A QUIRKY DYNAMIC IS AT play at the government-sponsored enterprises (GSEs)—borrower scrutiny is at an alltime high, even as credit conditions begin to loosen.

Partial Interest-Only (IO) loans reemerged in the second quarter and are now routinely being offered. Full-term IO loans are available as well, but only on lower leverage transactions. Meanwhile, Fannie Mae has lowered the underwriting floor on certain executions, and Freddie Mac has added some flexibility to its Capital Markets Execution (CME) program.

“We were in this very big tightening mode around credit,” says Michele Evans, a vice president of multifamily at Washington, D.C.-based Fannie Mae. “But we've relaxed some of our credit standards because we felt like it was the appropriate thing to do.”

This loosening up coincides with renewed confidence in the economy. After a dismal first quarter, GSE lenders reported a big spike in activity on both the acquisition and refinancing sides in May and June. Plus, with cap rates on high-quality assets continuing to compress, and many markets stabilizing across the country, the GSEs have grown more flexible.

“The general theme is more willingness to look at waivers,” says Don King, who runs the GSE platform for Bostonbased CWCapital. “It stems from the comfort level that we're at the bottom and, in some cases, seeing improvement. And we have a better feel for values because we're seeing properties trade.”

Still, despite the improving outlook— and even though GSE loans are generally nonrecourse—the focus on the sponsor has become the be-all and end-all of executions seeing completion.

“There are clearly signs that credit is loosening up, but the due diligence on borrowers has never been higher,” says John Cannon, who runs the mortgage origination business at Horsham, Pa.- based Berkadia Commercial Mortgage. “I've seen a lot more loans being done ”¦ but the scrutiny has gotten worse.”

Loosening the Reins

Word on the street is that Fannie Mae is making its changes—and getting a little more aggressive—in order to win back some business from Freddie Mac after a poor first quarter.

For instance, Fannie Mae has lowered the underwriting floors on some fixedand floating-rate executions, which allows borrowers to qualify for more proceeds. This lowering of the underwriting floor—a tool for sizing loans—has had a big effect on seven-year deals in particular.

“Freddie Mac had a huge advantage on seven-year terms, but that delta's been narrowed dramatically now,” King says. “Fannie was sizing to an underwriting floor that, at one point, was 80 to 90 basis points (bps) higher than what Freddie was sizing to.”

Fannie Mae also reorganized its multifamily business to compete more effectively with Freddie Mac. One advantage Freddie Mac has historically had is a willingness to engage in borrower differentiation—that is, large, premier borrowers could get better deals than smaller-volume borrowers. But Fannie's DUS model didn't lend itself well to that dynamic. So Fannie Mae is now taking a different approach, separating its multifamily production into two channels: Heidi McKibben will run Fannie's borrower channel, while Manny Menendez will run the more general lender channel.

But Freddie Mac has been busy, too. The company added seniors housing and conventional structured finance into its CME program in June, while giving the CME program more flexibility.

In April, Freddie Mac officially rolled out a menu of waiver options—everything from getting insurance waivers to requesting that the B-piece not be sold. Each waiver option comes with a price, though some (such as deferring an escrow request) will have little or no impact on pricing, while others (such as reducing or waiving insurance coverage) will have a much bigger impact on rates.

“We learned that borrowers were willing to pay a little extra for more options, so we enhanced the CME product by increasing flexibility,” says David Brickman, vice president of multifamily CMBS and capital markets at McLean, Va.-based Freddie Mac.

The company believes that over time, a certain volume of borrowers will gravitate toward the same combination of waiver requests. Brickman likens it to pizza— plain cheese pizza was all that was offered initially, with toppings being individually selected. But the company will track which combinations of waivers are most popular, and may offer a pre-packaged option, akin to a meat lovers or veggie pizza.

“Once we get a sense of these combinations, we may begin to offer them as packages so borrowers can quickly get what they need without having to manually select each option repeatedly,” Brickman says.

Under the Magnifying Glass

Despite these distinct changes to enhance flexibility, the GSEs are continuing to tighten up their scrutiny of potential borrowers—both from a single execution and portfolio-wide perspective.

The first question these days confronting any potential borrower is: Where's your schedule? Lenders are increasingly picking apart a borrower's entire portfolio of maturing loans to get a handle on just how much liquidity a borrower has—and how much they'll need in the future.

This focus on “global cash flow” wasn't much of a consideration during the height of the last boom period. After all, there was so much credit available on the market that lenders didn't stress out too much about whether a borrower's existing loan could get refinanced. Today, the scrutiny is not just on a borrower's multifamily portfolio, but their entire business. “The one thing you look at a little closer is what their liquidity will look like relative to their maturing portfolio over the next few years,” says Vince Toye, head of GSE production at San Francisco-based Wells Fargo. “That's what we're digging into; their overall maturity portfolio.”

In addition, the GSEs are sticklers in certain aspects of their business. For example, if your deal's narrative strays even slightly from the GSEs' requirement, it can easily get turned down. Consider student housing. The GSEs generally aren't fond of dorm-like deals; they prefer student housing deals with kitchens. But even if you've got a great dorm-style deal in all other respects, it's much easier for the GSEs to turn you down than to make changes to the program and reinvent the wheel.

“There's greater flexibility to get IO and some waivers on things, but if the deal has some structural flaw to it, it's tougher to get done,” says Berkadia's Cannon.