Who Has The Money?
Posted: Jan 30, 2009
Last rites were given to the CMBS market in the first half of 2008. Do not expect to see a resurrection in 2009. What once was providing approximately 25% of commercial real estate debt is at zero. CMBS AAA paper is trading around 13% as of mid-December, and BBB at rates in the mid 30% range. This is happening despite the fact that CMBS delinquencies over 30 days are 0.63% as of 12/15/08, but moving up. Sales of newly issued CMBS bonds totaled $12.2 billion in 2008 compared to $237 billion in 2007, per JPMorgan Chase & Co.
Life insurance companies have money. They were active through most of 2008, selectively picking the loans they wanted to make. Without surprise, the best projects, in excellent locations, with strong sponsors and lower loan to values got the money. For 2009, the ratio of maturing loans (in dollar terms) to new money for mortgage loans ranges from 20% to 80%, per life insurance company. Since these borrowers are unlikely to be able to refinance that debt elsewhere or sell the property upon favorable terms, expect some of the life companies to be extending these loans while others will not. The ones that will consider it are for the strong performing projects/borrowers upon today’s pricing and terms. Why underwrite
new loans when your in-place performing loans have solid track records is their thinking. On the other end of the spectrum, pay up or else. These lenders want their money back. Bottom line: not much fresh life company money for 2009, so seek it out early in the year. There is an estimated $160 billion in commercial real estate loans maturing in 2009 according to Foresight Analytics. The competition for these limited dollars will be keen. Another consideration for life companies is their choice to buy CMBS AAA at 13% (today), or whatever the yields may be throughout 2009, versus originating new loans at 6.5% (today). Life company portfolios are clean, with only 0.06% delinquencies over 60 days, per the Mortgage Bankers Association.
Freddie Mac and Fannie Mae continue to provide mortgage capital to the apartment industry. Interest rates for apartments range from 5.8% to 6.5% according to Towle Financial Services. Delinquencies over 60 days for Fannie Mae are at 0.16% and for Freddie Mac at 0.01%.
The commercial banks have money, but are stingy when it comes to loaning it out. The money center banks are taking care of their existing clients through loan renewals and new loans. The underwriting is more thorough than it has ever been, both for the project and the guarantors. Pricing has increased to Libor + 275 to 300. Prime rate based loans are gone. Debt coverage ratios are up. Regional and community banks also have money. Those not too burdened with problem loans are still in the market. They are cautious as the regulators have been scrutinizing
their real estate loan portfolios with a fine-toothed comb. Most banks will lend for five year terms at floating or fixed rates, but not all at fixed rates. Most banks are also putting a floor rate on their floating rate loans.
Taxable floating rate bonds are very attractive with the super low floating rates in the market. The challenge is obtaining the letter of credit. Letter of credit fees have also materially increased. Best bet: obtain the floating rate bonds and swap into a fixed rate. Mezzanine debt has mostly dried up. Many mezz lenders are working out of the deals they did in the last five years and are not in the market. Others who have money are not seeing many opportunities they are willing to take on. The pricing of mezz money has climbed back up into the high teens.
The entire commercial real estate finance market has not only re-priced risk, it is also lowering risk through the most conservative underwriting this author has seen in his 29 years in the business. Permanent mortgage loan spreads over Treasuries have moved from 100 bps to 400+ bps. Some lenders are ignoring the spreads and just quoting a rate that works for them.
Short rates for 2009 are going to remain low as the Federal Reserve focuses on revitalizing the economy. Long rates will also be attractive, but they may creep up toward the end of the year. Bond investors keep a keen eye out for any signs of inflation. If they sense it on the horizon, they react instantaneously, bidding down bonds. Many economists see the GDP contracting through 2nd quarter 2009.
There is a perfect storm that could unleash harsh de-leveraging for borrowers with maturities in the next few years. Foresight Analytics says there are $530 billion in loans maturing through 2011. Let’s say a borrower obtained an 80% LTV interest-only loan with an interest rate in the 5-6% range, with 1.15x debt coverage. The new underwriting is going to be 1.25x – 1.35x debt coverage, 25 year amortization and an interest rate in the 6.5% to 8.0% range. Recourse or partial recourse may also come into play. If the borrower did not have reserves before, he will now for tenant improvements, commissions, capital improvements, and real estate taxes. The loan amount calculated in this approach will be compared to the lender’s maximum loan to value (probably 60-65%), with the lender using the lower of the two. The result will be a much smaller loan and the borrowers will need to invest
additional equity or sell. Borrowers are recommended to project into the future what loan amounts they could obtain under various scenarios and take appropriate proactive measures.
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