New York City—On a cool, sunny day in California, the owners of the El Dorado Apartments , a small garden community in the San Francisco Bay Area town of Belmont, closed on a modest, $1.9 million loan from PNC ARCS, a division of PNC Financial Services Group, Inc.
As borrower and lender shook hands and signed documents, chaos raged on Wall Street. It was Oct. 10, and as European banks foundered, experts pronounced the U.S. credit markets frozen, and the Dow Jones Industrial Average fell below 8,000 for the first time since the aftermath of 9/11.
Lenders like PNC ARCS continue to make small apartment loans, unfazed by the biggest financial crisis in decades. That's in part because these lenders don't rely on the capital markets to fund their loans. Also, multifamily loans have had relatively few defaults so far, so they have little negative impact on the institutions that fund them.
“The sources for small loans are some of the sources that have been least impacted by the credit crunch,” says Jamie Woodwell, vice president of commercial real estate research for the Mortgage Bankers Association (MBA). “We have seen GSEs (government sponsored enterprises) and banks and thrifts continuing to fund.”
The loan for El Dorado Apartments was funded with capital from Fannie Mae's Small Loan program, which has been aggressively competing to attract borrowers to small loans, even during the capital crisis. “Fannie Mae is still in the marketplace,” says Holli Leon, executive vice president for PNC ARCS.
After the GSE was seized by a government conservator in September, Fannie Mae officials say it's still “business as usual.” Since then, its interest rate spreads have held relatively steady, after rising over the summer. El Dorado received an all-in rate of 6.9 percent for its seven-year Fannie Mae mortgage. For small 10-year Fannie Mae apartment loans, PNC ARCS quoted spreads of 240 to 255 basis points over Treasury bills in the first half of October.
“The conservatorship has given great stability to the spreads,” says Charles Krawitz, managing director of KeyBank Real Estate Capital, another originator of small Fannie Mae apartment loans.
Of course, interest rate spreads are only part of what determines interest rates. The benchmark rates that make up most of a loan's all-in rate leapt and fell back many times this fall, sometimes by more than 40 basis points on a single day like they did Oct. 8. Volatility disoriented lenders and borrowers trying to underwrite loans, but it also offered an opportunity, since many borrowers can wait to lock in a low rate, says PNC ARCS' Leon.
Also, despite volatility, benchmark rates remain historically low. As a result, the all-in rates lenders offer to borrowers remain relatively attractive despite the troubled capital markets. For example, the yield on the benchmark 10-year Treasury bonds have generally stayed below 4 percent since August, rising and falling between 4 percent and 3.4 percent. Before August, the yield had generally stayed above 4 percent since early 2004.
The underwriting of these loans also remains reasonable. For example, in strong markets, PNC ARCS asks for debt-service coverage ratios (DSCRs) starting at 1.15x for loans covering 75 percent of the value of the property.
Some commercial banks also continue to make small loans to apartment properties from their own balance sheets—sometimes even if that balance sheet is in trouble. For example, Washington Mutual kept making small loans even as the bank was threatened with insolvency and its stock price collapsed in September. It's still unclear whether Washington Mutual will cut back its lending activities after its governmentarranged takeover by JPMorgan Chase, though as of early October, the bank was still offering to make loans, according to industry experts.
Enough community banks made apartment loans this fall to allow Green Park Financial to announce a program at the end of September to buy pools of these loans to sell to Fannie Mae. Green Park is considering 10- to 15-loan pools to combine and plans to complete its first sale to the GSE by the end of the year. The individual apartment loans in these pools average $2 million. The loans will be relatively low leverage, covering an average of 65 percent of the value of the property and with a DSCR averaging around 1.35x, according to Green Park.
Apartment deals such as these are being made even as the banking business weathers its own crisis. In the second quarter, 117 banks made the latest watch list of troubled institutions released in August by the Federal Deposit Insurance Corp. (FDIC). That's the longest the watch list has been since 2003. It's also a rapid increase from 90 institutions on the list in the first quarter. However, it's still a handful compared to the roughly 7,500 banks across the country.
In October, the government poured $250 billion into commercial banks that were presumably at some risk of failure. Of that money, $130 billion went out in allocations of $2 billion or less, and more than 1,000 banks could receive infusions of cash, according to early reports.
Despite the crisis, banks continue to make apartment loans, in part because so far these loans have been a relatively bright spot even on troubled balance sheets. Only 0.17 percent of multifamily real estate loans held by FDIC-insured institutions had been charged-off , or counted as losses, in the first half of the year, according to the FDIC's Quarterly Banking Profile for the second quarter. That's compared to more than 1.79 percent for home equity loans and more than 5 percent for credit card loans. Apartment fundamentals remain relatively strong in many markets.
Also, unlike credit card debt, permanent multifamily loans are collateralized by income-producing property. In the event of a foreclosure, the lender can seize the apartments and use the rents from those apartments to help mitigate its loses.
“If you look at the multifamily loans, they've generally been performing really pretty darn well,” says MBA's Woodwell. “Banks aren't having to provision a lot for loan losses.”