BID® Daily Newsletter
Aug 14, 2007

BID® Daily Newsletter

Aug 14, 2007

THE BUTTERFLY EFFECT AND CRE LENDING


The "butterfly effect" is occurring once again and goes to prove how in this interconnected world, problems in one market can quickly spill over into others. The recent turmoil in the credit markets has created a certifiable opportunity for bank lenders. Problems in subprime lending have roiled most asset-based securitizations, causing the market for all but the most plain-vanilla issues to grind to a halt. As a result, real estate conduits that provide long-term fixed rate funding to the CRE market are much less competitive in the last 3 weeks. Since most of these conduits rely on the capital markets for funding, recent turmoil has put a stranglehold on activity. Investors are now hyper-concerned over credit and Wall Street is finding it nearly impossible to place non investment rated tranches. Wider spreads are simply making securitizations non-economical at this juncture. As a result, conduits are unable to ascertain their next funding date, thereby limiting the amount of new product they can fund. In addition, commercial paper conduits, which normally fund new production on a short-term basis until a critical mass of loans can be collected for securitization, have also been reduced. This is further drying up liquidity. This is one reason why we reported that pricing on CRE lending has increased by 20bp in July, the biggest monthly increase since 2001. While many conduits were driving CRE pricing down to the Libor + 80bp range for high quality transactions, pricing has now widened back out to Libor + 125bp. For average quality transactions, pricing has increased even more and is now 40bp higher from record tight levels, to an average of Libor + 190bp. The current market provides community banks with an excellent opportunity to go back over deals that were lost in the past 60 days to make sure the borrower received the funding they were promised by a competitor. Further, for new transactions, community banks can now garner higher returns and should reexamine pricing. Banks interested in winning more profitable loan business without longer term fixed rate risk, can still utilize our turn-key swap program or take advantage of our BLP product (which allows the borrower to pay fixed and the your institution to receive floating through a loan participation structure). As we have said before, reducing construction lending exposure and offsetting earnings with a combination of CRE, C&I, agriculture and selected consumer exposure are some of the smartest moves community banks can undertake in such a volatile market. Consider that shocking an average longer term CRE portfolio with a recession-type scenario (15% decline in property values, DSCR fall below 1x), results in net charge offs approaching a survivable 2.28% of loans over a 2Y period of time. Compare that to the typical community bank construction portfolio, repeat the shock and most will find that losses approach a non-survivable 6.00% in as little as 6-months. All of this is a long winded way of saying that while bankers may have heard the beating of the butterfly's wings at the end of last year, the wind from those wings are now blowing some over. While we are not a fan of growing a bank in this market, if the strategic plan calls for growth, at least architect credit and the sales force to focus on more stable credits. Going after the CRE conduits is one such path that community bankers can currently exploit and gain quick traction, while reducing risk.
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