Traditionally, a borrower would tap a balance sheet lender because of its ability to lend quickly and quite likely to build a relationship with the institution. If they wanted the best deal, though, they would go to a debt fund.
Now, with interest rates on the rise and because of the way these entities manage their own capital sources, the costs have become comparable, says one balance sheet lender. “We are more competitive than we have ever been,” says Scott Larson, managing principal of Pangea Mortgage Capital.
With costs basically the same now, balance sheet lenders are also able to better compete on their strengths of flexibility and relationship building.
Larson tells of an office deal in Houston that it competed with a debt fund for in the fourth quarter. “It was a uniquely structured transaction that needed flexibility because of the borrower type and the underlying ground lease. We were able to more nimbly structure the deal than other folks bidding on it.”
PMC won another deal that had some hair on it due to local municipalities’ requirements and the possibility that the scope of the construction could change, Larson relates. PMC was more competitive because it was able to work with the construction approval process.
The reason for why balance sheet lenders have become competitive in this environment with debt funds is due to their difference in capital structures. Balance sheet lenders own the loan from origination to payoff, while many debt funds rely on the securitization market to sell off their loans.
In the rising interest rate environment, the premium that the bond investors ask for when buying into the securitization has increased, which has meant debt funds have had to increase their own interest rates and spreads as a result, Larson explains.
Debt funds’ relationship with the securitization market also explains why it can be difficult for them to compete on flexibility. Lenders that use securitization have to create a homogenous set of loans in order to package and sell them into the secondary market. Balance sheet lenders, on the other hand, Larson says, “can look at loans from a holistic point of view and don’t need them to fit into a certain box. We have a lot more latitude.”
That has always been the case of course and this is not to say that debt funds are no longer competitive. Larson says debt funds are very competitive on straightforward transactions that don’t have unique needs or require customization. “They still provide a very attractive product.”
Balance sheet lenders have also been hit by higher interest rates but Larson maintains that “those of us that use modest or low leverage have found they can continue to operate and expand business, albeit while being more mindful of future loans. We haven’t seen the type of disruption that other groups have had.”