Do Low Coupon Lenders Really Want to Make New Loans?
“Sticking your head in the sand might make you feel safer, but it’s not going to protect you from the coming storm” – Barack Obama
Most commercial real estate pundits agree on one thing: the commercial real estate lending markets have not fully felt the shutdown of the economy in March. For now, forbearances by lenders have concealed the full impact. The CMBS market, for example, has seen delinquencies rise from 2.2 percent in April to over 7.15 percent in May, according to Trepp. The increase is almost entirely in the 30-day delinquent category. Now, borrowers will have to navigate the arduous process of dealing with special servicers to get any relief. The reason that this is such a problem is inherent in the way that CMBS loan documents are structured. Special servicers need to follow the loan documents without too much of their own discretion allowed. This restriction has always been the negative when doing a CMBS loan. As an example, according to a survey from the American Hotel & Lodging Association, 91 percent of hotel loans financed by banks had their payments adjusted due to the pandemic. While only 20 percent of CMBS hotel loans had their payments adjusted, as the borrowers attempt to engage with the servicers, partially explaining why the delinquency rate spiked for CMBS loans.
But do low coupon lenders (primarily banks) really want to do new loans? Here is where your favorite mortgage broker earns his keep, as most lenders say they are in the market, but many of those are just going through the motions. Now if you are a stable multifamily property, Freddie Mac, Fannie Mae, and insurance companies are all still actually quoting new loans. Freddie Mac reported that it received $8 billion worth of loan requests during the first two weeks of June, matching pre-pandemic levels. Freddie Mac went even further stating that they are reducing debt service reserve requirements [on select low leverage transactions] and is continuing to consider properties still in lease up and student housing. At the other end of the barbell, if you own a transitional property that requires a high-octane bridge loan, there are no shortage of debt funds or pseudo-hard money lenders willing to lend to borrowers at 10 to 12 percent. However, the canyon in the middle of that barbell has become much larger. Retail properties that aren’t grocery anchored, many office buildings and almost all hotels have become extremely difficult to finance in this environment. High interest rates plus lower leverage is the only remotely possible solutions for these asset classes. As for CMBS, the industry is still projecting $45 billion of loans for the year. We have had some lenders quoting with wide spreads and lower leverage than pre-pandemic, so while they say that they are back in the market, it’s clearly in a lukewarm fashion, if at all. In May, Argentic had the first securitization since the pandemic hit but pricing was very wide with AAA tranches at Libor plus 262 basis points (versus Libor plus 100 basis points pre-pandemic) and the junior most tranche (the A- rated C class) pricing at Libor plus 600 basis points. Meanwhile, construction loans have likewise become more difficult to finance. Multifamily construction can still be financed but at a significantly higher cost and lower leverage than pre-COVID. In general, all commercial real estate loans have become more expensive as spreads have increased across all sectors. This will eventually affect cap rates as overall returns are dampened as a result of both the interest rate rise as well as the increased equity requirement due to lower leverage.
Rarely discussed is the sudden reluctance of most banks to do new lending for anybody except existing clients. Every bank has some legacy issues with existing loans so most lending officers are being diverted to asset management to deal with those problem loans. An ancillary problem is that many banks provide warehouse lines to many debt fund lenders. Warehouse lines allow debt funds to finance the senior tranche of their loans at mid-single digits, thus enhancing the returns of the overall loan done at high-single digits. We know of one debt fund that uses Deutsche Bank as a warehouse lender. Deutsche Bank, for one, is effectively out of business during this pandemic. Warehouse lines were supposed to be the safer alternative to collateralized loan obligations (CLOs) since CLOs were reliant upon the public markets to finance their paper. With warehouse lines being pulled by these banks, debt funds’ only alternative is to keep 100 percent of the loan on their books and not leverage their return. If they promised their investors a 12 percent return, they now need to charge 12 percent (plus fees) to achieve that same dividend.
Dan E. Gorczycki is a Senior Director for Avison Young New York, LLC, and specializes in arranging senior debt, mezzanine, and joint venture equity solutions to commercial property owners.