It appears the lenders that have been sitting on the sidelines for the past several years have worked through many of their problem loans, and are now looking to redeploy capital.  That combined with the fact that the overnight funds rate is so low, the only way for these Banks to get solid returns and to begin to return to the strong profitability of the past is to lend money.  Because most of the institutions are risk adverse, what has happened is they have gotten more aggressive on their rates and terms to the most qualified borrowers.  In essence they are willing to buy low risk business at low rates, because although it provides a low return, that return is much better and much safer than any other investment they can make with their capital.  Some of the more aggressive loan programs we have seen are as follows:

1)   Private lending groups offering 3, 5, 7 & 10-year fixed-rate commercial loans on historically performing apartment buildings and investment properties with rates starting in the low to mid 4% range with cash-out up to 75% of appraised value.

2)   Banks offering aggressive financing programs on apartment buildings up to 80% loan to value with rates starting in some cases below 4% as the Banks look to compete with Fannie Mae and Freddie Mac for the apartment market.

3)   Traditional Banks in certain markets getting aggressive on investment real estate including mixed-use, retail, industrial, and office properties, with rates starting in the low 4% range for conforming and historically cash-flowing properties with loan to values up to between 70% and 75%.

4)   Insurance companies have come back into the market and are offering non-recourse financing for credit tenant properties up to as high as an 80% loan to value at rates starting in the low 4% range and going up from there with terms up to 10 years and beyond.

5)   Traditional Banks getting very aggressive on owner-occupied properties with interest rates starting in the low 4% range and sometimes below 4% for strong borrowers with solid relationships and good historical cash-flow.

6)   Traditional Banks offering operating lines of credit and equipment financing at very aggressive interest rates starting as low as Libor plus 2.00% (roughly 2.35% today) for strong Borrowers with solid historical cash-flow and good business models.

Although aggressive pricing has certainly returned to the market, and loan demand from all likes of commercial lenders is much higher than it has been in years, credit quality is still the challenge, and many lenders are still cautious about any property, business or loan request with any sort of troubled history or where the cash-flow, loan to value, and business model are not very solid.  Because of this many requests are still not getting done by most lenders, and many lenders are still hesitant to take on certain types of requests, so finding the right financing for every borrower can still be challenging.  However, with many commercial lenders available, including many outside of traditional financing that most borrowers do not run into every day like private lenders, insurance companies, conduits, etc., there are many options available to get not only quality deals done at very competitive rates, but also higher risk deals done as well that the traditional banks still have not gotten comfortable with doing.

For the first time in years it once again makes sense for commercial loan borrowers to check the rates on their current loans and to consider refinancing to a lower rate, because based on where rates are at today they can look in financing at some of the most historically low rates commercial lending has ever seen.  Here at Commercial Lending X we are always available to answer questions about what type of loan programs are out there and to assist our Clients in getting the best financing available in the market for their loan request.  Please never hesitate to contact us with any questions at anytime.

1) Reduced Note Payoff – sometimes a Bank either due to acquisition, due to a desire to move less desirable loans off its books, or due to a severe drop in the value of its collateral, will allow a commercial loan customer to do a discounted note payoff, where the Borrower can payoff the loan for an amount less (sometimes substantially less) that they currently own. For the Borrower this may be a great deal putting their commercial loan at a solid loan to value and enhancing the cash-flow and overall performance of their commercial loan. Unfortunately many traditional lenders either have a policy or just are not comfortable funding a commercial loan that will lead to another Bank taking a discount or even loss (even though no loss might exist because of an FDIC assisted loss share or because the loan was purchased at a discount). Because of this often times a bridge loan is used to fund the discount, either as a new loan or a discounted note purchase, which allows the borrower time to adjust its balance sheet and then go back to the traditional banking market six months to a year later with a clean performing asset and seek to refinance the bridge loan at a better more conforming loan rate at that time.

2) Tenant Build-outs – in today’s market commercial lenders are very hesitant to fund any sort of construction, especially if there is any speculative risk, for commercial properties. If a tenant needs to make some improvements to get some new tenants into a property, sometimes that commercial loan borrower just needs some short-term working capital. A bridge loan can fill this need providing the borrower with capital and flexibility and giving them time to complete and stabilize a property. Once completed and stabilized they can move the project to more traditional long-term financing.

3) Quick Acquisition or Note Purchase – most traditional commercial lenders cannot fund the acquisition of a property very quickly, and most will not fund a commercial note purchase. Sometimes it is advantageous for a borrower to purchase a note over purchasing a property in certain circumstances. A commercial loan borrower can utilize a bridge loan, which can typically be closed in 30 days or less, to quickly acquire a property or a note, taking advantage of a solid opportunity. Shortly after acquisition and stabilization, the commercial loan borrower can then work on getting more permanent financing in place with a long-term lender.

4) Construction Financing – Again, in many cases traditional lenders are hesitant to take on construction risk in today’s market. They worry about cost overruns, tenants not taking occupancy, failure of a builder to perform, etc. In order to alleviate some of these concerns, commercial loan borrowers can utilize a bridge lender to get the construction financing needed for their new project, whether it is an investment property, build-to-suit, or owner-occupied property. Once completed the Borrower can exist the loan via a refinance to a traditional lender, a refinance into an SBA loan program for owner-occupied, or a sale of the property if it is build-to-suit.

The above are just four of the main reasons a bridge loan might make sense for a commercial loan borrower, but there are certainly many other circumstances where use of such a product may apply. If you are seeking financing and failing to find it via traditional means, it might make sense to look at bridge financing. Often times it just takes a short amount of time to stabilize a property or fix a problem with a property, and then the property can be flipped to a more traditional bank loan.

Before we finish on this topic, I would like to point out that bridge financing is definitely more expensive then traditional bank financing. However, the cost needs to be weighed against multiple things. First, there is the opportunity cost. A commercial loan borrower needs to judge what they gain or lose by doing or not doing this transaction on a longer-term basis. Secondly, the financing is likely about twice as expensive as traditional bank financing, but that expense only lasts for as long as the bridge financing is in place. If the project can be refinanced in six months, then the difference in rate may be somewhat nominal (just a couple of points), over the potential longer-term income. Lastly, there is always a time component to money. If you can get a deal done today even though you had to pay slightly more to do so, over waiting and searching another six months or a year for a lender to complete that project, you may find yourself ahead of the game from a timing perspective. Again, there are many reasons and times bridge financing makes sense, so we recommend you consider it for your next project when you run into opposition from traditional lenders. You may just end up finding it is the preferred way to go.

The confusion often lies in the fact that borrowers can get 15 to 30 year fixed rate and term residential mortgage loans, and they think the same should apply for their commercial loan.  The primary difference is in how these different loans are funded.  Home mortgage loans are typically made by Banks or residential mortgage lenders, but in most cases the Bank’s do not retain ownership of these loans.  The loans are sold to the secondary mortgage market where they are pooled into mortgage-backed securities, which are sold into the equity markets.  Investors purchase mortgage-backed securities for the long-term fixed interest rate of return they provide as they are typically seen as a safe investment as most mortgage-backed securities are guaranteed by the Federal Government or carry insurance that provides guaranty of payment of principal and interest.

Commercial loans on the other hand are typically held by the commercial banks or the commercial lenders that make them.  Banks, as an example, typically lend out their deposits.  Banks attract the deposits they lend usually by offering a rate of return on different deposit accounts, such as money market accounts, savings accounts, and certificates of deposit.  As most depositor money is put into Bank’s on a short-term basis, or in the case of a checking or money market account could be moved out at anytime, Bank’s must quickly adjust their interest rates to keep deposits in the Bank when the market shifts.  Because of this, if interest rates paid for deposits in the market start to go up, Bank’s must increase their interest rates.  This affects the Bank’s capital cost.  Since Bank’s determine the interest rates they can charge their commercial loan customers largely based on the Bank’s internal costs, any change up or down in interest rates effects their returns.  Because it is hard for Banks to forecast interest rates very far into the future, they are hesitant to lock interest rates in for very long.  Which is why most commercial loan terms and interest rate locks do not exceed five years or are even less than that.

Now, in some cases commercial lenders run a product special where they may offer a longer-term fixed interest rate and term.  And in some cases commercial lenders will offer longer-terms, but will have the rate adjust to market rates at some point during the term to be sure they are covered should their cost of deposits change during that loan term.  There are some lending programs, such as some multifamily lending programs offered through Fannie Mae & Freddie Mac that offer longer-term fixed rates, or some programs funded by insurance companies, but these are rare and most commercial loan borrowers do not qualify for these programs.  The programs are usually designed for assets that have long-term income potential, such as large well-located apartment buildings or retail centers with strong national tenants on long-term leases.

It would be nice if a secondary commercial loan market existed allowing commercial loan borrowers to lock in long-term fixed interest rates on long terms, but that is unlikely to happen.  Commercial loan requests are so different from one another, it is hard to create a product or products the market can get comfortable with.  Unlike residential lending, which is very standard, most commercial loans by the nature of their cash-flow and the assets that secure the loans, do not warrant long-term fixed interest rates.  It does not make sense to put a retail center with leases that do not exceed five years on a term longer than the five years the leases last.  Commercial lenders do not want to commit to provide money for longer than the borrower can evidence the ability to repay the loan.  Even without those options, there are still many good loan options out there for commercial loan borrowers, and we here at CLX are more than happy to help borrowers find the options that best fit their needs.

In the old days a borrower would get an approval for a commercial loan and after approval their lender would contact several appraisal manager and collect bids for the work and try to place the work with the most qualified appraiser at the best price with the quickest turnaround. Now, based on new regulations, the FDIC wants commercial lenders to have as little to do with commercial appraisers as possible. In fact, they would prefer the two did not talk at all. All FDIC insured institutions must now have a third party within the Bank order the appraisals; someone separate and apart from the commercial lender. In fact the commercial lender is supposed to have no control or influence over the person ordering the appraisal, meaning often times the individual or group (for larger banks) assigned to manage the appraisal process is not even involved in the loan process. This has led many Bank’s to utilize an out-sourced appraisal management services to manage the process for them.

Although on the surface this process appears to make sense as it prevents collusion between lenders and appraisers, when examined more closely this process clearly creates many problems and is hurting the quality of the work getting done while increasing the cost and time involved, which the following examples will clearly demonstrate.

1) Unlike residential home appraisals, which are very standard, commercial appraisals can vary quite significantly depending on the property type. Often times the individual or group ordering an appraisal does not know if the specific appraisers bidding a job have experience in the industry or have done significant work with a specific property type. This can lead to appraisers with less experience completing appraisals inaccurately that they never should have been given the opportunity to work on in the first place. Commercial lenders used to verify that the appraisers doing the required work understood the property type, and often times those lenders knew which appraisers to use with certain property types because they knew which appraisers had experience in those industries based on past work.

2) Many commercial properties are quite unique and often times there are details or items that need to be addressed by the appraiser as part of the appraisal process. Sometimes the type of appraisal or type of conclusion needs to be adjusted based on the property type or some factor affecting a property. It is hard for commercial lenders to communicate those items to a third party individual or group who is actually ordering the appraisal and be sure that information gets communicated through accurately to the individual appraisers. Most of the individuals now managing the appraisal process do not understand commercial lending and what is needed. This often times leads to miscommunication that can greatly increase the time involved and the accuracy of the final reports produced by appraisers.

3) In the past commercial lenders would work hard to keep appraisal bid prices in check, and would often times work appraisal pricing down for their clients to keep the loan affordable and their commercial loan borrower happy. A third party individual or group has no incentive to keep prices in check. Plus, once an appraiser is on a bank-approved checklist, it is usually guaranteed to get the chance to bid a certain amount of work. Because of this there is no longer an incentive for an appraisal company to lower its bids to attract more business from an individual bank or lender. Appraisers know that pricing control is now gone from the lenders, and across the board the cost for commercial loan appraisals is up at least 50% and in some cases with certain property types it is up as much as 100%. Commercial loan borrowers are forced to bear the burden of this increased cost.

4) When commercial lenders were involved in the process, they could push commercial appraisers to complete appraisals quicker and could hold appraisers to deadlines because appraisers knew if they missed deadlines they would not get additional work from that lender. Now because of the involvement of an additional level of bureaucracy either from a third party within a bank or an out-sourced service, additional time is added to the process. Furthermore, these groups and individuals rarely hold appraisers to a timeline and often accept bids based on the best price and not necessarily the time it will take to get the appraisal done. Once again because appraisers know they are going to see the same amount of opportunities, they are less incentivized to work quickly on particular appraisals. Also, the lenders used to be able to work with the appraisers and get them information in advance and help coordinate cooperation from the borrower, greatly speeding up the process. But since the lender can no longer speak with the appraiser, they can no longer provide this assistance and the appraiser must get all of the paperwork from the borrower directly. In general, the turn-around time for commercial appraisals as gone from two to three weeks to a minimum of three weeks and often times four weeks or more.

5) In most cases commercial lenders are no longer able to talk with the commercial appraiser. Sometimes appraisal reports come back incorrect. The square footage may be wrong, lease information is missing, or in some cases the appraiser has just clearly missed the boat and the value is way off from where it should be. Commercial lenders can no longer work with appraisers to get reports corrected. Often times third party individuals or out-sourced groups are not good at relaying the problems and do not put pressure on appraisers to correct bad reports, and again because the quantity of work is guaranteed, appraisers do not have an incentive to correct bad work. This often leads to deals getting blown up because the lender can no longer get them done due to a bad appraisal.

6) The FDIC is requiring all appraisals to be reviewed by a third party for accuracy. Many banks have internal staff dedicated to reviewing commercial appraisals. In some cases Banks utilize out-sourced appraisal companies to provide the review. The review must be completed prior to loan closing, and in many cases adds several days to a week to the appraisal process. In addition, out-sourced reviews are not cheap, and the customer ends up paying for that review fee.

7) The FDIC is now requiring most Banks to get updated appraisals with each renewal; and for problem loans are sometimes requiring updated appraisals annually. The days are gone of a customer getting a long-term renewal on a commercial real estate loan without an updated appraisal. This is adding additional cost to borrowers on each renewal, even in cases where properties are at low loan to values and there really is no need for an updated appraisal because the loan is performing and is just being renewed and not modified or increased.

8) The use of out-sourced appraisal companies not only typically increases the time involved in the appraisal process, but also the cost. These companies typically work in one of two fashions. Third party appraisal companies either charge a flat fee for appraisal ordering and review (if they do the review work), or they mark-up the bids from the appraisers and earn a spread over what the appraiser is charging (sometimes it is a straight percentage). Of course the Bank does not pickup this expense and this cost gets passed through to the borrower as an additional appraisal expense.

9) There was a time when banks would accept commercial appraisals prepared for other banks or lenders so long as those appraisals were not too old. Unfortunately today that has pretty much gone by the wayside, and in many cases an appraisal ordered from one bank just a month or two before will not be accepted by the next bank that looks at the transaction. This is because of a combination of factors including additional pressure from the FDIC for banks to order their own reports and the lack of bank confidence in other lenders ordering process. Banks want to verify directly that there has been no collusion between previous lenders and appraisers, and many feel the only way to do that is to order a new appraisal through their own process.

Just to be clear, we are not advocating anything that would resemble collusion on the part of commercial lenders and appraisers. We identify that during the heat of the lending boom collusion certainly existed; but we firmly believe that was not the norm but the exception. Most commercial lenders are out to get an accurate valuation not only so they can make new loans but so that they are comfortable and confident the loan decisions they have made are good ones and were made with the best and most accurate information. There is nothing more infuriating for a commercial lender than getting forced to accept a bad appraisal and not being able to do anything about it. Appraisers are only human, and they miss things or make mistakes just like anyone else. But the way the system is currently setup, many appraisers are able to act like gods when it comes to their reports, able to write and say whatever they want with no real recourse for the lender or the borrower. And that is not fair to the lender and especially the borrower, who is ultimately paying for that appraisal and deserves the highest quality of work and should have the right to discuss the conclusion with the appraiser they just paid for the work.

There are certainly still many good appraisal companies out there and many good out-sourced appraisal management companies that are not taking advantage of customers, but still overall the system has changed for the negative and the impact has been felt by commercial loan borrowers across the board. Many commercial loans that should be getting done are not either because an appraisal cannot get done in a timely manner or cannot get done correctly, and at this point there is little recourse to a system that is flawed in many ways. Although it is unlikely the system will ever revert back to a point where commercial lenders fully control the appraisal ordering process again, nor should it; the system does need to change back to the point where commercial lenders can have input and be part of the decision making process. That is the only way to be sure the right appraisals get ordered from qualified appraisers for a specific property type, and to keep costs in check and be sure quality work gets done. Unless some changes are made, commercial loan borrowers will continue to be negatively impacted by the time, cost, and poor quality of the commercial loan appraisals getting done in this market. This will lead to lost deals, time, and money, and is not helping commercial loan borrowers in the current economy recover any faster.

There are several ways to check the reputation of a commercial loan broker / consultant you are thinking about working with, as well as some warning signs to watch out for. They include the following:

1) How did you hear about your broker? If it was a referral from a lender, friend, or someone who has worked with that broker before, that should carry a lot of weight and make you comfortable that individual is trustworthy. If you heard of that broker from an unreliable source, you may want to check their background and ask for some references.
2) Check out a broker’s references. Any broker hesitant to provide you with references is likely someone you should not be working with. If you take the time to check the references, be sure they are for people who have actually gotten financing through that broker before and not just a random friend of the broker or someone who applied and did not get financing done.
3) Be wary of brokers that charge up front fees. If a broker is confident they can get a loan request funded, then they are not going to require an up-front fee. However, if they are not confident they can get the loan funded, the only way to get paid for working on it is to charge a fee up front. Charging a fee up front also takes away some of the incentive for the broker to work hard to get the deal done because they are getting some pay no matter what. All good brokers should work on a “Success Fee” basis, meaning they only get paid when you close on your financing.
4) Be very wary of brokers who do not charge their borrowers fees directly or disclose to their borrowers their fees. A good broker will at least disclose and enter into a fee agreement with their client on the front-end. That way the client knows exactly what they are paying for the broker’s services. If they don’t disclose or hide their fee from the client, then it is likely the broker’s fee is getting baked into the deal with a higher interest rate or additional fees from the end-lender to the client, which might end up being more expensive to the borrower or cost the borrower more than they would have been willing to pay directly had the fee just been negotiated between the borrower and the client.
5) Make certain that any broker agreements you sign don’t obligate you to pay any fees until a closing takes place, and that just because a broker gets you an approval you are not obligated to accept that approval or pay the fee at time of approval. You want your broker to be working in your best interests, and only get paid for procuring you financing that you want and that fits your needs, and not just whatever is out there in the market.
6) In most cases a borrower should not have to make deposits for third party costs (such as appraisals, environmental reports, etc.) until there is a loan approval in hand from a lender. Be sure that approval is a commitment or a very strongly worded proposal letter just contingent on the third party reports, and be sure you pay the third party fees directly to the lender. That is the only way you can assure the fees are not being marked up and will go to pay for reports actually needed to get your loan done. If the broker requests appraisal fees without an approval or strong commitment letter, chances are they will not end up getting used to pay for the appraisal.
7) Very few lenders require commitment fees anymore and typically only in cases of a private equity loan, conduit loan, Fannie Mae loan, or a complicated deal that needs to close quickly and the lender wants assurances the borrower is moving forward before investing the time in getting to closing. If there is any sort of commitment fee, be sure it is refundable and gets applied to closing costs at time of closing and is not just a fee earned for issuing an approval. Also be sure the commitment fee gets paid directly to the end lender, and you have a firm loan approval in hand before paying the fee from the lender.
8) Lastly, be very wary of any commercial loan brokers / consultants that produce any sort of approval or commitment letter on their own letterhead. In most cases a broker is not the end lender, and is merely an intermediary. Because of this they cannot control the actual funding of a loan, so any approval issued by them is meaningless. If they have an approval from an actual end-lender, ask to see that approval. The only reason for them to hide an approval is either because they don’t have one, or they are charging a higher rate and fee than is in the approval and baking more into the deal that way. At the end of the day you end up with the relationship with the new lender, so you should see and understand the approval from that lender. Plus the only way you can be assured there is an actual approval or commitment in place is to see the actual lender approval letter.

There are plenty of good commercial loan brokers / consultants in the marketplace. The key is finding a good one that understands commercial lending and who is forthright and fair. Like in any industry, there are also plenty of bad brokers out there. By watching for the above warning signs, you are likely to avoid the bad ones and find the goods ones you can trust to help get your commercial loan done.

Ultimately, it all boils down to the relationship you have with your individual commercial lender. But anytime a lender requests a pay down mid-term that is not a planned or included in the loan documents, it should raise alarm bells. If you make the pay down you have to anticipate the bank is not going to give you that money back. And if the pay down is on a line of credit, the bank may reduce availability on the line of credit to the remaining principal amount still outstanding after the pay down was made. Most borrowers do not realize that almost all commercial loans have clauses in them where they can be reduced or called due in advance of maturity if the bank believes there is a problem or concern, or a covenant has not been met. And most lines of credit can be reduced upon any decision of management. If a bank is under an order from the FDIC, they may no longer be able to fund on a line of credit or advance on a construction loan, meaning a pay down will never get advanced back out at a later date. So a borrower has to be prepared that principal payments to commercial lenders that request them outside of the norm of standard payments is likely money that is gone and won’t be available again for a while.

Depending on the terms of your individual commercial loan, a borrower might not be required to make that principal pay down. Often times other terms can be negotiated, such as shortening the amortization, making small principal payments each month, or in some cases not making any change but providing updated financial information that gets the lender comfortable again. The key is to not rush into making a principal pay down until you are sure you can afford it and it will not impact your business. At the end of the day commercial lenders are ultimately out to protect themselves and the institution they work for, and in desperate times even good people say things and do desperate things to protect their jobs and their livelihoods. So be cautious when it comes to your decision on whether or not to make the principal pay down, and be sure to review your loan documents, and consult with your attorney and accountant to be sure the decision makes the most sense for you. And if the situation goes sideways, there are also outside consultants who do nothing but work with banks and borrowers in troubled situations, and they may be able to advise you on all of your options.

When a borrower receives that letter, the first thing they need to do is understand that their relationship with their existing lender is done. Although it is hard not to, the customer cannot take it personally. Often times lenders change directions on what they are doing and willing to lend on, and although your loan and relationship may be good, someone in Bank management has determined to make a policy change without regard to the relationships the Bank has with its existing customers. The best thing a borrower can do at that point is focus on moving on.

Certainly it helps to find out if there is a reason why the Bank no longer wants to do business with you. If there is a concern over collateral value, business cash-flow, and / or borrower and guarantor liquidity, sometimes these are things that can be addressed with your existing lender or may need to be addressed before you can approach another commercial lender. But if the reasons are policy driven, there is absolutely nothing the borrower can do.

Just remember, there is always hope. Other lenders are actively pursuing good loan requests, and there are many traditional and private lenders (with conforming rates), that likely want to take a look at your commercial loan request. As the Borrower you need to focus on getting your financial statements together and a package together to present to other commercial lenders. In most cases your existing lender will offer you short-term renewals to give you time to move the commercial loan out of the bank, although they often do so with higher rates and fees to encourage you to do so quickly. But lenders will typically only work with a borrower if that borrower is putting forth legitimate efforts to move the relationship from the Bank themselves.

So to review, the keys if you get that awful letter from your lender are: 1) try not to panic and understand you likely did nothing wrong and understand you have other financing options; 2) find out why the Bank does not want to renew your loan and try to address those concern(s) for either your existing bank or a new commercial lender if you can; 3) get your financials and loan request together to approach other commercial lenders with; 4) start contacting other commercial lenders; and 5) work with your existing bank on a short-term renewal to get the time necessary to move your commercial loan. Your existing lender does not want to put you into default. They just want the loan moved. They will work with you to make it happen. And if you need help getting it done, the experts here at CommercialLendingX.com are glad to help you out.

Furthermore, by keeping rates low, it gives the Bank’s confidence that their cost of funds will not go up. Because many Banks borrow from the Federal Government, any increase in interest rates would increase Bank costs. Concern over high Bank costs usually forces Banks to raise interest rates, specifically to their commercial loan borrowers. Typically Banks don’t have a large window into the future to see where rates might go, making it hard to determine what interest rates to charge today. By the Federal Reserve giving them a longer-term vision, it gives Banks more flexibility today in their loan pricing, and will likely keep rates competitive through 2011 and most of 2012. However, that same window may lead to Banks slowly increasing rates in late 2012 or 2013 as they prepare for anticipated rate increases from the Federal Reserve. In the meantime, commercial loan borrowers are going to continue to benefit from good low interest rates likely for another year and possibly much longer depending on the health of the economy, which should help to spurn the development of wealth and additional investments in both commercial real estate and business development.

Fannie Mae & Freddie Mac combined provide a majority of the credit for the housing market within the United States. All of the loans originated through these agencies are sold into the capital markets. Part of the attraction for investors in buying Fannie Mae & Freddie Mac loans are the fact they pay a fixed interest rate return and are guaranteed by the U.S. Government. Because Standard & Poor’s downgraded U.S. Government Debt, they were forced to downgrade the rating on the Fannie Mae & Freddie Mac securities the government backs. Likely this downgrade could mean increased borrowing costs to consumer customers as Fannie Mae & Freddie Mac are forced to charge higher interest rates to attract the investment capital to back these mortgage loans.

However, since the announcement by Standard & Poor’s, mortgage rates have actually fallen further, driven more by a combination of the government’s desire to keep interest rates in check and the weakening of the economy, which has seen a flood of capital leave the stock market for the bond and fixed income markets. Investors don’t seem to be too concerned with the downgrade, and remain confident that the U.S. Government will continue to stand behind the Fannie Mae & Freddie Mac loans sold.

The 12 Federal Home Loan Banks supply capital to the Banking industry though lines of credit to many banks. Banks rely on this capital to maintain liquidity. Since Bank’s tend to lend out a large portion of their deposits, they need access to immediate capital should deposit balances fall and the Bank cannot bring back in loan dollars quickly enough to meet depositor needs. In addition, Bank’s must maintain certain minimum liquidity ratios to meet government standards, and often times use loans from the 12 Federal Home Loan Banks to do so. Because the 12 Federal Home Loan Banks are backed by the U.S. Government, Standard & Poor’s was forced to downgrade their credit rating as well.

In theory this downgrade should lead to increased borrowing costs for Bank’s as the money supplied by the 12 Federal Home Loan Banks becomes more expensive, as a result of the money coming from the U.S. Government being more expensive. Any increase in borrowing costs to the Bank’s would typically get passed through to the Bank’s customers in the form of increased borrowing costs for consumer and commercial loan customers. However, to date the Bank’s have not seen a material increase in borrowing costs related to this move by Standard & Poor’s, and it appears Bank’s are not likely to do so on this move alone.

Overall interest rates have stayed steady or even in many cases fallen since the announcement by Standard & Poor’s. Most of the change has been driven by a combination of bad economic data and an overall weakening of the economy. Although investors did not like the downgrade by Standard & Poor’s, they also don’t believe it is that bad, and so long as the other rating agencies keep their AAA status on U.S. debt, the effects on borrowing costs of the Standard & Poor’s downgrade are going to be nominal. To date the effects have been relatively minimal if not non-existent on consumer and commercial loan pricing. However, should additional downgrades occur, it is clearly likely borrowing costs could be negatively impacted and interest rates climb substantially to all loan customers. Future downgrades are likely going to be the result of economic performance and how the U.S. Government manages it’s debt, and is unlikely to occur immediately, but is a risk to occur at anytime.

As it specifically relates to commercial lending and commercial loans, the effect should be minimal. The larger issue for bank’s was the debt ceiling, because the failure of the government to increase the debt ceiling could have negatively impacted many banks’ liquidity as those banks would have been incapable of borrowing from the Fed. However, with the debt ceiling increase the banks are fine. Although borrowing costs in the United States could go up slightly due to the credit rating downgrade, which would likely impact banks, because only Standard & Poor’s made the downgrade it is unlikely interest costs would go up much, limiting the impact to commercial loan borrowers who would likely see that cost passed onto them.

We continue to contend that the larger term impact to commercial loan and commercial lending is going to come from other factors such as the slowing economy, additional job cuts related to federal spending cuts and the longer-term outlook on unemployment, and the possibility of future tax increases, which typically negatively impact business and spending. If unemployment spikes back up and / or spending continues to fall, it is likely defaults on business and consumer loans would spike again, causing another pull back in commercial lending, and could cause some additional bank failures for those banks struggling and without the capital to support additional losses. However, such negative economic news would likely keep interest rates low, benefiting strong commercial loan borrowers. Like the economy as a whole, the commercial lending market is in unchartered waters, and it will take time for commercial loan managers to sort through all of the economic news and chart the best course of action. Certainly we are far from a full recovery in commercial lending, and until that happens, commercial loans will continue to be challenging to get.