The attempts by vulture funds to swoop on distressed assets and pick them up at bargain prices have made a difficult climate for debt financing worse.
But even with this pressure, the fundamental criteria on which hotel loans are made has not changed anything like the extent of the upheaval in the broader debt markets.
This was according to Peter Anscomb, corporate director, leisure, and head of hotel finance, Royal Bank of Scotland. He argued that hotel debt finance is now returning to a long term sustainable base.
Speaking at the 21st European Hotel Investment Conference, organised by Deloitte and held last month in London, Anscomb criticised the years leading up to the summer of 2007. "Private equity required large scale debt at cheap pricing and this chased asset prices up," he said. Financing had been based on the belief that forever upward was possible which is simply not realistic, he added.
In today's market, LTV had to be forgotten about, he conceded. It was more realistic to talk about loan to cost. Transactions struck at 20 times EBITDA offered no security for lenders – 12 times was more realistic.
Also needing change was the approach of operators "who have built businesses off other people's money". The operators and brand owners need to share in the risk, although not necessarily through putting cash on the table, said Anscomb.
The attempt by some operators to even contract how banks sell down their debt was unacceptable, he added. "They need to be willing to back their product and be prepared to be kicked out if it doesn't work."
When it comes to distressed situations, Anscomb said it was possible to "take a view" on amortising debt repayments provided there was some element of sharing the risk. "Where I have real problems is where funds can't meet cash calls," he said. But where the owner of a hotel was working with the bank to participate in the risk then the bank will work it out. "The hotel business has a fundamental future. Why crystallise losses now to make somebody else a profit?"
Since January of this year, RBS had lent somewhere between £100m and £200m on new hotel deals, he said. But this lending had only really happened in the past few months as "we went through a long period where we saw undeliverable structures".
Neal Ledger, managing director – property and hotel finance, Calyon Credit Agricole, said that it was true to say that banks were still lending on similar debt to EBITDA multiples as a few years ago. He cited 6.5 times to 8 times as a typical range.
But the problem is the decline in EBITDA means that LTVs have now shrunk to 40% -"in some cases I have seen 30%". This means investors face a tough time, as funding deals with close to 100% equity destroys IRRs.
"The funding gap at the moment is almost impossible," said Ledger. "Even at 50% LTV senior debt can often not be serviced via EBITDA".
For distressed assets, it was possible to sometimes close the funding gap with some mezzanine finance but there were not the right opportunities at present. "Some banks are deciding to roll up the interest because the hit to the p&l is less than selling at a distressed price."
He forecast there would only be a trickle of assets coming to market. Structures put in place in 2005 to 2006 with five year financings would be the key event to test how many distressed assets would come to market.
Jeremy Robson, managing partner at RAM Capital Partners, said that this milestone was a fallacy. "We have the same problem today. If I have a refinancing, will you force me to sell?"
He predicted that deals would be done but that they would be off-market and rarely reported. "It is not about IRRs, it is cash-on-cash. Mezzanine can be used to reduce the funding gap."
Robson argued that there was currently a huge demand for mezzanine financing and for these providers it was an attractive opportunity as "by taking a slightly more than senior debt risk you get double digit returns". But for deals to happen, somebody needed to take the pain.
Kingsley Seevaratnam, executive vice president, Europe, Westmont Hospitality, said the lack of deals was ultimately down to pricing. "The entry yield has to make banks comfortable that debt can be serviced," he said. "There will be a downward pressure on pricing – maybe I'll be sitting here for five years saying that."
In a separate presentation, Nick van Marken, global sector leader, corporate finance, tourism, hospitality and leisure, Deloitte, said the past year had seen the glass go from half empty to half full. "There is no certainty about the shape of the recovery but it feels a bit better," he said.
The recession had so far seen 25 hotel companies go bust but a lot of these were single assets. There was certainly a dearth of deals, with volumes down 90% year-on-year.
There was appetite for deals but no supply, which he linked to the bid-ask spread. "It is a tough environment to get deals done. They will be off market and discreet." There will be distressed sales, he added, but they would be done in a controlled manner.
During another separate session, Hilton CEO Chris Nassetta said that his company had stripped 15% to 20% out of the cost base both at the property level and at the corporate level.
The current "perfect storm" had given him the opportunity to make these changes. "Great companies that have prospered have taken advantage of times like these."
The Hilton restructuring has seen it shift from a geographical focus to a functional one. It was not just about efficiency but it was about working with owners. Hilton had reduced its fees in the US which was possible due to the size of its system, said Nassetta.
IHG CEO Andy Cosslett said that his company had surprised some by continuing with its rebranding of Holiday Inn. "If you can push on, because there is so little other noise, you can get a higher profile," he said.
A key change at IHG was embracing sensory experience of customers, something that has not previously been considered due to the service mentality within the industry. The sensory experience had led to changes in areas such as music and scent.
*The conference was held on November 18 at the Dorchester.