Financing projects is tougher than ever these days – but not impossible.
Getting lenders to lend hinges on a variety of factors, some of which borrowers can control and others they can’t.
Knowing the difference is key.
In an August 2, 2010 speech to state government officials in South Carolina, Federal Reserve Chairman Ben Bernanke urged, but did not require, banks to increase lending to small businesses. He noted that restrictive lending standards have been especially hard on small businesses, which rely on bank loans as a primary financing source. “Along with the other banking supervisors,” he said, “we have emphasized to banks and examiners that lenders should do all they can to meet the needs of credit worthy borrowers, including small businesses.” Meeting those needs, however, may take some time.
Sanford Sadler, Executive Vice President and Chief Credit Officer for Nevada State Bank in Las Vegas, agrees that financing a real estate or construction project today can prove nearly impossible. “For a real estate project in terms of an investor – if someone wants to build a hotel, an office building, something like that – yes, nearly impossible because there is simply no demand. We have not been asked for any of those loans.”
On the other hand, for so-called owner-occupied projects – for instance, a businessperson who owns a building and will operate out of it – there is “some demand,” Sadler says, “and we are doing some of those.”
“There are different levels of financing,” notes Kyle Nagy, Director of CommCap Advisors, a commercial mortgage banking firm based in Henderson whose “sweet spot” is loans of $1 million or more. “If you’re looking to build an office building or industrial or retail center then yes, it’s very difficult. We have enough of those right now, and we don’t need any new construction. That’s why banks are not doing construction loans unless they’re for build-to-suit projects, which have tenants in hand. They want the building and you can build it for them.” The majority of loans that CommCap is doing today are refinances of existing loans, specifically bank and life insurance company loans that are coming due.
Lenders, Nagy points out, have always worried about occupancy and cash flow, “but they’re focusing a little bit more on the borrower, the principal, today, and his experience and wherewithal to make it through this recession.”
The type of loan can make a big difference. Traditional loans, as with a commercial bank, are generally priced lower and for a slightly shorter term. Private money and nontraditional loans, by their nature, will be priced higher, according to Sadler, “and some may even take an equity ownership in the project.” Normally, non-traditional and private money loans will be used if the principal does not have the equity to put into it. “But you pay a price for that by giving up a little ownership and paying the higher rate.”
“Traditional loans are going to probably be priced a little more attractively for clients,” agrees Reed Radosevich, president of the 120-year-old Chicago-based Northern Trust Bank, which has been doing business in Las Vegas for a decade. Lenders are typically going to require higher underwriting standards, “meaning that if it’s a commercial real estate property it needs to be fully leased up. They’re going to have to have a sizeable amount of equity in the project. They’re going to have to have certain debt-coverage ratios, and properties are going to need to be cash-flow positive.”
Getting financing “still comes down to the basics,” says Sadler, “what I call the bread and butter, X’s and O’s.” Borrowers need to come to the table with “good, solid numbers, meaning that they’ve done their homework, and the numbers make sense. I have never seen a projection that didn’t work, so their assumptions have to be valid. They need to have a business plan: how is this going to work?”
Lenders, Sadler is quick to point out, “are people too, and as they are listening to proposals they’re thinking, ‘Hmm, would I buy that product? Would I stay there?’ So have good, solid numbers. Have a business plan that makes sense. And have a back-up plan, because nothing ever works out exactly as anticipated.”
Beyond simply running the numbers, lenders want to know that the borrower can put that information together in a cogent, purposeful manner, “meaning that they understand the proposal themselves,” says Sadler. “So many people come in with what they think is a great idea and not much beyond that.”
Potential borrowers “need to be very frank about what’s occurring in their businesses,” insists Radosevich. “If you’re very candid with your banker and give him a good story as to why trends were down – a key employee left, you lost your biggest client” – the process can be facilitated. “It’s easier to get your arms around what’s going on with the financials if there is a story behind what’s happening with the business.”
When it comes to commercial real estate, some lenders need to understand that “they are going to have to have equity in their projects, whether it’s a refinance or construction,” says Radosevich. “These days that would be 25% to 30% down in properties.” In the past, a lot of banks were lending with as little as 0% to 10% capital injection. “Certainly, one of the things you need to come to your banker with is an understanding that you are probably going to be required to have a larger down payment than in the past.”
Looking For Loosening
So when will the money supply loosen up?
“That’s a great question,” says Radosevich. “I think the real estate market needs to stabilize and business trends need to start inching up.” Bank balance sheets “need to begin to heal, and that is going to depend on how quickly banks can work through some of the credit issues. As soon as banks can get a handle on their balance sheets and have the proper capital requirements, that will probably allow them to take a more aggressive role in lending.”
According to Nagy, the supply of available money has already loosened up “substantially compared to ’07, ’08 and ’09. The end of ’07 was right when the credit crunch was really starting. ’08 and ’09 were very tough years for lenders — at least the lenders that we work with, which are mainly life insurance companies and larger banks. They have loosened up, and they are back in the market and quoting deals. We’ve seen more activity this year than we did all of last year.”
“All of these economic things depend on one thing: it starts and ends with employment,” Sadler suggests. “People have got to have jobs before they buy something, and even those who do have jobs have got to feel confident that they are going to keep them.”
As for whether or not a release of more loans is in the cards, Sadler confesses that he just doesn’t know. “It all goes back to demand. Every bank wants to make loans; if they don’t make loans they’re not going to be in business. But if they make too many bad loans they’re not going to be in business, either. It’s a balancing act — a little give, a little take, changing with the economic times a little bit here and there. We want to make good loans, we want to do right by our customers. Everybody is in this together, just slugging our way through it.”
Radosevich says his bank’s underwriting has not changed over the past five years; that, in fact, its loan portfolio grew by 40% in 2009. That said, “I think there are certainly a number of issues that are affecting lending as far as the entire banking industry goes.” Commercial real estate, like real estate in general, has “significantly plunged, so certainly that’s making it very difficult to finance or refinance any type of real estate out there unless there is significant equity in the properties.”
A weak 2009 and less-than-optimistic forecasts of businesses trends, Radosevich notes, add to lenders’ hesitancy. “If trends are headed downward, banks are going to qualify you on your most recent year. You’ll see a three-year average, and if you had a poor 2009 it will be very difficult to qualify. Banks in general are trying to work through the credit issues, and their balance sheets need to heal.”
And those hoping to finance projects need banks to heal, too.
Sanford Sadler of Nevada State Bank says he believes the FDIC gets an undeserved bad rap.
The Federal Deposit Insurance Corporation (FDIC), of course, created by the Glass-Steagall Act of 1933, both provides deposit insurance and examines and supervises certain financial institutions for safety and soundness, among other duties.
“What they do is say, ‘You have too much concentration in raw land loans,’” he notes. “‘You need to back off of that.’ Or, ‘Your loan-to-values are too high on these types of loans, you’ve got to be careful.’ Or, ‘Your loan-loss reserve is too low, you’ve got to add to the reserves.’ While they don’t say anything directly on a specific loan, it all filters down into that.”
Bank failures during what some are calling the Great Credit Crunch began with FDIC closing just 25 in 2008, which grew to 140 in 2009. FDIC shuttered five banks on July 30th of this year, bringing its total for the month to 22 and for the year 108. Almost all of the banks closed in 2009 and 2010, according to Richard Suttmeier, Chief Market Strategist for ValuEngine.com writing in Forbes, were “overexposed to construction and development loans and non-farm/non-residential real estate loans.”
“I think the banks have felt the pressure of the FDIC, which has made it a little bit more difficult for them to lend because of the regulators,” says CommCap’s Nagy. “I don’t know what impact they have on the life insurance companies, the institutional lenders, because I don’t know how much they are regulated by the FDIC. They are not depository institutions; they’re institutions that lend off of life insurance policies or banking relationships.” The FDIC and its regulators have been working with local banks to ensure that they’re viable, he adds, “and that may or may not constrain their financing.”
Northern Trust’s Radosevich sees the FDIC as trying to help banks out by “making sure they are really taking prudent underwriting steps. They are really trying to help banks assess and strengthen their balance sheets, and a lot of times that means that they’re going to restrict a certain type of lending that a bank can do because it may have a concentration in it already. FDIC is really trying to help banks work through their problem credits.”