Capital Markets: Financing Small Properties
Demand grows for ‘small-balance’ pools
Efforts to bring conduit efficiencies to small-balance loan pools should translate to better rates and lower fees.
By Brad Berton
(Apartment Finance Today, July/August 2005) — Institutional demand for commercial mortgage-backed securities (CMBS) is so strong, a few forward- looking capital markets innovators including CBA Commercial, LLC, and Imperial Capital Bank (ICB) are aiming to improve costs and terms for “mom-and-pop” borrowers as they sell pools of small-balance commercial mortgages into an eager secondary market
While it’s unclear whether the budding trend will have much staying power, the heightened competition certainly hints at attractive rates and terms in the near future for modest-sized loans for multifamily borrowers.
Real estate investors that purchase or refinance medium- and large-sized properties have been the biggest beneficiaries as Wall Street conduits efficiently bundle highly diversified pools of mortgages into bonds that remain in great demand. CMBS have performed so well, bond-buyer demand has allowed mortgage originators to offer attractive interest rates for solid multifamily properties in particular, with many long-term fixed-rate deals now closing in the vicinity of 5.25% or lower.
However, many of these Wall Street conduits, while pooling $1 billion or more worth of commercial mortgages, just don’t want to bother with loans of less than about $1.5 million. Just a handful of active conduit lenders actively court small-balance borrowers, including Wells Fargo, ABN Amro, JP Morgan Chase, LaSalle Bank and Column Financial (see Apartment Finance Today, April 2005, page 20), according to experts.
But now, several firms are specifically targeting securitized lending for small deals. Start-up CBA Commercial and long-established ICB are aiming to bring more efficiency to the small-balance marketplace with new conduit operations, said Gary Bechtel, managing director at real estate investment banker Johnson Capital in Irvine, Calif. CBA has just begun securitizing pools composed of small-balance commercial and multifamily mortgages. And ICB is preparing to do the same, said Rich Carlson, a director at Fitch Ratings in Chicago, who analyzes CMBS loan servicers.
Follow the leader
While CBA and ICB declined to discuss these operations, Carlson and Bechtel concurred that both appear to be following Bayview Financial, L.P.’s successes in originating small-balance loans and pooling them for securitization – in some cases bundled with single-family mortgages.
“These guys are aiming to bring the efficiency of the large-balance conduit market to the small-balance sector,” said Bechtel. Johnson Capital is forming a nationwide direct-lending operation specializing in the $250,000 to $3 million niche, he added.
“The theory behind these efforts is that securitization of small-balance pools amid strong investor demand ultimately translates to higher [loan] proceeds and better pricing that will win over borrowers,” Carlson said. In contrast to the huge traditional CMBS issues sold in the public markets, so far the smaller small-balance pools have typically sold to mostly institutional buyers through private placements, he and Bechtel explained.
While it’s impossible to say just how the additional competition and efficiency will affect small-balance borrowing rates, Carlson and Bechtel agreed that the gap between small-balance and traditional conduit rates seems destined to narrow as CBA, ICB and perhaps additional players ramp-up operations.
Miami-based Bayview, through its Commercial Direct division, is already funding fully amortizing commercial and multifamily loans up to $2 million at a loan-to-value (LTV) ratio as high as 90%, with no points or upfront fees and just a $500 lender fee at closing. Rates can be as low as 12.5 basis points over the prime rate, which factors to 6.125%, based on the 6% prime rate prevailing in mid-June.
Bayview boasts a long-established platform for securitizing residential mortgage pools. Now it also regularly securitizes pools of small-balance multifamily and commercial mortgages that it originates and buys, and like ICB, has been expanding lending programs that cater to small-balance borrowers.
The company, owned by its management in partnership with Allstate Insurance Co., securitized a $300 million pool of small-balance mortgages through a private placement in February, following three such securitizations last year that totaled $1.3 billion. Bayview also pools small-balance commercial loans with conforming and sub-prime residential mortgages and other assets into securities sold through public markets and private placements.
$3 billion small-balance goal
CBA officials didn’t respond to requests to discuss its programs and strategies. But the Stamford, Conn.-based operation’s marketing materials and other reports indicate that management’s goal is to originate and securitize some $3 billion in commercial and multifamily mortgages annually in the $100,000-to-$3-million range.
In February, CBA issued its inaugural $102 million securitization through a private placement, pooling loans with an average principal balance of just $387,000. The firm expects to complete another roughly $200 million transaction this summer.
Private merchant banking firm Cheslock Bakker & Associates formed CBA Commercial, which is headed by Chairman and CEO William K. Komperda. TH Lee Putnam Ventures, formed by Thomas H. Lee Partners and Putnam Investments, also invested in the start-up.
CBA is looking to work with 15 or more originations partners and has already established an alliance with New Century Financial Corp., an Irvine, Calif.-based operation known mostly as a sub-prime residential mortgage lender. New Century has offices in 29 states and also offers a variety of commercial loan programs in the $200,000-to-$3-million range. New Century also declined AFT’s request for an interview about the CBA program, but the commercial division’s Web site specified in mid-June that 10-year fixed multifamily rates for its most creditworthy borrowers ranged from 6.475% at a 60% LTV ratio to 7.1% at an 80% LTV ratio.
CBA is also finalizing an arrangement with another lender known for its sub-prime residential activities: ResMAE Financial Corp. of Brea, Calif. ResMAE, which Komperda co-founded and which is also backed by the TH Lee Putnam group, hadn’t yet begun originating under the CBA program at press time, according to a spokesperson.
Adaptability of sub-prime lenders
Such sub-prime specialists have substantial originations networks and processing operations in place that are more readily adaptable to small-balance commercial lending, compared to systems at large-balance conduit lenders, said Bechtel. Their immediate-term challenge is to develop greater expertise in underwriting income properties, he added.
Meanwhile, La Jolla, Calif.-based ICB is expanding its small-balance Imperial Capital Express lending program across the country as the bank positions itself for expected small-balance CMBS securitization activities. In February, the ITLA Capital Corp. subsidiary formed an alliance with Fannie Mae to originate and service fixed-rate multifamily mortgages under Fannie’s MFlex small-balance program.
ICB’s Express program covers fixed- and floating-rate loans as small as $100,000 and as large as $3 million or more. Rates for three- and five-year fixed-rate loans in early June ranged from 6% to 6.75% at a 75% LTV ratio, depending on the fee option selected, and 50 basis points higher at an 80% LTV ratio. The program allows for overall leverage of up to 85%, including secondary financing. Amortizations run 15 to 30 years.
ICB didn’t respond to AFT’s inquiries about its small-balance securitization plans.
Ongoing demand debatable
One factor potentially limiting the market penetration of small-balance conduit channels is the ever-intensifying competition from financiers including the established Wall Street conduits, various portfolio-type lenders and government-sponsored enterprises Fannie Mae and Freddie Mac, Carlson said.
Another factor is the uncertainty about the ongoing depth and breadth of investor demand for securities backed just by small-balance commercial and multifamily mortgages, Carlson added. While institutional investors have demonstrated resilient demand for public CMBS issues for several years running, some small-balance issues might ultimately prove too small and insufficiently diversified to generate the level of liquidity institutions want, said Carlson.
Nevertheless, small-property investors, at least for the near-term, can probably expect competition for their borrowing business to intensify as CBA and ICB ramp up their small-balance conduit operations. But as Carlson and Bechtel both pointed out, the newcomers may well have to go through some growing pains as they fine-tune their respective business models.
While CBA’s experts have extensive commercial and residential securitization and mortgage banking experience, they’re still establishing formal relationships with small-balance originators around the country. Prolific small-apartment lender ICB has positioned itself to securitize and service pools of small-balance loans it originates and acquires, but it doesn’t have extensive internal mortgage securitization or servicing experience to draw on.
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