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CREFW-Fall2014 10.15.14

we see in our portfolio loan business. Overall, there is just more pressure. From a historical perspective, we look at key metrics, and view today’s underwriting as still acceptable and attractive, versus historic norms, especially in light of strengthening real estate fundamentals that we are seeing. We agree that we are not at 2006-2007 levels. We feel pretty good about the loans we are making now. As you reflect upon what has happened over the last 12 to 18 months, it is a trend line that, if not altered, leads to a place that is 2006-2007. Kim Diamond: From our perspective, I would say we’ve definitely seen deterioration. I wouldn’t say that it’s been a precipitous change but rather a slow creep, and I don’t think that we’re in a danger zone at the moment but I fear that we might be if we keep following the current trend line. In the 2.5 years that KBRA has been rating conduits, we’ve seen average pool LTVs on our numbers migrate from about 90 percent to over 100 percent in recent deals. And looking at leverage alone understates the deterioration because we’ve also seen an increase in the use of IO structures. Full term IO is now at approximately 20 percent on average, up from 5 percent in 2012 and partial term IO is at approximately 40 percent up from 20 percent in 2012. In addition to the increase in leverage and IO, we’ve seen a large number of significant sponsor cash outs and we’ve seen some deterioration in structure like reserves that aren’t funded until a specific trigger event occurs as opposed to being funded up-front or reserves that are capped. The good news is that we have not yet seen a full-blown return to pro-forma underwriting. Mostly we’re still seeing cash flow in place, but we’re seeing some signs of deterioration here as well like rent averaging for non-credit tenants or credit being given for LOIs as opposed to signed leases. Again, I think we’re ok for now, but I would say that having roughly 40 conduit loan originators competing for business doesn’t bode well for the future. Sam Chandan: You mention the increase in the share of IO in the market and the increase in loan-to-value ratios. Clarify for me, when you mention those LTV numbers, those would be Kroll’s KLTVs? Kim Diamond: Yes. CRE Finance World Autumn 2014 16 Sam Chandan: And when we have less amortization, maybe the loan sizes get a little bit smaller. But that doesn’t sound like what you’re describing. Do you see offsets to the riskier loan structures? Kim Diamond: Not really. In fact, rather than smaller loan sizes, I think we’re seeing an increase in overall loan size especially when you consider additional financing. Most of the time the additional financing is in the form of mezzanine debt as opposed to other forms of debt that are not quite as innocuous; however, I don’t see a whole lot of compensatory factors truthfully. Peter Scola: This will be a shocker, Kim, but I think I have to disagree with you. laughter At CCRE, we take a very real estate specific approach when analyzing deals. To me, a ten-year IO loan on a 55 percent or 65 percent loan-to-value (LTV) or high debt yield, has a different risk profile than a 10 year IO loan on a 75 percent or 80 percent LTV. I think people would have vastly different opinions of those 2 examples based solely on those high level statistics. I think you have to go back to where you believe we are in the real estate cycle and whether you believe the economy has room to grow and improve. Assuming we’re not at the peak, one could extrapolate, and granted these are all macro extrapolations, that rental markets will continue to improve, occupancies will increase and leasing momentum and rates can improve. I think we’re at a point in the cycle where a lot of people believe that overall growth has a more upward bias than downward bias. If you believe what I just went through, credit performance should improve. As for cash-outs, we review these deals on a case-by-case basis. For borrowers that have owned a property for 10-15 years, have managed through different cycles, have invested capital and increased value, cash-out refis seem to be very supportable. When you create value, you’re supposed to be able to benefit from it. Overall, there are just a lot of both macro and micro factors you have to dig into when reviewing each deal. At CCRE, we take a CRE Finance Roundtable: The Risk Cycle “CMBS lenders not only face competition from each other, but also from local banks and life insurance companies, both of which have been willing to increase their leverage profile for certain assets.”


CREFW-Fall2014 10.15.14
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