What is a non-recourse loan?

In all forms of real estate, a landlord’s biggest partner is its lender, which can provide financing for up to 90% of a property’s value. Many experienced commercial property owners prefer “non-recourse” loans because the borrower/sponsor does not need to provide a personal guarantee of the loan obligation. Simply, if a property owner defaulted on the loan, the lender’s recovery is limited to the loan’s collateral, the property. Owners of properties considered to be the most volatile – hotels, shopping centers, office buildings – most often borrow non-recourse. While life insurance companies and banks will lend non-recourse, the terms would generally require exceptionally low leverage.

 

What do bonds have to do with this?

Non-recourse loans are “pooled” and sold to bondholders via Securitization. Securitization is the most efficient way to sell loans in bulk, because the loans are sold as “rated bonds”. Bonds are rated on a credit scale that allows buyers to compare the financial health across many business sectors.

 

Explain Credit Ratings

BBB Rated Company – As of 4/8/2020

For example, CVS Health Corp is rated BBB. CVS Corporate unsecured debt ranks senior to CVS Stock. Last month, if I were to buy an 8-year bond secured by CVS, I would be compensated with a yield of approximately 4%

 

BBB Rated CMBS – As of 4/8/2020

CSAIL 2019 C-16 is a Commercial Mortgage Trust. Last month an investor could purchase Class D rated BBB for a yield of 4.0%

 

Haven’t I seen this movie before? Credit Rating Agencies? AGAIN!?

Since the 2008 financial crisis, there have been efforts from many in the industry and new laws from policy makers that improved the governance and conflicts of interest within this industry. However, there is still a fundamental flaw in how bonds are rated and “tranched”. Since 2008, the number of rating agencies doubled, and credit ratings remain competitive for-profit businesses.

 

What will happen in the next 180 days? 

  • Within 45 days $300 Billion in mortgage bonds will be downgraded to ratings indicating eminent default
  • From day 120 to day 180 about $40 billion in bond holders will not receive interest
  • CMBS issuance will grind to a halt and the largest non-recourse loan market will be closed

There will be capitulation and confusion among a universe of buyers that thought they were buying low risk securities, that immediately fall to C, CC, CCC. Because loan pools differ, the arbitrage for us will be to underwrite and strategically purchase loan pools (otherwise known as our job)