This week, MortgageOrb spoke with David A. Cohen, regional director at GE Real Estate, where the balance-sheet lending program continues operating at high levels of activity. Cohen offers his views on where commercial mortgage-backed securities (CMBS) lenders may have gone wrong, why listening to national statistics on property trends might not be the best way to determine deal viability, and, of course, how soon the dormant lending segments might awaken.
Q: What are the most significant ways your own lending practices have changed pre-subprime meltdown/pre-credit crunch versus now? Do you foresee these changes as short-term, long-term or permanent?
Cohen: Overall, it's been a flight to quality: asset quality, sponsorship quality, and current coverage and loan-to-value and coverage of the assets that we are ultimately going to finance.
However, [the market woes] did not substantively affect our lending approach or our practices because we have always had prudent lending standards – a very high emphasis on due diligence in each and every transaction. We were not an out-of-the-box aggressive underwriter.
What happened [with the less conservative CMBS lenders] was that there was such a compression of margins and such a drive to make profits that they each, in essence, had to double their volume. In order to double volume and to win deals, they had to be overly aggressive in their underwriting practices. A lot of the CMBS transactions really moved toward pro-forma underwriting, but the practices of CMBS are supposed to be historic and current; they're not supposed to be underwritten to pro-forma numbers.
Q: Looking specifically at your CMBS fixed-rate financing business, how much activity is there these days? Are large loans (your Web site mentions your preference is $25 million-plus) more difficult in the current climate?
Cohen: There's been a big uptick in on-the-book business. We're seeing two types of business now on-book: Even with the stabilized properties, sponsors are coming to us for certainty of execution on on-book. I think that's the most important thing right now. Even if a property is stabilized and driving to a 1.20 debt coverage, they're still looking for that on-book certainty of execution.
On the other hand, there are also the value-add programs. We
ll give the borrower an initial funding and then lines of credit, which is very different from CMBS, where you're pre-funding the TILC reserves as well as the cap-ex reserves into the loan, and you'll have some negative arbitrage. What we'll do is fund it separately so that they can draw down and create value on those properties.
The traditional large-loan securitizations that many did no longer exist, and the time frame for that market's return is indefinite. So what we do is look at the large loans in a different way: We'll take down a large loan, and then we'll determine whether it's something we want to syndicate in part or in whole.
For example, we might take down a large tranche, break it into an A-note, and then syndicate a piece of the A-note while keeping the B-note on our balance sheet. It all depends on risk profile. A lot of the syndication market is sluggish, so it's not that easy to just go out and syndicate these loans anymore. For us, it's on a deal-by-deal basis.
The larger loans are tougher, but it depends on what the execution and how the balance sheet is going to handle it.
Q: What's the future for CMBS?
Cohen: I've always seen the CMBS market as an efficient market: It provides an efficient source of liquidity, and it's needed in our markets. Even as balance-sheet lenders, we all go back to the question of how liquid our loans are. I do think that the CMBS market will come back again, but at the same time, I think it's going to come back in a different form.
It is going to come back with more conservative, prudent underwriting and will also not come back as crowded: I think many of the CMBS lenders will have exited the market. There is also a lot of pressure on the rating agencies and the B-buyers as to how the deals are going be rated and, ultimately, who is going to buy which loans in which pools, and they're going to look to the prudent standards for buying those loans.
It's hard to drive a time, but I certainly think it's not tomorrow that this market is going to gain back its efficiency.
Q: What are your preferred property types right now? Which do you think post the most cause for concern this year?
Cohen: People say things like ‘The office sector is not going to be good this year,’ or ‘The multifamily market is going to be great this year,’ or ‘If we go into this recession, which is lingering around the corner, what's going to happen with retail?’ I don't look at deals that way; I look at the drivers of that particular deal.
Also, I'm very involved in the Northeast. I look at New York, Boston, Long Island, Westchester and northern New Jersey – which are all very good-driving markets. They have a lot of rent growth and favorable supply and vacancy numbers.
So I wouldn't single out any particular market or asset, as every asset depends on which market we're talking about. For example, there might be a very appropriate multifamily deal in a particular market that might be an 80% loan-to-value, whereas an office deal in that particular market should be 50% loan-to-value. Or, there might be certain markets, such as Hartford or Pittsburgh, where we may just want to stay away from office in that particular area.
You really have to evaluate every deal: where the debt-service coverage is, where it's located, who the sponsor is and what their value-creation program is. If we do go into recession, of course retail is going to be affected, and in New York City, if the layoffs continue on Wall Street, you may have a bit of a pullback in office and multifamily.
We always want to lean into the larger markets that have drivers, and we may want to pull back from the secondary and tertiary markets that may have more of an issue trying to accelerate their growth packages.
Q: Some commercial mortgage participants have called the subprime crisis a blessing in disguise, as out-of-control lending practices in residential were starting to creep into commercial lending practices in some cases. Do you think the market was heading into that dangerous territory? How frequently did you see risky lending/securitization/investment practices among your lender peers and investors?
Cohen: We needed the correction. It wasn't a real estate correction; it was a capital markets correction. Underwriting was very stretched, and it was going into dangerous territory. The CDO [collateralized debt obligation] players were getting very, very aggressive with their underwriting and what they were pushing into the market – with the limited equity that they were holding onto in each CDO deal. So I think this was a positive for the lending markets.
And if you look at portfolio lenders, it did provide a great opportunity for us to use our balance sheet for the on-book fixed-rate, floating-rate, mezz, preferred equity and things of that sort.
[When conduit lenders come back], we'll adjust our practices to the market accordingly. The CMBS market is still governed by what the rating agencies and the buyers look for. I don't think we will ever compromise our lending practices or due-diligence practices to try to stay ahead of the market.
CDOs will be one of the last pieces of the broken puzzle to come back. You're going to see CMBS come back first – very efficient, very conservative. And then once you have the buyers in the market again, maybe [the CDO market] will start to reappear. We have a long way to go.
