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Deal Me In: How Banks Are Staying In The Capital Stack

With competition in the debt market driving yields down on construction loans, nonbank lenders are turning to banks, often by splitting mortgages into two notes, to boost their yields.

Cushman & Wakefield Executive Director Beth Lambert at Bisnow's Dallas Capital Markets & 2018 Forecast event

“There is just a tremendous amount of competition,” Cushman & Wakefield Executive Director Beth Lambert said. “I never thought I would see a debt fund, when they first came into play, charge anything below 5% or 6%, 7% in some cases, but now you see them being a lot of times closely competitive to the banks at 3.5 and 4's.”  

Hunt Mortgage Group Managing Director Justin Short said that in this market, nonbank lenders are left with two options to get yields where they need to be: opt for riskier investments or lever senior loans. For Short, Hunt Mortgage Group and many other nonbank lenders, the preferred strategy is to lever.

To do this, nonbank lenders are offering up the debt they own to banks and through one method or another (A/B notes, warehouse lending, etc.), banks are financing nonbank debt. As this debt financing takes place, nonbank lenders are benefiting from a spike in their dwindling yields and the banks get dealt back into the capital stack for construction loans, a game from which regulators have largely excluded them as of late.

Hunton & Williams P​artner James "J.R." England, Principal/Director Metropolitan Capital Advisors Todd McNeill, U.S Bank Senior Managing Director Vish Ali, Cushman & Wakefield Executive Managing Director Beth Lambert and Hunt Mortgage Group Managing Director Justin Short

U.S. Bank Senior Managing Director Vish Ali said yields for nonbank lenders can go from roughly 5% to high single digits/low double digits when they lever, and the banks benefit from being a part of the capital stack, earning a good return for themselves and their capital, and holding a great position in repo facilities.

Though debt and equity are readily available in this market thanks to the trend toward creative, flexible financing, there are a couple of pitfalls. Lambert warned that borrowers ought to budget extra time for the negotiations process, which has become increasingly lengthy as members of the capital stack seek to write out as much risk as possible, and she said borrowers should remain disciplined despite the abundance of capital.