Financing Focus

Post-Bank Lending

Are borrowers making a shift to alternative financing sources?

Before 2008, lending decisions were generally driven by the economics of loan volume. The priority of making money through loan origination was hard-coded into the commercial banking culture, as compensation was based on loan volume not loan performance. Not surprisingly, the quality of loans in banks' portfolios deteriorated as risks mounted, setting the stage for the 2008 financial crisis.

In the wake of the 2008 financial crisis, the federal government enacted regulations designed to prevent incentives based on origination volume. The result was a tightening of credit and capital markets, and a larger pool of borrowers was unable to access loans.

As the economy recovered, the demand for debt financing grew. However, due to aforementioned regulations and bail-out conditions, banks were either unable or unwilling to make many of the loans they were making before 2008, even on low-risk properties. Increasingly, borrowers looking for loans couldn't find them through traditional channels.

Nonbank Resources

Alternative lending has always existed in one form or another alongside the traditional banking system. However, it's taken on a larger and more intriguing role over the past few years as an option to address the shortfall between borrower demand and the supply of lendable bank funds.

In considering the key lending segments, such as personal and small business, leveraged lending, commercial real estate, mortgage, and student loans, Goldman Sachs estimates the aggregate of alternative loans outstanding to be $4 trillion, compared with $8 trillion of bank loans. From 2009 to 2014, peer-to-peer loan issuance grew substantially, from $26 million to $1.7 billion. Loans made between individuals is nothing new, but technology-based platforms such as Lending Club and Prosper Marketplace have made these types of transactions easier than ever, which has enabled the exponential growth of this form of lending.

Within real estate lending, nonbanks' share of mortgage originations jumped to a record 42 percent in 2014, up from 10 percent in 2009. The advancing wave of commercial mortgage-backed securities maturities creates another opportunity for nonbank lenders. Many of these CMBS loans may not be eligible for refinancing from banks or CMBS due to cash flow shortfalls. Private lenders may be a viable and formidable option to fill this gap.

Private Lender Advantages

Since they are generally smaller, nimbler, and have less overhead, private lenders can cherry-pick loans without being subject to blanket regulations that render entire asset classes unattractive. This may contribute to safer loan portfolios overall. A massive opportunity has emerged for private bridge lenders to engage in these transactions, lending against commercial properties that are not quite ready for traditional bank financing.

Nontraditional private loans offer numerous advantages when compared to traditional bank loans. One benefit is that private real estate lending firms typically do not require personal recourse as they are underwriting the value of the real estate collateral as opposed to the borrower. This should provide a level of comfort to borrowers as they do not have to report this loan as a liability on their balance sheet.

By focusing on the real estate as the primary source of repayment, private lenders can lend to borrowers with subpar credit. An additional benefit is private lenders are able to close a loan relatively quickly because of the streamlined underwriting of the borrower.

For example, in one such $3 million loan, a borrower owned a vacant warehouse in downtown Phoenix, with plans to convert the space to creative office. Because the property was dilapidated and vacant, there was no cash flow and the conversion was going to take time, but the borrower knew there was a shortage of creative office product in the Phoenix area coupled with rising demand. The borrower had little net worth, and poor credit history but was experienced in these types of conversion projects, adding another level of comfort to the lender.

Overall, it is estimated that more than $800 million in profits could move from the banking system to nonbanks over the course of the next five years for the reasons outlined. Alternative lenders are well positioned to capitalize on this emerging shift in the financing landscape.

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Brian Good

Brian Good is president of Eagle Group Finance, a direct lender specializing in private money commercial real estate loans throughout the Western United States. Contact him at brian@eaglegroupllc.com

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