There is now little doubt that the coronavirus will spread globally and will cause more supply and demand shocks in the market. While economic activity will slow, the amount and duration of the slowdown are big unknowns. Community banks may not have exposure to Chinese markets and may not have significant exposure to the energy sector.
Government-sponsored enterprises (GSEs) have been lending to borrowers for many decades. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) have popular multifamily lending programs so much so that they now control the bulk of the market. For example, Freddie Mac’s total multifamily finance activity for 2018 was $77.5B, and Fannie Mae’s was $65.4B which means that if you have to compete, your bank needs to do so carefully as you have a high probability of getting adversely selected.
In past articles, we have talked at length about using agile methodology for application development, for technical product innovation, and for your risk processes. We are fans of forsaking the traditional “waterfall” approach for new products whenever possible and getting to marketing in a pilot program as quickly as possible so you can learn and iterate to success.
Much has been written about the merits of community banks developing banking expertise around specific verticals. We recently worked with a bank that won the banking mandate for a family-run funeral home. At first we were surprised that the term loan was 93% LTV. But when we looked at the entire underwriting package and the borrower’s financials (showing 3.2X DSCR) we recognized the importance of understanding industry specifics and how the funeral industry might be a perfect fit for many community banks.
The Merits of Specializing
Recent data, just released from Real Capital Analytics, shows that since the start of the year (month-end April), commercial real estate (CRE) has appreciated 2.6% in 2019. This is good news for banks as it shows that every significant loan sector likely has improvements in both debt service coverage and loan-to-value. In major markets, this appreciation has been closer to 4.9%, and in secondary markets, price appreciation has been 1.5%. In this article, we take a look at the details to help banks better manage their pricing and risk.
Whenever your bank is looking at underwriting commercial real estate (CRE), you are probably looking at a variety of macro factors such as rent and occupancy trends, absorption, and capitalization rates. However, since we see hundreds of underwriting packages a month from a variety of banks across the country, it is rare that we see banks, and even borrowers, adjust rents for new construction. In this article, we present our methodology, data, and adjustment factors that banks can use to have more accurate underwriting.
Commercial lenders should be aware of the important factors that drive customer behavior to borrow funds. Our clients borrow from us when they refinance debt, or purchase equipment, real estate, or finance working capital. However, there are three key elements that make debt especially appealing for borrowers. Commercial lenders that understand these three elements can better position themselves for success.
The Three Key Elements to Borrower
In an article two weeks ago, we discussed why community banks should desire prepayment provisions in their loans. We also acknowledged that in this very competitive banking market banks are unable to negotiate a meaningful prepayment provision. In this blog, we will identify techniques that some banks may use to obtain a meaningful prepayment provision, and we share a video explaining how CenterState Bank lenders use these techniques with commercial borrowers to negotiate a powerful prepayment provision.
In addition to traditional underwriting, some banks utilize a scorecard to rank their commercial properties. Projects are run through a scorecard and then rated on a numerical value. For banks without a credit or pricing model that provides a probability of default and expected loss, the scorecard allows an intermediate way to compare loan quality. In this article, we take a look at a sample scorecard and give banks some examples of how to use the methodology for better commercial real estate (CRE) underwriting and pricing.
Many banks today are satisfied to underwrite real estate secured loans on just two metrics: debt-service-coverage ratio (DSCR) and loan-to-appraised value (LTV). Banks typically approve credits above 1.20X and below 75% LTV – with many loan-specific factors that may skew these acceptable levels either way. For competitive reasons, we see some banks who are dipping to 1.10X DSCR, and some deals are approved at 85% or even higher LTVs. However, in today’s business c