Lenders take hard look at risks for new loans

After a pressure-packed few months in the credit markets, things are starting to simmer down.

The systems that allow commercial mortgages to flourish are back in motion, and loan activity has picked up significantly from August and September. By no means does the current market remotely compare with the frothy days of March of this year, but all things considered, it could be a lot worse.

Probably the single most important shift in the market since earlier this year is that lenders are underwriting real estate as if it actually carried risk. Imagine that! Issues such as the sponsor's experience and cash invested are now important, along with property-specific requirements such as adequate cash flow and market occupancy.

Loan proceeds are coming in approximately 5 percent less than earlier in the year, because debt service coverage requirements are higher -- now cash flows must cover the debt service a minimum of 1.20 times versus 1.15 times.

Another major shift is that Wall Street isn't lending on projections anymore. Much like no-documentation residential mortgages, many fixed-rate commercial loans were being closed based on where rents were projected to be rather than where they were.

Lending on projections has long been the focus of local banks, which have specific market knowledge and expertise to properly evaluate risk. At the height of the market, too many Wall Street-based lenders started moving in on local construction lenders' territory. Today, many such loans are getting written down.

Although it is difficult to determine the extent commercial mortgages played in some recent earnings announcements, it is clear that some of the largest commercial mortgage backed securities lenders are facing massive write-downs this quarter.

Citigroup Inc. wrote down some $5.9 billion in corporate loans and mortgage-related securities. UBS AG will take a $3.41 billion write-down. Soon to follow will be announcements from other top commercial mortgage lenders, such as JP Morgan Chase, Bank of America and Wachovia. If Citigroup and UBS are any indication, the hits will keep on coming.

Further complicating Bank of America's commercial real estate portfolio is its acquisition of LaSalle Bank last week from ABN Amro. Bank of America's real estate group inherited some $3 billion in commercial loans from LaSalle, and it is safe to assume that they won't be happy with all the assets they bought.

Surprisingly, commercial rates continue to be quite good and now range from 6.15 percent to 6.45 percent for 5and 10-year mortgages, according to the John B. Levy & Co. Commercial Mortgage Survey.

While rates are some 0.75 percent higher than the first quarter of the year, they remain attractive when considering a longer timeline.

With rates trending upward, however, the question plaguing most real estate players is "Where are values headed?"

Darrell Wheeler, managing director of real estate research at Citigroup, tried to tackle the vexing question in a recent research report. Wheeler contends in the report that interest rates play a much smaller role in values than other assumptions, such as available leverage and growth assumptions.

Using this conclusion, the report goes on to rank 70 to 92 markets in the country for each of the property types based on local fundamentals. Richmond appears in each analysis and has its best ranking in projected growth in hotel revenues, coming in at No. 29 of 92 markets. Its poorest showing is in projected growth for retail property revenues, ranking No. 56 out of approximately 79 markets that are modeled.