There are beginning to be some indications that once again people have short memories, and there is a refusal by many to look outside the US at what is happening around the world. After only a few months of feel good statistics, lenders are once again starting to forget the rules of underwriting and loan agreements. There is a strong belief among a growing number of economists and investors that the first quarter was better than the rest of the year will be due to the extraordinary warm weather and a catch up to a more sustainable level of staffing by many companies who over fired during the crash. With the warm weather consumers were able to get the malls easily and airplanes flew, making shopping and travel relatively easy compared to a normal winter. We now see unemployment figures again moving in the wrong direction, and other data suggesting the second quarter might be back to the same slog we have been experiencing for the past two years. Add to that, the end of the short honeymoon for Europe after Greece got its band aid and baling wire fix up. It could be that the worst is yet to come in Europe, as Spain and Italy struggle to remake their labor laws and overall economic models. In the end both countries will be saved, but it will get ugly as the spring turns to summer. Europe has many years to go before that situation comes right, and there will be periodic crisis along the way. If Hollande wins the French election, as is likely, then it will surely be worse rather than headed to resolution, as he tries to undo all the good agreements that have been reached. The Syrians have no intention of stopping massacring their people, and shortly the Saudis will arm the rebels and even Obama will figure out Assad is just playing he and the UN for suckers. The Israelis have made it clear that they are not waiting for more useless talks with the west trying to stop Iran. In short, the Mideast is going to become very violent later this year, and it may not be far off. China has a lot of readjusting yet to do, and a major political crisis with the Bo situation yet top play out. That is a much greater issue than many in the US are understanding, as it goes to the heart of how China moves ahead politically. The US housing mess is far from resolved even if prices do stabilize. Unfortunately, many people in the US and the capital markets seem to not be paying attention to what is really happening in the rest of the world. There seems to be a massive ignorance is bliss taking hold.

The result is a move to slowly head toward covenant lite. Some lenders are once again, and too quickly, loosing up on the covenants that are important to have when things go bad. It starts as a slow drift with bigger borrowers, and slowly migrates to the lesser quality borrowers over time. As more and more lenders restart their programs, they have to find ways to compete. There are only a couple of ways. Price, proceeds and covenants. It starts with spreads tightening, then migrates to lower debt yield requirements. 12% debt yields become 11% then 10% on so on. Then the better borrowers figure they have pushed that envelope as far as they can so they then turn to covenants.

I don’t know any more than any of you, what will happen with Israel and Iran. Syria seems easier to predict since they are already ignoring the UN monitors and violating the edict from the UN to pull back. The Saudis and Qatar are not going to wait for Washington to get the situation right. They are already starting to arm the rebels, and will step that up very soon. They are right there and can’t wait for the UN to waste more time. Europe is pretty predictable to continue in crisis, and then bailouts by the ECB and IMF. European banks will not be truly OK for years.

As the US election season really gears up, and nothing good happens in Washington, the country is racing toward the end of the tax cuts and toward the failure to reach a deficit agreement, and so the sequester gets triggered. Both are a disaster, and it is unlikely in a lame duck session that these will get truly fixed in the couple of weeks available. Romney does not take office until mid January, so even if the Republicans win the Senate, it will take weeks to push through correcting legislation. Even if the Republicans gain total control, they can’t just fix everything quickly. Yes, it is my view that Romney wins by at least 2%.

In short, lenders need to stay disciplined. The black swans are continuing to circle. Three months of improving stats do not make a real trend. This is not the time to be making assumptions that the world is all better and only wonderful days lie ahead. Uncertainty is still the situation, and nobody really can predict how all of this will play out. Therefore it is not the time to forget what you just went through.

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Joel Ross

Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.