It’s a construction loan portfolio. We fully expect that. But there’s much more to a successful move to the next stage for our sponsors than just where the interest rates are. So in short, yes, rates are a part of it, but there’s much more involved.
George Gleason: Manan, let me give a little more color on that, and Brannon can agree or disagree with this. But our construction loans, it is hard, but not impossible for those to move mid construction. And it’s easier in some states because of laying loss and so forth than it is in other states. So there’s somewhat of a natural friction to the loan moving mid construction. In addition to that, our loans contain minimum interest requirements that we’ve got to be paid X amount of interest for the — over the life of a loan. And if they pay us off before we earn that interest, they’ve got to pay the difference to us as a minimum interest charge. So that tends to keep loans on the books, even if the floors become higher than market until they burned off that minimum interest unless there’s an incredibly compelling reason to exit sooner.
The loans that are fully completed projects, that have met their minimum interest requirements, which are loans that would sort of naturally be ripe to go to a permanent refinance anyway. Those loans are more susceptible to being reified, if that floor has that right above market rates. And we expect those loans to go anyway to the permanent market when they can, when it’s advantageous for them to do so. So that’s not a negative to see either.
Brannon Hamblen: I was just going to add to that. Well, you’re absolutely right about all that, and the guys have been doing a phenomenal job with the floors we mentioned that, but they’ve also done a great job improving sort of the multiple on our loans, setting the minimum interest amount. So as a percentage of loan amount, they work really hard on that piece of it as well. So yes, I was bad to leave that one out. That’s a really important function.
George Gleason: And for those of you who are not familiar with it, the minimum interest is really not designed to be punitive to our customers. But it’s designed to make sure we achieve a minimum return on our capital allocation to that project because our typical loan is 50% of the cost of the project more or less. And so we may have a commitment out for a full-year or even 15 months or 18 months before we fund anything on that loan. We’re required to hold capital against 50% of that commitment amount before it’s funded. And so we could have a huge capital allocation for 18 months. And if the never fun, the customer decides they want to refinance to a lower rate or refinance to someone that will give them more leverage than we’ve allocated capital and never earned anything but an origination fee and some other fees on the loan.
So the minimum interest is necessary and calculated to make sure that we achieve a minimum return on equity over the life of the loan irregardless of when it prepays.
Manan Gosalia: That’s very if I really appreciate the fulsome answer there. Maybe just pivoting, you spoke about distressed transactions starting to pick up a little. What do you think drives that meaningfully higher? I know there’s a lot of private capital waiting on the sidelines. So is it a function of them just waiting for valuations to fall more? Or is it a resolution on this uncertainty on rates? Or what should drive some of those transactions meaningfully higher in your view?
George Gleason: Yes. Well, let me — I’m going to let Brannon answer that question, but I’m going to make sure that we don’t create any misunderstanding. Those distressed transactions we’re talking about are not our transactions. There are other transactions we see in the market. We have a huge view of the market across the U.S. So those are not our transactions. But Brannon, with that caveat and clarification, can you give some color to what’s going to be the precipitating event that causes more of that rescue capital to go to work.
Brannon Hamblen: Yes, sure. I think, Manan, great question, George, great clarification. We are talking about the broader world outside of our portfolio. But you identified a number of issues, all of which are in play. I think as it relates to multifamily, that’s a much more active market. Cap rates are more quickly reset, buyers determining where those sort of level down will start to draw them at a greater velocity into that space. I think the one that is sort of the longer-term opportunity if you’re looking at it from many of the many funds have raised billions of dollars for the opportunity to start to invest in distressed office. But they’ll be much more selective as it relates to the product type. There’s some pause waiting to see exactly how some of that falls out.
You’ve got a lot of leases that are going to mature over the next couple of years and have a lot of visibility into where occupancies are going to fall out in some of those older vintage product or even later vintage that have been leased up, but now trying to figure out who’s going to stay and who’s going to go. The interest rate issue that you brought up very clearly, they’ve raised a lot of capital, but they won’t to be able to lever that. And quite frankly, just finding debt capital out there with which to lever it, there are a lot of institutions out there that are the holders of that distressed product type and not eager to re-up or expand their portfolio in that product type. So it’s part capital markets, part interest rates, part just letting things play out in terms of who’s going to stay and who’s going to go in office in various markets.
