Book recs for understanding debt
Starting a position at a bank in the next few months on a pending team. All balance sheet lending with a fair mix between acquisition and construction and across all property types. Does anyone have any book recommendations to help lower the learning curve. Transitioning from a role in an investment sales brokerage.
[{"id": "fo6ptuq", "text": "Not a book recommendation but things to understand:\n\n1. Debt service coverage ratio (DSCR)\n2. Debt yield (DY)\n3. Loan to value (LTV)\n4. Loan to cost (LTC)\n5. Cap rates\n6. Interest reserve analysis and operating deficit models (for construction loans)\n7. How interest rate swaps work\n8. Defeasance (applies to CMBS loans primarily)\n9. Yield maintenance \n10. The 5 c\u2019s of credit (character, capacity, conditions, capital, collateral)\n11. Learn how Freddie Mac multifamily underwrites deals.\n12. Learn how Fannie Mae multifamily underwrites deals.\n13. Learn how CMBS groups underwrite different property types.\n14. Learn how life insurance companies underwrite different property types.\n15. Learn how debt funds underwrite different property types.\n16. Make sure you understand sponsor/guarantor analysis.\n17. Mortgage constant (also called loan constant)", "replies": [{"id": "fo6zjep", "text": "Lifeco Lender here... I'd be happy to provide an overview of these topics from a lender's perspective.", "replies": [{"id": "fo7g3yc", "text": "Yes please DM me when you have a chance! Really appreciate it!", "replies": [{"id": "fo7hhai", "text": "Think I'll just hit each one here so anyone reading can benefit and come back to it.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "fo79d4n", "text": "This is an excellent list to start with. If I had to pick one as being the most important to learn, I\u2019d pick DSCR. \n\nThe faster you understand how DSCR is calculated, massaged, manipulated, and guesstimated, the more useful you will be. Better yet, being able to spot what is *off about a DSCR* calculation from a few paces will really improve chances with CRE banking.", "replies": [], "depth": 2}, {"id": "fo7r3qy", "text": "Pg 1\n\n&amp;#x200B;\n\n&gt;Debt service coverage ratio (DSCR)\n\nFormula: NOI / Debt Service (can be based on IO - interest only payments - or amortizing payments). Expressed as \"\\_.\\_x\", as in the number of times the NOI can pay the debt service.\n\nTips: Often used to \"size\" the loan... Lender's want to make sure there's a healthy cushion of income in case of, for example, a world-wide virus pandemic that wipes out tenants' ability to pay rent. 1.25x is pretty standard for a Tier 2 (full leverage) Agency loan. LifeCo lenders will run a CM calc using a stressed mortgage constant based on 25-year amortization - a 1.50x will qualify as the \"best\" quality and require the lowest RBC charge (risk-based-capital).\n\nProtip: Debt Yield / Interest rate = DSCR (IO). Use the mortgage constant instead of interest rate to get the amortizing DSCR.\n\n&amp;#x200B;\n\n&gt;Debt yield (DY)\n\nFormula: NOI / Loan Amount. Expressed as \"\\_.\\_%\" Lenders started focusing on this metric after the GFC when historically low interest rates started skewing the above metric, DSCR.\n\n\\*\\*Debt yield is the preferred risk metric for sophisticated Lenders because it ignores 2 things that can skew perceived risk - cap rate compression (LTV) and interest rates (DSCR).\n\nProtip: Debt Yield = Cap Rate / LTV.  It's also essentially the inverse of the Debt/EBITDA metric found in traditional corporate finance. So for example, in a traditional PE LBO model you might target 8.0x Debt/EBITDA... that would be a 12.5% debt yield in the real estate world. \n\n&amp;#x200B;\n\n&gt;Loan to value (LTV)\n\nFormula: Loan Amount / Value (ie implied value or purchase price). Expressed as \"\\_.\\_%.\" The higher the %, the higher the risk. Lenders often triangulate between LTV/DY/DSCR to size loans - for example, loan proceeds might be limited to the lesser of the resulting loan amount using a specific parameter for all three metrics.\n\nProtip: LTV = Cap Rate / Debt Yield.\n\n&amp;#x200B;\n\n&gt;Loan to cost (LTC)\n\nSame as above LTV only the denominator includes total capitalized costs (e.g. acquisition + capex + leasing costs (TI/LC), or in the case of development, total development cost. More useful to construction and bridge loans than permanent loans.\n\n&amp;#x200B;\n\n&gt;Cap rates\n\nFormula: NOI / Value (ie implied value or purchase price). Expressed as \"\\_.\\_%.\" It's the inverse of an EBITDA multiple. So for example, a 4.0% cap rate is the same as a 25.0x EBITDA multiple.  Real estate uses cap rates to compare investments on an un-leveraged basis instead of EBITDA multiples because it's an asset class that is seen as a proxy to fixed income (so you can compare to bond yields), and because real estate almost always uses debt to create a leveraged return, so it's easier to compare a cap rate to other relevant yields like cash on cash, IRR, yield on cost, etc. than it is to compare a multiple to those yields (I'll hedge that by admitting many investors do not use leverage).\n\n&amp;#x200B;\n\n&gt;  \n&gt;  \n&gt;Interest reserve analysis and operating deficit models (for construction loans)\n\nI don't do construction loans, so if someone else who has more experience wants to chime in, please do so. I do however do bridge loans, and the concept is pretty much the same. Lenders will want to have cash set aside for specific event risks (payment of interest, payment of operating costs, payment of re-tenanting costs for a lease rollover, payment of capex needs, etc), so reserves are used to make sure that cash is available. Lenders do not want to have to chase recourse or sue under a guaranty - it's costly, takes a long time and gives leverage to the Borrower at precisely the worst time for the lender.\n\nAs far as modeling it - think about it like any other waterfall, only in reverse - the bucket should be filled with enough water to cover the intended cash shortfall item - operating expense deficits, interest payments, etc.", "replies": [{"id": "fo7r7uo", "text": "Pg 2\n\n&amp;#x200B;\n\n&gt;How interest rate swaps work\n\nA contract that says which counterparty pays the fixed rate side and which one pays the floating rate side. This is a bank thing. You pledge collateral to cover the payments if you go out of the money. Lifeco's don't allow this, unless its very high up the org structure and doesn't convey an interest in the Property. I don't sell the product and I don't allow it on my Properties. I'm sure a bank lender or mortgage broker can provide better explanations here.\n\n&amp;#x200B;\n\n&gt;  \n&gt;  \n&gt;Defeasance (applies to CMBS loans primarily)\n\nThe term defeasance is associated with MBS, but it's essentially the same as Yield Maintenance. Basically, in the event of a prepayment ahead of loan maturity, the Lender is losing its investment, so the Borrower will be required to provide an up front lump sum (yield maintenance) or a basket of (risk-free) securities that will replicate the payments the lender (or bond holders in MBS world) would have received under the terms of the loan.\n\nTo calculate YM, you want to model the payments for the loan until maturity, then use \"XNPV\" in excel to get your PV and subtract the principal outstanding at the time of payment. Usually, the prepayment fee is calc at the greater of the calculation above or 1%.\n\nThe trick is getting the right discount rate - typically, this is the mortgage equivalent yield of the closest US Treasury. So if there is exactly 120 payments left, congrats you can use the 10-year, otherwise, you probably have to interpolate to get the right yield. The next step is to convert the yield from semi-annual (bond yield) to monthly (mortgage yield). You can google that calculation, I won't bore you anymore.\n\nProtip: Lenders will often give you T's+25 bps or 50 bps for the discount rate calc for free; you just have to know to ask. This is money on the table.\n\nTo do defeasance, call a broker.\n\n&amp;#x200B;\n\n&gt;Yield maintenance\n\nOops, didn't see this one until now. See above.", "replies": [{"id": "fo7ra5b", "text": "Pg 3\n\n&amp;#x200B;\n\n&gt;The 5 c\u2019s of credit (character, capacity, conditions, capital, collateral)\n\nThis would be a longer post... don't have time right now.\n\n&amp;#x200B;\n\n&gt;Learn how Freddie Mac multifamily underwrites deals.  \n&gt;  \n&gt;Learn how Fannie Mae multifamily underwrites deals.\n\nThe agencies are dumb and don't know how to underwrite deals. These guys essentially fill out a form based on some programmatic parameters (revenue at T12, expenses at the higher of T12 + 2% or budget, replacement reserves $200/unit, or for properties older than X years, $300/unit). Maybe I'm salty because I can never beat the Agencies, but my political view is that tax payers should not be backstopping entities that provide ridiculously low-cost (mispriced) capital to wealthy landlords, but that's a topic for another discussion. Only I should be able to lend money to the people who don't need it, damnit! Whatever... Fannie uses Tier 2, Tier 3 and Tier 4 pricing models. They bake in a G&amp;S fee, then add on a bond holder spread and thats your credit risk premium - then add that to the index and off you go to calculate the lesser of \\_%LTV or \\_\\_x DSCR to get your loan amount. I have no idea why they skipped Tier 1.\n\n&amp;#x200B;\n\n&gt;Learn how CMBS groups underwrite different property types.\n\nI wasn't aware CMBS lenders know how to underwrite anything. They're even worse than Agency lenders IMO. They'll basically make the cash flow model fit whatever their B piece buyers will gobble up.\n\n&amp;#x200B;\n\n&gt;Learn how life insurance companies underwrite different property types.\n\nGold standard. We assume the world is going to end at any given point in time and go with the most conservative metrics / underwriting you could ever possibly withstand. Expect low leverage / low pricing - but we're really nice people! Keep in mind our capital comes from life insurance policy holders who will die in about 30 years when we need to pay out - so we absolutely have to ensure we do not lose principal, and if there is going to be a default, the loss-given-default is as low as possible.\n\nI've been at 2 different major Lifeco lenders - and both have had other products (bridge fund, agency platform, cmbs platform). I think Lifecos are the most flexible capital when times get tough for Borrowers. We're generally reasonable and as a Loan Officer, I am responsible for thorough credit analysis, more so than at a bank or agency shop, and I think generally you're going to find better credit analysis / collateral analysis at Lifeco shops. We also invest on the equity side, so we know our markets VERY well.\n\n&amp;#x200B;\n\n&gt;Learn how debt funds underwrite different property types.\n\nEssentially the same as what I've already covered - the extra nuance here is that when I'm pricing deals, I need to think about what I can get on MY leverage (whether in the form of an A note or a repo line), and that's going to impact where I can size the deal and at what pricing. I also do Mezz and Pref Equity out of this bucket of capital, so I have a few ways to play. These deals are a lot more fun to put together, but take a lot of work too, and you typically get paid off within 1 or 2 years, so it's a grind.\n\n&amp;#x200B;\n\n&gt;Make sure you understand sponsor/guarantor analysis.\n\nDo these guys have experience? Capital? How did they behave in past downturns? For example, the Trump Org would be a BAD sponsor. They do not get loans from legit financial institutions.", "replies": [{"id": "foiwdsn", "text": "LOL at the CMBS part. I\u2019ve got to send this to a buddy (who is a CMBS lender)", "replies": [{"id": "foks90l", "text": "Tell him I have friends who are LO at CMBS shops so it\u2019s all in good fun, nothing personal. They make a lot more money than me, so who\u2019s the real dummy.", "replies": [], "depth": 6}], "depth": 5}, {"id": "folhn00", "text": "Commercial appraiser here. Really great insight, thanks for this!  Perhaps the most concise/clear explanation of the relationship between LTV/DY/DSCR I've seen.\n\nSpot-on in your assessment of lenders, btw... CMBS underwriting is good for a laugh.", "replies": [], "depth": 5}, {"id": "fopqr3s", "text": "Working at a company that specializes in agency finance this made me both laugh &amp; cry on the inside. \n\nI\u2019m also working on two lifeco deals ATM &amp; can confirm that you guys are the nicest folks in the business. Really great write up!", "replies": [{"id": "for8s03", "text": "Thanks. Hopefully the agencies get capped out soon so the rest of us can get back to doing deals. Heard a T2 deal got priced at 3.25% recently. Ridiculous", "replies": [{"id": "forpsdw", "text": "Fannie currently has a 90 bps treasury floor so a 235 spread sounds about right. \n\nThe FED's buying of MBS is the sole reason why they can continue to deliver at this level - they are managing their cap pretty well at the moment.", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "fq43isl", "text": "I wanna take a class taught by you!  This is good stuff!!", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fo7n6bb", "text": "Check out Evergreen Capital Training on YouTube. Great video lessons on many of the topics you listed.", "replies": [], "depth": 1}, {"id": "fofpbts", "text": "[https://tsmfinancialmodels.com/blog](https://tsmfinancialmodels.com/blog)\n\nThere are some great blog posts (with videos) on a lot of the topics mentioned in this thread here!", "replies": [], "depth": 1}]