global equities, managing portfolios requires systematically assessing both alpha potential as well as non-linear transaction costs to be able to take advantage of them in a timely fashion.
The necessary quantitative equity tools provide disciplined formulation of driving fundamental and technical factors and allowing the estimation of each stock's return potential and constructing optimal portfolios.

NewOak's transparency, risk and portfolio management tools (OpenRisk and Stratus) are designed to enable its clients to source and execute high alpha opportunities in highly granular and hard-to-value assets along with the traditional fixed-income and equity portfolios. They provide full transparency for the risk and reward for portfolios as well as help manage process flows.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

U.S. Banks – It Ain’t Fair!
Tuesday, September 13 2011 | 07:57 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

When one of the largest US bank’s chiefs cries “it ain't fair”, it must not be fun anymore to run a US-based global bank. The challenge banks face is how to position themselves optimally to face Dodd-Frank, Basel III, litigation fights, and a deteriorating economy, all at the same time.

In addition to Dodd-Frank's regulatory reforms on their home turf, large US-based global banks will incur additional costs due to Basel III, including higher capital requirements, less favorable treatment of US government-guaranteed RMBS vs European covered bonds, restrictive securitization framework and tougher consumer-lending regulatory compliance requirements.

To complicate matters, most US banks must also deal with convoluted structured product litigation matters from a variety of angles including servicing, origination, packaging, distribution and management, which will be costly to the overall economy. The playing field seems to be tilted more favorably toward the large Asian financial institutions benefiting from faster growth and less onerous regulatory requirements. It is not just Basel III that is "anti-US", but Dodd-Frank and where the US is on our cycle of fiscal and monetary policies.
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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

How to Finance Infrastructure and Clean Energy Investments
Tuesday, September 06 2011 | 08:17 AM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

Investments in clean energy and infrastructure projects can help address the unemployment problem and make American business more competitive. The challenge is financing these investments in the current environment. There is a creative solution available that does not require new taxes, printing more money, or increasing the deficit.

The President is set to propose investments in infrastructure and clean energy in his jobs speech next week. There are several reasons that make spending on infrastructure and clean energy a good idea at this time: the jobs created are local and cannot be exported, the jobs created are in sectors like construction that are facing higher unemployment, it generates demand for products and services from a variety of industries creating more jobs, deteriorating US infrastructure is sorely in need of maintenance, and now is a good time to make these investments as raw materials and labor are cheap (maintenance is necessary and overdue - not doing it now just means that it will have to be done at a later time when it will likely cost more).

Even though infrastructure investment is a good idea, it faces two big problems.

First is the need to finance these investments. With the focus on reducing deficit, it will be difficult to get everyone to agree on spending money on these projects. The President has made similar proposals in the past. Republicans are almost certain to oppose more spending and any taxes to pay for it this time too. The bankruptcy filing this week by the solar power panel maker Solyndra, which had $527 million in loans from Federal government, and had been praised by the President, will be held up as an example by many of a poor government investment that put public money at risk, and a reason why government should not get involved.

The second problem is picking projects that are productive and not just a waste of money. Government may not be the best judge for picking the best projects.

The solution to both problems is increased involvement of private sector.

However, to get the private sector to invest in infrastructure projects, the government has to provide incentives, but in a way that does not increase deficit or taxes. One creative possibility for doing this may be by using the estimated $1 trillion of unrepatriated profits US companies hold in foreign subsidiaries.

American companies can generally defer paying taxes on foreign profits as long as they keep the money outside US. When they bring the money back to US, they have to pay the top corporate tax rate of 35%. To defer taxes, US companies generally have left large sums of profits in their foreign subsidiaries. These untaxed profits are part of the reason large multinationals have lower overall tax rates for which they have been criticized at times.

The administration has proposed taxing worldwide income of US companies, but faced strong opposition since that would put the US companies at a competitive disadvantage.

On the other end, US companies are arguing that they could bring back the earnings in their foreign operations if the US government offered a tax amnesty and permitted them to repatriate foreign earnings at a low rate of around 5% instead of the 35% federal tax they face at present. They argue that 5% tax could bring $1 trillion back to US for increased economic activity and could generate additional $50 billion in federal tax revenue.

The tax amnesty will not result in an increase in deficit or taxes, as government is giving up what it is not getting anyway - without it, these funds will not come back into the US economy, and the Treasury will not get the additional tax revenue.

However, the tax holiday idea has been opposed by many as the funds brought back will not necessarily be used to generate jobs. The companies could use the money for M&A activity, stock buybacks, and paying out dividends. A similar tax-amnesty program was implemented in 2004. However, of the $362 billion that was repatriated, very little was used for actual investments to create jobs.

A better idea, one that addresses this concern, will be to offer the tax amnesty only to the funds brought back that are actually invested in infrastructure and clean energy projects in the US. However, money is fungible, and it can be easily moved from one bucket to another. To ensure that the tax break really results in investments that create jobs, the repatriated money has to be separated from the other funds of the repatriating company. Hence, for this idea to be effective, the funds brought back must be invested with third-party private fund managers for a minimum number of years to qualify for the tax break.

A limited time tax amnesty will encourage US companies to repatriate earnings back to US quickly. A requirement to invest in infrastructure projects for a minimum fixed number of years (say something between 3 to 5 years) will ensure that the funds brought back create jobs. Companies will be allowed to invest in either debt or equity depending on their risk-reward preferences. Government will not be involved in making investment decisions. All investments will be chosen and managed by private fund managers, who will pick projects and investments based on sound economic calculations of cost-benefit and expected returns. The companies will be free to pick any fund manager based on their judgment of manager’s capabilities and investment strategy.

This basic framework could be enhanced in several ways. Companies could be encouraged to invest for a longer period by offering to reduce any taxes on the earnings from the infrastructure investments, if the investments are held for say 7 to 10 years or more. Also, companies could be allowed to use part of funds brought back to build new plants for their own use, or setup funds that finance purchases of company’s products.

This proposal is a middle of the road approach which addresses the problems the US economy is facing in a productive way and should be acceptable to both sides. Even if there are plans to change rules to tax worldwide earnings of US companies in future, it still makes sense to address the past earnings that are held outside US.

Longer term, the US needs to develop regulations that clarify and encourage private sector investment and involvement in the clean-energy and infrastructure sectors, both of which are essential for the growth and competitiveness of the US economy in the longer term. The areas that need attention from lawmakers and regulators include Public-Private Partnerships, securitization of infrastructure financing, and eligibility rules for MLPs and REITs.

Note: I originally wrote about this idea in November 2010 and shared it with several policy-makers, elected officials, industry chieftains, think-tanks, and members of the media. Given the state of the economy, the idea is more timely and urgent now. The original, more detailed, article is at http://marketsandeconomy.wordpress.com/2010/11/23/tackling-the-us-unemployment-problem/.
A version of this article was published in Thoughts on Markets & Economy.
0 Comment | Add Comment(s) | Economy, Jobs, President_Obama_Spee, Stimulus, Taxes, Unemployment, Infrastructure, Clean_Energy,


Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

CLO Manager Consolidation: Is The Timing Right?
Wednesday, August 31 2011 | 08:14 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

After 4 years of anticipation by investors, we are finally seeing CLO manager consolidation occurring in a meaningful but yet modest way.

The CLO market had gone from being driven by equity-investors/managers seeking leverage in early years, to an asset management/structuring fee play by the mid 2000’s. This led to a proliferation of smaller managers hanging on for the market re-opening for new issuance post-2007. Because of the pending Dodd-Frank’s risk-retention rules requiring issuers to keep 5% of equity and debt, smaller CLO managers without an outright equity capital or sponsorship are more willing to sell out.

The timing of these consolidations may appear unwise in light of the volatile markets, lower expected growth and uncertainties about European bank capital issues. However, since the funding spread of the existing CLOs are fixed, wider loan spreads for reinvestment will lead to higher equity cash flows and returns. Depending on the combined price of management fees and purchased equity cash flows, the strategy of acquiring smaller CLO managers could make sense today for larger managers.

Longer term, CLO manager consolidation is a negative factor for the corporate loan issuers as it reduces their investor base and their pricing power. Higher spreads due to a weaker economy is already expected, so the only good news for corporate issuers is that Libor will stay low for quite a while and keep their overall funding costs low.
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Janet Tavakoli, President, TAVAKOLI STRUCTURED FINANCE

Investing: Bad News, Good News, and What's Next
Tuesday, August 30 2011 | 02:14 PM
Janet Tavakoli
President, TAVAKOLI STRUCTURED FINANCE

The manic depressive market wildly swings up and down on each new news story: The Fed is meeting at Jackson Hole on August 27 possibly to discuss QE3 (or not), and that news may pump up the stock market. But China's banks seem to be using Enron's accounting manual, Europe's banks need liquidity and are loaded with bad debt, and U.S. banks only temporarily TARPed over trouble. Gaddafi's regime in Libya appears over, but Libya's oil output may not fully recover for years. Venezuela wants banks to open their vaults and send back its gold, but Wells Fargo says gold is a bubble. Pundits say gold is a barbarous relic, but exchanges and banks are now using gold as money. The U.S. is headed for hyperinflation with skyrocketing stock prices, but on the other hand, we seem to be deflating like Japan and doomed to a deflating stock market for another decade. Whom do you trust and what should you do? No one knows where the stock market or U.S. Treasury bonds are headed tomorrow, but in my opinion, here are some fundamentals to consider.

The Bad News Isn't Going Away

Until we have real global financial reform and restrain the banks, we won't have sustained growth. The stock market hasn't hit bottom. There's a crisis of confidence in banks and all currencies. We haven't taken effective steps to tackle the U.S. deficit through productivity. We haven't examined spending to eliminate fraud and waste, and we haven't addressed our need for more tax revenues by eliminating the Bush tax cuts (for starters).
Savers are punished by "stranguflation:" negative real returns on "safe" assets, declining housing prices, and rising costs of food, energy and health care. The Fed touts the falling cost of I-Pads, but how often do you buy one of those, and how often do you eat?

Good News (for Now)

The USD is still the world's reserve currency. Even though we devalued the USD, there has been a global flight to U.S. Treasuries pushing down our borrowing costs (yields). No one in the global financial community feels the U.S. has done its best to correct our problems, but severe problems in Europe, China's inflation, and Middle East unrest has money running to the U.S. Since we've devalued the dollar, we appear to be a bargain for foreign investors, even though they are terrified by our money printing presses and the potential for inflating commodity prices in the long run.

How did I play this? My own portfolio is currently more than 20% gold with some silver, and I bought out-of-the-money call options on the VIX when it was in the teens with maturities of 4-6 months. This is "short" stock market strategy, one could have also done well buying puts on the S&P a few months ago. In the first big stock market downdraft in August, I sold the options when the VIX hit the high 30's, and I'll buy more options again if the VIX falls again. Many investors are not comfortable with options, and this strategy isn't appropriate for everyone. The rest of my portfolio is chiefly in cash or deep value opportunities.

What Happens Next?

No one knows for sure, and anyone who tells you he or she does is selling snake oil. The situation is fluid. We tried to reflate our deflating economy. Our massive dollar devaluation may encourage investment, because it's protectionist. It reduces our cost of labor, among a few other "benefits." The problem is that the Fed has printed money, and we haven't done anything to position the U.S. for greater productivity. We're trying to inflate our way out of a problem without investing in productivity. This is a very dangerous way of attacking this problem. Even more "stimulus" would just be an attempt to inflate our way out of our long-standing deep recession. That's the foolish and unsuccessful strategy we've adopted so far. That could lead to runaway budget deficits (our deficit already looks intractable) and bring us to double-digit inflation. Even the European flight to US Treasuries may not save us from a deeper recession in that scenario.

If we don't overreact -- and we may have already overreacted -- our dollar devaluation results in our foreign trade situation first getting worse (as it has now) before it gets better. Now is the time (actually, we should have started years ago) to spend capital to increase U.S. productivity. The dollar's plunge relative to other currencies will eventually make us more competitive. This will be good for blue chip companies, in particular those that own real assets and manufacture items. The Fed and Washington may do anything, however, so one must watch the news.

What does this mean for the U.S. stock market?

In my opinion, it is currently not good value and feels like the 1970s when we experienced a recession followed by inflation. One should consider staying mostly in cash and expect stocks become cheaper. One might miss an interim rally, especially if the Fed announces QE3 (more "stimulus" and money printing) or more bank bailouts, but that is like using Kleenex laced with sneezing powder. We will see stock prices even lower than they are today. The old paradigm dictated that stocks were a buy when P/E ratios were 13 or less (and many are well above that), dividends at 4%, and book values at 1.3 or less. (This excludes oil companies, which tend to trade at lower P/E ratios in general.) I believe we'll see much better deals in coming months. In 1978/79 P/E ratios sank below 7 for blue chip companies.

Should one buy U.S. Treasuries with long maturities? The long end of the bond market doesn't reward investors due to the potential of rising interest rates. If interest rates spike to double digits, then one can reassess the situation.

Long term investors should consider buying commodities or companies that own physical commodities. We're running out of key commodities especially related to agriculture and fertilizer. Washington's brand of the latter isn't the type we need.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

The Stalling US Economy – Should the Focus Turn On Trade Pacts?
Thursday, August 25 2011 | 01:40 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

After spending months focusing on the U.S. debt ceiling and worrying about a possible U.S. downgrade, it is time to turn our attention to what really matters – reversing the stalled US economy through expanding trades. While the rest of the world has relatively free access to the U.S. markets, U.S. companies’ market access is restricted in many countries in the Americas, Asia, and Europe. Bi-lateral free trade pacts can open the doors for U.S. companies and create new jobs at home. Many ideas to stimulate the economy have centered around tax incentives or new government spending. In contrast, stimulating exports relies mainly on leveraging our existing foreign and military aids and considerable open access to our markets. It is crucial that the U.S. Congress makes a concerted effort to pass the long delayed free trade pacts with South Korea, Panama, and Columbia in September and the administration looks to forge new ones.

Given the grim prospects for the domestic demand, boosting U.S. sales overseas will be crucial to propel the economy and avoid a double dip recession. While Congress has been quibbling over passing trade agreements for several years, our trade counterparts have enjoyed free access to our markets. We are hopeful that the current economic setbacks will create a strong catalyst to a fundamental shift from reliance on domestic consumption and government spending to a more balanced approach with focus on exports and private initiatives. While cautiously watching the near term market dynamics and European debt crisis, we are long term positive on the US prospects and look for companies with good foreign sales growth potential.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

A New Kind of Risk
Thursday, July 28 2011 | 08:52 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

While the global markets are preoccupied with how to account for obvious risks such as breaching the US debt ceiling, Greece default and their domino effects. There are many risks that are not even in the minds of many investors let alone being priced-in by the markets.

There is a real risk of potential cyber attacks targeting companies or attempting to paralyze the global financial systems as a whole to achieve radical political goals. The recent Sony and Lockheed cyber attacks illustrate the degree of vulnerability of even some of the most technologically advanced companies. Given the lack of comprehensive models of cyberspace and absence of general appreciation of the overall financial markets’ vulnerability to a widespread attack, investors don’t seem to be so much focused on the risks and pricing that in their valuation. Just the fear of it will create regulatory, operational and legal risks that will cost companies a great deal in both capital and management distraction. We are far from fully understanding and pricing of cyber attack risks and the possible implications for the overall global markets.
0 Comment | Add Comment(s) | US_Debt_Ceiling, Greece, Cyber_Attacks, Lockheed, Risk,


Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

Leveling the Playing Field for Clean Energy & Infrastructure
Wednesday, July 27 2011 | 11:47 AM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

Historical factors sometimes result in favoring Oil & Gas over the newer renewable energy technologies. Eligibility for MLPs is one such area that can be easily fixed.

The need for additional capital to flow into renewable energy is clear. The sector has a strong dependence on government incentives while it develops towards price parity with conventional energy sources. Recently, Section 1603 Cash Grant program and the section 1703 and 1705 loan guarantee programs have provided some support. However, many of these programs are scheduled to expire in near future. In the past, the sector depended on tax-equity market for financing of projects. But, with lower profits especially at commercial banks which were active in the tax-equity markets, that market will not be able to play the same role as in the past. The clean energy sector needs more help.

The traditional energy sector has available to it a source of capital in form of MLPs (Master Limited Partnerships) that can invest in Oil and Gas. The MLP structure was created by Congress following the energy crisis of the 1970Œs to spur investment in the energy sector for oil and gas exploration, storage, refining, and transportation by providing specific tax advantages to investors. The MLP structure provides the tax benefit of a limited partnership and at the same time provides liquidity of common stock since the PTP (Publicly Traded Partnership) units trade on exchanges just like common stock. Since the MLPs generally hold income producing assets, the resulting high dividend attracts a lot of investors, providing capital to the sector.

Income earned from renewable energy projects, however, is not considered eligible for MLPs. This is because of historical reasons more than anything. When this law was passed in 80s, renewable energy sources were not in the same state as today. This historical factor results in favoring the old energy over the newer renewable sources. Political factors aside, a simple legislation by Congress can correct this to level the playing field. Infrastructure is another sector that is in need of capital, and could also be included.

This, by itself, will not be sufficient, but will be a logical and helpful step in the right direction.

Note: This summary presents the key points of the article The Case For Master Limited Partnerships (John Joshi & Malay Bansal, July 20, 2011) published on AOL Energy.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Bond Markets: Sending Mixed Messages?
Wednesday, July 20 2011 | 08:19 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

While US treasuries have rallied and demand for them has risen, bond funds are holding the highest level of cash over the last three years. Congress is debating how to reduce the ballooning US budget deficit by cutting spending and increasing taxes, while the demand for US treasuries has gone up by global investors seeking refuge from the European sovereign debt crisis. On the other hand, mutual funds in the US are setting up for an abrupt price drop in treasury prices and higher yields by increasing their cash positions and giving up yield in the interim.


Despite warnings from the rating agencies of a potential US downgrade if the debt ceiling is not raised in time, US treasuries are still viewed as a safe haven to protect against sovereign defaults in Europe and political uprisings in the Middle East. Regulatory changes in OTC derivatives’ collateral requirements are also adding to the demand for US treasuries. Of course a solution to the Greek debt crisis and a few signs of growth could lead to an abrupt sell off in treasuries, and that is what mutual funds and some of the US institutional money managers are betting on.
0 Comment | Add Comment(s) | Bonds, US_Treasury, Mutual_Funds, Global_Economy, Political_Climate, Sovereign_Defaults,


Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

CMBS Markets: Are They Normalizing?
Tuesday, July 12 2011 | 09:25 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Many aspects of the newest Deutsche Bank’s CMBS deal points to the market normalization and speaks well to the resilience of the CRE and CMBS asset classes.

According to Dow Jones, the $685 million CMBS deal is backed by the restructured loans on the Whitehall's Tharaldson portfolio of 168 business hotels, covering 42.8% of the appraised value of properties and interest coverage ratio of 2.88. The restructuring was made possible by the Abu Dhabi Investment Authority capital injection as a preferred equity. The fact that institutional investors are open to single-asset-type CMBS and a sovereign fund single-handedly jumping in to take on the entire preferred position indicates the investors are confident in the economy long term and are attracted to the asset class. Another element that reflects back-to-the future attitude is Morningstar’s assignment of AAA rating to all three top tranches of the deal, while the other agencies placed a lower rating on the second and third tranches.
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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

CMBS Loan Hedging Requires Care and Creativity
Wednesday, July 06 2011 | 06:43 PM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

CMBS loan hedging issues have often tripped even smart real-estate lenders. The current environment requires a careful and different approach than in the past.

Recent spread widening and volatility in CMBS market have drawn attention to hedging issues for loan originators in securitization shops. An article in this week’s Commercial Mortgage Alert (New Markit Index May Solve Hedging Woes) reported comments from market participants that the recent spread widening, which was equivalent to about 3% decline in value of loans held, hit all lenders, though to different extent depending on their hedging approach. In an increasingly competitive market with declining profit margins in loans, a 3% hit is clearly very significant for any origination business.

Last week, a Bloomberg news story reported that spread volatility was as an important factor in Starwood Property Trust’s decision to back away from originating debt that would be sold entirely into securitizations.
Hedging issues, even when people believed they were hedged, have tripped many very smart real estate lenders in the past. During the previous crisis, after the Russian debt problems in late 90s, the hedges made a huge difference. At the time, many CMBS lenders hedged using only treasuries. Only some used swaps. Those who used only treasuries were hurt doubly as treasury yields declined increasing the prices of treasury hedges they were short, while swap spreads jumped higher decreasing the value of their assets which were valued at a spread over swaps. Those who had hedged using swaps did not suffer that much. Those who did not use swaps had devastating losses. After that painful experience, everyone in the market moved to hedging with swaps.

Hedging with swaps still left the risk of adverse movements in CMBS bond spreads, a smaller risk most of the time. Few years later, as competition increased and profit margins declined, some started using total return swaps on the Lehman CMBS indices (now Barclays Indices) to hedge that risk too. Those legacy indices are not useful now as they contain old deals. Some people have turned to CMBX1 for hedging, as it is closest to the new issue bonds amongst the five CMBX indices. CDS on IG Corp indices have been used at times by some, and I have heard people exploring use of other tools like equity indices. However, all of these approaches need to keep in mind that any hedge used needs to have a very good short-term correlation with new-issue CMBS bond spreads – longer-term relationships do not mean anything. If the hedge can move in the opposite direction of the asset in the short-term, it’s not really a hedge.

Lack of a good hedge was one of the reasons that delayed restarting of CMBS lending. Last year, I suggested to Markit to create a new TRX 2 index based on the few new deals that had been done so far (Restarting CMBS Lending, Feb 9, 2010). The idea did not get much traction then. Julia Tcherkassova, who heads CMBS research at Barclays, articulated the need for a CMBS loan hedging mechanism internally, resulting in Barclays creating a US CMBS 2.0 Index earlier this year. That index provided a mechanism to hedge loans but it was not used much.

An instrument existed to allow hedging of loans but no significant attempt was made to use or develop liquidity in it by the industry. The reason is probably as simple as the fact that new issue spreads were generally in a continuous tightening mode till the recent sudden widening episode, and that made spread hedging seem not that important. Another factor is that the hedging is expensive. In the past, the cost of hedging with Lehman index was around 30 bps (on an annualized basis). With CMBS2 indices, that cost would have been about 110 bps. Given that the loan volumes are lower, giving up profitability becomes tougher. So the new Barclays index came, but was not met with a strong demand and remained unused. The wider bid-ask spreads also make hedging expensive. Commercial Mortgage Alert reported that Markit is close to rolling out a new TRX index, dubbed TRX.2. Since it is coming out after a widening that was painful for many, it might attract more attention. Hopefully, it will provide a liquid instrument that can be used effectively for hedging loans being aggregated for securitization.

However, another point to think about is that the new TRX index will likely come with or be followed by new CMBX indices. It remains to be seen if the new synthetic CMBX indices will introduce more volatility in cash markets as did the legacy CMBX indices. One thing is sure though – hedging is as important as anything else for loan originators and needs to be given proper attention. All the careful real estate analysis while making loans can come to nothing if sufficient attention is not paid to hedging while loans are being aggregated for securitization. Mechanically following the past methodologies will not be the best approach. The current environment calls for adjustments and creative ideas for hedges to be effective and less costly.

Note: A version of this article was also published in Thoughts on Markets & Economy.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

'Extend and Pretend' Policies
Wednesday, June 29 2011 | 08:40 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

The jokingly named ‘extend and pretend’ policies have worked in a few cases. But they could lead to much bigger systematic risk if the ultimate resolution of the European sovereign debt crisis is delayed further. The beginning of a potential domino effect is already being felt in the interbank lending, Euro, and money markets. Fear of a Greece default and subsequent spreading to Ireland, Portugal, Spain and Italy has started to cause US banks to curtail lending to European banks and has led to the weakening of the Euro. Since European banks debt constitutes a significant portion of non-government money market funds, there has been a recent trend of withdrawals from these funds. European bank credit is also causing T-Bill yields to trade in the negative to 1bp range, despite concerns about US fiscal ills and potential temporary default arising from a delay in increasing of the US debt ceiling. Continuation of these trends would make the pan-European systematic risk scenario more plausible by the week.
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Robert Sainato, Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

CRE CDO Opportunities
Wednesday, June 22 2011 | 04:06 PM
Robert S. Sainato CFA, CFP, CIC, CAIA
Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

CRE CDO COMMENTARY: General

CRE CDOs are extremely individual in nature (similar to older vintage ABS/Mult-Sector CDOs) and should only be analyzed using a "bottoms-up approach". Risk-adjusted yields can range from the extremely safe short 1-2 yr WALs earning mid single-digits yield, while longer WAL/Cuspier credits can earn high singles to low teens yield.

Each CRE CDO is unique in collateral: CUSIPed collateral (CMBS & REIT) and non-CUSIPed collateral (Whole loans, A-Notes, B-Notes, & Mezz Loans). In addition, deals are unique by vintage. For example, 2006 CMBS Mezz bonds may be trading in the 20s and 30s with significant losses expected while 2004 Mezz CMBS will be trading near 100 with little chance of loss. This type of mix between collateral and vintage can create a wide variety of risk/reward opportunities that may be difficult to source in other products.

CUSIP-Backed CRE CDO Opportunities:

These deals are very interesting as risk adjusted returns can range from mid singles to low teens. Well-covered deals backed by Dupers/older mezz CMBS generally trade in the 90s while deals backed by newer mezz CMBS trade in the 10s and 20s.

1) One opportunity in these deals, in our opinion, is the ability to source cuspier paper that is generally unavailable in the market. What we are talking about here is the ability source pooled assets that have significant potential upside while mixing some very solid assets/structure that can give you a potential floor on the downside.
2) WAL Risk/Opportunity: Careful analysis of loans and modifications can reveal potentially shorter or longer WALs for 1st Pay CRE CDOs. The Street is broad brushing extension and modification risk which could create opportunities or risks.

Loan-Backed & Mixed CRE CDO Opportunities:

Loan deals share similar opportunities and pitfalls as mentioned above but have further unique characteristics. These deals, although simpler in number to analyze (100ish loans in the whole CRE CDO deal) vs. a typical CMBS-backed CRE CDO of about 15,000 loans (150x100), can be somewhat difficult due to the lack of data on the underlying loans, especially when the loans are not found in CMBS deals. This lack of clarity further complicates these deals but also brings potential opportunities for the careful investor.

Maturity Wall & Extensions:

As seen below, CMBS investors and CRE CDO investors have a formidable wall of maturities on loans that need to be refinanced. Although the commercial real estate market seems to be stabilizing, the market still faces extensive refinancing risk. This risk is more formidable, in our opinion, than in the CLO market.

Borrowers in the CLO market have been able to refinance, as defaults remain low and balance sheets/income statements remain strong. In addition, when refinancing has not been an option, borrowers have then resorted to loan modifications and extensions. The CRE CDO market is different with little chance for refinancing existing loans. To refinance an existing loan the borrower would have to inject a significant amount of equity as real estate prices have dropped and NOIs have fallen. Therefore, we are seeing most CRE borrowers resort to mods (see below). We expect this trend to continue and mirror the maturity profile listed below.



Loan Extensions Reduce CRE CDO Delinquencies:

There has been a lot of talk about loan extensions and mods causing delinquencies to drop but little talk about the alignment or misalignment of interest that CRE CDO managers may have that can cause them to make seemingly irrational decisions to "extend/amend and pretend". What many are seeing is that some loan extensions and mods do not make sense and that the loan should instead be liquidated. This type of situation seems to arise more often in whole loan deals in which the manager had used the CDO as a financing tool and retained a significant portion of equity and mezz classes. By prolonging the pain via modifications & extensions, managers are maximizing payments to them and prolonging the life of the CDO. Payments (in the form of sub manager fees) and value (equity/mezz retained) are maximized while 1st priority note holders suffer. It is important to note that, in loan-backed CRE CDO deals, managers can have a lot or little say, depending on the seniority of the loan. For example, CRE managers owning whole loans have extensive decision rights in terms of modifications and extensions. These rights do not extend mezz loans, B notes, A notes, and CMBS deals.

Delinquency Rates Across Asset Types:

As seen below, delinquency rates for commercial real estate continue to increase (over the past 5 months), although at a decreasing rate, with multifamily and hotels leading the pack.



CMBS Loss Estimates Across CMBX Indices:

For those CUSIP CRE CDO investors, we list below loss estimates for CMBX published by Blackrock, BAML, and JPM for 2006-2008 CMBS. We compare this to defeased-adjusted credit support of AJs to As. For example, early 2006 originally rated AJs look well-supported with 6.8% cushion (13.5-6.7%).


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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

State Budget Gaps: Rosy Assumptions or Real Cuts?
Monday, June 20 2011 | 08:46 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Governor Jerry Brown of California vetoed the state budget that the California Legislation had just passed, stating that the plan increased the budget deficit short term and covered over the long term public finance issues.

Politicians seem unwilling to make cuts or increase taxes to achieve a balanced budget. The hope seems to be that by making rosy assumptions the problems will go away. States seem to be balancing their budget by not raising taxes or making deep spending cuts, but by making unrealistic assumptions on savings and underestimating expenses. The fundamental political differences between the democrats and republicans are not leading to spending cuts nor tax hikes, hence leaving large real budget gaps.

Political divide between parties is partially responsible for the states' fiscal mess. The US municipal bond markets are no different than the Greece sovereign bond situation when it comes to the outcome - ultimately the markets will force what needs to happen if politicians don't close the actual budget gaps before that. The political divide has delayed the adoption and implementation of the needed actions of higher taxes and more responsible spending.
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Douglas Long, EVP Business Strategy, PRINCIPIA PARTNERS

Investor Due Diligence: Seeing the wood and the trees
Thursday, June 09 2011 | 10:08 AM
Douglas V. Long
EVP Business Strategy, PRINCIPIA PARTNERS

How addressing investor due diligence requirements today demands operational control across the entire credit investment business.

In January 2011, Article 122a of the revised EU Capital Requirements Directive went live imposing a direct responsibility on investors and issuers to perform an adequate level of due diligence for any securitization transaction. Hubris continues to overshadow important technical considerations that are fundamental to an organization complying with new investor requirements. Directions are given in the implementation guidelines of Article 122a by The Committee of European Banking Supervisors (CEBS), now the European Banking Authority (EBA). However, implementing those considerations across the credit investment operation amidst a complex network of systems, information and processes to comprehensively and assuredly satisfy the regional supervisors is no small task.

Much focus is placed on understanding ABS, MBS and CDO investments on a deal by deal basis, but for a credit institution investing in these securities, due diligence is not only a deal by deal job. It requires a portfolio and business unit wide operational approach to understanding investments in context, alongside detailed and thorough deal analysis. Without this, credit institutions won’t be able to see the wood for the trees.

Before entering a position and in an ongoing manner, EU banks must demonstrate a thorough understanding of any given deal and that they have implemented ‘formal policies and procedures…commensurate with the risk profile of their investments in securitized positions’ to analyze and monitor any exposures arising from the performance or collateral underlying a deal. This demands a strong backbone to unify the necessary portfolio management and risk management activities but also the operational sophistication and business wide controls to establish due diligence processes and maintain compliance with internal investment guidelines.

Depending on the severity of a breach, an additional risk weighting of anywhere between 250% to 1250% can be applied to a securitization exposure. A revision to risk weighted penalties in the latest guidelines also states that the regulator, “shall increase the risk weight with each subsequent infringement” over time. The penalties are now clearly outlined in national supervisor’s implementation handbooks too, for example the Financial Service Authority’s (FSA) Handbook, BIPRU 9.15.16R.
What’s an investor to do?
Monitor and track risk exposures
At the deal level, understanding the risk characteristics of individual tranches means monitoring issuance details such as seniority level, cashflow profile, historical performance and credit enhancement.

Diligent investment analysis under today’s CRD means implementing consistent ways to analyze and manage all of the data relating to a deal’s structure and credit enhancement, the individual tranches of that deal and the performance of its underlying collateral pools. To avoid penalties, large credit institutions with growing exposures to different securitizations, will seek to find ways to consolidate the various data sets for all the deal information and performance data across its assets. This is the basis for sound investment analysis and risk management for individual deals, but also for effectively managing the entire portfolio and reporting to parent operations.

Know the structure
Investors must also understand, or be able to analyze the structural features of deals such as the waterfall, transaction triggers, embedded hedging counterparties or liquidity facilities.

A detailed understanding of the waterfall structure and strong cashflow models, alongside accurate, timely performance data is a pre-condition to informed and independent assumptions about the future behaviour of assets and proof of independence. Investors need to have the integrated cashflow models, performance data and analytical flexibility to forecast future performance for all the securities they hold, as well as for any potential investment. This demands the operational backbone to efficiently and consistently bring together all of these elements and incorporate internal credit research within a single view of credit and market risk factors surrounding the structured finance and fixed income business.

Underlying exposure statistics…and loan level if you have to
This requirement does not specify that investors track each loan underlying a deal. Rather, it defines collateral pool characteristics and stratifications, depending on the granularity of underlying pools and the asset class. If the risk profile of the deal requires an investor to analyze individual loans, then that must form part of the due diligence process but it is not a direct requirement each time. The EBA guidance highlights Key Performance Indicators that should always be considered, such as delinquency, default, prepay and foreclosure rates and other metrics like pooled credit scores and geographical diversification. Investors need the clarity and tools to make assumptions based on the pool performance exposures most relevant to every transaction type.

Ensuring comprehensive asset coverage and the comparability of performance measurements across asset classes, geographic regions and sectors is a major operational challenge in ensuring comprehensive credit analysis. The difficulty of incorporating performance data for multiple deals and asset types, from multiple internal and external sources and normalizing it for consistent analysis can be operationally complex and resource intensive to setup and maintain. Implementing a flexible infrastructure to consolidate this analysis sits at the heart of satisfying the requirement effectively and with confidence.

In-house due diligence
Where relying on third party financial models, the credit institution must be running equally adequate models itself with the ability to change inputs and stress levels as appropriate. While deal analytics providers provide tools like this for the assets they cover, a credit institution looking to analyze across the breadth of its structured finance and fixed income securities will require an integrated way to calculate future cashflow across the entire portfolio. Analyzing different asset classes in isolation leaves gaps and analytical limitations when attempting to perform due diligence at the portfolio wide level.

For each asset, being able to layer in model assumptions to independently verify and project future valuations is imperative. Institutions require the systems flexibility to be able to first see a complete view of the deal and its performance to make strong assumptions and then apply their assumptions to a cashflow model, both initially and then in an automated way over the longer term. Importantly though, this needs to be performed across all assets and data sources within a single environment to make fully informed investment decisions and proactively manage risk exposures.

On an ongoing basis…

All the information and calculations needed to make independent assessments over time, must be accessible on-demand in a timely and comprehensive way, and recorded for reporting purposes. Credit institutions need the operational rigor to see everything at once, bring in all the information required for analysis and then, with a fully informed view of the detail, have the confidence and tools to layer in assumptions regarding stressed scenarios.

Stress testing appropriate to each securitization position is key to satisfying the requirements. Doing so also provides an ongoing framework for due diligence when combined with the establishment of operational guidelines, risk limits and controls. Stress testing portfolio sensitivities and collateral performance exposures requires there is first a view across the breadth of risk exposures and an ability to define and analyze any combination of exposure parameters. Alongside the consistent integration of cashflow models and data, stress testing by business line; portfolio exposure (e.g. asset type; geography, sector, ratings etc) or performance exposure (e.g. delinquency rates; default rates; prepayment rates; foreclosure rates) can be sustainable and complete. Warning flags can be set for the most appropriate metrics of each asset class to automate early risk signals at the collateral, deal and portfolio level and highlight exposures demanding more in depth analysis. Future valuations can more effectively be projected under many different scenarios to inform prudent choices across the entire structured finance business.

The original Basel II enhancements to the securitization framework phrased due diligence as, ‘operational credit analysis criteria’. While credit institutions must prove they know every investment to satisfy the regulators, today they must also demonstrate they have the full operational sophistication required to do so, across all deals, portfolios and business lines.

Then if a tree falls in the wood, you can be there to find out if it makes a noise or not.

*as published in Structured Credit Investor, June 8th 2011
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Robert Sainato, Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

TruPS CDOs
Tuesday, June 07 2011 | 11:40 AM
Robert S. Sainato CFA, CFP, CIC, CAIA
Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

TruPS CDOs: Positive Convexity for Seniors, Mezz Tranche Optionality?

The TruPS CDO Market continues to underperform all other CDO markets to date, but this could change as soon as this year. We believe that certain TruPS CDO tranches could start to outperform due to substantially shortening WALs. At present, the market is assuming 0% CPR, translating to very long WALs. The market may be significantly overestimating the WALs of certain 1st priority tranches, especially if prepayments increase due to increased M&A activity, refis, and the Collins Amendment (see below). This effect could be even more pronounced in deals that have older bank TruPS paper in it.

For certain mezz tranches that are currently PiKing (those with only 1-5% negative OC cushion), we are bullish on certain cuspy tranches that may turn on in the future. The catalyst driving this is the new trend of deferring TruPS paper starting to pay again (see below). A careful fundamental analysis of the underlying deferrals could reveal significant upside in these cuspy TruPS CDO mezz tranches, as only a small number of deferral cures can greatly affect your return on these tranches.

Bank TruPS CDO Quotes (Assume 2005 or later)



Potential Increase in Prepays on the Horizon: M&A, Basel III/Collins Amendment, and Refis

Over the past six months, a new positive trend emerging is a pick up in M&A activity among small banks. Recently Iberia Bank took over ailing Omni Bank. Omni TruP debt, although paying at the time, was effectively prepaid.

Last year the Collins Amendment and Basel III passed, resulting in the loss of bank trust preferred debt TIER I status. This could result in many TruPS getting called beginning in 2013. Under the Collins Amendment, phase out of trust preferred Tier 1 credit begins in 2013 and ending in 2016. Although few banks have called their paper yet, this is likely to pick up in the near future.

Many older TruPS CDOs (pre-2006) hold bank TruP debt, strong with a high coupon. Some of these banks can easily refinance some of their paper. As defaults and deferrals continue to bottom and the new issue market picking up, we could see a significant number of banks prepaying.

Deferrals Beginning to Pay Again

Between M&A, new equity capital from third parties, and improvement in banks' asset quality and liquidity needs, we are seeing a number of issuers that were formerly deferring curing to pay again (see example list below). Corporate activity and equity injection have been major reasons for cured deferrals. In these cases, the new equity capital is received either through acquisition or injections from third parties. When this occurs, the deferred TruPS interest must be repaid before the new investors/holding company can be paid. Still, other banks are paying again due to better performance. For example, Inland Bancorp Illinois and Lawson Financial Corp (deferring TruPS) cured due to better performance (not M&A).

Some examples of banks that were deferring and have been since cured can be found below.



Tender Offers: A New Trend

Last year there were several requests for noteholder consent from distressed banks to tender their securities. All requests until this January have been denied. According to Fitch, they have received notification of the first tender offer ($20 bid) that was accepted. This is the first successful tender offer we have heard of and may be the start of a new trend. These types of transactions need to be analyzed carefully as it may or may not be beneficial to noteholders.

Optionality Down the Cap Structure

Some original AA-A rated PiKing paper has been underwater (negative OC Cushion) due to deferrals and defaults. Many of these tranches are underwater between 1%-10%. For those tranches that are "at the money" where they are only underwater by between 1-5%, there could be significant opportunity here. Given the trend in some bank deferrals curing, potential refis (especially on older deals), M&A activity, and slowdown in new deferrals/defaults (see default/deferral index below) there may be some tranches that get turned on in the coming months or years. If these tranches start paying again, returns could be extremely significant.

Swap Drag--Significant Drag on Deals but Should Improve Over Time

Hedge drag has been a significant factor hurting interest cash flow to date. Significant asset deferral/defaults combined with the low level of LIBOR have impaired many tranches. These imperfect hedges to date have been problematic, but it is important to note that as time goes by hedges "roll off" and as LIBOR rises (eventually), this mismatch may even help the deal (if LIBOR rises enough). Under the right circumstances, this problem now could reverse itself!
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Greece and the Sovereign Debt Crisis
Wednesday, June 01 2011 | 10:37 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

European Union finance officials are discovering the benefits of financial engineering in considering Collateralized Bailout ("CBO") as an alternative to sovereign debt restructuring. As the European Union finance chiefs explore various options to deal with the worsening Greece sovereign debt crisis, some EU countries suggest making any additional aid collateralized with national assets.

At this point officials deny any particular options. Given public opinion in Germany and Finland has been against further outright aid to Greece, any option to mitigate the impact of a Greece default would be attractive to the officials. Asset sales by governments to avoid default or raise needed cash have a long history, with an example being that a significant portion of the geographic area of the United States, such as Louisiana, was acquired through sale of land by other governments for cash. Yet a sovereign bond collateralized by a specific land or a national monument would be new. Structured finance traders may joke about a due diligence trip on a new "Apollo CBO" if it was a sovereign bond of Greece collateralized by Mykonos Island, though Greek nationals may not find that quite as funny. Given the financial conditions, we may also see collateralized or structured debt solutions considered in other public finance cases such as US municipal markets.
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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

Three Misconceptions about Issuer-Paid Ratings
Friday, May 27 2011 | 10:34 AM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

By Malay Bansal & John Joshi

The issuer-paid model for ratings is widely seen as one of the most significant aspects of the process that needs to be reformed. Yet, no good solution to reform this process has emerged. Part of the reason for that are three widely held misconceptions.

Issuers select which NRSROs will rate their deal, and they pay the rating agencies rating their deals. Many blame this dynamic for causing a conflict for the agencies, and enabling ratings-shopping by issuers. This is perhaps seen as the biggest problem in the current ratings system. Dodd-Frank and other rules in the US and Europe are trying to reform the process. Some proposals suggest removing references to rating agencies from rules, while others suggest regulating them more heavily. The former leaves a hole; the latter increases the perception that the ratings have official approval. No good solutions have emerged.

A previous article in this blog and in Structured Credit Investor (The Unrecognised and Unaddressed Ratings Issue, Malay Bansal, 7 July 2010) made the point that the ratings reform is proving to be intractable because the real issue is not being recognized or addressed in any of the reform proposals. The real problem is that the rating agencies are combining two roles into one. The first role is to provide a rating based on statistical analysis of historical performance of the assets (remember that the ‘SR’ in NRSROs stands for Statistical Ratings). The second role is that of a research analyst to provide an opinion on what might happen in the future. Currently, rating agencies combine the two. The ratings are a mix of statistical analysis and somewhat subjective opinion on the future. This allows rating agencies to downgrade companies or countries even while they are in the process of attempting to improve their financial condition. The official NRSRO status gives their subjective opinions extraordinary power and can actually have an impact on the outcome, making the ratings more pro-cyclical.

The logical solution is to separate the two roles. NRSROs should be doing Statistical Ratings – based on past performance of assets, known facts, events that have already taken place, and statistical models and methods that are well disclosed. They can put bonds on watch for upgrade or downgrade if a financial event is in progress or expected, but cannot downgrade or upgrade till the event actually happens. So they will not be precipitating events.

The second role of providing credit ratings in the form of opinion on future performance should be separated from the NRSRO role, and should be open to any research provider, including NRSROs. These credit ratings could be designated as ‘Informational Ratings’, without any legal or official role impacting investor charters, debt covenants, and so on, which will only use the ratings designated as NRSRO Ratings. This will take the non-NRSRO rating agencies back to sort of where rating agencies started – as market researchers, selling assessments of corporate debt to people considering whether to buy that debt.

The conflict of issuer-paid ratings could be avoided if issuers paid the fee for NRSRO ratings, which will be freely available to everyone, but investors paid the fee for research and informational rating available to subscribers only. Availability of the second will serve as the important function of checks and balances on the NRSRO ratings paid for by the issuers. However, neither issuers, nor the rating agencies seem to find that suggestion appealing. This is partly because of three widely held misconceptions about issuer-paid ratings.

Misconception 1: Issuers Pay for Ratings

Investors, naturally, don’t like the idea of having to pay for ratings, especially since they get it for free in the current system. However, the reality is that they are really the ones paying for it even now. The bankers for the issuer select, engage, and pay the rating agencies, but the payment comes from the money paid by investors for purchasing the bonds. By letting the bankers pick the agencies, investors tilt the balance of power to the issuer. Since they are paying for it anyway, investors should be open to paying for ratings more directly. This will reduce their concerns about the conflict of interest.

Some have criticized the high fees charged by the raters. However, there is another factor investors need to consider in this regard. If they want good quality output from the agencies, they need to be paid sufficiently to be able to attract and retain talented people. Lowering the fee is not the solution. Any scheme which involves investors selecting and paying for research from the agencies that provide better information and analysis will increase competition and provide the right incentives.

Another point in this regard is that only investors who purchase the bonds at initial issuance pay for ratings at present. Cost for investors will be lower if it was spread over all the investors. Subscription fees could be partly based on AUM, making it easier for smaller investors to subscribe.

Misconception 2: Investor-Paid Rating System will be Bad for Rating Agencies

Many, though not all, on the rating agency side, do not like the idea of having to rely on investors for their earnings. It is much better to get all the fees upfront, which sometimes includes the fee for surveillance of the deal throughout its life. However, the preference for upfront payment misses some important considerations.

First, there are a lot more investors than issuers. Even smaller payments from investors could provide the same or more revenue. Also, a smaller charge will cause more investors to sign on for the service.

Second, if the revenue is coming from investors, it is not dependent on the volume of deals, and will not fluctuate dramatically based on volume of issuance. This will provide more stability to those organizations, and allow them to focus on the quality of their work.

Third, more stable revenue would mean a higher multiple for the valuation of their businesses, which will be a positive for their owners and investors.

Fourth, if payment for rating is at the time of issuance, the agencies have to be picked to rate it. This does not align the interests of rating agencies with those of investors, creates a credibility problem, and leaves them open to criticism. By reducing the incentive to be picked to rate the deals at issuance, agencies will be better off, as will be the overall financial system, including the issuers.

Misconception 3: Ratings have to be either Issuer-Paid or Investor-Paid

Almost everyone seems to think that ratings have to be either paid by issuers or investors. However, it does not have to be one or the other. Just a sufficient portion of fee has to come from investors to provide the right incentives. Especially in structured finance transactions, where it is expensive to perform the right amount of due diligence to rate the deal, some amount of upfront payment may be necessary. However, if payment from investors is a significant portion of total revenue of rating agencies, investors and the financial system will benefit from the proper alignment of incentives that would create.

Clearly, splitting the rating agency role into two is a significant change. However, if done thoughtfully, it can be a significant improvement to the current system, and work for the benefit of everyone.

Notes: Views expressed are personal views only, and not of any affiliated organization or group. This article was originally published in Structured Credit Investor.


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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Fasten Your Seatbelts, We're Going to Have a Bumpy Ride
Monday, May 23 2011 | 09:48 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Emerging signs suggest the U.S. (currently the largest economy) is on a steady growth path, but big issues loom ahead. These include:

•high energy and commodity prices
•a gradual shift from doves to hawks in the monetary policy area
•further budgetary restraints
•working out an anemic housing market in limbo due to the overhang from the legacy non-performing mortgage loans resolution
•crisis in public finance
•further potential geopolitical curve balls in the Middle East and Africa ("MENA")
•potential sovereign debt restructuring (Greece, Ireland, Portugal)
•unrest in China due to unsustainable household income disparities.

One key uncertainty is the impact of the new regulations on the banking and financial systems and how it would impact market volatility and availability of credit during the transition period and the long term.

Many factors can dampen the above risks, yet the system has recovered enough stamina to survive the bumps. While energy and commodity prices are expected to continue to rise, the supply and demand will tend to meet in the long run through increased production and adjustments in consumption behavior, resulting in potentially moderate price shocks. The monetary policy makers will be cautious and walk a fine line between dampening energy-driven inflation with a fragile economy.

The municipal finance issues appear daunting. Yet if done wisely there are a variety of options, including reducing costs, improving efficiency, raising additional revenues, and utilizing innovative structures. Many of these risks can be smoothed out if the economy as a whole runs in 4th gear. These measures will reduce the level of public service, but the desire is that some of those services can be picked up more economically by the private sector. This is a step in the right direction.

The political issues in MENA will continue to brew and create headline news. However, major powers and the international community will come together in taking steps to keep the oil supply uninterrupted and reduce its impact to the global economy.

Chinese policy makers fully recognize the income disparity issues and have already established programs to moderate the imbalances in rural vs. urban income distribution, and to continue to stimulate internal consumption. There is also fear of a real estate bust and subsequent credit crisis in China, reverberating shock around the financial system. Given the massive Chinese reserve and controlled economy, this has not become a major issue. Many actually would like to see some correction in real estate and continued credit tightening to keep the inflationary pressures on commodities while expanding revenue and consumption in rural areas.

There seems to be a common belief developing among the Euro zone, ECB and IMF that a Greek debt restructuring is a strong possibility in 2012. Depending on form and terms of the restructuring of the debt, the knock-on effects to the rest of the financial system can be kept under control. The key is to make sure it doesn't bring down other major financial institutions holding the obligations.

The biggest uncertainty in the housing market is the manner and timing of the workout and servicing issues of the non-performing loans ("NPL") and REOs. The NPL and REO issue and the lack of clarity in the Dodd-Frank rules ultimately inhibit the normalization of the non-agency mortgage market and securitization. Given that housing is one of the critical pillars of the economy, we expect these issues will be worked out between the major banks and various regulatory and law enforcement agencies to pave the way for capital flows to the sector.

Last but not least, regulatory reforms impact on the financial systems will add a level of uncertainty that needs to be assessed as the rules become clearer. While the ultimate goal is to get to a better and more transparent financial system that would provide for more long term growth, short term they will have some unintended consequences that needs to be worked out.

Despite the challenges ahead, we believe these issues, combined with legacy matters, will be favorably resolved but it will take time. Hence, we remain constructive and view the environment as positive for investment in the intermediate and long term.
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Robert Sainato, Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

ABS CDO Commentary
Tuesday, May 10 2011 | 07:31 AM
Robert S. Sainato CFA, CFP, CIC, CAIA
Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

NAV Anomalies

Relying on NAV from outside sources (IDC/Mgr Marks etc.) can be a dangerous game as this can mislead investors. We strongly believe that Marks cannot be relied on. Spending additional time to independently mark the portfolio can help avoid potential pitfalls and can help investors spot significant misvaluation. This part of the analysis is especially important for cuspy and longer-WAL tranches. It is imperative that NAV is correct before asset-level assumptions can be used for deal-level cash flow analysis.

ABS/Multi-Sector CDO Opportunity: Buy Credit I/O ABS CDO's with Non-Agency Mezz. & Sub. Paper Underlying

The suspension of the foreclosure process has profound effects on non-agency credit I/O paper. By slowing down liquidations, cash flows to sub. and mezz. non-agency RMBS can continue for at least another 6 months which can have a profound effect on valuations of this underlying. Over the past few months, sub. and mezz. have been rallying (reflecting) longer timeline, but ABS CDO Credit I/O's (1st-pay '05-'07) ABS CDO's and 2nd-pay '04 and earlier paper haven't moved enough to reflect this improvement in cash flow.

ABS/Multi-Sector CDO Market Overview

The ABS CDO secondary market continues to trade up due to lack of supply and significant relative value. At this point, we are now seeing 1st-pay CDO risk-adjusted returns range from 7% (well-supported deals) to very low double digits (weaker deals). Investor interest for most of last year was mainly in older pre-2003 multi-sector deals, but we have seen this appetite change as of late. The lack of supply, rising forward rates, and foreclosure timeline extension have pushed many investors into "credit I/O" type investments. In terms of credit I/O bonds, these risk-adjusted returns did range from high teens to mid-20's but have now rallied to mid-teens returns (in general). Given the rising forward curve and lack of supply, we believe ABS CDO's will continue to outperform, especially at the credit I/O level.
Potential Supply & Basel III

Supply to date (secondary--no new issuance) has been relatively muted but this could change. On our trip to Europe, we spoke with several clients that have been beginning to talk about lightening up and having reluctance to buy ABS CDO's that are rated CCC. Basel III (although not in effect yet) is driving this decision-making. As most know, the big change in Basel III is treatment of CCC's for banks. Specifically, capital charges for banks will be a function of leverage. For example, if a bank is twelve times levered, the bank will have to hold 12 x 100%. Specifically, if the risk-adjusted return on the CCC ABS CDO is 12% and the bank has twelve times leverage, their effective return is negligible. This would make it prohibitively expensive to hold these types of assets. We need to monitor this trend very carefully since many European banks hold Legacy ABS CDO's and many European US banks have been a buyer of this paper.ABS/Multi-Sector CDO Opportunity: Buy 1st-Pay Seasoned Multi-Sector CDO's with Seasoned CMBS that are Cuspy

We mentioned this strategy in our last commentary, and it has performed significantly better than expected. At current levels, we still believe that the trade has more room.

The trade we mentioned in our last commentary involves the idiosyncratic loss surface/return profile of each one of these deals (ABS CDO's). To us, deals can fall into several camps. We have looked at deals that are very digital in nature (i.e. 25% return or 100% loss) and also deals that have a risk-adjusted yield of high single digits to low double digits with 5% to 0% downsides. However, there are deals that have a significant number of assets (ex. Seasoned CMBS) in them that are very option-like combined with other very solid assets. This mixture of assets is extremely hard to duplicate as most of these assets are difficult to find. The risk-adjusted return of this type of portfolio could be base case low double digits with a downside of 5%. The upside to this trade is in its optionality. On an optimistic scenario, potential upside could be over 20%.

We continue to encourage all investors to look for these types of deals. The way we uncover this is by running various scenarios and not just "base & stress" scenarios. This type of scenario analysis will help reveal "The Potential Optionality" of a trade.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Manufacturing-Led US Economy At Last, But Don't Count On It!
Monday, May 02 2011 | 03:45 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

Be careful what you wish for, you might just get it. Most economists prefer a more manufacturing-based US economy vs. a service and consumer dominated one. Well, it took a credit bubble, economic crisis and Dollar falling to get there. While we all feel poorer, manufacturing growth has been a positive factor keeping the economic recovery alive. However, this has been primarily driven by foreign demand, a cheap Dollar and some increased corporate spending,

Japan's natural disaster has introduced a few bottlenecks but China and Brazil have helped to more than balance that. If this continues, the general hope is gradually the unemployment will adjust to a more normal range. We may even get back some of those folks that had given up on the job market. Of course, the residential and commercial real estate markets will be key to the ultimate health of the economy. By then, we may even be tempted to regain some of our old bad habits and let others produce and save while we enjoy consumption.
0 Comment | Add Comment(s) | US_Economy, Manufacturing, Economic_Recovery, Unemployment, Japan, Real_Estate_Markets,


Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

US Economic Recovery? Yes, But...
Tuesday, April 26 2011 | 02:57 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

I attended a recent conference concerning the asset management sector held by Moody’s Investor Service. Their chief capital markets economist, John Lonski, presented an excellent macro view of financial markets. In Lonski’s view, the US is making some progress in economic growth, though tentative and not yet clearly sustainable.

There are several factors suggesting that domestic conditions are improving. First , the unemployment rate has been falling. According to government data released on April 1st, the rate has fallen to 8.8%, the lowest in two years. Payroll employment rose by 216,000 workers in March, after a gain of 198,000 in February. If such gains of 200,000 plus per month can be sustained for, say, six months, then both consumer and business confidence measures should also show significant improvement. Unfortunately, a large percentage of workers have stopped looking for work, which is not reflected in the official unemployment rate, a measure only of those actively seeking jobs.

Lonski also highlighted improvements in capacity utilization–a measure of the use of our productive capacity—which is running about 83.5% versus a recessionary low of about 68%. More normal capacity utilization should lead to higher business profits, which can allow companies to reduce their debt and improve their balance sheets. This would be favorable for the fundamental quality of the corporate bond sector and particularly for high yield bonds.

But there are some troubling factors that could endanger an economic recovery. The first is sharply rising energy prices. One measure of affordability is the ratio of gas station sales to employment income. In Febuary, this ratio reached 6.2%. Recessions began after this ratio reached 7% in 1980-81 and 2008. Crude oil is currently trading (West Texas Intermediate quality) at about $108.30 per barrel, versus a recessionary low below $40, an enormous increase.

Another retarding factor is the decline in home equity. The collapse in residential home prices has cut homeowners’ equity by $5 trillion, or 45%, versus the average level during the period between 2003 and 2007. This is not merely a sense of lesser wealth. Owing to the increasing importance of equity lines of credit to consumer spending, this contraction in home values directly impacts the ability of homeowners to make purchases. A favorable factor is that home affordability measures have been improving nationally, and affordability should be a leading indicator of recovery in values. Weakness of credit availability is compounded by the long-term aging trend of the U.S. population; older workers tend to spend less as they anticipate a lower level of income after retirement.

Lonski also expressed caution about the ongoing crisis in continental Europe. There is a great danger, he thinks, if the credit difficulties of Spain and Italy, large countries, approach those of Greece, Ireland and Portugal.

Because the unemployment rate remains relatively high, housing remains weak, and energy prices are high, Lonski doesn’t see a major risk of inflation in the US economy at this time. Indeed, under certain conditions, we run the danger of falling back into recession.

Lonski emphasized the centrality of residential housing in understanding the relatively anemic recovery that is underway in the United States.

Ron D'Vari CFA, CEO of NewOak Capital, and Andrew Szabo CFA, Managing Director of NewOak Solutions
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Robert Sainato, Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

Finding Relative Value in CLOs
Tuesday, April 19 2011 | 10:07 AM
Robert S. Sainato CFA, CFP, CIC, CAIA
Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

Generally speaking, we remain bullish on AAA to BBB CLOs and negative on Equity, as mentioned in the last blog. However, not all CLOs are created equal. For this piece, we would like to explore some nuances that are involved in CLO investing.

Asset-Liability Arbitrage

As seen below, the general CLO market trend over the last 6-8 months has been positive.



Even after this positive trend, from an asset-liability arbitrage perspective, CLOs still remain cheap (overall) as loan prices are around $96 while the weighted average price of all of the liabilities and equity in the CLO structure are ~$90.5. We believe most of this value is locked into the AAA to A tranches with the best risk/reward in the AAA's and AA's. During the CLO rally in February to early March, the asset-liability arbitrage (see below) closed its gap to around 3.2 pts at its lowest, but has since widened back out to 5.5 pts post-Japan/Middle East.



CCC's Overvalued? Defaults Understated?

Recently Deutsche Bank released its annual default study, which analyzes CCCs on a historical default/risk adjusted basis. The study concludes that current CCC loan prices do not adequately compensate investors for risk. The risk we are referring to is associated with the next economic downturn. We believe, as does DB, that cycles are going to become significantly shorter (we are in the 3rd year of the current bull move) because the government no longer has the necessary ammunition, i.e. rates at 0% cannot go lower and budget deficits are bloated and unlikely to go higher. In the past the US government, specifically the Fed and Congress, and foreign cooperation (via no inflation) was able to prolong economic cycles and give us a “Goldilocks” economy. In our opinion, this Pollyanna situation is long gone and reality (risks) will set in with substantially lower growth and shorter economic cycles. Additionally, defaults have been understated due to many extensions and prepays. Although the default wall has been pushed back as companies have prepaid, defaults are still likely to rise. Remember the long-term high-yield default rate averages over 4%, NOT 1-2% as most are modeling.

Arbitrage in PiK Risk

Currently, we see the average Junior OC cushion around 2.5% in the US CLO universe, which has increased considerably over the last two years due partly to managers being able to build par but also increasing CCC prices. If CCCs are overvalued and understated, as we explored above, a price correction and ratings migration in this part of the curve would have a negative effect on CLOs’ OC tests, causing some deals to PiK. However, down the cap stack (where PiK risk matters), in our opinion the market has forgotten deal language and is not pricing accordingly. PiK risk is important and deals with lower PiK risk should trade better.

For those that are taking these binary risks, thorough reading and understanding of CLOs’ indentures is essential. While most CLOs take CCC haircuts for OC tests across all parts of the capital structure, there are some deals where these haircuts vary from the senior OC tests down to the junior and interest diversion tests. We have seen some deals in the universe where CCC haircuts are only used for the junior OC and interest diversion tests. These deals can offer extra cushion to the notes above these tests as they will more easily divert excess interest from the equity to delever the structure, while not PiKing the single As, BBBs, and BBs in some cases.

Prepays and WAL: Smart Investors Can Outperform but Document Work is Essential

Relative outperformance can be gained by taking advantage of the different non-modeled WALs (where the manager can/cannot extend the WAL of the deal) via reinvesting beyond the reinvestment period/OC trigger avoidance/extension language etc. A lot of research has recently come out from the bulges regarding prepays in CLOs as the headline numbers, on an annualized basis, have been in the mid-20s for the index and mid-30s for CLOs. Many of these analysts suggest that these high rates are generally good for AAA/AA post-reinvestment and equity pre-reinvestment, and bad for AAA/AA pre-reinvestment and equity post-reinvestment.

In general, we believe these statements to be true but want to caution investors on many of the nuances to this. We strongly believe that investors must read the indentures closely to determine the effect as many deals allow for prepays to be reinvested post-reinvestment date, as long as certain criteria are met, with some even allowing unrestricted reinvestment of prepays.

The following restrictions typically apply to the reinvestment of prepays: Sr. Notes must not be downgraded from their original ratings and Mezz./Jr. Notes must not be downgraded more than 1 notch from their original ratings. Some deal language use both Moody's & SP ratings, while others only use Moody's. Below, we explore the possible effects of the Moody's upgrades in relation to prepays and WAL.

The recently proposed Moody's methodology changes could also an effect on which deals are able to reinvest prepays post-reinvestment date. Its new proposal, if accepted, would upgrade Sr. Notes 0-2 notches and Mezz./Jr. Notes 0-5 notches. Performing a quick back-of-the-envelope analysis, we see 76% of the Sr. AAA universe currently within 2 notches of their original ratings and 30% of AA's within 2 notches. In the Mezz./Jr. area, we see 85% of A's within 5 notches of the one-notch downgrade limitation, followed by 63% of BBB's and 43% of BB's. Although many deals can be upgraded, as seen above, deal quality and indenture language should be monitored closely to determine the extent to which prepays can be reinvested post-reinvestment date. This is an ironic case where, if upgrades do occur, some of the AAAs from cleaner deals could actually underperform some of the dirtier AAAs as the cleaner deals will be able to continue to reinvest and extend the deal, negating the higher prepays and driving AAA WALs up and DMs down.

See below for Moody's rating transition table, showing the percentage of each part of the cap structure across the US CLO universe and how many notches are currently downgraded from their original ratings. For example in Sr. AAA's, 36.91% are currently rated Aaa (their original ratings), while 19.66% are rated Aa1 (1 notch downgraded), 19.66% are rated Aa2 (2 notches downgraded), and 12.2% Aa3 and below (3+ notches downgraded).



If all of these restrictions are passed, then typically after the reinvestment date the proceeds from the prepaid loan must still be reinvested in a loan that is inside the maturity and has the same or better rating of the prepaid loan. This could effectively cause deals to run at a 0% prepay post-reinvestment (all prepays would be required to be reinvested in similar loans, maturity-, spread-, and rating-wise, simulating a similar asset to that which prepaid as noted above), extending the deal and lowering DMs at the top of the cap structure, while increasing yields on the equity for these deals. Investors should pay careful attention to the language in deals in which they are buying AAA/AA and equity.
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Robert Sainato, Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

Irrational Exuberance 2.0 - CLO Equity Edition
Wednesday, April 13 2011 | 08:44 AM
Robert S. Sainato CFA, CFP, CIC, CAIA
Managing Director, Structured Credit & Mortgage Group, ADVISORS ASSET MANAGEMENT

CLO Equity Overvalued? Can Investors Earn 20's and 30's Cash on Cash Returns and Sell Before the Next Credit Cycle?

Credit Opp/Hedge Funds have been clamoring for CLO equity, attracted to the very high cash on cash returns seen so far. We are seeing cash on cash returns on many deals producing 20's%/30's% returns. This cash flow is enticing investors similarly to how the Sirens lured Odysseus (for those familiar with The Odyssey). Equity/BB's and some BBB's in our opinion have run their course and caution should be warranted (especially for long-term hold investors).

We believe that the I/O & P/O parts of equity/BB's are overvalued in general. In our opinion, the I/O part is overvalued due to the likeliness of excess spread to drop because of a combination of high prepays (empirical loan prepays 25-35% CPR vs. valuation 15% CPR in models); all resulting in lower leverage and lower WAS of future Libor floor loans which will be invested in. Real IRR on the I/O is likely to be substantially lower than the cash on cash returns received thus far.

In addition P/O valuations are extremely levered (at the bottom of the cap stack) to loan prices, defaults and CCC's loan prices and percentages. Small negative changes in these can have profound effects on sub tranche and equity prices by making a cash flow positive investment stop paying. The significant OC improvement throughout the past 1.5 years will begin to wane as this improvement was the product of discount purchases, CCC price appreciation, and low defaults. As mentioned previously in section II, we firmly believe that defaults have been artificially held at bay due to prepays and overly optimistic CCC loan prices. We believe that this is not a normal cycle (as we have seen in recent years) and can see a downturn sooner than most are assuming in their valuations.

Incentive Mgr. Fees (IRR Hurdles) Hurting CLO Equity Cash Flows?

In many deals, we've seen that future equity cash flows can be affected by incentive mgr fees beginning to kick in over the next few years. This is a common feature in CLO's that causes the manager to be paid an additional fee out of the excess interest once the IRR, since inception, has reached anywhere from 10-15%. Most only begin accruing once the hurdle is hit, while some deals have accrued this incentive fee since deal closing, accumulating fees between as much as $6-8mm that will be released once the hurdle is hit. With most deals now cash-flowing to equity and excess spread having increased, this issue is beginning to arise in cash flow and pricing analysis.

The higher quality deals that continued to pay throughout the cycle will be first to hit these targets, as expected. There are a few deals that are close to hitting their 1st IRR hurdles within the next 2 years. Babson 2006-2 and Stone Tower V are two deals we see kicking in as early as this year, with 7% of the universe observed by us with hurdles (20 deals) having hit their hurdles by 2013. We project many more will hit their hurdles over the next 3-4 years, 30% by 2014 and 50% by 2015, as cash flows begin to tail off because of the reinvestment period ending, exacerbating the drop in cash flow to equity.

Investors should run the prospective cash flows to determine if hurdles are being hit, how the fees are paid/accrued, and how that affects equity return. Deals that are currently cash-flowing robustly could drop off suddenly upon the passing of this IRR hurdle, especially on those deals that accrue since closing – which can divert 50-60% from equity to pay off this accrual. A simple back-of-the-envelope analysis of collateral, reinvestment, and current cash flow is no longer sufficient, and we suggest investors have a very strong grasp of the deal's indenture and all of its intricacies before purchasing.

US CLO Equity Analysis from BWICs dated 2/15-4/8

BWIC volume for CLO equity spiked in February and March (as seen below), giving the market more clarity on where different types of deals’ equity tranches are trading.



Using these prints, we compiled a datasheet below including a few relevant datapoints for each deal’s equity tranche that traded. Included below is the Bloomberg ticker for the equity that traded, color for where it traded (if at all), the reinvestment date, Junior OC cushion, underlying weighted average asset prices, and then yields at six different scenarios using generic reinvestment assumptions. This data should help investors find out where comparables have been trading when looking at CLO equity offers, BWICs, or current holdings.


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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Prudential Supervision
Monday, April 11 2011 | 03:46 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

There are several forces that might govern a bank’s behavior and keep it from taking reckless risks in lending and investing, possibly endangering the safety of its depositors and investors. First, there is the market: investors who don’t like lending policies can sell the bank’s stock and bonds, causing their prices to fall. Second, there is the oversight of the bank’s management. Third, there is the oversight of the bank’s Board of Directors. Fourth, bank regulators act as watchdogs, seeking to protect the interests of the depositors; this oversight is sometimes called “prudential supervision.”

In the wake of the recent worldwide financial crisis, it appears that the controls exerted on many banks by the market, by management, and by the board, were not enough to prevent gross excesses in bank lending, particularly in the real estate markets.

These problems quickly became those of the government and taxpayers, because of national systems of deposit insurance and the perception that some banks and financial institutions were “too big to fail.”

Consider our own country, where the federal government bailed out commercial banks such as Citibank, Wachovia, JP Morgan/Chase and Bank of America, as well as investment banks and other financial institutions, notably AIG. Similar dilemmas have faced the European Union, including Greece, Italy, Spain, Portugal and Ireland (and others, such as Iceland, which are seeking membership).

These shortcomings have led to calls for more stringent prudential supervision. In the United States, one aspect of the new environment is the far-reaching Dodd-Frank legislation. Internationally, the Basel Accords, promulgated by the Bank for International Settlements, are now entering a proposed third stage (Basel III).

The Dodd-Frank legislation is so far-reaching that banks are still scurrying around trying to understand how to comply. One striking aspect, as emerging in regulations under the 2010 Interagency Guidance Appraisal and Evaluation Guidelines, is that affected financial institutions will need to establish more objectively the value of their illiquid collateral, such as whole loans, real estate owned and derivatives, preferably by third party (arm’s length) evaluators ( disclosure: this is one area where my own firm consults). There has been militant talk by Republican Party spokesmen to roll back key provisions of the legislation, so the legal situation will remain in flux. Tea Party representatives particularly deplore the emerging Consumer Protection Agency.

As to Basel III, the proposed revisions are intended to increase the quantity of quality of banks’ required regulatory capital. More specifically, there will be greater clarity about eligible Tier I and Tier II capital, and the lowest quality category, Tier III, will be eliminated from eligibility. There will be required stress tests, which are hypothetical projections assuming adverse conditions such as economic recession and declines in real estate markets.

Of course, there are real questions about the ability of regulators to anticipate problematic lending, any more than stock investors, managers or boards. At the least, though, such regulators experience different economic incentives from the other players and may be more fearful of the inexpensive borrowing power that is available to depository institutions, multiplying the profit or loss from lending and investing activity.

Ron D'Vari CFA, CEO of NewOak Capital, and Andrew Szabo CFA, Managing Director of NewOak Solutions
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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

What's Ahead for CMBS Spreads?
Monday, April 11 2011 | 08:23 AM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

A revived CMBS market, with new deals getting done, is helpful to REITs and other commercial real estate owners as it has started making financing available again. Spreads had generally been narrowing which helped loan originators by reducing the hedging cost and has been good for owners of CMBS bonds. However, recent spread volatility has left some people concerned, and wondering about the future direction of spreads and how to look at spreads on the new CMBS 2.0 deals in the context of 2006-7 legacy deals.

I always find it useful to start with views of market participants, and historical data for some perspective. Also, for legacy deals, estimates of losses are an important element. Below are forecasts for spreads for 2007 vintage CMBS for June 2011 published by industry’s weekly newsletter, Commercial Mortgage Alert at the beginning of the year, along with some other data. Comments and thoughts follow.



Recent Spread Widening

To focus first on what had people worried most recently – widening of GG10 A4 bonds by 50 basis points from mid Feb to mid March, it is important to step back and look at the bigger picture. GG10 spreads are more visible because it is a benchmark deal and trades more frequently. As the table “Recent Spread History” shows, (i) spreads did widen out, but are generally back to where they were before widening, and (ii) even when they widened out, they were inside where they were at the beginning of the year.
Another factor to look at is where spreads are compared to market’s expectations. The table above shows average prediction for 2007 vintage A4 bonds to be 184 over swaps. Mid March wide was swaps + 190 and the current spreads are swaps plus 165. Again, not as alarming when looked at in that context.

CMBS 2.0 Spreads

Spreads for new CMBS 2.0 deals widened out too, but not by as much. They went from 110 over swaps at the tight to 120 and are back to 110, compared to swaps plus 130 at the beginning of the year. Spreads did not widen much, but where could they go now? One perspective is looking at the history. The underwriting, leverage, and subordination in the new deals are comparable to what they generally used to be in 2003 to 2005 period. However, looking at spreads over swaps at that time will not be as helpful because of the impact of recent events in swap markets. A better approach will be to look at spreads over the risk-free rate, or the spread over treasury notes. In the 2003 to 2005 period, CMBS AAA bonds averaged around T+75, whereas generic single-A industrial corporates averaged T+77. Currently, new CMBS spreads are swap plus 110 or T+117 and single-A industrials are T+97. This back of the envelope analysis would suggest that new CMBS AAA spreads could tighten by 20 basis points from the current levels. The demand for bonds is there and there is not a big supply in the pipeline. So the technicals favor continued tightening.

CMBS 2.0 Vs Legacy CMBS

Legacy CMBS deals are a bit more complicated given the losses expected by market participants (see table above). In general, expectations of losses seem to average around 11.5% for 2006-8 deals. One simple way of looking at the deals would be to assume subordination remaining after expected losses. On that basis adjusted subordination for legacy A4 bonds goes from 30 to 18.5, which is similar to the subordination for AAA bonds in new deals. Subordination for legacy AM bonds with loss taken out goes from 20 to 9.5. That is roughly between single-A and BBB bonds in new deals.

This simplistic approach ignores several other factors that also come into play, but does the market see these as comparable? Market spreads for legacy AM bonds at swap plus 280 seem wider than 190 and 270 for new deal single-A and BBB bonds. Similarly, legacy A4 spreads at S+170 are much wider than S+105 for new issue AAA bonds. However, if you look at yields, legacy A4 is around 4.65, close to the 4.60 on new issue AAA. Similarly 5.80 yield on legacy AM bonds is between 5.42 and 6.22 on new issue single-A and BBB bonds.

Logical inference from above is that, in this yield-hungry world, the legacy bonds are generally in line with the new issue bonds in terms of yield, and legacy bonds should tighten along with new issue. The choice between them comes down to investors preference for stability, hedging, leverage, duration, etc.

The above would suggest that a general widening in legacy but not in new issue bond spreads, unaccompanied by any deal specific news, as happened recently, may be an opportunity to pick up some cheap bonds if you can do detailed deal analysis and are confident in ability to pick better deals.

Note: This article was originally published in Markets & Economy (http://marketsandeconomy.wordpress.com).
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Stephen Whelan, Partner, SNR DENTON US LLP

Auto ABS: Turbocharged or Stuck in Neutral?
Friday, April 08 2011 | 08:08 AM
Stephen Whelan
Partner, SNR DENTON US LLP

On March 29, 2011, several federal agencies issued a notice of proposed rulemaking (NPRM) to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act provisions regarding mandatory risk retention by “securitizers” of various asset classes. The Act established a baseline five percent risk retention, but authorized the agencies to establish higher (or lower) thresholds for identified asset classes. In the NPRM, auto loans received particular attention. The question remains whether the agencies’ proposals will turbocharge auto ABS--or leave it stuck in neutral.
Page 159 of the NPRM proposes “a zero percent risk retention requirement (that is, the sponsor would not be required to retain any portion of the credit risk) for ABS issuances collateralized exclusively by loans from one of the asset classes specified…and which meet the proposed underwriting standards.”

The good news is that the agencies recognized that “establishing a risk retention requirement between zero and five percent…may not sufficiently incent [sic] securitizers to allocate their resources necessary to ensure that the collateral backing an ABS issuance satisfied the proposed underwriting standards”. Other welcome news is that the NPRM added that “[t]o facilitate compliance…supervision and enforcement of the rule, the proposed standards are generally prescriptive, rather than principle-based.” That enables securitizers to avoid a regulatory guessing game.

However, ABS sponsors who have included commercial auto loans or leases in their securitized pools will be disappointed at the narrow approach taken by the agencies “to establish conservative requirements that are consistent with underwriting standards commonly used by the industry for unsecured [emphasis added] installment credits.” The proposed rules would exclude any lease financing and any loans to finance fleet sales or the purchase of a commercial vehicle. So the reduced risk retention would appear to be available to the larger auto consumer finance companies and not to ABS sponsors which finance commercial auto loans and leases.

The rules would force originators to determine that each obligor has a monthly total debt to income ratio of less than or equal to 36%. Documenting this analysis will require the originator to obtain data from each obligor about his monthly housing payments and other amortizing payments, credit card and lease obligations, alimony, child support and other court-ordered payments. Beyond this potentially intrusive investigation, the proposed rules would restrict qualifying auto loans to those with a fixed interest rate, maximum five year term using straight-line monthly amortization, and 20% minimum down payment. Each originator and securitizer will have to make its own determination whether these and other standards in the proposed rule are practical and worthwhile to obtain zero risk retention for any auto ABS issuance.

Because of the high likelihood that a few loans in the securitized pool could fail to meet the agencies’ standards, the proposed rules require the depositor to certify as to “the effectiveness of its internal supervisory controls for ensuring all of the loans backing the ABS are qualified loans” and the sponsor to (a) repurchase nonqualifying loans within 90 days “after the determination that the loans do not satisfy the underwriting standards” and (b) disclose to the ABS investors the loans which are repurchased and the cause for each repurchase. Much of this is customary in auto ABS, but the agencies ominously “seek comment on whether the sponsor should be required to repurchase the entire pool of loans [emphasis added] collateralizing the ABS if the amount or percentage of the loans that are required to be repurchased…reaches a certain threshold.” If adopted, this imposition would be a dramatic departure from industry practice.

The comment period for the proposed rules runs through June 10, 2011.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Windfall Rewards of Transparency Requirements of Financial Reform
Tuesday, April 05 2011 | 12:50 PM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

While the financial industry lobbyists, political parties, and regulators are still debating the exact form of implementation of Dodd-Frank Reform laws, the financial industry is gradually waking up and comprehending the enormous scope of the infrastructure required for the timely and accurate collection, processing and analysis required to meet the reporting and compliance requirements under the new laws.

For example, just the derivatives and securities lending collateral management would require very large new investments in processes, systems, and personnel. On its face the cost of new systems and processes may appear to put further pressure on profitability on top of the higher capital requirements.

However we would argue that the push for the additional transparency will bring about better internal visibility across business and functional units and better attribution of risk-reward for various business lines and activities.

Long term this should provide a more timely measurement of risks and reward opportunities and lead to a more proactive management that should improve profitability.
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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

Restarting CMBS Lending
Wednesday, March 30 2011 | 09:53 AM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

The DDR deal, the first CMBS deal after nearly eighteen months, was ten times oversubscribed. The following two deals also saw good demand even though they did not allow for TALF financing. So, clearly, there is good demand for CMBS bonds backed by well underwritten loans. Also, borrowers clearly want loans if they can get a reasonable cost of financing. DDR loan, with about 4.25% all-in cost of financing for the borrower, showed that a low cost of financing is possible even in the current market. Yet, prospects of a conduit style multi-borrower deal seem bleak at the moment. Any CMBS deals that come to market are expected to be single-borrower deals, as in those deals the borrower takes the market risk and not the underwriter doing the deal. Securitization shops do not want to take the spread risk while aggregating the pool because there is no way to hedge that risk, and so are unable to originate loans even though many are eager to restart their lending operation. If they do originate loans without ability to hedge, they would require much wider spread resulting in higher cost of financing than borrowers would find attractive.

Inability to hedge loans while aggregating a pool for securitization is one of the biggest obstacles preventing restarting of conduit lending for commercial real estate properties.

In the past, the conduit originators were able to hedge loans while they were aggregating a pool big enough to securitize. So, they were not exposed to risk from changes in interest rates and bond spreads between loan origination and securitization. The hedging generally involved hedging the interest rate risk by selling interest rate swaps, and hedging the bond spread risk by using Total Return Swaps on Lehman or Bank Of America CMBS indices. These indices allowed loan originators to effectively sell their risk to investors who wanted to gain exposure to CMBS in their investment portfolio. They sold the risk when they originated the loan, and bought it back when they securitized the loans. The hedge worked because spreads on new CMBS deals moved in parallel with the spreads on existing deals.

The problem now is that those indices are no longer appropriate for hedging, especially for new origination loans, because of two problems. One, ratings downgrades have impacted the composition of the indices. Second, and more important, the spreads on new bonds with newly underwritten loans cannot be expected to move in tandem with spreads on old bonds with the old underwriting. This lack of correlation between the two spreads makes the old bonds or indices unusable as a hedge for newly originated better quality loans.

What this means is that to hedge new loans with better underwriting, originators need bonds with better underwritten new loans. In other words, to originate loans, you need bonds with new underwriting, and to create bonds with better underwritten loans, you need the better underwritten loans. That’s the chicken-and-egg type problem of loan aggregation. This is what has prevented loan origination from restarting once the spreads on old bonds widened out.

To solve this chicken-and-egg problem, back in February 2008, I made a suggestion to Markit, which administers the CMBX indices. My suggestion was to create a new CMBX type of index based on future deals that met minimum credit quality. Only deals which met pre-set criteria based on LTV, DSCR, and other credit parameters would be eligible to be included in the new index. Trading of the index would have allowed the market to determine spreads on bonds backed by good newly originated loans, and provided a hedging mechanism for loan originators, solving the chicken-and-egg problem.

Markit discussed the idea in a conference call with the trading desks, but it was thought to require too much work to create, when dealers were busy with the market volatility. Also, the idea was complicated, since it was based on future deals. Additionally, the CMBX is based on CDS (Credit Default Swap), and cash and CDS markets do not always move together, and so the hedge would not have been as good as Total Return Swaps on cash bonds.

Luckily, things have changed since then.

One, Markit has created new indices called TRX, which are based on Total Return Swaps on cash CMBS spreads, which will be a much better hedge for loans than a CMBX or CDS type of hedge. Total Return Swaps are what many originators used in the past to hedge the credit spreads.

Second, new deals with newly underwritten loans have been done and exist now. So, it is not necessary to base the index on future deals, avoiding a lot of complexity. That simplifies things considerably.

One solution to the hedging problem for newly originated loans is to create a new TRX index based on the new deals. It will allow the originators to sell risk, and will allow all the investors (many who did not get any allocations in the over-subscribed deals that have been done recently) to get exposure to new CMBS bonds.

Some may argue that three deals is not enough diversity to create an index. Admittedly, it would be better to have a more diverse pool of deals for the index. However, even with just three deals, the index will allow many originators considering starting origination to solve the chicken-and-egg problem. Also, this by itself will not solve all the problems the CMBS industry is facing. Yet, it will be better to have something, even if it is not perfect, than to have nothing at all.

I urge Markit and the dealers to make available a new index that will be attractive to both loan originators and investors, and just might help solve one of the major roadblocks preventing restarting of CMBS lending.

Note: This article was published on Seeking Alpha.


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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

Rating Agency Reform: The Real Problem That Has Not Been Recognized
Monday, March 14 2011 | 09:39 AM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

The most important and the most basic issue related to ratings and rating agencies has not been recognized or addressed in reforms announced so far. Here’s a new idea on a practical solution to address this most fundamental issue, which also addresses the conflict of interest issue that has received the most attention so far.

The Reforms

Ratings agencies have been criticized heavily by many for their role in the U.S. financial crisis, in particular over conflicts of interest and their failure to recognize the high risks inherent in complex structured products. They have also been blamed for throwing fuel onto the fire of crises by belatedly and aggressively ratcheting down ratings. Numerous proposals have been put forward to reform the rating process to avoid these issues.

The US Congress, after resolving the differences between the House and Senate versions last week, is on the path to pass a sweeping financial regulatory reform bill aimed at increasing oversight and regulation of the US financial system. Among the issues addressed is reform of credit rating agencies. However, the compromise bill avoids most of the stronger proposals. The bill directs SEC to conduct a two-year study to determine if a board overseen by SEC should be setup to help pick which firms rate asset backed securities (the Senate version of the bill had required such a regulatory board). The bill also adopted a softer version of proposed liability provision than was in the house version of the bill (investors must show a company “knowingly or recklessly” failed to conduct a “reasonable” investigation before issuing a rating). The compromises are better than the extreme versions of proposals even though it means that the proposed regulations may not do much to change how the agencies operate.

Earlier, in mid April, SEC made some changes. In the update of Regulation AB, it eliminated the involvement of rating agencies in the shelf registration process by removing the requirement that the ABS be rated investment grade. This clearly has no impact on the rating process.

SEC also promulgated the Rule 17g-5, which went into effect on June 2, to address perceived conflicts of interest with issuer-paid ratings provided by nationally recognized statistical rating organizations (“NRSROs”). The rule aims to increase the number of ratings and promote unsolicited ratings for structured finance products. To achieve this goal, the rule requires issuers and hired rating agencies to maintain password-protected websites to share rating information with non-hired rating agencies. The concept is good, but if implementation means rating agencies will have to share all information with other agencies, they may have less incentive to dig deeper and find more data.

None of these changes are radical overhauls or even proportionate to the amount of criticism that was leveled at the agencies (Calpers has sued the three major bond rating agencies for $1 billion in losses it said were caused by “wildly inaccurate” risk assessments) or the wide ranging calls for ratings reform. In some ways, it is good that some of the more extreme proposals have not been adopted. But why is it so difficult to reform the rating process?

The Power of the Rating Agencies

One reason that makes it very difficult to make changes to the ratings process is that ratings are heavily embedded in almost every part of the financial systems around the world. They are used in investor’s charters defining what they can buy. They are used for calculation of capital charges for banks, insurance, and other financial companies. They are used in loan covenants and triggers on corporate debt. They are used to calculate haircuts on repo lines, along with many other uses.

Also, despite the recent failings, they serve a very useful purpose. Not everyone has the expertise and resources to analyze every security in detail. Presence of credit rating agencies gives smaller investors a starting point for analysis that they may not otherwise have.

This embedding of ratings in the financial system and reliance by so many participants on the ratings gives the nationally recognized statistical rating organizations or NRSROs tremendous power as ratings changes can have significant impact on companies, and even nations.

There are numerous examples of the impact that ratings changes can have. One recent one was during the onset of the 2010 European Sovereign Debt Crisis. What clearly played a role in triggering and escalating the crisis, even though it was not the cause, was the downgrade of Greece’s credit rating by three steps from investment grade BBB+ to junk rating of BB+. This came minutes after S&P downgraded Portugal by two steps to A- from A+. The announcement came at a sensitive time as the European Union policy makers and the International Monetary Fund were trying to hammer out measures to ease the panic over swelling budget deficits and create a financial rescue package for Greece. S&P followed the next day cutting Spain’s rating by one step to AA, and keeping the outlook as negative, reflecting the chance of further downgrades, with its projection of just 0.7% average real GDP growth annually from 2010 to 2016. Markets reacted violently to the cuts as investors worried about the safety of the debt of these countries, and contagion spread from Greece to other countries. Stock markets tumbled worldwide, and bond and currency markets had big moves and became very volatile.

Another way ratings impact markets is via the feedback loop between the markets and ratings through portfolios tied to indexes mandating certain holdings of particular debt. For example, the Barclays Euro Government Bond Index includes Greek debt as 4% of index, but only if the bonds maintain a certain credit quality based on lower of the rating from S&P and Moody’s. Greece had been 4% of that index but was excluded starting May 1, due to S&P’s downgrade. That in turn likely forced selling from investors tracking that index.

Critics assailed rating firms for fueling woe in Europe and Europeans criticized debt-rating agencies, accusing them of spooking the markets and worsening the plight of financially stretched governments such as Greece, struggling with heavy debt loads.

There are several other examples where a company needing to raise more debt in capital markets finds it cannot do so, or not at a reasonable cost, once it has been downgraded even while it was attempting to raise capital to improve its financial situation. The downgrade increases cost of financing as investors demand more yield reflecting lower rating. The downgrade may also result in existing investors having to sell holdings, further increasing the yields in the market. It can become a vicious circle increasing the likelihood of default. The downgrade reflects rating agency’s opinion of the outcome, but it also becomes a causal factor in determining that outcome. The rating agencies in effect become the judge, jury, and the hangman for the company.

The Real Problem That Has Not Been Recognized

In the current system, the rating agencies’ opinion can become a causal factor in making that opinion become reality. Time and again, in structured products and otherwise, it has been clear that the rating agencies are not infallible in their judgment, and do not have any special powers of predicting future. Their failures in predicting subprime mortgage performance have been appalling. But even if you look at the forecasts of defaults in corporate bonds, the predictions do not match the actual outcome, and the predictions themselves change over time, as they should.

So, if ratings are heavily embedded in the system and are needed, and yet rating agencies are not smarter than everybody else, and if they do not have special predictive powers about the future, how do we avoid giving their subjective opinions so much importance and extraordinary power?

The answer lies in recognizing the real problem – one that has not been addressed in any of the proposals so far. The real problem is that the rating agencies are combining two roles into one. First role is to provide a rating based on statistical analysis and past performance of the assets – remember that SR in NRSROs stands for Statistical Ratings. The second role is that of a research analyst to provide an opinion on what might happen in the future. Currently, rating agencies combine the two. The ratings are a mix of statistical analysis and somewhat subjective opinion on the future. This allows rating agencies to downgrade companies or countries even while they are in the process of attempting to improve their financial condition. At the same time, it leaves rating agencies open to criticism if they do not act and the feared worse outcome becomes reality before their downgrade. This also allows subjectivity and flexibility in ratings process that creates perceived conflicts of interest in issuer paid ratings.

The Solution

The logical solution is to separate the two roles. NRSROs should be doing Statistical Ratings – based on past performance of assets, known facts, events that have already taken place, and statistical models and methods that are well disclosed. They can put bonds on watch for upgrade or downgrade if a financial event is in progress or expected, but cannot downgrade or upgrade till the event actually happens. So they will not be precipitating events, and cannot be blamed for not downgrading sooner. This role will be limited to those approved as NRSROs.

The second role of providing credit ratings in the form of opinion on future performance should be separated from the NRSRO role, and should be open to any research provider, including NRSROs. These credit ratings could be designated as Informational Ratings without any legal or official role impacting investor charters, debt covenants, etc, which will only use the ratings designated as NRSRO Ratings. This will take the non-NRSRO rating agencies back to sort of where rating agencies started – as market researchers, selling assessments of corporate debt to people considering whether to buy that debt.

The information provided to NRSROs should be made available to all NRSROs and other non-NRSRO rating agencies, in a manner similar to password-protected website required under SEC Rule 17g-5. However, to promote competition and improve quality, the other rating agencies should be free to gather more information and not have to share it with others.

The conflict of issuer paid rating could be avoided if issuers were required to pay a fixed fee based on deal type (maybe to a group set up by the SEC or an industry association for that purpose) which would be divided between all NRSRO raters informing issuers of their decision to rate the deal after the issuers post the information on the password-protected website for credit raters. This will avoid ratings-shopping by issuers even though the agencies will be indirectly paid by the issuers. The NRSRO Rating will be provided to investors without any charge. The NRSROs will only provide the current rating, along with disclosing their rating methodology to investors. They will not provide any opinions or qualitative information.

For more qualitative information and opinions, investors will look to the Informational Ratings and more details from research providers (including NRSROs and non-NRSROs). This will be paid for by the investors looking for enhanced information and research. This will be the main source of income for credit raters and will incentivize them to compete with others for investor subscriptions and produce quality results.

Separating the two roles avoids the issues of rating agencies precipitating events if they act or facing criticism if they do not. It avoids the perception of conflict from issuer-paid ratings, by allocating costs between the issuer and the investors. It also preserves the role of rating agencies where its needed, while encouraging the investors to do more work on their own and look for third party unbiased research and opinion.

Note: Versions of this article were published in Structured Credit Investor and Seeking Alpha.


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Stephen Whelan, Partner, SNR DENTON US LLP

Dodging a Bullet on the Oregon Trail
Thursday, March 10 2011 | 02:17 PM
Stephen Whelan
Partner, SNR DENTON US LLP

Readers of this blog were alerted last month to potentially ruinous legislation which had been introduced in the Oregon legislature. Senate Bill 892 would have overridden any contractual “hell or high water” clauses and permitted a lessee or buyer with any “dispute” with the seller or lessor--even if unrelated to the sale or lease contract--to deposit any “payments” (not just periodic installment purchase or rental payments) into an attorney trust account or a statutory escrow trust account, until the dispute had been “resolved”. There was no provision for the seller or lessor to receive interest on any amounts so escrowed.

The legislation also would have applied to lenders and securitization investors, so the Bill threatened to complicate any financing involving Oregon equipment or an Oregon lessee--and probably any Oregon seller, lessor or lender. But this week, face to face discussions by the Equipment Leasing and Finance Association (and member law firm Farleigh Wada Witt) with the sponsor of the Bill were followed by withdrawal of the legislation. Further discussions are expected because of the sponsor’s unsatisfactory experience with processing equipment acquired for use in his business, but it appears that the Senator is aware that legislation as originally introduced could have impeded the flow of capital to Oregon businesses.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

New Regs Suggest Need for Independent Collateral Valuation
Thursday, March 10 2011 | 11:09 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

While much attention and scrutiny has been given to the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act on the financial services industry, other recent regulatory changes will also have profound effects on the way financial institutions do business. One key trend: the need for independent collateral valuation, particularly regarding complex or hard to value collateral, such as many asset-backed securities, whole loans, real estate, pools of receivables and leases.

The motivation behind the new regulations is a perceived need for independent, conflict-free, professional judgment, without influence or pressure that could possibly be exerted by parties having an interest in the transaction. Driving this perception has been the massive federal loss exposure in the aftermath of the subprime financial crisis.

The portfolio valuation requirements of the 2010 Interagency Appraisal and Evaluation Guidelines[1] (which replace the 1994 guidelines) flesh out the new federal expectations; these changes will have application to a wide variety of institutions, including: federally chartered banks and those accepting FDIC insured deposits; fund managers and others who make representations about collateral to public investors; investment bankers; and rating agencies.

Given the regulatory trend, it appears certain to us that the Agencies will follow the lead of the Financial Services Authority in the United Kingdom, which has required financial services firms to engage outside experts to provide independent, conflict-free valuation and risk analysis. This requirement provides an institution with a defendable (i.e., independent) valuation of the portfolio components.

Pursuant to the Guidelines, each financial institution must maintain policies and procedures which establish standards for obtaining current collateral valuation information. The institution may employ a variety of techniques for monitoring the effect of collateral valuation trends on portfolio risk associated with its lending practices.

Changes in market conditions underscore the importance of following sound collateral valuation practices and monitoring when originating or modifying real estate loans and evaluating portfolio risk.
The Agencies implicitly are addressing three major risk exposures that drive the government’s interest in objective third-party collateral validation practices:

1. The FDIC scheme of depository insurance, which depends crucially upon the soundness of bank lending practices.

2. Agency guarantees on mortgage-backed securities provided by Ginnie Mae, Fannie Mae and Freddie Mac.

3. The potential government responsibility to bail out financial institutions deemed “too big to fail.”

The drafting of the Guidelines is a joint effort of the Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; Office of Thrift Supervision, Treasury; and National Credit Union Administration (collectively, the “Agencies”). The Agencies have committed to work together to ensure that real estate lending is conducted in a safe and sound manner.

Note: Contributors to this blog post include members of the NewOak Capital team.
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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

What Do CMBS Spread Forecasts Say About Commercial Real Estate?
Friday, March 04 2011 | 01:15 PM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

Predictions about future bond spreads by market participants provide a window on their thinking about their expectations regarding the performance of the underlying asset class. CMBS industry’s weekly newsletter, Commercial Mortgage Alert published its semi-annual polling of predictions on CMBS spreads six months later last month. One interesting fact in the data was that not a single person asked for their prediction thought that the spreads will be wider six months later! Does this unanimity reflect wisdom of crowds and indicates a steadily improving commercial real estate market, or is this a contrarian signal with respect to where commercial real estate and CMBS spreads are headed? And how does that reconcile with forecasts of the real estate market conditions?



For the commercial real estate property market conditions, The Real Estate Roundtable has just published its 3rd Quarter 2010 Sentiment Index survey of more than 110 senior real estate executives. While the survey found significant concerns and uncertainty about economic & job recovery outlook, government policy, and capital markets, the overall sentiment is that the industry is in for a long slow recovery. The survey reports a Current Conditions Index (reflecting how markets are today vs 12 months ago), a Futures Conditions Index (expectations on how markets will be 12 months from now), and an Overall Sentiment Index, which is the average of the two. For the first time, the survey’s current and future conditions indices merged, scoring an Overall Sentiment Index of 74 (down from 76 in the previous quarter). This score suggests a relatively positive trend and a flat trajectory.



The actual data on commercial real estate is sending conflicting signals and is being read by different people in different ways. Cushman & Wakefield report last month showing US CBD office vacancy dropping to 14.8 % in Q2 from 15% at end of Q1 -first drop since 2007, CMBS statistics showing declining pace of deterioration in delinquencies, etc are seen by many as signs that the CRE market is stabilizing. Others point to declining rents and high unemployment as factors that point to further declines ahead. Both the viewpoints have some validity, which probably implies that the CRE sector might move sideways in near term with some volatility caused by which of the two views is stronger at any given point, till additional market data clarifies the picture more.

Going back to CMBS spreads, the tightening probably just reflects the sentiment expressed in other surveys of an expectation of slowly stabilizing CRE market. For CMBS, as opposed to properties, a consensus that the property price decline has stopped will be enough for bond spreads to tighten. Real estate prices do not necessarily need to go up for CMBS spreads to tighten. What happens if the sentiment on the economy sours impacting the view on the commercial real estate too? Even in that scenario, more and more people are coming to the view that the senior most CMBS bonds will likely not suffer a principal loss, which makes them attractive given the additional yield they provide compared to other similar investments. So, worsening economic conditions may actually cause people to move up in capital stack, creating demand for senior most bonds, and providing support for spreads. No one knows what future will bring, but logically, odds look in favor of the spreads moving in the direction suggested by the unanimous view.

All of the above is fine for trying to understand these markets, but one practical conclusion, and the real point of this article is this: if senior CMBS securities can go up in value even when property markets go sideways, and will have some support if the property markets decline, then logically, senior CMBS bonds have to be better investments at present than commercial real estate properties or loans for those who can invest in any of those.

Note: A version of this article was originally published 8/10/2010 on Seeking Alpha.The views in this article and my spread predictions in the Commercial Mortgage Alert article referenced are solely my own.


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Janet Tavakoli, President, TAVAKOLI STRUCTURED FINANCE

The Biggest Headache For Groupon And Facebook Investors
Friday, March 04 2011 | 10:02 AM
Janet Tavakoli
President, TAVAKOLI STRUCTURED FINANCE

Groupon makes its money by selling coupons for goods and services. It partners with local merchants. When you buy a coupon for a merchant's discount on Groupon, it reportedly takes a 50% cut in the U.S.

Groupon has had a few embarrassments. On Valentine's Day, FTD's flowers were priced lower than Groupon's "deals" and the online discounter had to apologize to customers. Moreover, merchants often put conditions and restrictions on Groupon discounts that dilute the value of the deal, similar to restrictions on redeeming air miles. Even so Groupon's valuations have ranged from $1.2 billion to $6 billion to $15 billion all in the space of a year. What's it really worth? More on that later.

Facebook is free and "always will be." It makes its money from ads and revenues from games (if users don't block them), albeit phone apps so far do not display ads. Michael Arrington at Techcrunch reported that Facebook is secretly building its own phone to control its own operating system. He noted that Li Ka-Shing is a Facebook investor, and he is an investor in the rumored INQ and Spotify phone project. While Facebook may remain free, it would have to figure out a way to get users to pay their phone bills.

Facebook has tremendous potential to exploit its 500 million users. In fact, one of Facebook's fundraisers is a genius at exploitation. Goldman Sachs, the Great and Powerful Oz of Finance (just don't look behind the curtain), has already opined on Facebook's value. In January 2011, it valued Facebook at $50 billion when it sought to raise $1.5 billion in Facebook financing.

Rich Teitelbaum of Bloomberg News reminded the financial world that Goldman Sachs Asset Management's anemic track record suggests that Goldman may not be the best go-to source for putting a value on an asset. Despite Goldman's public relations hype that it employs the "best and brightest," it trailed the average return of its peer group in every category. Goldman has an incentive to dangle a high valuation on Facebook in front of clients:

Jim Clark of Netscape and Silicon Graphics fame was irritated that Goldman wanted to fee stuff its Facebook offering with a 4 percent placement fee, a half percent expense fee, and a snatch-back of 5 percent of investors' potential profits.

A few months earlier, Clark had invested in Facebook through another financial firm at a lower price, and the other firm wouldn't potentially gouge him with Goldman's 5 percent pleasure-of-your-company tax. "I don't think it's reasonable," Clark told Bloomberg. "It's just another way for [Goldman] to make money from their clients." The question remains whether Clark bought his stake at a reasonable price.

"Blankfein Flunks Asset Management as Clark Vows No More Goldman," by Richard Teitelbaum, Bloomberg News, January 24, 2011

In January 2011, SharesPost Inc. valued Facebook at $82.9 billion on the secondary exchange. Whatever price the market will pay today, one has to be concerned about what it will pay tomorrow. Even if the future value of Facebook is say, $4 billion, Goldman will rake in fees.

Impermanent Value

Both Facebook and Groupon became successes because they are web based networks that required few management skills, minimum capital to start, and there were no barriers to entry. That is also their biggest problem. The ugly truth is that no one can tell you what they are worth as businesses.

Groupon's successful-so-far revenue model is its curse. It's both trying to hold its position in "established" markets, and it's trying to expand. The problem is that web users in other countries have noticed Groupon's success and the fact that Groupon has been paying high premiums for local established discounting web sites just to get at the client distribution lists.

Groupon's competitors are both buying sites for the same reason as Groupon, and local entrepreneurs can easily copy Groupon's business model. It seems all it takes is a good web developer, a two-page merchant agreement, and an accounting firm that can handle the taxes as a site expands internationally. Groupon may have a head start, but it has no long-term competitive advantage. That puts its margins, its market share, and it's ability to expand and hold its position in new markets at risk.

Smart investors look for highly skilled managers in industries with a long-term competitive advantage in a stable industry run by decision makers with a "here-today, here-forever" mentality. Between Groupon and Facebook, it seems Facebook has the better chance of making a case, but it hasn't made one so far.

Facebook seems to be thinking of ways to create a loyal user base by penetrating deep within its user base. It certainly has a shot, but it is unclear whether it can maintain a competitive advantage.

Users are fickle, and young users will gravitate to the next exciting new thing. The rapid success of Catherine Cook's myyearbook.com has to give investors pause. She started the site 6 years ago as a 16-year old high school student with a $250,000 investment from her brother, and the site is valued at $20 million. While it's no threat to Facebook, it has a fresh look, is responsive to users, and offers new spins such as allowing users to buy each other gifts and "lunch money."

Investors may wonder when the next bright young kid will eat Facebook's lunch and make it look like a site for old fogies. Facebook may adapt, but it would do itself favors by disclosing its revenues, and how it plans to face up to potential competitors.

Note: This post originally appeared in the Huffington Post.
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Ron D'Vari, Chief Executive Officer & Co-Founder, NEWOAK

Ending GSE Bailout is A Delicate Balancing Act
Thursday, March 03 2011 | 09:01 AM
Ron D'Vari
Chief Executive Officer & Co-Founder, NEWOAK

We agree to a well defined and transparent but gradual end to the bail out of GSEs. The process has to be designed with full understanding of the markets and free of political agenda.

On-balance sheet approach is a good aspiration but has its own pitfalls and challenges. The annual budgetary process for allocating on-balance and on-budget has proven to be problematic and has politicized the process as opposed to making it more effective and efficient. GNMA program history is a good case study.

We believe in the end there has to be two fluid markets existing side-by-side:
1) a revised conforming government guaranteed mortgage market,
2) standardized private non-agency market.

The underwriters of conforming mortgages should be more diversified than just the two GSEs. There is need for more of them and should be privately financed with some well defined tail risk protection from government. There should also be a limit on each conforming sponsor’s size to manage systematic risks and moral hazard. With that there would have be a non-risk-taking independent collateral agents to ensure transparency and uniformity. The underwriting guidelines should also be more dynamically adjusted through the economic cycle to minimize and protect against systematic risk. The independent collateral agents should be regulated but not part of direct government administration.

We do believe the securitization of non-agency market is critical but in this case uncertainty in well defined legal frame work and Dodd-Frank rules has severely been the bottleneck.

Significant unsold non-performing loans and REOs stock in the banking system will continue to be a major road block to the non-agency securitization.

We agree to a well defined and transparent but gradual end to bail out of GSEs. The process has to be designed very carefully. On-balance sheet approach is a good aspiration but has its own challenges. The annual budgetary process for allocating on-balance and on-budget has proven problematic and politicize the process as opposed to making it more effective and efficient. GNMA program history is a good case study.

We believe that there has to be two markets:
1) conforming government guarantee mortgage market,
2) non-agency market.

However the underwriters of conforming mortgages should be more diversified than just two agencies and these should be privately financed. Perhaps there should be a limit on each agency size due to systematic risk. With that there would have be a non-risk independent collateral agent party to ensure transparency uniformity. The underwriting guidelines should be more dynamically adjusted through the economic cycle to minimize and protect against systematic risk. The independent collateral agents should be regulated but not part of direct government administration.

We do believe the securitization of non-agency market is critical but in this case uncertainty in legal frame work has contributed to lack of market start.

Significant unsold non-performing loans and REOs continue to keep the non-agency RMBS a non-starter.

Standardized servicing need to also be addressed.

Lastly, lack of well defined rating criteria will be a problem to get the market started.

It is critical for US economy to have a well functioning residential mortgage markets and we believe it should be more of a national priority.
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Stephen Whelan, Partner, SNR DENTON US LLP

Ambushed on the Oregon Trail
Monday, February 28 2011 | 11:28 AM
Stephen Whelan
Partner, SNR DENTON US LLP

Senate Bill 892 was recently introduced in the Oregon legislature. It would affect any equipment sales or lease contract that contains a so-called “hell or high water”, or waiver of defenses clause and, by permitting the lessee or buyer to deposit payments into an attorney trust account or a statutory escrow trust account, would prohibit the lessor/seller or any assignee from enforcing the HHW clause or reporting the nonpayment “as a default or as information that may negatively affect the person’s credit rating…or ability to obtain credit.”

Commentators have identified at least one dozen defects or other problems with this Bill. One of them is that the Bill permits withholding of payments by reason of any “dispute” between the seller/lessor and the counterparty--not just a dispute over operation of the equipment or even a dispute relating to that particular contract. Another is that the Bill applies to any “payments”, so amount payable for maintenance, taxes, indemnities also could be placed in escrow, thereby forcing the lessor to pay property taxes or repair bills or else risk losing title to the equipment.

The Bill applies to assignees of the seller or lessor, so lenders, whole loan purchasers and securitizers would be prohibited from using the HHW clause to enforce payment. There is no provision for the lessor, securitizer or other assignee to receive interest, at the contract overdue rate, on the escrowed amounts.

In short, the proposal would undercut one of the linchpins of lease and securitized finance: the absolute and unconditional obligation of a lessee or purchaser to make payments. If enacted, it could force lenders, syndicators and securitizers to forbid any Oregon contract from being included in contract pools which they finance. Of course, the Bill is silent regarding which contracts would be affected, so the chilling effect on Oregon-related equipment would be even greater.
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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

Two Points For Investors
Tuesday, February 22 2011 | 02:46 PM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

If a picture is worth thousand words, the graph below is a valuable illustration of two very important points that investors would be better off to remember. This graphic focuses on the returns from various sectors in fixed income market, but the same concept generally applies to equities too.



The creators of the graphic intended to make the case for active management. I am assuming that anyone managing investments for themselves or others already believes in benefit of active management to some extent. The points I want to make go a little further.

The first point is that sector selection is much more important for generating superior returns than individual security selection. You could be very active in selecting securities, but if they are not in the right sector, the returns might suffer, no matter how much effort is put into picking the individual bonds or stocks.

The second point that this graphic makes to me is that, when I am picking funds, it makes sense to pick funds that have broader focus and a manager with expertise in multiple sectors. In other words, funds in which the manager has the expertise and ability to switch between different sectors may be able to do a better job than an investor trying to move between different funds. That thinking leads me to pick funds like PIMCO Total Return (PTTRX), Blackrock Global Allocation (MALOX), Vanguard Wellington Income (VWELX), and others.

Note: A version of this article was originally published on Seeking Alpha.


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Janet Tavakoli, President, TAVAKOLI STRUCTURED FINANCE

Muni Bonds: Matt Taibbi's* Antidote to Meredith Whitney
Tuesday, February 22 2011 | 02:36 PM
Janet Tavakoli
President, TAVAKOLI STRUCTURED FINANCE

The credit-worthiness of specific muni bonds, particularly non-general obligation project bonds, has become a hot topic since "AAA" bond insurers imploded, partly due to mispriced risk premiums on protection they wrote on value-destroying CDOs for Wall Street banks.

Meredith Whitney provided no research to back up her call on a recent 60 Minutes segment of coming defaults by large municipalities amounting to "hundreds of billions of dollars" (50 to 100 defaults). (Corrected Feb 9). Bloomberg News revealed that her muni report was on the state level and didn't cover large municipalities. That's a problem, since muni credit issues are granular and the severity of the problem -- or non-problem -- depends on the specific situation. Her unsupported claim gives muni-problem-deniers ammunition to claim there is no substance to the argument that there are serious problems with certain muni bonds.

The Columbia Journalism Review made a valid point when it called out 60 Minutes for not making sure Whitney could back up her claims. Max Abelson and Michael McDonald of Bloomberg News debunked her "untarnished" track record and Spaceballs-worthy jabberwocky:

Bloomberg News reported in October that about two-thirds of her stock picks since starting her company in 2009 had fared worse than market indexes. A 2008 Fortune cover story ranked Whitney 1,205th out of 1,919 equity analysts the previous year, based on stock picking.

"A lot of this is, you know it, but can you prove it? There are fifth-derivative dimensions that I don't think I need to spell out to my clients," [Whitney] said.

"Whitney Municipal-Bond Apocalypse Short on Specifics," Bloomberg News, Feb 1, 2011 (excerpted and condensed).

In contrast, Matt Taibbi's Rolling Stone expose of Jefferson County, Alabama's sewer project is a hair-raising account of financial corruption, bribes, cost padding, pay-to-go-away agreements between investment banks, and fee slamming that wildly inflated the cost of a sewer project from $250 million to $3 billion. It saddled Jefferson County's taxpayers with a too-onerous debt burden and broke the financial back of the county. JP Morgan agreed to pay a $25 million fine to the SEC and $50 million to aid Jerrson County's displaced workers for its role in the devastation (updated):

The county, it turned out, was more than $5 billion in debt -- meaning that courthouses, jails and sheriff's precincts had to be closed so that Wall Street banks could be paid...Homes stood empty, businesses were boarded up, and parts of already-blighted Birmingham began to take on the feel of a ghost town.

"Looting Main Street," by Matt Taibbi, Rolling Stone, March 21, 2010

Whitney might back up her claim by walking the media through at least one analysis -- if she has one -- of the specific problems of a large municipal bond issue, since it is beginning to look as if Whitney's claims are a series of PR stunts.

Whitney's claim-to-fame, a bearish bank call on Citi, was over-hyped. Her Citi call was late. Jim Rogers, a world famous investor with a provable track record, appeared with her in early 2007 on Cavuto on Business and explained why he was short (bearish on) Citi. Whitney refuted him and continued to rate Citi sector perform, yet Citi underperformed the sector during this time period. It wasn't until October 31, 2007, that she took Rogers' hint. Likewise her Bear Stearns call was late, and her Lehman call was tardy. I mentioned this in a commentary after either she or her PR people seemed to take credit for an apparently nonexistent early call on AIG. (See: "Reporting v. PR: Meredith Whitney and AIG," TSF, March 23, 2009 .)

Meredith Whitney's PR has more issues than Rolling Stone, but Matt Taibb^i provided evidence that he researched the substance of the problems behind a muni bond issue.

Endnote: (Feb 9, 2011): As I've mentioned in previous posts, there are serious fiscal problems that need to be addressed at state and local levels, but this varies by region and some issues are potentially solvable. For example, Illinois hiked personal income taxes from 3% to 5%. (I'm a resident of Chicago, Illinois.) The Chicago Mayoral race centers partly around steps, including budget cuts, needed to solve Chicago's serious fiscal issues: See also my previous post: "Third World America: 'Fast-Tracking to Anarchy;" HuffPo, August 25, 2010.

Further Reading: "Repairing the Damage of 'Fraud as a Business Model,'" TSF Address to the FHFA's Supervision Summit in Washington D.C., December 8, 2010.

^Feb 11, 2011 addition: Blloomberg News broke this story in September 2005 in an article titled "The Banks that Fleeced Alabama," by Martin Z. Braun, Darrell Preston and Liz Willen

Note: This post originally appeared in the Huffington Post.
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Stephen Whelan, Partner, SNR DENTON US LLP

Systemically Significant?
Monday, February 14 2011 | 01:10 PM
Stephen Whelan
Partner, SNR DENTON US LLP

On February 8, 2011, the Board of Governors of the Federal Reserve (the “Board”) issued a notice of proposed rule making under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The proposed rules establish criteria for determining whether a nonbank entity (1) is nonbank company that is “predominantly engaged in financial activities”, and (2) is a “significant nonbank financial company”. Both of these rules are important, because the Dodd-Frank Act gives the Financial Stability Oversight Council (the “FSOC”) the authority to determine whether a nonbank financial company shall be subject to the Board’s supervision, because it could pose a threat to the financial stability of the United States.

One of the necessary criteria for a company to be a “nonbank financial company” is that it be engaged “predominantly in financial activities”. Under the first proposed rule, a company would be “predominantly engaged in financial activities” if in either of its past two fiscal years, eighty-five percent of its consolidated annual gross revenues or consolidated total assets in that year were derived from or related to, respectively, “activities of a financial nature” or the ownership, control, or activities of an insured depository institution or any of subsidiary thereof. Additionally, the Board would have discretion to determine “based on all the facts and circumstances” that at least eighty-five percent of a nonbank company’s consolidated annual gross revenues or consolidated total assets are derived from or related to the aforesaid activities.

One factor, in determining whether a “nonbank financial company” is to be subject to the Board’s supervision, is the degree and nature of its connections with other significant nonbank financial companies and significant bank holding companies. In this regard, the second proposed rule defines a “significant nonbank financial company” as a nonbank financial company that is already supervised by the Board, or that had at least $50 billion of total consolidated assets as of the end of its most recently ended fiscal year. Furthermore, the FSOC may recommend to the Board that nonbank financial companies supervised by the Board report to the FSOC, the Board, and the FDIC on their credit exposure to other significant nonbank financial companies and significant bank holding companies. (A “significant bank holding company” is a bank holding company or foreign bank treated as a bank holding company that had at least $50 billion of total consolidated assets as of the end of its most recently ended fiscal year.)

These proposed rules are important to several companies in the equipment finance arena, because if any of those companies qualify as nonbank financial companies, then they could be subjected to supervision by the Board, similar to that imposed on bank holding companies, and could be required to report on their credit exposure to other significant nonbank financial companies and significant bank holding companies. It is as yet unclear how burdensome the increased regulatory oversight would be.

The deadline for comment is March 30, 2011.
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Malay Bansal, Managing Director, CAPITALFUSION PARTNERS

Tackling the US Unemployment Problem-Infrastructure Investments Without Increasing Taxes or Deficit
Friday, February 11 2011 | 09:44 AM
Malay Bansal
Managing Director, CAPITALFUSION PARTNERS

High unemployment is one of the most important issues the US economy is facing, and one of the most effective ways to tackle this problem is investments in productive infrastructure. Here is an idea that will encourage private investment in infrastructure without requiring increases in deficit or taxes, along with steps needed to ensure that the program will be effective.

High level of unemployment at 10%, or 17% if you also count the under-employed, is one of the biggest challenges the US economy faces today. Consumers are about 70% of the economy. People without jobs can’t spend as much on goods and services, and can’t buy houses, which does not help housing situation, another significant issue. US companies have managed to increase profits but partly by reducing costs and spending, which also does not help the economy grow. The QE2 program undertaken by the Federal Reserve is meant to help unemployment indirectly by driving interest rates lower, but its effectiveness is far from certain, and is being questioned by many.

Why Infrastructure Investments?

One generally agreed approach to increasing employment is investment in infrastructure projects. The jobs created are local and cannot be exported, and the jobs will be created in sectors like construction that are facing higher unemployment (about 21% of the eight million jobs lost in 2008 & 2009 were in the construction sector, which still has unemployment at 17% level). Also, spending on infrastructure generates demand for products and services from a variety of industries, creating more jobs.1

Another consideration in favor of infrastructure investments is that deteriorating US infrastructure is sorely in need of maintenance. American Society of Civil engineers estimates that US needs $2.2 trillion in infrastructure spending over next five years2. The collapse of the I-35W bridge over Mississippi River in Minneapolis in Aug 2007 was a vivid example of this need. Increased spending also makes sense comparatively - US spends 2% of GDP on infrastructure, while China and Europe spend 9% and 5% respectively.

Also, several factors make this a good time to make investments in infrastructure – raw materials and labor are cheap, as is cost of financing. The maintenance is necessary and overdue. Not doing it now just means that it will have to be done at a later time when it will likely cost more.

Issues in Investing in Infrastructure

The biggest issue is finding funds without increasing deficit or taxes. US National debt for the $14.5 trillion economy has already ballooned to more than $13 Trillion. In Sep 2010, the Obama administration proposed a plan to spend $50 billion on infrastructure investments. However, the congress has not approved the plan, and the increased focus on reducing deficit and spending in the newly elected congress will constrain spending by the federal government. The state and local governments have lower tax revenues due to weaker economy and lower real estate values, and are constrained in their ability to spend.
Need for funds is one problem. Another problem is picking projects that are productive and not just a waste of money. Government may not be the best judge for picking the best projects. Solution to both problems is increased involvement of private sector.

Investment in Infrastructure without Increasing Deficits or Taxes

To get the private sector to invest in infrastructure projects, the government has to provide incentives, but in a way that does not increase deficit or taxes. One possibility for doing this may be by using the estimated $1 trillion of unrepatriated profits US companies hold in foreign subsidiaries. American companies can generally defer paying taxes on foreign profits as long as they keep the money outside US. When they bring the money back to US, they have to pay the top corporate tax rate of 35%. To defer taxes, US companies generally have left large sums of profits in their foreign subsidiaries.

These untaxed profits are part of the reason large multinationals have lower overall tax rates for which they have been criticized at times. Earlier this year, the administration proposed restricting companies from deferring taxes on profits earned oversees (estimated to raise $210 billion in revenues over next 10 years), but faced strong opposition since that would put the US companies at a competitive disadvantage.

On the other end, US companies are arguing that they could bring back the earnings in their foreign operations if the US government offered a tax amnesty and permitted them to repatriate foreign earnings at a low rate of around 5% instead of the 35% federal tax they face at present (see editorial in Wall Street Journal on Oct 20, 2010 by John Chambers, the CEO of Cisco, and Safra Catz, the President of Oracle). They argue that 5% tax could bring $1 trillion back to US for increased economic activity and could generate $50 billion in federal tax revenue.

The tax amnesty does not cause an increase in deficit or taxes, as government is giving up what it is not getting anyway - without it, these funds will not come back into the US economy, and the Treasury will not get the additional tax revenue. However, the funds brought back will not necessarily generate jobs. The companies could use the money for M&A activity, stock buybacks, and paying out dividends. A better idea will be to offer the tax amnesty only to the funds brought back that are invested in infrastructure and clean energy projects in the US. A limited time tax amnesty will encourage US companies to repatriate earnings back to US. A requirement to invest in infrastructure projects for a minimum fixed number of years (say something between 3 to 5 years) will ensure that the funds brought back create jobs. Companies will be allowed to invest in either debt or equity depending on their risk-reward preferences. All investments will be chosen and managed by private fund managers, who will pick projects and investments based on sound economic calculations of cost-benefit and expected returns. The companies will be able to pick any fund manager based on their judgment of manager’s capabilities.

This basic framework could be enhanced in several ways. Companies could be encouraged to invest for a longer period by offering to reduce any taxes on the earnings from the infrastructure investments, if the investments are held for say 7 to 10 years or more. Also, companies could be allowed to use part of funds brought back to build new plants for their own use.

Will Private Investors Invest In Infrastructure?

If the government did allow repatriation at low tax rates for money to be invested in infrastructure, would there be demand for it? Can these projects generate returns that investors will find attractive? The answer to both is affirmative. Prequin reported recently that 28 US Infrastructure debt funds were on the road trying to raise $26.4 billion. Europe, smaller in size, but with better developed Public Private Partnership programs in the sector, had 38 funds trying to raise $29.3 billion. Large investors have expressed willingness to invest in these projects. Zhou Yuan, head of asset allocation at China Investment Corporation (CIC), said in November that CIC would be willing to invest in large projects like high speed links between US cities, and super high-voltage transmission lines that provide a good risk-return profile, and suggested US should invest $1 trillion over next 5 years in form of public and private equity partnerships to create jobs (instead of QE2) and improve competitiveness.

Ensuring the Program is Effective

An editorial in New York Times on Oct 23 opposes the idea of tax holiday for repatriating foreign investments citing the experience of 2004. In 2004, after strong lobbying by the US multinationals, the Congress passed the American Jobs Creation Act in which the Homeland Reinvestment provision gave US companies a one-time break to pay 5.25% rather than 35% in taxes on the repatriated foreign profits, with the intention that the repatriated money would prompt investment in the United States economy and spur job growth. To qualify for the one-time tax break, companies had to promise to use the money to invest in their domestic operations. They could not use it to pay dividends, or compensate executives.

The program was heavily used by large corporations – many in the pharmaceutical and technology industries. For example, Pfizer brought back $37 billion, and Hewlett-Packard repatriated $14.5 billion. The amount of repatriation exceeded expectations. In all, 843 corporations took advantage of the offer, bringing back $362 billion in foreign profits. Of that amount, $312 billion qualified for the tax break, giving those companies total tax deductions of $265 billion claimed from 2004 through 2006.

According to analysis later, of the $299 billion companies brought back from foreign subsidiaries, between 60 and 92 percent of it went to shareholders, through increased share buybacks or increased dividends. Repatriations did not lead to an increase in domestic investment, employment or R&D, even for the firms that lobbied for the tax holiday stating these intentions. For example, Dell, which repatriated $4 billion, spent $100 million on a plant in Winston-Salem, N.C, which they said they would have built anyway, and used $2 billion two months later for a share buyback. Also $100 billion was estimated to go right back to foreign subsidiaries.

The provision requiring domestic investment had wide definitions of the term investment and allowed corporations to use repatriated profits to shore up their domestic finances, pay legal bills and even bankroll advertising. While companies did make investments in their domestic operations, the repatriated money also freed up a corresponding amount of cash to pay out to shareholders or buy back stock.

Money is fungible. It can be easily moved from one bucket to another. Hence, to ensure that the tax break really results in investments that create jobs, that money has to be separated. Hence, for this idea to be effective, the funds brought back must be invested with third-party private fund managers for a minimum number of years to qualify for the tax break.

Longer term, the US needs to develop regulations that clarify and encourage private sector investment and involvement in the infrastructure sector. Public-Private Partnerships and securitization of infrastructure financing can play a very useful role in developing this sector which is essential for the growth and competitiveness of the US economy in the longer term.

1An Oct 2010 report from the Council of Economic Advisors & the US Treasury (An Economic Analysis of Infrastructure Investment) discusses the benefits of infrastructure investments in detail. Also, see Jan 2009 article How Infrastructure Investments Support the U.S. Economy: Employment, Productivity and Growth from PERI & AAM.

2Also see CBO Testimony on Current and Future Investment in Infrastructure.

Note: This idea was originally published at http://marketsandeconomy.wordpress.com/2010/11/23/tackling-the-us-unemployment-problem/


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Janet Tavakoli, President, TAVAKOLI STRUCTURED FINANCE

Blame the Victims and Enrich the Perpetrators
Wednesday, February 09 2011 | 03:28 PM
Janet Tavakoli
President, TAVAKOLI STRUCTURED FINANCE

It's outrageous the way subprime borrowers swarmed and solicited unsuspecting lenders and camped out in the offices of investment banks to push them to find ways to finance their insatiable need for capital to purchase homes. It's a scandal the way they got in bed with appraisers to get the home values stated at three to five times market value. It's criminal the way they falsified income to push through the mortgage loans. Oh wait... they didn't. [Hat tip to Nomi Prins, author of It Takes a Pillage.]

While there were instances of fraud by borrowers, the key drivers of our housing crisis were fraud perpetrated by mortgage lenders and securities fraud -- by some of our most revered financial institutions -- that provided money to fuel fraudulent mortgage lending.

After the largest bank bailout in world history, we have a national epidemic of foreclosure fraud. In cases where foreclosures are being delayed, banks are walking away from abandoned homes and sticking local taxpayers with the bill to clean up the mess they left behind.

Yet, as Arianna Huffington points out in her latest book, banks continue to find ways to get Americans to subsidize problems that the banks themselves were chiefly responsible for creating. Consumers struggle to keep up with payments as the unemployment rate rises along with food and energy prices, and loan resets kick in:

When they don't, banks, trying to offset losses in other areas, turn around, hike interest rates, and impose all manner of fees and penalties--all of which makes it less likely consumers will be able to pay off mounting debts.

Third World America: How Our Politicians Are Abandoning the Middle Class and Betraying the American Dream Pp. 77 & 78.

GSAMP: Garbage Sold at Mythical Prices

In 2007, the state of Ohio kicked the California-based New Century mortgage lending carpetbaggers out of the state and barred New Century from doing business after despicable practices. A complaint of alleged fraud on the part of Goldman Sachs detailed its close relationships with Countrywide, New Century, and Fremont. The complaint showed Goldman knew of "an accelerating meltdown for subprime lenders such as New Century and Fremont." Despite known serious loan problems, Goldman continued to securitize the loans and sell them in packages of residential mortgage backed securities.

Suspect deals like GSAMP-2006 S3; $494 million of securities bought by institutional investors in April 2006 were created and distributed by Goldman Sachs Alternative Mortgage Products (GSAMP).

Fortune's Allan Sloan and Doris Burke followed the deal as its value slid ever downward as well as the fudgy way the deal's deteriorating value seemed to be overstated by the trustee's report:

More than a third of the loans were on homes in California, then a superhot market, now a frigid one. Defaults and rating downgrades began almost immediately. In July 2008, the last piece of the issue originally rated below AAA defaulted -- it stopped making interest payments. Now every month's report by the issue's trustee, Deutsche Bank, shows that the old AAAs -- now rated D by S&P and Ca by Moody's [junk ratings] -- continue to rot out.

As of Oct. 26, date of the most recent available trustee's report, only $79.6 million of mortgages were left, supporting $159.9 million of bonds...But even worse, those mortgages aren't worth anything like their $79.6 million of face value, according to ABSNet Loan HomeVal...As of Sept. 26 -- a slightly different date from what we're using above -- ABSNet valued the remaining mortgages in our issue at a tad above 20% their face value. Now, watch this math. If the mortgages are worth 20% of their face value and each dollar of mortgages supports more than $2 of bonds, it means that the remaining bonds are worth maybe 10% of face value.

"Junk mortgages: It just gets worse, " by Allan Sloan and Doris Burke, Fortune, December 1, 2009.

"Countrywide Broke the Law"

In above mentioned complaint against Goldman Sachs, allegations of suspect practices from mortgage lenders, including Countrywide, now owned by Bank of America, were revealed. According to a former Countrywide employee:

"approximately 90% of all reduced documentation loans [also known as "liars' loans] sold out of a Chicago office had inflated incomes, and one of Countrywide's [mortgage brokerage arms] routinely doubled the amount of the potential borrower's income...so that borrowers could qualify for loans they could not afford."

When Countrywide's employees received documents verifying income that showed the borrower couldn't afford the mortgage and didn't qualify for a loan, they simply ignored it and "the loan was re-submitted as a stated income loan with an inflated income figure so as to facilitate the approval of the loan." In other words, the former Countrywide employee said that brokers, not borrowers, engaged in massive fraud to push loans through the system and earn commissions.

Illinois Attorney General Lisa Madigan told First Business Morning News: "Countrywide broke the law, homeowners did not."

Pump and Dump

The same banks that supplied money -- and in some cases now own -- suspect mortgage lenders also packaged up and sold those loans to investors. These banks also own or owned "servicers" that are supposed to act as stewards for investors. But if servicers cannot recover foreclosure costs combined with the costs of maintaining and reselling the house, they often abandon the property. After pumping up appraisals and falsifying borrowers' income on applications, banks are walking away. Once again, American taxpayers will foot the bill:

In Chicago, the mortgage servicers and trustees most often associated with the [abandoned] properties are Bank of America, with 314 properties; Wells Fargo (234), U.S. Bank (185), Deutsche Bank (178), and JPMorgan Chase (165).

"More banks walking away from homes, adding to housing crisis," by Mary Ellen Podmolik, Chicago Tribune, January 13, 2011. (Source of data on homes apparently abandoned in the foreclosure process is a new local study by the Woodstock Instititue.)

Despite evidence of widespread interconnected mortgage lending, securitization, and foreclosure wrong-doing and fraud, there are no meaningful felony indictments. Arianna Huffington suggests a solution and a long and difficult road ahead:

The most effective way of fixing the multitude of problems facing America is through the democratic process, but the democratic process itself is badly broken. That is why the first step toward stopping our relentless transformation into Third World America has to be breaking the choke hold that special interest money has on our politicians.

Third World America P. 172

Note: This post originally appeared in the Huffington Post.
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