Question For the Credit Guys: When Is A Borrower Over levered?
Hi,
I've been thinking about this question recently, especially from a lender's perspective. You have a borrower that has say a 10M net worth . They have 10M in debt across various projects and lenders. The net worth is a combination of project equity and other unrelated assets (say 5M project equity and 5M other assets). When do you determine that the borrower is over levered?
The multiple lenders who have given loans used the borrowers high net worth to justify giving out the loans. But in a worst case scenario, the project equity evaporates, the loans default, and multiple lenders are making claim on the remaining assets. On the other hand, if lenders evaluate a borrower too strictly, they would never lend any money.
Multiple ways to skin a cat and I’m curious to see how others respond.
It’s usually not just a question of how much leverage but also what’s leveraged. When I was a credit analyst (re specific group) we would ask for a full real estate schedule. The schedule would be split up into multiple buckets: stabilized, non-stabilized, under construction, and land/non-income producing RE. We would require property location, T12 and/or proforma NOI, total loan commitments, current loan balances, loan structures monthly payment amounts, and maturities. Using all of that, we would calculate global DSCR, debt yield, and debt/total capital. We would look at those figures within each of the buckets and as a whole portfolio. If debt/total capital exceeded 60%, that was usually when we would start digging in deeper as to which properties were highly levered, were they performing, etc. We never did but if a lender was extremely thorough, they could also start layering WALT and tenant credit.
Guarantor Analysis was always the most time consuming part of the loan memos.
creditcreditcredit did a nice job of laying out a guarantor analysis. This is critical in determining the creditworthiness of the borrower and ability to repay in a downside scenario. Most banks use a stressed interest rate and amortization and will layer that into the global cash flow to project further down the line. Also need to be cognizant of other contingent liabilities wherein the borrower may be liable (recourse vs non-recourse).
Thank you for your answer! The dilemma I am encountering right now is the smaller borrowers claim dubious project values as their net worth and the larger borrowers won't give you enough detail on individual properties. The 60% benchmark is a good indicator and I will keep that on in mind.
The above method worked great at the regional lender I was at - all of our borrowers were either companies or very high net worth. Very sophisticated and understood that this info is part of every underwriting.
I ran into the same issues you’re describing at my first job as a credit analyst at a community bank... homemade property financial statements, struggling to get financial info from guarantors, etc. This problem is made worse when you’re caught between a completely risk averse credit officer and a loan officer who doesn’t give a shit and just wants to put money on the books. The nice part about community banks is that your prospective borrowers don’t always have other options and the golden rule of banking actually applies - he who has the gold makes the rules. Put your foot down and tell these guys I can’t get your loan approved if you don’t provide me with this info. If the loan officer doesn’t give a shit and won’t ask or put you in touch with the borrower, tell the credit officer what you’re dealing with and ask for some help. It’s tough as all these old school blue blood borrowers grew up in a time when they could loans on a handshake and resist todays requirements.
Character is a big part of underwriting personal investors. Ask around your local market to gauge their reputation. Pull credit reports and background checks. Ask around what happened to them in 2008. Did they default on their deals and walk away or did they help the bank through the work out and actually pony up? Also, ask for proof of liquidity and if they’re listing their assets at market value, they better be listing the deferred tax liability - that’s a real easy way to artificially inflate net worth if they don’t.
Have you heard of SPE? How can other lenders claim on your collateral lol
Not all borrowers are large enough to have shell companies set up. And often the shell companies have their cash flows go up to the parent. So ultimately you want the parent company to sign off, which the other lenders have also done.
A simple question to answer is "how much stress the borrower's portfolio can handle given their leverage?" More specifically
Can their portfolio handle a 10% drop in NOI?
Can their portfolio handle a 200 bps increase in cap rates?
Can they handle both?
If you look back at what happened in both the 2008 and 1991 recessions and the portfolio will survive either of those then it is probably not overlevered.
Very helpful ideas. Thanks!
We would lookat the combined loan to value of all REO and also liquidity position. If half of his net worth ison one peoject we would probably want to understand it better. Also, if the deal is really small versus the net worth, such as a $2 million refi on a $10 million net worth borrower, it may be less of a concern if the ltv and dcr are strong.
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