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 May 14, 2020  

Disruption 2020: Lenders are preoccupied, and more cautious

  • Banks, life insurance companies and debt funds have all become more selective, and credit spreads have gapped out.

    • Life insurance companies have increased minimum debt yield requirements, simultaneously raising coupon floors to between 3.50%–4.25%.

    • Banks have increased spreads by approximately 25 to 75 basis points over pre-COVID-19 borrowing costs, with new rates between 3.50%–4.00%.

  • Asset management has significantly overshadowed the pursuit of new debt opportunities, diminishing liquidity.

  • Lenders have quickly shifted their focus to rent rolls, status of tenancy and collections. Borrowers are facing higher scrutiny on cash flow durability.

  • Leverage has dropped approximately 5% to 10% across lending avenues, and lenders are fortifying structural loan components by instituting upfront reserves.

  • CMBS delinquencies are rising, while lenders have been forced to modify the billions of loans still held on book and once slated for securitization.

    • Goldman Sachs and Citigroup priced a $771.9 million conduit offering backed by 29 loans (GSMS 2020-GC47). The AAA tranche priced at S+145 basis points and the lowest publicly offered class (A-) priced at S+385 basis points.

  • The private debt market is creating opportunities for family offices.

Building on our previous post on the availability of equity, the next piece of the puzzle is debt. While lending outlets remain active and open for business, asset management has significantly overshadowed the pursuit of new debt opportunities, diminishing liquidity in the debt markets. This has created a pronounced flight to quality overwhelmingly biased towards top-tier lending relationships, followed closely by an institutional preference for “bulletproof” opportunities at loan metrics that are decidedly more conservative than pre-COVID-19 terms.

CM_Disruption_Issuance Volume Comparison_graph

Lenders have quickly shifted their focus to rent rolls, status of tenancy and collections. Borrowers must be prepared to face heightened scrutiny from all lending sources, who are questioning rent collection and cash flow durability. However, rent roll clarity will serve only as a starting point for lenders to consider opportunities. Owners of multi-tenant commercial assets will be required to prove out successful rent collection, or they will struggle to obtain financing. Additionally, lenders are enhancing structure to their benefit by instituting upfront reserves. There has been an emergence of debt service and operating deficit reserves in response to COVID-19, and borrowers should anticipate increased structural components for the foreseeable future.

CM_Disruption_Super Senior 10-Year Spreads_updated

Achievable leverage has dropped approximately 5% to 10% across lending avenues, and credit spreads have simultaneously gapped out. Lenders will remain disciplined until they can gain further clarity on value shifts, maintaining leverage levels between 60%–70% (aside from agency financing) with a greater emphasis on amortization.

With optimistic underwriting quickly thrown out, construction financing and the transitional value-add bridge loan markets have pulled back. Just months ago, bridge loans secured by assets with vacancy and near-term rollover events attracted competitive bidding as appealing value-add candidates. Only deals with strong sponsorship and a sound thesis will attract construction financing in this environment. Until further clarity on the economy is obtained, lenders will shift to strict, highly conservative underwriting assumptions, making transitional bridge loans and construction financing difficult to obtain.

CM_Disruption_% of CMBS Loans_graph

Life insurance companies are very cautious, with many groups effectively on pause. Low-leverage, core industrial and multifamily opportunities are still being considered, but firms have increased minimum debt yield requirements by 100 to 150 basis points and simultaneously raised coupon floors to between 3.50%–4.25%.

Activity in the large loan origination space is choppy and more turbulent than in the middle markets. Even through the wave of PPP applications, several local and regional banks remain active and an outlet for strong sponsors. Local banks have shifted their appetite towards smaller loan balances. Banks have increased spreads by approximately 25 to 75 basis points over pre-COVID-19 borrowing costs, with new rates between 3.50%–4.00%.

In the CMBS sector, lenders have been forced to modify the billions of loans still held on book and once slated for securitization. Last week, Goldman Sachs and Citigroup priced a $771.9 million conduit offering backed by 29 loans (GSMS 2020-GC47). The AAA tranche priced at S+145 basis points and the lowest publicly offered class (A-) priced at S+385 basis points. While this is a sign of life, it is by no means an indication that the market will return to normal in short order. Origination shops will observe market activity in the upcoming weeks as they contemplate net new originations. The next chapter in CMBS will undoubtedly come with refined credit expectations across different asset types and a new set of B-Buyer hot buttons for issuers to address.

COVID-19-related transfers to CMBS special servicers total $8.5 billion (1.5% of outstanding CMBS); expect this to increase in upcoming months as rent collection struggles intensify. Since the pandemic began, borrowers representing $100.7 billion of loans (17% of  the total CMBS universe) have contacted their servicers to explore relief. Given the lack of liquidity to refinance hotel and retail loans, defaults will begin to spike. The loan sales market will see a surge in transaction volume and overall activity, as financial institutions will utilize note sales to create liquidity, modify balance sheets and lower risk.

This is creating an opportunity in the private debt market. Family offices are stepping up in this segment of the market. Preqin notes that family offices in the private debt space have more than doubled in the last five years.



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Authors:

Aaron Jodka
Managing Director, Research & Client Services
aaron.jodka@colliers.com
  Bryan Koop
Assistant Vice President
bryan.koop@colliers.com
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