Apartment Finance Today

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A Whole New Ballgame

APARTMENT FINANCE TODAY • July/August 2008

Capital Markets Execution program gets ready for prime time.

BY JERRY ASCIERTO

A player new to the conduit lending market is quietly offering loans with some great rates and terms.

The upstart provides five-, seven-, and 10-year loans with rates of just 6 percent, loan-to-value (LTV) ratios of up to 80 percent, and debt-service coverage ratios (DSCRs) that stretch down to 1.15x.

Even more astounding, this new kid on the block allows supplemental financing on its loans, dispelling the myth that all conduit loans are inflexible.

That new player is Freddie Mac, whose Capital Markets Execution (CME) pilot program is quoting deals left and right. The program gives Freddie Mac a hedge against the next time the market for commercial mortgage- backed securities (CMBS) comes back in full force, and at the same time broadens its customer base.

“The opportunity we have now is to convert conduit borrowers into agency borrowers, and we’ve seen an unbelievable amount of interest,” said Mike May, Freddie Mac’s senior vice president of multifamily sourcing. “We’re seeing an expansion of our footprint in terms of who we touch and who we’re talking to.”

Five Freddie Mac lenders, including Capmark Finance and Holliday Fenoglio Fowler (HFF), are participating in the pilot. An underwriting guide was finished by March 31, and in its first two months of operation, the program signed up nearly $100 million in multifamily loans.

While the credit parameters are consistent with Freddie Mac’s conventional program, the conduit execution offers lower pricing and higher leverage compared to the company’s standard portfolio loans.

Rates available through the CME program are on average five to 10 basis points lower than on Freddie’s conventional loans, and LTV ratios average about 3 percent to 5 percent higher. The largest amount of proceeds and biggest declines in spreads are offered on the longer-term loans.

The CME loans made by Capmark in early June include some with spreads of less than 200 basis points, and DSCRs of as low as 1.15x, according to John Cannon, executive vice president and head of agency lending for Capmark.

Freddie Mac is also offering interestonly (IO) terms through its conduit execution, though borrowers have to pay a premium for it: The DSCR or pricing is set to rise in accordance with how much IO the borrower seeks.

“It’s a more aggressive loan for borrowers looking for lower rates and more proceeds, but only if you’re comfortable with it being sold,” said May.

Like a standard conduit loan, the CME program features less-flexible loan documents and a stricter prepayment scenario than a portfolio loan. Borrowers are locked out from prepayment for two years after securitization, for instance. And all borrowers must be Special Purpose Entities, which are limited companies or partnerships created to isolate financial risk.

Freddie Mac will bundle the loans, work with the issuer to structure the offering, and then either purchase or guarantee the senior bond, while the subordinate bonds are sold to other investors. Under this arrangement, the loan’s originator is the primary servicer, allowing borrowers to procure supplemental financing after the loan is sold.

Flexing supplemental

The knock on conduit loans in the past was their lack of flexibility. Once a loan is securitized, an investor becomes the loan’s servicer—an investor that has no relationship with the borrower and no incentive to fundamentally alter its investment. But by buying or guaranteeing the senior bond in a CME issuance, Freddie Mac is able to offer what few other conduits have before.

“The ability to obtain supplemental financing is huge,” said Cannon. “That’s the biggest calling card and should win over a lot of customers.”

HFF has also seen much interest in the program from borrowers who once relied heavily on conduit financing. In early June, HFF closed its first CME loan, a $4 million refinance with an 80 percent LTV ratio and a 1.20x DSCR that featured several years of IO, according to Pat Kinlan, HFF’s head of agency lending.

Freddie Mac hopes to securitize two CMBS offerings by the end of this year, then the program will be rolled out to the broader network of lenders. “When this thing is completely baked and rolled out broadly, we’re going to be known as the high-quality conduit,” said May.