International Banking and Commercial Real Estate Finance

by 01 Oct 2012
The stagnant banking situation within the United States has opened the door to foreign investment  

(TheNicheReport) -- By most standards the world is interconnected in more ways than Christopher Columbus, Napoleon Bonaparte, and even Ronald Reagan could have ever imagined. Technology is one of the driving forces behind this global interconnectedness – as social media triumphed most forms of traditional communication, Wall Street has morphed into a global marketplace where effects are felt from Kuala Lumpur to Riyadh to Boston. The speed of business activity and news reporting has multiplied exponentially. The internationalization of the global finance sector is the new norm.

This piece is seeking to answer two questions: First, what role do international banks play in the U.S. realty lending market? Second, how does one assess that role from a cause-and-effect model? These two questions are related, because if we operate on the assumption that the global banking sector’s role in domestic real estate is an effect of globalization, then all things should be settled. In other words, there is a harmonious meshing of global finances (assuming the EU were not in a stage of crisis management) and lending was internationalized rather than regionalized. However, I propose that the reason internationalization is happening is that U.S. banks do not want to shoulder commercial lending as they once did, for a variety of reasons – some of which include uber-risk management policies, extremely low interest rates, and long-term economic growth.   This article will be broken into several parts.

First, it will explore the current commercial lending market in the United States. Second, it will assess international banking strategies within the United States. Third, it will attempt to offer an explanation for the behavior of various actors within the context of commercial real estate.   Commercial Lending Two common commercial lending products are used in the marketplace. Similar to residential, there are those that hold the loan on their balance sheets, better known as portfolio lenders, and then there are those that sell the loan into the secondary market, better known as conduit lenders. These are two distinct types of lending, and both generate profits through different methods. The portfolio lender generates a profit from a lending transaction from the spread or margin above the interest rate index (e.g., adding points on top of market interest rate).  The majority of the lending for these types of transactions is performed by insurance companies and commercial banks. Additionally, portfolio lenders could also include real estate investment trust funds, pension funds, and savings and investment funds.

The second option is a conduit lender. A conduit lender generates profits through a path of transactions. First, part of the profit comes from the difference between what the lenders can sell the bond at, combined with the value of the sum of all the loans in the pool. In some cases, a conduit lender may decide to also service the loan; however, all the interest payments are collected on behalf of the investors. But it is important to note that because interest rates are at historic lows, commercial banks are not making enough money to cover the expense of the transaction – the net interest margin is so low that it creates more of a loss than a gain. It appears the only way commercial lenders are making a profit is through charging more and more fees, which is a turnoff to certain consumers, particularly when the demand is at an all-time low.   Now that we have a basic idea of how products are generated in the commercial loan market, we can begin to explore historic commercial lending rates in the United States. As you can imagine, during the 2008 financial crisis to the current times, commercial real estate financing by banks has been reduced – and by the same token, the demand for those types of transactions has decreased.

Demand has fallen because of the underemployment and unemployment rates, declining individual wealth and assets, increased debt load held by companies and individuals, continued global economic uncertainty, and a host of other factors that show us a direct relationship between supply and demand with regard to access to commercial lending. It is also true that banks have changed their overall lending policies in response to increased legal framework and their own internal risk management reevaluation in attempts to remain solvent.   Nearly eight out of ten banks have tightened their lending standards with regard to commercial real estate (but we know this also to be true for residential, particularly with the onset of Dodd-Frank and changing tax code). Most banks have also increased their loan-rate spreads, more common in the United States but also done by international banks.

The banks only appear to be lending, in any significant way, to those institutions that have a large amount of cash on hand, to minimize their own risk.   Additionally, there are many medium and smaller banks that remain undercapitalized and in some cases totally insolvent, which also increases larger banks’ risk. Those that have lent now have balance sheets with assets where the economic valuation is substantially lower than when the transaction took place. Obviously, the banks’ foremost policy is to gain a handle on the underappreciated assets before committing themselves to new projects and expanding their transaction rate. The scenario just described is not, of course, unique to the United States; it is also taking place in the EU, and as a result, international banks and private investors have filled the gap.

International Bankers In our firm’s conversations with different commercial brokers and private equity firms within the United States, many of them have indicated to us that international loans are often a strong alternative to U.S. commercial lenders because they are unafraid of the risk that the U.S. lenders insulate themselves in, and often have more capital on hand. In a policy paper by VOX’s research unit, they argued, “While many advanced country banks are less likely to be active investors in the near future, banks from emerging markets, being in much better financial positions, are likely to step into the void, increasing their relative importance as foreign investors, especially within their geographical regions. As such, the foreign-bank landscape is likely to change substantially in the future.” Both emerging economies and also parts of Europe are moving capital into the United States faster than ever.

According to the Wall Street Journal, “Foreign investment in the U.S. last year totaled $234 billion, a 14% jump over $205.8 billion in 2010, with around two-thirds of the cash coming from Europe. The government initially estimated that investment flows dropped 4% last year. Foreign investment in the U.S. has now exceeded its average of the past 10 years in 2010 and 2011, suggesting America's lure for capital has recovered from the crisis.” It is also true that continued drops in U.S. home prices are attracting much of the foreign investment along with increased acquisition of companies by international capital.

The question we sought to answer concerns itself with the realty lending market within the United States. What we have learned up until this point is that the commercial lending market in the United States is much more regulated (both self and imposed), and it becomes increasingly harder to qualify for large financing, unless one went a mortgage broker route where relationships play a very important role in originating a loan. We have also learned that interest rates and decreased capital, combined with individual wealth drops and issues of employment, can create a supply-and-demand decrease for these types of projects.   All these negative factors combined have created an interesting market for the international financial system to play a role in not only lending in the United States, but the overall healing of the U.S. economy. We saw this through increased foreign direct investment numbers and a diversification in asset acquisition within the United States by international banks and investors.

A depressed market in the United States allows such foreign investment to thrive, which in turn can create opportunity within the domestic market due to a fresh infusion of global capital and a relief of the feelings of uncertainty within the United States, which, as all who watch the stock market realize, is important for growth. To the question of globalization, which is the cause and what is the effect?   I think the case is clear that despite globalization, the weakness in the U.S. economy and the stagnant banking situation within the United States has opened the door to foreign investment – in many forms. The internationalization of parts of the transactions domestically is an effect of the economic conditions – and should not be linked as a cause or product of globalization. This is important to understand from a brokering perspective for several reasons:
  1. The increasing regulation on the part of the government to the banks, and the banks to the consumers, forces brokers to continually update their frame of reference when deciding to take on a potential commercial client and know exactly what lender to place it with.
  2. Expand your lending rolodex to include international assets and banks; do not limit yourself to domestic lenders.
  3. Think outside the box in terms of obtaining financing. Banks are not the only option for brokers, though they always want it to appear that way.
  4. Grow patience with this market and realize that these transactions will be under enormous scrutiny before being closed, and your staff must be equipped with the adequate research skills and foresight to handle these types of loans.
  The market may make it difficult each and every day, but remember that you have options as a broker, and understanding the global political economic climate has never been as important as it is in today’s world. You may want to consider rereading your 11th grade social studies textbook, or hiring a PhD in international business before continuing to operate in the commercial lending market – global market.

Richard Russell Patrick R. CorcoranBy Richard J Russell / CEO and Patrick R Corcoran / Managing Director.

We are a registered mortgage brokerage firm with the New York State Department of Financial Services and have been for the past twenty years. Our primary function is real estate financing. We are able to transact mortgages for both residential and commercial through wholesale and retail channels. Our residential business dealings are focused solely on New York State, but we are in the process of extending our geographical footprint. 



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