Quarterly Market Snapshot: Market Imbalance vs. Macro Headwinds

Happy Sellers: Repeat bank sellers (test the market, overachieve on price, rinse and repeat) continue to populate our transaction sheets. Same, too, for non-bank funds and loan buyers selling positions and closing out legacy funds. Wow, those are some profitable tails! We’ve also seen some early-COVID buyers who had the courage to invest while we were masked in our homes, come back to the market now and take some tidy gains. Although macro-economic storm clouds can be seen in the distance, the market remains overwhelmingly seller friendly.

More Liquidity Than Assets: An old friend of mine used to say, “All assets seek liquidity”. Well, that maybe so, but the assets are playing hard to get at the moment and a significant supply-demand imbalance persists. The secondary market, or at least our little corner of it, is still awash in liquidity desperately seeking assets. The average number of investors registering for deals remains at historically high levels, as does the number of bids per deal. And as is usually the case when competition is fierce, transaction pricing is similarly high, generally exceeding seller expectations. It remains a seller’s market for any type of loan, especially one with some blemishes.

Loan Sales Keep Popping Up in Unexpected Places: Notwithstanding today’s strong credit market, one-off loan sales keep surfacing for a multitude of reasons. We’ve recently seen several large syndicated credits with unwilling sponsors and unhappy bank groups look to our market for relief. A large West Coast multifamily loan went sideways shortly after origination, and tight underwriting put the narrow cash flow coverage at risk. Out-of-footprint hotel loans got the exit nod following a bank merger and a recalcitrant borrower finally wore out his welcome at an insurance company. So far however, transactions seem to be driven at the loan-level or corporate level (M&A, CECL), rather than due to broadly deteriorating economic conditions.

Macro Storm Clouds: Banks and the general economy are flush with cash, but inflation is persistent and increasing. Energy, commodities and food prices are joined at the hip and ripping higher with supply challenges further exacerbated by the war in Ukraine and subsequent sanctions and self-sanctions. In his annual letter to shareholders, JP Morgan’s Jamie Dimon wrote that the bank is “prepared for drastically higher rates and more volatile markets.” Credit Suisse interest rates guru Zoltan Pozsar goes much deeper in his (very dense) March 31^st Money, Commodities and Bretton Woods III letter. Calling for higher rates and higher inflation, Pozsar writes “The current environment is perhaps more complex than in 1997, 2008 or 2020, for the problem is not only nominal (FX pegs, par or the great overdraft, respectively), but also real: commodities are real resources (food, energy, metals) and resource inequality cannot be addressed by QE…..you can print money but not oil to heat, or wheat to eat”.

Against this backdrop, it seems prudent to examine loan portfolios for areas of weakness while the secondary market is hot. Inflation pressures bank borrowers’ cash flows while increasing interest rates crimp refinancing options for marginal credits, drive cap rates higher, and usher in more focused regulatory review suggesting a proactive stance.

Crypto Loans: We recently began pricing bank portfolios with loans secured by Crypto as collateral which led to the question, what type of asset is Crypto? Is it a currency, a commodity, a speculative asset? We had a meeting with a large federal regulator at the same time and posed the question to them. The regulator’s response, “Do you see currencies in television ads with celebrity spokespeople? It’s a speculative asset unless we issue it.” Admittedly, the regulator had as many gray hairs as this writer, so consider the source of the comment.

Ukraine: As many folks know, we were very active in Ukraine helping its regulators and banks shed troubled assets over several years. We have colleagues and partners in Ukraine, all friends, who are now defending their homes and their freedom. Our Ukrainian friends and colleagues, and their fellow countrymen and women, are in our thoughts and prayers. We are inspired by their bravery and honor.