Quarterly Market Snapshot: Macro Pressures in a Bifurcated Market

December 2022
Credit sensitive (NPL and criticized loans) sale activity has been steady, with spikes of activity as some large portfolios hit the market. Trade rates remain high across the broader market. The rapid increase in interest rates has impacted loan pricing at the margin but a lack of supply (loans for sale) relative to demand (capital available) has kept pricing within range of expectations, allowing the market to clear.

On the other hand, performing loan sellers have not been so fortunate. NPL and criticized loans are often of shorter average duration with a range of assumed outcomes and exit strategies, while performing loans are priced based on simple bond math. This means that many would-be loan sellers have been caught offsides by rapidly increasing rates and must accept market discounts or be forced to hold sub-optimal earning assets on their balance sheet. This paper has flooded the market over the past few months and while public, market-wide data is scarce, all anecdotal evidence suggests that trade rates are low, but slowly increasing as interest rates stabilize, buyers find confidence and sellers accept sub-par pricing for below market rate performing loans to be the new normal.

The primary lending market continued to deteriorate during Q3. Index rates and spreads increased, offered leverage decreased and overall credit boxes shrunk. Some asset classes have gone largely “no-bid” and the days of easy financing are behind us. We are starting to see indications of this dynamic in our deal flow. That is, lenders are asking us to review transactions that until relatively recently, would likely have been refinanced by another financial institution.

Overall, the secondary market remains deal flow constrained with excess capital immediately available to mop up any incremental increase in volume. We think that this supply-demand imbalance is largely responsible for keeping prices elevated while the media screams recession-ahead. This is not to say that pricing isn’t negatively impacted with Libor/SOFR +300BP from 2021, merely that for now anyway, loan sellers should be comforted that the market looks nothing like the last recession and ample liquidity is available across virtually all collateral asset classes without show stopping haircuts.

Office remains on everyone’s mind and for good reason. Our pricing deal flow has increased and a few have trickled out to market when pricing expectations matched up favorably. With several recent trades under our belt and many more priced, we can draw a few conclusions

Secondary market risk-based pricing. Although the primary origination market appears to be shunning the office sector as a whole, the secondary has proven more receptive, especially for small balance and middle-market (sub-$50MM) credits. Pricing can vary widely, with observed trades at 90% to par for short duration performing and criticized loans, and deeper discounts for collateral impaired loans with capex and/or leasing issues.
Bifurcated market. Loans secured by well located, well maintained suburban assets with a diversified rent roll will trade largely on fundamentals as opposed to broad based fear and headlines. On the other hand, we’ve seen loans secured by assets with large near-term rollover, capital improvement needs and lease termination options significantly impairing collateral value and by extension, loan pricing.
CapEx and TI in focus. Capital expenditures and tenant improvement costs are a wildcard in valuations and require careful evaluation by lenders prior to any decision to foreclose. We’ve seen several scenarios where potential expenditures are enormous and on a NPV basis add very little to ultimate resolution value.