Notwithstanding all the talk of the CMBS industry's rapid recovery—80-plus percent activity growth last year, with another 25 percent projected this year—apartment lending by Wall Street’s active conduit lenders appears to have hit a speed bump.
And it’s not because bond-buyers are concerned about the kind of under-disciplined “pro forma”-based underwriting seen during the bubbly pre-recession peak. Rather, it’s a matter of conduit lenders facing increasingly effective, borrower-friendly competition from inherently more flexible balance-sheet lenders, commercial banks in particular.
While numerous conduits are aggressively competing for multifamily business, increasingly accommodating portfolio lenders—along with the government-sponsored enterprises (GSEs)—are giving them quite a run for their money, observes veteran dealmaker Bennett Newman.
With banks now willing to quote longer-term fixed-rate deals, and life insurers stretching loan-to-value ratios (LTVs) beyond historic norms to win high-quality transactions, it’s far from certain whether CMBS will continue recovering market share, says Newman, senior vice president with multifamily owner-operator Laramar Group.
As the latest data indicate, conduit lending to the apartment sector has rebounded pretty impressively in conjunction with the general CMBS revival over the past couple years. However the multifamily-specific recovery has stalled, at least temporarily, in recent months as healthy banks in particular have come to write more and more business.
The less discouraging news for CMBS participants—and market-rate apartment investors—is that the $2.5 billion in apartment loans securitized during this year’s first quarter more than trebled year-earlier activity, credit rating agency Standard & Poor’s reports. Accordingly, multifamily mortgages represented 17 percent of the loans taken to market during the quarter—more than double the year-earlier period, S&P also calculates.
After securitizing 240 apartment mortgages with a collective balance of $2.42 billion in 2012 (less than 5.5 percent of overall issuance), bookrunners pooled 507 multifamily-backed loans totaling $6.3 billion (7.6 percent of issuance) into 2013’s CMBS deals, according to research firm Trepp LLC. When you add in early 2014 transactions, apartment loans accounted for an even higher proportion of collateral, approaching 15 percent.
Of course it helps that delinquencies among CMBS apartment loans—which peaked at nearly 17 percent in 2011—have steadily fallen since and finally returned to single-digits earlier this year, Trepp specifies.
Nevertheless the more daunting development for conduits (but not necessarily for borrowers) is that the CMBS sector’s apartment loan holdings shrank by 1.6 percent (to $73.3 billion) during that same quarter, according to the Mortgage Bankers Association. And it was the banking sector that accounted for the lion’s share of that shrinkage. Banks’ collective apartment loan portfolios expanded at a heady 3.4 percent pace (to $272 billion), with agency lender portfolios inching up 0.1 percent (to $391 billion) and life companies’ expanding 0.7 percent (to $54 billion).
Newman thinks the primary apartment lender categories’ relative market-shares will be comparable once second-quarter numbers are crunched. He also points out an ongoing general shift in the marketplace: Notwithstanding the apparent stall in the CMBS arena’s once-frantic resurgence, the swollen interest among conduits, banks and life companies in apartment lending is clearly boosting competition in favor of borrowers.
Aggression All Around
Lenders representing all major categories are necessarily adjusting underwriting strategies and deal terms to win business amid today’s exceptionally liquid and competitive environment, says longtime mortgage banker Lee Weaver.
“We’re seeing slow-creep movement outside all the lenders’ boxes,” notes Weaver, a senior director with NorthMarq Capital who has arranged many multifamily financings through conduits and other lender types.
As conduit originators come to green-light mezzanine tranches behind senior debt, grow flexible in calculating net operating incomes, and become more active in tertiary markets and lower price-point collateral, their various competitors are likewise liberalizing traditional deal terms, experts note.
“Everybody in the market is becoming more aggressive, so we’re seeing more acceptance of longer interest-only periods, more pushing of proceeds, and more willingness to grant (underwriting policy) waivers to win deals,” Newman agrees.
For example GSEs Fannie Mae and Freddie Mac are occasionally allowing for some cash-out refinancings, even at 80 percent LTVs. Banks often soften traditional personal recourse guarantee requirements. And life company decision-makers feel compelled to stretch apartment LTVs up to 75 percent from historic maximums of 70 (or lower).
Indeed conduits and other multifamily lenders generally aren’t able to compete on loan pricing alone in the low-rate environment—nor through interest-only (IO) periods that have continued lengthening among all the lender types.
Full-leverage apartment mortgage quotes from all lender categories are typically in the mid- and high-4 percent range these days, with conduits generally quoting spreads on 75-LTV, 10-year transactions in the vicinity of 170 to 180 basis points over the prevailing comparable-term interest-rate swap benchmark, Weaver specifies. Some conduits will also do five-year deals, but the quoted spread over the five-year interest-rate swap will likely end up in the range of 225 to 250 basis points, he adds.
And IO for up to half the term on loans of seven years or longer has become a common structure for conduits and their competitors–although as Weaver notes, lenders generally offer somewhat lesser total proceeds relative to deals that amortize from day-one.
All of which might seem to suggest conduit underwriting is headed toward another bubble that could likewise burst in the event incomes or valuations decline in coming years, prompting defaults as borrowers can’t cover debt-service obligations or refinance outstanding balances at maturity.
But Weaver relates that today's wave of conduit deals, dubbed CMBS 2.0, and its far more exhaustive underwriting documentation has so far maintained reasonably prudent deal-making. He acknowledges, though, that decision-makers will ultimately need to rein in the ongoing “trajectory” toward increasingly liberal underwriting, describing the prevailing environment as “comfortably aggressive.”
Newman for his part is likewise comfortable that rates and terms today’s lenders are quoting still provide sufficient downside protection against potentially rising interest and capitalization rates, and sluggish or even negative effective rent growth. “At least as things stand today, I think lenders are well-positioned to weather a downturn.”
One might even argue that the first-quarter shrinkage in the CMBS apartment-debt universe indicates conduits are indeed exercising underwriting discipline, and declining to stretch beyond aggressive competing quotes.
Still, multifamily finance pros are quick to point out a few areas where particularly liberal strategies can win deals for conduits, such as NOI calculations, secondary financing provisions, and acceptance of non-traditional collateral.
CMBS lenders sometimes manage to boost loan proceeds by taking more liberal approaches than the federal agencies when it comes to certain underwriting assumptions, notes Eric Fixler, a managing director with Johnson Capital who has also helped arrange numerous market-rate multifamily financings with conduits and other lenders.
Conduits tend to be more flexible in accepting borrowers’ contentions that certain expenses will come in below norms for a given market. And compared to the GSEs, there’s generally a less rigid “fire wall” between conduit operatives and outside appraisers, Fixler elaborates. Nor do conduit underwriters focus nearly as much on a property’s likely income stream at maturity, he adds.
And CMBS lenders today are generally more willing and able than other active players to permit as much as a 10 percent mezzanine tranche subordinate to a 75 percent LTV senior loan. Some conduits have affiliated mezz investment operations, while others tend to work closely with a “go-to” third-party mezz lender. Fixler stresses, however, that loan pricing and proceeds still have to meet minimum debt coverage and yield parameters.
Perhaps predictably, conduits are also considering smaller loans today than they were when the CMBS rebound was in its infancy, and they’re looking at broader collateral profiles as well.
Over the past three years, minimum conduit deal sizes have fallen from $15 million into what’s generally considered small-balance territory.
“There are so many new (conduit lending) platforms in the marketplace, you should be able to find a home for a $2 million CMBS deal,” Weaver relates.
Conduits have likewise shown an increasing affinity for specialized non-subsidized multifamily properties such as student, seniors and manufactured-housing communities, although often at somewhat more conservative LTVs. Indeed borrowers looking to finance manufactured-housing properties in particular these days will likely end up with a conduit execution, Fixler suggests.
To illustrate how conduit lenders are winning deals today, consider Starwood Mortgage Capital’s $42.6 million loan which helped Laramar acquire the 689-unit Cove Apartments in Tampa’s Virginia Beach neighborhood. In terms of calculating maximum proceeds, Starwood operatives were generally constrained by a 1.25x coverage limit. But they were also more willing to consider Laramar’s proposed measures for reducing operating expenses, which carried considerable weight given Laramar had been managing the property for the CMBS special servicer that had taken title through foreclosure three years earlier.
“They were still diligent in their underwriting and weren’t going to accept our proposals at face value,” says Newman. “But they were able to be a bit more aggressive” than other would-be lenders in calculating near-term NOI. And the LTV that ended up at roughly 80 percent of the purchase price was “a percent or two” higher than the GSEs were comfortable with, he adds.
Likewise the 42-month IO period—half the seven-year term—was 12- to 18-months beyond what either agency offered, Newman continues. Starwood offered seven- and 10-year term options, and Laramar considered the prevailing yield curve as well as its planned hold period in opting for the shorter term. Starwood also quoted a surprisingly “aggressive” 4.33 percent coupon rate.
“I’d say that’s a testament to conduits’ desire to include more multifamily collateral in the mix” while marketing CMBS issues, Newman notes.
And it helped that Starwood’s operatives were willing to move quickly to fund the loan to a well-heeled borrower that needed to close the acquisition within 30 days of the property’s online auction. Nor did it hurt that Laramar has been managing the community for LNR Property, a sister company of Starwood Mortgage Capital (under parent Starwood Property Trust).
Laramar, an affiliate of which had sold the Cove property to the previous buyer in 2005, bought it back this time in partnership with Lubert-Adler Partners. The Starwood-funded loan that closed in mid-May is one of 17 apartment loans (totaling $223.7 million) securitized through the $961 million CMBS issue dubbed GS Mortgage Securities Trust 2014-GC22.
Meanwhile given the aggressive terms conduits and their competitors are offering, Laramar’s financial analyses as always carefully consider potential issues at maturity in years ahead—such as if debt rates rise 100 or even 200 basis points.
“You have to keep considering the downside,” Newman concludes.
Brad Berton is a freelance writer based in Portland, Ore.