Conduit lending helps connect Main Street businesses with Wall Street financiers and funding options.
For guidance on navigating the process, Smart Business spoke with Larry Silberman, group regional president of commercial real estate for MB Financial Bank, to learn the options that owners and investors have for long-term fixed-rate financing and how to match their needs to options.
How does an investor get access to long-term fixed-rate financing?
Most community banks don’t offer permanent debt options for long-term fixed-rate financing, so businesses usually go outside their main commercial bank. The primary options are through an insurance company or a conduit, at times accessed through correspondent mortgage brokers. Conduits typically package these loans into a portfolio securitized by selling bonds.
Commercial banks can add a lot of value as an intermediary, even if they don’t offer the desired funding vehicle. They already have a close relationship with their customers, an understanding of the properties and investments, knowledge of customers’ financial performance, and relationships with multiple mortgage brokers and insurance companies. The bank has the flexibility to match its customer with the most appropriate funding source, and the customer benefits from the convenience of working through his or her regular banker. There’s usually no cost premium to working through the bank as an intermediary. In fact, terms are often favorable to the customer.
How does funding through an insurance company differ from funding through a conduit?
Conduit loans tend to be more structured, and therefore less flexible for the borrower. Flexibility includes prepayment terms, provisions for the partial release of collateral, guidelines on rebuilding the property in case of fire or other damage, plus various interest and financing terms.
Because conduit loans are pooled and securitized, there is less flexibility for individual borrowers. The tradeoff is that they often have a better price. Conduit loans are also available to more borrowers, because insurance companies tend to be more conservative in their underwriting and more selective in their potential borrowers.
Are there any new long-term financing options?
The basic options remain the same, but there are several new variations. For example, now there are interest-only options for permanent long-term financing. Life insurance companies are starting to provide complete funding for projects right from the start of construction. Historically, insurance companies have gotten involved after construction was complete and the property was generating stable cash flow. Some lenders are also offering flexibility on non-recourse provisions, which allow the borrower to buy down the rate.
Negative arbitrage situations are also becoming more common. Say you need $5 million to fund construction of a project that will take 10 months to complete. Typically, you would draw $500,000 a month for 10 months and pay interest only on the outstanding amount. The new alternative is to be advanced the entire $5 million. The borrower takes the amount it doesn’t need immediately and invests in a short-term interest-bearing vehicle, such as commercial paper. ‘Negative arbitrage’ refers to the difference in the interest rates between the loan and the investment.
What advice do you have for businesses seeking long-term financing?
Be prepared with information, and be patient. Prospective lenders will want to see at least three years of financial data. This includes normal operating expenses, documentation of capital improvements, tax records, utilities and other fixed expenses, rent rolls and the leases for major tenants.
How does a company choose what type of loan is most appropriate?
It really depends on how much flexibility is desired, and the nature of the business or project being financed. If the financing is for a single, stable, long-term asset, such as a big-box retailer or outlot pad for a bank, then there is less need for flexibility, and the borrower can get better terms.
If the financing is to develop a property that will have multiple tenants, with less predictable cash flow, more flexibility will be needed over the long term. It can be hard for a business to know what flexibility it needs, so this is an area where there is value in using the commercial bank as an intermediary. The intermediary doesn’t have a vested financial interest or profit incentive in the option that’s chosen. This independence can help bring clarity to a potentially confusing decision.
LARRY SILBERMAN is group regional president for commercial real estate at MB Financial Bank. Reach him at email@example.com.