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Lender Competition Resurfaces as Liquidity Improves

May 4, 2010

While plentiful problems plague the commercial real estate sector, active small-balance mortgage bankers are happy to report that liquidity has clearly been returning to the space in recent months.

More debt investors are actively lending against stabilized small commercial properties, and the heightened competition is reducing interest rates and increasing the amount of loan proceeds available for a given transaction.

"People are hungry for deals again," observes Dan McIntyre, a director with Holliday Fenoglio Fowler in Washington DC. "Spreads are coming in.. and terms are clearly, demonstrably better" than they were as recently as late-2009, McIntyre relates.

While every proposed transaction still gets heavy underwriting scrutiny, McIntyre estimates interest rate spreads across the risk and size spectrums have narrowed by an average of at least 100 basis points since just last fall.

Meanwhile as more lenders join the small-balance fray, senior debt in many cases is covering 5 percent more of the capital stack than had been the case as recently as late last year.

Traditionally conservative life companies are returning to the small-balance space and allowing loan-to-value ratios of up to 70 percent with properties and markets they like, notes Keith Van Arsdale, president/CEO of BMC Capital in Dallas. These lenders had tended to stick with LTVs of 60 percent or lower through much of the recession.

And some of the relatively aggressive new mortgage REITs and debt funds will occasionally reach even higher - perhaps as high as 80 percent in cases where values appear well positioned for recovery, McIntyre adds.

Small-balance lenders are likewise loosening up generally with respect to debt-service coverage ratios. For deals where they were requiring minimum DSCs in the range of 1.5 to 1.6x last fall, quotes today are more likely to fall into the 1.25 to 1.35x vicinity, McIntyre specifies.

The new players and returning life companies represent more competition for community and regional banks, which for the most part remain the most active small-balance lenders. And as more and more banks are becoming comfortable originating new loans, all small-balance lenders are necessarily competing on price.

"We're definitely seeing more competition out there," Van Arsdale acknowledges. While activity remains well below the frantic days of 2006-07, "it's way better than a year ago," he adds.

Concurring with McIntyre that spreads generally have come in by triple-digits over a matter of months, Van Arsdale stresses that active small-balance lenders today tend to quote all-in rates without much regard to spreads over relevant indices.

Depending on collateral quality, term length, LTV and other factors, quotes for small-balance commercial mortgages these days are typically coming in at fixed coupon rates of anywhere from 6 percent to 7.5 percent.

With even more popular adjustable-rate loans, some banks and other lenders are tending to insist on rate floors in the 6 percent vicinity regardless of the contract spread. Hence with Libor still below 0.4 percent, a Libor-indexed loan with a spread of even 500 basis points would necessarily start at the 6 percent floor.

Logically these deals often also include a rate cap, typically factoring to 8.5 to 9 percent.

Quotes for three- and five-year fixed-rate deals have likewise become pretty attractive with the narrowing of spreads seen in recent months. With spreads ranging roughly from 325 to 425 basis points over the comparable-term Treasury yield, coupons of five-year deals are often in the low-6s.

Whether fixed or floating, a good chunk of the small-balance loans being originated these days carry three- and five-year terms, as lenders and borrowers alike remain hesitant to gamble on where rates will go over the longer-term, Van Arsdale and McIntyre agree.

All of which seems to bode well for small-balance liquidity's nearer-term recovery, as lending volume as recently as 2009's fourth quarter was still well off the year-earlier period, according to data compiled by Boxwood Means.

Hence, it's probably reasonable to conclude that small-balance ($5 million and under) commercial mortgage lending this year will ultimately mark an improvement over 2009, when originations fell 35 percent, to $93 billion, from the previous year.

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