Quarterly Market Snapshot: Macro Pressures in a Bifurcated Market
DebtX Team | 12/06/2022
$500 Million Has Sold or is Currently Bidding
By Kingsley Greenland and Kevin J. Kelley
The COVID-19 crisis has upended the financial services world, but it hasn’t changed the active participation of buyers and sellers in DebtX’s marketplace for whole loans.
Since early March, DebtX offered and closed sales on 13 loan portfolios totaling more than $150 million in unpaid principal balance. Last week, we announced the sale of a $370 million portfolio of real estate assets in Colombia. The portfolio will bid on Sept. 28, with initial due diligence starting on June 8.
Investor participation, including many banks, was exceptional for the recent sale of a $50 million FDIC portfolio with an agricultural concentration, which is now in the closing process. And, we just went live with a $13.5 million mixed performance commercial real estate portfolio, which bids May 27.
The Winning Strategy
We provide additional marketplace insight below, but we first want to emphasize one crucial point: Institutions that resolve their problem loans before others will emerge as the winners going forward. This strategy worked during the financial crisis a decade ago and we expect the same dynamic will play out again because the COVID-19 crisis will have a profound impact on bank balance sheets.
Traditional patterns of consumer and business behavior are likely to permanently alter the way banks originate and manage CRE, Commercial & Industrial, and specialty finance loans. For sellers, this fundamental shift may be a once-in-a-generation event that results in another round of bank M&A. For investors, the upheaval could be another opportunity to buy distressed debt.
Based on our experience helping banks sell loans in previous crises, institutions should begin preparing now for a parallel strategy of active balance sheet management (loan sales) and M&A. They should be taking steps to better understand the vulnerabilities in their portfolios.
First-quarter earnings already show that many institutions are under-reserved for future loan losses. More losses are inevitable because the full impact of the economic shutdown won’t show up until the second and third quarters. Commercial real estate values in particular, will adjust downward significantly.
The lack of forward-looking visibility is due to the fact most lenders don’t update key data, such as LTV, DSC, and DTI after loan origination. As a result, loans may show debt service that now doesn’t exist. This is a systemic problem across the industry; it’s not just a few lenders. One way DebtX is helping institutions see around the curve is by performing stress tests that analyze loan performance and the impact of the leverage.
Overview of the Current Market
The secondary loan sale market continues to function efficiently.
For investors, it’s mostly fine tuning. They are continuing to buy and have plenty of dry powder – money raised before the COVID-19 crisis. Overall, investors are being more selective in bidding and more conservative in their pricing models.
A small number of investment groups have moved to the sidelines, but they have been more than offset by new entrants coming into the market. To that point, we have recently seen a significant uptick in DebtX registrations by investment groups of all sizes. Some are raising new funds for what they expect to be a flood of distressed loans hitting the market in the second half of 2020.
Investors that have stepped back are discriminating about the assets they chase and how they underwrite them. These investor groups typically have non-discretionary funds that constrain them. Or, they are sitting on the sidelines waiting for a return to normalcy. They want to avoid catching the proverbial falling knife. Some have imposed moratoriums on acquiring the most directly impacted asset classes, such as hospitality, energy and restaurants/retail.
What is Trading?
Over the past six weeks, we have seen all asset classes trade. Liquidity (i.e., number of bidders per offering) has been off slightly, but not materially. We’ve sold residential, consumer, C&I, CRE and JDC portfolios during this period. Even after the imposition of travel restrictions and the recent collapse in oil prices, a hospitality deal in the Bakken shale region of North Dakota received multiple bids and traded.
Pricing ranges are more dependent than ever on the particular asset class. The assets most directly impacted by COVID-19 are under the most pressure. Some investors are modeling these assets to recessionary levels due to the current uncertainty. Most investors are already receiving COVID hardship requests to defer payments or modify terms of loans in their existing portfolios, which has spooked them to a certain extent. Anecdotally, investors tell us they are discounting bids by 5% to 20%, depending on the asset class. However, pricing across our recent sales was stronger than those levels would suggest.
In summary, a high level of liquidity remains in the secondary market for whole loans, with most trades clearing at levels just moderately below original expectations.
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