Man: Welcome to the Center for Investment Excellence, a production of JPMorgan Asset Management. The Center for Investment Excellence is an audio podcast that provides educational insights across asset classes and investment themes.

John O’Shea: Welcome everyone. Thank you for taking time to join today. I'm a client advisor here at JPMorgan Asset Management and I'm pleased to be joined by three of my colleagues. We've got Candace Chao, Co-portfolio Manager for the U.S. Real Estate Corp Mezzanine Debt Fund, and head of Mezzanine Acquisitions. Jay DeWaltoff is with us who's Co-head of the Commercial Real Estate Debt Group and Neil Day, Portfolio Manager within the Fixed Income Currency and Commodities Team. So over the next hour or so we are going to have a discussion about, one, the real estate debt markets; two, how the global pandemic has created dislocations across both public and private real estate credit markets; and three, how investors can capitalize on opportunities outside sectors supported by government interventions.

So with that let's get started. Candace, let me start with you to lay the groundwork. How have you seen real estate broadly been impacted by COVID-19?

Candace Chao: Sure. Well, I would say COVID has definitely impacted real estate in many ways. If you just think about the last few months, there have been millions of Americans who have lost their jobs. Many people who have office jobs are now working from home. Businesses and retailers have closed their stores because of lockdown and people hesitant to travel whether by air or by car.

So all of this impacts the way we use real estate and the ability for people and businesses to pay their rent obligations. So right now, rent collections is a very hot topic in the industry and collections have been trending lower than historicals in every active type so that's multifamily, retail office, industrial, and hotels. But not only that, it has been impacted equally and the quality assets has definitely been a factor in performance too.

So at one end of the spectrum, you have hotels and retail access and they have been the hardest hit with social distancing, measures, and mandated closure. Hotel occupancies dropped to 20% nationwide in April, which is about 50 percentage points off of the norm. And then rent collections on retail were on average around 50%. So now growth re-anchored and necessity-based retail performed far better than mall and centers with nonessential retail.

And then on the other end of the spectrum, you have multifamily and industrial assets. Multifamily has fared well since everybody is spending a lot more time at home these days and rent collections have been in the mid-90s. What will be interesting is to see if there will be a residential suburban inundation trend post-COVID with people working from home more and preferring to be in suburbs over urban locations. And then industrial rent collections have also been strong in the mid-90s obviously the infield lack mild locations closer to cities have been a very big beneficiary with the growing reliance on e-commerce these days.

And then lastly, for office, they fare better than retail and hotel assets but not as strong as multifamily and industrial. So rent collections for -- in the office market were roughly in the 90 percent range. What's interesting about the office industry is that prior to COVID, there was this trend to densify office -- so to jam in as many people in as little space as possible -- but in a post COVID world, will there be a reversal of that trend if more people are working from home or if there's just a general hesitation to work in close quarters with other people. So, it's a very interesting time and things are constantly evolving but I would say it's definitely too early to see if there are any conclusions about how this will all impact the real estate industry long term.

John O’Shea: Okay. Too early. Fair enough. Jay, can you provide some color on the state of mortgage lending markets - maybe specifically commercial banks and insurance companies?

Jay De Waltoff: Yes, sure (John). I think as you can imagine all lenders hit the breaks in late March as the country went into shut down and this certainly caused liquidity to evaporate in a very short period of time -- including liquidity that was being provided by commercial banks and insurance companies -- which accounts for approximately 50% of the annual origination volumes.

You know, I think insurance companies specifically, they've looked to public markets and left the great corporates for example as a proxy when they price loans and I think when those markets gapped out, made it very challenging. And then I think on the commercial bank side, we saw a lot of corporations cap their lines of credit and that really, you know, created some issues for commercial banks in terms of additional balance sheet capacity.

Fast forward to today, you know, I think we're starting to see some insurance companies come back to the market -- albeit very selectively -- now that the public market side -- the investment great corporates -- have calmed down and normalized, they're able to understand how to price a little bit better. But the commercial banks really haven't returned -- especially the large money center banks. So that is certainly creating a lack of liquidity.

John O’Shea: Okay. So, those are your traditional lenders. Candace, what are we seeing in the alternative lender space?

Candace Chao: They are similar to what Jay is saying. A lot of alternative lenders have also pulled back or they've been sidelined too. I think for those that are not as familiar with alternative lenders, they typically include mez lenders, debt funds, and mortgage (unintelligible)which is roughly 10% of the lending market. So they typically erase third-party capital and then a lot of them achieve their returns through leverage - just so with all the volatility in the markets early on, a lot of these warehouse lenders that provide lines for these funds instituted margin calls.

Earlier on with these margin calls, they were very much unexpected - they were sudden and unfortunately, a lot of these debt funds just had a tough time meeting these margin calls. Some had to liquidate positions at losses while others pre-emptively sold positions just to make sure they had enough cash on hand when that time came. Right now, the warehouse lenders are much more scarce and much more expensive, so that's really impacting the ability for a lot of these alternative lenders to write new loans. And then separately, the alternative lenders also typically focus more on transitional loans or loans backed by lower-quality assets - which have had a disproportionate (unintelligible) and performance issues.

So these lenders have been very busy with increased asset management issues just working with borrowers to modify loan terms. But see between the margin calls and these more focus on asset management issues today, this sector of the lending market is operating at a reduced capacity. But on the flip side, for groups like us that don't really use leverage and generally focus on hard quality assets, we, fortunately, haven't had to deal with a lot of these same issues so, with a lot of our competition sidelined, it just has allowed us to pick up some interesting opportunities.

John O’Shea: Okay. I'm sure we'll get into that in just a bit. Jay had mentioned gapping out (unintelligible) the public side. Neil, what are you seeing within the public commercial real estate debt markets?

Neil Day: Sure. The public CRE market better known as the CMBS market -- meaning Commercial Mortgage (Back) Securities Market -- is predominantly made up of three sectors. The conduit CMBS market - which deals with 50 to 75 loans pooled together with varying property types from office to retail, to hotels - that are located in numerous locations around the country.

Then we have the single asset - single borrower - CMBS sector which is made of deals secured by one loan made to a single institutional quality borrower with a collateral typically being a class A large single asset in a major market. An example would be Willis Tower -- formerly known as the Sears Tower -- in Chicago that was acquired by Blackstone.

Finally, we have the agency multifamily backed CMBS sector which encompasses securities issued by Fannie Mae and Freddie Mac. These deals are secured by 100 percent multifamily collateral, which is starred as the more stable and secure of all property types in CMBS.

The CMBS market experienced a sharp fell off in March and April similar to broader markets due to the COVID19 induced economic shutdown. However, due to the fiscal and monetary stimulus, much of the spread widening has been retraced, accept for down in credit securities -- which will be minus and below -- which continue to trade at significantly wider spreads compared to where they were in January and February of this year.

New issuance of CMBS deal is slowly starting to come back again, however, with collateral quality of a higher grade compared to what we saw pre-COVID.

John O’Shea: Okay. So, given all that as a backup, let's explore how we might be trying to position portfolios and where we might see some opportunity. Jay, have you seen changes to loan covenants?

Jay De Waltoff: Absolutely. I think in times like this if you're a liquidity provider, you have the ability to dictate structure of these loans that really does impact -- or enhance I should say -- your downside protection. And so from our perspective, we've been able to include things that -- may be pre-COVID -- the market really wouldn't allow such as an ongoing debt service coverage covenant which if breached allows the lender to trap all-access cash flow-limiting any distributions to equity.

In addition, we closed the loan -- you all will think this is interesting -- in May on a multifamily that didn't really have any issues but because of the market conditions, we were able to ask for and receive an upfront debt services that are equal to one year's worth of debt service that would remain in place for at least 18 months. Again, just because of uncertainty and we wanted to make sure our downside was protected.

John O’Shea: That's comforting. And you see that kind of covenant holding through June as well for any underwriting we might be undertaking?

Jay De Waltoff: I think it really depends on the situation. I think as the market evolves and the economy starts to reopen, you know, we are seeing more competition, albeit, in various select parts of the market. So, I think if it's a really high-quality deal, you might not see as much structure but again, I think if there's any types of moving parts or volatility or lease-up story -- whatever it might be -- I think in those situations you can absolutely dictate structure and get things that you were not able to get pre-COVID.

John O’Shea: Excellent. So, Candace how has spreads changed in your world?

Candace Chao: Spreads have definitely widened, I think, across the board in the last few months. Some of that spread widening is just a makeup for the drop in the underlying indices so keep in mind - like the 10-year treasuries was in mid one hundreds in the beginning of the year and now they're at 70 basis points. And then some of the spread widening is to account for the additional risk premium in today's market.

I wouldn't say those spread type moves staff proportionately, though, and the varies in widening really depends on a bunch of factors - including the risk of the loan, the tenor, the quality, the type of asset - but if we dapple with mortgages have lied in between 100 and 200 basis points versus mez which is at a riskier point of the capital stack as wide as anywhere from 200 basis points to 400 basis points. And then there's always a flight to quality in times of uncertainty so higher quality stabilized assets haven't widened as much as lower quality and more traditional assets. I think Neil noticed this in the public markets too, but I'm sure he's seeing the similar trends right now.

Neil Day: Yes. The type of capital structure in CMBS has retraced much of the spread widening that is, of course, due to the extraordinary amount of fiscal and monetary stimulus that was pumped into the real economy and into the public debt markets. Specific programs such as TALF helped to tighten AAA CMBS spreads from swaps with 350 to 400 area in March to current levels of swaps plus 100 - which is close to where they were trading in February's pre-COVID market.

However, the credit curve continues to be steep, especially in the secondary market - where triple B minus double B rated securities are lower in price by 20 to 30 percent from where they were trading in January and February of 2020. So, that equates to spreads in call it the swaps of 800 to 1000 area that is wider (unintelligible) from 500 to 700 basis points. Certain conduits seen with C minus bonds til trade currently with deals in the 8 to 10 percent range - which are some of the highest deals in all of fixed income credit markets.

John O’Shea: Those are pretty attractive yields, but they come with a quality warning, I suppose. Anything that you changed about your underwriting, Candace, given the consistency that we've just heard about in terms of quality?

Candace Chao: Yes. What I would say is that underwriting standards have tightened. I think most lenders across the board -- wherever you are in the capital stack mortgage world or in a bank like co -- they're being more cautious and they're underwriting loans with a lot more scrutiny today with everything that's just going on the market, it has shifted to a much more lender friendly environment so obviously as a lender I'm very happy about that. But as Jay mentioned earlier, you are seeing stricter covenants today and then we're also seeing a reduction in leverage because lenders are just taking a heavier hand to underwriting.

For example, on our platform, we typically model 10 (vari DCF) and for at least the first year or two of cash flow, we've made adjustments to account for lower rent collections and reduced rentals. Sometimes we even use flat rent growth or negative rent growth depending on the market and then we'll also stress test our cash flows with extended periods of vacancy, higher concessions, increased leasing costs, and so on just to make sure that we're lending against -- really we're doing assets as a lender. Yes, we really don't participate in the upfront like you do in equity so you really want to make sure that your thinking through all the right variables that can impact your cash flow and then you're coming up with the appropriate mortgage and structure for your loan.

John O’Shea: That's interesting. It sounds like you're taking a little more cautious approach - Certainly at that mez level. Jay -- a little more senior-level -- was your underwriting following the more conservative approach?

Jay De Waltoff: Yes. Absolutely. I think at the mortgage level across the active lenders in the space, we're certainly seeing what we're calling trading up in value - where those lenders that are back in the market that maybe were lending at 65 percent or up to 65 percent are now down to 50, 55 percent and are obviously proceeding with a great amount of caution. Certain lenders are even just focusing almost exclusively on multifamily and industrial property types just because they believe that those are easier property types to underwrite in this environment.

So, our approach I think generally is following in line with that strategy, however, I think we are also looking at some select opportunities to look at some shorter-term -- bridge lending -- where maybe there's some temporary disruption caused by COVID and we can deliver very attractive risk-adjusted returns for our investors in those situations.

John O’Shea: Excellent. Candace, I'd love to discuss your thoughts on finding better attachment and detachment points on secondary debt. Do you have any thoughts on that - on non-performing opportunities?

Candace Chao: Sure. I think everything Jay is seeing on the mortgage side obviously it benefits mez too. So to his point when senior lenders are delivering from 60% pre-COVID now down to 55 and 50, what that means is that it basically allows mez loans to start at a lower and more secure point in the capital stack. And just like senior lenders, mez lenders are also pulling back on leverage too for the function of some of the more scrutiny we're taking in underwriting.

Generally speaking, I'd say mez loans typically went up to around 75% LPV and now we're topping off around 70% LPV. So, if you compare pre and post COVID caps - at pre-COVID the mez start at what we call attached at 50% and detached at 75 versus now, we're attaching around 50 and then we're detaching around 70%. So, we've not only de-levered the whole position by 5% points, but we've also increased the total share of the capital stack which makes the position even more secure.

Just going back to my comments about spreads earlier - right now on high-quality stable mez paper, it's generally choosing yields between 7 and 10 percent in all that is the current income so the value proposition to a mez lender today is very strong because they're de-leveraging their positions but you're also picking up additional yields.

John O’Shea: And as you say that it probably goes without saying -- you probably eluded to it -- but you're talking about the same quality of property and location but at a much more conservative attachment point, right?

Candace Chao: That's right. The reason it's working in favor of lenders today we can stick with the same quality or move up in quality, you can de-lever and increase your yield, or you can act in stricter loan covenants in today's market.

John O’Shea: Excellent. Excellent. Neil, we have CMBS conduit Triple Bs and certain single asset - single borrower Triple Bs -- how have they done in this risk rally?

Neil Day: Sure. So, the conduit Triple B minus and the single bar were truly minus W minus sectors have lagged broad risk rally as I alluded to before. They continue to trade with yields in the 8 to 10 percent range. Spreads wider by anywhere from 500 to 700 basis points from where they were trading in February of 2020. Of course, there are fundamental reasons why it has lagged.

We expect CRE, especially the property types in CMBS to be heavily impacted from the change in travel and consumption habits. Indeed, the 30 plus day delinquency rate has jumped to 8% for the conduits in CMBS universe. However, in that large swath of the market where prices are significantly lower in the conduit Triple E minus and Sap B W minus space, we do see opportunities for investors to generate significant returns over the course of the next few years if one has a strong credit underwriting team which can pick the right investments.

John O’Shea: Let me just ask Neil just to follow on here -- I'd love to hear what you're thinking about the quality of new issuance in CMBS. To this point, we've been talking about exiting. What are you seeing that's new? And what do you think about it?

Neil Day: Yes. So, the CMBS market -- the conduit market -- has issued seven deals since the March-April shutdown. These deals are of higher quality and lower for leverage compared to the deals we have seen in pre-COVID markets. Assets in these deals are mostly class A properties located in strong locations, owned and managed by institutional sponsors. The leverage is also lower with the awaited LTDs of 35 to 50 percent currently in these deals whereas previously they could be anywhere close to 60 to 65 percent waited LTDs.

Also, in the current batch of new issuance, there was little to no retail, no hotels. So the probability of your loans defaulting is significantly lower versus what we saw pre-COVID.

John O’Shea: And you were saying earlier that the TALF program from the Fed was designed to keep spreads -- or help keep spreads tight -- that opportunity has pretty much gone away? How would you characterize that again?

Neil Day: Sure. So, the TALF is the 100 billion dollar loan facility that the Federal Reserve Bank in New York set up to inject normalcy into the public markets. It was intended to deploy loans earmarked for institutions which (unintelligible) purchase Triple A-rated securitized bonds, and including secondary CMBS. I think that has helped (tighten) spreads tremendously to the point where - I'm not sure if account funding is going to make sense for new entrants because spreads are only 20 basis points awry to where we were in Jan and February. So they're currently at (unintelligible) 100 area tighter by 200 basis points to 250 basis points from the lodge in March and April. So, the Fed has done its job.

John O’Shea: So Jay, how are you positioned -- how is the team positioned -- to take advantage of - clearly we've been discussing some opportunities are there with the right underwriting and the right time frame. How are you guys positioned?

Jay De Waltoff: Well, I think the platform in JP Asset Management in general is very well positioned to take advantage of the dislocations. We have a number of open-ended strategies actively looking at new investments and we also have a few tactical closed-end strategies that are in process and will be launched very soon to take advantage of the dislocation across the lending markets -- both public and private. And I think that makes us very valuable liquidity provider to the market given that we can look across the entire risk spectra.

John O’Shea: Excellent. Candace, can you put flesh around that and give us, perhaps, a live example of an opportunity that may have shifted since the turn in the volatility in the markets?

Candace Chao: Sure. We're seeing a very healthy pipeline of opportunities right now. We just recently signed up a 20 million dollar mez loan on a multifamily development in Chicago. It's very well located in the Fulton Market --which is one of the top submarkets in Chicago. Residents can walk to employment centers, public transportation, and there's a lot of retail and food and beverage outlets surrounding the property. And it's with a repeat sponsor so we're comfortable with their ability to perform and they have a very solid track record and a good balance sheet.

We actually started looking at this deal pre-COVID where our attachment and detachment point was around 60% and 75%. And given all the movement in the market we talked about, we ended up with attachment-detachment point around 49 and 59 percent. So we steal under the low position and then we also created a larger piece of the capital stack.

Originally pre-COVID, we were talking about pricing around LIBOR plus 700 basis points and now we're talking about pricing in LIBOR plus the 950 basis point range. So with these, typically you receive origination fee and the coupon, our total return on this deal is around 12% and that's all current income. There's no PIK structure or accrual structure, so, it's a very exciting opportunity, and we're glad we signed it up.

John O’Shea: Excellent. That's quite a pick up in return and you would say the underlying tenant base is the same level of risk as well?

Candace Chao: I'd say so. It's the same quality that we normally would have looked at pre-COVID and it's multifamily, which is -- as we talked about -- our most favorite asset class because people always need a place to live and rent collections nowadays are the strongest out of all other active classes.

John O’Shea: Let me ask Jay. We discussed and left out property types -- hotels for example. Have you seen any indicative pricing for the leisure world?

Jay De Waltoff: Yes. I have not. You know, I think we've been generally pretty cautious on hospitality. I think it obviously has - there's a lot of volatility with that asset class and you've effectively, kind of, you have to release your property every single day. So, you know, we only really have two hotels across our entire portfolio, but I think it's going to be really, really hard for anybody who's got a hotel and needs financing right now to get anything remotely attractive. Maybe if you could afford to pay 7 to 10 percent, you might find a mortgage lender out there that can highly structure a deal and get something done. But, I just haven't seen anything.

We have seen a little bit of activity on the retail side, though, that I think as Candace eluded to in her beginning comments. You know, I think for a strong grocery-anchored retail property, I still think you can get, you know, a decent bid. I think it's going to be low leverage just like everything else and you're going to pay more in terms of spread than you would for a multifamily or industrial property. But, we have seen some lenders show some interest in that property sector.

John O’Shea: Excellent.

Candace Chao: I just was going to add to your question there for, kind of a lesser favored assets class especially now with hotels, all the pullback we mentioned is even more extreme because senior lenders are pulling back from 50 to 50 on office and multi. There's going to be a pulling back from 50 to 30 or 40 percent on hotels if you even have a bid on that. So, there might be some opportunities there, but the pullback is much more extreme the further out you go on the risk curve.

John O’Shea: Excellent. Question with regards to geographic preference. Are you seeing more opportunities in any specific geographic area or penalty for any specific geographic area in the U.S.? Candace?

Candace Chao: I would say the probably is more of a pickup in some of the suburban markets right now, just with people wanting to get out of some urban locations which have been hard hit by COVID. I think we'll see some good opportunities in the multifamily space in suburban markets there. I think at least for the short term, we're finding that potentially urban areas with, like, multifamily high-rises, there is going to be a little bit of a pullback but it's hard to say if that's all going to be the long term or if that's just temporary with just a heightened nerves with COVID going on.

John O’Shea: Neil, are there opportunities that you and your team are looking to take advantage from the dislocation in CMBS secondary spreads compared to other credit markets? Is there better relative play in CMBS relative to other sectors?

Neil Day: I think JPMorgan Asset Management as a whole is looking at the CMBS universe. You know, at the 7 to 10 percent type yields, there's a lot of opportunity in the dominant credit space in CMBS. You know, picking the right investment is key and take Morgan Asset Management with the vast resource it has on the commercial real estate side from the underwriting team as well as the market expertise I think is in a good position to pick out those right investments for our clients, but certainly, it is a sector due to where the yields are and how much of a price drop that has occurred from where they were trading in January-February. It's there that we are looking at closely from the relative value perspective for our clients.

John O’Shea: Okay then. I think then I'm going to close it out and I hope everybody who's tuned in enjoyed today's call.

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