I have a great training article about commercial loans for you today. How do conduits price their commercial loans? After all, commercial lenders cannot buy a forward commitment from Fannie Mae or Freddie Mac, like a residential mortgage banker; yet most commercial loans today are fixed rate loans. How on earth do the commercial loan officers, working for these big-time commercial lenders, know what to quote?
In a prior training article, I explained that most commercial bankers quote their fixed rate commercial loans at 275 to 350 basis points over five-year Treasuries. You will recall that a basis point is 1/100th of one percent, so 300 basis points equals one 3.00%.
Example:
Suppose you call your local commercial bank and speak to a commercial loan officer about a commercial loan. He will look up five-year Treasuries and see that on July 3rd, 2019 they stood at 1.74%. He will then add between 2.75% (275 basis points) and 3.5% (350 basis points) to 1.74% to determine what rate to give you.
Does your client keep more cash on deposit than Fort Knox with his current bank? If so, in an effort to win your client’s deposit accounts, the banker might quote you 4.49% for a ten-year, fixed rate commercial loan, with one rate readjustment at the end of year five. If your client is a mere mortal, rather than a cash demigod, the bank will probably quote him 5.24%.
But these quotes are from banks. How would a conduit lender quote his commercial loan? After all, conduit loans are usually larger than $5 million, and the properties are reasonably desirable. Their rates on commercial loans have to be more attractive than bank loans, right?
You will recall that conduits originate commercial loans for the CMBS market. CMBS stands for commercial mortgage-backed securities. Think of a CMBS loan as a huge, fixed-rate, commercial real estate loan written to cookie-cutter standards.
CMBS lenders have very little flexibility (that darned cookie cutter), but if you qualify, you get a ten-year, non-recourse, fixed rate commercial loan at a rate that is at least 40 basis points cheaper than what a bank can offer. When you are talking about a commercial loan of $10 million, 40 basis points is real money. In addition, conduit loans are FIXED for the entire ten years!
So when you call a commercial loan officer at a conduit, how does he know what to quote you? Remember, unlike residential loans, you cannot lock your rate on a commercial loan. When you apply for a conduit loan, you have to take the current fixed rate at the moment of closing, and the process takes at least 75 days. Every day, from the time of application until the day of closing, your interest rate will change.
So I recently asked my good friend, Tom Lawlor at Morgan Stanley, how conduit commercial loans are priced. Here are his kind answers:
Q: Are CMBS loans still quoted based on swap spreads?
A: Conduit loans are quoted as the greater of (matching) Treasuries or swap spreads, plus an agreed upon margin.
Swap spreads are financial instruments where nervous corporate Treasurers will swap their adjustable rate loans from the bank for a fixed rate loan from some speculator. Obviously, for taking the risk that interest rates might skyrocket, the speculator makes a handsome profit on the deal.
Swaps spreads change daily, and you can find them posted here.
Example:
Your client is seeking a $12 million, ten-year, fixed rate, non-recourse commercial loan from a conduit. Because your client is seeking a ten-year commercial loan, the conduit quotes him a negotiated margin over the greater of ten-year Treasuries (notice the matching term) or ten-year swap spreads.
On the date that the attorneys draw the loan documents, ten-year Treasuries are 2.00% and swap spreads are 2.15%. The conduit will therefore use the greater of the two indexes.
Q: What are some typical margins over swap spreads for multifamily?
A: 140-185 bps
Q: What are some typical margins for office, retail, and industrial properties?
A: The margins are similar to those of multifamily. Pricing is most determined by the debt yield ratio or the debt service coverage ratio (DSCR), with the margins on hotel loans being 15-30 bps wider.
Note:
Because I didn’t want you to get confused between the speads over the index and swap spreads, I have used the term, margin. In real life, where the lofty conduit lenders dwell (remember, their minimum loan is $5 million), they use the term, spread, over the index, rather than margin.
By George Blackburne