sessionc3 finance… · non – recourse ! solutions ! higher level of pre – sales combined with...

SESSION C3 FINANCE SESSION: HOW DO LENDERS STRESS TEST

THEIR DEALS? AN INSIDE VIEW

Moderator: Steven Hart, Managing Director, Prairie Region , CMLS Financial Ltd. Panel: Geoff Coombe, AVP & Regional Director, Commercial Mortgages, Prairie Provinces, Manulife Financial Jeff GoveD, Calgary Regional Head, Commercial Real Estate, HSBC Bank Canada Jason Jogia, Director & Group Lead, Prairie Region, ScoFabank Dean Proctor, VP & Deputy Regional Manager, Prairies, Canadian Western Bank

CANADA’S MORTGAGE COMPANY.™ Over 35 years, 7000 customers and 6 billion in assets. A dedication to Customer Forward.

-

20

40

60

80

100

120

140

160

180

200

2011 2012

Billions

Estimate

CMLS Survey

Size of the Market

$173 B


-

5

10

15

20

25

30

35

2011 2012

Billions

Estimate

CMLS Survey

2012 Origination – A BIG YEAR

$33 B


0%

2%

4%

6%

8%

10%

12%

14%

5 Year GoC Interest Rates

Source: Bloomberg


0%

1%

2%

3%

4%

5%

6%

7%

Commercial Mortgage Loans 5 Year Spreads and Coupons

Coupon Spread Source: Canadian Mortgage Loan Services Limited, Bloomberg Source: CMLS Financial, Bloomberg


Canadian CMBS History

•  First Canadian CMBS in 1998 •  Expected 2013 volume is approximately one-third of peak 2006 issuance volume

-

500,000,000

1,000,000,000

1,500,000,000

2,000,000,000

2,500,000,000

3,000,000,000

3,500,000,000

0

2

4

6

8

10

12

Out

stan

ding

Bal

ance

# of

Tra

nsac

tions

Canadian CMBS Outstanding

# of Transactions Outstanding Balance

COMMERCIAL BANKING 7

RISKS •  Inflationary Costs

•  Interest Rates

MITIGANTS •  Fixed Price Contracts •  Developer Experience •  Contingency •  Presales/Preleasing •  Stress test unfixed costs •  Completion and Cost Overrun

Guarantees

•  Contingency/Interest Reserve •  Unfixed revenue

Interim Construction Stress Testing


RISKS •  Sales/Market

•  Timing/Scope

MITIGANTS •  Presales/Preleasing •  Deposit Level •  Time to completion •  Rental Economics •  Contract provisions •  Stress test unfixed revenue

•  Developer Experience •  Local Market Knowledge •  Nature of project •  Contingency level




•  While Lenders stress test a project a Lender can not look at a project in isolation, thus Lenders must look at the support of the covenant involved in the project to further mitigate key identified risks

•  Cost Overrun Guarantees •  Completion Guarantees •  Financial Guarantees •  Cross Collateralization


Case 1

SITUATION: •  Client seeking interim construction loan to build 4 storey condominium with 55 units and

retail component in inner-city Calgary •  Project cost: $20,500,000 •  Client wants to mobilize construction a.s.a.p. in advance of presales in order to:

•  Mitigate against rising costs •  Take advantage of the inflationary sellers market •  Demonstrate to market that project is mobilized

KEY RISKS: •  Sales/Market – Unproven market acceptance of product with lack of presales •  Inflationary Costs – if project launch is delayed face higher construction costs

SOLUTION: Staged presales test 1.  Initial land loan @ 60% of land cost - allows commencement of development 2.  Zero sales – ~25% equity requirement 3.  25% sales – ~20% equity requirement 4.  50% sales – ~13% equity requirement


Case 1

Benefits to Lender Benefits to Developer 1. Sales/Market risk is mitigated through added equity upfront of 25%. - Ensures LTV remains conservative (< 52%) which substantiates rental economic underwriting model

1. Phased solution provides our client with access to bank financing at various stages to ensure project is developed in their desired timeframe.

2. Inflationary costs risk is mitigated through fixed price contracts and short time horizon to completion.

2. Further allows for equity repatriation as sales momentum builds within the project. - Further enhances client’s overall ROE


Case 2

SITUATION: •  Client seeking interim construction loan to build 65 unit 4 storey condominium in Edmonton

AB. Subject building is the 2nd phase of an existing bank financed project (identical building) •  Project cost: $12,000,000 •  Client wants to mobilize construction on next building to take advantage of strong market

•  Continuation of sales momentum in existing building •  Wants to sell out of first building before achieving sales milestones in second. •  Client does not want to inject excess equity at this time – held flat at 15%

KEY RISKS: •  Sales/Market – untested demand in second building due to lack of presales •  Scope/timing – product in initial building could cannibalize sales in second building

SOLUTION: Cross collateralization •  Zero presales requirement in 2nd building based on strength of presales (80%) in 1st building •  Upon completion of 1st building, portion of proceeds will be injected in second building to

increase equity to 25% or, •  @50% presales sales in 2nd building – equity remains flat at 15%


Case 2

Benefits to Lender Benefits to Developer

1. Sales/Market risk is mitigated through the cross collateralization and undertaking to inject further equity if sales momentum stalls.

1. Solution allows client to manage cash resources effectively.

2. Scope/timing is mitigated through added equity from net sales proceeds in Building 1 if sales are cannibalized in Building 2.

2. Allows client to sell out of initial building and repatriate equity from initial building when presales are achieved.

Canadian Western Bank

¨  Case Study # 1 ¤  $ 7.5MM interim construction financing over a 35M square feet multi – tenant retail

development

¨  Challenges ¤  Non – metropolitan location ¤  Only 40 % pre – leased at the time of authorization (market risk) ¤  Partially owner – occupied

¨  Solutions ¤  Staged loan authorization:

n  $ 500M à no leasing, land advance for predevelopment n  $ 4.5MM à 55 % LTC and 40 % pre – leased n  $ 6.5MM à 75 % LTC and 75 % pre – leased n  $ 7.5MM à 86 % LTC (70 % LTV), construction complete, substantially pre – leased,

refinanced over 25 years


¨  Mitigation ¤  Seasoned developer with historic track record of completing projects on time and on budget ¤  Long – term leases (solid mix of national, regional and local tenants) minimizing rollover risk ¤  Satisfactory covenant support / liquidity in case of a cost overrun / cash call, project delay or

slow lease – up ¤  Major construction components under a fixed price contract, reducing the potential for a cost

overrun or cash call

¨  Stress Testing ¤  As this is a build and hold project, we examine the ability of the sponsors to handle increases

to the budget during construction and what impact this might have on LTC and LTV underwriting assumptions as well as the potential ability of the project to handle more debt if an increased loan authorization is requested

¤  Upon completion and consideration of takeout financing, we consider how the property on a standalone basis can handle shocks, namely increases in vacancy, decreases in rental rates, increases in interest rates and rollover risk of tenants upon lease maturity


¨  Case Study # 2 ¤  $ 20MM interim construction financing over a residential lot development

¨  Challenges ¤  Stub loan after initial phase ¤  Deposits utilized in the loan program ¤  Non – recourse

¨  Solutions ¤  Higher level of pre – sales combined with increased deposits from reputable builders to help

mitigate stub loan component ¤  As an alternative to sponsorship, a Letter of Credit / cash reserve facility was established to

cover off the potential for cost overruns / cash calls, project delays or pre – sale rescissions / slow sales on remaining lot inventory


¨  Mitigation ¤  Experienced land developer ¤  Pre – sales from Tier 1 home builder group with stipulated lot takedown requirement

minimizing the probability of sale rescissions ¤  Major construction components under a fixed price contract, reducing the potential for a cost

overrun or cash call

¨  Stress Testing ¤  As this is a develop to sell project, we examine the standalone metrics of the project to

ascertain the following: n  Pre – sale coverage of loan facility (potential market risk / exposure on unsold inventory) n  If there is a cost overrun / cash call or project delay, how is profitability impacted n  Protracted or rescinded sales (will an extended marketing campaign elevate the project

budget via additional carrying costs that again hamper profitability) n  If sale prices decline (how does this potentially impact the value of unsold lot inventory as

well as the value of the residual land component / is the project still viable going forward)

Over the past few years Life Companies have adopted Moody’s and/or DBRS raFng matrixes

A number of underwriFng factors come into play, with various weighFngs, that affect required LTV and Stabilized DSC levels and affect loan raFngs assigned by lenders and accordingly affect interest rates offered by lenders.

STRESS TESTING COMMERCIAL MORTGAGES

Calgary Plaza -‐ 123 Somewhere Street SW

DescripQon: 45,000 square foot, class B, mulF-‐tenant, retail strip anchored by a 15,000 SF naFonal drug store.

The property was built 10 years ago and has received proper maintenance since it was built.

The property has a desirable locaFon an upper income neighbourhood in southwest Calgary.

EVALUATING THE PROPERTY Property Type & Quality

Effective Age

Location

RATING: GOOD - VERY GOOD

EVALUATING THE TENANCY

Leasing InformaQon: Anchor tenant (drug store) has extended their lease for another 10 years. Remaining tenants have typical remaining lease tenures.

The drug store is a financially strong enFty and the remaining tenants are a mix of local and regional firms of typical financial strength.

A lease just rolled yielding a current vacancy of 1,200 SF or 2.6%, however, the property’s historic occupancy level was superior to comparable properFes.

Remaining Lease Tenure

Financial Strength of Tenants

Current and Historic Occupancy

Lease Rates

RATING: GOOD - VERY GOOD

Lease rates in the property average $32 per square foot, while the anchor tenant pays $28 per square foot. Lease rates are somewhat below going Market. All leases are triple net with operaFng costs averaging $8 per square foot.

The Borrower -‐ Joe Smith’s Real Estate Holding Company

The borrower provided un-‐audited externally prepared C/A financial statements for the year ending 2012.

The borrowing enFty owns the subject and a good number of commercial real estate assets with substanFal equity in each property.

The borrowing enFty is a limited company with Joe Smith as the sole shareholder.

Joe Smith is a somewhat experienced commercial real estate owner/operator and has a good reputaFon in the business.

Borrower is seeking best pricing vs. most aggressive loan term opFons. Borrower is prepared to provide loan recourse if necessary.

EVALUATING THE BORROWER Quality of Financial Information

Financial Condition of Sponsor

Borrower Structure

Reputation and Experience

Additional Security & Guarantee

RATING: GOOD

EVALUATING THE LOAN – Key Stress Test Factors Key Factors

Examining Loan Options & Pricing

•  Loan to Value RaQo (LTV) -‐ 0% – 75%

•  Stabilized Debt Service Coverage RaQo (DSC ) -‐ 1.20X and up

•  Refinance capacity at end of term (DSC and LTV)

These three factors account for approx. 75% of the stress test raFng. Note the raFngs may be massaged using common sense. Loan raFngs are internally re-‐evaluated annually.

60% LTV

Recourse

20 year am

1.5X DSC / 25 year am Spread: 150 BPS

A+ 65% LTV

Non-‐recourse

25 year am


A-‐ 72.5% LTV

Non-‐recourse

25 year am


BBB

Based on the aforemenFoned stress tesFng we can offer the borrower the following loan opFons:

RESTRICTED

HSBC BANK CANADA Project: Multi Family Rental Project Structure: Term Debt Drawn $15,000,000

Term Debt Undrawn $2,500,000 Purpose: Payout Construction Debt (drawn amount) and provide Capital for

another project (undrawn amount) at a future specified date Term: 5 year term, 20 year amortization Loan to Value: 70% Sensitivity Analysis: DS cover requirement at current rates plus 1% Challenge: Borrower wants to take advantage of the lower interest rate

environment on both the drawn and undrawn portions of the loan. Solution: Provide a 5 year interest rate SWAP against 30 day Bankers’

Acceptance to hedge against any increase in interest rates. Forward starting SWAP allows for the advance of the Undrawn

portion at a future date

Companies with floating rate

borrowings are exposed to interest

rate volatility

Rate volatility translates into

interest expense volatility

Swaps can be used to manage interest rate

risk, to reduce variability of interest

costs, and net income

•  Currently, companies are enjoying an environment of historically low interest rates

•  Many clients have floating rate loans based on short-‐‑term interest rates, such as 1-‐‑month Bankers’ Acceptance (BAs)

•  The interest rate on these loans is reset monthly at prevailing market levels

•  This can lead to fluctuations in interest expense •  Swaps can be used to manage interest rate risk by fixing the BA

component of the loan, to reduce variability of interest costs, and net income

Lender

HSBC (or third-‐‑party)

Swap Counterparty

HSBC

Client

Floating-‐‑Rate Loan Underlying Risk

Interest Rate Swap Hedging Instrument

Floating 1mBA + Stamping

Fee

Fixed [5%]

Floating 1mBA

RESTRICTED

HSBC BANK CANADA

AFTERNOON REFRESHMENTS SPONSOR

sessionc3 finance… · non – recourse ! solutions ! higher level of pre – sales combined with...

Documents