Lenders Entering 2011 With Rising Optimism
Lenders are feeling better about their prospects than they have for years — but they're not ready to break out the champagne just yet.
For the first time since the market crash, positive signs abound. Commercial real estate prices seem to be stabilizing. Property sales are picking up. Interest rates remain near rock-bottom lows. And the securitization market is finally starting to revive.
Against that backdrop, lenders are cautiously optimistic. Insurance companies are increasing their mortgage allocations. And securitization pros expect commercial MBS issuance in the U.S. to triple this year, to $39 billion (see list of predictions on Page 15).
The optimism is driven in part by improving real estate fundamentals, which are giving investors confidence to resume property acquisitions. Increasing demand has pushed capitalization rates on many investments down to 7-8%. “Most loan coupons are in the mid-5's, so relative to the cap rates, that's positive leverage,” said one veteran CMBS lender.
As hints of a rebound emerged, roughly a dozen banks resurrected their CMBS lending operations, including Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, J.P. Morgan, Morgan Stanley, RBS, UBS and Wells Fargo. Optimism has been further fueled by a massive bond rally that has made securitization programs more competitive with portfolio lenders.
But CMBS executives said property deals alone won't be enough to keep their shops busy. What's needed to sustain growth is strong refinancing activity. Yet many borrowers with maturing loans are heavily overleveraged, thanks to the sharp drop in property values from the market peak. As a result, they will be hard-pressed to qualify for new loans large enough to pay off the existing mortgages.
One key measure that lenders now use to evaluate the credit quality of a loan application is “debt yield,” or the ratio of a property's net operating income to the mortgage amount. It's a test that many property owners can't pass.
“Debt yields will be the real challenge this year,” said Darrell Wheeler, CMBS strategy chief of Amherst Securities. “For a loan to work for CMBS, the debt yield needs to be at least 10%. But about half of the $44 billion of loans that will mature in 2011 will have a debt yield under 9.8%. Lending standards could become more aggressive, but in our view there is a limit to how far those standards will drop.”
One veteran CMBS lender echoed Wheeler's concerns: “I think most of the securitization shops active last year were rolling over old loans that they had done in 2002 and 2003 and 2004. But they can't keep doing that forever, because everything that was written after 2004 is now basically underwater.”
Among portfolio lenders, the picture is sunnier. Insurance companies and foreign lenders — especially Chinese banks — nabbed some of the biggest lending assignments of the past year. Bank of China originated an $800 million loan for a Brookfield Office Properties partnership on the building at 245 Park Avenue in Midtown Manhattan. MetLife took down a slew of big loans, including a $390 million mortgage for a partnership between AXA Equitable and J.P. Morgan Investment Management on another Midtown office building, at 1285 Avenue of the Americas.
The outlook is even better for 2011, according to MetLife mortgage chief Mark Wilsmann. “As long as the structured-finance markets are hobbled and relative value is good, life companies are likely to increase their allocation to direct lending,” he said. “Most life companies I know are planning on increasing volume in 2011.”
Balance-sheet lenders have long favored trophy properties in major markets, where the downturn did the least damage. That focus is not likely to change. For example, SL Green, the New York REIT, is more than willing to consider loans in its home market.
“We are very bullish on New York,” said managing director David Schonbraun, who oversees the acquisition of loans in the secondary market and the origination of mortgages, which are typically subordinate to senior loans written by balance-sheet lenders. “There are definitely some distressed situations, but values in New York have come back more than in most places.”