The largest commercial banks continue to build their capacity to offer every kind of real estate loan in every part of the country.

Several large banks have opened lending offices in the last year far outside the footprint of their branch banks and can now follow their customers into virtually any market nationwide.

Commercial banks have also extended their reach by merging with or purchasing companies capable of making permanent loans to apartment properties.

There will certainly be further mergers – some loan pros are speculating on Citibank and Deutsche Bank, for example. But experts don’t expect the next wave of mergers to alter the way banks do business in the way that the last wave did.

Most large and many mid-range bank lenders already offer permanent conduit loans, Fannie Mae and Freddie Mac program loans, and even Federal Housing Administration-insured loans, and they now enjoy referring their construction loan borrowers to their permanent lending operations.

Smaller banks compete with flexibility

Despite the heavy competition, small and mid-sized banks are making more loans – both construction loans and permanent loans – to apartment properties.

In fact, several decidedly regional mid-sized commercial banks, such as New York Community Bancorp, Inc. (NYCB) and Independence Community Bank, are among the largest holders of multifamily debt in the country.

NYCB grew its multifamily lending business by 5.8% in the first quarter of 2004 alone. NYCB is the $26.5 billion holding company for New York Community Bank. Likewise, Independence has less than $20 billion under management, compared to the whopping $200 billion managed by Washington Mutual, Inc.

Relatively small banks are able to lend more in part because of their flexibility. Many of these banks have found ways to make permanent loans, either from their own balance sheets or through Fannie Mae or Freddie Mac programs.

Smaller bank lenders, such as Dallas-based Guaranty Bank, can tailor the long-term loans they offer to the needs of their borrowers. Seattle-based HomeStreet Bank is another example.

Corus Bank Commercial Real Estate, based in Chicago, has proven its flexibility by becoming one of the nation’s leading nonrecourse construction lenders, according to loan experts.

Smaller banks are better positioned to lend to relatively small borrowers. Of course, even the largest banks will gladly make very small loans. However, it may be difficult for some small borrowers to make their initial contact with the largest banks. “A small borrower might not get their attention with a good $10 million project,” said Robert Kaplan, managing director for Holliday Fenoglio Fowler, L.P.

In contrast, smaller banks will sometimes lower their net-worth requirements for small, local borrowers. Local banks also bring an intimate knowledge of their market to their deals. A local bank’s branches also benefit from positive publicity if the project goes well.

“Some of the second-tier banks are the smartest real estate lending banks in the country,” Kaplan said. “Each market has a few extraordinary smaller banks.” Local recommendations are the best route to find excellent small bank lenders in your own area.

Commercial banks of all sizes are looking to make new loans from their balance sheets to replace the mortgages they lost during the refinancing boom. Because of low interest rates, many borrowers with longer-term commercial bank loans refinanced with new permanent financing. Often the new loans were originated by the same commercial bank, but the new loans used low-interest money from Fannie Mae, Freddie Mac or Wall Street investors, not money from the bank’s balance sheet.

“If your loan book shrinks, your income goes down and you need to make some new loans,” said Mike Slocum, head of real estate financial services for Wachovia.

Unfortunately, good deals are hard to find in today’s apartment markets. The high vacancy rates in many markets might finally start to edge down if the nation continues to produce new jobs. Until then, loan underwriters are looking carefully at every deal that comes in, and lenders are fighting hard to make loans to the best deals.

 “There’s been a tremendous compression of spreads,” said Karl Zavitkovsky, managing director for Bank of America’s commercial real estate banking group’s central division. “Rates have probably dropped 50 basis points in the last six months.”

A variety of lenders quote interest rates between 200 and 225 basis points over the London InterBank Offered Rate (LIBOR) for typical construction loans, though for the right deal, banks will bid each other down as low as 135 basis points over LIBOR.

Debt-service requirements are also negotiable, though many banks will still ask for a coverage ratio of 1.2 to 1.

Most of all, banks rely on their relationships with existing customers to bring in business. “The way that you stay competitive is to provide good service and provide fast answers,” Zavitkovsky said.

Commercial banks are so eager to lend to apartment properties that many are now offering nonrecourse construction loans.

The borrower of a recourse loan must pay the loan back using its own money if the lender forecloses on the loan when the unfinished property backing the loan is not yet worth enough to pay the loan balance. This means that corporate or personal assets could be at stake.

Until recently, most construction lenders demanded this kind of guarantee. But today, lenders are under pressure to compete, and they’re willing to negotiate.

Some lenders offer partial recourse loans. Until work is finished at the project, the borrower is responsible for the entire amount of the construction loan. But once the project is ready for occupancy and the development has some value for the bank to seize, the borrower is responsible for only 50%, or even less, of the value of the construction loan in the event of a foreclosure.

 “In a very competitive market you see guarantees burn-down [shrink] faster,” Zavitkovsky said.

Lenders even offer nonrecourse loans with no guarantee at all. At least 10 major banks now offer them, according to Kaplan.

Lenders will even match a nonrecourse construction loan covering 60% of a project’s projected value with nonrecourse mezzanine financing, Kaplan said.

However, the lender must be very comfortable that the developer will finish the project. “It’s really designed for experienced developers with experienced architects, contractors and attorneys,” Kaplan said. The banks also charge higher interest rates when they assume the construction risk on a project – how much higher depends on the bank.