Capital Flows Keep Pricing Elevated

January 2021

We said goodbye to 2020 on a high note. Loan sales closed in December totaled ~$220MM in UPB across 49 offerings on behalf of ten separate bank clients. The trade rate was a superb 92%. As in previous months, hospitality led the way, with small balance commercial loans becoming more prevalent as banks look to exit time consuming small balance workout credits.

We’ve often discussed that increasing investor interest and activity in our market, along with a supply-demand imbalance is clearly keeping prices elevated. December was a continuation and acceleration of these trends. It resulted in a record number of investor NDAs executed per deal and pricing for the month approximately 5.5 points in excess of seller reserve prices. A large bank sale that was split into 14 offerings sold for an average of 12 points in excess of reserve! Needless to say, there were lots of happy folks at that closing.

So what’s driving this? Are reserve prices set too low? I doubt it. Nobody wants to leave money on the table, and everyone wants to push us and the buy-side to get the highest price possible. Could it be the election, economic stimulus, or further deficit spending? Possibly, that can’t hurt pricing. At the end of the day, we think it is very simple: excess capital. Lots of capital has been raised to purchase risk assets and the supply of those assets has not materialized anywhere close to a level required to satisfy the demand. This proved to be particularly relevant to hotel loans as the year progressed. Generalist debt investor capital has gravitated toward this sector as other sizable opportunities were lacking. We see this in the numbers. It is increasingly common to see 200+ investor NDAs executed on any given deal.

So what does this mean? It means that if you have a hotel loan you’d like to exit, you can put it in the market and immediately have 200+ vetted and accredited investor groups under NDA having a serious look. Note that we’re not going the play the “rolodex” game here. We have a huge contact list, as does everyone else. Anyone can buy a list and send the deal out to 100K “investors.” Who cares. What matters is vetted eyeballs under NDA looking at the deal, and moving that to close-able bids.

Pricing has increased as well. Hotel equity investors hoping to purchase loans at levels and yields seen in the last downturn have been largely disappointed. They have been replaced by debt generalists satisfied with mid-high single-digit returns. Of course, there are exceptions, challenged markets, convention, group travel, anything with heavy F&B will be case by case. However, your small balance – middle market economy, limited, select service deal is going to trade as a non-bank “high” yield deal rather than the distressed level we saw during the Great Financial Crisis.

Looking Ahead
Predictions are difficult due to so many consequential externalities, government intervention, regulation, etc., but we’ll leave you with a few:

High-yield performing hospitality loan sales will continue, and distressed sales will increase. If CMBS Special Servicers accelerate debt and/or equity dispositions, banks with hotel loans in markets with a lot of CMBS loans may well see their collateral values impacted by distressed sale comparables. I’m looking at Houston, NY and Chicago with a sideways glance at Los Angeles, Dallas, Philadelphia and Atlanta.
There will be no bank loan sale “tsunami.” Banks don’t “need” to sell. They may choose to sell, they may be highly motivated to sell, but they are not forced sellers in the true sense of the word. They don’t have repo lenders. They don’t have margin calls. And, they are largely well capitalized. There are lots of good reasons to sell loans, and that’s why so many of our repeat clients do so on a regular basis. However, having the proverbial gun to their head to do so is not one of them.
Bank loan sales will be slightly elevated for the first half of 2021 and accelerate toward the end of the year. Cares Act provisions, the Covid vaccine, economic stimulus and hopes for more economic stimulus will keep the marginal credits in-house at many banks, while forward-looking institutions will start the clean-up earlier, taking advantage of high pricing.