By Brian Holstein
Navigating the CMBS market can be a confusing and challenging process. Here are three CMBS secrets that will strengthen your negotiating position and ensure that you leave nothing on the table.
#1 – EVERYTHING is Negotiable!
Remember, this is not a car loan, or even a home loan for that matter. If your attorney or broker does not have at least 30-50 individual comments to a loan agreement (not including the swapping of “sole and absolute” for “reasonable”), you are leaving money and excess risk on the table. Just like the legal system, the key to a well negotiated loan agreement is “precedent.” If it’s been done before, it can likely be done again. And if a requested change will not result in a lender’s requirement for additional securitization reps and warranties, the change can likely be granted without a fight. If it does not violate a published rating agency requirement (permitted indebtedness, material alterations, insurance requirements, etc.), it can also likely be accommodated.
#2 – How They Make Money
CMBS lenders are wholesalers (or traders) by nature. They buy (originate) wholesale, and sell (securitize) retail. They are not in the business of buy and hold. The plan is to originate loans at interest rates higher than what they can later be sold at in the bond market. On a ten-year loan, every 14 basis points of interest rate above what the underlying bonds sell for, equates to 1% of lender profit. On a five-year loan, the math becomes 25 basis points for every 1% of lender profit. This is a function of bond duration, or rather the inverse of bond duration, to be exact (for the nerds out there). In today’s market, the average targeted loan profitability is typically 1-3 percentage points and the average hold period prior to securitization is 1-3 months. If you assume the midpoint of both profitability and hold period, the average loan should generate an annualized return on investment of 12% (0.02 ÷ 2 × 12).
Why should this matter to a borrower? CMBS spreads have risen approximately 100 basis points in the past 12 months, much of that movement coming in the past 4-6 months. Consequently, re-trades have become far too commonplace. The easiest way to combat a spread re-trade is to be aware of both how much money your lender is attempting to make as well as any underlying movements in the CMBS bond market, from application to close. If you know that blended 10-year bond yields have risen 10 basis points and your lender is asking for an extra 24 basis points to close your loan, you should stand up and tell your lender that you are not ok allowing them to profit an extra 1% (6% annualized!) for no good reason. And if the lender originally priced your loan to make 2% points and is still making more than 1%, even after factoring in rising spreads, there is no justification for any re-trade whatsoever!
#3 – How They Make Even MORE Money!
If you think there is a chance that you will pay your loan off early down the road, you may have already thrown away three to four months of interest. A standard loan agreement will require you to prepay the loan through maturity. A well negotiated loan agreement will require prepayment only through the beginning of the “open period,” which is typically 90-120 days prior to maturity. What your lender does not tell you is that bond buyers always assume that your loan will be paid off no later than the beginning of the open period and bonds are priced accordingly. Therefore, agreeing in advance to prepay the last 90-120 days of interest is your future loss and bond investor’s gain.
Although loan servicing is a low margin business, it is nonetheless a profitable one. It is for that reason that lenders sell loan servicing to third-party servicers, which adds to their overall upfront profitability. Be wary of brokers who promise to place your loan for free, receiving only servicing rights in return. There is no free lunch here. If a lender gives away a loan’s servicing rights “for free”, it must make up for the loss in profit by passing along a higher spread to the borrower. Also, most lenders will not actually agree to sell servicing rights on an individual loan basis, meaning the broker will have a limited pool of lenders with whom they can approach. As such, those promising to arrange a loan “for free” in return for such servicing rights are not acting in your best interest.