The market for permanent loans continues to be dominated by the government-sponsored enterprises (GSEs), but conduits, life companies, and banks are giving Fannie Mae and Freddie Mac a run for their money.
While the GSEs control the lion’s share of the perm-loan market, banks remain very active, even as they cut back on construction and bridge loans. And life companies have remained extremely competitive in their sweet spot: lower-leverage, fixed-rate deals.
“By and large, the life companies have been winning that business for the last several months,” says Mitchell Kiffe, a senior managing director with brokerage firm CBRE. “Both Fannie and Freddie are having a difficult time competing on low-leverage loans. The life companies are beating them, sometimes by as much as 40 to 50 basis points [bps].”
There was a time when the GSEs routinely beat life insurance companies on pricing up and down the leverage spectrum. But those days are gone, Kiffe says, partly because life insurance companies are portfolio lenders and keep their loans on the books rather than securitize them.
“The cost of the GSEs selling securities went up significantly in the first quarter,” says Kiffe. “There’s been a little bit of a pullback on IO [interest only] by both GSEs, and a little bit on proceeds—on the margin, they’ve been a little less liberal.”
One particular bright spot has been Freddie Mac’s small balance–loan program, which began in late 2014. For many years, Fannie Mae had a cornerstone on the small-loan market (or loans below $5 million), but Freddie’s entrance into the space has been met with widespread approval.
“The Freddie Mac small balance–loan has been a product the industry had been screaming out for,” says Eric Fixler, a senior director at brokerage firm Marcus & Millichap. “Over the past 90 days, they’ve continually dropped the lender spread on small balance–loans. On five-year money, you’re coming in the mid-3% range, and even lower in major markets.”
Not to be forgotten, the commercial mortgage–backed securities (CMBS) market has grown more competitive of late, offering interest rates much lower than what was to be had in the first quarter.
“In the past four months, we’ve seen a resurgence in conduit deals,” says Fixler. “Some deals that were pricey at the beginning of the year have been pulled in 40 to 50 bps from where they were.”
Underwriting terms, such as IO periods and loan-to-cost (LTC) ratios, are fairly comparable with a GSE execution, though the GSEs will max out at 80% leverage, where the typical CMBS loan is closer to 70%.
“There’s a fairly limited number of multifamily deals that are really going CMBS,” says Kiffe. “While it’s true CMBS pricing has come in a lot, and the market is more stable, we’ve found that, by and large, the market for good-quality multifamily loans is dominated by the GSEs, banks, and life insurance companies.”
The market certainly faces some headwinds. The Dodd–Frank risk-retention regulations are still being ironed out and go into effect later this year. Those regulations may require lenders to retain as much as 5% of a loan on their books—to ensure lenders have “skin in the game,” as they say.
“It’s an evolving CMBS market. There’s a view that the increased pricing due to risk-retention structures will be about 25 bps, which is a lot lower than what I was hearing in the beginning of the year,” Kiffe says. “I think the capital is forming and people are reacting to the new regulations.”
The biggest issuers, like Morgan Stanley or JP Morgan, are already preparing to withstand the slings and arrows, leading brokers to believe the market won’t be losing much, if any, capital going forward.
“Will the CMBS guys push back a little bit more? We’ll find out after the regulations are in place and [see] how the B-piece buyers will react,” says Fixler. “But most CMBS shops we’ve spoken to say they’ve already prepared for it, by establishing lines of credit and other financial instruments in anticipation of the changes.”
But CMBS faces other challenges. There’s the execution risk, for example—a borrower can’t lock in a rate in advance, and rates change daily. And the issue of servicing after securitization continues to be an Achilles' heel for conduits, compared with balance-sheet lenders and the GSEs.
While the perm-loan market continues to hum along, the big story in the debt world going forward will likely be the dearth of construction capital.
“Right now, the trend is not our friend,” says Kiffe. “I think construction-lending activity will continue to diminish, especially as we get later in the economic and credit cycle.
"A big part of the cutback is the supply–demand equation and just a general view that we’re getting later in the cycle, and perhaps the lease-up risk is more significant now than it was a couple of years ago,” Kiffe says.