Joel Ross is uniquely qualified to opine on the sharp rise in delinquent hotel loans held in commercial mortgage-backed securities. After all, in 1993 Ross and a partner, Lexington Mortgage, created the first Wall Street hotelprogram in conjunction with Nomura. “I take full responsibility for all the good or bad,” joked Ross during a recent panel discussion at the 16th annual Lodging Conference in Phoenix.
Now a principal of New York-based Citadel Realty Advisors, a real estate investment banking firm, Ross vividly recalls a discussion that took place on the trading floor of Nomura in 1993 that proved to be prophetic. “One of the Nomura bankers and I actually had a conversation about how this was going to end horribly, that there was going to be a gigantic financial crisis, that everyone on Wall Street was going to lose their jobs, and we knew exactly how it was going to play out,” says Ross. “All of these people who run around telling you, ‘We didn't know, we didn't get it,” they are all full of crap because a whole bunch of us knew.”
Ross still possesses the original underwriting manual for CMBS hotel loans that he helped write in the early 1990s. The manual required borrowers to have a 1.5 debt-service coverage ratio on a 12-month trailing net cash flow basis. Borrowers were required to have an audit. “Appraisals were never considered because we always thought they were useless. It was all cash, cash, cash,” says Ross. “That was the way underwriting started. By 2005, it was, ‘Are you breathing? Here's a loan.’”
In the early days of CMBS there were four tranches, or four different classes of notes, each with different bond credit ratings. During the real estate frenzy of 2005 through 2007, there were up to 16 separate tranches. “It became so complicated that the bond buyers never knew what they were buying,” says Ross.
Second wind for CMBS?
Despite the financial troubles that many borrowers of securitized hotel loans are grappling with today, the once dormant CMBS shops appear to be staffing up again. Lodging Conference attendees were surprised to hear of at least one shop offering financing at 80% loan-to-value and underwriting based on pro forma revenues rather than trailing 12-month cash flows.
“There is going to be a tsunami of new CMBS originations because the same guys will make the fees and they will refinance the old stuff,” remarked David Berins, managing partner of-based hotel consultant Berins & Co., during a panel discussion on hotel receivership moderated by NREI.
“For the borrowers it's going to be heaven because unless there is a rise in overall interest rates, their mortgage interest is going to go down by 200 to 300 basis points by refinancing with the new CMBS debt,” explains Berins.
But what about a hotel whose property value has fallen significantly? If the existing hotel loan was underwritten with a 65% to 70% loan-to-value and the new CMBS is at 80% loan-to-value, borrowers should be able to refinance in light of falling interest rates, says Berins.
The full brunt of the CMBS crisis has yet to strike the struggling hotel industry, warns Ross. The delinquency rate on CMBS hotel loans 30 days or more past due rose from 18.92% in August to 19.33% in September, according to Trepp LLC. Meanwhile, the pressure is mounting on lenders and special servicers to abandon the “extend and pretend” approach to troubled loans, insists Ross.
“Everybody has dragged this out as long as they can. I personally believe that next year that game is starting to be over,” says Ross. “But that is why not much [distressed property for sale] has shown up yet. It's there, and guys are dying, but nobody wants to blow the whistle. We're getting to a point where the whistle is going to get blown and that's next year, I think.”
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