Gary Leach
Defaults low

Wall Street investors are shunning not only subprime loans but, at least for the moment, virtually all mortgage-backed securities. The result is a large vacuum where commercial real estate borrowers used to go for low-interest loans averaging $10 million to $15 million, and the opening could be a bonanza for Massachusetts banks.

“In the past month, the world has changed dramatically,” said George J. Fantini Jr., chairman of Fantini & Gorga, a commercial mortgage brokerage in Boston and affiliate of Boston-based Eastern Bank. “Why? Because suddenly, with this subprime crisis Â… securitized lenders are in such disarray that they don’t know how to price their loans, because they don’t know how much [they’re worth] or to whom they can sell them.”

“The bottom line,” added Brian Koss, managing partner at residential loan specialists Mortgage Network in Danvers, “is that any lending to Â… anything not backed by the government is suspect. People are opening up their [mortgage-backed] securities now and seeing that they’re poisoned. Everyone is nervous as to what the values will be.”

The new dynamic puts commercial loan securitizers effectively out of the market they once controlled, and may put banks back in the driver’s seat. Banks often keep commercial loans in their own portfolios rather than seeking to bundle and sell them, so the funding source is stable. In the current market, that’s an advantage, Fantini said.

Securitized lenders – which as recently as last month were offering loans to office, hotel and retail developers at just 1 to 1.3 points above Treasury rates, and attractive terms of 10 years or longer – issued $140 billion worth of long-term commercial real estate loans in 2006, Fantini said. Life insurance companies, which had a banner lending campaign last year, wrote $40 billion worth of loans at similar rates (slightly higher for hotels), he added.

Insurers such as John Hancock and Prudential reap the interest-rate profits from commercial loans they write and use them, in part, to pay benefits to policy holders, Fantini said, adding that until around 1990, they were the largest commercial-loan providers.

It’s impossible to tell exactly how many commercial real estate loans banks wrote last year, he said, because they many don’t report commercial origination volumes publicly.

But just a year ago, he said most banks “were getting beat up badly by the securitized lenders. They were doing anything they could possibly do to retain a [commercial] customer,” but they had higher rates or wanted personal guarantees and a shorter term, and couldn’t compete in a market awash in cheap credit.

Last month, according to Fantini & Gorga’s Lender Surveys, which are published quarterly in Banker & Tradesman’s Commercial Real Estate Monthly special section, banks were charging interest rates up to 3 points above Treasury rates for commercial real estate borrowers.

In recent weeks, Massachusetts lenders said they’ve noticed increased borrower interest in their commercial real estate loans, though the terms haven’t changed much.

For financial safety and soundness reasons, regulators generally won’t allow banks to offer loan-to-value ratios nearing 100 percent, said Gerry Nadeau, executive vice president for commercial banking at Rockland Trust. High loan-to-value ratios have been a popular feature of securitized commercial loans, he said, while most banks require a minimum down payment on commercial real estate loans of 20 percent.

“We have not changed our loan terms,” Nadeau said. Rockland Trust has a commercial real estate portfolio in excess of $1 billion. “The customers are now there for what we’ve been offering all along. They may find our offer more desirable than a month ago.”

Based on conversations he’s had with banking counterparts in other states, he said, the renewed interest in bank-backed commercial loans is occurring nationwide.

While most community and regional banks are wary of stepping in to fill the void that now exists in the high-risk subprime mortgage market, they are anxious to boost commercial lending activity, according to industry observers.

Commercial real estate loans have documented cash flows and collateral values, which make them attractive to banks, said Executive Vice President for Commercial Lending Ray Eisenbeis of Commerce Bank in Worcester. Until recently, such loans also were attractive to Wall Street investors, and the resulting competition lowered pricing.

Commercial borrowers, perhaps in part because of the benefits of favorable terms, have defaulted on their loans just 0.25 percent of the time this year compared to a 10-year average loan delinquency rate of 7.8 percent, said Gary Leach, senior vice president for commercial lending at Eastern Bank, citing recent Fitch Ratings statistics.

That compares to a current 16 percent delinquency rate nationally on high-interest-rate subprime and Alt-A residential loans, he said.

Citizens Bank Senior Vice President for Middle Market Commercial Lending Ray Hoefling said banks are definitely interested in picking up the commercial real estate slack.

He said Citizens Bank had vied for some commercial loans only to see borrowers turn to the securitized marketplace for better terms. Some of those deals now have “fallen by the wayside” with the promised funding not coming through, he added.

Smaller community banks probably won’t be as affected by the recent shift in commercial real estate lending opportunities as the larger ones, said Keith Keogh, senior vice president and head of commercial lending at Dedham Institution for Savings.

Commercial loans make up just 20 percent of the $894 million-asset mutual’s overall lending activity, he said. He oversees a $100 million loan portfolio.

“The typical loan that a bank like ours is looking is the $3 million to $5 million deal. The [borrower] wants the personal service, and that’s not going to change,” he said.

How long banks may enjoy a commercial real estate advantage uncertain, depending largely on how long it will take Wall Street investors’ jitters to settle down, said Jim Jones, founder and president of First Wellesley Consulting in Wellesley.

“In turbulent times, the market typically overcorrects then recorrects,” he said. “But for the next six to 12 months, I do believe bankers will still be in the [most advantageous] position for these deals.”

If the loans continue to perform better than residential subprime mortgages, he noted, the market will correct faster. If they falter, it will reinforce the current stand-offish trend among securities investors.

Robert Segal, chief investment officer at J. William Mantz Investment Advisors in Danvers, said local banks should take advantage of the “tremendous opportunity” offered to them now.

“The banks have been under competitive pressure from Wall Street firms and mortgage brokers,” he said. “Now, they’ve seen some of that go away.”