INNOVATIVE FINANCES BLOG

The fourth source of poor economic performance may derive from failures, often based on ignorance, in the management of risk. It involves concepts equally as sophisticated and complex as the economic concept of value.

Bernstein begins his book on risk with the provocative question, “Why is the mastery of risk such a uniquely modern concept?” He views risk as the concept that defines the boundary between modern times and the past.8 Prosperity, like risk management, is a new thing. So is it just a coincidence that wealth creation began about the time that the tools to manage risk began to take form?

It is an intriguing hypothesis, but it is clouded by the fact that many other types of progress accelerated at the same time. Nevertheless, a likely suspect for past economic stagnation might have been a general failure to manage risk. Clearly, there was no way prior to 1500, or likely prior to 1750, to develop scientific risk-management techniques. The mathematical tools were not there, the concept of probability was just evolving, and the notion of statistical sampling had not been developed. Risk management was still heavily tied into theology—pray for rain.

From a valuation viewpoint, the most important thing about risk in business is that there are two kinds, and they can work in opposite directions. One type of risk is unique (sometimes called private1 risk). It is risk that is unique to your particular situation and is partially subject to your control. Unique risks can usually be expressed in terms of probabilities. Examples of unique risk are the probability that our R&D project will fail, that we will drill a dry hole, or that the bank in which our savings are deposited will close its doors.

The other form of risk is market (or systematic risk), which is your exposure to volatility that you cannot control in your current situation. Examples of market risk are the probability that interest rates will increase, that the price of natural gas will rise, that electric power will be deregulated, or that health care will be partially nationalized. An electric utility would be concerned about the first three of these market risks, while a pharmaceutical firm would be concerned about the first and the fourth.

The advancing agent may at times fill the gap where there is an interest shortfall on the senior notes, or to make a cure advance on a B-note. Another form of financing, a revolving credit facility, may be used to aid the acquisition of assets.

An interest advance may be made by the advancing agent in the event of an interest shortfall on the senior notes if the advance is deemed recoverable.

Such an advance would be reimbursed along with any accrued interest first in the interest waterfall and then with principal proceeds, if interest proves insufficient.

A cure advance may be made by a B-note investor to cover a shortfall in property cash flow and forestall a default. In the CRE CDO structure, such an advance may be made by the advancing agent contingent on approval by the majority of subordinate noteholders, if the portfolio manager believes the advance to be recoverable.

The revolving credit facility (RCF) may be drawn on to fund the acquisition of assets during the investment period and the reinvestment period. The RCF serves to reduce the negative carry effect of retaining a large cash balance in the deal and gives the manager flexibility with the timing of acquisitions. Draws on the credit facility are reimbursed pro rata with Class A interest.

Value influencing property characteristics can be property-specific or market-wide: the former refers to the spatial, physical and legal attributes of the property itself and the latter refers to the characteristics of the market as a whole or the market sector in which the property operates. Fundamentally, the market value of a property reflects its capacity to fulfil a function. If the property is a shop, for example, then its value will be determined by factors such as trading position, length of frontage, accessibility, planning restrictions and tenure. We shall see later how it is important to be able to quantify financially these value factors as part of the valuation processs (comparison adjustment). This is not an easy task and provides substance to the argument that valuation is as much an art as it is a science.

There are two levels of property value analysis: property-specific and market overview. The value of a property is largely determined by its competitive position in the market in which it operates. Therefore, both property-specific and market-wide factors must be considered to delineate the market by investigating property type features such as (single or multiple) occupancy, use, construction types, design, amenities, geographical extent, available substitutes and complementary land uses.

The built environment cannot be treated like a clinical laboratory and in practice variations in valuations will occur. Rates of inflation will alter, market conditions will change the expected rates of return and unforeseen events will happen. The calculations performed in valuations assume ceteris paribus.

While the Mortgage Broker Practices Act generally prohibits taking a fee upfront, a licensee performing a loan modification may charge fees upfront for services to be provided.

Licensees that charge a fee for loan modification services in advance of the services being provided must obtain a signed fee agreement for loan modification services from the borrower. Any fees paid in advance of services provided must go into the company’s trust account prior to disbursement, or be submitted to an independent escrow or title company to be held until disbursed at the instruction of the parties consistent with the fee agreement. Licensees are prohibited from collecting fees via direct access to a borrower’s bank account or via use of the borrower’s credit card.

A loan modification normally begins with a hardship analysis which is an examination of the borrower’s current mortgage, income, expenses, and ability to repay. The hardship analysis includes meetings or conversations with the borrower(s) and a determination of the borrower’s eligibility for a modification based on the particular lender’s eligibility requirements or the eligibility requirements of a federal modification program. The hardship analysis, sometimes referred to as “Phase I services,” should take no more than five hours to complete. The usual or customary fee for a hardship analysis of an owner-occupied first lien mortgage and second lien, if applicable, is $750 or less.

The simplest business activity tax asks a business to report its value added by activities in a state and pay a small percentage of that (e.g., 0.25%) as state tax. A different approach asks for this payment only if it is larger than what is owed under the corporate income tax. This approach doesn’t change the tax liability of most profitable corporations but provides a minimum tax for corporations experiencing losses and non-corporate business forms such as partnerships.

New Hampshire has such a tax. Nevada has seriously considered one and may have enacted it. The concept had considerable support in Texas in 1997 and probably would have been enacted except for a problem that exists in Texas but doesn’t exist in Tennessee. The Texas Constitution bars any tax based on income, so the Tennessee tax on dividends and interest would be unconstitutional in Texas. As applied to a company selling professional services, the value-added tax base is almost identical to what an income tax base would be. For sure, any Texas business activity tax would have been tied up in court and might have been declared contrary to the state’s constitution.

For more detail on business activity taxes and proposals that some form of this tax be adopted in Tennessee, see the Tennessee Department of Revenue paper, Business Taxes: Current Structure And Options For Change.

The easiest way to think of value added by a firm is to subtract the value (cost) of what it buys from other firms from its total revenues. For example, the value added by a car manufacturer is its selling price of a car minus what it pays to the companies that make the axles, sold the paint, transported the cars to the dealers, etc.

Another way to think of value added is as what a company pays out to anyone other than its suppliers. That is the sum of: (1) compensation of its employees and (2) payments to providers of capital including interest and the components of profits or return on equity which are retained earnings and dividends.

Firms differ greatly in the in the percentage of their revenues associated with value added. A huge percentage of the revenues of grocery stores, for example, goes into paying producers of cereal, meats, frozen goods, and its other suppliers. Only a tiny percentage of the revenues of accounting firms goes to pay suppliers of office space and paper clips; most goes to employee salaries.

The concept of taxing value added continues to receive substantial attention at the federal and state levels.

Eliminating the federal corporate income tax and substituting a value added tax for it and perhaps for all or part of the federal individual income tax interests many people for many complex reasons. The most lasting one is economic competition. Nearly all the major industrial nations have value added taxes. This and the provision of the international agreement on trade and tariffs means: (1) when Mercedes sells a German-made car in Germany, the price includes a value added tax of over 10% but when it sells the same car in the U.S. the 10% is subtracted but (2) when Ford sells an American-made car in the U.S. the price includes U.S. and stateq corporate income taxes and when it sells the same car in Germany the corporate income tax
burden cannot be subtracted.

A value added tax was adopted in Michigan several decades ago for a different reason. Most corporate income tax revenue in Michigan came from the production of vehicles, vehicle parts, and capital goods, like machine tools — all subject to business cycles. Some years, nearly all these manufacturers would have losses and with no income to tax would pay no state corporate income taxes, at a time when the state government most needed revenues. In good years, these companies would make large profits and pay large sums to the state. By shifting its tax base from profits to value added, Michigan reduced the volatility of its revenues.

Value added taxes have been seriously considered for other states, such as Louisiana, and have some highly respected advocates such as a prominent former director of the National Association of State Budget Officers. This family of proposals typically involves using a value added tax as a replacement for the corporate income tax and, in some instances, other taxes. Business activity taxes are conceptually similar to value added taxes but are normally discussed as overlays to existing corporate income taxes and in the few states without corporate income taxes.

To mortgage crisis

The problem with the mortgage crisis in the U.S. continue to help because no reported deferrals of interest for the creditors nothing. The deferral moves on the other hand, the problem only to back out, replacing it right now to clarify and so the market out. The U.S. mortgage crisis will continue in the coming year to problems within the financial industry, as yet, not all the affected banks loans fully sighted, examined and re-evaluated.

Due to the good business sense the Americans are not only U.S. banks will be affected, but banks around the world.

Confidence among themselves

Because of the U.S. mortgage crisis has also had the confidence of banks worldwide, among much worse. That is understandable, because of a bank which has bad loans resold, it will be no quickly acquire new loans. This “small” confidence crisis “among themselves can cause the banks more and more and uncouple its” own soup “cook. This also applies to the lending of money among themselves. This may in turn lead to possible funding problems of other banks.

Now comes the credit crunch in the U.S.

On 12.12.2007 banks have started in the U.S. even greater losses in other loan types, not just in real estate loans, reported. This was currently student loans and some credit card defaults. If this crisis is now further expanding areas of credit, then there may be a major credit crisis in the U.S.. How to get from the U.S. mortgage crisis could recognize, this crisis is also not on the U.S. remain limited. This would, therefore, with a small time lag even Germany, Europe and other countries, as well as banks that meet.

Germany Loans

The currently existing and potential new credit problems in the U.S. could ensure that credit in Germany on the one hand are expensive and, secondly only to borrowers with good credit be awarded. If the banks to continue lending by this can lead to a lower growth of the German economy, because when companies get less fresh capital, they can also invest less. For individuals it can come so far that these loans without fully Schufa queries by the credit variants should be deleted, or only by a few service providers are awarded.

Deposit Guarantee

FundGermany has over other countries a major advantage, the Deposit Guarantee Fund. All banks in Germany are legally obliged to join the fund. By the Deposit Guarantee Fund of the Federal Association of German Banks, the balances of each customer / saver in private banks up to 30% of the relevant liable capital of the bank at the time of the last published annual report fully secured. The protection of the Deposit Protection Fund covers all “non-bank deposits”, so that the assets of individuals, businesses and public bodies. When the protected deposits are essentially visual, time and savings deposits and on behalf Savings bonds denominated.

Through this deposit protection fund are German savers facing a possible bankruptcy of a German bank much better protected than in other countries.

Conclusion:
It now remains to be seen how far the U.S. mortgage crisis to a possible worldwide credit crunch expanded, or whether the banks in cooperation with the central banks of these problems under control.

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