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Commercial banks fight Wall Street for CMBS deals

Commercial banks make a huge comeback, challenging Wall Street for the rising number of CMBS deals and feeding other lending needs through a variety of vehicles.

Real estate historically has been a local industry with financing originating at neighborhood thrifts and banks or, for bigger projects, insurance companies. Occasionally, on a major development, Wall Street stepped up to the plate to raise capital.

That comfy world changed in the 1980s when the United States dropped into a severe real estate depression, the aftereffects of a wild building spree spurred by tax breaks and high liquidity. Overbuilding and the removal of tax incentives meant the death knell for highly leveraged developers. Their defaults toppled a great many financial institutions, most notably the savings and loans. Other financial companies such as banks and insurance firms that had been active real estate lenders dropped from the market.

The federal government in the form of the Resolution Trust Corp. was installed to clean up the mess. To do the job quickly, the RTC unleashed the commercial mortgage-backed security. It proved so effective, Wall Street immediately picked up the baton and ran with it, creating an industry. In 1997, CMBS volume reached a record $44.7 billion.

Coincidental to the rise of CMBS, or debt securitization, was the sudden popularity of real estate investment trusts, or equity securitization. In 1992, eight new REITs went public and the industry raised a record $6.5 billion. The subsequent years have all been good to the REIT business, so by 1997, the industry was able to boast a record capitalization of $45.1 billion.

So much attention has been focused on Wall Street's emergence as a player in real estate that the traditional lenders such as the commercial banks have almost been forgotten. But the banks have roared back into the real estate business, not only challenging Wall Street for a larger piece of the CMBS pie but also dishing out capital to all sorts of real estate ventures in a wide variety of vehicles from new construction loans to refinancing to interim lending.

As the world of real estate changed in the 1990s, so did commercial banking. Regional banks merged or acquired other banks, thus creating huge financial companies with national reach. In addition, the large commercial banks began acquiring stock brokerage companies which, in turn, became internal mechanisms to do the securitizations that Wall Street had done for them.

While the conduit field is extremely competitive, banks are nevertheless increasing their role in the origination and securitization of this product, suggests Kenneth Witkin, executive vice president of the Real Estate Finance Group at Fleet Financial Group.

More capital, higher risks The involvement of commercial banks in the real estate industry is both comprehensive and bifurcated. The big national banks try to do it all, and they try to do it all over the country. The regional banks offer limited or specialized products, but are increasingly squeezed by Wall Street and other commercial bank securitizations which put pressure on pricing. It's become a very congested marketplace with a lot of capital being tossed around.

"There is more capital available today than there is demand, which has resulted in lenders taking on higher levels of risk at lower yields," observes Thomas Fennell, senior vice president in charge of Marine Midland Bank's Commercial Real Estate Division based in Buffalo, N.Y.

The markets have been incredibly liquid, adds Ed Blakey, senior vice president and division manager for Wells Fargo's Commercial Mortgage Origination in San Francisco. "Is it good for banks? Excess has been more positive for borrowers than it has been for lenders as it relates to pricing and structure in the long term."

In the short term, Blakey says, the banking community remains disciplined.

"There is a lot of lending going on, but if you look underneath, you don't see a collapse of fundamental underwriting," claims George Emmons, executive vice president and national manager at KeyBank in Cleveland. "The industry still maintains preleasing, and it is not doing 100% financing. We are not participating in many of the practices of the late 1980s and early '90s."

Nevertheless, competition for the commercial banks is coming from every direction - not just Wall Street and insurance firms but from other financial companies. For example, take a company like Ocwen Financial of West Palm Beach, Fla. The $3 billion financial services holding company owns Ocwen Federal Bank and is a significant shareholder and manager of a REIT called Ocwen Asset Investment Corp. Best known as an acquirer of distressed loan portfolios, the company also lends on a variety of income-producing property types such as office, industrial and retail. It has also been a big lender to hotels and the seniors housing industry. Ocwen Asset Investment focuses on the purchase of subordinate mortgage-backed securities and the acquisition and financing of large commercial properties, says Jordan C. Paul, senior vice president of Commercial Finance for Ocwen. Deal sizes are typically between $5 million and $50 million, with the average being about $20 million. They tend to be highly leveraged loans which often include a value-added or repositioning component.

Ocwen, including its REIT, financed, acquired and provided commitments for over $1.2 billion in commercial real estate loans and properties last year. Peter Schwartz, vice president of Ocwen's Diversified Lending Group, notes that "there is a great deal of competition in the real estate lending industry, and that has some impact on spreads, though this has not affected Ocwen quite as much as the typical commercial bank because the niches we operate in are not as price-competitive."

With so much competitive head banging and so much liquidity, even loan structures are beginning to change, and that is what concerns the industry. In the longer term, easy money translates to weaker structures, weaker pricing and ultimately overbuilding.

Strong market keeps lending in check Even with so much capital out there, what has kept the whole system in check has been the strength of the real estate sector. As Wells Fargo's Blakey notes, "capital providers who have been absent from the market for many years have found their way back into it, and frankly that is a reflection of the fact that so many markets are so strong and the recovery significant."

1998 will register the strongest overall property performance in nearly a decade, predicts Hessam Nadji, senior vice president/director of research services at Marcus & Millichap in San Francisco. "The overall market recovery of the past three years has finally brought most property sectors back into balance. Higher occupancy levels, improving rental income, availability of capital, soaring investor demand and ideal economic conditions have created the strongest real estate market this decade."

To which Nadji adds, commercial mortgage delinquencies are at a 10-year low.

For the most part, individual markets are in equilibrium, but there are hot spots concerning different asset classes. One city might have too much retail on the drawing boards, while another is overbuilt in apartments. "Some markets are more conservative than others, while some are heated up more than others. The particular dynamics of each individual market are different," says Kenneth Goetz, a senior vice president for National City Bank in Cleveland. "Our budget calls for a continued increase in lending activity as the economy is still good, and the markets that we are in are not really overbuilt in most categories."

For the first nine months of 1997, the market was floating in capital, but since the market crash in Asia last autumn, things have corrected themselves, observes Ben McGrath, a managing director at Chase Securities. "Spreads are stabilizing in some sectors and, for the first time in the current bull market, spreads may even widen. CMBS spreads have already widened, and bank market spreads have at least stabilized."

McGrath for one thinks the economy will begin to slow down, but that won't necessarily be such a bad thing for real estate as interest rates are trending downward as well, and that is going to encourage a lot of refinance activity.

As far as National City is concerned, there should be more opportunities to do construction lending this year. In addition, Goetz notes, his bank's customers are always on the acquisition trail and, to some extent, looking to refinance existing loans. "In 1998, we should see an increase in activity over what we did in 1997," he adds.

National City is a $53 billion financial institution with operations in Ohio, western Pennsylvania, Kentucky, Indiana and, through a recent acquisition, Michigan and Illinois. Its lending activities are regional, but it does a wide mix of lending, including construction, acquisition, refinance and even permanent. It doesn't brag a conduit, but the bank does have the capability of placing loans permanently if that is what the customer desires. In 1996, the bank did about $700 million in originations and then pushed that up to $800 million in 1997.

"The vast majority of our customers like the flexibility that a relationship lending organization like us provides rather than the kind of inflexibility that is associated with insurance companies and conduits," Goetz says. "Most of the deals we do on a construction or acquisition basis stay with us."

This doesn't mean National City is isolated from national competitors. "There is definitely more competition out there," Goetz adds. "We sell creativity and flexibility to our borrowers which is why we don't worry quite as much as some others when it comes to the spread differential between insurance companies, conduits and ourselves."

Local banks feel competitive pressure Competition from conduits has, however, made life difficult at other regional lenders. Marine Midland Bank offers a broad range of products and services for real estate developers in New York. Like National City, Marine promotes a relationship-based lending philosophy. The bank provides loans for nonowner-occupied commercial real estate with a minimum size of $1 million for construction, refinancing, acquisition, miniperms and letters of credit in support of tax-exempt bond issues. Last year, the bank originated over $400 million in new business, and this year's goal is to equal or better last year's production.

Marine Midland's Fennell claims that while New York has lagged behind the performance of our national economy over the past few years, the state has recently shown signs of picking up momentum. The difficulty in the origination of new business is due to the competitive environment created by a movement from private to public markets, Fennell says. "The Wall Street firms just make it more difficult for us to compete in the marketplace. We have seen, in general, a liberalization of terms and conditions, as well as a reduction in pricing on all product lines from construction to miniperm loans."

The $18 billion Union Planters Bank covers eight states in the deep South from its base in Memphis, Tenn. Concerning real estate, Union Planters offers construction loans, capital for acquisitions and permanent loans. Unfortunately, this business is being squeezed from numerous angles, which was reflected in the bank's originations - about $50 million last year, which was down from the year before. Union Planters expects originations to decline again in 1998.

There is no problem with its market. For most of the '90s, Memphis has been red hot with construction in almost every asset class. "Over the last two years, we have seen a huge run in new construction of retail, office, industrial and multifamily," says Mike Ritz, senior vice president and manager of real estate lending. "While it will take time for that product to get occupied and stabilized, there is more product to lend to."

Most of Union Planters' lending falls into either the construction or acquisition categories. It also does a lot of permanent lending but that has, as Ritz says, become considerably more competitive as the conduits have really put a squeeze on business.

"One of the things we will be doing in 1998, because so much of our portfolio is being played off by conduits, is to broker loans," says Ritz. "Instead of fighting the conduits, we decided to join them, so to speak, and we are now brokering loans to conduits for our customers, not just our loans but any loans."

Many of the large national lenders have already gone the conduit route. According to Commercial Mortgage Alert, the newsletter which covers the CMBS industry, among the most active players in conduit securitization last year were such banks as First Union, ranked No. 4; NationsBanc Montgomery, No. 9; Chase Manhattan, No. 12; Citicorp, No. 13; and Wells Fargo, No. 20.

As Steve Plavin, a managing director at Chase Manhattan, likes to put it, his bank competes as much with Wall Street as it does with other commercial banks. "There are a couple of banks that we compete with regularly, but our strategy is to use the capital markets to provide the best execution for our clients as opposed to looking only to our own balance sheet. We commit our balance sheet but ultimately look to the most efficient sources of capital, which may or may not include Chase for any given transaction."

Chase is the leading arranger of syndicated real estate loans. It only does construction lending as part of a larger multiproduct relationship. The bank is a permanent lender through its CMBS activities for any property of $3 million and up. These loans are primarily nonrecourse, fixed-rate mortgage loans that are aggregated and securitized.

Chase Manhattan does a lot of interim mortgage financing but again primarily on larger deals, mostly $50 million and up as opposed to the $3 million and up deals that go into the conduit.

"In our CMBS activities, we do our own underwriting, funding, hedging structuring, securitizing and servicing," Plavin explains. "Most of the models employed on Wall Street utilize a number of different players to do all that." Last year, Chase securitized over $2 billion of originations.

REIT financing breeds competition One area in which Chase expects business to boom over the next year is REIT financing. Chase is active with REITs as a syndicated lender and underwriter of high-grade and high-yield bonds as well as CMBS. "There will be a huge volume with the REITs in 1998, bigger than in 1997, which saw huge growth over the year before," says Chase's McGrath.

KeyBank is holding two big initiatives in 1998. First, it wants to grow its CMBS conduit originations from $400 million to $1 billion, and secondly, it wants to double its REIT exposure from $750 million to $1.5 billion.

"The big story in real estate today involves capital flows to REITs and CMBS. Both of these are capturing a high marketshare," Emmons reports. KeyBank's loans to REITs are basically revolving credit facilities to assist working capital needs or for project financing. The bank did much work last year with Simon Debartolo, the big shopping center REIT.

While it may be based in Cleveland, KeyBank now boasts national scope. The financial company has 22 commercial real estate offices in four U.S. time zones. Last year, its loan production was $4.25 billion, up significantly from $2.85 billion in 1996. KeyBank had a terrific year in 1997, Emmons notes, and looks for a year equal or better in 1998.

"I would attribute our success to the way we are structured," says Emmons. "We have commercial real estate credit offices in each one of our four regions, and they are basically there on the spot to review and help with the underwriting of our credits. By having local market people right there, we are able to give rapid and intelligent answers to our clients." KeyBank also doesn't have a limiting cap size for a project.

Lenders continue adding products Fleet Financial Group is not yet in the conduit business, but continues to explore opportunities to add this product to its lending operations. The Boston-based financial giant totals $85 billion in assets and, of that, real estate contributes some $9 billion. The company does more than $4 billion in commercial loan originations a year.

Fleet Financial can do it all - construction, interim, miniperm and mezzanine. There are some banks that do project finance, others that only want to do syndicated loans, while still others just want to do conduits where there is no risk, says Fleet's Witkin, but "we want to do it all, to provide all disciplines."

One big product for Fleet will be real estate loan syndications, a service which not only generates fee income and is a portfolio diversifier but, more importantly, it helps the bank provide its highly valued customers with the strength of the Fleet balance sheet to underwrite sizable transactions. "It is a growth area for us," Witkin says.

Another bank hoping to do it all is First Union Corp. The aggressive financial services company recently acquired Signet Banking Corp. (closed Dec. 1), CoreStates Financial Corp. and Wheat First Butcher Singer Inc. When all is said and done, the Charlotte, N.C.-based firm will be transformed into a financial services powerhouse with $204 billion in assets.

While First Union's commercial bank does construction loans, miniperms and permanent loans, its Real Estate Capital Market Group provides such services as direct debt origination, placement and sales for Class-A commercial real estate, secured and unsecured lending for REITs and other real estate companies, origination and placement of permanent debt, construction and equity for affordable housing, loan syndication of secured and unsecured commercial real estate loans and off-balance-sheet real estate-related products, including synthetic leases. The company also did about $350 million of credit tenant leases last year.

"What we try to do is develop a one-stop shopping approach for the commercial real estate customer," says Michael Greco, managing director of Real Estate Capital Markets Group. "Our salespeople are trained to recognize the need for whatever properties or product types are in our menu so we have a single source that goes out and talks to the customer." First Union typically works with all the usual income-producing type properties, plus healthcare, hotels and nursing homes.

In 1995, First Union did its first securitization and has continually pushed up those numbers. Last year, the company securitized $2 billion of originations. One notable achievement was First Union joining with Lehman Brothers on a $2.2 billion offering of securities backed by commercial mortgage loans - the industry's largest commercial mortgage securitization.

Greco remains optimistic First Union can do even better in 1998 with securitizations climbing to $2.5 billion to $3 billion. "I don't think the collapse of the Asian markets last autumn or the subsequent turmoil in the stock market will have an effect on real estate, unless there is a serious collapse," he says. "More important are interest rates. The general location of interest rates in this loan environment is more than offsetting the volatility that is being observed in the stock market."

First Union's cross-town rival, the equally aggressive NationsBank, also wants to be known as a company that can do it all: construction lending, miniperms, bridge loans, acquisition loans and permanent take-out loans through its conduit. The bank even has a group that places commercial financing on a long-term basis, the traditional mortgage banking technique.

In terms of just commercial, interim lending and construction loans, NationsBank did an outstanding $12 billion in originations last year. That doesn't even take into account the permanent take-out placements on conduit originations.

The big Charlotte-based financial company lends nationwide through its conduit, but its other lending is basically within the regions it does business in as a banking institution - Mid-Atlantic, Midwest, Southwest and Southeast. While it also lends to all real estate sectors, its main focus is on traditional income properties, office, multifamily, retail and industrial. "We lend to the lodging sector, but it's not at the top of our list," says Ron Curtis, senior vice president of the Real Estate Banking Group.

NationsBank expects 1998 to be a good year, says Curtis. He bases his prediction on four factors: a stable interest rate environment, continued expectation of low inflationary environment, a continuing sound economy and balanced real estate markets.

"There may be exceptions here and there in certain property types and in certain public markets, but generally speaking we see balanced markets," he adds. "It's a result of more market discipline than there has been in past economic cycles."

Curtis recognizes there is plenty of debt and equity capital in the market today, but as he says, he hasn't seen any dumb deals yet. "We now have more real estate that is influenced and controlled by publicly owned companies. There is also a tremendous amount of public information available now on markets relative to demand and supply as compared to 10 years ago," he adds. "Between all of this additional information and the influence of public companies, we see most new construction to date as market driven. We have even seen evidence of market correction in terms of reduced supply in some submarkets when the absorption and vacancy figures began showing signs of softness. Clearly, a phenomenon not evidenced in the '80s.

"Wells Fargo maybe based in California, but like its East Coast brethren, when it comes to real estate, it has a national reach with 16 offices throughout the country. Its product mix is very broad in that it works the traditional commercial banking arenas of construction finance, interim finance and lending to REITs, while a capital markets group does mezzanine finance and higher yielding more transactional type business. In addition, Wells Fargo boasts an active fixed-rate lending program, the conduit.

The company lends to all sectors of the real estate market. It has even done such unusual plays as parking garages and movie theaters. Last year, Wells Fargo's origination volume rose to $7.5 billion.

One business that Wells Fargo intends to crank up is its conduit. "We have a larger commitment, and we are building our infrastructure significantly," says Blakey. "Our volume more than doubled from 1996 to 1997."

Last year, the conduit originated $11 billion. The outlook for '98 is very positive, though Blakey adds one caveat: Fixed-rate lending is interest rate sensitive and, therefore, any significant fluctuations in the market will have an impact on volume.

Real estate markets have been stable for the last two or three years because there has been limited supply of new product, Blakey says. "With stable markets and increased liquidity, as we go forward into 1998 and beyond, there is a risk of overbuilding," he adds. "For the time being, the liquidity in the market benefits borrowers with low rates."

* American General Hospitality Corp. bought 14 hotels for $270 million from Financial Security Assurance. * Boston Properties took a portfolio of nine buildings, valued at $139.6 million, from Mulligan/Griffin Associates. * First Industrial Realty Trust paid $138 million for operations of closely held Sealy & Co. and $200 million for 106 properties from Pacifica Holding Co. * Simon DeBartolo Group and Macerich Co. formed a joint venture to buy 12 regional malls for $489.5 million and the assumption of $485 million of debt.

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