← The Kirsh Connection
The Kirsh Connection
Buying Distressed Loans: Finding Opportunity Where Others See Risk with Michael Moreno
00:33:28
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- [00:01]
A
Hi, I'm Andrew Kirsch, co founder of Sklar Kirsch. On this podcast, I interview industry leaders. You'll hear their real time opinions on today's market, their background, unique career highlights, and guidance for newcomers to the industry. This is the Kirsch Connection. We're at the most famous steps probably in U.S. history. The steps in front of the Philadelphia Art Museum, also known as the Rocky Balboa Steps. We did it. We successfully ran up the steps. We're having a great time on our east coast trip. By the way, we're staying at the same hotel as the Dodgers. We won't tell you the name of that hotel just yet. On this episode of the Kirsch Connection, we have Michael Moreno from Safe Harbor Capital where he talks about how his company buys distressed debt. Enjoy the podcast and enjoy Rocky Balboa. Welcome to another edition of the Kirsch Connection. I'm here with Michael Moreno, partner, Executive Managing Director of Safe Harbor Capital. Michael, how are you doing today?
- [01:06]
B
Great. Andrew, nice to see you.
- [01:08]
A
Where does this podcast find you?
- [01:11]
B
I'm in Europe actually and have been here touring visiting current investors as well as potentially future investors for our fund.
- [01:18]
A
Oh, wow. Well, that's great. Thanks for. I guess it's what, 9:00pm where, where you are, Noon my time. Yeah. Where specifically in Europe are you?
- [01:29]
B
I'm just outside of Italy or just outside of Rome actually. So this is the, the weekend break in between a lot of days of meetings.
- [01:39]
A
Ah, that's great. Well, a good place to, to be. So to the extent that my audience doesn't know about Safe harbor, why don't you give them just a little overview and then we'll. Well, we'll dive in a little later.
- [01:53]
B
Sure. Thank you. So Safe harbor is a specialty private credit shop that really focuses in on buying non performing loans from small to medium sized banks that are collateralized by commercial real estate and investment properties, primarily in the southeast Florida, but we go as far north as New York and as far west as California. All primary markets and the loans themselves tend to be of smaller size versus what you typically see in the marketplace. So these are loans of between 2 and $25 million on average. And these are loans that wouldn't be part of a larger portfolio sale. These would be individual loans tied to an individual asset that we're analyzing on a granular basis.
- [02:34]
A
Got it. And so are they performing loans, distressed loans, you know what type of loans are they?
- [02:41]
B
Sure. So 80% of what we're doing is buying non performing loans or distressed loans. So These have gone through some kind of a maturity default, covenant breach or payment default. And these are loans that we purchase from these small to medium sized banks. We then modify the loan into something that is a performing loan that allows the borrower a year to two years to either repay us back with proceeds from a sale or refinancing. So this is very much a loan to loan strategy, not a loan to own strategy. So it's really making sure that we can modify it into something that makes sense and holding it to maturity and generating a good interest rate for our investors.
- [03:23]
A
During the GFC days, my days as a lawyer from 2008 through 2012, every day it seemed that I had a client coming up to me saying, all right Andrew, we've got three days. I can buy these pools of loans at a massive discount. Just make sure there's no nuclear missiles within the loan purchase agreement. But assuming you say it's good, we're going to buy this tape of loans. We're not seeing that level of loan acquisitions during, you know, these days. It's usually one offs, you know, maybe a smaller portfolio. Why do you think? Well, first, I guess my question is, do you see that difference between today versus the gfc and why do you think there is that difference? Sure.
- [04:14]
B
I mean, look, the gfc, you had totally different dynamics. And back then I was doing more corporate distress as opposed to real estate distress. But it was across the board where you had mass selling of portfolios driven by basically everything from people panicking to margin calls to let's sell anything and everything that we can sell to take care of that that we can't sell here in this marketplace. It's very much more like there are problems in the CRE market on the loan side, but they're not panic problems. Right. You basically had a lot of the loans in 24 and 25 that were refinanced or extended out. You have a big maturity wall in 26, 27 and 28 coming up. But it's more calm, it's addressing specific problems as opposed to having wholehearted problems across the board. And different banks have different experiences. Larger banks have a much higher asset base that they can kind of lean on even if they have problems in their CRE portfolios. And the larger banks are more exposed to big office loans that we're just not interested in or involved in. The smaller banks, they really depend on CRE loans. So different from the GFC where everybody was selling. Here you have a situation where I think smaller banks, 10 billion to $100 billion. Banks are saying, okay, well, we can't extend the pretend anymore, which is a term that everybody uses. But more importantly, we need to take care of these loans or get off our balance sheet, these loans that are causing the most amount of problems because we can't reserve fast enough and we can't have our capital base suffer just to cover these problem loans. We'd much rather sell it to a safe harbor or somebody like us, let them have the problem and then let us focus on the business of lending out capital at these higher interest rates, which is much more interesting for those teams to do.
- [06:13]
A
Yeah, I will get more into the types of loans that you guys are purchasing, but let's sit back, talk about your background first. You know, where'd you grow up?
- [06:24]
B
Sure. I'm a born and bred New Yorker and I actually started. I've been a credit person for over 30 years. I started at the old Chemical Bank, Andrew, if you remember those days, and loan syndications and private placements, then did a lot of emerging markets work and then got into the asset management business a long time ago, back in 1997 at IAG. I then eventually made it to corporate distressed. So I was one of the four owners of a firm called Black Diamond Capital Management. We managed about $10 billion. We had a controlled distressed private equity fund, a hedge fund and a CLO business. And that's where I really got exposed to kind of the nuances related to corporate distress. And then eventually we did some real estate loans when I was at the firm. And the difference between real estate distress as well and larger facilities and getting involved in bankruptcies that brought in a lot of different players in large syndicated loan formats versus what we're doing, which is the only person on the balance sheet in the balance sheet or in the cap structure in a particular deal. Anyway, so I moved from Black Diamond. I did something entrepreneurial for about 10 years, totally unrelated to asset management. Wanted to get back into the asset management business, work for Avenue Capital, which is a very large kind of credit shop based in New York with offices all over the world. And then eventually wanted to do something more entrepreneurial again. So joined Safe harbor about two and a half years ago and am involved in. I sit on the investment committee, but involved in a number of different aspects of the business itself.
- [07:57]
A
No, that's great. And so you all, you already alluded to the loans that you guys acquire from banks. Do you originate at all?
- [08:09]
B
We do about 20% of the portfolios, originated deals. And that really involves situations where it's a situation that's too complex for a bank to deal with or want to deal with. So we'll get a phone call from a credit officer, a bank credit officer and saying, look, I've got this client, they want to do a loan on this building. But the LTV is a little high and we can't get into looking at other properties that they may have, or they may have shares in a private company, things that we can use and be creative using to increase the collateral package and better the credit itself. And obviously you're going to get paid for that. But the banks are just not into coming up with those types of solutions in this marketplace. What they want to do is something right down the middle of the fairway. And for people like us, it gives us a great opportunity to source or originate some really good deals. But again, that's about 20% of the portfolio. The bread and butter of our business is buying these non performing loans and then modifying those.
- [09:09]
A
And so in terms of the types of loans that you're purchasing from these banks, talk about the type of asset class, the geographical locations, the size. I know you briefly described it, but if you could get into a little more detail, that would be helpful.
- [09:30]
B
Sure. In terms of the types of loans, again, these are commercial real estate loans and I'll get into specifics as well as individual homes, but they tend to be investment properties all wrapped in a commercial loan as opposed to owner occupied resi paper, which is another big market, but not a market that we play in. On the commercial loan side, we tend to stay away from. And again, you have to remember these are smaller loans so we're not exposed to or tend to stay away from very large office buildings because that's just not what we do. We tend to stay away from construction or development loans. That's a very different market, which is a good market, but has very different risk profiles than what we like to do. We like to have something that's typically already vertical. We like multifamily, we like hotels, warehouses, retail, and maybe smaller office buildings as opposed to the larger office buildings that are out there. In terms of geographical focus, we're based in Miami, so we definitely have a bias towards the Florida market generally. But as I alluded to before, we do like to go as far north as New York and as far west as California, but they're always primary markets. You know, one of the things that we're always careful about when we're underwriting all of these credits is, you know, you do your analysis, your comp Analysis. You do your replacement value analysis. And depending on the asset, you're going to do your discounted cash flow analysis just to see how that business is running. Like a hotel is not just real estate, it's a real operating business. But you also want to look at the velocity of the market. So what does that mean for, for us in the few instances where we actually foreclose on the property and get the keys? We want to make sure that there's depth in the market because we're not in the business of operating a hotel or a multifamily or name your favorite asset. What we want to do is be able to sell it. And so we want to operate only in those markets where there's real interest in that particular asset so that you're not dragging on the returns through a whole a long hold period because you can't actually sell that asset quickly in that particular marketplace.
- [11:38]
A
Yeah, look, that all makes sense in terms of what type of discount are you getting when you're buying on average? Because obviously every deal speaks for itself. Every asset class, every borrower location. But are you pro forming a particular discount to par?
- [11:57]
B
That's a good question. Look, and it's always an interesting question when people talk about distressed. I think that's one of the first things that investors focus on is, okay, what's your average discount? My argument is different or my viewpoint is different. What I want to know is what is our. What are we purchasing versus the value of the underlying asset? Right. As a general statement, we're purchasing at a discount to the legal balance. So for example, if it's $10 million building, it's a $5 million loan. Let's say it's been in default for six months at a default rate of 20%. Okay, so if I'm paying 5 million for the loan and I'm getting half a million dollars worth of accrued interest for free, that's great. On day one, on a gross basis, you're up 10%. That's much more important to me because I'm at a 50% loan to value versus what's the discount to the par value of the loan? Right. Because if you're in an 80% LTV and you have a 20% discount to the par value of the loan, well, who cares? Because, you know, you're still way above where I'm at on a loan to value basis. So we're really more value players. What are we buying this loan at versus what we feel the value of the underlying property is at? Having said that getting a 5 or 10% discount on the legal balance isn't bad either. And there are some instances where we're shown alone where for us the LTV doesn't make sense. Our average LTV, by the way, is about 50% and our Max is 69%. So if the LTV doesn't make sense, we will ask the bank or lender for a discount. Sometimes they'll hit the bid and they'll take it and sometimes they won't. But for us it's much more about what is this loan versus what's the value of the underlying asset and how
- [13:50]
A
many deals are you purchasing, how many loans are you purchasing a month, how much money are you putting out, you know, monthly or annually?
- [14:00]
B
Sure, we're just finishing up a raise on our fourth fund. That fund, let's say has 200 million 300 million of equity capital at the end of the day, will have as a, and will have as a portfolio anywhere between 65 and 80 loans in it that will be purchased over a three year investment period. And in terms of real volumes, just to give you a sense, the average loan that we're buying, we're typically getting between 60 and 80% of the purchase price using leverage and many times from the same banks that are actually selling us the loan. So let's say if you have $200 million worth of equity, you're going to end up buying somewhere between 650 and 800 or 650 and $750 million worth of loans over a three year period of time. So call it a quarter of a billion to 350 million per year.
- [14:58]
A
And sometimes the very banks that you're buying will provide the note on note financing.
- [15:04]
B
Absolutely. Or we actually have warehouse facilities, Andrew. So what's really interesting is they're taking this loan that's a problem loan or they have to potentially, potentially take a reserve against it. They're selling it to us and we're using their warehouse line and they're simply moving it from a non performing loan bucket to a performing loan bucket under our warehouse facility.
- [15:24]
A
And so how do you look at a lot of headwinds? The war In Iran, the 10 year treasury is now bouncing around 4 or 5. Gas Oil prices are up mainly because of the war. How do you view the market in general right now in terms of both real estate and the credit markets?
- [15:51]
B
Look, let's start with real estate and then I'm no economist but I certainly have opinions in terms of the general market in the real estate market. I think at the beginning of this year, certainly the end of last year, a lot of people were hoping that interest rates were going to be driven down and that would save a lot of these credits. Right. Because it's hard to. And nobody Underwrote to a 2 to 300 basis point increase in the underlying rates, reference rates. Right. So I think people were saying, well, if interest rates come down 50, 100 basis points during the course of 2026, this will be good and we won't have to restructure or focus on these loans because they'll have adjusted and it won't be as harsh of a hit in terms of operating cash flow. For example, if it's a hotel or a multifamily or the like. What we see now is a complete elimination of that scenario, as we all know. And so I think banks and other lenders are facing the reality that they can no longer depend on the lowering of interest rates or a decrease in inflationary pressures that they have already experienced and will, in my view, continue to experience. So now they've got to address the problem. Right? And addressing the problem is either restructuring what you have on your balance sheet or getting rid of it. And so for us, we've seen and expect to continue to see a pickup in banks and other financial institutions wanting to sell these assets off their balance sheets. And we're already starting to see a pickup in our deal volume. Just to give you a sense, we've seen our pipeline increase 3, 400% in the last three years. And that I think will continue to increase and accelerate over the course of the next 24 to 36 months in terms of the overall economy. Again, I'm not an economist and would never pretend to be, but these are real pressures on these companies on all fronts, are on many fronts. And I think that forget about the AI. The application of AI and how it's going to affect businesses is a whole different aspect of people's business plans that they need to address across a number of different sectors. But inflationary pressures and higher interest rates are fundamentally going to put pressure on a lot of these companies, especially smaller to medium sized companies that are not involved in the technology side and certainly on the technology side. And everybody's read the same headlines as I have. The AI unknown is going to affect a lot of companies that went to the credit markets and benefited from the credit markets over the course of the last three to four years, especially those private equity driven buyouts that need to be addressed. And I just think that it's much More complicated to try to figure out how to restructure a balance sheet when you don't know where the EBITDA is going to fall because you don't know where, how that company is going to be able to react or be affected by AI coming into their everyday lives. So it's going to be an interesting, it's going to be an interesting cycle. A lot of my friends who do corporate distress are, I think, looking forward to a heck of a cycle for us in our small part of the market. We're certainly seeing the benefits of increasing volumes and I think we'll be able to continue to see great opportunities over the course of the next three to four years.
- [19:14]
A
Yeah, it sounds like a rising interest rate environment, which we've been in, has helped your business as banks need to raise capital, offload these loans off their balance sheet. You've been on both the corporate credit side and the real estate credit side. How would you compare them to each other?
- [19:45]
B
Look, generally speaking, real estate is much less complicated than corporate distressed to.
- [19:51]
A
I'm a real estate a lawyer, not a corporate lawyer.
- [19:57]
B
I mean, look, when you're dealing with a company that has gone through a restructuring or reorganization or Chapter 11 restructuring, you have to deal with a lot of different, more complex elements than you ever would if you just had a building, right? You have customers to deal with and you've got market share that you've potentially lost as a result of the downturn. As a result of going through chapter 11 management teams have a hard time focusing during restructuring. You got to get that ramped up again and you have to deal with the underlying issues that cause that bankruptcy or that, that faltering of that company's operations. Sometimes it's just macro factors and you're going through a cycle, but a lot of times it's fundamentals related to how the business is being run and you have to address those and you have to stabilize that company and then you have to run it for a period of time to the point where you can then package it in a pretty bow and give it to your favorite investment bank to sell it to the next private equity or strategic buyer. That process is not only more complex, but takes a heck of a longer time than what we're seeing in the real estate side. Generally speaking, right? Where we assign a value to a particular building that we feel comfortable with, we have a loan against it. And if after you've done the modification and actually for you have to go through a foreclosure process because the underlying borrower Defaults again, well, then you get the keys to the, to the asset, and then you're just selling it into a market that hopefully you've analyzed correctly. And we'll take that asset off your hands. Now at a 50% LTV, you've got a lot of breathing room built into this equation or this scenario, Right? So even if we discount it at 20% or 30%, you're still going to get your principal, your interest, and your accrued default interests out. With a company, it's a trickier situation where you're trying to refinance, potentially a deal where you come out of bankruptcy, the EBITDA has been adjusted, or you don't know where the do is going to end up, and you're trying to buy this debt and trying to figure out, okay, what am I buying versus how much EBITDA this business can generate and how quickly can I stabilize that ebitda? In whatever market conditions you're finding yourself in today, and certainly in today's market conditions, it's a lot more complex to be able to figure that EBITDA number out, which is going to be underpinning the entire restructuring that you're going after now.
- [22:21]
A
Are you purchasing any loans from private debt funds?
- [22:24]
B
Oh, for sure. I think JLL came up with some statistics that's like 430 private lenders had raised funds over the course of the last few years. A lot of these fund managers don't have that restructuring experience. I always like to say banks are great at lending and not great at collecting when there's a problem. I think private lenders or some private lenders have that same issue. They're just not built for it. So we are getting a lot of phone calls from a number of private lenders who have done everything from construction loans, even though we don't like buying those all the way through bridge loans on whatever number of deals. And they're saying, okay, we have a problem. Would you guys be interested in taking this off our hands? So. So it's not just the banks, and that's a very good point. It's also private lenders that have come into this market over the course of the last number of years.
- [23:22]
A
We're seeing a lot of debt funds fall into hard times. You know, the public ones, you know, their stocks are trading at, you know, way off their highs. I mean, virtually almost worthless. They are reeling from the originations that they made in 20, 21 and 22. Forced to take back the real estate. We're seeing debt funds be a lot more Aggressive in any way that they can raise capital aggressively, pursuing guarantors, taking non recourse, carve out guarantees and trying to extend the interpretation of trying to get some, some repayment there. The loans that you're buying, are they non recourse or recourse?
- [24:13]
B
A lot of the loans that we're buying and almost in every scenario we want to get a personal guarantee from the underlying borrower.
- [24:20]
A
Yeah. And so what we're seeing is just a lot more aggressiveness, I think is what I said earlier. They're trying to raise capital. So whether it's from their guarantors or, or selling loans, you know, they are, they're, they're hurting.
- [24:38]
B
They are. And the thing is, again, going back to the, the whole idea of what the market conditions that we're finding ourselves in today, it's not like you're going to have, there's not going to be no quick release in terms of capital flows into the marketplace from government. Right. You're not going to see an influx of money flow into this market. And so it's going to be a challenge to find that extra capital from outside investors and to address the problems that inevitably they're going to have in their portfolio. I mean, I read a statistic that you have year over year from 24 to 25, 25 is when the latest statistics are available, you have double digit increases in, in default rates in the CRE market. Right. That's a problem. And it's especially a problem with smaller banks. I mean we, we were looking at, and we bought a deal where the one loan, if they had taken a reserve against it, represented almost 20% of that bank's EBITDA for the quarter one loan. Right. So that's a problem because how. Right, it's, it's massive. And when you have the average smaller bank's CRE portfolio representing 75% of the underlying, 74.3% of the underlying assets of that bank, that's a problem. They don't have the fallback of credit card portfolios or car loans or trading businesses. The banks have all made a tremendous amount of money over the last quarter or two in trading profits. Your local community bank doesn't have that. And so there's a real focus on. Okay, well the fundamentals of these banks has been CRE lending and they need to make sure that that balance sheet is as clean as it possibly can be, especially going through a cycle that is not going to benefit from calmness or lowering of interest rates anytime soon.
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A
Yeah. And when you are transacting with these banks or these debt funds? Is there competition? I mean, how are you establishing these relationships? Is it a bid process that there are other groups like a Safe harbor who are trying to get this paper, walk my audience through what, what just this process is like and how you've been able to establish these relationships with these types of banks and lenders?
- [27:02]
B
Sure. So huge shout out to my partner and the founder of Safe Harbor, Rafael Serrano. He started Safe Harbor 20 years ago, started managing funds about 10 years ago, and has built an incredible reputation and a network of banks and other private lenders that have seen Safe harbor consistently play in the marketplace, no matter what the market conditions are. So it's not an opportunistic endeavor. It's not a situation where Safe harbor comes in when default rates are high and there's blood in the water. It's us consistently finding a solution for a lot of these banks and lenders on a. On a basis that they know how we operate, we make decisions and can give answers very, very quickly. We say no a lot. We only transact in less than 5% of the deals that were shown in terms of our pipeline. But when we do say we're going to do something, we do close the transaction. So there's a real trust in the, in the banking community and the private lending community when it comes to Safe Harbor. And that trust has allowed us to continuously increase our pipeline and quite frankly, increase the number of relationships that we have because we have that reputation in the marketplace, and it's one that served us well. So it's really Rafael leading a team of people that have those relationships with those banks and private lenders that's allowed us to grow the way we've grown over the course of the last number of years.
- [28:28]
A
Yeah, absolutely. I mean, it's all about relationships in this business and pretty much any business. I guess my final question here, Michael. I want to be respectful of your time, especially when, you know, you're in Europe. There's a lot, you know, a lot of groups, especially since it's been a struggle on the equity side for, you know, now really four years, and a lot of capital has shifted to the debt side. And we saw groups. I know you guys don't play in preferred equity in mez, but we saw a massive amount of capital in the last couple years go into that area of the cap stack where rates originally were at, you know, 14, 15% for pref. And now I heard even a quote today for 85% leverage, a pref piece Being in the single digits, so in the nines. And so there's all this capital being in private credit. So I guess my question here is, you know, how do we view, how are we going to see the private credit industry over the next five years where there seems like every day there's a new debt fund that is popping up. Yet at the same time we're seeing a lot of stress on banks. And how, what is the future of the community bank? Are we going to just have the large money center banks survive and all these regional banks, who knows what their future is. So it's this weird dichotomy of a lot of money going into debt funds, a tenuous situation with community banks. And so the whole credit banking situation that we're used to is, is evolving right in front of our eyes. And so how do you see this all playing out over the next, the second half of this decade?
- [30:16]
B
That's a big question. Look, There are over 4,000 banks in the U.S. there's got to be. And we're already starting to see consolidation, especially in the smaller bank size. But community banks and the regional banks will always have an important part in the marketplace because JP Morgan can't put out the capital that they want to put out in some of these communities in some of these smaller deals on a consistent basis. Right. That really is the job of the local community bank or the regional bank to take care of those marketplaces. So I think the markets in terms of number of names or players in the marketplace will shrink. But I do still think that there'll be, there's an incredibly important role to be played by these community banks and these regional banks in the market going forward. So I don't think that's going to be an issue. And those community banks will inevitably compete with private lenders that are coming into the marketplace. And seeing that if you actually service these markets well, you're going to make a good spread and it's a good market to play in the. But I think that'll just make everybody better. And I think that will offer more options for borrowers which will obviously and hopefully drive just growth generally, especially in certain markets like a Miami and other places in Florida and the like. So I think it'll be good. I think you'll see again consolidation, stabilization, competition, healthy competition from private funds in hopefully a growing opportunity set when it comes to some of these other markets that have seen incredible growth over the course of the last three, especially two, three years. And I think that'll continue to occur over the course of the next few.
- [32:08]
A
Yeah. No. Fascinating. Well, didn't mean to end on such a big question, but yeah, look, the. The insight that you provided my audience on the credit side and purchasing loans from banks and debt funds. It's an aspect of the business that I wanted to address and happy and honored that you came onto our show.
- [32:34]
B
Not at all. Andrew, thank you very much. It's been a real pleasure.
- [32:37]
A
Absolutely. And that is another episode of the Curse Connection.
- [32:44]
B
We're at the Philadelphia Museum of Art and Andrew Bing. Andrew is making me film. So he can run up the stairs like Rocky. Oh, Andrew, don't we just love him? And they're going, and they're going, and they're going. And he has made it. And
- [33:13]
A
we did it. We climbed the Rocky step. There's Rocky. Let's go, guys. You need a few more.
- [33:24]
B
And now he's there. And I'm going to be stopping.
- [33:27]
A
Here we go.