LOSING THE RIVALRY
Why life companies just can’t seem to compete with the GSEs’ current pricing.
IN EARLY OCTOBER, when the GSEs started quoting 10-year deals in the mid–4 percent range, most life insurance companies threw in the towel, unable to follow Fannie Mae and Freddie Mac down to those levels.
Since life companies are balance-sheet lenders, they have to match assets with liabilities. And when the industry benchmark—the 10-year Treasury—falls to historically low yields (it hit 1.8 percent in early October), that poses problems for life companies.
As a result, life companies have had to institute interest-rate floors—in the 4.6 percent to 4.75 percent range—to keep their deal rates at a level they’re comfortable with. In the early fall, life companies started to pull back on pricing and proceeds, leaving the market pretty much exclusively in the hands of the GSEs.
Another factor at play here is timing. Life companies were so aggressive in the first half of the year that many hit their quotas early and grew more selective as the year went on. Most are upping their allocations in commercial real estate for 2012, but that’s still a limited supply of capital reserved for a select portion of the market—lowerleverage deals on institutional-quality assets.
And ultimately, that means that come 2012, life companies will still be contenders— but they’re a long way from being market makers.
Fannie Mae and Freddie Mac have heard the footsteps coming over the past year, but their perch atop the multifamily debt market looks safe for 2012.
The government-sponsored enterprises (GSEs) are expected to again capture about 60 percent of the market for permanent multifamily debt this year, the same as in 2010. And even though they face growing competition from life insurance companies, banks, and the occasional conduit lender, the GSEs will likely win the majority of the market in 2012, as well.
“Their market share might fall, but I don’t think it’s going to fall all that much for a while,” says Don King, head of GSE production at Boston- based CWCapital. “Conduits don’t appear to be an issue, commercial banks don’t seem to be lending all that much, and life companies will be a factor, but their high-water mark was below 10 percent of the total market anyway, so it won’t have a huge impact.”
The way the competitive landscape changed over the summer of 2011 offers a preview of 2012. Six months ago, the GSEs were facing stiff competition from life insurance companies, many of which were able to price inside of the GSEs by a significant amount, particularly for lower-leverage loans on institutional-quality properties. And even the CMBS industry came alive in the second quarter—for about 30 days in the spring, as conduits briefly featured pricing that was right on top of the GSEs’, even for trophy assets. But the economic volatility of the summer— seen everywhere from Greece’s demise to the U.S. debt ceiling standoff—bumped the CMBS industry out of the game, while the rock-bottom yield on the 10-year Treasury made life companies less competitive.
The good news, however, is that Fannie and Freddie remained steady in their pricing and underwriting, despite their position as market makers. “The GSEs are still very competitive,” says Grace Huebscher, president and CEO of Bethesda, Md.–based Beech Street Capital. “I think the outlook will be the same volume or more next year. If the economic picture becomes more stable, the acquisition flow will keep up, and if rates stay low, you’re going to see a lot of refis.”
Here’s a look at the pricing, products, and programs that will likely shape the GSEs’ lending platforms over the next year.
The Horse Race
Fannie and Freddie were basically pricing neck and neck at the beginning of the fourth quarter. Freddie does seem to have a slight advantage over Fannie due to its inherent underwriting model. Yet, ironically, Freddie’s overall business model is slowing its pipeline.
Fannie Mae programmatically uses underwriting floors—a tool for sizing loans—and it tends to limit proceeds. Freddie’s exit test, on the other hand, seems a little more forgiving.
For 10-year deals, which are sized based on an underwriting floor of 5.5 percent, Fannie Mae has been very willing to consider flexibilities and grant waivers on that floor. But it’s on five- and seven-year deals where those floors become more significant, which means the waiver would have to be greater.
“Sometimes, Fannie just can’t get all the way to where Freddie is going to be,” says Todd Goulet, senior vice president at Clevelandbased KeyBank Real Estate Capital. “In good markets, Freddie can get pretty aggressive on five- and seven-year money—it seems like more deals pass their exit test than Fannie’s.”
Yet, as the traditional fourth-quarter busy season got under way, Fannie Mae had the upper hand in terms of processing times. Last year, Freddie Mac was absolutely crushed with business in the fourth quarter, exposing the Achilles’ heel of its “prior review” underwriting model. And with rates as low as they’ve been, the company expects to see high demand in the closing months of the year.
Freddie made some moves throughout 2011 to open up that bottleneck—hiring thirdparty underwriters to handle its overflow and improving its internal loan-processing technology —but its stream remains partially dammed. “What was historically a 60-day process—and if you needed it quicker, you could get it—is now more of a 75-day process,” says Goulet.
The ongoing “brain drain” at the GSEs is also conspiring to slow things down. Over the past year, Freddie Mac has lost not only its head of multifamily, Mike May, but also Mike McRoberts, its national head of sales and production, as well as many regional directors. Insiders suspect this brain drain may be a problem as the GSEs head into 2012, though not enough to thwart business volume.
“Both GSEs are working hard to support their growing business, and Freddie Mac has been adding positions. The hope is that Fannie Mae will be able to add as well,” Huebscher says. “We’re hopeful the regulators won’t encourage downsizing, which would be a big mistake, especially in the multifamily business.”
Brightening Up the Corners
Both GSEs have complemented their conventional fixed-rate businesses by sharpening other programs. For example, Fannie will likely see more floating-rate business next year. In mid-2011, it reintroduced its capped ARM product, and market response has been favorable.
The GSEs are also honing niche businesses such as seniors and student housing. Fannie’s student housing program had recently been obscured by Freddie’s more aggressive approach. Part of the disparity was due to Fannie’s requirement to do deals only at universities with enrollments of 20,000 or more. This year, the agency lowered the bar to 10,000.
Meanwhile, Freddie Mac has made some changes to its seniors housing program, which had seen a drop in volume. In September, the company broke from its regional model and approved a dozen lenders to originate seniors housing loans anywhere in the nation.
In all, the GSEs will dominate the multifamily landscape again next year, even as more money begins to flow from the private sector. After all, should banks, life companies, and conduits be unable to keep up, the GSEs will still have to compete against each other.
