The State of the Debt Markets

On July 23, Sam Peacock, VP of Investments and Asset Management for Excelsior Capital, moderated a conversation with Stephen Brink, Vice President and Principal at First Southern Mortgage, Graham Gilreath, a Capital Advisor at First Southern Mortgage, and Travis Johnson, Managing Director of Debt Production at Principal Global Investors. They discussed the state of the debt markets and if/when we can get back to pre-COVID lending levels.

In this webinar they discussed:

1. Lending terms pre COVID
2. Five main buckets of capital sources and how COVID has affected each
3. How COVID affected lenders terms and commitments
4. Lending terms in a post COVID world

A Look Inside the Webinar

What were lending terms pre COVID and how were they affected by COVID?
Pre-COVID, any property could be financed. It was just the matter of finding the right lender and negotiating the right price and structure. In general, pre COVID lending terms were more relaxed and had better rates available. According to Stephen Brink, “In the last 30 years, we’ve priced the loans over the treasury rates, whatever the corresponding term of the treasury was”. However, “In post COVID we have all gone to a flat interest rate or whatever the floor rate is”. Travis Johnson also touched on the idea of how as a lender, you deal with competition. With the debt fund side, you have 25-35 lenders available which makes for a lot of competition. Even with all of the changes due to COVID, competition is still present.

Effects of COVID on the 5 Buckets of Capital Resources

Banks

With the onset of COVID, some banks immediately offered 90-day deferrals which Graham Gilreath calls an “all in this together attitude”. Others evaluated each deferral request. All in all, most banks stopped looking for new clients and new banking relationships have stopped.

Life Companies
Before COVID, corporate bond yields were at the lowest ever. When COVID hit, corporate bond yields exploded and according to Graham, “when that happened, Life Companies stopped quoting new business so they could just go buy those bonds”. As the pandemic has continued, some life companies have pulled out of the market completely and a small handful still quote competitively – but with conservative terms.

Commercial Mortgage Backed Security (CMBS)
CMBS is a way to aggregate a number of different mortgages and also diversify risk. CMBS originates loans and those loans are issued out into public markets. Lenders were very active pre-COVID. However, when financial markets tanked due to the pandemic, so did CMBS markets. CMBS quotes dried up and deals couldn’t get done.

Agency Lenders
Frannie and Freddie have been a bright spot in the midst of the pandemic. Agency lenders are quoting new business, limited to multi-family properties. Post-COVID, larger reserves are now required to be deposited once the loan is closed.

Debt Fund and Mortgage REITs
This bucket presents a lot of leverage for high interest rates. When the pandemic struck, their warehouse lenders made it difficult for them. Debt Fund and Mortgage REITs can provide a lot of liquidity, but it comes with some risk.

Lenders Terms and Commitments

Sam Peacock gave the example of a recent deal that was in the final stages of being drafted but was switched up due to COVID. “It was a deal we really liked, and it had a great profile for CMBS”… “It was set to close April 4th, but obviously with everything going on CMBS pretty much dried up with the public market. So, we had to get creative”. It switched from a CMBS to Bank Debt. For them, the lenders were not honoring the terms, but it wasn’t the lenders fault that CMBS was “pretty much on pause everywhere”. Due to these changes, it gave Excelsior Capital the opportunity to get creative with the deal.

On the other hand, Travis Johnson discussed Life Company deals. With COVID, the terms and commitments with these types of deals were not as affected. This is because with a Life Company deal, a rate is locked, and there is not a ton of market risk. If an application was signed up and a rate was locked prior to COVID hitting, then those deals were all followed through with and honored.

Lending Terms in a Post-COVID World

As life starts to return to a “normal”, the hope is that lenders will come back into the market strong. We are already seeing signs of this. Each week more lenders are getting back into the market. Today, they are either working for capital preservation or working for yield.

Life insurance companies are on the capital preservation side of it. With life companies, leverage and credit profile have changed. Deals are much more focused and conservative. According to Travis Johnson, “from a Life Company position, we are risk off basically on any retail asset in general”. On top of this, underlying credit is being more deeply analyzed. The favored property types are warehouse and multi-family. From Travis Johnson’s deal structuring standpoint, “pre COVID Life Companies were averaging 60-65% being the top end. Where I am at today and probably where a lot of my peers are, is staying sub 60% on Life Company deals”. However, the benefit of all of this is that the lenders are all chasing the same deals which results in very aggressive rates.

The rates are actually at or below where they were in mid February before the pandemic.
When it comes to lending and Frannie and Freddie loans, we can see how the market is coming back. Frannie and Freddie pricing loans are a little bit over 3%, while life insurance companies would quote the same deal at 3% or a little bit below that. As Stephen Brink said, “These are the best interest rates that you’ve seen in the last 50 years”. Soon, more and more debt should become available.

To hear more of what our panelists had to say, be sure to watch the full recording and subscribe to our newsletter to be notified of upcoming webinars!