We often hear banking customers explain that competition is intense for quality (and sometimes even marginal) lending opportunities. Some banks even make fatalistic arguments that community banks cannot compete against life insurance companies or conduit lenders because of price or structure. We do not agree and attempt to prove it every day here at CenterState. Community banks have various competitive advantages in the market for the cost of funding, structuring ability, local market, product knowledge and ongoing service flexibility. However, one thing that we have found is that if a lender cannot differentiate the bank’s commercial lending products from the competition, then the borrower cannot make an informed decision.
One of the lender’s jobs is to understand the borrower’s financing needs and propose solutions that make the most sense for that customer. This may mean that the banker may end up recommending going to a large bank, insurance company or conduit lender, and while this hurts, this needs to occur if bankers truly want to be thought of as “trusted advisors.” Additionally, borrowers are often overwhelmed with their financing options and are looking for assistance in choosing the optimal financing option. As such, it often becomes the lender’s job to differentiate the bank’s product with the alternatives, explain the pros and cons of each financing alternative available and then use appropriate reasoning to make an objective recommendation to the borrower.
Every community bank lender needs to understand the table below and how their bank’s product compares to the competition. Life and conduit lending products serve a fundamental need in the market, but these are not superior products in most situations where community banks compete.
Below are nine parameters and a comparison of community bank financing compared to life insurance and commercial mortgage-backed securities conduit lenders (CMBS).
Community banks do not have a cost of funding disadvantage versus life insurance companies or conduit lenders. In fact, historically and over the long term, most community banks have anywhere from 50 to 150bps cost advantage to life and the CMBS market (that is just the fundamental cost advantage in retail deposits). Community banks do, however, have an overhead disadvantage to these competitors. Currently, life and CMBS deals are priced between 1.75% to 2.25% over LIBOR. On average, community banks are pricing 25 to 50 basis points higher. However, for higher pricing, the borrower may benefit from some tangible advantages listed below.
Banks are typically charging anywhere from zero to 50 basis points for term loans on stabilized, general-purpose properties. The life and CMBS market is currently charging 1% and if the deal is brokered, the borrower should expect to pay another 1 to 2% at closing. These numbers can vary greatly. Both community banks and life companies are able to roll closing costs into the loan. As an example, we are closing a $3 million loan without charging the borrower any closing costs (appraisal, environmental, survey, and mortgage). All of the costs are all rolled into the fee being generated utilizing our ARC (hedge) program – with the borrower’s knowledge and request.
Here is where the community bank lender can shine. Prepayment penalties are steep to outrageous on life and CMBS originated loans. We have seen prepayment costs that can run up to 35% to 40% of the loan amount ($400k on a $1mm loan). Bank loans can be structured to be more flexible. In fact, in today’s market, community banks are successfully selling the symmetrical prepayment provision where on prepayments the borrower receives a fee if interest rates are higher. If a borrower believes that in the future there is any material reason that the loan might be prepaid, assigned or the property sold, then the prepayment provision offered by banks is far superior.
Most borrowers are not averse to offering personal guarantees on debt. However, for some borrowers, this is a real issue. At 65% loan-to-value (LTV), many life and CMBS loans do not require personal guarantees. We are seeing banks respond to this challenge by accepting limited guarantees (a percentage of the loan amount spread between owners) or expiring guarantees (when LTV falls below a certain level). Further, many banks utilize cross-default protection where the borrower has multiple and disparate properties financed with the bank. This cross-default provision is often superior as it likely results in both a lower probability of default and a lower loss given default when compared to a personal guarantee.
This is another area where banks can outshine the competition. Banks can offer construction, accreting loans, standby LOC, multiple draw term loans, and asset-based financing that life and CMBS lenders are not equipped to match. The more structure and flexibility required for the borrower, the better the bank’s offering looks.
Life and CMBS conduit lenders often have (even, want) limited interaction with the borrower and will rarely amend terms and conditions after a loan closes. For borrowers that are 100% certain that after origination they will never want to open their loan terms, the life and CMBS loan may work out fine. However, for borrowers that anticipate amendments, prepayments, business changes or possible loan assumption and assignments, banks offer much more flexibility. This is another area that is not marketed enough by community banks.
Banks can be very flexible on structuring covenants and reps and warranties that make sense for the specific borrower and their global cash flow situation. Life and CMBS lending criteria are very tight – if the loan does not fit the “box,” approval is often difficult to obtain.
Many banks offer limited term options with some banks choosing not to compete for seven or ten-year terms. This is a major mistake, as we usually recommend (depending on credit profile) that not only does a long term limit competition from other community banks, but the risk profile usually improves and profitability is dramatically enhanced. We work with community banks that routinely extend credit out to 20 years and eliminate the interest rate risk (and interest rate related credit risk for that matter) through our ARC hedge program.
Banks have been reluctant to amortize term loans that finance long-term assets for terms greater than 25 years (in some cases banks are still trying desperately to hold on to 20-year amortization terms). Life and CMBS markets will give 30-year amortization periods for certain loans (typically 65% LTV, general use property and useful longer than the am term). We find this to be a conundrum. Here is a comparison of the math on the LTV difference between the 25 and 30-year amortization:
Assuming a starting LTV of 65%, and no decrease or increase in the value of the collateral, the LTV differences at 5, 10, 15 and 20 years into the loan for 25-year and 30-year amortization, respectively, are: 58% vs. 60%, 48% vs. 53%, 36% vs. 44%, and 20% vs. 32%. If you run these differences through a loan pricing model, you will find that the higher LTV levels offer no appreciable difference in risk. As such, we argue that banks should be more flexible on amortization structure in order to better compete with both life and CMBS conduits.
Two Case Studies
We would like to share two recent examples of how bank deals are superior to alternatives to financing offered by life and CMBS vehicles.
We work with a borrower who has a number of loans at the bank. He has also secured more than a dozen life company loans over the course of the last 5 years. The bank has been flexible in working with the borrower, transferring credit from one property to another, transferring the loan from one LLC to another, increasing and decreasing the loan to fit that project’s immediate financing needs. His life insurance company has been less than flexible. No one will return his calls. Most times he has no direct contact at the life company (his relationship managers at the life company have come and gone).
Recently, the city has asked our borrower to demolish a small structure on one of his property for zoning reasons (a move that will also improve the frontage for his office building and improve the value of the life company’s collateral). However, the borrower’s loan documents prohibit him from demolishing any structure used to secure the debt without the life company’s consent. The city is now fining our borrower every day for not demolishing the structure and unfortunately, no one at the life company will return his call. He thought about refinancing his life company loans, but the prepayment costs are 20% to 30% of the loan amounts depending on the specific loan.
Our second case study is a competitive bid situation between a community bank and a life company on an $11 million office term loan. The community bank has a small loan with the borrower and was competing to win this larger credit. Both lenders offered a 15-year fixed rate loan, both had the same advance rate (strictly a refinance with no cash out). The life company pricing was LIBOR plus 1.90%, and the bank pricing was LIBOR + 2.65%. The borrower asked the bank to sharpen their bid – the lender was able to accommodate the borrower at LIBOR + 2.60%. Why did the borrower accept a 70bps differential? Refer to the table above – our lender did a splendid job in differentiating the bank’s product and highlighting the value proposition.
In summary, if your lenders can properly use the information in the table above for every instance that they are in competition, your bank’s ability to win quality loans at margins above your competitors’ markedly improves.
Submitted by Chris Nichols on March 05, 2015