www.hiddenval.com
3/11/2009
The Credit Crisis Continued: 2009 Outlook
Hidden Value Investment Management
Brett Tynes – C.J. Liepman
Entering 2009 amid worsening conditions in the financial and credit markets, we felt an
update to our 2008 Credit Crisis report was in order. Credit has long been integral to the
U.S. economy, and it is here we often look for signs of economic healing.
We want to thank Mike Spoor for his insights into the commercial lending markets.
Industry contacts like Mike help us identify “real-time” trends and risks developing on
the economic landscape. This type of feed-back from different industry participants has
helped us position our client’s investment portfolios to avoid most of the losses of 2008
and prior years. We hope you find value as well.
Below are the Observations:
“I just returned from last week’s Mortgage Bankers Association’s annual Commercial Real Estate Finance
Conference (“CREF”). The CREF conference is a five day event and is held every year during the first week in
February. Historically it has been attended by as many as approximately 4,500 mortgage brokers, lenders,
real estate attorneys and vendors. The MBA claims that there were 1,800 people registered this year. It
seemed like the group was smaller than 1,800. The lenders represent the Wall Street firms, the insurance
companies, the commercial banks, the credit companies and a large number of boutique lending entities.
I have brought back from the CREF conference some thoughts and observations as to what you can expect
from the lenders in 2009:
The Wall Street Conduit Lenders are all but out of business. A few of the Wall Street firms attended
the conference to “show the flag,” but none are looking to book any loans in 2009.
We met with several of the Insurance Company Lenders at the CREF Conference. Some of the
Insurance Companies have money to lend, but the terms will be very conservative. One of the
insurance companies we visited with was willing to look at a loan request in the 60% LTV range, but
their pricing started at 8%. Maybe for a Class A apartment deal they would consider an interest rate of
7.5%.
One of the big issues for the Insurance Companies in 2009 will be how to handle maturing loans in their
portfolios. The Insurance Companies realize that borrowers with notes maturing in 2009 will not be
able to find alternative financing, so the insurance companies will most likely have to use a portion of
their 2009 allocation to renew maturing loans. Some of the Insurance Companies will use as much as
50% of their funds allocated to new loans in 2009 to just renew maturing loans where the insurance
company already is the lender. Then there is the point that why make new loans when you can simply
renew a loan on a property that you know well and have 5-10 years of track record with the borrower.
With less competition due to the Wall Street conduits gone from the market and Fannie Mae and
Freddie Mac currently in a more conservative lending mood, the Insurance Companies can cherry pick
the deals they want to lend on. Expect the Insurance Companies to be very conservative, lend to only
the four major property types (multifamily, anchored retail, office and industrial), and price their loans
higher than in prior years. With less competition, the Insurance Companies will undoubtedly raise their
interest rates in 2009. This will apply to new loans as well as the loans they are rolling over and
renewing.
The Agencies (Fannie Mae and Freddie Mac) got put into conservatorship back in September. Both
have significantly tightened up on their loan underwriting criteria since September. Fannie doesn’t like
Houston at this time and has essentially stopped booking loans in Houston. Fannie will only consider a
loan in Houston at a Debt Service Coverage of not less than 1.35X and a LTV not to exceed 65%.
Freddie issued in early February new underwriting guidelines that are much tighter and more
conservative. Freddie has not ruled out Houston, but will only look at strong Class A and B deals with
proven operators and strong sponsorship.
No one at the CREF Conference knew what the Agencies will look like a year from now. The new
Administration and Congress have to figure out what to do with Fannie and Freddie. Changes are
inevitable. The bright point is that the multifamily groups at both Fannie and Freddie have preformed
well, generate meaningful profits and generally have pristine loan portfolios with very low delinquency
rates.
Look for FHA to become a more viable lender option in 2009 for apartments. The process is long and
difficult and the fees are very pricey. But FHA is still doing 80% LTV deals with 35 year amortization
with the Debt Service Coverage requirement at 1.18X. Interest rates would be in the 6.5% range
today. If you can wait 4-5 months to close an FHA loan, it may be the best option for apartment
financing to day. The process is painful, arduous and frustrating, but FHA may offer the best execution
today for permanent apartment financing.
The Commercial Banks will certainly be in the spotlight in 2009. We need to break the banks down
into several catagories to discuss how they will act in 2009.
1. The big TARP banks (those that received bailout money) will be all but paralyzed in 2009. As
has been well documented in the financial press, the big banks took the money and have not
utilized it the way Congress or the Treasury expected. They will start making car loans again
and maybe some home acquisition loans. Making loans in these 2 catagories will help when
they get called in front of the House Financial Services Committee and the Senate Banking
Committee. Working capital loans for business will come later. I do not expect to see the large
TARP banks actively making commercial real estate loans in 2009.
2. The regional TARP banks will focus their energies on car loans, home loans, SBA loans and
small and middle market business working capital loans. The regional banks will be very
reluctant to make any commercial real estate loans. In many parts of the country the recession
will result in lower occupancy rates, lower rental rates and less absorption. The regional banks
will also be under pressure from their regulators (FDIC, OCC and the Fed) to reduce exposure
to commercial real estate. For the regional banks to look at a new commercial real estate loan,
the deal will have to be gold plated, have strong sponsorship and experienced borrowers with
strong liquidity positions. Expect the regional banks to only consider low leverage deals (less
than 65% LTV) and price their loans with floor interest rates in the 6.5% to 7.0% range.
18 Augusta Pines Drive, Suite 221W, Spring, TX 77389 (281) 516-3870 office (281) 516-2664 fax btynes@hiddenval.com 2
Securities offered through NEXT Financial Group, Inc., Member FINRA and SIPC
Hidden Value Investment Management is not an affiliate of NEXT Financial Group, Inc.
3. The community banks will be the most active commercial real estate lenders in 2009. This
subgroup of banks did not, for the most part, receive TARP money and consequently won’t have
to listen to Barney Frank and Chuck Shumer tell them how to run their banks. The smaller
community banks see 2009 as a year when they can cherry pick good relationships away from
their larger competitors. The community banks have money to lend on commercial real estate
deals and will make loans. Expect low LTVs and conservative underwriting. Interest rates will
be 6.5% or higher. Be prepared to hear the community banks ask for deposit relations as a
requirement of loan approval. The community banks need to generate deposit account to grow,
and these banks will not be bashful about requiring deposit relationships equal to 10-20% of the
loan amount. One of the drawbacks with the community banks is loan size. The small
community banks generally cannot fund a loan much bigger than $4 to $5 million.
The big issue for the Commercial Banks in 2009 will be how to balance dealing with Congress and at
the same time keep the regulators from criticizing all the new loans Congress wants them booking.
This will be a difficult and challenging balancing act for the banks.
As I mentioned in 2008, the Mezzanine Lenders will continue to be active and have money to lend.
Expect the Mezzanine Lenders to take overage leverage up to 75% and in a few rare cases up to 80%.
The Mezzanine debt will continue to be expensive, with mezzanine rates in the mid teens. Also expect
the Mezzanine Lenders to have a lot more control in how a project will get done, in requiring
preferential returns to the Mezzanine Lenders and in determining NOI expectations. You should
anticipate that the Mezzanine Lenders will act and look like equity partners or JV partners where they
are in control of a project.
The Boutique Lenders and Hard Money Lenders will continue to have money available and are
eager to place loans. Their rates and fees are higher and their loan terms are shorter. We visited with
several of the Boutique Lenders at the CREF Conference. Expect interest rates from the Boutique
Lenders in the 12% range, with the fee being a couple of points. For many deals, the Boutique Lenders
will be only lenders to consider looking at a deal.
I came back from the 2009 CREF Conference with a number of observations:
1. We should fully expect to see property values drop in 2009 and into 2010. The appraisers will continue
to raise cap rates, forcing property values lower. Many of the sales comps the appraisers will be using will be
from distressed sales and not from arms-length sales.
2. There will be numerous defaults on commercial real estate loans this year, many coming when loans
mature and borrowers cannot locate alternative financing. Expect the loan servicers to be very creative when
dealing with maturity defaults.
3. There will be fewer financing alternatives available. You may not like the terms and conditions, but in
2009 any loan may be better than no loan.
4. Low leverage and higher Debt Service requirements are a part of the borrower landscape in 2009. The
obvious conclusion is that borrowers will have to bring more cash to the closing table.
18 Augusta Pines Drive, Suite 221W, Spring, TX 77389 (281) 516-3870 office (281) 516-2664 fax btynes@hiddenval.com 3
Securities offered through NEXT Financial Group, Inc., Member FINRA and SIPC
Hidden Value Investment Management is not an affiliate of NEXT Financial Group, Inc.
5. There will be an ever increasing number of opportunities in 2009 to acquire properties at significantly lower
prices. All of the people at the CREF Conference acknowledged that properties will be trading at lower
prices than in the period from 2005-2008. This will apply to all property types.
6. It will take most of the year for Congress and the Administration to figure out what to do with Fannie and
Freddie.
7. Experienced borrowers and property owners will be able to find financing. For inexperienced operators or
first time buyers financing will be almost impossible to find in 2009.
To get deals closed in 2009, borrowers will in many cases need to be prepared to bring more cash equity
to the closing table. Look for tighter loan underwriting which will mean lower leverage, lower Loan-to-
Value requirements, higher debt service coverage ratios and no pro-forma underwriting. Most of the
lenders will have instituted interest rate floors in the 6.5%% to 7.0% range. Most of the lenders will only look to
make loans secured by the four main property types (multifamily, office, anchored retail and industrial). The
new Stimulus Bill will open the door for loans to get done through SBA programs in 2009 secured by single-use
or owner-occupied properties.”
2009 thus far, has continued to show constrained credit availability. Until we see the
wider availability of credit, be prepared for tight lending standards to continue to impact
the U.S. consumer, the industries that depend on them, and the investment markets in
general.
We hope you find value in this “part 2”research note. We felt it could be of use to many
of our private clients and colleagues who may be considering the purchase of real estate
in this volatile environment.
Please let us know if we can help you, your family or friends structure their investment
portfolios to navigate through this market period.
Regards,
Brett Tynes
About Hidden Value Investment Management (H.V.I.M.):
Hidden Value is an Independent Investment Management firm providing high-level,
absolute return driven, investment portfolio management. Together, Hidden Value’s
managers have over 40 years of experience utilizing flexible value, growth and fixed
income strategies. With an approach designed to find positive market returns in all
market conditions, Hidden Value’s managers are free to use multiple investment
disciplines geared toward protecting capital and growing wealth.
18 Augusta Pines Drive, Suite 221W, Spring, TX 77389 (281) 516-3870 office (281) 516-2664 fax btynes@hiddenval.com 4
Securities offered through NEXT Financial Group, Inc., Member FINRA and SIPC
Hidden Value Investment Management is not an affiliate of NEXT Financial Group, Inc.