Pittsburgh, Pa. - An 80-year-old building in a tired neighborhood on the fringe of Pittsburgh’s central business district recently received an interest-only conduit loan.
Conduit lenders, who make loans that are then pooled and sold to Wall Street investors as bonds, have been pledging for years to lay off using risky gimmicks like interest-only financing to lure borrowers. At the very least, they promised interest-only loans would only be offered to strong properties in promising markets.
But suddenly, interest-only financing seems to be right for practically any borrower in practically any market. “Traditional area and market analysis has kind of been thrown out the window,” said Nick Matt, managing director for Holliday Fenoglio Fowler, L.P., in Pittsburgh. Matt arranged the Pittsburgh loan, which was to a 500-unit portfolio of apartment properties including the 80-year-old building. The borrower, who didn’t want to be identified, will pay only the interest on the loan for the first four years of its 10-year term, and then will start making principal and interest payments over the next six years, using a 30-year amortization schedule. The balance of the loan will come due in a balloon payment at the end of its term.
The lender also waived the insurance fee on the loan, along with the tax escrow. The legal fees were capped at $8,500, and the borrower will pay $250 per unit per year into a structural reserve—but only for two years. That two-year limit is unusual for a building so old, which will probably need some capital repairs. The usual 1 percent fee for another borrower to assume the loan if the property is sold was cut in half to just 0.5 percent.
Conduit lenders have to offer extras like these to compete. “People are trying different things in order to get in the door,” Matt said. Most conduit lenders have already done everything they can do to offer a competitive interest rate, with the result that most quotes now offer borrowers roughly the same rate, with only a few basis points difference.
Typical interest rates for a 10-year conduit loan to an apartment property range from 90 to 100 basis points over the yield on 10-year Treasury bonds, Matt said. For example, the loan to the Pittsburgh portfolio has an interest rate of 100 basis points over Treasuries. The Pittsburgh loan covers 80 percent of the portfolio’s value.
Conduit lenders are also straining to make larger loans to apartment properties. “We’re seeing very high-leverage deals that wouldn’t have been done last year,” said Ronnie Levine, managing director for Meridian Capital Group, a mortgage broker based in New York City.
Conduit lenders once typically required a debt-service coverage ratio of 1.2x. But lenders are now sometimes willing to make loans so large that the monthly payments are exactly equal to the current income from the property, giving them a debt service coverage ratio of 1.0x. These borrowers must make a case that they can boost the rents at their properties and usually bring a significant amount of their own equity into the deal, Levine said.
Levine is also still helping borrowers find conduit financing that covers 90 percent of the value of a property, usually with the help of a mezzanine loan.
“There are no formulas any more,” Levine said. “Underwriting is being tailored to specific properties.”
Conduit lenders had seemed poised to tighten their underwriting standards earlier this year. But the bond investors that buy up pools of conduit loans haven’t been demanding safer loans. Instead, these investors seem eager to buy almost any loan that conduit lenders can think to originate.
Bond investors purchase these loans as commercial mortgage-backed securities (CMBS). As 2006 wound down, experts were projecting the biggest year ever for CMBS, more than $200 billion in bonds issued in 2006 in the U.S. alone. That’s up from about $170 billion in 2005, which was already close to double the previous year’s volume.
Despite the huge supply of CMBS hitting the market, strong demand for this debt has kept the price of the securities from dropping. In the beginning of December, investors were buying AAA-rated CMBS with average yields 72 basis points higher than the yield on equivalent Treasury bonds. That’s barely changed from the yield six months ago of 79 basis points over Treasuries, according to Lisa Pendergast, managing director for RBS Greenwich Capital, a conduit lender based in Greenwich, Conn. The yield on these bonds has floated within a range of about seven basis points all year, Pendergast said.
Even with all of the concessions offered by lenders, a surprisingly small percentage of loans get into trouble. Just 0.67 percent of the fixed-rate conduit loans tracked by Greenwich Capital were 30, 60, or 90 days delinquent as of October 2006. That’s a steep drop from this decade’s high of 2.48 percent in October 2003.
Still, multifamily loans account for 36 percent of those bad loans, even though they only make up 19 percent of the loans in Greenwich’s pools.
In response, some conduit lenders are pulling away from at least one type of multifamily financing: condominiums. Until recently, condominium conversions have accounted for more than a third of all multifamily conduit loans, Pendergast said. Often developers used floating-rate conduit loans to buy up large portfolios of apartments and convert them to condominiums.
But as the condominium market cools, lenders are less eager to lend to conversion projects. “We, as lenders, are going to focus more on the old standby: rentals,” Pendergast said.
That means even more competition among conduit lenders to make loans to a limited number of apartment properties, and even looser loan terms are likely to be coming soon to a lender near you.
