How is Covid 19 Impacting Interest Rates and Leverage

Introduction

Today we are discussing the capital markets in broad strokes with some finer points relative to the self-storage asset class. Specifically, with COVID, where are we today? Is the market influenced exclusively by where treasuries are? Is it sponsor specific? Is it geographically based? What about rates?

Broad Strokes

With a broad stroke, rates have relatively been unchanged from pre-COVID to the current environment. And everyone sees that treasuries have retracted quite a bit. Prime has retracted, Libor is at near zero, but spreads have widened out given the inherent risk that we are in an uncertain environment.

That being said, there are certain product types out there that we've financed and that the banks and the permanent loans are looking for and they are with the bridge lenders and the mortgage rates and the debt funds.

Those types of lenders typically require a capital markets execution that's done through warehouse lines or CLO executions. Those letters pricing, they're either out of the market or their pricing is extremely wide because their capital markets executions aren't there. So when we had pricing, let's say, in the L 300 or 350 range from a debt fund, that's going to look more like L plus 500 to them because they're unable to finance their position in the capital.

A big question is: What percentage of business is represented by portfolio lending versus the conduit markets versus life versus smaller credit unions and local banks? How is it best to diversify?

It is best to do a lot of financing with local, regional, and even national banks for construction, fortuitous acquisitions, and even term loans when borrowers want a little bit more flexibility on a prepayment. There are also CBS live company type permanent debt as well as preferred equity and mezzanine financing, and then some JV capital. In addition to that, the non-recourse bridge financing is useful enough in today's environment that we're not seeing a whole lot of bridge lending getting done.

Is there a difference from a rate in your perspective between CMBS markets right now and everything else?

CMBS at this point is the highest real LTV we've seen thus far and is about 65% and relative to everything else let's say, banks, credit unions, they could still stretch up to 70 or 75, assuming recourse and assuming a strong borrower. So, I'd say that's the difference between CMBS markets right now and everything else driving leverage.

So CMBS is still non-recourse provided we still have the conventional clauses and so forth?

Absolutely.

And we don't see that changing. The general theme that we're seeing, and today, again, sitting in the middle of the summer of 2020, as the CMBS market has reopened general leverage is down about 10%. So deals that you were getting done at 75% pre-COVID are 65%, at 65% pre-COVID are now 55%. So that's what you're seeing. That being said, as we get through this COVID environment and there's more product to be financed, we think that the leverage points will come up again.

So reopened presumes that there was a previous closing. How long was that the case and was it just for CMBS exclusively, or what were you all's experiences?

Mainly CMBS but also the CLO executions and the warehouse lines also were shut down. CLO is a cousin to CMBS.

We saw the CMBS completely come to a halt in mid-March and they reentered the market around the last week of May. And when they did, like anything else, they dipped back into the market with caution and as such, they dropped leverage and they tried to maintain their spreads equal to a rate of where they were before, although the ten year is so low that you can borrow on a CMBS itself for the right deal.

So there's aggressive money out there if you have a deal that fits.

Also, to point out, the capital markets closed. There was a lot of liquidity in the market, it just depended on where you were to get it from and at what leverage and price. And when the CMBS market, we like to look at the CMBS market, the top of the food chain, because when the CMBS market shuts off, that's the ultimate backstop and exit to other types of lenders. So banks, bridge lenders, more transitory assets we usually underwrite to a CMBS exit because that's the fail-safe and the liquidity for all the product types. When the CMBS market turns off, all other capital sources proceed with caution because they're not sure whether there's an exit. Now that the CMBS market has come back into play for product types that are outside of hospitality and some retail, those other lenders, banks, bridge funds, life companies, et cetera, are coming back into the market.

To say it a different way, the banks and the credit unions never got to see pristine, fully leased up, stabilized cash flow in deals that they got to make loans on, it was very rare. Their bread and butter was making loans on construction or transitory product types or something whereas we mentioned before, that borrower just wanted flexibility. So when that happens, banks don't have to go down the risk spectrum to make loans. So they say to themselves, "Why would we take construction risk when we can make loans on these stabilized assets because CMBS is no longer?” So, they're going to go take their share of those assets at the moment.

Now that CMBS is opening back up, those loans will start to move off those bank's books and the banks will then start to have to divert their attention to what they used to do, which was construction assets that aren't quite nearly stabilized where you need some recourse. And so you'll see the market start to open back up at a lagging effect from CMBS opening back up. So while some borrowers will tell you, "We don't want to borrow CMBS, we don't like their product type," it's definitely a good thing to see them come back because as we mentioned, it is a top of the food chain and when those lenders come back on the market and provide liquidity, it takes the loads off the banks then it starts the engine to go again.

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