End of Chapter 20 Questions and Answers
1. How is the commercial mortgage underwriting process different from the residential
mortgage underwriting process?
Answer: There is much more emphasis on the property and income generation of the
property versus emphasis on the borrower in residential lending. In non-recourse loans
the borrower is not considered in detail but the property is carefully reviewed. In
commercial lending the LTV tends to run lower, generally no more than 75%.
Commercial loans are not pre-payable except with significant penalties.
2. Who are the primary lenders of commercial mortgage money? Use updated sources of
data from the Federal Reserve Bulletin or other resources to estimate the market share of
commercial banks, life insurance companies, pension funds, savings institutions, REITs,
and mortgage backed securities.
Answer as of 2002:
Commercial Banks
Savings Institutions
Life Insurance Companies
Foreign Investors
Mortgage Pools and
Conduits - CMBS
Pension Funds
Individuals, and others.
REITs
51%
6%
14%
1%
18%
<1%
5%
4%
3. A property has an stable net operating income of $1,500,000 per year. With a loan to
value ratio of 75%, a required debt service coverage ratio of 1.20, and contract rates at
9.0% for 25 year am, 5 year balloon notes, what is the maximum mortgage that this
property can borrow?
Answer: $1,500,000/1.2/12 = $104,166.67 for payments that support $12,412,669 for a
9% 25 year amortization. The 5 year balloon does not factor into the calculation nor will
the LTV unless the appraised value is less than $16,550,225 in which case the LTV will
limit the loan to less than that supportable by the income and debt coverage ratio.
4. Describe the primary elements in a loan application package.
Answer: Summary of loan request:
1.
Loan amount.
2.
Type of loan and key loan terms
3.
Security offered for loan and appraisal.
Package requirements:
1.
Project description.
2.
3.
4.
5.
6.
Tenancy (Pre-leasing).
Peer property, area and market analysis on rents and vacancy rates.
Financial data on the property
Compliance with land use regulations.
Developer history and experience, financial condition.
5. Why are lock outs so common for commercial property loans? What is yield
maintenance?
Answer: Lock outs are a result of the high cost of underwriting and processing a
commercial loan. The lender does not want to allow prepayment of several million
dollars on a surprise basis. A yield maintenance charge is a penalty that is equal to the
difference between the interest rate on the loan and a low risk investment such as a
Treasury Bond over the remaining term of the loan. This penalty makes it unattractive to
refinance for the purpose of lowering the interest rate paid.
6. What is meant by financial engineering?
Answer: Financial engineering is the manipulation of cash flows from a pool of
mortgages to try and maximize the value of the flows based on the various appetites of
the capital market for different levels of risk and different terms.
7. What is different about the CMBS market from the secondary residential mortgage
market?
Answer: The cash flows are blended to create new instruments with various levels of
risks in the CMBS market. In the residential market the mortgages are merely pooled and
may be rated with respect to risk but cash flows are not manipulated into new investment
vehicles with various risk levels as they are with CMBS. The secondary residential
mortgage market is dominated by one agency, Freddie Mac, while the CMBS market is
private with a number of major private players.
8. How do rating agencies determine the riskiness of a default on a commercial
mortgage?
Answer: They assess the probability of default. They use debt coverage ratios, tenant
and market reviews but do not review the likely severity of the loss should foreclosure be
necessary.
9. Why are mortgage workouts so common when a commercial property loan is in
trouble?
Answer: The costs of foreclosure are high and the difficulties of taking over a property
can be high. The borrower is often in the best position to help manage the property out of
trouble.
10. How big is the CMBS market today? How much did it grow in the last year? Where
do you think future commercial mortgage money will come from?
Answer: Over $300 Billion and growing fast at about $50 to $70 Billion a year. It is
likely that commercial loans will come from the same sources but some investors may
buy CMBS shares rather than make direct loans. This added liquidity may bring some
new players into the market such as pension funds and institutional investors.