Walker & Dunlop, Inc. (WD) Earnings Call Transcript & Summary

Hey, good morning. This is Richard Hill, again, Head of U.S. Commercial Real Estate Research at Morgan Stanley. Thanks for joining us for our, I think, fifth panel at the CRE symposium. This one on CRE debt. Before I turn it over to panelists to briefly introduce themselves and their firms, a quick housekeeping item. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for employees of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to the Morgan Stanley sales representative. So with that, I'm going to turn it over to our panelists to introduce themselves. Steve, maybe I can start with yourself, if you can briefly introduce yourself and Blackstone mortgage REIT.

Sure. So I'm Steve Plavin. I'm the CEO of Blackstone Mortgage Trust, and BXMT is the senior mortgage investment vehicle within Blackstone Real Estate. I'm sure most of you are familiar with Blackstone, but -- on the real estate side, but we're obviously a large debt and equity investor globally and also in equity and in debt. And BXMT is a vehicle that we started about 7 years ago to address senior mortgage lending on large-scale assets, major markets, top owners. And today, we have about an $18 billion portfolio and about a $4 billion book value, so it's a significant vehicle. And we're happy to be part of this, Richard, and look forward to your questions.

Yes. Thank you. Kara?

Thanks, Rich, for having me. My name is Kara McShane, and I run commercial real estate at Wells Fargo, which is inclusive of all of our balance sheet lending activities as well as our capital markets or CMBS businesses.

And Brannon?

Hey, Rich, great to be with you again. Thanks so much. Brannon Hamblen, President and COO of the Real Estate Specialties Group here at Bank OZK, predominantly a construction lending platform with approximately $21 billion portfolio today.

And Willy, last but certainly not least.

Willy Walker, Chairman and CEO of Walker & Dunlop, commercial real estate finance company predominantly focused in the multifamily space, very significant presence with Fannie, Freddie and HUD, but then also putting out capital from, quite honestly, the 3 other panelists there, institutions across the country.

Yes. So, Kara, maybe I can start with you given that you oversee all commercial real estate at Wells Fargo. We've obviously seen tremendous growth in the commercial mortgage market. According to our data, it stands at $3.7 trillion, has grown at a 7% rate over the past several years. What do you think about overall for growth of the industry? Not specifically Wells Fargo, we're happy to talk about that, but I'm really more interested going forward, specifically, I should think about COVID-19. Are we going to continue to grow at the same rate as previously? Or do you think that there's a little bit of a slowdown coming?

Good question, Rich. I think that there's likely a little bit of a slowdown coming. That growth rate is -- I just don't think it's sustainable sort of in the short term this year. And when you look at what is likely to happen to property valuations, in some cases, it may have already happened. And when you look at what is likely to happen from an LTV perspective, as you think about commercial real estate debt, unlikely we're going to see leverage increase. If you think about cap rates widening to price risk a little differently in this environment, I think all of those things together will lead to less overall debt certainly for the near-term future.

Sure. And I think that's helpful. Willy, I'd love you to compare and contrast your view specific to the multifamily sector given that you're almost entirely focused, if not entirely focused, on multifamily. Do you think multifamily, that will continue to grow maybe because fundamentals are a little bit stronger?

Well, the role that the agencies play in the market, Rich, is obviously providing a significant amount of liquidity to the multimarket right now. And then if you look at the NHMC survey that came out yesterday on the rent collections in the first 5 days of the month of June as was the case in April as well as in May, rent collections have held up very, very strong in the multifamily space which I think only reinforces the sense that multifamily of all the commercial real estate asset classes is sort of most favored nation status, if you will. And so with the combination of rent rolls, in fact that people have to live somewhere, combined with the liquidity that the government agencies provide to the market, multi is holding up very well. To your question as it relates to volumes, there's no doubt to go back to what Kara just said, there's no doubt that aggregate volumes will fall off quite a bit given that there's not a whole lot of investment sales activity going on in the marketplace today. But I would say there is some, and that's actually surprising. If you'd said to me in late March or early April that we would actually have investment sales activity taking place at Walker & Dunlop in May, I would have put a lot of money against that. And we actually had 5 transactions transact during the month of May, and we are seeing buyers come back to the market as well as sellers taking properties to market. So the fact that the market is back up and it's not operating at nearly the same level as what was before, but the fact there's actually transaction volumes today speaks a lot about multi because other asset classes just right now, there's no bid on properties right now.

Yes. That's helpful. And, Steve, maybe I can turn it over to you before we're going to Brannon. I think there's a misperception about the type of loans BXMT originates because you're broadly classified as a commercial mortgage REIT, but you tend to finance different types of properties. Has this been a competitive advantage for you in any regard? Or do you think there's also going to be a slowdown?

I think that they'll be generally in industry. Loan demand for us is generated by transaction activity. And generally, sellers aren't selling and borrowers aren't borrowing because they don't perceive this being a good time to sell or borrow. Over time, people will be -- will need to transact, have loan maturities, still decide that maybe a slightly reduced price is actionable and they should go forward. So I do expect to see an increase in -- a general increase from here in business opportunity and loan demand, but it's slower now. I think the thing that's distinguished us so far in this environment is that we focus on very large deals. Our average loan size is about $130 million. And so it means large assets, larger sponsors. And the borrowers that we're working with tend to be sponsors of funds that have multiple billion-dollar portfolios. And so as we've got into this more difficult period, they have the financial ability to support their assets. So even though they're more impacted by the current market environment than others, when you have the strong sponsors, and I know Wells has the same focus, that we have strong sponsors that you get, you can outperform. And so I fully expect us to outperform in the current environment like we did rolling into this environment.

Yes. And so, Brannon, maybe I can conclude with you on the market. There's a lot of focus on construction volumes. What do you think that means for construction lending?

Yes, I would echo what the others said, Rich. The volumes should be down. I mean we're coming off the longest expansion since like 1854 or something since they started keeping record. We can't expect that, that's not going to fall off of that. It's not going to affect the volume at some level. There -- our pipeline, and we've seen that hit. There are still -- to Willy's point, there are still deals going off, and we're still underwriting and quoting deals through this time. To your earlier question, there is an advantage in this period, I think, I mean we've always, as Steve has, and when we've done a number of deals with Stephen's group focused on that quality and sponsorship. Those guys are going to be the winners in all this as things transition as we revamp and figure out what the new normal looks like, be having relationships with those types of sponsors is going to be a tremendous advantage. And then I think to pushing down the risk scale and leverage and realizing some benefit on the price side, too, is in the cards. But on the whole, we do expect less volume.

Got it. And, Steve, maybe I can go back to you. By all accounts and the statistics we look at, the commercial mortgage market has become increasingly competitive over the past several years from a variety of participants. Do you see a shakeout coming on the other side of COVID-19 for that competition? Or is there a scenario where demand for commercial real estate debt actually increases on the other side of this?

I think there'll definitely be a shakeout. We've already seen it with some of the companies in our sector have run into some difficulty, primarily with securities portfolios that we had financed on short-term repo. So I think they'll be -- I think the mortgage REIT sector will be a little less competitive on the backside of this, which I think will be beneficial for us. And I think some of the private funds are having some challenges as well. So I do presume that there'll be a better competitive environment. But what we need to see is the resumption of volume and transaction activity. And we've always been able to compete and get our fair share. So what we want to see is a larger set of opportunities, and we anticipate that will come in the second half.

And so I want to go to Willy then back to Kara. Willy, I'm torn on what we're going to see in the multifamily side because, again, fundamentals are strong. But do you think you will see less competition on the other side of this? Or will people actually move to focusing more on multifamily than previously?

It'd be hard to see that there'd be more focus -- I don't know, Rich, it's a hypercompetitive marketplace, right? It has been for quite some time. And so I don't know if there'll be much change. But I do think that given how well multi is going to hold up into this and that, I think many people thinking about values are looking and projecting sort of a year from now. And if you've got a retail property, there might be big question marks about the value of that retail property a year from now. I think everyone is thinking that multifamily properties a year from now are more than they are today. And as a result of that, even if rent rolls get beat up on specific instances, people will probably want to hold on to those assets and will probably feed those assets if they need to. And sort of just jumping on the back of what Steve said a moment ago, if you look at where Fannie and Freddie have had forbearance requests and then multifamily portfolios. Freddie Mac forbearance request so far, 75% of those requests have been on small loans. And so back to sort of what Steve said, where most of his big clients are large sponsor groups, I would say also in the agency space. A lender like Walker & Dunlop is really focused on larger sponsor groups. We don't have those small loans in our portfolio. There are plenty of small loan lenders who have had immediate issues as it relates to these smaller loans. If you're an owner of a multi-property that has 4 units in it, and 1 of those people walks out, you're at 75% occupancy overnight. And so I would just say that, that's the area of the market right now where we are seeing some weakness, and those are the borrowers who, quite honestly, don't have the big pockets to be able to feed loans when and if they come out of forbearance and they haven't gotten their occupancy back to where it needs to be.

Helpful. And, Kara, one of the things that has struck me about the last several years is the increased competition from local and maybe even smaller regional banks. How you think about a large-cap bank relative to those local and smaller regional banks? I could argue that I feel much more comfortable with the Wells Fargo lending than maybe I do at small local community bank. But can you sort of think about how those competitive pressures have taken away supply from the likes of Wells Fargo, if they have it all?

Sure. So I would say going into this COVID crisis, the lending markets were as competitive as they had ever been. And the competition wasn't just coming from one sector, right? It wasn't just local banks. It was mortgage REITs, debt funds, lifecos. I mean everybody was in the market, and it was very competitive, and we had a decade-long expansion. So this -- the situation now, I think that we're in, particularly with the liquidity disruption in the market in March and some of the stress that we've seen in the mortgage REIT space and the debt funds, that's the initial stress. The longer-term stress is what happens to fundamentals and what happens to the portfolios of the various institutions that we're lending. So I think the biggest key to the success is going to be how well capitalized this institution and what is their access to liquidity. And so those 2 things, I think, favor an institution like Wells Fargo that is very well capitalized and has access to -- relatively to liquidity. So from that standpoint, that's -- I think, will fare well sort of relative to the other participants in the market.

Sure. And, Brannon, maybe I can just conclude with you. We've seen a shift in -- to construction lending in a search for yield. I think we can debate, if everyone moving into the market is qualified to do so. But maybe I'm leading the witness here, but could you maybe talk about what you think about competition on the other side of this?

Sure. And there's the short run and then the longer run. I think what we're seeing on the deals that are in the marketplace, there are different -- a couple of different participants on all these different deals that we're talking to about seeing necessarily a real concentration there, but a lot of those are more sort of the smaller local lending institutions. And I'm not sure that there's a complete sort of understanding of what the market is doing and where those -- where the markets wanting to price some of those things. So -- but in the long run, if either you sort of -- you do figure out what the market is and you go there or you lose capital, et cetera, et cetera, there's a bad result there. I think everyone's made the point, hypercompetitive in the space, but when you're dealing with the really strong sponsorship that we've all noted, there is a premium placed on execution. We place it on the sponsor. They place it on the lending institution. And I think in the end -- I was talking to one of my guys yesterday and he's quoting a deal where we're probably 7%, 7.5% lower leverage and we're wide on spread, 30 bps. And there's a capital partner that's still pushing hard for us because they know we've executed. And I know all these guys on this call have experienced that. So there seems to be a lot of liquidity in the market, more competition, but I think execution wins at the end of the day.

Yes. That makes sense to me. Steve, I want to go back to you. Willy talked about forbearance and multifamily loans. And look, they seem like they've been a relatively nonevent and what we track for multifamily. But can you maybe talk about the forbearance that you've seen in your portfolio? You had mentioned specifically that you have high-quality sponsors. So has that mitigated the forbearance requests that you might have expected at some point?

I think it has. We -- it gets to the point some of the others have raised, is that when you have sponsors and borrowers who have the ability to fund interest and operating deficits even when revenues are shut down. The smaller middle market borrowers don't have that ability, but our borrowers do. So we're starting off from a point where they do have the ability to pay interest and pay operating deficits even in this environment where revenue has been shut down, and nobody could have reasonably anticipated this would occur. So that's the starting point. We've been trying to do philosophically is support our borrowers and trying to help them get through this period of time. I mean the obligation to do this is with the equity, not with the debt, but we have things that we can do to be helpful. On a hotel loan, it might be releasing some capital reserves and scenarios where the capital won't be invested given the current state of things, providing some other structural flexibility, help with some covenants that can't be met because the hotels are either are closed or their operations are curtailed. But the financial burden is staying with the borrowers. And the borrowers have been -- have done the right way to keep abreast with their ability to fund and their willingness to fund. And so I think, again, we're dealing with stronger sponsors, and I think Willy made the point as well, that they just have greater ability to fund a greater ability to perform in difficult times. And we're seeing that come to pass.

And, Kara, Wells Fargo actually has a pretty big master servicing portfolio for CMBS. And so maybe not thinking about your balance sheet portfolio, but your master servicing portfolio. Have there been any surprises or lessons learned over the past several months in terms of forbearance process for your master servicing portfolio?

I would say from a surprise perspective, I think we were prepared for the worst, right? When the crisis first hit, we looked at -- obviously, we looked at our entire portfolio, but we looked at our servicing portfolio in particular and thought about how bad it could get in terms of what we could be expected to advance in any particular month. And I would say that the numbers have come in far below our worst-case sort of scenario for expectations. So I think that's been a positive surprise. And frankly, each month that has gone by, I keep expecting it's going to get worse, right? Like May is going to be worse than April. June is going to be worse than May. And so far, we've been surprised from that standpoint as well. So I think that the CMBS market is doing as much as it possibly can. And I think both master servicers and special servicers are trying to be really collaborative with borrowers to really work through these issues as much as they can be with respect to the various pooling and servicing agreements that exist. So I think it's going as well as it can be right now. And on the balance sheet side, I'll just echo what Steve said. Most of our accommodations have been in the form of noneconomic. So covenant waivers, access to reserves, allowing reserve waivers. So they don't have to fund the reserve or they could just access reserve to service debt. So those types of things are really what we're seeing, and that's sort of across the board, CMBS and balance sheet. And from an actual, like, forbearance of interest or amortization, I mean, the number is a very, very tiny percentage. So we're just trying to be flexible and take it on a case-by-case basis and help our sponsors that we feel like Willy and Steve do. We have really well capitalized sponsors, and we just want to be part of the solution, not part of the problem.

Got it. And, Brannon, naive question, but how does forbearance work on a construction loan when you're actually building a property? Can you walk us through what you're seeing in your portfolio?

Sure. Well, of course, construction loans are not always in construction, and they ultimately get to the end and are opening, and that's generally where you see it as more as they're completed and moving into the ramp stage where the requests were made. Like the other guys mentioned, we've had the similar experience with our sponsorship in the handful of situations that we participated in some sort of part of the solution. It's -- from a regulatory point of view, it's pretty clear what we can and can't do and have done some deferral, but typically with a matched sort of contribution. To Steve's point, it's ultimately the equity responsibility and everyone stepped up to do that. But it depends on the property type. It depends where you are in the process. Delays in construction or not at all uncommon or surprising to a lot of our sponsors. So it hasn't been a huge impact there. Don't expect it to be a huge impact from just a pure construction delay point of view. It's more where you're open and operating or about to that you kind of have some issues.

Can I just jump in behind Brannon and just say that the one area where in the last crisis you did run into problems was in lease-up velocity and where construction lenders were getting caught without having to take out financing on a permanent loan. Today, if you're -- if you've got an asset that you had a Bank of the Ozarks construction loan on and you're leasing that up, there is plenty of capital to take out that construction loan and put permanent debt on or a bridge loan to get you to permanent debt. And there are big institutions playing in that space, and then they're all the specialty finance companies are playing in that space. And so I'd just say that, that was last time around a real concern for the bank, so getting off and out of their construction loans in this time right now, so far, that has not turned out to be a problem.

That's very helpful, Willy, and I appreciate you adding that. Maybe I can stay with you. How have lending standards changed at all on the multifamily side? Are you seeing tighter LTVs? Are you seeing higher DSCRs? Is it really just a focus on sponsor? Is it property type? Where is it a combination of all of it?

Well, I mean, the thing that you have right now is you've got, obviously, a very low base rate in treasuries. And then you've also had extremely tight spreads because the Fed has stepped into the market and bought during the crisis. And then subsequently, private capital has come in. Last week, the Fed was presented with about $500 million of Fannie Mae DUS bonds, and they didn't buy a single bond, which basically says that the market is functioning properly right now. We're looking at spreads that are at swaps plus 65 to 70 and sometimes tighter than that on Fannie and Freddie paper. And so the combination of a low base rate as well as really tight spreads is making it a very attractive environment for borrowers to refinance properties into. And so then the question is, what are you underwriting off of? There are 2 things that have predominantly driven the market and change. First of all, the agencies are asking for reserves. And so depending on the leverage level of the loan, if it's a full leverage loan, you're asking for a year's principal interest, taxes and insurance reserves. If it's -- what's a Tier 3 loan in Fannie Mae parlance which is kind of a mid-leveraged loan, you're asking for 6 months. And then if it's a low leverage loan below 5% LTV, you're not asking for any additional reserves. But those reserves are giving us as lenders who are taking the risk on those loans a lot of confidence that the borrower is going to be able to pay us for the next year, sort of regardless of what happens as it relates to roles as well as lease-up velocity on new properties. So that's been one significant change. And then I guess the other is just that because there hasn't been a lot of transaction volume in the months of April and May, the cap rates are that appraisers are using to underwrite deals and to appraise values haven't really moved that much. And as a result of that, while we're sitting there trying to take a conservative view, at the end of the day, it's all cash flow. It's not really LTV. It hasn't been an LTV lending environment for any of us for the last decade. So I think that that's really one of the fundamental shifts that has happened in the commercial real estate space. They rather than lending on LTVs or they could be assessed and be very, very subjective, all of us have moved to cash flow. And so as long -- on our side, as long as it's got a 125 debt service coverage, we'll go forward with the deal. And so you don't really have to worry too much about what the appraiser is coming in is relative value because we're really looking at the cash flows and whether we like the performance of the asset.

That's more detail than I could hope for, but not surprised coming from you, Willy. Kara, can you maybe compare and contrast just high level what you think about underwriting standards here?

Sure. So I would say our underwriting standards have not changed materially. We tend to underwrite consistently throughout cycles, and we're really never focused on LTV despite the fact that we have a very low average LTV in our portfolio. And now more than ever, you have to question the V. So we are very focused on cash flow or the ability for future cash flow. And I would say that really more than anything, we're just seeing more structure come back in. So we've seen, as a market, the erosion of structure over the last decade. We've seen a compression of spreads. And so those 2 things are reversing now. You're seeing more upfront structure, as Willy mentioned, whether that's debt service reserves. I think you're going to see less use of springing reserves and those types of things. But for the most part, very similar, I think, this tighter upfront structure.

Got it. That's helpful. Steve, I have a question coming in for you on the web. Actually 2 questions for you. First of all is a question about margin calls and not necessarily specific to BXMT, but I think there's a lot of confusion about why some commercial mortgage REITs have received -- have had margin calls and others haven't. My sense is that the margin calls have been primarily related to securities that are on warehouse or repo. Could you maybe just talk through the process for low actual loans that are warehouse can repo and how those are monitored?

Yes. We haven't received any margin calls. And margin call language that people have related to loans differs a lot from lender to lender. And so we feel like we have very strong language. We have strong underlying loans, and we have great bank relationships. So we haven't received margin calls. The lenders that had securities portfolios and on short-term repo with capital markets, mark-to-market provisions, they were margin very heavily in sort of the March, April time frame. And so we don't have securities in our business. It's all first mortgage loans for the most part. So we were not particularly vulnerable to that kind of margin calling. And also by virtue of our loans to loan performance, and we do business with, we're just less likely to be margin called. But it's still a risk in terms of using warehouse financing in your business. And we proactively reduce the leverage with all of our lenders, including Wells with -- by reducing our asset level debt, creating a little bit more flexibility for us and stability on our balance sheet. And I think with the goal of having a great foundation for new business, we've raised more capital. We're sort of ready to look at what the next-generation of loans will look like. And I sort of agree with Kara that we expect there will be a little bit lower on leverage, a little bit higher in spread, a little bit better structure some of the things that we've seen as you progress through the cycle. We're entering a period of volatility and low transaction volume. And when it resumes, that's what we would expect to see. And so being positioned to be there with capital when we see the beginnings of loan demand on -- for major assets consistent with our profile, I think there'll be great quality opportunities. And if you have stable liabilities, and you're very well positioned to take advantage of those.

That's helpful. Kara, a question coming in for you. It's a bigger-picture question, but I think it's a good question for you. But how do you gauge the overall degree of availability of CRE debt in the markets? Do you look at -- you track CMBS spreads? You track default delinquencies? What do you look at to measure the overall availability of CRE debt?

That's -- it's an interesting question. I mean I probably really just the look and feel of what's going on as we're -- what we're being asked to bid on and what the competitive landscape as we're bidding, quite frankly. I mean we certainly look at what's going on in the CMBS market and how much issuance there is annually. But we really look -- we look at all the MBA data and look at all the sectors, how much is coming in from the bank market, the life company market. But given that we're everywhere all over the country and really active in most markets, I mean, I think we have our finger on the pulse in terms of what the competitive landscape is at any given time. And I would just say, there's a tremendous amount of capital that is still available and waiting on the sidelines to take advantage of any type of distress. We're getting incoming calls daily looking for that to stress. And rates are still historically low. So all of those things combined with the fact that I think most of the maturities that are coming are really low leverage balance sheet debt. I think we're going to be in very good shape as an industry in terms of being able to have enough capital for the sector.

Brannon, I'm going to give you last word. We're running up on our lot of 35 minutes' time. But the question is coming for you on the web. As you think about the various different commercial property types, where do you see the most opportunity to lend right now? And maybe where you think the biggest risks are. That's -- and by the way, I'd open this up for everyone, but it's really a question that, I think, is trying to be nice, which is what property is actually like and not...

Well, opportunity can be defined in different ways. There's growth, there's yield. There's this, that and the other. But look, I mean, Willy's going to be very busy in the multifamily space. We all would agree with that. No contest there. In industrial, the change in the retail landscape is really pushing advantage to industrial. I think that's pretty well known. I think the question is going to -- on the other end, everybody is pretty aware of hospitality and retail and the tough road that they have to hoe. But there's opportunity there as well. I mean coming out of the last cycle, we were doing a lot of hospitality lending. Those contracts change every day, like the others, we're pushing down the scale and leverage, making sure our structure is strong and getting better yield. Office is the one that's really going to be interesting. How does that evolve in the future? And it's all been evolving. A lot of the trends we're seeing, we're already in place and just be accelerated by the pandemic. But that's one that, again, working with the sponsors that I think we all work with, it's going to be really fun to figure out. And I use fun loosely, but what does the future of office look like is a question we all want to figure out, and I think there'll be some interesting opportunities there.

Well, great, guys. Thank you for all -- number one, thank you for your partnership. Thank you for your willingness to do this. Your insights and your leadership are extremely important to Morgan Stanley, but also the broader industry, so thank you. Unfortunately, we have to cut it short given as a virtual panel, we move on to other panels. So for those that are dialing into the next panel on health care, please make sure to click on that specific link. But, Brannon, Willy, Steve and Kara, thank you for your willingness to chat with us today. We appreciate your insights.

Thank you.

Thanks very much.

Thanks, Rich.

Thanks, guys.