MBA CREF 2020: Is Late Cycle Behavior Creeping Back In?

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The “Risky Business: Late Stage Cycle Conversation” panel on Tuesday saw industry experts resurrect ghosts of lending past to assess how far we’ve really come since the global financial crisis. 

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Moderator Kelly Wrenn, a partner at Ballard Spahr kicked things off asking  “What got us in trouble, and how has behavior changed since then?”

Chris LaBianca, a managing director at UBS, noted that loan-to-value ratios used to be at 74 percent and today they’re around 58 percent. “It’s a pretty stark contrast,” he said, also pointing to healthier debt yields, debt service coverage and lower leverage as indicators of a better-behaved market. But, don’t get too comfortable. The percentage of CMBS interest-only loans in the market was 80 percent pre-crisis and last year that number was actually 82 percent. “I think the CMBS metrics are a good barometer of the whole market,” he said. 

Speaking of the credit approval process, LaBianca said an old school, back-to-basics approach is the best one. “You know the phrase, ‘Everything you need to know you learned in kindergarten’? Everything you need to know about lending you learned in credit training,” he said.

Joel Traut, a managing director at KKR, said the firm remains very disciplined on a few factors when pursuing lending opportunities: sponsorship, which is “absolutely paramount in effectuating a business plan”; the quality of the real estate; markets and “which ones exhibit more demand on a secular basis”; and business plans coupled with the ability of the sponsor to achieve them. 

When the conversation swung around to areas where there’s some erosion of structure in deals, panelists pointed to some trouble spots in value-add transactions. Structure is becoming laxer, panelists said, with loan terms being extended out, interest-only loans on the rise and cash management requirements being stripped away. 

Late cycle risk is “weighing very heavily on every decision we make,” Gregg Gerken, head of U.S. commercial real estate lending at TD Bank, said. “We’re not loan to own but approaching it as ‘loan-to-what-if’ and not underestimating everything that has to go right [in a business plan]” he said. 

As one example of late-cycle behavior, Gerken said that borrowers are pushing for full-term interest-only loans, whereas in the past one- to two-year interest-only would have been the norm. “Interest rates are very low, so why wouldn’t you want to pay your loan down?” he said. 

Echoing some concerns around the CRE CLO market described by previous panelists, Romina Padhi, a senior credit officer at Moody’s Investors Services said that continuous refis on transitional assets are giving her some pause. 

LaBianca gave the worrying statistic that on roughly 50 percent of the loans securitized since the crisis the net operating income today is less than anticipated at the time of underwriting. 

It’s not all doom and gloom, though. “Things have been so good for so long, LaBianca said. “Even if there was a 20 percent correction in property prices, we’d still just be back to 2016.”