Private mortgage insurance quote

As it faces new competition, the conduit component of the commercial mortgage-backed securities (CMBS) market continues to develop and refine itself.

Many in the industry say they expect more loans to come into the CMBS market through conduits, which originate smaller commercial real estate loans (anywhere from $150,000 up to $15 million) that are pooled and then securitized. Others point to an inevitable consolidation of conduit originators as CMBS faces increased competition from many conventional lenders who are back in action, stepping up activity and grabbing their share of loans.

Nonetheless, as conduits continue to come of age, the process shows signs of maturity and increased efficiency. Large financial institutions such as banks and insurance companies are becoming new sponsors. As another sign, sponsors are forming strategic alliances that can better respond to specific financing needs and that help reduce the costs of the conduit process. And sponsors are more frequently specializing, originating loans to different property niches, thus broadening the market by lessening the dominance on multifamily properties. This helps reach a broader array of potential borrowers and could also attract more investors to securities that are backed by more diverse property types, which are, therefore, potentially less risky.

Added to all of this are advancements in information technology, such as electronic processing, that reduce operating costs, just as standardization and increased tracking of data makes for easier analysis for investors.

Conduit volume to rise

The overall dollar volume of conduits is expected to increase in 1995, just as it has for the last two years, according to Carl Kane, managing director and head of the capital markets group at Kenneth Leventhal & Co., New York. Kane estimates $4 billion to $6 billion of loans coming into the market via conduits this year, up from $2.2 billion in 1994 (out of a $20 billion total CMBS issuance last year). Kane also views conduits as healthier than the overall CMBS market. But some players may be squeezed out this year.

Securitization is a process that the commercial real estate industry needs, says Stan Cheslock, president of Cheslock, Bakker & Associates, a Stamford, Conn.-based investment banking firm. "There has to be a secondary market for commercial real estate loans to better place the credit risk," he says. "But it's very competitive because the volume was not there to support all the conduits. Now conduits are diversifying their product."

The conduit business is "more competitive," says Steve Wendel, vice president at ContiFinance, New York, a subsidiary of Continental Grain Co., mainly because of the return of banks and life insurance companies. "I don't expect the market share (of CMBS) to shoot up, he explains, adding that he is skeptical of real expansion of true loan-by-loan conduits.

"Lots of people come out with a product and make a big splash," says Raymond M. Anthony, a director in the real estate division of Nomura Securities International Inc., New York. "But a lot of people come and go."

In many cases they go because they do not have the financial resources, manpower and long-term commitment required to aggregate the critical mass of loans necessary to make conduits work, Anthony adds.

"It is not a quick in-and-out business," notes Robert M. Greer, senior director at Cushman & Wakefield, New York, and national manager of the National Mortgage Conduit Program, a venture between C&W and Fidelity Bond & Mortgage Co., Blue Bell, Pa., which serves as loan underwriter and servicer.

Greer says some conduits are "dropping out fast," be they mortgage bankers or Wall Street firms, because "some don't have the resources to do the due diligence, originating and underwriting that's required."

Jeffrey Davis, chairman of Cambridge Realty Capital, a Chicago-based merchant banking firm, has seen competition from conventional lenders cut significantly into conduits' lending on senior housing loans. He says conduits provided $1 billion in financing for senior housing, but now Wall Street has put a tremendous premium on these properties. In addition, they are the target of whole loan lending by conventional lenders.

"Banks and insurance companies are back in the market feet first, and the financing is more attractive than conduits," Davis says.

"There's clearly a place for conduits, but I think there will be consolidation," he adds. "It's hard to know what is necessarily a conduit deal today."

Banks are big sponsors

Some of die earlier conduits were sponsored by investment banks and mortgage banks "with limited capabilities," Kane says. Nevertheless, he believes that conduits are operating more efficiently because large financial institutions such as commercial banks and life insurance companies are moving in as new sponsors.

Unlike many previous sponsors, these institutions can do the entire conduit job - originate, underwrite and master service - under one roof, Kane says. This overall shift in sponsorship will produce a better-capitalized, better-managed business, and these one-stop sponsors benefit from being able to keep rather than share the profit, as they can make originations as well as master service fees.

Mike Greco, former senior vice president of New York-based Donaldson Lufkin & Jenrette, moved to lead First Union Bank's conduit business last summer. "I saw the business moving to depository institutions," says Greco, who is managing director of Charlotte, N.C.-based First Union Capital Markets. "Banks have the ability to do this business more efficiently than Wall Street. We have a lower cost of funds, a better origination base and every service in-house. We can make more money on the carry (of loans)."

Rising interest rates hurt the first few months of the bank's conduit business, but it closed on $100 million of loans in the fourth quarter, followed by an active first 60 days of 1995, vice president Steve Jones says. It has loan programs for multifamily, retail, industrial, congregate care, nursing homes, hotels and office properties. "We're taking this business and offering it as a bank product," Jones adds.

First Union expects to aggregate $400 million to $500 million in loans in 1995. While it hasn't securitized loans yet, it expects to this year.

Charlotte, N.C.-based NationsBank Capital Market inc., a subsidiary of NationsBank Corp., also started its multifamily conduit a year ago and expects to offer two $200 million, private-label multifamily securitizations by year-end, vice president Rob Schweitzer says. The first is planned for the end of April. The bank also expects to have health care, retail and industrial conduits in place during the second quarter.

"These sectors will become more competitive, but that won't have a bearing on whether we're in or out of the business," Schweitzer says. "We are in this to make money, but the programs also serve the needs of the corporation in terms of balance sheet management (by reducing the amount of much of the real estate it holds)."

Because of competition, NationsBank's multifamily conduit has become a more aggressive originator, underwriting more Class-C-plus and -C properties and fewer Class-B properties. Bank-sponsored conduits may be more adept than Wall Street and their correspondents at tapping these markets.

"The B- and C-property market is vast, (but) it takes more coverage to identify the borrowers and produce the volume, Jones says. "We're probably in a better position to do this than Wall Street."

Banks also say their ability to do everything in-house is a plus for borrowers since owners deal with just one contact instead of separate originators or servicers.

"It still comes down to product," adds Neil Cullen, vice president of AMI Capital, a Bethesda, Md.-based Fannie Mae DUS multifamily lender that's working on securitized deals with New York-based First Boston and First Union. "The First Boston/First Union marriage may be a model in terms of getting volume. There are a bunch of players out there that are holding $200 million in loans, but they can't hold forever," says Cullen.

There will be a huge shakeout in conduits this year, at least in multifamily, Cullen adds. Some Wall Street firms will survive and there will be six or eight banks in the business. In the meantime, Cullen says it will be difficult to quote pricing to borrowers, particularly as conduits will likely account for a growing share of apartment lending as the stock of multifamily product ages. The majority of business he is interested in underwriting now is between 15 and 25 years old. And conduits have to figure out how to create a vehicle for low-income housing, since 60% of all multifamily business in recent years has used the low-income housing tax credit.