A case in point is Kodak, which filed for bankruptcy in January. Since then, the press has been touting the potential for Kodak’s portfolio to provide a multibillion-dollar capital injection. Here is why such an auction — if it occurs at all — is unlikely to come close to expectations.

The unique Google situation

First, the speculative talk and the ramp-up of investor expectations about the value of patents are due to the Nortel auction, which was truly a unique circumstance. The game of “keep-away” that the Rockstar Consortium (Apple, Microsoft, Research In Motion, Ericsson and Sony) played with Google began when it became clear well before the auction that Google itself had little in the way of intellectual property to counter-assert, should any of its competitors come calling with patents in hand. This absence-of-protection made Google vulnerable, and everyone knew Google would be on the hunt for these assets.

Google’s vulnerability has diminished tremendously following its $12.5 billion acquisition of Motorola Mobility and its portfolio of 17,000 patents, along with follow-on purchases of two 1,000-patent portfolios from IBM. Thus, for a possible auction of Kodak’s 1,100 patents, one can’t expect Google to fuel the rivalry for these assets. Google’s need is nowhere near as acute as it once was.

Limited wireless use

Second, the stature of the Kodak portfolio is nothing like the Nortel portfolio when it comes to wireless standards such as Universal Mobile Telecommunications System (UMTS) and Long-Term Evolution (LTE) that are important to handset and network infrastructure manufacturers. For example, Kodak has not declared a single patent to the European Telecommunications Standards Institute (ETSI) as being essential to mobile communications standards, although companies such as Motorola, Nortel, Qualcomm, Microsoft, Alcatel, British Telecom and HT (among others with hundreds, if not thousands, of such declared patents) have done so.

This means that the same cast that was chasing the Nortel portfolio, which had 583 standards-essential patents, will likely be ambivalent about the assets Kodak might offer.

Licensee issues

Third, Nortel’s patents had few encumbrances or licenses granted to others that would reduce the infringement value of the portfolio if any acquirer were planning to monetize the assets through a licensing program.

Although the Kodak encumbrance situation is not publicly known, some have opined that there must be a lengthy list of licensees to the portfolio, based on the $1.9 billion in intellectual property (IP) licensing Kodak reported between 2008 and 2010.

The encumbrance situation, of course, would immediately become known to bidders should an auction process be constructed by Lazard Ltd., an advisor to Kodak. Such a revelation would serve to scale the size of the unlicensed markets Kodak’s patents read on, possibly diminishing portfolio value.

Cell phone cameras of the future

Lastly, the cell phone has become the aggregation platform for many technologies, including camera technologies, which are patented and likely infringed by the products being made and shipped by cellular manufacturers. Thus, it is in the interest of manufacturers to continuously seek noninfringing alternatives that can replace the older patented solutions so that the royalty stack on their products can be reduced and profit margins maintained while prices drop.

Does the Kodak portfolio stake out the camera technologies of the future? Is the industry headed toward camera technologies that Kodak already owns? We see new technologies, such as the Lytro camera that focuses pictures after they are taken. If we believe these technologies will supersede Kodak in the cell phone, then Kodak’s portfolio value declines further.

Kodak has been making some moves to position its portfolio in a way that will aid in capturing whatever value may be there. It recently moved its IP assets into a separate business unit, and this could be a tactic to force bidders in any M&A process to value the portfolio separately from the typical values derived from studying Kodak’s financials.

In the final analysis, if we had to predict the value ultimately achieved in a sale for this portfolio, the factors above would lead us to be thinking of values in the hundreds of millions of dollars but not billions of dollars.

Once the Kodak portfolio picture comes into focus, investors are likely to be a little less anxious to snap the shutter.

ALCHEMY: What is the current macro-environment for commercial real estate?

SABSHON: We are seeing an improvement in the overall U.S. economy. Clearly, this recovery is having a positive impact on the substantive metrics for commercial real estate. As a result, we have seen slightly more aggressive real estate investors, and, on the higher end of the quality scale, a tightening of capitalization rates, showing that prices are increasing slowly and the gap between buyers and sellers is shrinking.

So, things are improving in the commercial real estate market at a slower pace than we might like, but it appears to be headed in the right direction.

ALCHEMY: What CRE sectors are showing strength?

SABSHON: We are seeing incremental growth in corporate office occupancy rates, and there is a trickle-down to other sectors of the market as well. Retailers appear prepared to increase square footage in the coming 12 months. Health care demand generally is growing, given the demographics of the aging population, and we have seen the impact of that across the country in senior housing and hospitals.

One of the real surprises has been lodging. Hotel occupancy rates, after having been hit hard in the downturn, are now rising again, and that is having an impact on the pricing of hotels across the entire spectrum from limited service, corporate travel, boutique hotels and even to destination resorts.

ALCHEMY: Have you seen regional divergence similar to that of the residential market during the recovery?

SABSHON: Yes. As a national real estate investor with portfolio holdings in 47 states, we look at the market as a whole. It is very clear that the first places we have seen material improvement in the commercial real estate market are “gateway entry” cities, such as New York, Washington and San Francisco. We are also seeing dramatic improvement in capitalization rates in what I would call “brain centers,” locations with top universities and active clusters of technology firms, such as Austin, Boston and Silicon Valley.

Since the election of the current administration, Washington, D.C., and surrounding areas have seen tremendous tightening in cap rates. There is some suggestion that this particular market may have topped out, and there is anxiety that cap rates have gotten a bit frothy — possibly the only place in the country where that perception exists.

ALCHEMY: Is the CRE market facing risk factors independent of the broad economy?

SABSHON: One trend comes to mind. For many years there has been concern that Internet shopping would replace brick-and-mortar stores. The reality is that we are not seeing a steep decline in brick-and-mortar shopping; rather, we are seeing larger retailers that used to occupy 50,000 to 60,000 square feet shifting their formats to stores with 30,000 square feet or less.

If a customer walks into one of these smaller format stores now and wants to buy an item not in stock, systems are set up to order that item and deliver it, often within 24 hours. Retailers are finding they can achieve 90 percent or more of their sales with a much smaller inventory and therefore require less square footage.

This creates a challenge for landlords of large-format store properties. As leases roll over, tenants may not stay, and, if they do, landlords may have to divide a property to make it suitable for multiple tenants.

ALCHEMY: The big question mark for the CMBS market is delinquency rates. What’s your forecast?

SABSHON: My view is that we are not likely to see any dramatic improvement in delinquency rates in the remainder of 2012. If I had to guess, I would say we are likely to see the delinquency rate start to increase as we go into the second half of 2012, into 2013 and beyond.

The primary term for CMBS is 10 years, but issuers write 5- and 7-year loans as well. So if you look at 2007 as the most aggressive period of underwriting in the history of the CMBS industry, you see the 5-year loans coming due for refinance. In another few years, the 7-year loans will be due, and then the 10-year loans.

Suppose you have an office building that was valued aggressively at $100 million in 2007 and a CMBS lender originated an $80 million loan. In the economic downturn, the value of the building dropped by as much as 40 percent. The value today may have recovered somewhat but, even if it is now valued only 20 percent off its peak 2007 valuation, that $80 million loan is now supported by an $80 million building.

Add to this scenario a return to far more conservative underwriting practices. The $100 million property with an $80 million loan is now an $80 million property with an $80 million loan that is coming due. If the lender is going to cap the refinancing at 60 percent of value, the new loan is for only $48 million. With the current culture of the marketplace, existing lenders are simply not going to completely refinance these loans. Some opportunistic mezzanine lenders may help by bringing perhaps another 10 to 15 percent of leverage to the borrower, but there remains a serious shortfall.

There is a reckoning that is now unfolding, and it’s going to fall on two groups: the CMBS investors in those loans and the equity owners of those properties.

ALCHEMY: Where do you see origination activity heading this year?

SABSHON: The attractiveness of CMBS at any given time is the arbitrage created by making a mortgage loan at one spread and selling the associated bonds at another, tighter spread. As market fundamentals change, that arbitrage expands and contracts.

We saw in 2011 great volatility in global debt markets caused by concerns over Europe and the U.S. As a result, bond investors demanded substantially higher yields, and CMBS lenders were not in a position to originate loans with a comfort level as to where the corresponding bonds would price.

To compensate for that lack of confidence in bond markets, CMBS lenders who tried to originate in the second half of last year added a significant additional spread in their loan quotes to cover the potential for bond yields to widen. As a result, they were no longer competitive with balance sheet lenders. Many CMBS lenders simply sat on the sidelines.

This year’s Mortgage Bankers Association of America lender poll estimated $69.6 billion in 2012 CMBS origination. I suspect that this is not a realistic expectation. Will origination exceed $30 billion this year? There are a lot of “ifs.” If the crisis in Europe is muted, if the U.S. economy continues to improve at a slow pace, if nothing truly dramatic transpires in the upcoming presidential election, then I expect that CMBS lenders will continue to be active in the market with, perhaps, 30 percent more origination activity than last year.

More conservative, less leveraged deals in desirable sectors and geographical regions found willing bond buyers. With valuations nearly 40 percent below peak levels, a mood of cautious optimism that U.S. commercial properties were finally near a bottom permeated the market.

Many researchers predicted that total new CMBS origination might exceed $70 billion for the year, in line with averages for years prior to the bubble period that crested in 2007 with more than $230 billion in aggressively underwritten bonds placed. Then Greece happened.

The Euro crisis impact

Volatility exploded in European debt markets over concerns that peripheral EU economies and primary banks there were nearing financial meltdown, with the risk of Greek default as the straw breaking the camel’s back. As fears of contagion spread through global markets, investor confidence for riskier debt instruments evaporated, forcing many money managers to cut back their allocations despite improving fundamentals and the significant credit already risk-priced into the market.

According to Barclays Capital CMBS strategist Keerthi Raghavan, over-extended large players exacerbated market pressure. “Last year, dealers were carrying a lot of inventory on their books, and when things took a turn for the worse, there was a lot of liquidation,” he says. Panic in the secondary markets spelled the end for new issues and total origination equaled less than $30 billion for the year.

In a case of “déjà vu all over again,” to quote Yogi Berra, the CMBS markets in 2012 find themselves in much the same place they were at this time last year. With the threat of collapse in Europe blunted by European Central Bank intervention and with consistent signals of modest improvement in the broad U.S. economy, investors are again cautiously approaching the market.

Barring any new geopolitical or systemic shocks, the Barclays CMBS research group anticipates total new origination will register in the range of $70 to $75 billion.

The end of “extend and pretend”

Even as investors warm up to new ultra-high-quality paper, the hangover from the boom years is just beginning. The first of the 2007 vintage CMBS begin maturing in 2012, part of a total of $300 billion in commercial loans coming due this year, according to Barclays Capital. What’s more, 2012 is only the tip of the iceberg. CMBS analytics firm Trepp LLC estimates that more than $1.7 trillion in total commercial real estate debt will mature between 2011 and 2015, more than 60 percent of which is secured by properties “under water,” meaning they are valued at less than the mortgage loan.

With compressed valuations creating unappealing asset-to-loan ratios and with poor liquidity for all but the best new deals, refinancing prospects are slim. It’s unlikely then that weaker deals can delay the day of reckoning, making increased delinquencies and defaults probable as the year progresses.

Distressed markets

However, none of this will necessarily scare off yield-hungry investors, as the deep discounts offered to buyers of distressed legacy bonds look increasingly compelling in light of a positive economic backdrop.

“I think 2012 is going to be a year in which people need more yield and carry,” says Royal Bank of Scotland’s Brian Lancaster, who heads MBS, CMBS and asset-backed securities strategies for the bank. “I think a lot of legacy CMBS offer that, once you do your homework and analyze the bonds.”

Lancaster and his team see the best opportunities in the legacy markets among the most senior class or the so-called mezzanine AAAs or the junior AAAs. “There is this dynamic in the market where corporates tend to lead and the structured products markets follow, and corporates have just gone through a tremendous rally,” he says. “At some point, the relative value of CMBS will become compelling.”

While investors brave enough to buy into deals that have attractive restructure economics may be rewarded with attractive terms, equity investors willing to buy into the riskiest of distressed issues at the right price stand to realize tremendous returns.

“We clearly see the next several years as a very positive entry point for real estate equity investors who are able to access assets — properties and/or loans, that are coming out of these distressed CMBS situations,” says David Rabin, who co-manages a $2.5 billion commercial property equity portfolio at BNY Mellon’s URDANG real estate division. “The market is going to have to find a level where the prices of these assets make sense, and therein lies the opportunity,” he concludes.

ALCHEMY: How do you see the CMBS market shaping up for 2012 and beyond?

RABIN: We’re definitely seeing the lenders out there. We’re seeing debt available in secondary markets. You need more equity to get deals done now; the underlying standards are still tighter; and lenders are more focused on sponsorship than they were before, so you need to have a track record.

For credible buyers who have equity and are willing to invest it, debt is becoming more plentiful. It’s our view that as the year progresses, barring some external shock, that trend should continue.

ALCHEMY: Will the demand for new issues expand as volume picks up?

RABIN: The question always is: Does the debt follow the investors or do the investors follow the debt? I think it’s the latter. We already see investors pulling away from the trophy core product because they think that pricing has gotten too aggressive. So they’re looking in that next level down for quality assets, and more of them are aggressively chasing opportunities there. We are still seeing the markets dominated by the life companies and balance sheet lenders rather than the CMBS market.

The CMBS market fills a critical need because it was funding a lot of the B and C class assets and secondary and tertiary markets before the collapse. I think there is still a shortage of debt in those spaces, and you see a wide spread between cap rates of “trophy” class assets and the handful of top markets in the U.S. and those of B assets and secondary markets. That’s driven as much by the lack and pricing of debt as it is by investor appetite.

Investors generally are looking for yield, but they are looking for yield on a leveraged basis and that is very expensive or difficult to access currently. That all adds up to drive values down in secondary and tertiary markets. From our perspective, the CMBS market coming back to speed would add a lot of liquidity and narrow the cap gap.

ALCHEMY: When do you see the market returning to full speed?

BLUM: If you go back 10 years, you will see that total CMBS origination in any given year might have been $50 billion. Then it started to climb into the $75 billion range, and then we went on the wild ride that crested in 2007 with roughly $230 billion.

But with 2011 coming in at $35 to $40 billion in new issuance — and especially after a very light 2010 and a nonexistent 2009 — when we see volumes in the $75 billion range again, that will be a signal that the CMBS market has returned to full strength. I think we are still several years away from that.

ALCHEMY: What are institutional investors looking for in commercial real estate right now?

RABIN: We see a lot of rethinking about how to invest in real estate. Following the early 1990s period when the Resolution Trust Corporation was selling off assets and investors were able to buy them for nickels and dimes on the dollar, they came to believe that 20 percent annualized returns from real estate were consistently achievable. As a result, over the successive two decades, the industry continued to try to chase those returns. Institutional investors began to view real estate as a total return investment.

Now they are recalibrating. They say, “We need cash yield. We’re only getting 2 percent on our Treasuries but we have an 8 percent actuarial hurdle and current obligations.” Lo and behold, they come to the conclusion that real estate is an asset class that provides current yield! They have dialed back their total return expectations, but insist there be a meaningful cash component right out of the box.

ALCHEMY: How does the CMBS market play into that? Are there opportunities for buyers who are comfortable ultimately owning the collateral properties?

BLUM: Well, there are a lot of problem assets. Special servicing is still near an all-time high.

RABIN: Although underlying collateral determines how a loan will be treated, we see a strong window of acquisition for investors who are staying with real estate from the equity perspective. They have the ability to wade through these problems, stay in front of special servicers in order to know when assets are coming to market and be ready with capital to act on a reset basis.

We see the next several years as a positive entry point for real estate equity investors who are able to access assets — properties and/or loans — that are coming out of these distressed CMBS situations. The market is going to have to find a level where the prices of these assets make sense, and therein lies the opportunity.

BLUM: CMBS are going to have to be part of the solution to the CMBS problem. So many of the assets that are outside of the top five markets in the country have been financed by CMBS. There is simply not enough interest among banks and insurers in restructures in these secondary markets. So part of the solution will be through CMBS markets themselves.

Family members were invested with Bernard L. Madoff Investment Securities LLC (BLMIS) and had encouraged Chaitman, who specializes in lender liability at the firm of Becker & Poliakoff LLP, to review BLMIS’ trading strategy and consider investing too.

“It appeared to me to be a conservative, diversified investment. BLMIS had been in business since the 1960s; it was averaging returns of approximately 10 percent at short-term capital gains rates, so it was not an aggressive investment,” she says. “BLMIS had been investigated several times by the SEC and had always come out clean.”

In the weeks following Madoff’s arrest, Chaitman made herself available to help investors across the country. “Mostly, they had life questions, not legal questions,” she says. “People had lost their cash flow, and they didn’t know how to put food on the table.”

This pushed Chaitman on the unexpected path of donating her time and expertise to helping fellow Madoff victims. In early 2009, she worked with her cousin, Andrew Lerman, an accountant, to clarify the theft loss under the Internal Revenue Code, to try to get tax refunds for Madoff victims.

Their efforts, combined with those of others, resulted in a Revenue Ruling that allowed victims of Ponzi schemes to declare a theft loss for 95 percent of their loss investment, including phantom profits on which they had paid taxes, less any money they anticipated receiving from the Securities Investor Protection Corp. (SIPC).

At the present time, Chaitman represents more than 850 Madoff victims, including 364 defendants in clawback actions brought by the Madoff bankruptcy trustee. She represents on a pro bono basis those clients who cannot afford to pay legal fees. Chaitman also continues to lobby, on a pro bono basis, for reform of the Securities Investor Protection Act, which she believes has failed investors.

Although she had hoped to be retired at this stage of her life, she is grateful for having a profession that allows her to continue working, and she is philosophical about her difficult experience.

“In those stressful weeks following Madoff’s arrest, a good friend told me that my Madoff loss would turn out to be a positive experience for me. He was right. I have had the satisfaction of helping hundreds of people. And I have gained an intense education in our government through my lobbying efforts.”

However, traditional mezzanine debt funds suffer from structural issues that give investors pause. Small Business Investment Companies (SBICs) may provide the solution they seek.

SBICs are privately owned and managed investment funds, licensed and regulated by the U.S. Small Business Administration, that use their own capital plus funds borrowed with an SBA guarantee to make equity and debt investments in qualifying small businesses.

Improved investor protections

While some are bank subsidiaries, quite a few SBICs are available to investors in the form of limited partnerships. The combination of attractive financing arrangements and aspects of the SBA’s regulatory regime results in funds that have lower cost of capital and greater investor protections compared to traditional mezzanine funds.

Although most entities that borrow from SBICs are neither public nor likely to go public, attached equity warrants (with payouts determined by formula) are typical, and put provisions attached to those warrants give an SBIC considerable influence over its borrowers. In many cases, for example, SBICs can insist on board observer status, allowing them to monitor their borrowers closely.

Generally about two-thirds of SBICs’ returns derive from interest received (and distributed), with the remainder from the exercise of such warrants. Naturally, returns vary with market conditions. Current conditions, in which competition from other funding sources is weak, suggest returns of around 2.5X to limited partnerships, for an internal rate of return in the high teens (net of fees, which are usually pitched at 2 percent plus a 20 percent incentive).

SBICs, which may borrow up to twice paid-in private capital, can draw SBA financing on a just-in-time basis, virtually simultaneously with draws on investors. Draws from the SBA are priced at 150 basis points over Libor, plus 250 basis points in fees. SBA warehouses these drawdowns and every six months repackages them into 10-year debentures that it may retain or sell to the public, priced at spread over the 10-year Treasury yield (premiums vary; 125 basis points is typical).

SBICs may repay these SBA loans without penalty and in any order, e.g., if a loan financed with a 4.75 percent debenture is repaid, the SBIC may use the repayments it receives from its borrowers to repay a drawdown backing a higher coupon or shorter maturity debenture. Debentures have no call provisions for SBICs in good standing.

SBIC investment advantages

Although the program has been in existence since 1958, most investors have only recently become acquainted with SBICs; they are more familiar with mezzanine programs managed by private equity general partners or by investment banks. The former often lend to firms in which their other funds hold equity stakes, and the latter often lend in pursuit of IPO mandates.

SBA regulations regarding the total equity exposure of “associated” firms relieve investors of concern about the first of these potential conflicts of interest, while the preference of many SBICs for lending to borrowers that have no intention of going public relieves them of the second.

Sources within the SBIC community report that the SBA’s annual audits are quite thorough, which provides investors additional protection. SBICs are eligible for use in ERISA and other tax-protected accounts, and their returns are not classified as Unrelated Business Taxable Income.

The SBA requires that SBIC funds have strong credit underwriting credentials. This gives them certain advantages with respect to knowledge of credit analysis and experience of the regions or industries to which they lend. The latter gives them valuable familiarity with the economic and commercial lay of the land, as well as connections among potential borrowers and centers of influence. This in turn enhances their ability to attract borrowers, which is essential for rapid deployment of assets and, thus, for attractive returns.

While SBICs’ restricted leverage might hamper their return potential relative to other funds, high leverage is generally not appropriate for funds intended primarily for income generation.

Neither are high or unpredictable borrowing costs. SBA financing would be difficult for nonparticipating funds to replicate. Granted, it comes at the cost that SBICs can demand little protection from prepayment risk. However, the equity of borrowers that are able to prepay loans is likely to be an attractive asset, offering the reasonable possibility that returns on warrants could recompense SBICs for the opportunity cost of prepayments.

SBICs are not, of course, for everyone. They usually have 10-year lockups; they cannot deploy capital from the date of subscription; distributions even from a fully invested fund are uneven; and they exhibit a J-curve. Investors must be qualified purchasers. But in these yield-starved times, where private equity struggles to achieve satisfactory returns, investor interest in SBICs is increasing.

Status, enjoyment and history

Ultra- and high net worth individuals and family offices are known to acquire collectibles because of a passionate interest in such objects, which serve as status symbols and often are gathered so as to build a family collection of heirlooms. These purchasers recognize the implicit “store of value” benefits accruable, and it’s important not to underestimate the “consumption payouts” and emotional gains offered, despite the fact that these benefits are difficult to quantify, audit and evaluate.

Foundations, trusts, museums, institutions and arts organizations, public and private, also have been and continue to be keen buyers of collectibles. This is especially true for high-end stringed instruments. For example, the Australian Chamber Orchestra (ACO) has established the ACO Instrument Fund, a managed investment fund that gives investors the opportunity to participate in the ownership of a bank of historic stringed instruments. The fund lends these instruments to the orchestra’s musicians for use in concerts and recording sessions.

In the case of watches, Geneva’s Patek Philippe Museum, which showcases “horological history,” paid almost CHF2.10 million (approximately US$2.3 million) last November at auction to acquire a 19th century Patek Philippe 18-karat pink gold, 24-hour pocket watch in exceptionally good condition and accompanied by the original Certificate of Origin and Patek Philippe sales receipt.

New types of investors are definitely showing interest in collectibles, according to Alfredo Paramico, Fund Manager of Precious Time, a Luxembourg specialized investment fund focused on timepieces. “We have a European insurance company that invests a predefined percentage of its asset allocation budget in the fund primarily because it is a real asset, but also for the financial gains that could range from 10 to 15 percent net of fees, per annum,” he says.

Paramico, who has been collecting watches for more than 30 years, agrees that the real risk of investing in the fund is duration risk. However, because of the growing interest the fund has drawn from new market participants, he is convinced that investing in rare, well-documented and in-original-condition pieces will continue to garner a price premium.

The investment path

If financing is not a constraint, then owning the select object most likely will yield the highest payoff financially and emotionally. Prospective owners can source their desired objects by following catalogs issued by specialized auction houses, working with independent experts in the field, combing the network, and attending dealer events and conventions.

A word of caution: Be sure to factor in the potential cost of restoration, ongoing maintenance, correct storage, insurance, fees, taxes, duties or charges, all of which sometimes may end up exceeding the purchase price. In addition, concentration (e.g., a car model, a particular watch model or violins from a particular maker) impairs the diversification benefits and increases the risk of exposure to market volatility, price reversals, changing tastes, fashion and trends.

Investing via a hedge fund, pooled investment vehicle or similar repository can help spread the idiosyncratic risks and has made investing in prized collectibles accessible. It is important, however, for investors to evaluate the implications of the fund’s domicile, to ensure that there are no conflicts of interest in the investment structure and that the investment manager abides by applicable regulatory, legal, tax and compliance requirements.

To optimize returns, it is recommended that such investments be held for at least three to five years. That is, the lock-up terms and conditions need to be understood, and one needs to be cognizant that sizable co-investor redemptions could affect performance.

Buyers must beware

Preinvestment effective and thorough due diligence is essential. Cases of fraud and forgery have occurred in the world of collectibles, as these markets are highly complex, fragmented, inefficient and often not transparent. There are no shortcuts to verifying provenance and the paper trail.

The condition of the original is decisive; whether, if, when, how often and by whom the object has been restored affects price. Rarity is yet another significant factor in calculating value.

The experts agree that high-end collectibles will continue to appreciate. Demand continues to outstrip limited supply, allowing prices to continue to stay supported and value to appreciate. The rare stringed instrument market bears this out.

“Fortunately, and unlike some of the other asset classes or collectibles, stringed instruments are not prone to bubbles, since these objects are also tools of the trade,” says Jason Price, Director at Tarisio, the online auction house dedicated to fine stringed instruments and bows. “They tend to be possessed by musicians, collectors and those who are knowledgeable and have a genuine interest.”

Florian Leonhard, Director at Florian Leonhard Fine Violins, concurs. “Irrespective of financial market conditions, there will always be an audience for this music and for it being played. This caps the price volatility, and you can still expect to double your money in 10 years if you invest knowledgeably in a violin.”

It’s a similar scenario for vintage cars. Annual figures for 2011, released by the independent investment research house, Historic Automobile Group International (HAGI), reveal that values in some segments of the classic car market have advanced by more than 20 percent. “Classic cars are more than a safe place to ‘park’ money; they really are better than gold,” says Dietrich Hatlapa, HAGI founder.

There is also agreement that fine watches, vintage cars and rare violins are trading at lower multiples and price premiums when compared with other collectibles — of course, this will never be an apple-to-apple comparison. But here is a sense of how each performed last year.

The HAGI Top Index, measuring the performance of 50 key collectible classic cars, advanced by 13.89 percent in 2011. Over the same period, Precious Time delivered a performance of 11.97 percent. Last June, Tarisio sold the “Lady Blunt” Stradivarius of 1721 for a world record $15.9 million.

HAGI’s Hatlapa sums up the ­rationale for investing in collectibles. “Once a model has become collectible, it has never become uncollectible.”

The meeting included a visit to the Jwaneng diamond mine, a joint venture of the government of the Republic of Botswana and De Beers Centenary AG and the richest mine in the world by value, so I knew I would learn a lot. But I didn’t expect that attending this meeting would become my own personal episode of the old television program, “Wild Kingdom.”

An 18-hour, nonstop flight brought me from Newark, N.J., to Johannesburg, where I transferred to a flight to Botswana’s capital, Gaborone. Bleary-eyed, I arrived at the meeting hotel, the stunning, five-star Grand Palm Casino and Convention Resort.

After a rest, I set out to explore the resort and to meet a colleague for a drink in the attractive pool area, which was surrounded by lush landscaping. As my friend and I chatted, I had the feeling I was being watched. I turned to look and sitting quietly behind me was a vervet monkey, a medium-size simian common to the area that is recognizable by its Darth Vader-like black “mask.” It turned out that a troop of between 30 and 40 vervet monkeys lived in the trees just beyond the pool gardens.

His head cocked, the monkey seemed to be eavesdropping. Seeking diamond investment advice, maybe? Stealing trade secrets I could live with, but stealing my lunch was something else all together.

The next day as I sat by the pool having lunch, I got up to take a phone call. When I returned, I caught a glimpse of a monkey scampering away with my sandwich in hand. At least he had the decency to leave my beer!

Wildlife is everywhere in Botswana. It is common see a giraffe or a springbok grazing a short distance from the road. We all enjoyed a good laugh when, as we
were preparing to leave the Jwaneng mine, a resourceful herd of goats was using parked cars as stepping stools to reach the branches of some appetizing trees.

The IDMA meeting’s focus was on developing ways to sustain Botswana’s diamond industry beyond the useful life of its diamond mines by encouraging the creation of ancillary industries, such as cutting, polishing and jewelry making.

Ensuring that this emerging nation benefits from its diamond wealth is fair and just. I only hope that Botswana finds a way to adopt the positive aspects of the 21st century while maintaining its ties to the natural world. Those monkeys made that long, hard trip worthwhile, and I hate to think they might not be there next time I visit.

Elizabeth von Habsburg, managing director at Winston Art Group, one of the largest independent art advisory firms in the U.S., says the demand for loans using art as collateral has increased substantially, especially over the past 18 months. “It is a burst of liquidity that people have simply not before thought much about,” says von Habsburg.

The size of the art loan market is hard to pin down, but evidence is clear that it is set to grow. The Deloitte/ArtTactic Art Advisor and Art Collector Survey completed in October 2011 found that while only 24.4 percent of advisors and 9.8 percent of collectors reported having used art as collateral for a loan, 50.4 percent of advisors and 67.5 percent of collectors believed there will be an increase in the art lending market in the next two to three years.

Loan structures

Collectors interested in taking out loans should be aware that administration fees are typically paid up front and usually include the cost of an appraisal, an assessment of the time it would take to achieve a sale at the appraised price in the current market, a title search and title insurance to prevent loss in the event the person getting the loan does not actually own the title to the work.

Once an appraisal is complete, loans are usually structured for at least a year, after which they are renegotiable, with borrowers able to monetize from 40 to 50 percent of a collection’s full value. While art loans are available on works with an individual value of as little as $500,000, typically, the majority of loans in the market are backed by collections, with most collateral packages valued between $3 million and $5 million. Modern art is more prevalently used as collateral, since the original nature and ownership of a work is easier to verify than that of a traditional piece.

Banks enter the arena

Such loans have typically been the territory of specialist art lenders. More recently, major banks offering private client services have entered the mix. “Banks that have traditionally shied away from using unconventional collateral are now realizing that with the right advisors and expertise, such loans are manageable,” says Howard Spiegler, who co-chairs the arts group at Herrick, Feinstein LLP.

Borrowers can leverage an existing relationship at a major bank, says Spiegler, to obtain lower interest rates and the ability to borrow a higher percentage of an artwork’s appraised value. “Borrowers who are regular private bank clients can get a better deal than if they went to a niche lender. This is because if something goes wrong, the bank can look to the other assets of their client besides the artwork being posted. It is part of a bigger banking relationship,” he says.

Additionally, when choosing a lender, borrowers ought to be aware that depending on the vendor they choose, they may or may not be able to maintain possession of the works during the course of the loan.

If the artwork must be handed over, it is likely to be put in storage. “Not surprisingly, banks do not want to get involved in storing and preserving artwork, so it has become normal operating procedure for the borrower to maintain possession, but smaller niche lenders are less likely to accept the associated risk,” says Spiegler.

Certainly, today, it seems that making the most of one’s assets is limited only by one’s imagination. —Elise Coroneos

Hildene Capital Sees Double-Digit Returns

As midsize banks regain their footing, a hedge fund is reaping double-digit rewards from investing during the financial crisis in collateralized debt obligations backed by bank debt.

With banks beginning to pay deferred dividends, New York-based Hildene Capital Management LLC is realizing the value of collateralized debt obligations (CDOs) tied to bank debt known as trust preferred securities (TruPS). Despite the legal difficulties investors have experienced in keeping CDO collateral intact, Hildene’s founder Brett Jefferson was able to return 13 percent net to investors last year, and he says his fund’s performance may outpace that this year.

“The recovery in community banks is gaining momentum as we enter 2012, and the Fund may be on the edge of a significant positive move during the next six months as improving revenue from individual bank and insurance company issuers start to filter though the complicated structures in which they are held and impact pricing of the securities helped by Hildene,” Jefferson wrote to investors in January, referring to the fact that the firm has been keeping the credit rating agencies abreast of the improving situation of banks that have resumed paying dividends. The result has been that the agencies have been raising the ratings on some securities that are now performing fully.

Opportunities in the financial crisis

TruPS were a popular capital-raising mechanism during the past decade among smaller banks that didn’t have access to the IPO market or didn’t want to raise money by issuing stock. These securities pay a dividend, which may be deferred for up to five years should the issuer experience financial difficulty, and were packaged into CDOs sold to institutional investors. When the financial crisis hit, banks stopped paying dividends, giving rise to distressed TruPS. In late 2008, Jefferson and fund COO, John Scannell, seized the opportunity to buy TruPS at very low prices.

“When a bank defers, the TruPS is treated as a default and given very little recovery value in the raters’ model,” Scannell explains. ‘When the bank starts to pay again, the TruPS comes back and is treated as a par security. This creates the potential for great volatility in perceived performance, if you don’t have a credit view of each bank. We did, so it also created a great distressed buying opportunity for us.”

Hildene’s $3 million fund grew to $450 million within four years as the firm successfully convinced investors that private investments would recapitalize community banks and dividend payment would resume. In 2011, 35 community banks returned to paying dividends, an event that Jefferson called “a remarkable step, given that some industry professionals expected all deferring banks to fail.”

TruPS CDO database saves the day

Uncovering exactly what bank debt a TruPS CDO contains can be difficult — but necessary — if an investor wants to assess the potential of an issuer to be taken over or recapitalized by a stronger bank. With painstaking due diligence, Hildene created a proprietary database of TruPS CDO deal portfolios, note valuations, offering memoranda and other documentation and shares free of charge at www.trupsinfo.com.

Hildene has emerged as somewhat of a champion for TruPS CDO investors. Jefferson persuaded Bank of America’s top CDO trader, Scott Farrell, who is an expert in TruPS, to leave the banking giant to join Hildene and execute the firm’s TruPS strategy. In February, Hildene participated in successful legal action that prevented BankAtlantic, which has $300 million in outstanding TruPS, from harming the bank’s value (and, therefore, the value of outstanding TruPS) by selling off the bank’s assets out of the holding company to banking giant BB&T. Since the TruPS were tied to the holding company, this could have wiped out their value.