Colorado Real Estate Journal - December 3, 2014
The commercial mortgage-backed securities financing industry continued to gain market share in 2014. Several of the CMBS lenders Essex Financial Group has done business with have demonstrated speed of execution, a high level of deliverability and the ability to provide better economics compared with alternative nonrecourse permanent loan sources such as life insurance companies. In addition, several have a wider variety of loan programs, including on-book bridge loans that can be converted to permanent loans upon stabilization. A handful of CMBS lenders are trying to differentiate themselves by developing alliances in the top 20 metropolitan statistical areas with mortgage bankers that service large loan portfolios. The level of servicing quality and the accountability with the originating mortgage banker/servicer continue to be the primary strengths of a life company loan and the weaknesses of CMBS financing. Strengths of a securitized loan include: • Speed of execution/efficient processing – CMBS loans can be closed in less than 45 days; • Although the rate is typically higher vs. a life company, the higher leverage and interest-only payment terms provide better economics over the holding period (assuming exit is timed well); • More flexibility on borrower track record and financial strength; and • Multiple assumptions. Weaknesses of a securitized loan include: • Servicing conflicts of interest – lack of accountability and conflict of interest with a master servicer representing best interest of first-loss position bondholders; • Prepayment choices – defeasance or yield maintenance? Any open prepayment term on the back end of the loan or a stepdown fixed prepayment percentage are significantly cost prohibitive; • Higher transaction costs – lender legal fees are usually twice the amount vs. a life company; • No rate lock (spread only) until closing; • Assumption timing takes more than twice the time it takes to originate a loan; and • Master servicer has right to change leasing and capital improvement reserve structure at loan assumption. Strengths of a life company loan include: • Rate lock at application; • Lowest fixed rates; • Longest terms (10 to 30 years fully amortized); • Loan commitment to confirm deliverability prior to waiving financing contingency; • Prepayment choices and more flexibility – yield maintenance, open prepayment periods, stepdown (5,4,3,2,1 percent years six through 10); • General account loan; and • Usually locally serviced by loan originator, which provides borrower with better servicing due to originating mortgage banker’s accountability and motivation to maintain and earn repeat business. Weaknesses of a life company loan include: • Acquisition time frames of 30-day due diligence and close 15 days later are very difficult for most life companies to meet. Most are reluctant to commit to delivering a loan commitment within 45 days; • Some may sell a portion of the loan to a third-party investor, which can cause problems with modifications or assumptions; • Life companies get bought and sold and staff changes over time; • Significantly more conservative underwriting; • 30-year amortization terms are limited to lower leverage and/or higher-quality properties; • Higher-quality properties and borrowers required; • More location sensitive – prefer top 20 MSAs and are very selective in secondary markets; • Higher levels of leasing capital reserves on high-leverage loans; • More conservative structuring around major tenant rollover risk; and • Interest only is challenging above 65 percent loan to value on most product types. The main tradeoff with a securitized loan is a lack of future lender flexibility in the event the borrower’s business plan goes in the wrong direction. Life insurance loan servicing is typically more efficient and the servicing contact is experienced and motivated to assist with solving unforeseen problems. Life insurance company loans are usually originated as “general account” loans where the lender retains 100 percent of the loan amount on their books through the loan term. However, it’s not unusual for some life companies to sell a portion of the loan to a third-party investor, which can create problems with layers of approval on situations such as a loan assumption or an interest-only payment request if the cash flow is temporarily low. Life insurance company loans are typically the best lending sources for borrowers requesting lower-leverage permanent loans at the lowest interest rate that will be serviced by an experienced staff with an alignment of interest. CMBS loans usually provide better economic terms at leverage levels life companies won’t offer. However, senior management ethics vary and some are known to retrade for sport. Choosing a lender with a track record with the mortgage banker is important. Choosing a mortgage banker that can provide full cashiering servicing might be just as important. This provides a local mortgage banker that also has a local servicing group with more administrative control. All investors would prefer a permanent fixed-rate loan that’s serviced by the lender that originates the loan by a qualified and experienced staff that operates efficiently and in a timely manner. If the CMBS industry finds ways to provide better servicing via local mortgage bankers that have local servicing groups, they could likely take more market share from life companies. Right now they’re just winning on economics and willing to do deals life companies won’t.