GOVERNMENT MALFEASANCE

At a time when capital formation is already being suppressed by macroeconomic conditions, the regulatory estate is making it more expensive and riskier for lenders, both bank and non-bank, to do their basic job of lending. More capital, more limitations on trading, more headcount devoted to reporting and compliance as opposed to lending. More anxiety over complying with often inconsistent, contradictory and opaque rules. More anxiety about striving, innovation, straying from the herd? The psychological and emotional penumbra on the financial sector participants of all this is meaningful. That will only exacerbate institutional instincts to be cautious, perhaps even a bit timid. This penumbral impact itself will impair capital formation as a first derivative of the actual regulatory actions.

Cliffs Notes summary; this regulatory environment is inconsistent with our expectation that the financial sector can be relied upon as a critical engine of growth.

It’s all rather distressing, isn’t it? But, playing the cards dealt is the only option. Remember, a lack of revenue can be as highly correlated with severely diminished bonus pools (and indeed unemployment) as realized losses. Distressed conditions will ease eventually and markets will repair, just not soon enough to allow us to hunker down and wait.

We need to find stuff to do. So, here’s what I’m thinking about.

First, find borrowers willing to borrow at spreads consistent with the new price of risk and new cap rates. Eventually, reconciliation will be attained and the entire market will reprice in terms of both the value of fixed assets and the price of debt and fresh capital, but, in most cases, not for a while. If, however, this works well for you now, please feel free to ignore the rest of this note. You’re good.

Be a buyer when scale and risk aversion bite. The increased regulatory pressure on the banking and lending world is likely to cause disintermediation of commercial loans (mortgage loans and others) and indeed parts of loan platforms. Loans will trade. Pools of loans will trade. While reconciliation will only slowly penetrate the borrower community, the financial marketplace will have gotten the joke. To the extent business realities and regulatory burdens impact many shops, there will be willing sellers in the marketplace.