This Time Is No Different

This time is no different. We are headed into the same mistakes as last round. In the oft repeated scenario, lending is back for both real estate and for commercial deals. Just as we did in 1993 when I created the first hotel CMBS programs, we began with a tough set of underwriting criteria, we ignored appraisals as being unrealistic, and we focused on who was the sponsor and what was the real historic cash flow. No projections, no special adjustments, no nothing other than getting to true cash flow and debt cover of 1.5 on trailing 12. Maximum loan was 60% initially of our valuation. It rose to 65% by 1994.As we all know, and as we predicted at the time in late 1993, competition heats up, lenders want to fill the bucket, and the bonus pool awaits closings. In 1993 the tighter underwriting lasted several years and only slowly mitigated until by 2006 there was none at all, negative debt cover was allowed and people actually believed appraisals even though they were even more phony than in 1993 and during the S&L bonanza. Corporate lending was equally ramped up over the same period. Then we went to CDO’s, CLO’s, and finally to virtual loans in pools. Many of us warned repeatedly in 2005 and on that covenant light was creating a very bad situation, and when things crashed the lenders would be very sorry.

So here we are just seven years after the market began its slide in late July 2007, and crash in 2008, and what do we find. Covenant light, CDO refreshed, CLO refreshed, What began this time as 11%-12% debt yield, has slipped to below 9 already in some cases. Leverage levels can sometimes reach 70% again. Appraisals are back as phony as before. While sponsorship remains a key metric, this will eventually slip. There are probably few people remaining doing underwriting who were around in 1993-94, and while some of those veterans may be in very senior positions now, they are not doing the detail work.