Commercial Loans & Mortgage News - January 29, 2002
Q & A with JP Morgan
In an effort to provide current insight to the latest trends in the capital markets, we're fortunate to have Derek Layne of JP Morgan Mortgage Capital participating in a Q & A session with Peter Slaugh. Located in Los Angeles, Mr. Layne is on the production team covering the West Coast, Nevada, Utah, Arizona, Idaho and Montana.
Q: What types of trends are you seeing in the capital markets these days?
A: US Treasuries are in a wait and see mode currently, as are stocks. With the War on Terror finding success, the treasury market rebounded from its recent dip into the low 4% range to stabilize in a more normalized 5% range. So long as the economy continues to show signs of some improvement and there are not other world events that would cause uncertainty, I think we are in a fairly decent trading range of between 4.75% and 5% for the 10-Year UST. Of course this could change tomorrow.
Q: How are spreads reflecting the current economic outlook?
A: We feel that CMBS spreads are very attractive compared to corporate bonds. There is a lot of issuance planned in the first quarter of 2002 and we will have to wait and see how all of that paper executes. After 9/11 CMBS showed signs of volatility, but it got back on track within a just a few weeks of that calamitous event. CMBS was actively bid on at securitization during the 4th quarter, driving spreads back down a few basis points; Swaps came in this way as well.
Q: From your perspective, what is the economic outlook for 2002?
A: I think the economy is definitely in a position to bounce back, but it will take more positive earnings and outlooks from most of the DJ 30 and the top S&P 500 firms to substantiate that notion. Tech companies are beginning to spend money again through acquisition or R&D. The retail sector is still amid uncertain conditions. With Kmart recently filing for Chapter 11 and most retailers still experiencing problems, the retail sector is still in a turbid state.
Q: What property types remain attractive from a lender's point of view, and why?
A: All lenders are being aggressive and have a predilection toward multi-family properties and grocery anchored retail centers that are doing high sales per square foot. These assets simply execute well and improve subordination ratings. Every conduit probably wishes they could close a lot more multi-tenant industrial product, but the life companies seem to get most of that product. Office product is currently a bit more challenging to hit on. With the spike in vacancy and softening of rents it is just extremely difficult to achieve a dollar level that a borrower is willing to accept. Having said this, we are still closing a decent amount of office product on somewhat more conservative underwriting standards.
Q: What property types are on the "watch list", and why?
A: Anything single tenant. There has to be a solid story behind a conduit entertaining single tenant product. Those stories that work are a combination of 1) solid location, 2) solid borrower, 3) low leverage, and/or 4) very well underwritten deals that have a low risk probability of getting a haircut from the B-piece buyers or receiving unfavorable treatment from the rating agencies. Single tenant product, especially in markets dominated by tech firms, are very hard to get done. Most single tenant product out there right now on the west coast is just not conduit product. Having to underwrite rents down to market and take higher vacancies just does not leave enough cash flow available to make the loan dollars attractive to the borrower. Hotel and healthcare properties are currently out of favor given the weak economy, and some over building in these areas.
Q: Are there still so few B-piece buyers in the market? And how does this translate to underwriting practices?
A: With the nascent role of the B-piece buyers driving the market, there has definitely been an alteration in how conduits underwrite deals. However, the top conduit lenders understand that there has to be a balance between the rating agency underwriting parameters and the way the B-piece buyers are looking at deals.
Q: Do you expect to see an increase in mezzanine financing to make up any shortfall on traditional debt being provided?
A: Yes, but more in the form of preferred equity, not in the form of debt, through sources other than the first lien holder. Mezz financing is kept on the books and there are not many conduit lenders out there who like to use their books for such debt.
Q: If so, how must those interests be secured in order to meet any restrictions being set forth by the first lien holder?
A: The Lenders are still required to disclose how much "debt" is on the property so there will be loan-to- value/loan-to-cost constraints on the entire debt financing. JP Morgan will allow for Mezzanine Financing in conjunction with our senior piece on a case-by-case basis, provided that the Mezzanine Lender's interest is secured at the partnership level.
Q: What are the most notable trends that have taken place over the last 12 months?
A: Over the past 12 months, the market has, most notably, seen the impact of the limited number of B-piece buyers dictating more and more credit decisions. All lenders want to maintain their profit levels post securitization and with the ability of the B-piece buyers to shave some of the profit with 'kick outs' and/or haircuts, lenders now are definitely focusing on the true end game in the conduit environment.
Q: Are conduits expected to maintain a large source for commercial real estate lending, and how are they expected to compare to life companies and regional banks?
A: Conduits are expected to see increased competition amongst each other this year, even more so than in the past. The reason for this is the fact that not many, if any, conduits are doing any loans for hospitality type properties, e.g. hotels (full or limited service), assisted living and congregate care property types. Life Companies will continue to dominate the markets that they wish to enter and take good product. However, since most LC's do not go above certain loan to value levels, there will also remain a lot of conduit product. Regional banks are making aggressive stands to do more real estate loans and most are doing very unconventional types of loans. Eventually these regional banks will need to clear their balance sheets. Conduits will step in and hand select those loans that they know will securitize. The conduit will leave the loans that have a high probability of default based on a number of things, but the lending practices and the way the deal was aggressively underwritten are definitely at the top of the list. Once this is realized by the regional banks that are making certain types of loans, regional banks will begin to tame their aggressiveness.
Q: Are lenders still tolerant of developers making a profit, or is a disconnect beginning to occur with tighter underwriting parameters?
A: Lenders never have preferred to cash out a borrower. In most cases, lenders will not cash a borrower out unless they have caused a significant increase in value and have owned the property for a measurable period of time.
Q: The national MBA conference is taking place next month, what mood and/or message will your company be looking to project to the participants?
A: We believe that it is going to be much more competitive this year in the conduit market. Primarily due to the conduits all aggressively bidding on the core asset types. Well-located properties with good tenants, solid history, and strong sponsorship will be actively bid. However, JP Morgan Mortgage Capital believes that we will have one of our best years yet. With our ability to aggressively compete in the low leverage market with the likes of the Wells Fargo and Bear Stearns we believe that our overall production volume will increase. Also, having a dedicated large loan program in New York for all deals over $50 MM, a fixed cost group in Atlanta for smaller loans ranging in the $1.5 MM to $3.5 MM range, and full underwriting staffs in all of our regional offices we believe that we are offering our clients the most well rounded lending services in the market today.
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Chief Executive Officer Peter Slaugh founded Steelhead in 1999. In the relatively short period since its inception, Slaugh has built Steelhead into a leading resource for debt and equity placement nationwide. Slaugh is primarily engaged in growing the company and its lender relationships, as well as working on financings.
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